Analysis of Supreme Court's Decision in Morgan Stanley Capital Group, Inc. v. Public Utility District No. 1 of Snohomish County

U.S. Supreme Court holds Mobile-Sierra presumption applies to electricity contract rates both before and after the contract becomes effective, regardless of whether rate is challenged by a purchaser or seller.

In Morgan Stanley Capital Group, Inc. v. Public Utility District No. 1 of Snohomish County, the United States Supreme Court addressed two issues (1) whether the Mobile-Sierra presumption that a contracted electricity rate is just and reasonable applies to challenges to the rate by purchasers as it does to challenges by sellers, and (2) whether the presumption applies only when the Federal Energy Regulatory Commission (FERC) has had an opportunity to review the contract rate before it becomes effective. 128 S.Ct. 2733 (2008). The Court held that the presumption applies regardless of the status of the challenger (buyer or seller) or whether FERC reviews the contract before it becomes effective.

In 2000 and 2001, there was a dramatic increase in the price of electricity in California. During this time period, FERC allowed wholesale electricity purchasers to look to other markets than California to obtain their electricity for sale to consumers. However, the increased prices spilled over into other western states, and California utility companies entered into long-term contracts with power providers outside California that locked in rates that were high by historical standards. When energy prices dropped, the utility companies asked FERC to modify the contracts, contending that the rates were not just and reasonable.

The Federal Power Act allows wholesale electricity sellers to set electricity rates with purchasers through bilateral contracts, requiring all wholesale-electricity rates to be “just and reasonable.” 16 U.S.C. § 824d(a),(c),(d). Under the Mobile-Sierra doctrine, FERC must presume that the electricity rate set in a freely negotiated wholesale-energy contract meets the “just and reasonable requirement.” See United Gas Pipe Line Co. v. Mobile Gas Serv. Corp., 350 U.S. 332 (1956); FPC v. Sierra Pac. Power Co., 350 U.S. 348 (1956). This presumption may be overcome only if FERC concludes that the contract “seriously harms the public interest.” Thus, a contract may only be set aside upon a finding of unequivocal public necessity or extraordinary circumstances, such as when the rates impose an excessive burden “down the line” to consumers. Under this standard, FERC affirmed the administrative law judge’s decision that the contracts did not seriously harm the public interest, and refused to modify the contract, despite the purchasers’ claims that the sellers had unlawfully manipulated market prices through fraud and deception.

On appeal, the issue was whether the Mobile-Sierra presumption applied because, unlike other situations, FERC did not review these independently negotiated contracts before they became effective. The Ninth Circuit held that Mobile-Sierra did not apply because the contracts could only be presumptively reasonable when FERC had an initial opportunity to review the contracts before they went into effect. Essentially, the court held that the Mobile-Sierra presumption only comes into play when FERC will be reviewing one of its previous decisions. The court held that, in such a situation, FERC must consider factors such as “market dysfunction.” The court also held that, even if Mobile-Sierra applied, the standard for overcoming the presumption is different for a purchaser—whether the contract exceeds a “zone of reasonableness.” Accordingly, the Ninth Circuit remanded.

Justice Scalia wrote for the majority in the Supreme Court, holding that FERC was required to apply the Mobile-Sierra standard regardless of whether the seller or buyer challenges the contract and regardless of when the contract rate is challenged (before or after it becomes effective). The Court based this ruling on the recognition that the rates are freely negotiated between sophisticated parties. Thus, the proper inquiry is whether the rates seriously harm the public interest—not whether they are unfair to one of the parties that voluntarily entered the contract. The Court rejected the Ninth Circuit’s “market dysfunction” factors, holding that it would be “a perverse rule” to render contracts less likely to be enforced when there is volatility in the market. The Court also rejected the Ninth Circuit’s “zone of reasonableness” standard when buyers challenge the contract, which requires FERC to determine the marginal cost of the power sold. Instead, the Court held that the same “seriously harm the public interest” standard applied to all FERC challenges, whether the challenge is brought by the seller or buyer.

However, the Court ultimately affirmed the Ninth Circuit’s remand because FERC failed to examine the possibility of an “excessive burden” on “down the line” consumers under the contracts relative to the rates consumers could have obtained after elimination of the dysfunctional market. Further, the Court held that FERC needed to clarify its holding regarding the buyers’ claims of market manipulation. In so holding, the Court recognized that FERC can set aside a negotiated contract where there is unfair dealing in the contract formation stage, such as fraud or duress. This reasoning applies when the “market dysfunction” is created by illegal actions by one of the parties. In these situations, the Mobile-Sierra doctrine does not apply because, essentially, the contract was not freely negotiated.