Ring Around the Subsidiary

Embattled California utilities use controversial way to protect assets from bankruptcy.

Craver says he avoided challenges from the administration by explaining ahead of time how ring fencing would help avoid a bankruptcy filing. Thanks to the new financing, he explains, “Edison International and all of its unregulated subsidiaries have met all our obligations, debt and otherwise, in full and on time.”

Unbreakable?

Of course, that still leaves the principal subsidiary, SoCalEdison, deep in the red. Craver estimates that the utility, California’s second largest, will have $3.9 billion in unpaid wholesale energy costs by the end of this year. “SoCalEdison is clearly in severe financial stress,” he says.

State legislators have been slow to develop the governor’s promised rescue plan. But even if the utility succumbs to bankruptcy, Craver says he isn’t worried about creditors breaking the ring fence. To do so, he says, they would have to petition the judge for a “substantive consolidation” of the various entities on the grounds that there is no true distinction between the utility and its sister subsidiaries. “That’s extremely rare,” says Craver, “especially in the context of large corporations where typical separation formalities are observed.” Moreover, he notes, Mission Energy Holding is a secured borrowing, so unsecured creditors would not improve their position by breaking through the ring fence.

S&P analysts cautiously agree, although they note that “the economic disincentives that create barriers to filing [for bankruptcy against] Mission Energy Holding are considerably less compelling than those that exist for Edison Mission Energy.”

The next few months will be crucial for ring fences at both PG&E Corp. and Edison International. For PG&E Corp., the goal is for its utility to emerge from Chapter 11, its ring fence intact. For Edison, the goal is to avoid Chapter 11, and any test of its ring fence. See you in court. [/p>

SO WHY RING FENCE?

Protecting one corporate entity from the financial woes of another is an old game. Corporate raider Carl Icahn, for example, spent years trying to separate Nabisco from litigation-prone tobacco unit R.J. Reynolds. But ring fencing, which seeks to do the same without a corporate spin-off, can be a mixed blessing.

“Ring fencing costs a lot of money. It restricts the way you can do business. And there’s a negative overtone to it,” says Dan Streek, interim CFO of Kansas City, Missouri-based energy firm UtiliCorp United and CFO of its unregulated subsidiary Aquila Inc.

Streek says he considered a ring fence while planning an April initial public offering that took 20 percent of Aquila public. “I thought perhaps I should ring fence the trading operation from the rest of Aquila to get an investment-grade rating,” he says. But when it became clear that Aquila as a whole would make investment grade, the move no longer made sense. In fact, even without a ring fence, and despite UtiliCorp’s 80 percent ownership stake, Aquila has a higher credit rating than its parent. “Generally, a ring-fence strategy is a defensive move or a survival move,” says Streek.

UCLA law professor Lynn LoPucki agrees. “The only time it matters whether you have ring fenced is when you are in financial trouble, or a creditor is anticipating the possibility that you may be” in trouble, he says.

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