A recent decision by the Pennsylvania Commonwealth Court regarding a proposed telecommunications merger may signal a higher threshold for state regulatory approval of “non-traditional” utility mergers, particularly where merger applicants must demonstrate “affirmative benefits” to the public from their transaction. On February 20, 2007, the Commonwealth Court of Pennsylvania issued its decision in Popowsky v. Pennsylvania Public Utility Commission, 2007 PA. Commw. LEXIS 63 (2007) (“Popowsky”). In Popowsky, the court rejected a proposed merger of Verizon Communications, Inc. and MCI, Inc. and remanded the matter to the Pennsylvania Public Utility Commission (“PAPUC”), finding that the merger had not been shown to provide sufficient affirmative benefits to the public.

Because the Verizon/MCI merger closed late in 2006, it is unclear how Popowsky will affect that transaction. The decision’s consideration of the “affirmative benefits” test, however, potentially presents new challenges for future gas and electric utility mergers. Increasingly, such utility mergers do not involve the combining of two existing utilities, but rather represent “non-traditional” transactions through which investment firms acquire utility assets. For purposes of applying an “affirmative benefits” test, non-traditional merger transactions differ from typical utility mergers because they often do not yield the type of “synergy savings,” ( i.e., elimination of redundant positions and systems) that can translate into rate reductions for ratepayers. The court in Popowsky was clearly troubled by the absence of any rate-related benefits for ratepayers, a concern no doubt heightened by the fact that the merger in question projected substantial synergy savings.

As in many states, the Pennsylvania Public Utility Code requires the issuance of a new certificate of public convenience when a public utility merges with another company. In order to issue a certificate, the Commission must “determine that the granting of such a certificate is necessary or proper for the service, accommodation, convenience, or safety of the public.” The Supreme Court of Pennsylvania has determined that this statutory standard requires merger applicants to prove that the proposed transaction “will affirmatively promote the ‘service, accommodation, convenience or safety of the public’ in some substantial way.” York v. PAPUC, 449 Pa. 136, 141, 295 A.2d 825, 828 (1972).

The merger at issue in Popowsky had previously received approval from the U.S. Department of Justice, the Federal Communications Commission, and nineteen state utility commissions. The merger applicants also had articulated Pennsylvania-specific benefits including: the continued presence of a good and responsible corporate citizen; the continued availability of good jobs and cutting-edge technology; an enhanced broadband network and services; and the absence of competitiveness issues. While public estimates had put the net present value of merger-related savings at over $7 billion nationwide, with Pennsylvania-specific savings somewhere between $320 and $815 million, the state’s method of setting rates for telecommunications utilities did not guarantee a share of these cost savings to Pennsylvania ratepayers.

A variety of intervenors challenged the merger before the PAPUC, demanding the imposition of an array of conditions and concessions. A PAPUC Administrative Law Judge (“ALJ”) found that the merger provided actual benefits to large enterprise customers and residual benefits to mass market customers through merger efficiencies and through faster deployment of advanced communications, information and entertainment services. In approving the merger without any conditions, the ALJ relied heavily upon the fact that federal regulators had already reviewed and approved the merger. The PAPUC subsequently adopted the ALJ’s findings, relying on the federal processes and determining that the “public interest” standard also included a determination that the merger will not have anti-competitive effects or impair the ability of the merged entity to continue to provide service at just and reasonable rates. PAPUC Vice-Chairman Cawley dissented, finding that the evidence only demonstrated benefits for the merger applicants.

Siding with Vice-Chairman Cawley, the Commonwealth Court remanded the case to the PAPUC with instructions to either reject the merger or impose conditions that would benefit the public in a substantial way. The Court expressed great concern that the type of merger-related rate reductions usually produced by utility mergers were no longer guaranteed to consumers whose rates for telecommunications service were not determined on a strict cost-based formula. The Court criticized the PAPUC for relying too heavily on prior approval of the merger by FCC and the Department of Justice, and for failing to perform “a Pennsylvania specific analysis of the merger” concerning the merger’s potential anti-competitive effects. The Court further warned that a utility merger must assessed based upon its impact on “all affected parties,” and that the PAPUC must reject or impose conditions on mergers that are not affirmatively proven to provide substantial benefits. The Court specifically rejected the notion that the public interest is benefited merely by a company maintaining its presence in the Commonwealth, particularly for a company like Verizon, the incumbent local phone carrier whose presence would continue regardless of the merger.

Popowsky suggests that, absent tangible, rate-related benefits to all consumers, it may become more difficult for investment firms, which tend to be located in states or countries outside the utility’s home jurisdiction, to win regulatory approval from state regulators under an “affirmative benefits” standard with promises of continued “good corporate citizenship” and locally-based management. Already, for example, the pending acquisition-through-merger of another Pennsylvania electric utility, Duquesne Light, by an international investment consortium has been stalled while the merger applicants respond to the implications of the Popowsky decision. In addition, future merger applicants likely will need to provide a state-specific review of a merger’s potential competitive effects, regardless of previously obtained federal approvals. In sum, in light of Popowsky, non-traditional merger applicants would be well-advised to offer tangible rate-related benefits, whether through shared synergy savings, rate caps, rate freezes, or some other mechanism, as part of their application for state-level regulatory approval.