On June 26, 2008, the Supreme Court decided the much-anticipated case of Morgan Stanley Capital Group, Inc., v. Public Utility District No. 1 of Snohomish County (Morgan Stanley). Although the Court affirmed the Ninth Circuit’s decision to remand the case to the Federal Energy Regulatory Commission (FERC or the Commission), the Court reversed the Ninth Circuit on the most important legal question presented by the case: the applicability of the Mobile-Sierra doctrine to contracts executed pursuant to market-based rate authority.

The Federal Power Act (FPA) requires all wholesale electricity rates to be “just and reasonable.”1 Ratepayers subject to generally applicable tariffs may at any time file a complaint at the Commission asserting that the rates they are paying are unjust and unreasonable and must be reformed. The Mobile-Sierra doctrine, developed principally in two Supreme Court cases2 and refined in countless cases in the courts of appeals, provides for a different approach for Commission review of rates that have been negotiated and executed pursuant to bilateral contract. Under Mobile-Sierra, a rate that has been voluntarily entered into by contract is presumptively reasonable with respect to the parties to the contract and, therefore, the Commission need only ask whether the rate would “adversely affect the public interest.”3 The Mobile-Sierra doctrine is thus sometimes referred to as the “public interest” standard.

The cases that became Morgan Stanley originated in the Western energy crisis of 2000 and 2001, during which several western utilities entered into high-price, long-term contracts with sellers acting pursuant to market-based rate authority granted by the Commission. When the crisis had passed, these utilities filed complaints before the Commission seeking to modify the contracts. The utilities argued that the Mobile-Sierra public interest standard should not apply because the contract rates had never been initially approved by the Commission. The Commission rejected this argument, concluding that the Mobile-Sierra standard applied and that the contracts at issue had not adversely affected the public interest.

The U.S. Court of Appeals for the Ninth Circuit granted the utilities’ petition for review and remanded the case to the Commission.4 The Ninth Circuit held that contract rates are only presumptively reasonable where the Commission has had an initial opportunity to review them without the Mobile- Sierra presumption. As a consequence, the Ninth Circuit would have required contracts executed pursuant to market-based rate authority to be filed and reviewed by the Commission without the Mobile-Sierra presumption. This review, the Ninth Circuit stated, must involve a consideration of the market conditions at the time and must result in the reformation of contracts executed at a time of market “dysfunction.”

Writing for the majority,5 Justice Scalia began with a point of broad agreement with the Ninth Circuit: “There is only one statutory standard for assessing wholesale electricity rates, whether set by contract or tariff—the just-and-reasonable standard.”6 From there, however, the Court departed from the Ninth Circuit’s reasoning. The Court rejected the view that the Mobile-Sierra doctrine is a separate standard from the just-and-reasonable standard to be applied only after a contract rate has already been approved. Rather, the Court explained that Mobile-Sierra “provided a definition of what it means for a rate to satisfy the just-and-reasonable standard in the contract context—a definition that applies regardless of when the contract is reviewed.”7 Put differently, Mobile-Sierra created a presumption for the Commission to use in applying the just-and-reasonable standard; it did not create a standard separate from the statutory standard.

Having sided with Morgan Stanley and the other petitioners on the critical question of law – whether the Mobile-Sierra public interest standard applies to contracts executed under market-based rate authority – the Court nonetheless affirmed the Ninth Circuit’s judgment and remanded the case to the Commission. The Court found two defects in the Commission’s explanation for upholding the contracts. First, the Court found that the Commission’s analysis of the contract rates at issue was incomplete insofar as it only looked at the effects of those contracts on consumers at the time of contract formation, without considering the burden imposed “down the line.”8 In other words, on remand the Commission may not confine its analysis to comparing the contract rates to prevailing market rates at the time of contract formation, but must look to the current burden imposed by the contracts (presumably by comparing the contract rates to current market rates).

Second, the Commission noted that where there is evidence of market manipulation, Mobile-Sierra does not apply. Before the Commission, the complainants had alleged that some of the contracts at issue were the product of market manipulation. Reviewing the Commission’s responses to these allegations, the Court remanded on the grounds that it was “unable to determine from the Commission’s orders whether it found the evidence inadequate to support the claim that respondents’ alleged unlawful activities affected the contracts at issue.”9

Justice Stevens dissented, arguing that the FPA creates a single standard of “just and reasonable” review, irrespective of whether rates are formed unilaterally or bilaterally. Justice Stevens rejected the majority’s contention that the Mobile-Sierra standard is merely a different application of “just and reasonable” review, contending that there “is no significant difference between requiring a heightened showing to overcome an otherwise conclusive presumption and imposing a heightened standard of review.”10 He went on to characterize FERC’s victory in the case as “a Pyrrhic one”11 for which the Commission paid “a tremendous price[:] The Court has curtailed the agency’s authority to interpret the terms ‘just and reasonable’ and thereby substantially narrowed FERC’s discretion to protect the public interest by the means it thinks best.”12 However, as noted above, the Court did not entirely foreclose challenges to contract rates, and at the very least, market-based rate contracts that are the products of market dysfunction or manipulation will continue to be subject to after-the-fact review before FERC.