LAWRENCE GOLDBERGTERRANCE L. STINNETTMERLE C. MEYERSDENNIS D. DAVISDANIEL M. LINCHEYKATHERINE D. RAYMIRIAM KHATIBLOUKATHY L. QUONHAE)I HONGYOSHIE VALADEZANN E. SOTER

LAW OFFICES

GOLDBERG, STINNETTr MEYERS & DAVISA PROFESSIONAL CORPORATION

44 MONTGOMERY STREET, SUITE 2900

SAN FRANCISCO, CALIFORNIA 94104

TELEPHONE(415) 362-5045

FACSIMILE(415) 362-2392

krayggsmdlaw.comJune 7, 2004

Re: Pacific Gas & Electric Company, Debtor, Case No. 01-30923

TO PARTIES WHO HAVE REQUESTED SPECIAL NOTICE:

You are being served herewith with a copy of Modesto Irrigation District's Response ToDebtor's Objection To Claim (the "Response") in the above-referenced case. Due to the largenumber of parties who have requested special notice in the debtor's case and due to thevoluminous exhibits which have been filed in support of the Response, copies of the followingdocuments filed in support of the Response will be provided upon written request to theundersigned (email address: kray~gsmdlaw.com):

1. Declaration of Roger Vanhoy2. Declaration of Christopher J. Mayer3. Declaration of Scott T. Steffen.

Very truly yours,

GOLDBERG, STINNETT, MEYERS & DAVISA Professional Corporation

ByKatherine

KDR:kdr9678

Enclosure

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MERLE C. MEYERS (STATE BAR NO. 66849)KATHERINE D. RAY (STATE BAR NO. 121002)GOLDBERG, STINNETT, MEYERS & DAVISA Professional Corporation44 Montgomery Street, Suite 2900San Francisco, CA 94104Telephone: (415) 362-5045Facsimile (415) 362-2392

SCOTT T. STEFFEN (STATE BAR NO. 078937)JOEL S. MOSKOWITZ (STATE BAR NO. 048374)JOY A. WARREN (STATE BAR NO. 135844)MODESTO IRRIGATION DISTRICT1231 1 t StreetModesto, California 95354Telephone: (209) 526-7388Facsimile (209) 526-7383

Attorneys forMODESTO IRRIGATION DISTRICT

UNITED STATES BANKRUPTCY COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN FRANCISCO DIVISION

IN RE: Case No. 01-30923 DM

PACIFIC GAS & ELECTRIC COMPANY, a Chapter II CaseCalifornia corporation,

Date: June 21, 2004Time: 1:30 p.m.

Debtor, Place: 235 Pine Street, 22nd FloorSan Francisco, CA

Federal I.D. No. 94 0742640.

TABLE OF CONTENTS

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II.

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B.

C

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r~taKROI JND .l

RESPONSES TO PG&E'S OBJECTIONS ....................... 2..................

M ''s Wholesale Electric Pow er Sales ............................................. 2

I. MID's Claim Already Reflects PG&E's Pre-petition Payment;

Therefore, MID's Claim Should Not Be Reduced .2

2. PG&E's Argument That Energy Delivered To PG&E Outside The

"Deviation Band" Is "Lost" Misinterprets the IA, and Does Not Apply

to Sales of Energy In Any Case ................... 2

Sales from New Hogan Power Plant. . ........................ 4

MID's Antitrust Claim .. ........................ 4.

Neeative CTC Claim ....................... 4

1. AB 1890 Allows Departing Load Negative Competition Transition ...............................

Charges (CTC) .......... 4; . ; ;.. i;4

2. Commission Has Approved, And PG&E Has Provided, CTC

Credits/Refunds to Customers ............................................... 6

3. PG&E And Its Bundled Customers Received An Overall Benefit

From MID's Service to Departing Load Customers During The

Period In Which Negative CTC Accrued .............................................. 17

4. PG&E's Reliance On The August 24, 2000, Letter From The

Commission's Energy Division Is Misplaced.8 ............................. :

5. PG&E's Past Practice Estops It From Arguing The Invalidity Of

Negative CTCs..................................9................. 9

6. Public Policy Supports Departing Load Negative CTC ....................................... 10

7. MI Has Standing To Claim Negative CTC ............................... 10

8. MID Is Entitled To $6,652,288 From PG&E For Unpaid Negative

CTC. : : ; I 1

MODESTO IRRIGATION DISTRICT'S

RESPONSE TO DEBTOR'S OBJECTION TO CLAIM

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MID'S RESPONSE TO DEBTOR'S OBJECTION TO CLAIMCaseNo.01 .30923 DM

MID'S RESPONSE TO DEBTOR'S OBJECnON TO CLAIMCase No. 01.30923 DM

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9. PG&B's Claim For Damages Is Not Determinative Of MID's Claim

To Negative CTCs; ....................................... , 1 I

E MID's Sate to the CAISO . ;11

F. PG&E is Not Entitled to Setoff of the State Court Action ........................................ ,.,.,; .12

1. PG&E's State Court Claims Are Without Merit .......................................... i . 14

2. PG&B Is Not Entitled To Unspecified Offsets ................................. 15

mH. CONCLUSION ............ , .......... , 16

1 TABLE OF AUTHORITIES

.2 Bads arian v. Graorn-, 31 Cal. 2d 744.(1948) .............................................. 12

3 Boll v.Walsh 7 Cal. 84,(1857) .................... ; ., ; .... 12

4 Crest Ce Assn. v. Dieden, 54 Cal.2d 744 (1960) ................................................ 9

s D u.uesne i ieht Co. v, Barasch. 488 U.S. 299 (19881) . ......,

6 *Fox v. C 15 F;2d 1507, (9th Cr. 1994). .. 13

, Q;ssman l~ioprson 146 Cal.Rptr. 741 (1978) ............................... 12

8 5 a ,, 86 D.R. 280 (Bkrtcy.,M.D. Fl .1988 ,........ 13

9 In re Clark Retail Enterrises. IcJ . 3,0S B.R, 869 (Blrtcy,, E.DI111. 2004), , .... 12In re E1virodyne kdustcs. Inc., 183.R. 8 12 (Bktrcy., N.P. Il-. 1995) ....... 1............................. 13

In re Hardy. 97F.3d 1384 (I1 th Cir..,1996) ................................. 15

12 Inre Holm 931 F.2d 620 (9th Cir. 1991) .......................... 13,15

13 InreJoveEneineergiaLe jn., 92F.3d 1539(llthCir..1996) ... . ............................ 15

14 In reLumdell 223 F3d 1035 (9th Cir. 2000) . . ......................... 13.15

15 ,.nre Luz Interrnationa. Ltd.p , 219 B.R. 837(9th Cir. BAP 1998) .... ............................ 13

16 In re Marriaze of William 20,3 Cal.App. 909 (Cal.App.5 Dist. 1984) ....... ,........,.....,....,...,. 12

17 In re PSA 277 B.R. 51 (Bkrtcy;.D., Del. 2002). ...............................,,,.,.;.;.,.,.,,.,.,.,. 12

8 In re Tran-Aqtijqn ,Co 2002 WL 32341923 (Bank-.,

19 N.D. Cal. 2002) , ......... , . _ .. ,.,.,.. : .. 12

20 Kain v.lnipet P.,2 Jipmet GrOUD 114 S.Ct. 303, on remand 174 B.R. 1482 1 ~ ~ J 4 9 4.1

21 , BrtY,, D. M s ,1994).- ..........;... .. ,,....... ....................... ,,, ..}...;.., ................... 1 3

22 Raleihj . Den. oL 120U.S. Ct. 1951 (2000) ........................................ 13

Schenle Hated 21,Cal.App.3d 177 (1971 .... . . 924 i Maine Western. Inc .v, 14 Cal.4ti.557 (1996) .. ...................... 9.............9

25 td tate V. Norj; VU .5.03 U.S. 30 (1992) ....... .................................. 4,15

26 West GasAsn. v. ArRources Bdard, 37 C4.3d 502 (1384) ...................................... 9

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M'DS RSESPONSEBTC DEBTOR'S OBJECTIONTO CLAIMCaso No. 01-30923 DM

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MiD'S RESPONSB TO DEBTOR'S OBJTiON TO CLAIMCue No.01N30923 DM

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11 U.S.C. § 106 ......... .......... . . ; 14,15

IIU.S.C.§106(a)(5)........................4............. ................... ............ .............................

1I U.S.C. §553111111- .. 13

I I U.S.C. § 558 ................... ; . 12

Cal. Code of Civ. Proc. § 399 . .................. . _ 12

Cal. Code of Civ. Proc. § 431.70 .................. ; 12

Cal. Code of Civ; Proc. § 741. 12

California Gov't Code § 815.6,.1 ...................... 15

Cal. Pub. Util. Code § 368, subd. (b) ...................... ;.;.;.....,.,. 5,7,8

. V.

1 Ia

2 BACKGROUND

3 On April 6,2001, Pacific Gas and Electric Company ("PG&B") filed a voluntary petition for

4 relief uader Chapter ' I ofthic.BankruptcyCo-de.. On September:5, 2001, Modesto Irrigation District

("MID"), a- California irrigation district timely filed its Proof of Claim ("MID's Claim"). MID's Claim

6 conts offive,disprete elements, as follows: (1) amounts unpaid and owing for the wholesale sales of

7' electric power duri the period Mayl, 2000, hrough April 6, 2001 (the "Wholesale Electric Power

s Sales Claimn'); (2) ciargesfor.powernsold by MID to PG&E at MD's New Hogan Power Plant; (3)

s antitrust damages b~ased or litigation filed by MID against PG&B (U.S. District Court, N.D.Cal. Case10 Nn..998-3009 WMP) (th '"Antitrnst Claim"); (4).cpmpensati for "negative CTCs," as more particularly

: set forth in MID's Claim, and described herein;. and (5) compensation for power sold by MID to the

12 [Califoraia In endent5ysae J Operator (the .'CAISO'.)on behalf of PG&E (the "CAISO Power Sale

13 ~Clairns . , . ;? - ;

14 . Oprahout.Aprl,I, 2004, PQ&E filecdits Objectio s to MID's Claim (hereinafter, "PG&E's15 ObJectjons"!), and the hearing thereon wa ontiAued to June 21, 2004 by stipulation of the parties. By

16 its Objections; PG&E seeks entry of an order dismissing certain components of MID's Claim as well as

17 disallowance of MIl's Claim in its entirety,. including.those components which PG&E concedes are not

18 ripeofor full adjudication, i.e., the Wholesale.Electric Power Sales Claim, the Antitrust Claim and

10 CAISO Power Sale Claims, PG&E's request for disallowance of MID's Claim in its entirety is based on

20 PG&E's alleged right-of setoff for claims against MID which (a) have been asserted against MID in

21 State Court and in CPUC proceedings. but which have been unsuccessful to date, and (b) have never22. been asserted against MID in any~forun and are for unknown amounts based on a "variety of theories,

X inqiuding violation of sta¶,ute,,negligence, intentional interference with economic relations, intentional

24 interference with prospective economic advantage,, inverse condemnation, and unjust enrichment.'

25 Despite IPG&E',s contertiQn in its Nqticethat its Objections "involve only matters of law that can be

26 determined in theiz ntirety at the initiathearing," both PG&E's Objections and MMD's Response thereto

27 amply demonstrate thathpre are significant material factual disputes to be resolved in determining the

28 validity andamount,ofMM's Claim. Cqisequ ntly, MID submits that the initial hearing on PG&E's

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MID'S RESPONSE TO DEBTOR'S OBJECTION TO CLAIMCase No. 01.30923 DM

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MID'S RESPONSE TO DEBTOR'S OBIECTEON TO CLAIMCast No. 01-30923 DM

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Objections should be treated as a status conference, in accordance with Local Bankruptcy Rule 3007-i,

so that the Court may address appropriate procedures for resolution. of MID's Claim arnd PG&B's

Objections, including conversion of this contested matter to an adversary proceeding. In the event the

Court intends to receive evidence at the initial hearing and to rule on th r merits, MID respectfilly,.,

requests that the PG&E's Objectons te overriledfor each of the foUowipn reasons:

RESPONSEST TO P(Q&E'S OBJECTIO1I(S.

ft. I -JJ I VTM UI --- f 4 L ~ - n - - O " -I-. -.I'

MID has asserted a claim in the amount of $1,894,818 for wholesale eectric power that MID

sold to PG&E during the periods May 1, 2000, through April 6,2001, inclusive. PG&E's Objection

asserts that: (a) it already paidMD the sum of$1,431,424 forpreuctition ne~rgysales, and thatMID's

claim must be reduced by that amount; (b) MID is not entitled to payment for any amount of energy

delivered to PG&E above the "deviation band" established in the Interconnection Agreement (the "IA")

between MID and PG&E; and (c) MID's claim should be limited to the actual amount paid by tle

CAISO to PG&E. None of PG&E's assertions has merit, and its objections should be overruled

1. MID's Claim Already Reflects PG&E's Pre-pet#l!on Payment Therefore, MID'sClaim Sbould Not Be Reduced.

MI concurs that PG&E paid to MID the sum of $1,431,424 for prepetition ehergy sales.

However, as the Declaration of Roger VanHoy states, MID credited that amount to PG&E's bill, and

already reduced the amount due and owing from PG&E to MI) by that amount. MID's claim is the

outstanding balance after receipt of that payment. See Declaration of Roger VanHoy filed herewith,

p. 2:17-24, and Exhibit "A" thereto. Thus, contrary to PG&E's assertion, MID's claimashould not be

reduced.

2. PG&E's Argument That Energy Delivered To PG&E Outside The "DeviationBand" Is OLost" Misinterprets the IA, and Does Not Apply to Sales of Energy InAny Case.

PG&E asserts that MID misinterprets the parties' FERC-approved IA in calculating the amount

of money owed to MID. PG&E's Objection, ¶30, PG&E's argument is apparently based on the

provisions of the IA that require MID to balance the amount odpower it schedules to be imported

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against that which is actually imported, measured during half-hourly increments. Under the IA, MID

must remain witkr 5 megawatts (MW) of the amount it schedules. If MID's actual power imports

exceed its scheduled imports by more than 5 MW, it must pay a penalty to PG&B for all power beyond

the 5 MW "deviation band." If the amount of power MID ex orts is exceeds its scheduled exports by

more-than 5 MIN, then that power above the 5 MW "deviation band" is deemed to be delivered to PG&

free of eharge. The latter generally occurs when MID either purchases or generates more power than it

needs to serve its customers. ,PG&E's.Objection contends that whenMID sot'poo*eI to Pd&E, MID effectively exported

more than it scheduled, making all excess power above the 5 MW deviation band free to PG&E. There

are several obvious problems with PG&E's position,

First, it presumes that any sale to PG&E was transacted under the IA. However, as the

Declaration of Roger VanHoy makes clear, the sales at issue here were transacted pursuant to the FERC

approved Westem Systems Power Pool Agreement (the "WSPP Agreement"). That the parties agreed

that power sales could take place independent of the IA id beyond dispute. The IA specifically provides

ohftransactions such as that addressed in MID's Claim: Section 6.3 of the IA provides for3'Coordinatin Services.' In relevant part, that section provides::

At anytime duning this Agreement, the Parties may choose to negotiategowcs Si.s or t''inission'services as Coordiuiation Seivices,'as~ iolows:

6.3.1 The price for each Coordination.Service shall be negotiated and established within aceiling, the formula for determining which has been filed with FERC in advance.

Thus, MID and PG& contemDlated and agreed that hey~cquld enter into power purchases and

sales, exclusive; fthe 'deviation band" constraintsupon terms and conditions pertinent to each such

transaction. PG&E's argument that M:ID is not entitled to payment beckise the sale could not have

taken place under the IA is readiiy disposed of-

If PG&E meallybelieved this argument is correct, then each time MID delivered that power to

PG&E, PG&E should haie accounted for the power wnL'is the "deviation band. This is because the IA

requires that if excess power is delivered within the bandwith (+/- 5MW deviation from the scheduled

amount) such.imbaltnce is to be repaid by like amounts ofpower in the next half-hour, or as soon

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thereafter as is possible. IA, Section 4.6.1. However, PG&E did not do so, The reason, of course, is

that PG&E understood that thse transactions were traditional purchase arrangements, under which it

was to pay for all thepower, inciuding that within the "Deviation Band." Declaration of Roger VanHoy

3:25-5:26.

PG&E's objection to MID's claim with respect to energy sales should be overruled.

B. Sales from New Hogan Power tiant. ,

MID's Claim sought $76,800 for power MID sold to PG&E from MID's New Hogan Power

Plant. Since that claim was filed, MID has learned that Calaveras County Water District filed a

duplicative claim. MID hereby withdraws this portion of its Claim.

C. MID's Antitrust ClaIM.

MID brought suit in the United States District Court, Northern District of California (Case No.

98-3009 MHP), alleging, in general terms, that PG&E had engaged in anti-competitive conduct. On

April 21,'2004, the Couiitfiled its Amended Memo randm and Ordef granting summary judgment in

,favor of PG& on the basis that MID had not suffered antitrust damage.ID has , ofof :? ; ,;ef:i t; ill PG& on :1e Xa AL..i of

appeal, and. plans to pursue that appeal, If the matter is remanded to the District Court, MI will pursue

its antitrust claim vigorously. The ruling that PG&E cites is.not yet final,, and this Cpurt Should mnake no

separate ruling on PG&E's objection.

A. Negative CTC CaIm.

1, AB 1890 All1ws Departing Load Negative Competition Transition Charges

(CTC). l -;:: I A'

PG&E deliberately plislo~nstrues M's claim for negativq CYCs. Competition transition

charges, "CTCs," are a creation of the California Legislature. They were contrived as part of AB 1890

to permit PG&E and the other electrio utiUties to recover the uneconomic costs of generation resources

"stranded" as a result of the electric market restructure. California Public Utilities Code section 367

provides: "The commission shall 1detifd and determine those costs and categori*socosts for

generation-rqlated assets and obligations. . thatwere being collected in A ision-aproyed rates on

December Q., I -9 and th t may become uneceonoic as a result of a.coaspetitve genoeration market in

that these costs may npt be recoverable in marketprices in a comptiti e market. . .'!,Jhesp generation

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related costs were then to be recovered on an equal basis from all customers, whether they remained as

"bundled" customers, elected direct access or departed for self-generation or aiternative utility service.

Section 368 isubdivision (b)- thus states in relevant p art.

. The cost recoveryrplan shall provide for identification andseparation of individual rate components such as charges for,-energy, trfanshiission diributioh public benefit programsand recovery of uneconomic costs. The separation of ratecomiponents required by this subdivision shall be used toensure'that custornerspf the electrical corporation Gino becomeeligible to purchase electricity. from suppliers other than the.eictrical cdrpoi A ay tesah unbundled component charges,other tfan e-ergy, that a bundled service cisten~er pays. No costshifting among customer classes, rate schedules, contract, or tariffoptions shall result from the-separation required by this subdivision.

(Cal. Pub. Litil, Code 6 3d8, subd. (b), emphasis added.'

Llstiosilcg CTe; theCgllferfiaPubiic Utilities Comni.ssion (the "Comnission") provided

clear policy guidance - CTCs were to be collected in a "manner that is competitively neutral, is fair to

various claim s dfratepayr5 anid doesi-ot increase rates." Commission Decision (D.) 95-12-063 as

nodifled'y'D: 960'1-009 [Paited of 72, Paii V; The goal was not necessarily to guarantee full transition

cost recovery by the electric utilities but to' design a rate structure that would in whole provide the

uuilities "With the opportutnitylo earn a fair return on their investment." I. at Part V, Section C, citing

Wouesne Light Co: v. Bar*c. 4 1Xt. 299 (1 988).

The Commission determined that the CTCs were to be calculated on a residual basis by

subtricting thy iower xchange ("Pi ) energy cost from the generation portion of the bundled rate

'-PG&E's tarifF allowing colltcti6n of CTCs, as uporoved by the Commission, contains a clear statemen

about CTC equality as set forth in Secton 368(b). PG&B Electric Preliminary Statement Part BB (Cal..P.U.C. Sheet No. 19907-t, filed April 1, 2003) states: I

C[ C Paymnent Amounts: Bundled Service, Direct Access, and Virtual Direct AccessCustomers-Will bebilled for and are responsible for maring ClS aid othernonbypassable charge payments to PG&E as part of their regular monthly bills for utilityservice, as pecifitedin accordance with thiebilling procedures specified in the RateSchedule under Which service istao. Departing Load custmners a re resporisible forthe same CTC and other nonbypassable charge payment amounts as any similarlysituated Bundled Serzvce4Direct Access, or Virtual Direct Access Customer.(Emphasis added.)

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MD'S RESPONSE TO DB3TOR'S OnJECrION TO CLAIMb T n I.iwn7 nmTV

MID'S RESPONSE TO DEnTOR'S On WION TO CLAIMCascNo. 01-30923D

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(determined by subtracting the PX energy cost from the total bundled rate). D.97-08-056, Part VIII,.

Section B.I. PG&E adopted this calculation in its CIC tariffs Eie'mpt and B-Depart. Thus, the

uneconomic portion of PG&EB generation resources that would be ircluded in the CTC was determined

by subtracting the market benchrnwrk (thePYX energy price)-from thenet costof the generation

resources 2 . By the very nature opQttocalcuiation presented, the potential rfoid ncgaoive result eiists.

Thus, the Commission provided for the recognition of negative CTCs.

2. Commission Has Approved, And PG&EHas Provided, CTC Credits/Refunds toCustomers.

The validity of a utility granting customer refunds/credits when the market costs are higher thin'

the generation asset costs was recogrunzed by the Cormumission, at the request of PG&E afid the other

utilities, in the direct access context. In Decision 99-06-058 the Commission approved a settlement

among the utilities and direct access customers whereby tariffprovisioris prohibitirig negative direct

access bills (or credits to direct access customets9j was eliminated. PG&bEagreed to provide bill credits

to direct access customers v.here the PX credit exceeded the total bill. D.99-06-058, p. 16. The

mandated revisions were subsequently made to PG&B's relevant tariffs. Language was inserted

clarifying that "the customerwill receive a credit for the Power Bxchange componet." PG&E Advice

Letter 1883-E. In November 1999, and during the period July through October 2000, as well as certain

months thereafter, PG&E in fact refunded such bill predits to its customers. See PG&E's Petition for

Modification of Decision 97-10-087 dated November 9, 200O,4 stating that "Tor te past four months

direct access customers in California have been receiving negative utility charges."

This Court has also approved payment of customer claims for such credits/refunds. Various

direct access customers have submitted large claims against PG&E's estate for CTC related

The Commission recognized that "it would be obviously unfair if, as nart of our restructuring, wewere to require customers to pick up the cotts of high-cost generation without at the salre timeaccounting for the benefits of low-cost generation. . .3The eliminated provision was referred to as the "zero minimum bill" provision. For direct accesscustomers the CTC was reflected in their bilis as "the PX credit." (For purposes of this 6ziorandum,the terms "PX credit' and "Negative CTC" have common meaning.),On Dernember 21, 2000, PG&E filed an Amended Petition for Modification stating that it was

suspending its direct access credit refund policy. The matter wnadisctiised in proceedings before theCommission.

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credits/refunds. PG&E has settled some of these claims for high-fractions of the amounts claimed. This

Court has approved these settlemients. For example;'on July 14, 2003, this Court approved a stipulation

and release related to Claim No. 12010 by the Association of Bay Area Governmeents Power (ABAG

Power). -The Claim 'for S21,355,463:88 was allowed as anunsecured non-priority claim in the amount ol

$7,oo00,000.00, plus'accrued interest from December 1, 2000; at asi annual rate of 4.19 percent.

.The reasons for allowing bill credits to direct access Encrgy' Service Providers such as ABAG

Power apply equally to allowing negative CTCs tor entities suh as' MMI, who vere responsible for

paying the CTCs of certain departing load customers during the iame time period. It removes inherent

biases against competitionrand custonmef choice, the ultimate goal of the Legislature in enacting AB.

1890. Cal;:Pub. Util. Code § 330. To disregard negativeCTCs for-departing load customers in the face

of such allowancez for irect access ctustomers would also violate the prohibition of Califomia Public

Utilities Code section 308 against discrimination and cost shifting among customer classes.

3. PC&E Mnd Its Bundled Customers Received An Overall Benefit From MID'sService to Departing Load Customers During The Period In Which Negative CTCAccrued.

There is no basis for treating departing load customers differently from direct access customers

with regard to negative CTC payments. The reasons justifying payment of direct access claims, as

re6ognized by the Commission and this Cog apply equally to departing load. PG&E's suggestion that

any recofnition of negative CTQs would "compound" its losses - causing it to incur the stranded costs

and pay out the negative CTCs (Objection, p. 9, lines 8-9) must be disregarded, Stranded costs are only

those uneconomic costs that cannot be collected from customers in a competitive market. Contrary to

what the Legislature envisioned when it enacted AB 1890, PG&B aid not divest its generation assets,

but rather retained ownership and use of many of its resources, Where the costs associated with such

resources is lower than the market cost of power, generation costs are not uneconomic. The utility

incurs no loss from "stranded" costs for that period. Just the opposite occurs. The utility and its

bundled customers benefit from the use of the less expensive generation resources instead of market

purchases. Negative CTCs are a mechanism to account for this benefit.

Furthermore, PG&E ignores the value to it and.its bundled customers of MI) providing electric

generation to departing load customers during the 2000-2001 time period. MID service to such

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MID'S P.BSPONSS TO DEBTOR'S OBJECTION To CLAIM MID'S RESPONSE TO DEBTOIt'S OBJECTION TO CLAIM

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customers saved PG&E generation-related costs that exceed the value of MmD's negative CTC claim.

MID provided electic service, including power supply, to appr6ximately 50 Megawatts of former

PG&E electric customer load during this period, FG&B saved power supply purchase costs because

PG&E did not have to purchase enenegy at a loss for this customer load during periods when PG&E's

power supply purchase rates were substantially above PG&E's frozen retail rates. PG&E cost savingsP

createdby MID's actions are presently held by PG&E in the form of unpaid negative CTC credits.

Frorn aPG&E power supply perspective, MID's situation is identical to the situation Where the power

supply for these customers came from a direct access Energy Service Provider. There is noequitable

justification for PG&E to object to MID's negative CTC claim while providing full or substan ially full

payment of negative CTC PX credits to direct access Energy Service Providers.

The Commission's stated policy guidance on CTCs, its determination of C'C calculations, and

its approval of PG&E's CTC rate structures, all support the recognition of negative CTCs as. well as.. '.

positive CTCs. Negative CTCs prevent the cost shifting between various customer glasses prohibited by

California Public Utilities Code section 368, subdivision (by and prevents the utilities from obtaining a

disproportionate return on their generation assets.- . - ..-;. r :-'

4. PG&E's Reliance On The August 24, 2000, Letter From The'Commission's EnergyDivision Is Misplaced. '

PG&E relies solely on a single letter from the Commission's onergyDivision to support its

Aegition that negative C Viar'e, unlavgi:lt i'G&' provides no reference'to any law hathastin-g

contravened. This is because, asset forth above, it cannot do so. Negative CtCs are well.within the

mandates of AB 1890 and the Commission's policy dtermiunations regaiding the implementation of

such legislation. Payment of negative CTCs is also consistent with PG&E's electric tariffs for departing

load customers.:- ;" ' f - ' ' ;/

First, a letter from a Commission staff member, even an Energy Division Manager, does not

have the force and effectof a Cork .on Decision. Nor does it hav.pny precedential ya.pI regarding

the legality of negative CTCs ,under AB 1890. The particular letter at issueod,4 ates appsitipn that

would, if interpreted as suggested by PG&E, be contrary to established ,Co.'mission decisions

permitting credits or refunds for direct access customers. D.99-06-58, Enforcerient.of such letter

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would lead to discriminatory rate treatment for departing load customers in violation of AB 1890,

Commission policy, and PQ&E's Commission approved tariff.

Second, the August 24, 2000, Energy Division letter,, by PG&E's own testimony, resulted from a

meeting between PG&E and members of the Commission's Energy Division No notice of the meeting

was provided to other interested parties. No opportunity was provided to such interested parties to

participate in the process or provide support for positions contrary to PG&E's. Such interpretation of

legislative action and implementation of PG&BEtariff impacts can only be made through properly.n y..

noticed Comnmission proceedings providing opportunity for participation by potentially affected parties.

A fundamental premise of administrative rulemaking is that notice of same provide "'a reasonable

opportunity for those subjectto such rules to present views and arguments in advafice of their

}prorrulgation."' Schenlev Affiliated Brands Cor. v, Kirbv 21 Cal.App.3d 177, 192 (1971); see. also

;*esternOil & Gas Assn v. Air Resources Board. 37 Cal.3d 502l 526 (1984). Had this letter been the

official determination of the Commission on this question, it was invalidly adopted as an "underground

regulation." Tidewater Marine WesternL Inc. v. radshkw 14 Cal.4th 557, 568-577 (1996).

l The August 24, 2000 Energy Division letter does not support a denial of MID's negative CTC

claim.

5. G&E's Pdaz Practice Estops it Fom Arguing The Invalidity OfNegatlve; CTCs.. ,

PG&E's.policy'and actual practicb of providing bill credits and refinds to direct access

custorners is set forth above. PG&E aiso has a past practice of recognizing negative CTCs. In its

calculations of annual net positive CTCs due to PG&E and attributable to MID's customers during

calendar year 1999 (before the onset of the 2000-2001 Calffobiia Liergy Crisis), PG&E credited MID

thy the value of negative CTCs that PG&E determined to exist in the Mnonth of November 1999.

Declaration of CbistopherJ. Mayer, 6:8-r'i. Suchecourse of dealinigisint contrary to any law,

,¢ommissiosi decision, ot PG&E Utariffprovision. PG&E's actions at the'ine the negative CTCs were

occur-ing is stroug evidence of its coritemporaneous understanding of its obligations to departing load

custcmers, See, e.g., Crestview Cerietarv Assn. v. Dieden, 54 Cal.2d '744, 753-4 (1960). PG&E should

no, now be allowed to argue that negative CTCs cannbt be recognized.

. . -9-

Mm's RSsPONse TO DEBTOR'S OBjECTION TO CLAIM MID'S RESPONSE TO DEETOR'S OBJECrION TO CLAIMMM'S PESPONSE TO DEBTOR'S OBJECrION TO CLAIM

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6.' Public Policy Supports Departing Load Negative CTC.

As set forth above, publiecpolicy strongly favors conpetition, and choice among electric'eaergy

providers. Imposition of CTC charges for departing toad without conmmnsurate nega'dve CTC credits is

anti-competitive., PG&E w1oull expenence a windfall, while departinag loadbots thiacost. .Whenthe

mnarket price' exceeds PG&' portfoio costs, str anoded coit,s arm by definition

eltinated, In addition, PG&E experiences' real dollar savings by not having to piurchase Ower to serve

the extra load that has departed to other service providers such as MID. Such $avings ar.:not capped,

Negative CTCs provide the balancenecessary to sustain departing load competition.

7. MMID Has Statiding To Claim Negative CTC.

,, PGB also attemnpts to disputeMID's '-standing'toclaimnegative CTCr. PG&BSinterprets

MID's contractual obligations to its customers, concluding that because MID's agreements with its

cstomers only explicitly address MID's assumnption of responsibility for CTCg owed'to PO&B, MID

4annot claim rights to negative CTCs,, PG&E points to no contractual language denyiringMlD the-

zegative CTCs, Contracts must be'tinterpreted as to give effect to the mutu" intention oftthe paittins at

it existed at the time of cortracting." Cal. Civ. Code § 1636;: The parties to the ag eemrnhts refefeiced

hy PG&B, of which PG&E is not one, do not dispute the inrent of those agrc~irents.5 The contra'tiual

7pig ncut of CTC responsibility to MID was atl-encompassing - the'CT'ditirin e ictin.e 'P'idid

covered by the contracts, whether positive or niegativi, being to D -*c ' -

Furthernore, PG&E itself~as in the past recognized MID's sight to receive payments connected

with the CTC cbligations. Duiiing ti e1997-1998 period imnediately preceding the period of MID 's

negative CTC claim, PG&E'acfto W a $1,823,995 payment fron MMID for net CTCs due from MID's

customers. Subsequent decisions of the Commission reduced the rates used to calculate the CTCs

rcsulting in a $456,586 crcdit; PG&E sought andreceived approval of the Commission pursuant to its

Advice Letter 1964-E to pay this gredit directly to MID and not toMID's customers. PG&E ultimately

did pay this amount directly to MID. Declaration of Christopher J. Mayes, 5:26-6:7. PG&E's self-

MID assumed CTC responsibility on behalf of several departing load customers. The negative CTCs

claimed by MID areattributablein part toxach of those custoiers. No customcr has protestedMID'sclaim or filed any claim of its own for the negative C 'Cs.

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'setving reversal of its previous position cannot be supported. MID has standing to claim the negative

CTCs related to'the identified customer loads.

8. MI is Entitled To $6,652,288 From PG&E For Unpaid Negative

, ' CT.C. -. ' ,'.-'

'PG&3'iiotes that, if any negative CTCs are allowed, MID's claim must be reviewed to ensure its

accuracy. Mn) has undertaken such review. Duc to several events occurring after MID submitted its

claiun, most'significantly the Commission's issuance of Dccision 04-01-026 setting the end of the rate

cotrol period as of Janury 18,2001, MEDhas madeanuinberofadjustments to its claim. These

a4junstmens arie described in detal initho Declaration of Christopher J. Mayer filed and served herewith,

MID's nekative CTC claim should be revised from $10,104,226.00 to $6,652,288.00.

9. PG&E's Claim For Damages Is Not Determinative Of MID's

C,,: mi 'TcNegativeC"S.'

i PG&E alleges that thc negative CTCs MID seeks would be due, if at all, to customers MID

served in violation of California law. It is worth noting that PG&E did not refuse to bill or collect CTCs

on such basis. Where PG&B recognized the obligation related to a customer load, it must likewise

equitably recognize any benefit that may core due to such customer klad. PG&E's allegations are

wrong, but should in any case be disregarded, . .. -

E. MID's Sale to the CAISO, . -

; hlCAIEO p wer sale claim should be allowed, subject to offsrt, if any.

'a Q's ection statos,: ".:. [a]lthough this portion of the Claim is disputed by reason of the

ongoing FF.RC p-oceeings, this'Obje tion Will not addresiDobtor's'reponses to this portion of the

Claim .. :' PG&E's Objection, at 5:24-26. Likewise, PG&E'also states' .".. this Objection will not

address the PG&E's sesponses to this portion of the Claim." PG&B's Objection, it 13:5-6. Thus,

subject only tb any reduction in the amount of MID's claim that may result from the ongoing Mitigated

Market Clearing Price proceeding now pending before FERC, the portion of MID's Claim relating to the

CAISO power sales should be allowed.

, -11-

MID'S REsPONSE TO DEBTOR'S OBJECTION TO CLMCue No. 01.30923 DM

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MID'S RESPONSE TO DEBTOR'S OBJECTION TO CLAIM

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F. PG&E Is Not Entitled to Setoff of the State Court Action.

PG&B claims that it is entitled to set off against MID's claims amounts PG&E claims are

owed by MID to PG&E. In particular, PG&E identifies the following: (a) damages PG&E seeks in an

action filed by PG&E against MID in Stanislaus County Superior Court (the "State Court Action");

(b) amounts sought by PG&E in various California Public Utilities Commission dockets; and (c) other

unspecified claims. Section 558 of the Bankruptcy Code provides that the estate shall have the benefit

of any defense available to the debtor as against any entity other than the estate. Although the defense

of setoff is not specifically listed, courts have held that Section 558 preserves any right of setoff the

debtor may have had under state law. In re Clark Retail Enterorises, Inc., 308 8.R 869, 896 (Bkrtcy,,

E.D. Ill. 2004); In re Tran-Action Cdmmercial Investors. Ltd., 2002 WL 32341923 (Bankr., ND, Cal.

2002), In re PsA, 277 B.R. 51, 54 (Bkrtcy, D. Del. 2002).

Under California law, the riglit of setoff was formteily set forth in the statute providing for

counterclaims (forner Cal. Code of Civ Proc. §438), Although counterclaims are now abolished under

California law, the right of setoff remains the!subjectdof specific statuiesj includiiigtat ION of Civ.

Proc. §§ 431,706, 741 (regardinggood~faith improverofttd), aof'tns

#ction). Independent of statutory setoff; California law, recognizes the doctrine-of cuitabli -ff-

Ipursuant to which a judgment debtor may-seek setoffof a claim against judgment creditor. See, p Lin

re Marriage of William, .203 Cal.Rptr. 909, 914 (Cal.App.5 Dist. 1984); Grosstnan.vi'Lioson, 146

Ca1.Rptt. 741 (1978). When aliabilityis contingent, and notfited,-it is.uiavailablais asetoffwithout

the consent of the plaintiff. Bell v. Walsh. 7 Cal. 84 (1857). Further, a claim urged as a setoff, must be

mature at the time equitable setoffissought. Bazdasarian v. Gragnot' 31 Cal. 2d 744 (I 948).

'6.Cal. Code of Cv. Proc. §431.70 states:Where cross-demands for money have existed between persons at anypoint in tinMe when neither

demand was barred by the statute oflimitations, and an action is therafter co nericed by'ond'suchperson, the other person may assert in the answer the defense of payment in that-the two.d mands areCtmpenaated so far as they eual each other' hetwithstanding that enpende action asserting theperson's claim would at the tirne f efillg the.answer be barred by the statute of lUiitations If the cross-dianid Would otherwise be barred the statute of limiiationi,.the relief accorded under this sectionshall not exceed the value oft'.e relief.gante4 in the otherparty. Thedefensmaprovidedby this sectioninot available if the cross-demand is barred for failure to assert it in a prior action under Section 426.30.[Neitherperson can be deprived of the benefits of this section by the ass.gnment or death of the other.For the purposes ofthis section, amoney judgment is a "demand for money" and, as applied to a moneyjudgment, the demand is barred bythe statute of limitations Zhen enforcement of the judgment is barredunder Chapter 3 (commencing with Section 683.010) of Division I of Title 9.

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In the instant case, PG&E objects to MlD's Claim based on an alleged right of setoff, but fails to

carry its burden of proof on its objection.. The law is well-established with respect to the burden of proof

on claims and objections to claims. A proofof claim which sets forth sufficient facts to support the

claim is prima facie evidence of its validity and amount in accordance with Federal Rule of Bankruptcy

Procedure 3001(f) and will be deemed allowed absent a timely objection. In re Holm 931 F.2d 620, 623

(9" Cir. 1991). The'burden of going forward then shifts to the objecting party to produce sufficient

evidence to 'negate the pnrma facie validityof the filed claim. Rarii h v. IlI. Dept. of Revenue, 120 U.S.

C:. 1951 (2000). Thits;iin 6bjfecting to a claim, the debtor must establish sufficient, credible facts to

rebut the proufof claim, and the trial court is not require ti' befieve the debtoxiand shift the burden to

the creditor. .Inre Lundell. 223 F.3d 1035 (9:' Cir. 2000)1 Thedebtor's burden is significant, as an

objection does not deprive a claim of itspresurptive validityounless it is supported by substantial

evidence. Kahnv. Juniper Deelogment GrouI 114 S.Ct. 303,onremand 174B.R. 148 (Bkrtcy.D.

Mass. 1994). PG&E's burden ofproof ith respect to its claim objection is also consistent with its

burden in asserting a right of setoff as an affirmative defens. o, 4n hW , 86 B.R. 280, 282

(Bkrtcy. M.D. Fl. 1988) (setoff constitutes an affirmative dxefense,)q v,. Citicorn Credit Services. Inc.,

15 F.2d 1507; 1514 (94 Cir. 1994) (the party asserting an affirmative defense has the burden of proof of

the defense).

Based on the evidence in the record, PG&E has failed to carry its burden with respect to its

setoff defense. MID concurs that PG&E may offset damages awarded to PG&E in the State Court

Action, or as a result of the CPUC Dockets, to the extent that PG&E actually can prove that it is entitled

o'such damages and obtains such a damage award. However, no such damages have been awarled to

PG&E and, as discussed in detail below, PG&B's claims in the State Court Action and before the CPUC

Dockets are without mnerit. Tus, to the extent PG&E seeks disallowance of MID's Claim based on suc

setoff rights, PG&E's Objection is premature at best an4 should be overruled to the extent PG&E seeks

an immediate decision on the 'merits. See eg., In re Luz International. Ltd., 219'B.R. 837, 843 (9th Cir.

BAP. 1998) (reversible error for bankruptcy court to make a final adjudication of setoff in complex

financial transaction in the context of motion for relief from stay); In re Envirodvne Industies. Inc., 183

B.R. 812, 826 (Bktrcy,, N.D. 111. 1i995) (determniniation of whether setoff under Section'553 of the

B karuptcy Code would be premature pending determination of merits of counterclaim on which setoff

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MID'S R5SPONSE TO DEBTOR'S OBJECrION TO CLAIMCue No, 01-30923 DM

MID'S RE5PONSE TO DEBTOR'S OBJECMON TO CLAIMCae No. 01.30923 DM

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was based);. With regard to PG&B's claim for an offset from "other affirmative claimrs" (see PG&E

Objection, at 14:16), PG&E's contentions are notidentified with any particularly nor supported by any

evidence and are therefore insufficient to enable MID to prepare a response, let alone to satisfy PG&E's

burden of proof on its objection to MID's Claim, andfor that reason should be overruled.

1 PG&E's State Court Claims Are Without Merit.

PG&E filed its State Court Action on June 6,2003, PG&B is now on its Third Amended

Complaint. This version seeks damages based on four common law grounds, violation of a "mandatory

duty," and inverse condemnation. As recently as March 12,.2004, the Stanislaus County Superior Court

granted a demurrer to PG&E's second amended complaint on the ground that PG&E had not stated facts

sufficient to state a cause of action. The problem with ?G&E's complaint is that the California

legislature has abolished all common law theories of liability against public agencies (such as MID). As

*to PG&E's theory that MID had violated a "mandatory duty," the-court concluded that any duty imposed

by the statute MID was alleged to have violated was not enacted to protect PG&E's interests, and

therefore could not be the basis for.a damages action. Moreover, 'MID argued that PG&B had not.

bmuffered the requisite "injury" under the California Tort Claims Act (Cal. Govt. Code § 810 et seq.)

Pinally,.as to inverse condemnation, PG&E has not alleged a "taking" of a cognizable property interest.

ough PG&E tas amended its complaint following the sustaining of the most recent demurrer, it has

alleged no new causes of action, nor facts materially different than those set forth in its most recent

uinsuccessful pleading. MID has demiurred, and a hearing is set for-July J2,-2004. A -true and correct

Oopy of MID's Demurrer and supporting papers is attached as Exhibit "A"Wt6 the supporting declaration

of Scott T. Sieffen.

Since PG&E cannot state a cause of action against N4D, it is not entitled to a setoff of those.

amounts against MID's claim,

Despite PG&E's assertion to the contrary, ME) has not, by filing its Claim, waived its sovereign

in~iunity with regard to-the causps of action in the State Court Action. Waivers of sovereign immunity

are set forth in 11 U.S.C. § 106.. In particular, Section 106 (a)(5) provides:

"Nothing in this section shall create any sublstantiye claim for reliefor cause of action not otherwise existing under this title, the federalRules of Banlruptcy Procedure, or nonbankruptcy law."

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Thus, PG&E. "must demonstrate that a source outside of section 106 entitles [it] to the relief

sought." In re Hardy. 97 F.3d 1384, 1388 (11th Cir. 1996). Waivers of sovereign immunity"must be

unequivocally expressed ... (and] are~not generally to be liberally construed." In re Jove Engine 'Ms.

I., 92 F.3d 1539, 1549 (11th Cir. 1996), citing United States v. Nordic.Villaze. Inc., 503 U.S. 30,33

(1992).

The California Legislature abrogated all common law and judicially created causes of action.

Accordingly, Stanislaus County Superior Court granted MID's demurrer to four of PG&E's six causes

of action on that ground. Further, the Court ruled that PG&E could not establish a duty designed to

protect its interests sufficient for PG&E to state a "mandatory duty liability" under California

Government Code § 815.6, nor was there a taking of an interest sufficient to state a cause of action in

inverse condemnation. Since the Superior Court has ruled that PG&E cannot state a cause of action in

that forum, PG&E's argument that MMD has waived sovereign immunity has no bearing on the merits of

its claim for offset based on the State Court Action.

2. PG&E Is Not Entitled To Unspecified Offsets.

As discussed above, PG&E has the burden of proof with respect to its objection and

setoff defense and has failed to articulate with any specificity the validity or amount of the "other

affinrative claims" which PG&E assert as an offset. In particular, in its Objection, PG&E alludes only

to damage claims in unknown amounts based on a "variety of theories, including violation of statute,

negligence, intentional interference with economic relations, intentional interference with prospective

economic advantage, inverse 'condemnation, and unjust enrichment."'

Given the fact that none of the "other affirmative claims" have been asserted by PG&E against

MDN, there is no indication whatsoever of the amount which PG&E alleges should be setoff against

MID's Claim on account of the "other affirmative ciaittif," and that PG&E's Objections is devoid of any

facts or evidence to support the validity and amounts asserted in the "other affirmative claims," PG&E's

Objection on this ground should be overruled. In re Lundell supra 223.F.3d at 1039; I re Holm.

suMr. 931 F.2d at 623.

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MID'S RESPONSeTO DEBTOR'S OnJECTION To CLAIM MID'S RESPONSE TO DEBTOR'S OnJECTION To CLAIM

MlbS RESPONSE.TO DEBTOWS OBJECTION TO CLAIM MID's RESPONSE TO DEBTOR'S OBJECnON TO CLAIM� 11. .1 -- I.,

CONCLUTSION*

3 Based on the foreoiig, MIDrespec fiully requests that PG&E's Objections be overruled and for

4 such other and further relief as the Court deems proper.

Dated: June 7,2004 .

6 .MODESTO IRRIGATION DISTRICT

and

GOLDBERG, STINNETT, MEYERS & DAVISA Professonal Corporation

By:,. -. .. ene.ay.StateBarNo. 121002)

*12 , Attorneys fr odesto Irrigation District

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MID'S'RESPONSE TO DEBTOR'S OBJECTION TO CLAIMr,.,. Vn AlAA01 nUt