Opposition Brief — United States v. Wabash Valley Power Ass'n, 117 S. Ct. 389 (1996) (No. 96-342)

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No. 96-342

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IN THE

Supreme Court of the United States

OcTOBER TERM, 1995

IN THE MATTER OF WABASH VALLEY

POWER ASSOCIATION, INC.

THE UNITED STATES OF AMERICA, ON BEHALF OF

THE RURAL ELECTRIFICATION ADMINISTRATION,

Petitioner,

WABASH VALLEY POWER ASSOCIATION, INC.,

Respondent.

On Petition for a Writ of Certiorari to the United

States Court of Appeals for the Seventh Circuit

BRIEF IN OPPOSITION OF RESPONDENT

WABASH VALLEY POWER ASSOCIATION, INC.

Don F.. MorTON LEE A. FREEMAN, JR.

PARR RICHEY OBREMSKEY Counsel of Record

& MORTON JOHN F. KINNEY

c/o Wabash Valley Power JAMES T. MALYSIAK

Association, Inc. FREEMAN, FREEMAN

722 N. High School Road & SALZMAN, P.C.

P.O. Box 24700 401 N. Michigan Avenue

Indianapolis, Indiana 46224 Suite 3200

(317) 247-1596 Chicago, Illinois 60611

Davip H. KLEIMAN (312) 222-5100

JAMES P. MOLOY

DANN PECAR NEWMAN

& KLEIMAN, P.C.

One American Square

Suite 2300

Box 82008

Indianapolis, Indiana 46282

(317) 632-3232

Counsel for Respondent

Midwest Law Printing Co., Chicago 60610, (812) 321-0220

THE QUESTION ACTUALLY PRESENTED

The Rural Electrification Administration (“REA”) pre-

sents only one question for this Court’s consideration:

Whether the Court of Appeals created an exception to

the “absolute priority rule” of 11 U.S.C. § 1129(b\2)B)(ii)

for a not-for-profit cooperative whose members continue

to elect its directors even though its unsecured creditors

have not been paid in full. This question is not properly

raised here by the REA because the Seventh Circuit

recognized no such exception. Instead the Court of Ap-

peals applied the absolute priority rule to the specific

and unique facts found by the Bankruptcy Court, re-

viewed and accepted by the Disty.ct Court and the Sev-

enth Circuit and binding on REA here, and concluded,

primarily as a factual matter, that the rule was not vio-

lated. The Seventh Circuit did not purport to create an

“exception” to the absolute priority rule as REA asserts,

but instead explained why the rule had not been violated

in this particular instance. Therefore, the only question

that properly could be presented to this Court is:

Did the Court of Appeals correctly find—based on

the detailed facts found by the Bankruptcy Court

and accepted by the District Court and settled legal

principles previously determined by the Indiana Su-

preme Court and the Seventh Circuit—that Wabash

Valley’s Reorganization Plan does not violate the

absolute priority rule because as a state-regulated,

not-for-profit public utility, Wabash Valley's Mem-

bers have no equity interest in Wabash Valley, can-

not receive any profits or dividends from Wabash

Valley’s continuing operations, have no claim to any

of Wabash Valley’s property even if it were liquidat-

ed, and retain the right to elect its board of directors

because of provisions of their power supply contracts

with Wabash Valley?

Eee

PARTIES TO THE PROCEEDING

REA’s petition includes a list of the parties to this pro-

ceeding.

TABLE OF CONTENTS

PAGE

THE QUESTION ACTUALLY PRESENTED. i

PARTIES TO THE PROCEEDING ........... ii

TABLE OF AUTHORITIES .................

EE REE 6s GaAs eacbiceesveccncesis

EEN ET oe 4

EE EAS Pe

Wabash Valley’s Marble Hill Rate Case .....

REA’s Attempts to Preempt State Regulation

of Wabash Valley’s Rates ................ 7

Valuation of Wabash Valley .............. 9

REASONS FOR DENYING THE WRIT ..... 11

The Seventh Circuit Did Not Create An Ex-

ception To The Absolute Priority Rule For

Not-For-Profit Cooperatives ............... 11

II.

The Seventh Circuit Correctly Recognized

That The Wabash Valley Plan Maximizes The

Creditors’ Economic Recovery, And The De-

cision Below Will Not Adversely Affect REA’s

Ability To Recover Loans To Other Rural

Blectric Cooperatives ......cscscccsccscces 20

« a A SP

AE EN

fe Ska

SLL SES LL RE ch BO CEI ED ETE OR a

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wie in ta

PETS Pes a ee

‘

A. The Undisputed Findings By the Bank-

ruptcy Court Clearly Show that REA

Will Recover Substantially More Under

the Wabash Valley Plan than REA’s Only

Alternative, Liquidation .............. 21

B. The Decision Below is Limited to Wabash

Valley’s Unique Circumstances and Will

Not Affect REA’s Ability to Collect

Loans to Other Rural Electric Coopera-

OR ova nc nce sia neeGusaeseeteuseaeess 22

ITI.

REA’s Assertion Of An Unqualified Right To

Veto The Wabash Valley Plan Has No Sup-

port In The Bankruptcy Code And Is Incon-

sistent With The Public Policy That Underlies

Chapter 12 on... ccceccccccccensesncccsaces 26

CONCLUSION «oo scccscccnsussesudannceedaces 29

APPENDICES ovo vcccceencvcsssseeannenccdess infra

TABLE OF AUTHORITIES

Cases: PAGE

Anderson v. City of Bessemer City, 470 U.S. 564

OOD ais ka hick eaSka beads eee Kee 4

Briscoe Enterprises, Ltd., II, Matter of, 994 F.2d

1160 (5th Cir.), cert. denied, 510 U.S. 992

CREED 6c Kk SUS ONS oe ORE EKEK WW debe ke Ree eS ES 26, 27, 28

Bonner Mall Partnership, In re, 2 F.3d 899 (9th

Cir. 1993), cert. denied and vacatur motion de-

nied sub nom. U.S. Bancorp Mortgage Co. v.

Bonner Mall Partnership, 513 U.S. __, 115

ee SR Oe: err eee 16, 27, 28

Citizens Action Coalition of Indiana, Inc. v. North-

ern Ind. Pub. Serv. Co., 485 N.E.2d 610 (Ind.

1985), cert. denied, 476 U.S. 1187 (1986).... 6

Citizens Action Coalition of Indiana, Inc. v. PSI

Energy, Inc., 664 N.E.2d 401 (Ind. App. 1996) . 6

Citizens Action Coalition of Indiana, Inc. v. Pub.

Serv. Co. of Ind., Inc., 552 N.E.2d 834 (Ind.

Ay, IGG) cans ccscaceiccacdscsessisccevess 6

Eastern Maine Electric Coop., Inc., In re, 125 B.R.

S20 (Bankr. D.Bhe. WORE) soc csc ccd stuns caws 15

Norwest Bank Worthington v. Ahlers, 485 U.S. 197

CRON ik a is 0 ERR eee 1, 14, 15, 16

Nat’l Rural Utilities Coop. Fin. Corp. v. Public

Service Comm’n of Ind., 552 N.E.2d 23 (Ind.

1990), aff'g 528 N.E.2d 95 (Ind. App. 1988) ...

Ry Pe epee eee ee ter etfs 3, 7, 12, 23

NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984). 28

Toibb v. Radloff, 501 U.S. 157 (1991)......... 28

Unruh v. Rushville State Bank, 987 F.2d 1506

CHOGR CER. BRD cc cen cccncceneccsveeccs 1, 2, 14, 15

United States v. Kimbell Foods, Inc., 440 U.S. 715

(IDTD. once cvkcccdseasued es kkalasasneeene

(errr ree riviera c, Prey Car

Wabash Valley Power Ass’n, Inc. v. Rural Elec-

trification Administration, 903 F.2d 445 (7th

Cir. 1990), affg 713 F. Supp. 1260 (S.D. Ind.

FOOUE hvac wateacécheiesn 3, 7, 8, 18, 19, 23, 24, 25, 26

Wabash Valley Power Ass’n, Inc. v. Rural Elec-

trification Administration, 988 F.2d 1480 (7th

Cir. 1993), affg 773 F. Supp. 1178 (S.D. Ind.

j: } ra ie PROP TERT oy Shs are 3, 8, 25, 26

Wabash Valley Power Ass’n, Inc., In re, 72 F.3d

1906 (7th Cir, 1906) ......sccesacescessees passim

Statutes and Regulations:

Bankruptcy Code, 11 U.S.C. §§ 101 et seq.:

43 U2 BOG. is akc ha cveuscus 0 cease < 13, 17

11 UBC. SER vio anccveseccdnves 26

41 VAG. OSes coca ve vnvdons tweens 27

13 UBL. S TED ook «csc veccces 12

Ind. Code Ann. (Burns 1995):

06 SB-F-3.1-1. 60 COR acc cin bac cs ine vivenes 4

ESE Tae 2 eerererrrervrrrrrerer 25

Miscellaneous:

Electric Utility Week, September 2, 1996, at 14. 24

Electric Utility Week, September 23, 1996, at 3 . 22

Electric Utility Week, September 30, 1996, at 1. 24

The Wall Street Journal, September 16, 1996, at

BA ic ceicsgeintsiiaseenee eee

The Wall Street Journal, October 3, 1996, at A-3 .

BRIEF IN OPPOSITION OF RESPONDENT

WABASH VALLEY POWER ASSOCIATION, INC.

Respondent Wabash Valley Power Association, Inc.

(“Wabash Valley”) opposes the petition filed by the Rural

Electrification Administration (“REA”). REA fails to iden-

tify any substantive conflict between the decision of the

Seventh Circuit here and this Court’s decision in Norwest

Bank Worthington v. Ahlers, 485 U.S. 197 (1988), or the

Tenth Circuit’s decision in Unruh v. Rushville State

Bank, 987 F.2d 1506 (10th Cir. 1993), nor does the peti-

tion raise any important question of federal law requir-

ing resolution by this Court. REA’s petition should be

denied because:

1. The Seventh Circuit’s decision is extremely fact-

specific and is based upon facts unique to Wabash Val-

ley. REA consistently ignores the extensive findings of

fact by the Bankruptcy Court regarding the Wabash Val-

ley Plan that were affirmed by both the District Court

and the Seventh Circuit. Those factual findings, which

are binding on REA here, contradict every material as-

sertion that REA makes regarding the Wabash Valley

Plan.

2. REA mischaracterizes the Seventh Circuit’s decision

as creating an exception to the absolute priority rule for

all not-for-profit cooperatives. The Seventh Circuit

created no such exception. The Seventh Circuit correctly

decided that based upon the unique legal and contractual

relationship between Wabash Valley and its Members

and Wabash Valley's status as a state-regulated, not-for-

profit public utility, the Wabash Valley Reorganization

Plan does not violate the absolute priority rule. The

Members have no equity interest in Wabash Valley, and

cannot profit at REA’s expense now or in the future.

Wabash Valley’s situation is clearly distinguishable from

the for-profit farmers in Ahlers and Unruh who retained

the “right to the future profits of their farms,” Unruh,

987 F.2d at 1508, as well as their interests in the land

that could be liquidated at a profit in the future. The

Members’ right to elect Wabash Valley's directors results

from the power supply contracts that Wabash Valley

assumes as part of its Plan, not because of their pre-peti-

tion interest in Wabash Valley.

3. The outcome below was determined largely by pre-

vious decisions by the Indiana Supreme Court and the

Seventh Circuit, to which REA and Wabash Valley were

parties and which REA never requested this Court to

review, holding that Wabash Valley cannot raise rates to

repay REA’s loan guarantees because Marble Hill was

never used and useful, and that REA cannot preempt

state rate regulation to impose rate increases to repay

any part of its Marble Hill loan guarantees.

4. The Seventh Circuit properly recognized that the

Wabash Valley Plan “makes economic sense” because it

maximizes the recovery for REA and other creditors.

REA abandoned its own Plan before the Seventh Circuit, -

arguing instead that Wabash Valley must be liquidated

even though as a result of REA’s de facto auction of

Wabash Valley, its Members are paying more for Wabash

Valley than anyone else offered and the creditors will re-

ceive $457 million under the Wabash Valley Plan—in-

cluding $431 million for REA (65% of its pre-petition

claim)—or $282 million more than the $175 million they

would realize through liquidation of Wabash Valley’s

physical assets, the only alternative now offered by REA.

5. The Seventh Circuit properly rejected REA’s unsup-

ported assertions of harm to REA’s lending program. The

Aes Tea rn, ae

Seventh Circuit correctly concluded that REA’s loan

guarantees to Wabash Valley are governed by idiosyn-

cratic legal and factual circumstances that cannot ad-

versely affect REA’s relationships with other borrowers.

6. The Seventh Circuit also correctly dismissed REA’s

claim of absolute power to veto Wabash Valley’s Plan as

inconsistent with the express language of the Bankrupt-

cy Code and contrary to the clear public policy that Con-

gress incorporated in Chapter 11 to promote the rehabili-

tation of debtors, especially where creditors like REA

ignore economic reality and seek to liquidate the debtor

regardless of the cost to itself and others.

OPINIONS BELOW

In addition to the opinions in REA’s Appendix, there

are three previous decisions (copies of which are included

in Appendices A, B and C), to which REA and Wabash

Valley were parties and which REA never asked this

Court to review, that are largely determinative of the

arguments REA makes in its petition. The opinion of the

Indiana Supreme Court in Wabash Valley’s Marble Hill

rate case denying any rate increase to repay Marble Hill

indebtedness because the project was never “used and

useful” in providing public utility service is reported at

552 N.E.2d 23 (App. A). The two previous opinions by the

United States Court of Appeals for the Seventh Circuit

rejecting REA’s attempts to preempt state regulation of

Wabash Valley’s rates are reported at 903 F.2d 445 (App.

B) and 988 F.2d 1480 (App. C).

STATEMENT OF THE CASE

REA’s “Statement” misstates or ignores numerous ma-

terial findings of fact by the Bankruptcy Court that were

reviewed and accepted by both the District Court and the

Seventh Circuit. These findings demonstrate that review

by this Court is unwarranted because the issue that REA

seeks to raise turns on the specific facts of this case that

were decided adversely to REA. These factual findings

are binding on REA because it never sustained its bur-

den of establishing that these were clearly erroneous. See

Anderson v. City of Bessemer City, 470 U.S. 564, 572

(1985).

Wabash Valley’s Regulated, Not-for-Profit Status

Wabash Valley is a not-for-profit generation and trans-

mission electric cooperative (“G&T”) organized under Ind.

Code §§ 23-7-1.1-1 et seg. (App. 70a 4 2)' The Indiana

Utility Regulatory Commission (“IURC”) regulates the

rates Wabash Valley charges its Members and requires

that rates be sufficient to cover only actual power supply

costs and a modest capital reserve. (App. 73-74a 9417-18;

App. 137a 4164) If Wabash Valley collects revenues that

exceed its actual power supply costs, the [URC requires

those overpayments to be credited against future fuel

cost increases. (App. 74a 418) Indiana law precludes

Wabash Valley, as a not-for-profit corporation, from pay-

ing any earnings or dividends to its Members. (App. 70a

' Record references are to REA’s appendix and the separately

numbered paragraphs in the Bankruptcy Court’s Findings of

Fact. Factual statements in the ematey Court’s Conclu-

sions of Law stand as additional Findings of Fact. (App. 167a

4246)

cineca

94) Under Indiana law and Wabash Valley’s articles of

incorporation, the Members cannot receive or retain any

interest in Wabash Valley’s assets that can be sold or

liquidated at a profit, and upon dissolution of Wabash

Valley, any assets remaining after payment of debts and

return of capital contributions escheat to the State. (/d. )

The Supply Contracts and

REA’s Marble Hill Loan Guarantees

In 1977, Wabash Valley entered into forty-year (later

extended for another ten years) all-requirements whole-

sale power supply contracts (“Supply Contracts”) with

each of its Members. (App. 72-73a 914) Those agree-

ments require [URC regulation of Wabash Valley’s rates

on a not-for-profit basis and give the Members the right

to elect Wabash Valley’s directors. (App. 73a 415; App.

135a 9158) If either of these conditions were violated by

Wabash Valley (or a successor), this would cause Wabash

Valley to breach the agreements and the Members could

purchase their power requirements elsewhere. (App. 89-

9la 9955-58; App. 134-135a 94157-159)

REA actively encouraged Wabash Valley and other

G&Ts to invest in nuclear power plants. (App. 75a 720

n.5) Beginning in 1978 Wabash Valley invested approxi-

mately $460 million in the Marble Hill nuclear plant

that Public Service Company of Indiana (“PSI”) was con-

structing. (App. 75a 920) REA approved the Supply Con-

tracts as the primary collateral for its Marble Hill loan

guarantees; REA did not seek further repayment guaran-

tees from Wabash Valley’s Members. Although the Sup-

ply Contracts were patterned after REA’s form agree-

ment, the requirement that the [URC must approve the

rates Wabash Valley charges is not a standard REA pro-

vision. (App. 73a 916) REA admitted that it was not

aware of any other power supply contract securing REA

loans that includes such a specific state rate regulation

requirement. (App. 73a 716; App. 113a 4111)

Wabash Valley’s Marble Hill Rate Case

Following PSI’s cancellation of Marble Hill, Wabash

Valley prosecuted fraud and other claims against PSI

and Marble Hill contractors that resulted in a recovery

of over $185 million for the benefit of REA and the other

creditors. (App. 78-80a 9927-33) Wabash Valley also

tried to restructure its loans with REA and, at REA’s in-

sistence, filed a petition for IURC approval for a 51%

rate increase to repay the Marble Hill debt. (Jd.) REA

and another Wabash Valley creditor, the National Rural

Utilities Cooperative Finance Corporation (“CFC”), inter-

vened and participated fully in the Marble Hill rate case.

(App. 75-76a 921 n.6) Applying Indiana’s “used and use-

ful” rule,” the IURC dismissed Wabash Valley’s petition.

(App. 75-76a 921) The Indiana Court of Appeals and Su-

preme Court subsequently affirmed the IURC’s decision

and held that because Marble Hill was never “used and

* The Indiana courts applied this same standard to deny any

recovery of sunk costs for two Indiana investor-owned utilities,

NIPSCO and PSI, that also had invested substantial amounts

in canceled nuclear power plants. See Citizens Action Coalition

of Indiana, Inc. v. Northern Ind. Pub. Serv. Co., 485 N.E.2d

610, 614-615 (Ind. 1985), cert. denied, 476 U.S. 1137 (1986);

Citizens Action Coalition of Indiana, Inc. v. Pub. Serv. Co. of

Ind., Inc., 552 N.E.2d 834, 837, 840 (Ind. App. 1990); and Citi-

zens Action Coalition of Indiana, Inc. v. PSI Energy, Inc., 664

N.E.2d 401, 403-404 (Ind. App. 1996).

seit SIRES a

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useful,” Wabash Valley cannot raise rates to repay the

Marble Hill loan guarantees. Nat’! Rural Utilities Coop.

Fin. Corp. v. Public Service Comm'n of Ind., 552 N.E.2d

23, 27-28 (Ind. 1990) (App. A 9-10), aff'g 528 N.E.2d 95

(Ind. App. 1988). REA was a moving party in the appeals

to the Indiana Court of Appeals and Supreme Court.

REA did not seek review of the Indiana Supreme Court’s

decision by this Court.

As of the petition date, Wabash Valley owed REA $669

million, of which approximately $540 million was Marble

Hill-related. (App. 76-77a 4 23)

REA’s Attempts to Preempt State

Regulation of Wabash Valley’s Rates

After the Indiana Court of Appeals affirmed the dis-

missal of Wabash Valley’s request to raise rates to pay

for Marble Hill, REA sent letters to Wabash Valley, the

IURC and the Michigan Public Service Commission pur-

porting to preempt state regulation of Wabash Valley’s

rates. (App. 85a 945) The Seventh Circuit unanimously

affirmed the District Court’s conclusion that REA’s con-

duct was “arbitrary, capricious, not in accordance with

law, and of no force and effect whatever,” stating that

“Calfter all, the REA made its loans and guarantees on

the assumption that state regulation would apply.”

Wabash Valley Power Ass’n, Inc. v. Rural Electrification

Administration, 903 F.2d 445, 455 (7th Cir. 1990) (App.

B 20), affg 713 F. Supp. 1260 (S.D. Ind. 1989) (“Wabash

Valley v. REA I”). The Court of Appeals also ruled that

claim preclusion barred REA from raising an implied

preemption argument when REA had failed to make such

an assertion in Wabash Valley’s Marble Hill rate case.

Id. REA did not ask this Court to review the Seventh

Circuit’s decision.

On the eve of the confirmation hearing, REA once

again tried to preempt state regulation of Wabash Val-

ley’s rates, this time by formal rulemaking. (App. 86a

447) And once again both the District Court and Seventh

Circuit held that REA lacked authority to preempt state

rate regulation on an ad hoc basis whenever rates did

not generate sufficient revenues to repay REA loans.

Wabash Valley Power Ass’n, Inc. v. Rural Electrification

Administration, 988 F.2d 1480 (7th Cir. 1993) (App. C),

aff'g 773 F. Supp. 1178 (S.D. Ind. 1991) (“Wabash Valley

v. REA IT”). The Seventh Circuit reasoned that the Rural

Electrification Act reflected the assumption by Congress

that “REA could protect itself by setting conditions on

the extension of credits,” including commitments by state

regulators to set rates high enough to enable loan repay-

ment. App. C 23-24, 988 F.2d at 1490-91. The Seventh

Circuit stated that “REA failed to so qualify its loan

guarantees to Wabash Valley” and that “[dlistilled to its

essence, the REA would have Wabash Valley’s subscrib-

ers absorb the losses stemming from Wabash Valley’s de-

fault and the REA’s mishandling of its security arranye-

ment.” App. C 24, 988 F.2d at 1491. The Court of Ap-

peals concluded that REA lacked the authority to dictate

who shall bear the risk of non-payment, especially be-

cause the reasonable interpretation of “the structure and

operation of the subsidies provided through the REA

reflect a congressional preference for the government’s

bearing this risk, rather than cooperative members.” Jd.

Once again, REA did not seek review by this Court.

Valuation of Wabash Valley

REA does not mention, much less challenge in its peti-

tion, the exhaustive consideration that the courts below

gave to the valuation of Wabash Valley, even though

valuation is a critical step in the reorganization process

because it defines how much Wabash Valley’s creditors

can recover and whether Wabash Valley should be reor-

ganized and continue operations or be liquidated. The

parties stipulated that the liquidation value of Wabash

Valley’s physical assets was $175 million. (App. 81a 136;

App. 136a 7160) The Bankruptcy Court found—and the

District Court affirmed (App. 48a)—that Wabash Valley’s

fair market value as a going concern was no more than

$190 million. (App. 136-154a, in particular 7201) Wabash

Valley's going concern value was limited by its unique

status as a regulated not-for-profit utility where its prin-

cipal asset, the Supply Contracts, require state regula-

tion of Wabash Valley’s rates on a not-for-profit basis

and give the Members the right to elect Wabash Valley's

directors. (App. 135a 9158) If these contract rights were

breached, the Supply Contracts would not be enforceable

against the Members and they would be free to purchase

their power requirements elsewhere. (App. 134-135a

4157-159)

The Bankruptcy Court also valued Wabash Valley

based on the cost savings it provides for its Members

compared to alternative power sources. (App. 98-102a

4475-85) The Court found that Wabash Valley was more

valuable to its Members than to any other potential buy-

er “because Wabash Valley is tailored exactly to their re-

quirements” (App. 101a 982), and that $221.7 million

was the most that Wabash Valley’s Members would pay

to continue its operations, or what one witness referred

: 10

to as “the maximum value you could possibly squeeze out

. . . of [the Members] before it would pay them to go find

other arrangements.” (App. 155-158a 49207-209, 213)

The Seventh Circuit specifically affirmed the Bankruptcy

Court’s findings on the Supply Contracts and valuation

as not clearly erroneous. Jn re Wabash Valley Power

Ass’n, Inc., App. 5-12a, 72 F.3d at 1309-1313.

The valuations of Wabash Valley were corroborated by

the fact that REA had conducted a de facto auction of

Wabash Valley, and no buyer was willing to offer more

than the $221.7 million that the Members pay under the

Wabash Valley Plan. REA conceded having received “ex-

pressions of interest” from three utilities—two for-profit,

investor-owned utilities, PSI and Indianapolis Power &

Light, and Big Rivers, a Kentucky-based G&T—and that

PSI had made “a very formal offer” to REA. (App. 112-

ll4a 44110, 114; App. 182-183a 938) REA rejected the

PSI offer, never advised the Court of the terms PSI

offered, nor did REA ever seek the Court’s approval of

any offer to acquire Wabash Valley. (Jd.) The Bankruptcy

Court made a specific finding that “the reasonable in-

ference is that none of the utilities that had expressed

interest in acquiring Wabash was willing to submit a bid

that surpassed what Wabash is proposing to pay REA

and the other creditors... . [I]f REA had received a

better offer, REA certainly would have presented that

offer for the Court’s consideration. REA never did.” (App.

182-183a 938)

Under the Wabash Valley Plan, REA and the other

creditors will receive payments having a present value of

$457 million (including Marble Hill-related settlements

worth at least $185 million that Wabash Valley ob-

tained), compared with only $175 million if Wabash

Valley’s tangible, useful assets were liquidated. (App.

67a; App. 81a 436) Simply put, under the Wabash Valley

Plan REA and the other creditors will receive $282 mil-

lion more than they will under the only alternative now

proposed by REA, liquidation. REA will receive nearly

$431 million under the Wabash Valley Plan (App. 67a),

or $256 million more than it would recover if Wabash

Valley were liquidated.

REASONS FOR DENYING THE WRIT

THE SEVENTH CIRCUIT DID NOT CREATE AN EX-

CEPTION TO THE ABSOLUTE PRIORITY RULE FOR

NOT-FOR-PROFIT COOPERATIVES.

REA misstates or ignores binding factual findings and

settled legal principles to give the false impression that

the Seventh Circuit created “an exception to the absolute

priority rule for not-for-profit cooperatives.” (REA Pet. 8,

12, 14, 17, 18)

The Seventh Circuit never even suggested such an ex-

ception. The Court of Appeals properly applied the abso-

lute priority rule and concluded that the Members’ right

to choose the directors of the reorganized Wabash Valley

does not violate the rule because based upon Wabash

Valley's unique circumstances the Members have no

equity interest in Wabash Valley and no present or

future ability to profit at REA’s expense.

REA ignores that the Seventh Circuit explicitly applied

the absolute priority rule to “the unusual structure of the

entities involved”—particularly the Members’ unique in-

terests in Wabash Valley which is both a not-for-profit

and regulated cooperatively owned utility—that made

“the rules of Chapter 11 bankruptcy, primarily designed

as they are for profit-seeking enterprises . . . less than

straightforward to apply here.” App. 15-17a, 72 F.3d at

1313-1314. The Court of Appeals ultimately concluded

that “[blecause of the way in which the rights of the

Members of Wabash are constrained both by state law

and by the organization’s own bylaws, we believe the

Members may continue in control of the reorganized co-

operative without violating the absolute priority rule.”

App. 20a, 72 F.3d at 1315 (emphasis added). The Sev-

enth Circuit further noted that “/bjJeyond complying with

the rule, this outcome also seems to make economic

sense, since it maximizes the value available to meet

creditor claims.” Jd. (emphasis added).

Under the absolute priority rule as incorporated in 11

U.S.C. § 1129(b\(2)B)ii), the question is whether Wa-

bash Valley’s Members are “old equity” holders who have

traded on their “insider” status to acquire “new equity”

in the reorganized Wabash Valley while REA receives

less than full repayment of its unsecured claim. App.

19a, 72 F.3d at 1318. The short answer is that the Mem-

bers have no “equity interest” in Wabash Valley. The

findings of facts by the Bankruptcy Court (App. 70-78a

112, 4, 14-15), which the Seventh Circuit sustained (App.

16a, 72 F.3d at 1313), establish that under the governing

Indiana statutes and Wabash Valley’s articles of incorpo-

ration and bylaws, the Members cannot receive any prof-

its or dividends, and they have no present or prospective

ownership interest in Wabash Valley’s assets that can be

sold or liquidated at a profit. In the Marble Hill rate

case, the Indiana Supreme Court previously determined

that the Members are not “investors” in Wabash Valley,

App. A 7-8, 552 N.E.2d at 27, a decision that is binding

on REA here. In Wabash Valley v. REA I, another panel

of the Seventh Circuit similarly concluded that “non-

profit utilities are not supposed to make ‘profits’ and do

not have ‘equity investments’ in the legal sense. . . .”

App. B 7, 903 F.2d at 449. The Seventh Circuit thus

properly concluded here that under Indiana law, Wabash

Valley’s articles of incorporation and bylaws, the Mem-

bers have no equity interest in Wabash Valley.

Similarly, the Members’ right to elect the directors of

the reorganized cooperative does not violate the absolute

priority rule. The Supply Contracts, which Wabash

Valley assumes under 11 U.S.C. § 365, require that the

IURC continue to regulate Wabash Valley’s rates on a

not-for-profit basis and that the Members retain the

right to elect Wabash Valley’s directors. The Seventh

Circuit affirmed the Bankruptcy Court’s findings (App.

89-92a 9955-60; App. 134-135a 9157-158) that a vio-

lation of either of these conditions would breach the Sup-

ply Contracts and free the Members to purchase their

power requirements elsewhere. App. 10a, 72 F.3d at

1311. Wabash Valley must assume the Supply Contracts

in their entirety so that the Members remain obligated

to purchase their power requirements from Wabash Val-

ley, thus producing a future income stream for the bene-

fit of REA and the other creditors. If the Supply Con-

tracts were invalidated and Wabash Valley liquidated as

REA proposes, REA would receive $256 million less than

it will under the Wabash Valley Plan.

In this connection, the Seventh Circuit noted that “con-

trol” alone is not the determinative issue and that the

absolute priority rule is implicated only where those in

control can realize a financial gain by sharing in the

reorganized entity’s profits or assets. App. 29a, 72 F.3d

at 1318. The Seventh Circuit correctly concluded that

Wabash Valley's Members “are not owners in any usual

sense of the term,” App. 16a, 72 F.3d at 1313, because

there is no possibility that the Members can profit, now

or in the future, at REA’s expense. The Seventh Circuit

explained how Wabash Valley’s unique status as @ regu-

lated and not-for-profit electric utility clearly distin-

guishes Wabash Valley from the for-profit farmers in

Ahlers and Unruh who retained the “right to the future

profits of their farms,” 987 F.2d at 1508, as well as their

interests in the land that could be liquidated at an

appreciated value for a profit in the future:

Pursuant to state law and the rules of the co-

operative, Wabash Members receive no profits,

nor do they have any current or prospective own-

ership rights in the corporate assets. Under In-

diana law any assets remaining to the coopera-

tive after a liquidation or dissolution escheat to

the state.

* * *

Control of the cooperative provides no opportuni-

ty, either currently or in the future, for the Mem-

bers to obtain profits or any equity in Wabash’s

assets and control itself is not an equity interest.

Further, control of Wabash’s Board provides the

Members with no opportunity to benefit at REA’s

expense. App. 16a, 33a, 72 F.3d at 1313, 1320."

3 In return for their agreement to purchase their power re-

quirements from Wabash Valley for forty years, the Members

bargained for and received certain rights to protect their in-

terests, including the rights to elect Wabash Valley’s directors

and to have the IURC regulate its rates. (App. 89-91a 1155-58;

App. 134-135a 99157-159) The Wabash Valley Plan allows the

(continued...)

Wabash Valley is unique because none of the incidents

of control of a for-profit business exists. Under the bind-

ing facts found by the Bankruptcy Court and the legal

principles settled by prior decisions of the Indiana Su-

preme Court and the Seventh Circuit, Wabash Valley

cannot earn a profit from ongoing operations, nor can it

pay a dividend to the Members.* And unlike the debtors

in Ahlers and Unruh, the Members have no current or

prospective ownership interest in Wabash Valley’s assets

that can be sold or liquidated at a profit.’ Under these

specific circumstances, the Members’ right to “control”

the reorganized Wabash Valley by continuing to elect its

directors is clearly distinguishable from the typical for-

* (...continued)

Members to maintain the system of governance and communi-

cations that they have developed over many years to share

information and resolve common issues through collective

efforts.

* That the Seventh Circuit’s decision was grounded upon legal

and factual considerations that are unique to Wabash Valley

is demonstrated by the fact that the Court of Appeals consid-

ered and distinguished other “not-for-profit” cases such as Jn

re Eastern Maine Electric Coop., Inc., 125 B.R. 329 (Bankr.

D.Me. 1991), as “decided under Maine law and under different

corporate articles and bylaws... .” App. 23a, 72 F.3d at 1316.

The Court of Appeals further stated that “relevant decisions

of the [Indiana] state courts involving Wabash and the par-

ticulars of the Wabash bylaws both distinguish this case” from

Eastern Maine. App. 25a, 72 F.3d at 1317.

° Ahlers is also distinguishable because the debtors did not

contest the conclusion that their retaining an equity interest

in the for-profit farm violated the absolute priority rule. 485

U.S. at 202. Moreover, unlike here where all creditors will re-

ceive substantially more under the Wabash Valley Plan, only

the wholly unsecured creditors fared better under the debtors’

plan in Ahlers. Id. at 206.

profit debtor. There is no possibility that the Members

can “profit” in the future while REA receives less than

full repayment of its unsecured claim.°

REA effectively concedes this point and argues instead

that the Members may benefit by paying lower prices for

power if Wabash Valley remains in existence. But that is

precisely the reason for a not-for-profit cooperatively

owned electric utility. The Seventh Circuit correctly held

that this “potential for lower prices” does not implicate

the absolute priority rule because such lower rates are

not “property received on account of an equity interest.”

App. 28a, 72 F.3d at 1318. The rates that the Members

pay are a result of Wabash Valley’s unique status as a

state-regulated, not-for-profit utility. Indiana law requires

the IURC to set Wabash Valley’s rates to cover only its

actual power supply costs. If Wabash Valley's rates pro-

duce revenues beyond those costs, those overpayments

must be credited against fuel cost increases. (App. 10a,

72 F.3d at 1311; App. 74a 918; App. 137a 4164) As the

® Contrary to REA’s contention (Pet. 8 n.6), the Seventh Cir-

cuit did not reach the so-called “new value exception” to the

absolute priority rule in this case, App. 19a, 72 F.3d at 1315,

and, therefore, this is not an issue properly raised by REA’s

petition. Nevertheless, the Wabash Valley Plan also satisfies

the new value exception because the Members will make “a

substantial, necessary, and fair new value contribution” of $3.2

million. See generally In re Bonner Mall Partnership, 2 F.3d

899, 908-909 (9th Cir. 1993), cert. dismissed and vacatur

motion denied sub nom. U.S. Bancorp Mortgage Co. v. Bonner

Mall Partnership, 513 U.S. __, 115 S. Ct. 386 (1994). Al-

though in Ahlers this Court declined to reach the issue wheth-

er this exception survived the adoption of the 1978 Bankruptcy

Code, “the majority of courts that have considered the question

have held that the new value exception is alive and well.” Jd.

at 907.

Seventh Circuit stated, Wabash Valley’s assumption of

the Supply Contracts under its Plan (and under 11

U.S.C. § 365) “will obligate the Members to fulfill all

their obligations under the Contracts and will entitle

them to all the benefits of the Contracts including the

right to name Wabash’s Board of Directors.” App. 14a, 72

F.3d at 1312-1313. The Members’ primary obligation

under the Supply Contracts is to purchase their power

requirements from Wabash Valley until 2027. Wabash

Valley has corresponding contractual obligations, includ-

ing the requirement to provide reliable service to the

Members at the lowest possible cost. REA understood

and approved those provisions of the Supply Contracts as

the primary collateral for its Marble Hill loan guaran-

tees. Under these circumstances, Wabash Valley’s con-

tractual obligation to seek and obtain power supply op-

tions that may result in lower prices for the Members

does not implicate, much less violate, the absolute prior-

ity rule.

Moreover, REA could not recover any more than what

it will receive under the Wabash Valley Plan even if

there were an equity interest in Wabash Valley that

REA could assume. REA is bound by the Bankruptcy

Court’s finding, reviewed and accepted by the Seventh

Circuit (App. 122a, 72 F.3d at 1312), that Wabash Val-

ley’s maximum value is the $221.7 million that the Mem-

bers will pay under the Wabash Valley Plan. Even if

REA controlled Wabash Valley, it could not earn a profit

or pay a dividend to itself because under settled princi-

ples of Indiana law and the Supply Contracts, Wabash

Valley’s rates must cover only actual power supply costs.

If REA tried to set higher rates, IURC regulations re-

quire that “any excess of revenues over expenses and

over a limited reserve must be credited against fuel ad-

justment charges.” App. 10a, 72 F.3d at 1311.

In any event, the Bankruptcy Court valued the future

benefits to the Members of being able to aggregate their

power purchases through Wabash Valley (the $31.7 mil-

lion difference between Wabash Valley’s $190 million

going-concern value and the $221.7 million value to the

Members), and that amount will be paid to REA and

CFC on their unsecured claims. The Bankruptcy Court

correctly concluded that by identifying and paying this

“significant tangible premium” for the benefit of REA

and the other creditors, “there is no residual economic

benefit for Wabash’s Members.” (App. 184-186a 9941, 45)

Thus, even if the benefits of possible lower prices in the

future implicated the absolute priority rule, which they

do not, under the Wabash Valley Plan the Members pay

the creditors the full value of any price benefits they may

obtain through a reorganized Wabash Valley.

The Bankruptcy Court’s valuation analysis and find-

ings are also dispositive of REA’s argument (REA Pet.

19) that the reorganized Wabash Valley could convert to

a for-profit entity. First, REA ignores the fact that the

Supply Contracts require Wabash Valley to be operated

as a regulated, not-for-profit utility. (App. 67a; App. 89-

91a 9956-58) Second, the Bankruptcy Court’s $190 mil-

lion going concern valuation of Wabash Valley was prem-

ised upon a sale to a for-profit purchaser and the conver-

sion of Wabash Valley to a for-profit utility. (App. 92-98a

4961-74; App. 136-141a 44160- 175)’ Finally, the two for-

’ As part of its valuation findings, the Bankruptcy Court

found that the Members have no incentive to renegotiate the

(continued...)

profit utilities that expressed interest in acquiring

Wabash Valley and converting it into a for-profit enter-

prise were not willing to submit bids that even matched

the $221.7 million that the Members will pay under the

Wabash Valley Plan. (App. 182-183a 938) Contrary to

REA’s speculation, the fact is that the market placed a

very low value on the opportunity to convert Wabash

Valley to a for-profit entity.

REA’s real complaint is that it has not been able to im-

pose any rate increase to repay the Marble Hill loan

guarantees. REA’s position is untenable because it

ignores the dispositive holding by the Indiana Supreme

Court and two previous decisions by the Seventh Circuit

holding that REA cannot preempt state rate regulation

to raise Wabash Valley’s rates to pay for Marble Hill. As

the Seventh Circuit previously recognized, REA’s predic-

ament is simply because REA accepted as its primary

collateral Supply Contracts “with Wabash’s customers

that oblige them to pay no more than the state rate; it

did not secure [member] guarantees.” Wabash Valley v.

REA I, App. B 16, 903 F.2d at 453. The current panel of

the Seventh Circuit reached the same conclusion: “Two

factors outside the Members’ control have prevented REA

from collecting more of its outstanding debt: the non-

profit structure of cooperatives and, most important, the

fact that the only conceivable source of funds—increased

rates—is foreclosed by state law and the prior decisions

of this court.” App. 33a, 72 F.3d at 1320 (emphasis

” (...continued)

Supply Contracts to a for-profit basis unless this would result

in rates lower than what the Members would pay their “host”

investor-owned utilities if Wabash Valley ceased to exist. (App.

139-140a 9171)

added). In particular, the “principal reason” the Supply

Contracts did not provide a reliable source of revenue to

repay the Marble Hill loan guarantees “was the refusal

of Indiana regulators to recognize Marble Hill as an

asset for ratemaking purposes,” a risk that REA knew or

should have known of as a promoter of nuclear power.

App. 31a, 72 F.3d at 1319.

In short, there is no basis for REA’s assertion that the

Seventh Circuit created a new exception to the absolute

priority rule for not-for-profit cooperatives. The Seventh

Circuit’s decision rests instead on the unexceptional hold-

ing that the question of compliance with the absolute

priority rule must be answered by close examination of

the governing law and specific facts of each case. Here,

the Seventh Circuit carefully applied the rule to Wabash

Valley’s one-of-a-kind circumstances and found no vio-

lation. |

Il.

THE SEVENTH CIRCUIT CORRECTLY RECOGNIZED

THAT THE WABASH VALLEY PLAN MAXIMIZES THE

CREDITORS’ ECONOMIC RECOVERY, AND THE DE-

CISION BELOW WILL NOT ADVERSELY AFFECT

REA’S ABILITY TO RECOVER LOANS TO OTHER

RURAL ELECTRIC COOPERATIVES.

REA tries to buttress its petition by suggesting (a) that

the Seventh Circuit “improperly speculated that [REA]

would be better off under the Wabash Plan than under

other alternatives” (REA Pet. 11 n.9); and (b) that the

decision below will adversely affect its ability to collect

loans to other rural electric cooperatives. (REA Pet. 9,

19) Both of REA’s arguments are not properly part of the

__ question REA purports to present, and both are clearly

contrary to the facts as found by the courts below.

A. The Undisputed Findings By the Bankruptcy Court

Clearly Show that REA Will Recover Substantially

More Under the Wabash Valley Plan than REA’s

Only Alternative, Liquidation.

Contrary to REA’s suggestion, the Court of Appeals

was not speculating when it observed that the Wabash

Valley Plan “makes economic sense” because REA will

recover far more than under REA’s only alternative,

liquidation. REA does not dispute that under the Wabash

Valley Plan all creditors will receive $457 million, and

REA’s share is nearly $431 million. Because REA now

has abandoned its own Plan, REA’s only alternative to

the Wabash Plan is liquidation of Wabash Valley’s phy-

sical assets which will yield $282 million less. Given the

constraints of Indiana rate regulation that absolutely

prohibit a rate increase to pay for Marble Hill, App. 31a,

72 F.3d at 1319, the Seventh Circuit correctly concluded

that the Members’ “continuation as customers in control

of Wabash is a means of maximizing the value of the

estate for the benefit of creditors.” App. 27-28a, 72 F.3d

at 1318.°

* The Court of Appeals recognized that the higher return for

REA under the Wabash Valley Plan “does not excuse compli-

ance with the absolute priority rule, but it is nonetheless a

fact of which we must remain aware.” App. 32a, 72 F.3d at

1320. REA’s steadfast demand for liquidation confounds com-

mon sense. A financially accountable commercial lender could

never rationalize insisting upon an option that results in a

$256 million loss for itself (and $282 million for all creditors).

B. The Decision Below is Limited to Wabash Valley’s

Unique Circumstances and Will Not Affect REA’s

Ability to Collect Loans to Other Rural Electric Co-

operatives.

Equally misplaced are REA’s assertions that the de-

cision below will adversely affect REA’s loans to other

rural electric cooperatives. REA submitted no evidence

below to support these claims.’ And once again REA

ignores the numerous facts, found below and binding on

REA, that are unique to REA’s Marble Hill loan guaran-

tees and that establish that Wabash Valley’s situation is

sui generis and will not recur if REA places appropriate

conditions on extensions of credit. The critical fact con-

cerning REA’s Marble Hill loan guarantees is that REA

accepted as its collateral Supply Contracts that are ex-

pressly conditioned upon state rate regulation which, in

turn, resulted in the application of Indiana’s used-and-

useful rule when PSI abandoned Marble Hill. This pro-

® REA’s conduct contradicts the argument it makes here. REA

recently agreed to write off $982 million of the $1.22 billion

(for a net recovery of $237 million) that another G&T, Soyland

Power Cooperative, had borrowed with REA loan guarantees

to invest in Illinois Power’s Clinton nuclear plant. The Wall

Street Journal, at A-4 (September 16, 1996); Electric Utility

Week, at 3 (September 23, 1996). REA’s decision to accept this

writedown has nothing to do with the Seventh Circuit's

decision here since Soyland had not filed for reorganization

and operates in a state, Illinois, that does not regulate coop-

eratives’ rates. REA also recently agreed to write down $530

million in loans to Deseret Generation & Transmission Coop-

erative as part of a larger REA bailout of its “troubled” bor-

rowers. The Wall Street Journal, at A-3 (October 3, 1996).

REA’s insistence that Wabash Valley be liquidated is inexpli-

cable if REA’s objective actually were to maximize its recovery

on troubled loans. Liquidation of Wabash Valley would mean

that REA would receive $256 million less than it would receive

under the Wabash Valley Plan.

vision is unique to the Wabash Valley Supply Contracts.

(App. 73a 915; App. 135a 4158)

REA has no basis to suggest that the outcome here

poses a “significant threat . . . to [REA’s] legitimate . . .

expectations” as a creditor. (REA Pet. 19-20) If Marble

Hill was not completed—clearly a foreseeable risk for

REA as lender—the reasonable expectation was that the

IURC would apply Indiana’s longstanding used and use-

ful rule and bar any recovery of Marble Hill costs

through rates. As the Indiana Supreme Court stated: “At

the time the Wabash loan was approved, the REA ad-

ministrator knew or should have known that Wabash’s

requirements contracts with its members served as the

security for the loan and that those contracts provided

that the rates paid by the members had to be approved

by the [Indiana] commission, and this knowledge was or

should have been factored into REA’s decision to make

the loan.” App. A 12-13, 552 N.E.2d at 29.

REA’s unsupported concerns about its relations with

other borrowers hardly are a sufficient basis for this

Court to grant review. This is particularly true because

REA has the responsibility to insure that its loans are

properly collateralized. United States v. Kimbell Foods, -

Inc., 440 U.S. 715, 729 (1979) (rejecting argument that

“nationwide standards favoring claims of the United

States are necessary . . . to safeguard the Federal Trea-

sury from defaulting debtors.”). The Seventh Circuit

summarized REA’s remedy in Wabash Valley v. REA I:

Congress’ assumption when it created the Rural

Electrification Act in 1936 seems to have been

that the REA could protect itself by setting con-

ditions on the extension of credit... . The REA

may refuse to make loans unless state agencies

guarantee rates high enough to allow repayment.

It may refuse to approve a loan unless the cus-

tomers (whose promises to buy power are the real

security for the debt) guarantee the loan or auth-

orize the REA to dictate rates. If either state or

customer balks, the REA may deploy its funds

elsewhere. . . . The conditioning power is a big

club, which can achieve (effective) preemption

and more. .. . But REA did not use this power

when extending credit [to Wabash Valley]. It ap-

proved contracts with Wabash’s customers that

oblige them to pay no more than the state rate; it

did not secure [member] guarantees. App. B 15-

16, 903 F.2d at 453.

REA also fails to inform this Court of a critical fact

that differentiates Wabash Valley’s situation from REA’s

other purportedly “troubled” borrowers. None of REA’s

loans to other G&Ts involves a project like Marble Hill

that was abandoned before completion. In all other in-

stances, REA has a security interest in actual “used and

useful” assets that were completed and have substantial

value. For example, another major REA G&T borrower

involved in a bankruptcy proceeding is Cajun Electric

Power Cooperative, and several bidders have offered

roughly $1 billion to acquire Cajun’s non-nuclear gener-

ating assets that were financed with REA loan guaran-

tees. Electric Utility Week, at 14 (September 2, 1996)."° In

addition, REA’s predictions of imminent financial ruin

are belied by the fact that only a small minority of states

‘© The financial problems of another REA G&T borrower, Big

Rivers, that recently filed for bankruptcy relate to a surplus

of high-cost generating capacity, not a project like Marble Hill

that was abandoned before completion. Electric Utility Week,

at 1 (September 30, 1996).

regulate cooperatives’ rates, Wabash Valley v. REA I,

App. B 2, 903 F.2d at 448, and an even smaller minority

strictly apply the used-and-useful rule. And even the In-

diana statutes were amended in 1985 to allow utilities to

recover through rates prudent expenditures for post-

April 1985 capital projects abandoned before completion,

provided the IURC previously had reviewed and certifi-

cated such projects. See Ind. Code §§ 8-1-8.5-1 et seq.

Finally, because the Seventh Circuit’s decision is lim-

ited by Wabash Valley’s idiosyncratic factual and legal

considerations—most especially its status as a regulated

and not-for-profit public utility—this case does not, as

REA asserts (REA Pet. 9, 19), provide a “roadmap” for

other non-profit debtors such as homeowners’ associa-

tions to avoid compliance with the absolute priority

rule.'' On the contrary, in the decision below and in its

two previous preemption decisions, the Seventh Circuit

provided REA with a detailed “roadmap” of the condi-

tions (e.g., binding commitments by state regulators to

set rates sufficiently high to repay loans and requiring

Member guarantees) that REA could place on extensions

of credit to protect its financial interests. Wabash Valley

v. REA I, App. B 15-16, 903 F.2d at 453; Wabash Valley

v. REA II, App. C 23-24, 988 F.2d at 1490-1491.

‘' The Seventh Circuit never suggested that its decision ex-

tends to homeowners’ associations or other nonprofit entities

as REA suggests. (REA Pet. 17, 20-21) On the contrary, the

Court of Appeals emphasized that Wabash Valley’s defining

characteristic is that its operations—and most significantly the

rates it can charge—are regulated by the [URC pursuant to a

comprehensive statutory scheme.

Ii.

REA’S ASSERTION OF AN UNQUALIFIED RIGHT TO

VETO THE WABASH VALLEY PLAN HAS NO SUPPORT

IN THE BANKRUPTCY CODE AND IS INCONSISTENT

WITH THE PUBLIC POLICY THAT UNDERLIES CHAP-

TER 11.

The practical thrust of REA’s petition is that as the

principal creditor REA has an unreviewable right to

liquidate Wabash Valley without any judicial “second-

guessing” even if creditors receive much less through

liquidation.'* REA’s position is refuted by clear statutory

language and is plainly inconsistent with the public

policy to rehabilitate debtors that underlies Chapter 11.

11 U.S.C. § 1129(a)(10) expressly provides that a plan

may be confirmed over the dissent of one or more credi-

tors if at least one class of impaired claims votes in favor

of confirmation, even if the class holds a minority of the

debt. See generally Matter of Briscoe Enterprises, Ltd., II,

994 F.2d 1160 (5th Cir.), cert. denied, 510 U.S. 992

(1993) (plan approved over objections of majority credi-

'2 REA argues, for example, that a reorganization proceeding

is nothing more than a device to sell the debtor to the credi-

tors. (REA Pet. 11) In Wabash Valley v. REA I, App. B 19, 903

F.2d at 455, the Seventh Circuit concluded that REA “seeks

not neutrality but preference” because REA attempted to pre-

empt state regulation of Wabash Valley’s rates even though

the Indiana Commission and courts had applied the used-and-

useful requirement in a nondiscriminatory fashion to all In-

diana utilities, including Wabash Valley’s partner in the Mar-

ble Hill project, PSI. Wabash Valley v. REA II rejected REA'’s

attempt to manipulate the bankruptcy process to give REA the

exclusive right to set the rates of any cooperative that files for

bankruptcy as an invalid attempt by REA “to shift the risk of

default on REA loans from the REA to cooperative members.”

App. C 4, 988 F.2d at 1483.

siesta

tor). Section 1129(b)\(1) similarly provides that a court

“shall confirm” a reorganization plan notwithstanding

the objections of a class of creditors if the plan does not

discriminate against and is fair and equitable with

respect to each impaired, non-consenting class of claims.

Had Congress intended to limit cramdown to cases where

a plan is supported by creditors holding a majority of the

debt, it easily could have drafted § 1129 to require that

result. On the contrary “the very purpose of the Code’s

cramdown provision . . . is to allow the court, not the

creditors, to decide whether a ‘fair and equitable’ plan

should be confirmed over creditor objections.” In re Bon-

ner Mall Partnership, 2 F.3d at 915. REA has no unqual-

ified right to derail confirmation of the otherwise “fair

and equitable” Wabash Valley Plan, especially because

REA now concedes that the Wabash Valley Plan satisfies

all the other requirements for cramdown.

REA also ignores the fact that it is not the only party

with an interest in Wabash Valley’s bankruptcy. Other

creditors such as CFC and PSI have a significant interest

in Wabash Valley’s continued operations. CFC did not

appeal from the Bankruptcy Court’s confirmation of the

Wabash Valley Plan even though its pre-petition claim

was roughly $35.5 million. (App. 77a 724) PSI, which

also asserted over $140 million in claims (App. 77-78a

126), voted in favor of the Wabash Valley Plan. App. 14a,

72 F.3d at 1313.

Moreover, in adopting the statutory framework for

reorganizations under Chapter 11 of the Bankruptcy

Code, Congress articulated a strong policy in favor of the

rehabilitation of debtors especially where a creditor, such

as REA here, is intent on liquidating the debtor regard-

less of the cost to itself and others. Briscoe Enterprises,

994 F.2d at 1162 n.1 (“The policy is that the public good

is served by rehabilitations and a law that prevents

creditors from getting immediate satisfaction but gives

the creditor as much as the creditor could get upon liqui-

dation and compensates him or her for the delay is prop-

er to force upon creditors.”). REA’s preference for a rule

that prohibits electric cooperatives from ever filing for

reorganization cannot be squared with the purpose of

Chapter 11. “[Wh)hile the protection of creditors’ interests

is an important purpose under Chapter 11... successful

debtor reorganization and maximization of the value of

the estate are the primary purposes.” Jn re Bonner Mall

Partnership, 2 F.3d at 915-916, citing NLRB v. Bildisco

& Bildisco, 465 U.S. 513, 527 (1984) and Toibd v. Rad-

loff, 501 U.S. 157, 163-164 (1991). These policy concerns

are especially important here because REA’s only alter-.

native to the Wabash Valley Plan is liquidation and a

much smaller recovery for all creditors. Chapter 11 was

designed to avoid precisely such economically irrational

liquidations, and by permitting reorganizations, “Con-

gress presumed that the assets of the debtor would be

more valuable if used in a rehabilitated business than if

‘sold for scrap.’” United States v. Whiting Pools, Inc., 462

U.S. 198, 203 (1983).

CONCLUSION

REA fails to inform this Court of the unique circum-

stances of this case and further ignores or misstates

numerous factual findings and settled legal principles

that are binding on REA here. Contrary to REA’s claims,

the Seventh Circuit did not create a new exception to the

absolute priority rule for not-for-profit cooperatives. The

Court of Appeals carefully applied the absolute priority

rule to Wabash Valley’s unique circumstances as a regu-

lated, not-for-profit cooperative and correctly found that

the Wabash Valley Plan clearly satisfies the rule. The

Wabash Valley Plan is also consistent with the rationale

of the absolute priority rule because, based upon the

Bankruptcy Court’s findings of fact and the settled legal

principles previously determined by the Indiana Supreme

Court and the Seventh Circuit, the Members’ control of

the reorganized debtor provides them no opportunity to

benefit at REA’s expense. There is no possibility for the

Members, either currently or prospectively, to obtain

profits or any interest in Wabash Valley’s assets that can

be liquidated at a profit. The Seventh Circuit correctly

noted that the Wabash Valley Plan also makes economic

sense because the Members’ continuation as customers

in control of Wabash Valley maximizes the value of the

estate for REA and the other creditors.

The bankruptcy process here worked well. Wabash Val-

ley marshaled its assets and recovered over $185 million

from the parties responsible for the Marble Hill debacle.

As a result, REA and the other creditors receive a total

recovery of $457 million—$431 million for REA alone—

under the Wabash Valley Plan compared to the $175 mil-

lion they would recover under REA’s only alternative to

the Wabash Valley Plan, liquidation.

Maint acc cori ae sn anon

For the foregoing reasons, Wabash Valley Power Asso-

ciation asks the Court to deny the petition.

Respectfully submitted,

Don F.. MoRTON LEE A. FREEMAN, JR.

PARR RICHEY OBREMSKEY Counsel of Record

& MORTON JOHN F. KINNEY

c/o Wabash Valley Power JAMES T. MALYSIAK

Association, Inc. FREEMAN, FREEMAN

722 N. High School Road & SALZMAN, P.C.

P.O. Box 24700 401 N. Michigan Avenue

Indianapolis, Indiana 46224 Suite 3200

(317) 247-1596 Chicago, Illinois 60611

(312) 222-5100

Davip H. KLEIMAN

JAMES P. MOLoy

DANN PECAR NEWMAN

& KLEIMAN, P.C.

One American Square

Suite 2300

Box 82008

Indianapolis, Indiana 46282

(317) 682-3232

Counsel for Respondent

October 4, 1996

No. 96-342

In THE

Supreme Court of the United States

OcTOBER TERM, 1995

IN THE MATTER OF WABASH VALLEY

POWER ASSOCIATION, INC.

THE UNITED STATES OF AMERICA, ON BEHALF OF

THE RURAL ELECTRIFICATION ADMINISTRATION,

Petitioner,

WABASH VALLEY POWER ASSOCIATION, INC.,

Respondent.

On Petition for a Writ of Certiorari to the United

States Court of Appeals for the Seventh Circuit

APPENDIX TO BRIEF IN OPPOSITION

A-1

APPENDIX A

NATIONAL RURAL UTILITIES

COOPERATIVE FINANCE CORPORATION,

Appellant,

PUBLIC SERVICE COMMISSION OF INDIANA,

Wabash Valley Power Association, Inc.,

Office of the Utility Consumer Counselor,

City of Fort Wayne, Indiana, Public Service

Company of Indiana, Inc., Fruit Belt Electric

Cooperative, Jay County REMC, United REMC,

Warren County REMC, Boone County REMC,

Kankakee Valley REMC, and United States of

America on Behalf of Its Rural Electrification

Administration, Department of Agriculture, Appellees.

UNITED STATES of America, Appellant,

PUBLIC SERVICE COMMISSION OF

INDIANA, et al.

No. 93S02-9003-EX-215

Supreme Court of Indiana.

March 21, 1990.

DeBRULER, Justice.

Appellants here are the Rural Electrification Adminis-

tration of the United States government (REA) and Na-

tional Rural Utilities Cooperative Finance Corporation

(CFC), lenders who advanced funds to the Wabash Valley

A-2

Power Association (Wabash) to be used toward the com-

pletion of the Marble Hill nuclear power generation

plant, a joint enterprise Wabash had undertaken in con-

junction with Public Service Company of Indiana. Fol-

lowing the abandonment of construction at Marble Hill,

Wabash filed a petition with the Public Service Commis-

sion of Indiana (now the Indiana Regulatory Commis-

sion) for a fifty-one percent rate increase intended to gen-

erate funds to pay project-related debts. The commission

dismissed Wabash’s petition with prejudice, noting that

under this Court’s holding in Citizens Action Coalition v.

Northern Indiana Public Service Co. (1985), Ind., 485

N.E.2d 610 (NIPSCO),' a utility may not recover sunk

costs associated with the cancellation of a nuclear power

project through a rate increase. The Court of Appeals

affirmed the commission’s decision, fully addressing the

issues raised by REA and CFC in their appeal. National

Rural Utils. Coop. Fin. Corp. v. Public Serv. Comm’n

(1988), Ind. App., 528 N.E.2d 95. We grant the petitions

for transfer and affirm pursuant to Indiana Rule of Ap-

pellate Procedure 11(B)(3). A brief summary of the reso-

lution of the issues raised on appeal follows.

‘ NIPSCO has twice appealed unsuccessfully from orders sub-

sequently entered in that cause. The resolution of the latest

appeal appears in Northern Indiana Public Service Co. v. Citi-

zens Action Coalition of Indiana, Inc. (1989), Ind., 548 N.E.2d

153. That decision, which reaffirms our original holding that

a utility cannot recover sunk costs associated with a failed

nuclear facility through a rate increase and which clarifies the

entitlement of ratepayers to interest on refunds and to attor-

neys’ fees, does not affect the reasoning nor the validity of the

Court of Appeals’ decision in this case and will not be further

cited in this opinion.

A-3

I. The commission acted within its jurisdiction when it

entered its order since the order constituted neither an

advisory opinion nor a declaratory judgment.

REA argued that because Wabash did not strongly sup-

port its petition for a rate increase, there was no case or

controversy before the commission and that the resulting

order was therefore merely an advisory opinion, which

the commission had no jurisdiction to enter. Jurisdiction

requires an actual, existing justiciable controversy be-

tween adverse parties. One aspect of adverseness is the

propriety and ability of one of the parties to call upon the

tribunal to adjudicate its cause. Because all rate increas-

es must be approved by the commission, it had primary

jurisdiction to hear the petition, and as the entity seek-

ing the increase, Wabash was the proper party to invoke

the commission’s jurisdiction. The validity and desirabili-

ty of the proposed rate increase, which would have had

an immediate and substantial impact on Wabash, its

ratepayers, and its creditors, was vigorously contested by

adversarial, interested parties and intervenors. The com-

mission’s order was a ruling on a live case or controversy

and not an advisory opinion.

REA argued that the commission exceeded its jurisdic-

tion by issuing what amounted to a declaratory judg-

ment. The commission’s duty is to enter orders based on

impartial findings of fact, and the commission is not em-

powered to enter declaratory judgments. REA contended

that because no factual record existed as to whether

Wabash was entitled to emergency rate relief, the com-

A-4

mission had issued a premature legal opinion, i.e., an im-

permissible declaratory judgment. However, these parties

appeared before the commission to contest the merits of

a proposed rate increase, not to have their rights, status,

and relations determined. The commission’s order was a

ruling on a pending petition, and the commission was not

stripped of its jurisdiction because this ruling was based

on the legal conclusion that NJPSCO controlled the out-

come of the controversy at hand nor because the rights

of Wabash’s creditors would be affected by its decision.

II. The commission did not abuse its discretion by dis-

missing Wabash’s petition on the merits rather than

for lack of prosecution.

REA and CFC argued that since Wabash’s petition

could have been dismissed procedurally for failure to

prosecute under 170 I.A.C. 1-1-21, the commission com-

mitted error when it dismissed the petition on its merits.

The cited provision gives the commission the discretion

to dismiss a petition for failure to prosecute if there has

been no activity on the petition for six months and after

notice has been given to the parties that the dismissal

will occur. Wabash requested and was granted a stay in

the proceedings pending the decision of this Court in

NIPSCO. The commission did not exercise its discretion

to dismiss for failure to prosecute and did not give the

requisite notice of dismissal. In light of Wabash’s request

and the determinative impact that NJPSCO had on the

case at hand, the commission did not err in dismissing

Wabash’s petition on its merits.

A-5

III. The commission did not err in concluding that

Wabash was not entitled to the rate relief it request-

ed.

This Court held in NJPSCO that an investor-owned

utility cannot implement a rate increase to recover costs

associated with a facility which was never used or useful

in the production of energy. This holding is applicable to

and determinative of the issue at hand, appellants’ ef-

forts to distinguish their situation from that in NIPSCO

notwithstanding.

REA and CFC sought to distinguish this case from

NIPSCO on the basis that the ratepayers here were the

owners, and therefore the risk-bearers, of the utility. In

NIPSCO, the utility was investor-owned, and the rate-

payers were simply customers paying for service, not in-

vestors seeking returns. Appellants contend that, as

members of a cooperative association, the ratepayers

here were not merely customers, but had invested in the

utility and were therefore subject to the risk of loss in-

herent in any investment activity.

In support of their view, appellants advanced as per-

suasive authority case law from other jurisdictions in

which the courts stated that members of electrical coop-

eratives were both customers and stockholders of the

utility. However, the question presented here, who must

bear the risk of loss for a cancelled nuclear power proj-

ect, is clearly distinguishable from the issues presented

in those cases, whether cooperative members are compe-

tent to sit on a jury in a trial where the utility is one of

the parties and whether a utility has the power of emi-

A-6

nent domain. The cases cited by appellants have no ap-

plicability, and therefore no persuasive effect, here.

Appellants also advanced a statement made by the

commission in an unrelated case,Jn re Hoosier Energy

Rural Elec. Coop., Inc. (August 12, 1987 Cause No.

38315), and a quotation from an interim order issued by

the commission in this case as evidence that the Wabash

ratepayers were investors and should be held subject to

risk of loss for the failed Marble Hill project. In Hoosier

Energy, the commission discussed the financial responsi-

bility of cooperative membership, but the resolution of

the case turned on principles unrelated to the “used and

useful” standard and is wholly inapplicable here. In an

interim order issued in this case, the commission noted

that the application of NJPSCO to the facts at hand

would have the apparent result that no one would be re-

sponsible for the debts incurred by Wabash. Wabash, of

course, remains responsible for its debts; the question

becomes whether it will be able to pay or be forced into

bankruptcy like other insolvent debtors, a question which

the commission could not, and did not, decide. The com-

mission’s powers and duties are to determine the propri-

ety of requested rate increases, not to allocate the re-

sponsibility for payment of a utility’s debts, and the com-

mission appropriately refrained from issuing a finding

that would purport to fix that responsibility. The com-

ment from the commission’s interim order cited by ap-

pellants provides no basis for imposing on Wabash’s rate-

payers the obligation to repay Wabash’s debts.

The appellants argued that language from NIPSCO

which shielded the ratepayers in that case from liability

for the failed Bailly N-1 project at issue there provided

peers

A-7

a basis for subjecting Wabash’s ratepayers to liability for

the failed Marble Hill project here. We stated in NJIPSCO

that it was inconceivable that

consumers could be required to replenish lost

capital which had never become “used or useful”

property or, in other words, be required to act in

aid and support of the utility as an insurer of the

investor’s risk, unless consumers received an in-

terest in return which provided an opportunity to

earn a return on the capital supplied.

NIPSCO, 485 N.E.2d at 615. The risk of loss for a util-

ity’s nuclear power generation project is to be borne by

its investors to the extent of their investment. The

NIPSCO ratepayers were insulated from liability for the

Bailly N-1 debts because they were purely consumers of

the utility. Appellants contended that the Wabash rate-

payers were not purely consumers, but were investors

who received “an interest ... which provided an opportu-

nity to earn a return on the capital supplied” for monies

paid into the cooperative and who were subject to risk of

loss on their investment.

Cooperatively-owned utilities were created to provide

low cost electricity to rural areas which investor-owned

utilities found impracticable to service. Stockholders in

such a utility are required to “invest” a set amount,

termed a membership fee, in order to receive service, and

they are refunded any payments made in excess of the

charge for service actually received. Appellants made the

incorrect assertion that this return of overpayment is the

same as a return on an investment, thereby making the

cooperative members investors in the utility. The refund

of an overcharge is in no way analogous to the payment

of a dividend. Further, unlike the stockholder in an in-

A-8

vestor-owned utility, these “investors” have no choice as

to whether or how much to invest, and the terms of

Wabash’s articles of incorporation provide that patrons

or owners are not to furnish capital to finance utility

plants nor are they to recover profits from utility opera-

tions, thus precluding meaningful participation in the

utility as investors. Finally, allowing a cooperatively-

owned utility to generate funds to repay debts incurred

in pursuit of a failed nuclear power plant by way of a

rate increase would produce the intolerable result of sub-

jecting its “stockholders” to unlimited liability for invest-

ment decisions into which they had no input and from

which they had no recourse in the marketplace.

Case law from other jurisdictions, statements by the

commission in this and other cases, and the language of

this Court in NJPSCO provide no basis for appellants’

assertion that our holding from NIJPSCO is inapplicable

to the controversy at hand.

Appellants next contended that differences in rate-

making methodology between investor-owned and coop-

eratively-owned utilities? precluded the application of

NIPSCO to this case and cited I.C. 8-1-13-17 in support

of this proposition. That section, as in effect at the time

* Rates of investor-owned utilities are based on rate of return

principles; rates of cooperatively-owned utilities are based on

principles of revenue requirements.

A-9

of the commission’s order,’ provided in pertinent part:

A reasonable and just charge for service . . . shall

be such charges as shall produce sufficient reve-

nue to pay all legal and other necessary expense

incident to the operation of the system, to include

... interest charges on bonds or other obligations

[and] to provide a sinking fund for the liquidation

of bonds or other evidences of debt... . Any rate

too low to meet the foregoing requirements shall

be unlawful.

Appellants argued that under this section, any rate

which is set so low that a cooperatively-owned utility is

unable to pay its debts is unlawful. Their argument,

however, failed to consider the statutory definitions of

“service” and “system,” two key terms which give the

above-cited provision its meaning. A utility may impose

a charge on its ratepayers only for service, which is de-

fined as “the furnishing of energy, and the rendering of

engineering, financial, accounting, or educational services

incidental to the production, transmission, or use of

energy.” I.C. 8-1-13-3(m). Further, the rate a utility

charges for the service provided to its ratepayers may in-

clude the expenses incurred in the operation of its sys-

tem, which is defined as “any plant, works, system, facil-

ities, or properties . . . used or useful in the generation,

production, transmission, or distribution of energy.” I.C.

8-1-13-3(e). Marble Hill provided no energy to Wabash’s

ratepayers; therefore, any charge purportedly imposed

for service would have been inappropriate here. Like-

* An amended version of I.C. 8-1-13-17 went into effect sub-

sequent to the dismissal of Wabash’s petition. The provisions

of the amended statute are not applicable here.

A-10

wise, Marble Hill never became “used or useful” in the

production of energy; therefore, none of the operation ex-

penses associated with the project were properly charge-

able to the Wabash ratepayers.

A utility’s rates must be based on service regardless of

method employed by the utility to set them. The distinc-

tion between rate-of-return ratemaking and revenue-

requirement ratemaking is irrelevant in the context of

recovering from ratepayers the costs associated with a

facility which was abandoned before becoming used or

useful. Appellants’ argument that NJIPSCO does not con-

trol the outcome of this case based on this distinction

was without merit.

Appellants argued that NJPSCO was distinguishable

from this case because Wabash received the commission’s

approval to borrow funds for the Marble Hill project,

thereby coming under I.C. 8-1-8.5-5.5, which allows a

utility, under specified circumstances, to recover the

costs associated with a cancelled facility through a rate

increase. Appellants, however, are precluded from claim-

ing entitlement to the statute’s protections because they

waived the issue by not raising it before the commission.

Even in the absence of waiver, this statute was not in

effect until well after Wabash invested in the Marble Hill

project; therefore, it was not applicable to the facts at

hand. I.C. 8-1-8.5-5.5 requires that a commission approv-

al certificate be obtained prior to the onset of a project’s

construction and that the approval be based on an as-

sessment of consumer needs and a determination that

the proposed facility will meet those needs. If changes in

6 tlt Cy tee ee Sa rt

A-11

circumstances subsequently warrant modification or

revocation of the approval certificate, the ratepayers are

properly chargeable with the costs of the facility since

both the decision to undertake and the decision to aban-

don the project were made following a consideration of

their effects on the ratepayers.

Prior to the enactment of the statute, utilities had un-

fettered discretion to make investment decisions, and it

was therefore inappropriate to impose on the ratepayers

the cost of decisions that had been entered into with no

formal analysis, consideration, and determination of how

those decisions would affect them. Even had the statute

been in effect when Wabash initiated its Marble Hill in-

vestment, the statutory prerequisites were not met such

as to trigger the availability of a rate increase to recover

the costs of the failed facility. Such recovery is allowed

only where the commission has analyzed the risks asso-

ciated with the proposed facility, held a public hearing,

issued a certificate approving the construction, then sub-

sequently revoked or modified the certificate. The com-

mission engaged in no risk analysis and held no public

hearing, nor did it issue, much less modify or revoke, an

approval certificate. Rather than approving the Marble

Hill project, as appellants characterize the commission’s

actions, the commission approved Wabash’s request to

borrow the funds necessary to finance the investment

project that it had decided to pursue. The decision to

abandon the Marble Hill construction came from Public

Service Indiana upon its determination that it was finan-

cially unable to continue the project. I.C. 8-1-8.5-5.5 does

not interdict the applicability of NJPSCO to this case.

A-12

Appellants attempted to distinguish NJPSCO on the

basis that Wabash is insolvent, whereas NIPSCO was

not. Our determination of who bore the risk of loss for

the cancelled nuclear power facility in NJPSCO was not

based in any way on the utility's financial stability, and

appellants cited no other authority from our courts or

legislature in support of this argument. Appellants relied

on two commission orders which permitted a rate in-

crease to allow utilities to avoid insolvency. Their re-

liance, however, is misplaced since the order granting the

rate increase in both cases specifically excluded the costs

of cancelled facilities from the rate base. Wabash’s in-

solvency does not preclude the application of the holding

in NIPSCO to the facts at hand.

REA contended that the resolution of this case by the

application of NIPSCO would be contrary to the histori-

cal basis upon which cooperatively-owned utilities were

established, namely, the provision of low cost electricity

to rural areas. REA noted that future loans and guaran-

tees from REA to Indiana cooperatives, the loss of which

would reduce the availability of low cost electricity in the

state, may be jeopardized by such a result. Threats of

future sanctions by a federal agency provide no basis for

acting in contravention of statutory authority and our

own precedent. At the time the Wabash loan was ap-

proved, the REA administrator knew or should have

known that Wabash’s requirements contracts with its

members served as the security for the loan and that

those contracts provided that the rates paid by the mem-

ai aaa

ee ee ee

A-13

bers had to be approved by the commission, and this

knowledge was or should have been factored into REA’s

decision to make the loan. A federal agency is no more

protected from the potential for loss due to the insolven-

cy of a debtor than is any other lender.‘ The ability of

REA to exercise its discretion in making or refusing to

make future loans depending on the outcome of this case

may be a business reality, but it is not a justification to

ignore otherwise controlling precedent.

Appellants advanced no valid argument which pre-

cludes the application of NJPSCO to the facts of this

case.

IV. The commission did not err in dismissing the peti-

tion without considering whether Wabash was en-

titled to emergency rate relief.

Subsequent to the presentation of its case in chief to

the commission, Wabash requested leave to file a supple-

mental or amended petition for emergency rate relief.

The commission granted the request, but advised

Wabash that no action would be taken on that petition

until after this Court handed down its decision in

NIPSCO. Wabash then moved for and was granted a

temporary stay on its original rate increase petition, but

did not file the petition for emergency rate relief, even

though it had been granted leave to do so. The commis-

sion did not err in refusing to consider and rule on an

* REA also advanced the proposition that a rate set by a state

regulatory commission may be implicitly pre-empted by the

Rural Electrification Act if the ability of the wholesale coop-

erative to repay its federal loan is seriously compromised, but

conceded that no pre-emption question was actually before the

court for consideration and determination.

A-14

issue which was never placed before it, and an appellate

court will not review issues on appeal that were never

before, and therefore never ruled upon, by an adminis-

trative body.

V. The commission’s dismissal of the petition did not vio-

late Wabash’s constitutional right not to have its

property taken without just compensation.

CFC contended that the commission’s order violated

Wabash’s Fifth Amendment right not to have its proper-

ty taken without just compensation. Because this issue

was not raised before the commission, it was waived. We

note, however, that even in the absence of waiver, it is

doubtful that Wabash’s creditors would have standing to

raise this issue and that two courts from other jurisdic-

tions have rejected the argument that the application of

the used and useful standard for utility rates amounts to

an unconstitutional taking. See Petition of Pub. Serv. Co.

(1988), 130 N.H. 265, 539 A.2d 263; Barasch v. Pennsyl-

vania Pub. Util. Comm’n (1987), 516 Pa. 142, 532 A.2d

325.

The Third District resolved the claims in this appeal in

a correct manner and correctly affirmed the commission’s

decision. Accordingly this Court does now, pursuant to

Indiana Rule of Appellate Procedure 11, order that the

opinion of the Third District not be vacated or held for

naught, but instead that it be and now hereby is in all

respects summarily affirmed.

Summary affirmance ordered.

bs Lage ce eae A cht Shiota

A-15

PIVARNIK and DICKSON, JuJ., concur.

SHEPARD, C.J., dissents with opinion.

GIVAN, J., dissents. I dissent. I stand on my dissents

in Citizens Action Coal. v. No. Ind. Pub. Serv. (1985),

Ind., 485 N.E.2d 610 and N. Ind. Pub. Serv. v. Citizens

Act. Coal. (1989), Ind., 548 N.E.2d 153.

SHEPARD, Chief Justice, dissenting.

I agree with the majority’s conclusions about most of

the statutory and procedural issues presented by this

appeal. I do not agree, however, that the constitutional

issues presented by the federal parties have been waived.

Moreover, I think that these issues cannot really be re-

solved by issuing a simple dismissal of Wabash Valley’s

petition in reliance on Citizens Action Coalition v. Nor-

thern Indiana Public Service Co. (1985), Ind., 485 N.E.2d

610. Accordingly, I think the dismissal was erroneous.

The Utility Consumer Counselor claimed in his brief

before the Court of Appeals that these issues had not

been presented to the Commission. Brief of Office of the

Utility Consumer Counselor at 23-24. I am satisfied that

National Rural Electric adequately, though barely, pre-

served the constitutional questions when it resisted the

Consumer Counselor’s petition to dismiss by asserting

that dismissal on statutory grounds would deprive

Wabash Valley of rates adequate to survive a Fifth

Amendment challenge. Brief of Intervenor National

Rural Utilities, Record at 598, 606-609. It is apparent

that this assertion presented only a Fifth Amendment

takings claim and not a Fourteenth Amendment due

process claim. See generally Shepard, Land Use Regula-

tion in the Rehnquist Court: The Fifth Amendment and

Judicial Intervention, 38 Cath.U.L.Rev. 847 (1989).

A-16

The parties’ debate about waiver before this Court is

somewhat different than it was before the Court of Ap-

peals. National Rural Electric seeks transfer on grounds

that the Court of Appeals wrongly found waiver. The

Consumer Counselor and Wabash Valley Power have

both chosen not to respond to this grounds for transfer.

Their decision does not operate to concede the issue, but

it does yield the field to National Rural Electric.

The merits of the constitutional issues cannot be ade-

quately addressed through a motion to dismiss based on

our NIPSCO opinion. As Justice Rehnquist has written,

judicial determinations of Fifth Amendment takings

claims are “essentially ad hoc, factual inquiries.” Kaiser

Aetna v. United States, 444 U.S. 164, 175, 100 S.Ct. 383,

390, 62 L.Ed.2d 332, 343 (1979). Adjudication of a claim

that a regulatory scheme takes a party's property with-

out due compensation in violation of the Fifth Amend-

ment must necessarily be based upon a full evidentiary

hearing. Hodel v. Virginia Surface Mining & Reclama-

tion Ass’n, 452 U.S. 264, 101 S.Ct. 2352, 69 L.Ed.2d 1

(1981).

The rate proceeding initiated by Wabash Valley Power

was suspended awaiting this Court’s decision in the

NIPSCO case. It was dismissed promptly afterwards, so

there was never developed the sort of full factual record

upon which the federal parties’ constitutional claims

could be adequately addressed. I think these parties are

thus entitled to have these claims heard rather than dis-

missed.

My colleagues express “doubt” that the federal parties

have standing to raise these questions when Wabash

Valley Power does not do so. The majority does appear to

recognize that because the Court rules against the fed-

A-17

eral parties on grounds of waiver, such “doubt” is not a

part of the holding of today’s decision. Equally entitled to

speculate, I suggest that the creditors are dealing with

a debtor which has little interest in seeking rates ade-

quate to pay off. The creditors are in a posture reminis-

cent of the party who must call a hostile witness in order

to prove his case but cannot get much cooperation on the

witness stand. In circumstances like that we grant a

party the right to lead the witness. I would be inclined to

afford the creditors in this litigation the opportunity to

present issues the debtor seems uninterested in pursu-

ing.

Pe Pe es

Ch cut ae Nie eS sath Prt

B-1

APPENDIX B

WABASH VALLEY POWER ASSOCIATION, INC.,

Plaintiff-Appellee

and

State Of Michigan And Michigan Public Service

Commission, Intervening

Appellees,

RURAL ELECTRIFICATION

ADMINISTRATION, Defendant-Appellant.

No. 89-2482

United States Court Of Appeals,

Seventh Circuit

Argued April 3, 1990.

Decided May 23, 1990.

As Modified Aug. 22, 1990.

Before WOOD, Jr., EASTERBROOK, and MANION, Cir-

cuit Judges.

EASTERBROOK, Circuit Judge

Rate regulation for electricity rests on the theory that

generating stations and transmission lines are natural

monopolies. Unless constrained, suppliers charge monop-

oly prices in order to satisfy their investors. States hold

electric utilities to the cost of service (including a compet-

itive rate of return on invested capital); the Federal

Energy Regulatory Commission does the same for whole-

B-2

sale electricity transmitted across state borders, pre-

empting state regulation. 16 U.S.C. § 824(b); FPC v.

Southern California Edison Co., 376 U.S. 205, 84 S.Ct.

644, 11 L.Ed.2d 638 (1964). When the electric utility is

owned by its customers, however, there is no reason to

think that the seller will charge a monopoly price—or

that if it does the customers will care. If the firm charges

a monopoly price, the profits return to the customers as

dividends, deferred rebates on the purchase price.

The natural-monopoly explanation for regulation of in-

vestor-owned utilities has been challenged. E.g., George

J. Stigler & Claire Friedland, What Can Regulators

Regulate?: The Case of Electricity, 5 J.L. & Econ. 1

(1962), reprinted in Stigler, The Citizen and the State 61

(1975); see also Paul L. Joskow & Richard Schmalensee,

Markets for Power: An Analysis of Electrical Utility

Deregulation (1983). For customer-owned utilities there

is no equivalent debate: either way, the customers win.

Most states accordingly do not regulate the prices

charged by these firms. When the federal Rural Electrifi-

cation Administration lends money to a utility—which it

does at bargain rates for customer-owned firms—the

Federal Energy Regulatory Commission drops its own

system of price control, believing that customers of such

firms don’t need “protection” from their own managers’

decisions. Dairyland Power Cooperative, 37 F.P.C. 12

(1967). See also Salt River Project Agricultural Improve-

ment & Power District v. FPC, 391 F.2d 470 (D.C.Cir.

1968).

Yet 11 states do regulate the prices charged by cooper-

ative electric utilities. Arkansas Electric Cooperative

Corp. v. Arkansas Public Service Commission, 461 U.S.

375, 103 S.Ct. 1905, 76 L.Ed.2d 1 (1983), holds that

B-3

neither the hands-off attitude of the FERC nor any gen-

erally-applicable rule established by the REA preempts

state regulation. Why might states choose to regulate the

prices charged by customer-owned utilities? We can think

of two answers, both of which start from the premise

that the equity investors (shareholders, members) of a

corporation are not its sole “owners”. Other persons also

invest: creditors invest money in exchange for a promise

interest plus repayment; employees invest specialized

skills that may not be so useful at other firms. These in-

vestors obtain contractual rights. The equity investors

“own” only the rights to control and profit not assigned

by contract to other investors. Electric utilities commonly

depend more on debt financing than on equity financing.

So perhaps the “real” owners—at least the effective con-

trollers—of an electric co-op are the debt investors, who

would be tempted to raise prices past the competitive

level in order to make their loans more safe or hike up

the rate of interest. When creditors control the firm, they

may be inclined to set a monopoly price and not rebate

the profits to the equity-investor-customers. Regulation

then would play the same role it does in traditional

theories.

If one possibility is that regulation prevents the debt

investors from exploiting the equity investors, the other

possibility is that regulation enables the equity investors

to exploit the debt investors. Customer-investors—resi-

dents of the state who wield political influence there—

may seek regulation of “their own” utility's prices in

order to depress revenues so greatly that they no longer

can pay off the debt investors. They hope to emerge from

bankruptcy with control of the firm and entitled to keep

all future revenues for themselves. Without regulation,

B-4

the debt investors may have contractual rights to force

price increases sufficient to pay the debt in full; regula-

tion plus bankruptcy law may provide a one-two punch

allowing the customer-cum-equity-investor to escape

these contractual provisions yet remain in control of the

utility.

Neither the customer-exploits-creditor hypothesis nor

the creditor-exploits-customer hypothesis is troubling if

the firm depends on a flow of fresh capital under new

contracts; the need to return to capital markets frequent-

ly ensures that contractual terms are competitive, and

anyone who violates commitments made then cannot be

expected to be invited back. When, however, an event

sufficiently large in the life of the firm or the industry

occurs, it may be worth accepting the injury to one’s

reputation for square dealing. In this “last period”, the

gains from breach exceed any loss from fetters on future

bargains.

According to the Rural Electrification Administration,

the Wabash Valley Power Association has entered that

last period and is doing its best to extract the value of

loans the REA made. Wabash is a non-profit generation-

and-transmission utility whose customers operate in

Indiana, Michigan, and Ohio. Indiana and Michigan

regulate the rate customer-owned electric utilities may

charge for power. Over the years the REA loaned

Wabash a sum that, with unpaid interest and further ad-

vances to prevent other lenders from foreclosing, comes

to about a billion dollars. Wabash promised the REA to

set rates high enough to ensure that the principal and

interest would be repaid. To make doubly sure, before

B-5

lending money the REA required Wabash to obtain state

agencies’ approval for its projects. On top of that, the

REA takes a security interest in a co-op’s assets, includ-

ing its contracts with customers—contracts that require

customers to take their requirements of electricity from

the co-op at rates high enough to repay the loans. The

REA thought that this combination of contractual devices

would protect it. It has been proved wrong.

During the 1970s one of Wabash’s neighbors, the for-

profit Public Service Company of Indiana, decided to

construct the Marble Hill nuclear generating station.

Wabash purchased a 17% interest in the project. To

finance its share it borrowed $480 million on the

strength of the REA’s guarantees. In January 1984 Pub-

lic Service of Indiana abandoned construction of the Mar-

ble Hill station because costs had risen so high that fur-

ther work would throw good money after bad. Wabash

was out the money, and unless it raised its rates could

not repay the lenders. It did not raise its rates and de-

faulted; the lenders exercised their rights under the

REA’s guarantees, compelling it to pay in Wabash’s

stead. The REA, pointing to its contract, instructed

Wabash to file for rate increases sufficient to assure re-

payment. Wabash complied with transparent insincerity,

making it clear to the state regulators that it would be

delighted if they said no. (So the REA contends, and

given the posture of this case we must take facts and in-

ferences in the REA’s favor. Because as a practical mat-

ter Wabash serves the interests of its owner-customers,

this interpretation of its behavior before the state agen-

cies is plausible.)

Public Service of Indiana applied for its own rate in-

crease and emerged empty-handed. Until 1984 the

B-6

Indiana Utility Regulatory Commission believed that an

investment prudent when made may be included in the

rate base even though things turn out poorly. When Nor-

thern Indiana Public Service Co. (NIPSCO) applied for a

rate increase to cover the expense of its abandoned Bailly

N-1 plant, the Commission granted the request. In re

NIPSCO, No. 36689 (Aug. 11, 1982). The court of appeals

reversed, Citizens Action Coalition v. NIPSCO, 472 N.E.

2d 938 (2d Dist. 1984), affirmed, 485 N.E.2d 610 (Ind.

1985). Indiana’s courts concluded that unless an invest-

ment is “used and useful” the utility is not entitlea to a

return on its investment. Public Service of Indiana even-

tually agreed not to include Marble Hill in its rate base.

In re Public Service Co. of Indiana, No. 37414 (Mar. 7,

1986).

Such a limitation is the automatic result of competi-

tion, for a firm that builds a useless plant cannot charge

more than its rivals who have invested astutely. If all

firms overbuild, then there will be “ruinous competition”

as price falls to marginal cost, and no one can recover

the cost of capital investment. Risk of ruination makes

capital more expensive (investors demand compensation

for the chance that they will receive nothing). A risky

business will have a higher normal rate of return on in-

vestment than a utility protected against failure by the

exclusion of business rivals. So as Duquesne Light Co. v.

Barasch, 488 U.S. 299, 109 S.Ct. 609, 617-18 n. 7, 102

L.Ed.2d 646 (1989), observes, a policy of disallowing a

return on a utility’s unusable projects logically entails a

higher rate of return on usable investments, and the

Constitution may compel the adjustment. See also

Richard J. Pierce, The Regulatory Treatment of Mistakes

in Retrospect: Cancelled Plants and Excess Capacity, 132

U. Pa.L.Rev. 497, 525-32, 541-44 (1984).

B-7

Indiana allows its for-profit utilities to charge rates re-

flecting the greater risk created by the used-and-useful

rule. Citizens Action Coalition v. Public Service Company

of Indiana, Inc., 552 N.E.2d 834 (3d Dist. 1990). For non-

profit utilities the equation between greater risk (because

of disallowing return on failed plants) with higher yield

and greater assurance of recovery (by allowing a return

on all investments prudent when made) with lower yield

does not work. Because non-profit utilities are not sup-

posed to make “profits” and do not have “equity invest-

ments” in the legal sense, the state does not allow in-

vestors any return on “investment”. It asks instead only

what the firm’s “costs” are—wages, materials, and debt

service. Excluding a failed project from the rate base

means that debt investors get nothing.

When asking for a rate increase, Wabash contended

that the used-and-useful rule should be applied only to

for-profit utilities, which alone are entitled to return on

investment. Moreover, it contended (on instructions from

the REA), in a co-op the members are risk-bearers in the

same sense as the investors in a for-profit firm. Conse-

quences of mistaken decisions come home to roost in for-

profit firms in lower returns on investment; for non-

profits, the penalty should be visited through higher

rates. The United States intervened in the administra-

tive proceedings to drive horne this contention that non-

profit utilities should be treated differently. The regula-

tory agency disagreed and applied the used-and-useful

rule across the board. Jn re Wabash Valley Power Associ-

ation, Inc., No. 37472 (Jan. 14, 1987). Wabash did not

seek judicial review, but the United States did, joined by

the National Rural Utilities Cooperative Finance Corpo-

ration (CFC). Both the appellate court, CFC v. Public

B-8

Service Commission of Indiana, 528 N.E.2d 95 (Ind. App.

3d Dist. 1988), and the Supreme Court of Indiana, 552

N.E.2d 23 (1990), agreed, the latter in a 3-2 decision. The

majority reasoned that because co-ops were established

to “provide low cost electricity to rural areas”, rates

should not be allowed to rise even when the owner-mem-

bers are responsible for the costly blunder, id. at 27. Be-

cause “{a] utility may impose a charge on its ratepayers

only for service”, and Marble Hill provides none, “any

charge purportedly imposed for service would have been

inappropriate here.” Jd. at 28.

Shortly after the court of appeals rendered its decision,

the REA took matters into its own hands. On November

23, 1988, the acting administrator of the REA sent

Wabash a letter (copies to regulatory officials in Indiana

and Michigan) asserting federal control over Wabash’s

rates:

By this letter, we notify you that the REA hereby

exercises jurisdiction over the rates charged by

Wabash. Thus, the Indiana Commission and the

Michigan Commission are no longer entitled to

serve as regulatory authorities whose approval

must be obtained for changes in Wabash’s rates.

The Commissions may retain the right to exercise

jurisdiction over matters unrelated to Wabash’s

rates so long as Federal interests are not compro-

mised. Wabash is hereby instructed to raise its

rates 9% across the board immediately upon

occurrence of any of the following events [all hav-

ing to do with approval of the bankruptcy court).

Wabash shall, in addition, raise its rates 9%

across the board on the first and second anniver-

sary of the first occurrence of any event listed

above. We believe that Wabash is capable of re-

B-9

paying its debt, and calculate that the required

rate increases are the minimum necessary. We

are requiring phased-in rate increases rather

than an immediate one-time increase to enable

Wabash and its members to adjust to the higher

rate level... . We will notify you of any different

or additional rate increases to be implemented,

either as part of a plan of reorganization [in

bankruptcy] or otherwise.

Wabash did not put the rate increases into effect or ask

the bankruptcy court for permission to do so. Instead it

filed this suit, seeking a declaratory judgment that the

REA lacks authority to preempt state law and exercise

direct control over its rates. Michigan intervened to sup-

port Wabash; Indiana has filed papers as amicus curiae

backing Wabash’s views.

The district court granted Wabash’s motion for summa-

ry judgment. 713 F.Supp. 1260 (S.D.Ind. 1989). It con-

cluded that because formal published policies of the REA

defer to state regulation, its letter to Wabash is ineffec-

tual. Jd. at 1266-67. Although Arkansas held open the

possibility that state laws preventing the REA from re-

covering its loans might be preempted, the district court

concluded that the REA’s failure to argue preemption in

the state litigation forecloses it from raising the subject

in a separate suit. Jd. at 1267-69.

Although none of the parties has raised the question,

our initial inquiry concerns federal jurisdiction. Wabash,

a debtor in bankruptcy, has been told to raise its rates.

The REA believes that the additional revenues will

enable it to pay all of its debts and emerge prosperous.

B-10

By contrast, the plan of reorganization proposed by

Wabash’s members, based on the assumption that

Wabash will not raise its rates, proposes to pay only

about 50% of the debt to the REA, the senior secured

lender. Junior creditors would get nothing, given the

absolute priority rule of 11 U.S.C. § 1129(bX2)A). Wa-

bash has filed this suit for the purpose of opposing the

receipt of additional income. We can see why Wabash’'s

members oppose a rate increase, but they did not sue.

Wabash itself appears to be better off as a result of the

REA’s directive. Where is the injury in fact sufficient to

create a case or controversy under Article III of the Con-

stitution? See Love Church v. Evanston, 896 F.2d 1082,

1084-85 (7th Cir. 1990).

Wabash is operating as a debtor in possession. A

debtor in bankruptcy is supposed to maximize the value

of the estate, which opposition to a rate increase does

not. This suit serves the interests of Wabash’s members

at the expense of the interests of Wabash’s creditors. We

are surprised that the bankruptcy judge has allowed

Wabash to operate as debtor in possession, when the

clash of interests between creditors and its current man-

agement is so obvious. Nonetheless, the REA has not

asked for the appointment of a trustee, see 11 U.S.C.

§ 1104(a). Because the bankruptcy court has allowed

Wabash to prosecute this action (no one asked the court

to block the suit), we ask only whether Wabash can

establish injury in fact.

Wabash argues that it may suffer two injuries. First,

if it charges the rates the REA demands, state regulatory

officials may require it to disgorge the proceeds and pay

penalties to boot. Second, rates exceeding those autho-

rized by state law may put Wabash in violation of con-

APIO DRL EL A >

B-11

tracts with its members requiring them to purchase their

requirements of electricity from Wabash. Freed of their

commitment, these members may turn elsewhere for

wholesale power (if cheaper power is to be had); the loss

of business may make the price increase unprofitable.

Both of these sequences are speculative. We do not know

the penalties that would apply if the REA’s attempt to

preempt state law should fail; more, unless the states

require rebates at the current interest rate, it could be

profitable to collect revenues now and return them later

with penalties. As for the members’ willingness to turn

elsewhere for power: Wabash does not represent to us

that its members have wholesale power available at less

than Wabash’s current rates plus the increase the REA

demands. Still, it is possible that such power may be

available in the future, and that higher rates now may

lead to losses later.

Although this is thin gruel, it is no thinner than the

claim in Duke Power Co. v. Carolina Environmental

Study Group, Inc., 438 U.S. 59, 98 S.Ct. 2620, 57 L.Ed.2d

595 (1978), that but for a law limiting the damages that

could be assessed against the operator of a nuclear plant,

the plant would not be built and the risks of radiation

would be reduced. The Court thought this sufficient to

establish the standing of persons who live near the pro-

posed plant, id. at 72-81, 98 S.Ct. at 2629-35, even

though the effect of the law on construction was far from

clear. (The law put a cap on liability, but the corporate

form does that automatically. Firms could have estab-

lished even tighter caps on liability by holding their

plants as subsidiaries.) Wabash has a logical causal

chain between the federal decision and potential injury.

This gives it standing. There is injury in fact, and the

injury is redressable by a favorable decision.

B-12

We say this cognizant that if injury befalls Wabash,

the REA bears the cost. The REA is the residual claim-

ant of the firm. Unless Wabash raises its rates, the REA

stands to lose about half of its billion-dollar investment.

If Wabash raises the rates only to find, because custom-

ers switch or states impose penalties, that the firm is

even worse off, the REA bears the entire loss. Obviously

the REA does not perceive much risk of these losses; it

has no reason to compel Wabash to take steps that will

reduce the realization on the debt. Still, just as we do not

pierce the corporate veil to find standing in the interests

of Wabash’s members, cf. Jn re Kubly, 818 F.2d 643 (7th

Cir. 1987), so we respect the corporate form rather than

look straight to the interests of the REA. Wabash, and

not the REA or its members, is the plaintiff. Wabash’s

exposure to loss as a result of a price increase is enough,

if barely, to allow a decision by an Article III court.

Prudential concerns do not counsel dismissal. Behind

the haze created by the corporate form and the bank-

ruptcy proceedings, there is a substantial and justiciable

dispute: who bears the loss of Marble Hill, the federal

government or Wabash’s members? Once we pass from

the constitutional test to prudential concerns, it becomes

significant that Wabash is acting as a tool of its mem-

bers. Although a corporation technically does not “repre-

sent” its investors, many cases allow organizations to re-

present the interests of their members. See Auto Workers

v. Brock, 477 U.S. 274, 281-88, 106 S.Ct. 2523, 2528-32,

91 L.Ed.2d 228 (1986). Moreover, if we were to throw the

case out the sides would switch, and it would come back

immediately. Wabash would refuse to raise its rates; the

REA would file suit to compel it to do so, Wabash would

stand on state law, and the legal questions would recur.

B-13

These questions must eventually be settled between

these parties, and now is as good a time as any.

A second jurisdictional question is whether Congress

has authorized a suit in the district court. Wabash con-

tends that an agency’s action is contrary to law. The Ad-

ministrative Procedure Act authorizes declaratory judg-

ment actions in such circumstances, see Gardner v. Toilet

Goods Ass’n, 387 U.S. 167, 87 S.Ct. 1526, 18 L.Ed.2d 704

(1967), and an amendment to the APA in 1976, see 5

U.S.C. § 702, largely waives the sovereign immunity of

the United States in equitable cases. Bowen v. Mas-

sachusetts, 487 U.S. 879, 108 S.Ct. 2722, 101 L.Ed.2d

749 (1988). The difficulty is the Tucker Act, 28 U.S.C.

§§ 1346(a), 1491, which assigns to the Claims Court all

actions seeking equitable relief based on a contract with

the United States. Wabash contends that when it bor-

rowed the money, the REA agreed to the application of

state law. An effort to obtain specific performance of that

promise (if the REA made it, a matter we do not discuss)

belongs in the Claims Court. See Sharp v. Weinberger,

798 F.2d 1521, 1523-24 (D.C.Cir. 1986) (Scalia, J.).

In the district court the REA argued that Wabash’s in-

vocation of contractual rights required the district court

to transfer the entire case to the Claims Court. The dis-

trict court disagreed, holding that it may issue declarato-

ry relief so long as that relief is not grounded in contract.

713 F. Supp. at 1263-64. We agree with that conclusion

for the reasons the district judge gave. See also Sharp,

798 F.2d at 1524; North Side Lumber Co. v. Block, 753

F.2d 1482, 1486 (9th Cir. 1985). Notwithstanding its

recognition of jurisdictional limits, the district court

dwelt on the REA’s promises to Wabash. 713 F. Supp. at

1269-70. Because any effort to obtain specific perfor-

B-14

mance of a contract with the United States belongs in

the Claims Court, the district judge should not have con-

sidered Wabash’s contractual claims. We put these to one

side and consider only whether the arguments based on

the APA support the judgment of the district court.

Ill

Arkansas holds that as a rule states may regulate the

prices charged by co-ops to which the REA has extended

credit. The Court mentioned two possible exceptions:

There may come a time when the REA changes

its present policy, and announces that state rate

regulation of rural power cooperatives is inconsis-

tent with federal policy. If that were to happen,

and if such a rule was valid under the Rural Elec-

trification Act, it would of course preempt any

further exercise of jurisdiction by the Arkansas

PSC. . . . Moreover, even without an explicit

statement by the REA, a particular rate set by

the Arkansas PSC may so seriously compromise

important federal interests, including the ability

of the [debtor] to repay its loans, as to be implicit-

ly preempted by the Rural Electrification Act.

461 U.S. at 388-89, 103 S.Ct. at 1914-15. The REA con-

tends that its letter of November 1988 is a change of

policy and expressly preempts state law. It also contends

that the rates set by Indiana and Michigan “so seriously

compromise important federal interests, including the

ability of the [debtor] to repay” that they are preempted

implicitly. We discuss these in turn.

The Supreme Court did not say that the REA may pre-

empt state law at will. It said that if the REA were to

ahi terotonina ia cAc a8 a of

;

B-15

change its policy, and “if such a rule was valid under the

Rural Electrification Act”, then state law must yield.

There are three questions: has the REA changed its

policy?; does it have substantive authority to replace

state with federal regulation?; has it exercised this auth-

ority in the proper way?

At the time the Court decided Arkansas, language in

the REA’s Bulletin 111-4 recognized that states may reg-

ulate the rates of its borrowers. The language of Bull.

111-4 on which the Court relied, 461 U.S. at 387-88, 103

S.Ct. at 1914, is still in force. The REA has not yet

changed its “policy”, although it has attempted to force

Wabash to change its rates. The REA has not established

its own ratemaking apparatus or said that rates must be

left to the market. Instead it has left the general rule in

place and has prescribed for Wabash a rate that has

nothing to do with anything except repaying the loan.

This is not the sort of express preemption Arkansas con-

templated.

There is, moreover, substantial doubt about whether a

rule preempting state regulation would be “valid under

the Rural Electrification Act”. Neither REA’s letter to

Wabash nor its brief in this court cites any provision of -

the statute allowing it to regulate the rates charged by

its borrowers. Unless the REA has this authority, it is

hard to see how it can preempt state law, given the

holding of Arkansas that federal law does not occupy the

field. REA needs a source of authority to set up a system

making demands inconsistent with those of state law, so

that under the Supremacy Clause the federal obligation

would prevail.

Congress’ assumption when it created the Rural Elec-

trification Act in 1936 seems to have been that the REA

B-16

could protect itself by setting conditions on the extension

of credit. (The opinions in Arkansas collect the legislative

history, which we do not rehearse.) The REA may refuse

to make loans unless state agencies guarantee rates high

enough to allow repayment. It may refuse to approve a

loan unless the customers (whose promises to buy power

are the real security for the debt) guarantee the loan or

authorize the REA to dictate rates. If either state or

customer balks, the REA may deploy its funds elsewhere.

Since Indiana’s adoption of the used-and-useful standard,

the REA has refused to make or guarantee new loans to

co-ops in that state. The conditioning power is a big club,

which can achieve (effective) preemption and more. See

Trans-Alaska Pipeline Rate Cases, 436 U.S. 631, 98 S.Ct.

2053, 56 L.Ed.2d 591 (1978). But REA did not use this

power when extending credit. It approved contracts with

Wabash’s customers that oblige them to pay no more

than the state rate; it did not secure guarantees.

We need not decide whether the REA has statutory

authority to abandon Bull. 111-4 and adopt a general

system of regulation. It has issued a notice of proposed

rulemaking, 55 Fed.Reg. 12194 (Apr. 2, 1990), to consider

thoroughgoing substitution of federal for state regulation.

It would be inappropriate to interrupt that process by de-

ciding in advance whether the REA has statutory auth-

ority. Its effort to preempt state regulation of Wabash’s

rates alone founders on a mundane obstacle: it neglected

to use the procedures required by the APA.

In order to preempt state authority, the REA must

establish rules with the force of law. Regulations adopted

after notice and comment rulemaking have this effect.

Fidelity Federal Savings & Loan Ass’n v. de la Cuesta,

458 U.S. 141, 153, 102 S.Ct. 3014, 3022, 73 L.Ed 2d 664

B1 Rite AI ae a0: irowt Be

B-17

(1982) (“[flederal regulations have no less pre-emptive

effect than federal statutes.”). Yet although ratemaking

is a “rule” under the APA, 5 U.S.C. § 551 (4), the REA

did not follow the procedures the APA prescribed for

rulemaking. It sent Wabash a letter. There was no

notice, no opportunity for comment, no statement of |

basis, no administrative record, no publication in the

Federal Register—none of the elements of rulemaking

under the APA. 5 U.S.C. § 553. See Thomas v. New York,

802 F.2d 1443 (D.C. Cir. 1986) (Scalia, J.) (holding that

a letter from the Administrator of the EPA does not have

the force of law because it was not issued after notice

and comment and was not published in the Federal Reg-

ister). See also Brock v. Cathedral Bluffs Shale Oil Co.,

796 F.2d 533, 538 (D.C.Cir. 1986) (Scalia, J.) (rule not

published in the Federal Register is not a regulation). Cf.

Cosby v. Ward, 843 F.2d 967, 979-81 (7th Cir. 1988).

In support of its submission that a letter may preempt

state law, the REA relies exclusively on Blum v. Bacon,

457 U.S. 132, 140-41, 102 S.Ct. 2355, 2360-61, 72 L.Ed.

2d 728 (1982). This is a baffling citation, because the

case involved several regulations, published in the Fed-

eral Register after full notice and opportunity for com-

ment. The case did not involve an informal procedure

remotely similar to the one the REA followed. We have

not found any case holding that a federal agency may

preempt state law without either rulemaking or adjudi-

cation. Perhaps closest to the mark is a case saying that

a consent decree negotiated between an auto manufac-

turer and the Federal Trade Commission may preempt

state regulation of the manufacturer’s warranty policies.

General Motors Corp. v. Abrams, 897 F.2d 34 (2d Cir.

1990) (holding that the decree is not inconsistent with

B-18

the state’s rule). The Second Circuit did not discuss Mar-

tin v. Wilks, U.S. __, 109 S.Ct. 2180, 104 L.Ed.2d 835

(1989), which holds that a consent decree may not fore-

close the rights of non-parties. Because neither the state

nor the consumers were parties to the FTC’s case, it is

hard to understand how the decree could blot out their

claims based on state law. Whether the decree has such

an effect should depend on whether it was adopted by

the agency as its own policy following the procedures the

APA requires; then the preemption would come from sub-

stantive rules rather than the parties’ assent. See United

States v. AT & T, 552 F.Supp. 131 (D.D.C. 1982), af-

firmed without opinion under the name Maryland v.

United States, 460 U.S. 1001, 103 S.Ct. 1240, 75 L.Ed.2d

472 (1983), holding that an antitrust consent decree may

preempt state law when the states have had an opportu-

nity to intervene and their contentions have been re-

solved on the merits. It is unnecessary to pursue the

question. There has been no consent and no rulemaking.

Procedural shortcomings prevent giving this letter the

force of law.

The other string to the REA’s bow is its contention that

when a state sets a rate so low that the federal advance

cannot be repaid, that rate is preempted. To the extent

the REA believes that states must adopt rules of law

that always allow federal lenders to recoup their invest-

ments, it is mistaken. See United States v. Kimbell

Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711

(1979). Although obligations to federal lenders are deter-

mined under federal law, see Kimbell and, e.g., D’Oench,

Duhme & Co. v. FDIC, 315 U.S. 447, 456, 62 S.Ct. 676,

Sar ES EES Ee ae Sa a 9 oot

By oo ey 6 hat wee

B-19

679, 86 L.Ed. 956 (1942), the obligation here runs from

Wabash to the REA; the REA seeks to affect relations be-

tween Wabash and its customers, not relations between

Wabash and the federal government. What is more, Kim-

bell holds that the federal rule governing the relation be-

tween the United States and its borrowers will be taken

from state law, provided that law is not hostile to federal

interests. The REA dees not suggest that Indiana has

depressed Wabash’s rates because the federal govern-

ment is its principal lender. Wabash received the same

treatment as Public Service Co. of Indiana (which does

not have federal loans), and under state law the REA

receives the same treatment as any other lender to

Wabash. The government seeks not neutrality but prefer-

ence.

Its best line of argument is based on D’Oench, which

holds that when the federal government takes over a

failed bank, the relations between the bank and its cus-

tomers are governed by federal law. See also Public Ser-

vice Co. of Indiana v. Hamil, 416 F.2d 648 (7th Cir.

1969). The REA has not taken over Wabash, so the state

is not trying to regulate the federal government. Yet once

the debt to the REA becomes the residual claim—the one

that will be paid from any new receipts—it might make

sense to say that Wabash and the REA are fused. When

a borrower from the federal government is far under

water, regulation of it is regulation of the United States.

Even this analogy may not be sufficient, however, be-

cause the argument that states may not regulate the

federal government comes from intergovernmental tax

immunity cases. In recent years the Court has held that

states may levy taxes that as a practical matter fall on

the federal treasury, provided the taxation is neutral be-

B-20

tween governmental and private payors. Washington v.

United States, 460 U.S. 536, 103 S.Ct. 1344, 75 L.Ed.2d

264 (1983); United States v. New Mexico, 455 U.S. 720,

102 S. Ct. 1373, 71 L.Ed.2d 580 (1982). Neutral regula-

tion that affects the REA’s coffers may be treated sim-

ilarly. After all, the REA made its loans and guarantees

on the assumption that state regulation would apply.

Lack of guarantees from Wabash’s customers—coupled

with the obvious incentives of a customer-owned borrow-

er—may have led to an adjustment in the interest rate,

which, in turn, increases the rates Wabash charges. (If

there was no adjustment, people at the REA were asleep

on the job.) When the risk materialized, the REA has de-

manded shelter of federal law plus the interest rate that

reflected the risk created by state law. Nice cushion, if

you can get it.

We need not decide whether the REA is entitled to a

federal rule that protects agencies that did not protect

themselves. (More realistically, a rule that protects the

Treasury from federal employees who neglected to take

precautions and private parties who take advantage of

their omissions.) Once again, we stop short of a decision

on the merits because of a procedural bar. The REA was

a party to the administrative proceedings and obtained

review from the state courts. It did not argue that

Wabash’s rates should be increased because federal law

preempts the used-and-useful rule or otherwise requires

the state to set rates high enough to repay the loans. Its

argument was based on state law. Under 28 U.S.C.

§ 1738 the final decision in the REA’s case blocks further

litigation in federal court if a state court would deem the

judgment preclusive. Principles of claim preclusion apply

to the United States as to other litigants. United States

B-21

v. Stauffer Chemical Co., 464 U.S. 165, 104 S.Ct. 575, 78

L.Ed.2d 388 (1984); Montana v. United States, 440 U.S.

147, 99 S.Ct. 970, 59 L.Ed.2d 210 (1979). So the question

is whether Indiana would allow the REA, having chal-

lenged an administrative decision in state court under

state law and lost, to urge in a different suit that state

law is inconsistent with federal law. We think the

answer is no.

Alleghany Corp. v. Haase, 896 F.2d 1046, 1049 (7th

Cir. 1990), assumes a negative answer to this question

under Indiana law. See also Button v. Harden, 814 F.2d

382 (7th Cir. 1987) (Illinois law). Indiana, like most other

states, does not allow a party to split a single claim for

relief. Multiple legal theories supporting relief on account

of one transaction must be litigated at one go. Fischli v.

Fischli, 1 Blackford 360, 361 (Ind. 1825); Comparet v.

Hanna, 34 Ind. 74, 77-80 (1870); Hammond Pure Ice &

Coal Co. v. Heitman, 221 Ind. 352, 47 N.E.2d 309 (1943).

We summarized Indiana’s law of preclusion in Leal v.

Krajewski, 803 F.2d 332, 334 (7th Cir. 1986), observing

that claim preclusion follows from a combination of (1) a

judgment rendered by a court of competent jurisdiction,

(2) on the merits, (3) in a suit between the same parties,

where (4) the matter now at issue was, or could have

been, decided. All four elements are present here. The

REA could have raised its preemption argument in state

court but withheld it.

The agency reminds us that many Indiana decisions

say that only matters “within the issues” of the first

case—that is, subjects on which “the same evidence will

support the issues involved in both actions”—are deemed

precluded. E.g., M.R. v. Meltzer, 487 N.E.2d 836, 841

(Ind.App. 4th Dist. 1986); Biggs v. Marsh, 446 N.E.2d

B-22

977, 982 (Ind.App. 3d Dist. 1983). As we understood it in

Leal, this is another way of asking whether the two suits

deal with a common occurrence. Two different legal theo-

ries in support of relief (state law in the state court, pre-

emption in federal court) do not arise out of separate

occurrences, and a party who neglects to put in the

evidence that would support the withheld legal theory

cannot later point to its own omission as justification for

filing another suit. See Ulrich v. Drischell, 88 Ind. 354,

359 (1882); Jones v. American Family Mutual Insurance

Co., 489 N.E.2d 160, 166 (Ind.App. 2d Dist. 1986); Mox-

ley v. Indiana National Bank, 443 N.E.2d 374 (Ind.App.

4th Dist. 1983). Such an approach would gut the rules of

preclusion. Like today’s case, Leal deals with a suit in

state court to challenge an administrative decision on

state grounds, followed by a suit in federal court contest-

ing the decision on federal grounds. We held that Indi-

ana would deem the federal grounds foreclosed because

they had been withheld in state court, when the federal

grounds supplied only a different legal rationale for relief

arising out of a single occurrence. The same conclusion

is appropriate here.

Anticipating that we would agree with the district

court’s understanding of Indiana’s law, the REA tries to

sidestep § 1738 on the ground that it expressly told the

state court that it was reserving all federal questions for

federal court. It refers us to a footnote in Haring v.

Prosise, 462 U.S. 306, 313, n. 7, 103 S.Ct. 2368, 2373 n.

7, 76 L.Ed.2d 595 (1983), reserving the question whether

preclusion would be appropriate in a case under 42

U.S.C. § 1983 in which a litigant has withheld a federal

question from state court. When Haring was decided, a

debate was under way about whether § 1738 applies in

crit tt

B-23

full measure to cases under § 1983. Our case does not

present that question. More to the point, Migra v. War-

ren City School District Board of Education, 465 U.S. 75,

104 S.Ct. 892, 79 L.Ed.2d 56 (1984), a case the REA does

not cite, resolves adversely to it even the question left

open in Haring. See also Village of Bolingbrook v. Citi-

zens Utilities Co., 864 F.2d 481, 485 (7th Cir. 1988). Sec-

tion 1738 requires the application of state law. Indiana

does not allow a party to split its claim just because it

has announced distinctly to the tribunal that it is going

to do so.

Echoing United States v. Michaud, 897 F.2d 264, 267

(7th Cir. 1990), we express concern over what seems to

be an emerging pattern at the Department of Justice of

citing cases while not informing the court that they are

no longer authoritative or do not support the proposition.

The Department cites United States v. Mendoza, 464

U.S. 154, 104 S.Ct. 568, 78 L.Ed.2d 379 (1984), which

holds that offensive non-mutual issue preclusion does not

apply to the United States, while omitting Stauffer and

Montana, which hold that claim preclusion applies in full

force. The REA contends that because preemption is a

question of federal law it is particularly appropriate for

federal court, so that ordinary principles of preclusion do

not apply. Marrese v. American Academy of Orthopaedic

Surgeons, 470 U.S. 373, 105 S.Ct. 1827, 84 L.Ed.2d 274

(1985), which the REA does not mention in this part of

its brief, is to the contrary. It contends that, despite

§ 1738, claim preclusion “is an equitable doctrine subject

to equitable principles” (Br. 36), citing Premier Electrical

Construction Co. v. National Electrical Contractors Asso-

ciation, Inc., 814 F.2d 358, 364 (7th Cir. 1987), which

does not support the proposition (it did not involve either

B-24

§ 1738 or claim preclusion), while ignoring Federated De-

partment Stores, Inc. v. Moitie, 452 U.S. 394, 101 S.Ct.

2424, 69 L.Ed.2d 103 (1981), which rejects it. And as we

have observed the government's brief relies (exclusively!)

on Blum v. Bacon for the proposition that letters from

federal administrators may preempt state law, although

Blum involved formal regulations rather than letters.

This is not a pattern to be welcomed.

One final potential limitation on preclusion. Indiana’s

courts rejected the REA’s challenge to the administrative

decision. Michigan has not had an opportunity to address

the matter, and it is at least conceivable that Michigan

would allow the United States to try again. Michigan

would be bound to allow litigation on the question

whether it, like Indiana, applies a used-and-useful rule

in the first place to non-profit utilities. That subject was

not and could not have been decided in the Indiana case.

Would Michigan also let the REA argue that state law

has been preempted? Perhaps. Section 1738 provides,

however, that in federal court the preclusive force of a

state judgment depends on its effect within the rendering

state, rather than within some other state that has an

interest in the controversy. At all events, none of the

parties contends that Michigan would allow litigation of

preemption in its courts following the omission in In-

diana. We limit our reach to the subjects that have been

presented.

* * *

Everything we can see about the incentives of

Wabash’s members and the operation of Indiana’s law

suggests that federal taxpayers have been taken to the

cleaners. States that show creditors the door may expect

ed ek Se

B-25

loans to be few and costly. The REA has stopped lending

there. Other creditors will charge more. Indiana’s econ-

omy will suffer. Indiana seeks to limit the damage

through a 1987 law that abrogates the used-and-useful

rule for new plants, and allows rates to be based on all

prudent investment, provided the utility obtains the

state commission’s approval in advance. Ind.Code § 8-1-

8.5.-1 et seq. If this works, Indiana will have transferred

to the federal government and to other investors (most

from out of state) the cost of its adventure in nuclear

power, while keeping its industry healthy for the future.

Creditors may be skeptical of Indiana’s promise; at oral

argument counsel for Michigan said that his state would

feel free to repudiate such a promise if new legislators or

regulators had a different view. Cf. Chemical Bank v.

Washington Public Power Supply Co., 102 Wash.2d 874,

691 P.2d 524 (1984). None of this matters today, for the

REA lacks a sound legal basis on which to preempt In-

diana’s law. Appointment of a trustee in the bankruptcy

court might have been the best recourse, but that is

water under the bridge.

AFFIRMED.

Se eee

C-1

APPENDIX C

WABASH VALLEY POWER ASSOCIATION, INC.,

an Indiana not-for-profit corporation,

Plaintiff-Appellee,

RURAL ELECTRIFICATION

ADMINISTRATION, Defendant-Appellant.

No. 91-3673

United States Court Of Appeals,

Seventh Circuit.

Argued Sept. 10, 1992

Decided March 16, 1993

Before FLAUM and RIPPLE, Circuit Judges, and

SHADUR, Senior District Judge.*

FLAUM, Circuit Judge.

The history of this appeal from a grant of summary

judgment against the Rural Electrification Adminis-

tration (“REA”) is long and unhappy. In 1978 the REA

approved $360 million in loan guarantees to the power

supply cooperative Wabash Valley Power Association

(“Wabash Valley”) to invest in a 17-percent share of the

Marble Hill nuclear power facility. The Public Service

Company of Indiana owned the other 83-percent share.

Subsequently, the REA committed to additional guaran-

* The Honorable Milton I. Shadur, of the Northern District of

Illinois, is sitting by designation.

C-2

tees of $588 million to Wabash Valley’s Marble Hill ven-

ture, for a total of $948 million in loan guarantees. To

collateralize these guarantees, the REA required Wabash

Valley to enter into forty-year all requirements contracts

(officially labelled wholesale power contracts) with each

of its distribution cooperative members. According to the

terms of these contracts, the REA agreed to be bound as

third-party beneficiaries to rates “subject to the approval

of the Public Service Commission of Indiana.”

Because of sizable cost overruns, the Public Service

Company canceled the Marble Hill nuclear power facility

in January of 1984. That April, Wabash Valley requested

a rate increase from the Indiana Utility Regulatory Com-

mission (“IURC”)' in order to repay loan monies expend-

ed on Marble Hill that the REA had guaranteed. Prior to

any resolution of the rate increase by the [URC, Wabash

Valley defaulted on its REA loans and filed for reorgani-

zation under Chapter 11; and the REA was left holding

the multi-million-dollar bag. At the time of filing,

Wabash Valley had outstanding debts to the REA total-

ling $671 million. Subsequently, Wabash Valley’s petition

to the IURC for a rate hike to cover its obligations to the

REA was denied. Relying on its decision in Citizens

Action Coalition v. Northern Indiana Public Service Co.,

485 N.E.2d 610 (Ind.1985), cert. denied, 476 U.S. 1137,

106 S.Ct. 2239, 90 L.Ed.2d 687 (1986), the Indiana Su-

preme Court reiterated that the “used or useful” rule ap-

plies to customer-owned utilities and upheld the IURC’s

denial of Wabash Valley’s request for a rate hike. Na-

tional Rural Utilities Cooperative Finance Corp. v. Public

' The Indiana Utility Regulatory Commission was formerly

the Public Service Commission of Indiana.

C-3

Service Commission of Indiana, 528 N.E.2d 95 (Ind.App.

1988), aff'd, 552 N.E.2d 23 (Ind.1990).

Having failed to recoup in state court the monies ex-

tended to Wabash Valley, the REA asserted jurisdiction

over ratemaking by means of a preemption letter to

Wabash Valley and the IURC. The REA’s letter instruct-

ed Wabash Valley to raise its rates immediately and de-

tailed a rate schedule. We found the REA’s preemption

letter to be invalid because it did not comply with the

notice and comment requirements of the Administrative

Procedure Act. Wabash Valley Power Association v. Rural

Electrification Administration, 903 F.2d 445 (7th Cir.

1990) (“Wabash I”). At the federal court level, the REA

also raised the possibility of implied preemption for the

first time. We held that principles of preclusion prevent-

ed the REA from asserting an implied preemption argu-

ment at that late stage of the litigation. Jd. at 455.

While that case was still pending before this court, the

REA published a notice of proposed rulemaking. 55 Fed.

Reg. 12194-12202 (April 2, 1990). After the notice and

comment period, the REA promulgated two new preemp-

tion regulations. 55 Fed.Reg. 38638-38654 (September

19, 1990). The first rule, concerning preemption for in-

adequate rates, reads in pertinent part:

(a) State regulatory authority jurisdiction over a

power supply borrower’s rates shall be preempted

by the RE Act if the Administrator shall have de-

termined that the borrower’s rates approved by

the state regulatory authority are, after taking

into account the borrower’s costs and expenses,

inadequate to produce revenues sufficient to per-

mit the borrower to make required payments on

its secured loans and the borrower has failed to

make required payments on its secured loans.

C-4

7 C.F.R. § 1717.305 (1991). The second rule, concerning

borrowers in bankruptcy, provides:

State Regulatory Authority jurisdiction over an

REA borrower’s rates shall be pre-empted by the

RE Act and REA shall have exclusive jurisdiction

over the borrower’s rates:

(a) On October 19, 1990, with respect to any

borrower by or against whom a case under the

Bankruptcy Code of 1978, as amended, was com-

menced prior to and remains outstanding on

October 19, 1990; and

(b) With respect to all other borrowers, upon the

filing of a petition by or against the borrower

commencing a case under the Bankruptcy Code of

1978, as amended.

7 C.F.R. § 1717.354 (1991). Stripped of their semantic

trappings, both the preemption regulations and the

bankruptcy regulations are rules designed to shift the

risk of default on REA loans from the REA to cooperative

members. After the REA promulgated these rules,

Wabash Valley brought suit in federal court for a declar-

atory judgment to prevent their enforcement. The district

court held the rules to be invalid. We affirm.

As a federal credit program, the REA promotes and

facilitates investment in electricity (and telephones, to a

lesser extent) for rural areas in order to ensure that

these regions receive power at reasonable prices. See

Congressional Budget Office, New Approaches to the

Budgetary Treatment of Federal Credit Assistance (1984);

M. Weidenbaum & R. Harnish, Government Credit Sub-

sidies for Energy Development (1976). It has traditionally

C-5

performed this function by reducing the cost of funding

to cooperatives, as well as other nonprofit organizations,

through the provision of insured loans and loan guaran-

tees. Until recently, the Rural Electric and Telephone Re-

volving Fund (*“RETRF”), rather than the REA itself, ad-

vanced monies for the loans and guarantees and has

borne any losses incurred under the rural electrification

program.” The RETRF, in turn, has financed its lending

from repayments of principal and interest and sales of

certificates of beneficial ownership to the Federal Financ-

ing Bank (“FFB”).*

When offered at the government’s cost of borrowing,

loans made by the REA subsidize rural power. The in-

terest rate the government has to pay for money is only

the return on a risk-free investment. Without federal as-

sistance, REA borrowers would have to pay a higher rate

of interest to obtain insured or guaranteed loans because

of the non-zero risk involved. The difference between the

government’s rate of interest and the rate the borrower

would have otherwise had to pay is the subsidy; the cost

to the government is the risk of default. In private credit

* Under the Federal Credit Reform Act of 1990, the REA Re-

volving Fund was phased out and replaced by a Liquidating

Account covering loans made before October 1, 1991. In addi-

tion, a Financing Account was established to cover funds ad-

vanced after October 1, 1991. See 2 U.S.C. § 661 (Supp.1992).

° Insured loans, which constitute a small percentage of REA

credit activity, are made at a 5 percent interest rate. The lion’s

share of REA credit consists of loan guarantees, almost always

made by the FFB, at an interest rate “not more than the rate

of interest applicable to other similar loans then being made

or purchases by the [FFB].” 7 U.S.C. §§ 935-36 (Supp.1992).

This rate is equal to the Treasury’s borrowing rate plus one-

eighth of a percentage point. App. Brief at 4 n. 1.

C-6

markets, interest rates and guarantee fees incorporate a

risk premium.‘ This premium both induces lenders to

bear the risk of default and assures that, on average,

payments by borrowers are sufficient to cover default

losses. In government lending, default risk exists in at

least equal measure. The cost of this risk, which is borne

by taxpayers without direct compensation, is the fee that

would be required to induce a lender to bear these risks.

Consequently, when the guarantee program of the Rural

Electrification Act, 7 U.S.C. § 901 et seg. (1980 & Supp.

1992) (“RE Act”), requires all REA borrowers to pay a

rate of interest only marginally higher than the govern-

ment’s cost of borrowing (.125% higher), the rate paid by

REA borrowers is substantially lower than on long-term

borrowing by companies seeking credit in private mar-

kets.

Both of the current loan mechanisms of the REA reflect

these subsidies. REA-insured loans contain a hidden

interest subsidy representing the difference between the

interest rate the borrower would obtain without REA

assistance and the interest rate the government must

pay for money. Moreover, the insured loans contain an

explicit subsidy if the government is making insured

loans at interest rates below its cost of borrowing. REA-

guaranteed loans also provide both a subsidy to borrow-

ers in the form of interest rate savings and a cost to the

government in the form of risk.* When the chance of

* The Rural Electrification Act prohibits the REA from charg-

ing a guarantee fee. 7 U.S.C. § 936 (1980).

°> Further evidence of a policy of subsidizing rural electrifica-

tion is found in the statutory provision affording the REA the

(continued...)

C-7

default by the firm is high, a guarantee can have sub-

stantial value on a large loan.®

Furthermore, all REA loans contain a more latent sub-

sidy which is reflected in the amount of leverage that the

REA allows its borrowers.’ Loans to cooperatives repre-

> (...continued)

discretion to lengthen the repayment period of loans and to

subordinate the government’s lien position in the event of

default by a REA-financed cooperative. 7 U.S.C. §§ 912, 934

(1980 & Supp.1992). The existence and duration of these sub-

sidies strongly indicate that Congress has recognized the need

for the federal government to absorb some of the costs of rural

electrification.

® The present value of a loan guarantee is the amount lenders

would be willing to pay today to relieve themselves of all risk

of default on an otherwise equivalent unguaranteed loan. R.

Brealey and S. Myers, Principles of Corporate Finance 567

(1988).

7 The favorable treatment accorded to power supply borrowers

would appear to impede one of the basic goals of REA assis-

tance—functioning without it. In a 1973 amendment to the RE

Act, Congress urged that cooperatives “be encouraged and

assisted to develop their resources and ability to achieve the

financial strength needed to enable them to satisfy their credit

needs from their own financial organizations and other sources

at reasonable rates and terms consistent with the loan appli-

cant’s ability to pay and the achievement of the Act’s objec-

tives.” 7 U.S.C. § 930. However, the very structure that Con-

gress adopted undermines the ability of cooperatives to de-

velop other sources of financing. The extremely high leverage

of power supply cooperatives makes fixed payment debt issued

by such cooperatives very risky for creditors, which would lead

to unusually high interest rates on that debt. See J. Van

Horne, Financial Management and Policy 506 (1989). At the

same time, the nonprofit status of these cooperatives prohibits

them from soliciting private equity capital in order to improve

their capital structure. Moreover, the policy of keeping capital

(continued...)

C-8

sent the entire investment in their property, whereas pri-

vate companies must finance a large part of their in-

vestment through more costly classes of securities rather

than bonds. The more leveraged a firm is, the higher the

required return on the debt will be in order to attract

capital. Therefore, the more leveraged the position of a

rural electric cooperative, the lower the interest rate it is

charged in proportion to what the market would charge.

In an world unconstrained by the RE Act, the risk in

a project of the scope of Marble Hill—in conjunction with

the obvious incentives of a customer-owned borrower

such as Wabash Valley to charge low rates—should lead

the REA to adjust the interest rate charged, which

would, in turn, increase the rates Wabash Valley would

charge its customers. However, the RE Act allocates to

the REA and its Administrator only limited authority for

effectuating the goals of the RE Act. As a consequence,

the REA is obliged to rely on its financing documents—

the wholesale power contract, the loan contract, and the

security instrument—to condition repayment and thereby

protect itself.

Il.

As we indicated in our previous decision, customer-

owned utilities can function as self-regulating entities

because they have no incentive to charge excessive rates

for the electricity they sell. Wabash I, 903 F.2d at 447.

Therefore, REA-financed cooperatives do not require pro-

7 (...continued)

contributions by distribution cooperative members to a mini-

mum forecloses another avenue of improving their capital

structure.

C-9

tection against their own managers’ decisions. Despite

the incentives provided by the structure and operation of

the RE Act, however, borrowers do not have unfettered

discretion. The REA itself exercises control over all of its

borrowers through the imposition of contractual require-

ments (and not through the explicit regulation of electric-

ity rates). In addition, eleven states also regulate prices

charged by their cooperative electric utilities. In these

states the REA makes its loans and guarantees with the

knowledge that state regulation applies.”

The relationship among the power supply cooperatives,

distribution cooperatives, and the REA is structured

through the wholesale power contract. This contract obli-

gates a distribution cooperative to purchase all of its

electric power over a fixed term (in this instance, forty

years) from a power supply cooperative. When lending

money to the power supply cooperatives, the REA re-

quires that they enter into wholesale power contracts

with member distribution cooperatives. (Likewise, when

entering into such relationships with distribution cooper-

atives, the REA requires those distribution cooperatives

to enter into similar contracts with power supply cooper-

atives.) This arrangement ensures that power supply bor-

rowers will be able to earn revenue from the sale of

* For example, the language of Wabash Valley's mortgage

agreement repeats the more general language of standard

REA mortgages, which provide that cooperative rates would be

“subject to applicable laws and rules and orders of regulatory

bodies.” According to Arkansas Electric Cooperative Corp. v.

Arkansas Public Service Comm’n, 461 U.S. 375, 388, 103 S.Ct.

1905, 1914, 76 L.Ed.2d 1 (1983), “any reference in an REA

document to a ‘regulatory commission’ could only mean a state

regulatory agency.”

C-10

power sufficient to meet their costs. One level of protec-

tion is the security interest the REA takes in the physi-

cal assets of both types of cooperatives as well as in the

respective rights and interests of each party under the

wholesale power contracts.

In addition to taking a security interest in the assets

of the power supply cooperative, including the wholesale

power contracts, the REA requires a power supply bor-

rower, such as Wabash Valley, to obtain the approval of

state regulatory agencies for its investment projects be-

fore lending any money. Within this system of supervi-

sion, the wholesale power contracts themselves constitute

the lynchpin of the REA lending program. A state regu-

latory agency that sets cooperative utility rates too low

would frustrate the effectiveness of the wholesale power

contracts. As a result, the REA contends that ratemaking

by state regulatory agencies which seriously compromises

the ability of REA borrowers to make required payments

is subject to preemption.

When the federal government acts within its constitu-

tional authority, it is empowered to preempt state laws

to the extent it believes such action to be necessary to

achieve its purposes. The Supremacy Clause of the Con-

stitution authorizes this federal action, and the phrase

“Laws of the United States” of Article [V encompasses

both federal statutes themselves and federal regulations

that are properly adopted in accordance with statutory

authorization. For this reason, the Supreme Court has

not only established a number of ways in which Congress

can be understood to have preempted state law, see

C-11

Louisiana Public Service Comm’n v. F.C.C., 476 U.S. 355,

368-69, 106 S.Ct. 1890, 1898-99, 90 L.Ed.2d 369 (1986),

but the Court has also recognized that “a federal agency

acting within the scope of its congressionally delegated

authority may pre-empt state regulation.” Jd. at 369, 106

S.Ct. at 1898-99.

In order for the REA to enforce its preemption regula-

tions, it must overcome two significant obstacles. The

first hurdle is the longstanding presumption against pre-

emption of an area traditionally subject to state regula-

tion. See California v. ARC American Corp., 490 U.S. 93,

100, 109 S.Ct. 1661, 1665, 104 L.Ed.2d 86 (1989). When

regulation is of a field traditionally occupied by the

states, “we start with the assumption that the historic

police powers of the States were not to be superseded by

the Federal Act unless that was the clear and manifest

purpose of Congress.” Rice v. Santa Fe Elevator Corp.,

331 U.S. 218, 231, 67 S.Ct. 1146, 1152, 91 L.Ed. 1447

(1947). The same principle applies when an agency acts

to preempt the field. Hillsborough County v. Automated

Medical Laboratories, Inc., 471 U.S. 707, 715, 105 S.Ct.

2371, 2376, 85 L.Ed.2d 714 (1985). More than fifty years

of state regulation of cooperative utility rates (in those

states that have continued to regulate these rates) since

.the enactment of the RE Act certainly reflects the fact

that Congress has not occupied the field. Therefore, the

REA must demonstrate a conflict between state regula-

tion of cooperatives and the federal rurai electrification

program that is strong enough to overcome the presump-

tion that state ratemaking can constitutionally coexist

with the federal financing regime.

The second obstacle in the REA’s path is the scope of

the agency’s authority in rulemaking. Legal authoriza-

C-12

tion for preemptive federal regulations follows from two

fundamental precepts. “First, an agency literally has no

power to act, let alone pre-empt the validly enacted leg-

islation of a sovereign State, unless and until Congress

confers power upon it. Second, the best way of determin-

ing whether Congress intended the regulations of an ad-

ministrative agency to displace state law is to examine

the nature and scope of the authority granted by Con-

gress to the agency.” Louisiana Public Service Comm'n,

476 U.S. at 374, 106 S.Ct. at 1901. Under the very defer-

ential standard of review enunciated by the Supreme

Court, our inquiry is whether a federal agency has prop-

erly exercised its own delegated authority rather than

simply whether Congress has properly exercised its leg-

islative power. Thus, in determining when state law is

pre-empted by federal regulation, a “narrow focus on

Congress’ intent to supersede state law [is] misdirected”

because “[a] preemptive regulation’s force does not de-

pend on express congressional authorization to displace

state law.” Fidelity Federal Savings & Loan Assn. v. De

la Cuesta, 458 U.S. 141, 154, 102 S.Ct. 3014, 3023, 73

L.Ed.2d 664 (1982). If authorized by statute, the regula-

tions of an agency will preempt state law that conflicts

with such regulations or frustrates the purpose of those

regulations. City of New York v. F.C.C., 486 U.S. 57, 64,

108 S.Ct. 1637, 1642, 100 L.Ed.2d 48 (1988); Capital

Cities Cable, Inc. v. Crisp, 467 U.S. 691, 104 S.Ct. 2694,

81 L.Ed.2d 580 (1984).

Much of the discussion—and disagreement—over the

REA’s authority to preempt turns on the single Supreme

C-13

Court decision in this area. Arkansas Electric Cooperative

Corp. v. Arkansas Public Service Comm'n, 461 U.S. 375,

103 S.Ct. 1905, 76 L.Ed.2d 1 (1983), established that, as

a rule, states may regulate electricity prices charged by

cooperatives that have received credit from the REA.

However, the Supreme Court identified two potential ex-

ceptions:

There may come a time when the REA changes

its present policy, and announces that state rate

regulation of rural power cooperatives is inconsis-

tent with federal policy. If that were to happen,

and if such a rule was valid under the Rural Elec-

trification Act, it would of course preempt any

further exercise of jurisdiction by the [state regu-

latory authority] .... Moreover, even without an

explicit statement by the REA, a particular rate

set by the [state regulatory authority] may so ser-

iously compromise important federal interests, in-

cluding the ability of the [cooperative] to repay its

loans, as to be implicitly preempted by the Rural

Electrification Act.

Id. at 388-89, 103 S.Ct. 1915. Earlier in this protracted

litigation, the REA forwent the chance to press the

second exception, which may have been its strongest

argument. When originally proceeding in Indiana to

recover its investment, the REA, for reasons that are not

clear to us, did not raise the possibility of implied pre-

emption. Having failed to raise the implied preemption

argument in the administrative and judicial proceedings

in Indiana, the REA was prevented by principles of pre-

clusion from attempting to do so in federal court. Wabash

I, 903 F.2d at 455. When this avenue was foreclosed in

the previous litigation, the REA enacted the two new

C-14

regulations.’ Although the REA does not directly attempt

an implied preemption argument in this appeal, the

ugency relies on the relevant language in Arkansas Elec-

tric to reinforce its assertion of statutory authority to

preempt state utility regulation. In response, Wabash

Valley contends that res judicata effectively prohibits the

REA from relying-on implied preemption, particularly if

the intent of its rulemaking is to circumvent our earlier

holding.

Res judicata, and its paternal twin collateral estoppel,

have been the subject of widespread discussion in num-

erous cases. See, e.g., United States v. Mendoza, 464 U.S.

154, 157-59, 104 S.Ct. 568, 571, 78 L.Ed.2d 379 (1984);

Federated Dep’t Stores, Inc. v. Moitie, 452 U.S. 394, 398,

101 S.Ct. 2424, 2427, 69 L.Ed.2d 103 (1981); Allen v.

McCurry, 449 U.S. 90, 101 S.Ct. 411, 66 L.Ed.2d 308

(1980); Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326,

99 S.Ct. 645, 649, 58 L.Ed.2d 552 (1979); Smith v. City

of Chicago, 820 F.2d 916 (7th Cir.1987). According to the

Supreme Court, res judicata prevents a party “from re-

litigating the same cause of action against the parties to

a prior decision.” Mendoza, 464 U.S. at 163, 104 S.Ct. at

574. More illuminating, the Fifth Circuit has elaborated

that res judicata “treats a judgment, once rendered, as

the full measure of relief to be accorded between the

same parties on the same ‘claim’ or ‘cause of action.’ . . .

®° The concurrence regards our conclusion that the REA

missed its chance to press the implied preemption argument

held out by the Supreme Court in Arkansas Electric as silence.

In fact, that language suggests a possible recourse for the REA

absent specific regulatory action. Once the REA enacted the

preemption regulations—its explicit statement, we naturally

turn to its authority to do so.

C-15

Under these rules of claim preclusion, the effect of a

judgment extends to the litigation of all issues relevant

to the same claim between the same parties, whether or

not raised at trial.” Kaspar Wire Works, Inc. v. Leco En-

gineering & Machinery, Inc., 575 F.2d 530, 535-36 (5th

Cir.1978).

Because this litigation originated in Indiana, its rules

of preclusion determine whether res judicata bars the

REA from applying its regulations to the REA. See Mar-

rese v. American Academy of Orthopaedic Surgeons, 470

U.S. 373, 105 S.Ct. 1327, 84 L.Ed.2d 274 (1985); see gen-

erally Hart and Wechsler’s The Federal Co::7ts and the

Federal System, 1627-29 (3d ed. 1988). According to In-

diana law, which we summarized in Leal v. Krajewski,

803 F.2d 332, 334 (7th Cir.1986), claim preclusion follows

from the following four factors: (1) a judgment from a

court of competent jurisdiction, (2) on the merits, (3) in

a suit between the same parties, in which (4) the matter

at issue was, or might have been, determined in the

former suit. Rather than a claim or a cause of action,

therefore, we are left to decide whether there is a coin-

cidence in the matter at issue in this and the previous

litigation.

Indiana’s formulation for what constitutes a matter at

issue is more narrow than our federal rule, under which

a single cause of action consists of “ ‘a core of operative

facts’ which give rise to a remedy,” Jn re Matter of Ener-

gy Cooperative, Inc., 814 F.2d 1226, 1230-31 (7th Cir.),

cert. denied, 484 U.S. 928, 108 S.Ct. 294, 98 L.Ed.2d 254

(1987) (quoting Car Carriers, Inc. v. Ford Motor Co., 789

F.2d 589, 593 (7th Cir.1986)). For purposes of claim pre-

clusion, “[e]very [matter] which was within the issues,

and which, under the issues, might have been proved,

C-16

will be presumed to have been proved and adjudicated.”

Peterson v. Culver Educational Foundation, 402 N.E.2d

448, 460 (Ind.App.1980) (quoting Town of Flora v. In-

diana Service Corporation, 222 Ind. 253, 53 N.E.2d 161

(1944)): see Yellow Cab Co. v. Williams, 583 N.E.2d 774,

777-79 (Ind.App.1991); M.R. v. Meltzer, 487 N.E.2d 836,

841 (Ind.App.1986); Biggs v. Marsh, 446 N.E.2d 977, 982

(Ind.App.1983). As we recognized in Wabash I, the in-

quiry under Indiana law is essentially whether the two

suits deal with a common transaction or occurrence. 903

F.2d at 456. Under this conceptualization, a very expan-

sive construction of Indiana’s rule of res judicata might

conceivably extend to the REA’s attempt to apply the

preemption regulations to Wabash Valley.

The procedural posture of the litigation substantially

complicates this analysis. At one level, it does appear

that the REA has resorted to rulemaking in order to

avoid the impact of our earlier holding. The REA never-

theless maintains that its authority to expressly preempt

particular state rates can be implied from the RE Act

itself. Arguably, the fact that the REA has waived im-

plied preemption with respect to Wabash Valley would

militate in favor of finding that res judicata bars the ap-

plication of these regulations—which are themselves de-

rived from implied authority—to Wabash Vailey. It

would follow that to the extent that the REA is relying

on implied preemption, our earlier decision has foreclosed

any revisiting of that issue.

However, this reasoning is flawed in two important re-

spects. First, the REA’s argument is not simply one

founded on the principle of implied preemption. It is as-

serting the implied authority to engage in preemptive

rulemaking rather than the authority to impliedly pre-

C-17

empt. In this regard, the REA asserts that its regula-

tions are compatible with the statutory responsibilities

delegated by the RE Act to the Administrator of the

REA. Second, the matter at issue for purposes of Indiana

law are regulations that could not have been the subject

of the preceding litigation because they were not in exist-

ence. While the timing and rationale of the preemption

regulations may be suspect, that alone is not sufficient to

bring the use of those regulations against Wabash Valley

within the principles of res judicata. Such a conclusion

would be an unwarranted distortion of the posture of the

litigants in Wabash I and the Indiana rules of preclu-

sion.'”

Il.

The fact that res judicata does not bar this suit does

not relieve the REA of the need to establish the validity

of the regulations themselves. According to the standard

REA apparently can no longer rely on federal law to overcome

Indiana’s regulation of Wabash Valley’s rates. This approach

to claim preclusion lavishes attention on the potential outcome

of the REA’s actions at the expense of identifying the claim—

in the sense of the cause of action. In defining the scope of

claim preclusion (and not issue preclusion, which is irrelevant

to a subsequent suit between the parties to an earlier action),

our ultimate source is the Indiana courts. When other facts or

conditions intervene, forming a new basis for a claim, claim

preclusion does not apply. Cf. South Bend Federation of Teach-

ers v. National Education Ass’n, 180 Ind.App. 299, 389 N.E.2d

23, 34-35 (1979). Accordingly, the issue of resorting to implied

preemption was put to rest in our previous opinion. Enforce-

ment of the preemption regulations was not. It is axiomatic

that the reach of claim preclusion extends only to those theo-

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