As California burns, inverse condemnation and cost recovery issues dominate California’s electric utilities’ legal framework

In what appears to be the new “normal,” California is off to another unfortunate, devastating and destructive start to wildfire season. From the legal perspective, much of the focus has been on potential liability of electrical utilities throughout the state, and in particular under the doctrine of “inverse condemnation.” Under this theory, a public entity is generally liable when private property is damaged for a public use, regardless of foreseeability or fault. So, for example, if a tree branch snaps due to high winds and thereafter strikes an electric utility’s transmission line and sparks a wildfire, the electric utility could potentially face liability for all the billions of dollars of damages caused by the wildfire — even if the electric utility acted without fault and satisfied all maintenance, inspection and other regulatory requirements.

The underlying purpose of inverse condemnation is to socialize a burden that should be assumed by society. See Holtz v. Superior Court, 3 Cal.3d 296, 303 (1970). If a handful of members of the community suffer a loss substantially caused by a public improvement, those individuals are compensated for the loss by the community as a whole. The idea is that the entire community benefits from the public improvement and it would be unfair for the individuals damaged to be burdened with a disproportionate share of the costs of that public improvement. This concept generally works with public agencies serving as a conduit for the spread of the loss: although the public agency pays the inverse condemnation damages to the impacted community members, the costs may be socialized by recouping those costs from the public at large through taxes or rate increases.

So why does this concept not work in the context of California’s wildfires? Why has PG&E declared bankruptcy? One of the main reasons inverse condemnation has received so much attention is because the majority of California’s electrical supply is provided by private, investor-owned utilities — not public agencies. These electric investor-owned utilities (or “IOUs”) cannot levy taxes or special assessments, and cannot unilaterally raise customer rates to make up for the wildfire losses. Instead, the ability of the electric IOUs to recoup wildfire-related costs from customers is subject to review and approval by the California Public Utilities Commission, which engages in a “prudent manager” analysis to determine whether the electric IOU may recover such costs. In theory, this mechanism permits electric IOUs to recover prudently-incurred losses through rate increases. However, in practice, such a determination can take years and the substantive analysis is subject to considerable, after-the-fact scrutiny. In the analogy of the Monday Morning Quarterback, there is virtually always something different or better the electric IOU could have undertaken with respect to operations, maintenance, design, decision-making, etc. Consequently, this uncertain cost recovery framework is fundamentally inconsistent with the underlying premise of inverse condemnation liability that losses caused by public improvements may be socialized or spread among the larger benefiting community.

The Legislature and the governor have taken several steps this year to try to financially stabilize the state’s electric utilities, including the passage of Assembly Bill 1054 — signed by Gov. Gavin Newsom on July 12, 2019. These efforts included the creation of a fund to facilitate payment of wildfire-related liabilities, a change in the cost recovery review process before the commission for wildfire-related costs, and an establishment of safety certification protocols for electric IOUs, among other policies. Unfortunately, if the start to this year’s wildfire season is any indication, all of this legislation may just be a Band-Aid. The needed solution is for the state to reconcile the application of inverse condemnation with the cost recovery framework for IOUs. Either inverse condemnation should not be applied to IOUs or the cost recovery framework should allow IOUs to automatically pass through all inverse condemnation-related wildfire costs to customers. However, both options face considerable obstacles.

With respect to the first option, elimination of inverse condemnation strict liability for IOUs could resolve the conceptual inconsistency mentioned above and electric IOUs could still be held accountable under tort-based liability (such as negligence) for wildfire-related damages if they negligently designed, maintained, operated, or constructed their infrastructure. Nonetheless, because the doctrine of inverse condemnation arises out of the California Constitution (which requires that just compensation be paid when “private property is taken or damaged for public use”), there is an open debate on whether reform of the doctrine of inverse condemnation for electrical IOUs would require a constitutional amendment. Some argue that the Legislature has the authority to enact legislation modifying how inverse condemnation is applied to IOUs because the California Supreme Court has never itself addressed the applicability of the doctrine to IOUs who cannot always socialize the costs of liability. Others have argued that any reform would require a constitutional amendment because multiple state appellate courts have already determined that inverse condemnation liability may be applied to IOUs. If a state constitutional amendment is required, there would likely be significant political obstacles to obtaining the requisite two-thirds vote of each chamber of the Legislature, let alone approval by the state’s voters.

With respect to the second option, allowing IOUs to spread inverse condemnation-related wildfire costs to customers could also bring the overall framework closer to the paradigm contemplated by the courts in developing the doctrine. This second option would not trigger the state constitutional issues present for the first option above. Instead, the Legislature has clear authority to modify the standards the commission must apply in reviewing what costs IOUs may recover in customer rates (as demonstrated by Senate Bill 901 in 2018 and Assembly Bill 1054 this year). However, this option likely faces significant opposition given the political atmosphere following significant wildfire events attributed to electric IOUs in recent years. Critiques of this approach would also argue that allowing costs to always be passed on to customers under any circumstance eliminates any incentive for electric IOUs to invest in adequate safety measures.

In the end, California’s wildfire dilemma is much larger than just electrical infrastructure. Climate change, development in high fire risk areas, underinvestment in critical infrastructure, myopic local government planning, and growing affordable housing challenges all play a role in this. The wildfire problem requires a bigger solution than just addressing liability issues. Nonetheless, the state should strive towards reconciling its inverse condemnation liability regime with what is currently an incompatible cost recovery framework. There are considerable opportunities for productive compromises to be reached on both fronts. 