In a pair of orders announced at its October 20, 2022, open meeting, the Federal Energy Regulatory Commission (FERC) clarified that an affiliate relationship exists where non-independent directors are appointed to the board of a public utility by an investor owning less than 10%. In addition, FERC found the appointment of non-independent directors constituted a change in control for which Federal Power Act (FPA) Section 203 was required. Although FERC declined to find that an affiliate relationship existed in another circumstance where independent directors were appointed to a public utility at the behest of an investor owning less than 10%, the orders and Commissioner Glick’s comments nonetheless indicate that FERC will be taking a closer look at whether investor connections to public utilities create affiliate relationships. Public utilities and investors in them should carefully consider these two FERC orders in structuring their relationships going forward and ensuring that all necessary regulatory authorizations are obtained.<
Director Appointment Constituting Control
In Evergy Kansas Central, Inc., 181 FERC ¶ 61,044 (2022), FERC found that the appointment of an investor’s executive chairman to the board of a public utility was sufficient to convey control and create an affiliate relationship despite the investor owning just 1.1% of the public utility. The investor entered into an agreement in 2021, pursuant to which the public utility would appoint to its board the executive chairman of the investor’s board and a former senator. The public utility argued that the board of director appointments did not create an affiliate relationship because the investor owned just 1.1% of the public utility and thus was entitled to a presumption of lack of control under section 35.36(a)(9)(v) of FERC’s regulations.
FERC, however, disagreed and found that the investor was an affiliate by virtue of the appointment of its executive chairman to the public utility’s board (FERC did not address the appointment of the former senator). FERC explained that “[b]oard membership confers rights, privileges, and access to non-public information, including information on commercial strategy and operations,” and “[w]here an investor’s own officer or director, or other appointee accountable to the investor, is appointed to the board of a public utility or holding company that owns public utilities, the investor itself will have those rights, privileges, and access, and thus the authority to influence significant decisions involving the public utility or public utility holding company.” Accordingly, FERC found that the presumption the investor lacked control of the public utility based on its less than 10% ownership interest was rebutted in this instance, and the investor was deemed an affiliate.
In the same order, FERC found that presumption of lack of control was not rebutted with respect to a different investor that owned a 4.597% interest in a public utility. Like the investor FERC found to be an affiliate, this investor entered into an agreement with the public utility pursuant to which the size of the public utility’s board of directors would be increased by two directors and two individuals recommended by the investor would be appointed to the additional director seats. FERC found that the appointment of the two individuals recommended by the investor was not sufficient to convey control, in part because the individuals appointed to the board were independent of the investor and not compensated by it.
In TransAlta Energy Marketing (U.S.) Inc., 181 FERC ¶ 61,055 (2022), FERC addressed affiliation and change of control issues in the opposite circumstance: an investor that owned more than 10% of a public utility but that entered into an agreement through which it expressly limited its control. The investor at issue, in this case, entered into a standstill agreement with the public utility to purchase debt securities with an option to convert the securities into an equity interest. In conjunction with the debt security purchase, the investor agreed to a number of restrictions aimed at preventing it from exercising control over the public utility, including the general inability to vote any common shares it held. But the investor was allowed to select two new directors for the board. Despite subsequently increasing their holdings in the public utility in excess of 10%, the investor made no filings with FERC on the grounds that there had been no change in control and, among other things, no affiliate relationship had been established because the standstill
In anticipation of the standstill agreement expiring (along with the restrictions on the investor exercising control), the public utility filed under FPA Section 203 for authorization of the investor’s acquisition of more than 10% of the public utility. FERC, however, found that the standstill agreement had not deferred the need for Section 203 approval as the parties claimed and that the parties should have previously sought 203 approval under both Sections 203(a)(1) (for disposition) and 203(a)(2) (for acquisition). As to the Section 203(a)(1) approval, the Commission noted that—as in Evergy—the appointment of the two of the investor’s directors to the public utility’s board was sufficient to convey control and there were no explicit prohibitions in the standstill agreement that prevented the investor from influencing the day-to-day activities of the public utility. But even if the investor could be deemed to lack control such that no approval was required under Section 203(a)(1), under Section 203(a)(2) approval is required for acquisitions of securities whether or not there is a transfer of control if the acquisition is over $10 million as was the case here. FERC thus concluded that the parties had failed to timely file a Section 203 application.