Item 3. Legal Proceedings .

In addition to the following legal proceedings, PG&E Corporation and the Utility are involved in various legal proceedings in the ordinary course of their business.

Pacific Gas and Electric Company Chapter 11 Filing

On April 6, 2001, the Utility filed a voluntary petition for relief under the provisions of Chapter 11 of the U.S. Bankruptcy Code, or Chapter 11, in the U.S. Bankruptcy Court for the Northern District of California, or Bankruptcy Court. On April 12, 2004, the Utility's plan of reorganization under Chapter 11 became effective. On this date, the effective date, the Utility emerged from Chapter 11. On the effective date, the Utility paid all valid claims, deposited funds into escrow accounts for the payment of disputed claims upon their resolution, reinstated certain obligations, and paid other obligations.

The Utility's plan of reorganization incorporated the terms of the Settlement Agreement. Under the Settlement Agreement, the CPUC has waived all existing and future rights of sovereign immunity, and all other similar immunities, as a defense in connection with any action or proceeding concerning the enforcement of, or other determination of the parties' rights under the Settlement Agreement, the plan of reorganization or the confirmation order. The CPUC also consented to the jurisdiction of any court or other tribunal or forum for those actions or proceedings, including the Bankruptcy Court. The CPUC's waiver is irrevocable and applies to the jurisdiction of any court, legal process, suit, judgment, attachment in aid of execution of a judgment, attachment before judgment, set-off or any other legal process with respect to the enforcement of, or other determination of the parties' rights under, the Settlement Agreement, the plan of reorganization or the confirmation order. The Settlement Agreement contemplates that neither the CPUC nor any other California entity acting on its behalf may assert immunity in an action or proceeding concerning the parties' rights under the Settlement Agreement, the plan of reorganization or the confirmation order.

The Settlement Agreement generally terminates nine years after the effective date of the plan of reorganization, except that the rights of the parties to the Settlement Agreement that vest on or before termination, including any rights arising from any default under the Settlement Agreement, will survive termination for the purpose of enforcement. The parties agreed that the Bankruptcy Court will have jurisdiction over the parties for all purposes relating to enforcement of the Settlement Agreement, the plan of reorganization and the confirmation order. The Bankruptcy Court retains jurisdiction to resolve remaining disputed claims. The parties also agreed that the Settlement Agreement, the plan of reorganization or any order entered by the Bankruptcy Court contemplated or required to implement the Settlement Agreement or the plan of reorganization will be irrevocable and binding on the parties and enforceable under federal law notwithstanding any future decisions or orders of the CPUC.

Two former CPUC commissioners who did not vote to approve the Settlement Agreement filed an appeal of the Bankruptcy Court's confirmation order with the U.S. District Court for the Northern District of California, or the District Court. On July 15, 2004, the District Court dismissed their appeal. The former commissioners have appealed the District Court's order to the U.S. Court of Appeals for the Ninth Circuit, or Ninth Circuit. The Ninth Circuit heard oral arguments on the appeal on February 13, 2006. It is uncertain when a decision will be issued.

Under applicable federal precedent, once the plan of reorganization has been "substantially consummated," any pending appeals of the confirmation order should be dismissed as moot. If the Bankruptcy Court's confirmation order is overturned or modified on appeal, PG&E Corporation's and the Utility's financial condition and results of operations, and the Utility's ability to pay dividends or otherwise make distributions to PG&E Corporation, could be materially adversely affected. PG&E Corporation and the Utility believe the former commissioners' appeal of the confirmation order is without merit and will be rejected.

Pacific Gas and Electric Company vs. Michael Peevey, et al.

On November 8, 2000, the Utility filed a lawsuit in the District Court against the CPUC commissioners. In this lawsuit, the Utility seeks a declaration that the federally tariffed wholesale electricity costs that the Utility had incurred to serve the Utility's customers are recoverable in retail rates under the federal filed rate doctrine.

Under the Settlement Agreement, the Utility agreed to dismiss the filed rate case with prejudice on or as soon as practicable after the later of the effective date of the plan of reorganization and the date on which CPUC approval of the Settlement Agreement is no longer subject to appeal. On August 11, 2003, the Ninth Circuit issued an order staying proceedings in the filed rate case as requested by the Utility. Since the appeal brought by two former CPUC commissioners challenging the

Bankruptcy Court’s confirmation order incorporating the terms of the Settlement Agreement is still pending in the Ninth Circuit, as discussed above, the Utility has not yet dismissed its complaint.

Diablo Canyon Power Plant

The Utility's Diablo Canyon power plant employs a "once-through" cooling water system that is regulated under a NPDES permit issued by the Central Coast Regional Water Quality Control Board, or Central Coast Board. This permit allows the Diablo Canyon power plant to discharge the cooling water at a temperature no more than 22 degrees above the temperature of the ambient receiving water, and requires that the beneficial uses of the water be protected. The beneficial uses of water in this region include industrial water supply, marine and wildlife habitat, shellfish harvesting and preservation of rare and endangered species. In January 2000, the Central Coast Board issued a proposed draft cease and desist order alleging that, although the temperature limit has never been exceeded, the Utility's Diablo Canyon power plant's discharge was not protective of beneficial uses.

In October 2000, the Utility and the Central Coast Board reached a tentative settlement of this matter pursuant to which the Central Coast Board agreed to find that the Utility's discharge of cooling water from the Utility's Diablo Canyon power plant protects beneficial uses and that the intake technology reflects the best technology available, as defined in the federal Clean Water Act. As part of the Central Coast settlement agreement, the Utility agreed to take measures to preserve certain acreage north of the plant and to fund approximately $6 million in environmental projects and future environmental monitoring related to coastal resources. On March 21, 2003, the Central Coast Board voted to accept the Central Coast settlement agreement. On June 17, 2003, the Central Coast settlement agreement was executed by the Utility, the Central Coast Board and the California Attorney General's Office. A condition to the effectiveness of the settlement agreement is that the Central Coast Board renew Diablo Canyon's NPDES permit.

At its July 10, 2003 meeting, the Central Coast Board did not renew the permit and continued the permit renewal hearing indefinitely. Several Central Coast Board members indicated that they no longer supported the Central Coast settlement agreement accepted in March 2003, and the Central Coast Board requested a team of independent scientists, as part of a technical working group, to develop additional information on possible mitigation measures for Central Coast Board staff. In January 2005, the Central Coast Board published the scientists' draft report recommending several such mitigation measures. If the Central Coast Board adopts the scientists' recommendations, and if the Utility ultimately is required to implement the projects proposed in the draft report, it could incur costs of up to approximately $30 million. The Utility would seek to recover these costs through rates charged to customers.

The Utility believes that the ultimate outcome of this matter will not have a material adverse impact on the Utility's financial condition or results of operations.

Complaints Filed by the California Attorney General and the City and County of San Francisco

On January 10, 2002, the California Attorney General filed a complaint in the San Francisco Superior Court for the County of San Francisco, or Superior Court, against PG&E Corporation and its directors, as well as against directors of the Utility, based on allegations of unfair or fraudulent business acts or practices in violation of California Business and Professions Code Section 17200, or Section 17200. Among other allegations, the California Attorney General alleged that past transfers of funds from the Utility to PG&E Corporation during the period from 1997 through 2000 (primarily in the form of dividends and stock repurchases), and allegedly from PG&E Corporation to other affiliates of PG&E Corporation, violated various conditions established by the CPUC in decisions approving the holding company formation. The California Attorney General alleged that the defendants violated these conditions when PG&E Corporation allegedly failed to provide adequate financial support to the Utility during the California energy crisis.

The complaint seeks injunctive relief, the appointment of a receiver, restitution in an amount according to proof, civil penalties of $2,500 against each defendant for each violation of Section 17200, a total penalty of not less than $500 million and costs of suit. The California Attorney General's complaint also seeks restitution of assets allegedly wrongfully transferred to PG&E Corporation from the Utility.

On February 11, 2002, a complaint entitled City and County of San Francisco; People of the State of California v. PG&E Corporation, and Does 1-150 , was filed in the Superior Court. The complaint contains some of the same allegations contained in the California Attorney General's complaint, including allegations of unfair competition in violation of Section 17200. In addition, the complaint alleges causes of action for conversion, claiming that PG&E Corporation "took at least

$5.2 billion from the Utility," and for unjust enrichment. The City and County of San Francisco, or CCSF, seeks injunctive relief, the appointment of a receiver, restitution, disgorgement, the imposition of a constructive trust, civil penalties of $2,500 against each defendant for each violation of Section 17200 and costs of suit.

The complaints were filed after the CPUC issued two decisions in its investigative proceeding commenced in April 2001 into whether the California investor-owned electric utilities, including the Utility, complied with past CPUC decisions, rules and orders authorizing their holding company formations and/or governing affiliate transactions, as well as applicable statutes. The order states that the CPUC would, among other matters, investigate the utilities' transfer of money to their holding companies, including during times when their utility subsidiaries were experiencing financial difficulties the failure of the holding companies to financially assist the utilities when needed, the transfer by the holding companies of assets to unregulated subsidiaries, and the holding companies' actions to "ringfence" their unregulated subsidiaries. In May 2005, the CPUC closed this investigation without making any findings. Under the Settlement Agreement, the CPUC agreed to dismiss with prejudice PG&E Corporation and the Utility from the CPUC's investigation as to past practices.

PG&E Corporation believes that the intercompany transactions challenged by the California Attorney General and CCSF were in full compliance with applicable law and CPUC conditions. The challenged transactions forming the bulk of the restitution claims were regular quarterly dividends and stock repurchases. As part of its annual cost of capital proceedings, the Utility advised the CPUC in advance of its forecast stock repurchases and dividends. The CPUC did not challenge or question those payments.

In February and March 2002, PG&E Corporation filed notices of removal in the Bankruptcy Court to transfer the complaints to the Bankruptcy Court. Subsequently, the plaintiffs filed motions to remand their actions to state court. In June 2002, the Bankruptcy Court held that federal law preempted the California Attorney General’s allegations concerning PG&E Corporation’s participation in the Utility’s bankruptcy proceedings. The Bankruptcy Court directed the California Attorney General to file an amended complaint omitting certain of his Section 17200 allegations and remanded the amended complaint to the Superior Court. The Bankruptcy Court retained jurisdiction over CCSF’s causes of action for conversion and unjust enrichment, finding that these claims belong solely to the Utility and cannot be asserted by CCSF, but remanded CCSF’s Section 17200 cause of action to state court. In both cases, the parties appealed the Bankruptcy Court’s remand order to the District Court. In August 2002, the California Attorney General filed its amended complaint in the Superior Court. The Superior Court has coordinated the California Attorney General’s case with the case filed by CCSF.  

On October 8, 2003, the District Court reversed, in part, the Bankruptcy Court’s June 2002 decision and ordered that the plaintiffs’ restitution claims under Section 17200 be sent to the Bankruptcy Court. The District Court found that these claims, estimated by plaintiffs to be approximately $5 billion, are the property of the Utility’s Chapter 11 estate and are therefore properly within the Bankruptcy Court’s jurisdiction. The District Court also affirmed, in part, the Bankruptcy Court’s June 2002 decision and found that the plaintiffs’ civil penalty and injunctive relief claims under Section 17200 could be resolved in Superior Court. The California Attorney General and CCSF appealed the District Court’s remand order to the Ninth Circuit.

While the Ninth Circuit appeal was pending, the Superior Court held a trial in December 2004 to consider the appropriate standard to determine what constitutes a separate violation of Section 17200 in order to determine the magnitude of potential penalties under Section 17200 (up to $2,500 per separate “violation”). The Superior Court did not address the question of whether any violations occurred. In March 2005, the Superior Court issued a decision rejecting the “per victim” and “per [customer] bill” approaches advocated by the plaintiffs, standards that potentially could have resulted in millions of separate “violations.” The Superior Court found that the appropriate standard was each transfer of money from the Utility to PG&E Corporation that plaintiffs allege violated Section 17200. In July 27, 2005, the California Court of Appeal summarily denied a petition filed by the California Attorney General and CCSF seeking to overturn this decision.

On January 10, 2006, a three-judge panel of the Ninth Circuit issued a 2-1 decision reversing the District Court’s October 2003 order regarding which court had jurisdiction of the California Attorney General’s and CCSF’s restitution claims. The Ninth Circuit ruled that the plaintiffs’ restitution claims constituted actions to enforce their police or regulatory power, actions which are exempt from the provisions of the Bankruptcy Code permitting removal of state actions to Bankruptcy Court. The Ninth Circuit remanded the restitution claims back to the Superior Court. PG&E Corporation has filed a request for rehearing en banc with the Ninth Circuit.

The Ninth Circuit did not address the California Attorney General’s and CCSF’s underlying allegations that PG&E Corporation and the other defendants violated Section 17200 . The Ninth Circuit also did not decide the issue of who would

be entitled to receive the proceeds, if any, of a restitution award , and PG&E Corporation continues to believe that any such proceeds would be the property of the Utility. The Settlement Agreement provides that all claims by the CPUC against PG&E Corporation or the Utility arising out of or in any way related to the energy crisis are released, including the CPUC’s investigation into past PG&E Corporation actions during the energy crisis. Accordingly, PG&E Corporation believes that any claims for such proceeds by the CPUC would be precluded.

PG&E Corporation believes that the California Attorney General’s and CCSF’s allegations have no merit and will continue to vigorously respond to and defend against the litigation.   PG&E Corporation believes that the ultimate outcome of this matter would not result in a material adverse effect on PG&E Corporation’s financial condition or results of operations.  

Compressor Station Chromium Litigation  

The following 12 civil suits are pending against the Utility relating to alleged chromium contamination: (1)  Aguayo v. Pacific Gas and Electric Company , filed March 15, 1995, in the Superior Court for the County of Los Angeles or Los Angeles County Superior Court, (2)  Aguilar v. Pacific Gas and Electric Company , filed October 4, 1996, in Los Angeles County Superior Court, (3)  Acosta, et al. v. Betz Laboratories, Inc., et al. , filed November 27, 1996, in Los Angeles County Superior Court, (4)  Adams v. Pacific Gas and Electric Company and Betz Chemical Company , filed July 25, 2000, in Los Angeles County Superior Court, (5)  Baldonado v. Pacific Gas and Electric Company , filed October 25, 2000, in Los Angeles County Superior Court, (6)  Gale v. Pacific Gas and Electric Company , filed January 30, 2001, in Los Angeles County Superior Court,  Puckett v. Pacific Gas and Electric Company , filed March 30, 2001, in Los Angeles County Superior Court, (9)  Alderson, et al. v. PG&E Corporation, Pacific Gas and Electric Company, Betz Chemical Company, et al. , filed April 11, 2001, in Los Angeles County Superior Court, (10)  Bowers, et al. v. Pacific Gas and Electric Company, et al. , filed April 20, 2001, in Los Angeles County Superior Court, (11)  Boyd, et al. v. Pacific Gas and Electric Company, et al. , filed May 2, 2001, in Los Angeles County Superior Court, (12)  Martinez, et al. v. Pacific Gas and Electric Company , filed June 29, 2001, in San Bernardino County Superior Court and (13)  Miller v. Pacific Gas and Electric Company , filed November 21, 2001, in Los Angeles County Superior Court.

 

All of these civil actions, referred to as the Chromium Litigation, are now pending in the Los Angeles County Superior Court, or Superior Court. There are now approximately 1,200 plaintiffs in the Chromium Litigation who seek compensatory damages, more than 1,000 of whom are also seeking punitive damages. Although the plaintiffs’ complaints in the Chromium Litigation do not state the amount of compensatory or punitive damages claimed, approximately 1,000 of the current plaintiffs filed claims in the Utility’s Chapter 11 proceeding requesting compensatory damages in an approximate aggregate amount of $500 million and others filed claims for an "unknown amount." These claims were not discharged when the Utility’s plan of reorganization became effective.

In general, plaintiffs and claimants allege that exposure to chromium contamination in the vicinity of the Utility's gas compressor stations located at Kettleman and Hinkley, California, and the area of California near Topock, Arizona, caused personal injuries, wrongful death or other injuries, and seek related damages.

 

On February 3, 2006, the Utility entered into a settlement agreement with attorneys for approximately 1,100 plaintiffs in the Chromium Litigation. The following cases are covered by the settlement agreement: Aguayo , Aguilar , Acosta , Baldonado , Bowers , Boyd , Gale , Martinez , Miller and Puckett . The Utility has agreed to pay $295 million to the settling plaintiffs. The Utility will deposit the settlement amount into escrow on April 21, 2006. The settling plaintiffs are required to execute general releases in favor of the Utility, PG&E Corporation, its officers, directors, employees, and other affiliates, as to any and all claims asserted or which could have been asserted in the Chromium Litigation. After receipt of releases from at least 90% of the settling plaintiffs, executed requests for dismissals with prejudice of the settled cases, and documentation evidencing the Superior Court’s approval of the compromises or settlements with the settling plaintiffs who are minors, payments will be released from escrow to plaintiffs’ attorneys for the plaintiffs who have submitted executed releases. If 90% of the settling plaintiffs do not execute releases by September 15, 2006,   including a release signed by each of the eighteen plaintiffs scheduled to participate in the first trial, the Utility may, at its option, terminate the settlement agreement. In order to obtain 100% of the settlement funds from escrow, plaintiffs’ attorneys must submit releases from or on behalf of 100% of the settling plaintiffs.

 

With respect to the unresolved claims, the Utility will continue to pursue appropriate legal defenses, including the statute of limitations and the exclusivity of workers’ compensation and factual defenses, including lack of exposure to chromium and the inability of chromium to cause certain of the illnesses alleged.

 

The Utility has recorded a $314 million reserve in its financial statements with respect to the Chromium Litigation. PG&E Corporation and the Utility do not expect that the outcome with respect to the remaining unresolved claims will have a material adverse effect on their financial condition or results of operations.