<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
October 5, 1998
Duquesne Light Company
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(Exact name of registrant as specified in its charter)
Pennsylvania 1-956 25-0451600
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State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification No.)
411 Seventh Avenue
Pittsburgh, Pennsylvania 15219
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (412) 393-6000
N/A
(Former name or former address, if changed since last report.)
<PAGE>
Items 1-4. Not applicable.
Item 5. Other Events.
Incorporated herein by reference as Exhibit 99.1 is a press release dated
October 5, 1998, issued today by DQE, Inc. (parent of Duquesne Light Company).
Incorporated herein by reference as Exhibit 99.2 is a letter dated October 5,
1998, from David D. Marshall (President and CEO of DQE, Inc., parent of Duquesne
Light Company) to Alan J. Noia (Chairman, President and CEO of Allegheny Energy,
Inc.).
Item 6. Not applicable.
Item 7. Exhibits.
99.1 DQE, Inc. press release dated October 5, 1998
99.2 Letter dated October 5, 1998, from David D. Marshall to Alan J. Noia.
Items 8-9. Not applicable
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Duquesne Light Company
----------------------
(Registrant)
Date October 5, 1998 /s/ Morgan K. O'Brien
--------------- -----------------------------
(Signature)
Morgan K. O'Brien
Vice President and Controller
2
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EXHIBIT 99.1
CONTACT: Susan Fritschler FOR IMMEDIATE RELEASE
(412) 393-4060
DQE TERMINATES MERGER
Pittsburgh, PA October 5, 1998 - DQE, Inc. today informed Allegheny Energy,
Inc. that it has terminated the Agreement and Plan of Merger between the two
companies as of this date. With today's action, DQE can now devote its full
attention to ensuring a fair and reasonable transition to electric competition
in Western Pennsylvania, including the implementation of Duquesne Light
Company's plan to auction its generating assets. This auction plan has the
support of a broad group of stakeholders, including the Pennsylvania PUC, the
City of Pittsburgh, the Office of Consumer Advocate and representatives of
industrial and small business customers. Duquesne looks forward to working with
all stakeholder groups to implement this plan in a manner that is fair to
employees, mitigates stranded costs, and enhances competition in the
marketplace.
<PAGE>
Exhibit 99.2
October 5, 1998
VIA FACSIMILE
- -------------
Mr. Alan J. Noia
Chairman, President and Chief Executive Officer
Allegheny Energy, Inc.
10435 Downsville Pike
Hagerstown, Md. 21740
Dear Al:
This is to advise you that the Board of Directors of DQE, Inc. has determined
to terminate, and hereby does terminate, effective immediately, the Agreement
and Plan of Merger dated as of April 5, 1997, between our two companies ("the
Agreement"). The Board has taken this action pursuant to the provisions of the
Agreement for the reasons set forth below.
1. Termination Under Section 8.2(a). Pursuant to Section 8.2(a),
--------------------------------
either party may terminate the Agreement if (a) any of the conditions to
consummation of the merger enumerated in Article VII has not been satisfied,
including the condition that all of the representations and warranties contained
in Article V will be true and correct as of today, or (b) any governmental
approval is not being pursued diligently or in good faith. Because neither
condition is satisfied, DQE has the right, which it hereby exercises, to
terminate the Agreement as described further below.
Representation under Section 5.1(f). In Section 5.1(f), Allegheny
-----------------------------------
represented that, except as contemplated in the Allegheny Power Final Operating,
Cash and Capital Budget for Year 1997 and Forecast Years 1998 through 2001,
there has not been a change in Allegheny's financial condition that is
reasonably likely to have a Material Adverse Effect on Allegheny, as that term
is defined in Section 5.1(a). As explained in my letter of July 28, 1998, a
copy of which is attached as Exhibit A, the Pennsylvania PUC ("PaPUC") orders
regarding the merger and restructuring plans constitute such a Material Adverse
Effect.
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 2
In making this determination, DQE has relied on the sworn testimony of
Allegheny's officers, the statements of its attorneys, Allegheny's disclosures
to shareholders and its other public statements regarding the impact of the
PaPUC orders. In these statements and testimony, Allegheny has itself
explicitly stated that the PaPUC orders will cause "severe financial harm" and
Allegheny has quantified that harm with respect to its impact on earnings,
return on equity and asset value for Allegheny as a whole. Using these
representations, the effect of the West Penn restructuring order is to reduce
Allegheny's earnings by 43% during the relevant period. The PaPUC orders result
in a total asset impairment of $1 billion to Allegheny, which represent
approximately 29% of Allegheny's market equity. These adverse effects, among
others, are clearly material, as Allegheny itself has acknowledged, and clearly
constitute a Material Adverse Effect, as defined in the Agreement, warranting
termination of the Agreement.
By contrast, under Duquesne's restructuring order, Duquesne will fully
recover its stranded costs through an auction of generation, with the sole
exception being $142 million in stranded costs associated with certain cold-
reserved generating units and certain regulatory assets. The effect of this
order on DQE as a whole, as compared to the representations contained in the
DQE, Inc. 1997 Five Year Plan referenced in Section 5.1(f), is a 9% reduction in
earnings during the relevant period and a 4% reduction in DQE's market equity.
The disparate impacts of the PaPUC orders on our two companies speak for
themselves.
I note that Allegheny has never, despite our urging, provided DQE with
any information or analysis that would allow DQE's board to reach a contrary
conclusion with respect to the effect of the PaPUC orders on Allegheny. Indeed,
since DQE informed Allegheny of its concerns in this regard on July 28, 1998,
Allegheny has been silent as to why DQE should not consider such adverse effects
on Allegheny to be material. For example, in your letter of July 30, 1998, you
state that the PaPUC orders "do not constitute a material adverse effect," but
you do not provide any explanation or information as to why this is the case.
Three weeks earlier, on July 9, 1998 Victor Roque wrote Tom Henderson that "DQE
fails to understand, and you do not explain, the basis for Allegheny's
suggestion that the stranded cost disallowances could not be considered material
under the merger agreement." To this date, neither Tom Henderson nor anyone
else at Allegheny has responded with an explanation as to why DQE should not
continue to rely on the public representations of Allegheny regarding the
"severe" harm caused by the PaPUC orders.
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 3
By this silence, DQE believes that Allegheny does not seriously
dispute DQE's determination that the PaPUC orders have given rise to Material
Adverse Effects under Section 5.1(f). Indeed, despite our requests for
assurance that such adverse effects be remedied by this date, Allegheny has
failed to provide such assurance and has taken no action at all that is
reasonably likely to remedy such effects. There being no representations other
than Allegheny's sworn testimony, the representations of its attorneys, and its
disclosures to shareholders on which DQE could reasonably rely, you have left us
no choice, in carrying out our fiduciary duty to shareholders, but to terminate
the Agreement as we have done.
Representation Under Section 5.1(g). Under Section 5.1(g), Allegheny
-----------------------------------
has represented that there are no "facts or circumstances of which [Allegheny's]
executive officers have knowledge that could result in any claims against
[Allegheny] . . . [that] are reasonably likely to have a Material Adverse Effect
on it." This representation ceased to be true and correct when Allegheny took
the position, on the record before the PaPUC, that the PaPUC orders would cause
severe financial harm.
I note that, soon after DQE publicly disclosed its concerns regarding
such adverse effects, Allegheny began making public (albeit unexplained)
statements that it had not suffered a material adverse effect under the
Agreement. In DQE's view, however, Allegheny cannot have it both ways, arguing
to the PaPUC, the Commonwealth Court, and the U.S. District court that it has
suffered severe financial harm, but claiming to DQE that any such harm is
immaterial. It is clear to DQE, for the reasons set forth in the preceding
section, that Allegheny has indeed suffered severe financial harm and your
unexplained assertions to the contrary carry no weight with DQE.
Representation Under Section 5.1(i). Under Section 5.1(i), Allegheny
-----------------------------------
has represented that there is no order of any Governmental Entity that would
"prevent or materially burden or materially impair its ability to consummate"
the merger. DQE has the right, which it hereby exercises, to terminate the
Agreement because the September 16, 1998 order of the Federal Energy Regulatory
Commission ("FERC") prevents and otherwise materially burdens or impairs
Allegheny's ability to consummate the merger by April 5, 1999, the latest
Termination Date provided for in the Agreement.
The FERC order prohibits Allegheny/DQE from consummating the merger
until we divest the Cheswick electric generating plant. Given the complexity of
divesting a plant such as Cheswick, including the appropriate resolution of
operational and labor
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 4
issues, the process for auctioning the plant and negotiation of the associated
contractual arrangements, and the lead time for the associated regulatory
approvals, it is a practical impossibility that such a plant sale could close
prior to April 5, 1999. I note in this regard that the recent divestiture of
Duquesne's interest in the Ft. Martin plant to Allegheny took over one year to
complete, from commencement of due diligence to closing of the transaction.
In addition, the FERC order requires that, unless settlements can be
reached with all affected wholesale customers by October 16, 1998, a hearing
would commence on wholesale rate issues. To the extent such a hearing is
required, it would not, under normal and customary FERC procedures, be completed
prior to April 5, 1999. To date, Allegheny has made no representations or
statements to the effect that such a hearing can or will be avoided and, under
the circumstances, it is reasonable for DQE to assume that such a hearing will
be required.
I note that, in response to the FERC order, Allegheny has stated that,
instead of divesting Cheswick, the Cheswick property could be transferred
"irrevocably and permanently" to a trust that would operate and maintain the
plant and subsequently auction it to qualified bidders. This position, however,
conflicts with the FERC requirement that applicants either divest Cheswick or
proceed to a hearing on market power mitigation. Under these terms, Allegheny
could either proceed to hearing with its trust proposal or file a request for
clarification that its trust proposal qualifies as the equivalent of
divestiture. Instead, Allegheny simply asserted to FERC that its trust proposal
was a "method of divestiture" and stated that it would "file" the relevant
documents once the trust was in place. This is symptomatic of Allegheny's
pattern and practice of simply "asserting" rights and positions in both the
PaPUC and FERC proceedings, despite the fact that such positions had not been
explained or justified in any detail and that such positions related to highly
disputed issues between Allegheny/DQE and interested parties. In each instance,
these positions were rejected or modified in a manner adverse to Allegheny/DQE.
Moreover, even assuming the FERC were to consider the trust proposal
to qualify as a divestiture, it is a practical impossibility that such an
"irrevocable and permanent" transfer to a trust could be completed by April 5,
1998 because, prior to effecting such a transfer, Allegheny/DQE would need to
complete the same business arrangements associated with a divestiture, including
negotiating and executing agreements transferring legal title to the Cheswick
property, providing for the must-run status of the plant, apportioning
environmental and other liabilities between the parties, establishing
interconnec-
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 5
tion arrangements and services, and providing for access to transmission and
ancillary services.
In addition, because the trust would be responsible for operating and
maintaining the plant, Duquesne and the trustee would need to resolve adequately
all labor-related issues (e.g., treatment of union contracts, pension and
retirement benefits, severance agreements, and corporate support services) prior
to the transfer. A transfer to a trust also would require arrangements not
associated with a divestiture, including definitive agreements governing the
auction process, compensation and indemnification of the trustee,
representations, warranties and covenants regarding the prudent operation of the
plant prior to divestiture, and covenants and representations regarding the
commercial and organizational structure of the trust to assure the FERC that
market power would be mitigated prior to divestiture. The foregoing
arrangements would require substantially the same regulatory approvals as a
divestiture.
In sum, Allegheny's representation under Section 5.1(i) is no longer
true and correct because the FERC order prevents or otherwise materially burdens
or impairs consummation of the merger as contemplated by the Agreement. In
addition, because the FERC order constitutes a governmental order rendering
performance under the Agreement a practical impossibility, DQE has, in addition
to all the termination rights described herein, no further obligation to perform
under the Agreement.
Representation Under Section 5.1(e). DQE also has the right to
-----------------------------------
terminate the Agreement because the representations contained in Section 5.1(e)
are not true as of this date. Section 5.1(e) requires that Allegheny's reports
filed with the SEC "not contain any untrue statement of a material fact or omit
to state a material fact . . . necessary to make the statements made therein, in
light of the circumstances under which they were made, not misleading." This
representation is not true as of this date because, as described below, DQE
believes that Allegheny's statements regarding the nature and effect of the
PaPUC orders, a material matter, are not correct and are misleading.
The first such statement relates to the nature and effect of the PaPUC
condition that Allegheny/DQE divest 2500 MW of generating capacity unless they
can demonstrate, in a hearing to be held in January 2000, that market power has
been mitigated. In Allegheny's August 1998 second quarter report, however, you
informed shareholders that divestiture would be required only "in the unlikely
event that the [Midwest ISO] does not
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 6
have nonpancaked transmission rates in effect by June 30, 2000." This statement
was not correct at the time nor is it correct today.
While it is true that Allegheny proposed that the PaPUC order
divestiture only if "pancaked rates" were not eliminated, the PaPUC rejected
that limited condition in favor of a broad condition requiring applicants to
demonstrate whether market power had been mitigated irrespective of any single
factor, such as the elimination of pancaked rates. Indeed, Allegheny's own
consultant testified that, even if the Midwest ISO's transmission rate proposal
was adopted, it would not mitigate Allegheny/DQE's market power. The FERC has
subsequently confirmed this point, finding that "the rate pancaking alluded to
by Applicants will not be eliminated by any future reform of Midwest ISO
transmission pricing because the rate pancaking involves the assessment of
transmission charges by transmission providers that are not members of the
Midwest ISO." Consequently, it is clear that Allegheny's statements to
shareholders regarding a critical regulatory condition to closing this merger
are not correct and are misleading.
In addition, since the time that DQE raised its concerns regarding the
effect of the PaPUC determinations as to stranded cost recovery, Allegheny has
made misleading statements regarding its prospects for improving the level of
stranded cost recovery. These statements include, among others, misleading and
unreasonable predictions regarding the outcome of settlement negotiations and
the treatment of merger synergies. The statements described in this section
provide DQE the right, which it hereby exercises, to terminate the Agreement for
breach of the representation under Section 5.1(e).
Diligence and Good Faith Under Section 8.2(a)(iii). Section
--------------------------------------------------
8.2(a)(iii) provides that the Termination Date shall be extended to April 5,
1999 only if, among other things, "any Governmental Consent that has not yet
been obtained is being pursued diligently and in good faith." DQE has a right
to terminate the Agreement at this time under Section 8.2(a)(iii) because
Allegheny has not pursued, and is not pursuing, regulatory approvals with due
diligence or in good faith. As explained in previous correspondence, and as
discussed in other sections of this letter, Allegheny's regulatory proposals and
submissions as to stranded cost recovery and market power mitigation have
reflected, and continue to reflect, an absence of due diligence, good faith and
commercially reasonable action, giving DQE the right, which it hereby exercises,
to terminate the Agreement.
2. Termination Under Section 8.2(b). Section 8.2(b) provides that
--------------------------------
either party may terminate the Agreement if any Governmental Consents have been
obtained that
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 7
contain terms or conditions that would cause the conditions in Section 7.1(c)
not to be satisfied, including the condition that any such consents not
constitute a Material Adverse Effect. DQE has the right, which it hereby
exercises, to terminate the Agreement under Section 8.2(b) because, as indicated
in DQE's letter of July 28, 1998 and as discussed above, the PaPUC orders
respecting the merger and associated restructuring plans, which disallow a
combined $1.5 billion of the companies' stranded cost claim, constitute a
Material Adverse Effect. This disallowance represents 25% of the market equity
and 40% of the book value of the merged company. These effects are clearly
material and permit either party to terminate the merger agreement under Section
8.2(b), a right that DQE hereby exercises.
In addition to the foregoing, the PaPUC order is unacceptable with
respect to the conditions regarding market power mitigation for the reasons
stated in my letter of July 28, 1998 and in DQE's letter of August 24, 1998 to
the PaPUC. As described therein, the PaPUC order requires the merged company to
divest 2500 MW of generation unless it can show, in a hearing to commence in
January 2000, that the PaPUC's market power concerns have been mitigated by that
date. As recently confirmed by the FERC, this divestiture is virtually certain
to be required because nothing in the Midwest ISO, as proposed to and approved
by the FERC, will change market conditions to mitigate the concerns that caused
the PaPUC to adopt this condition.
Despite the likelihood of such a divestiture, there are no safeguards
in the PaPUC order to protect the companies from any resulting financial harm.
The financial exposure to the applicants is significant, as the PaPUC will have
the ability to select which plants are sold and which purchasers are eligible to
buy them. It can therefore reject the highest bid(s) and require the applicants
to accept less than fair market value for their assets. Even if fair market
value is received, our own testimony quantifies that value as far less than book
value. There is, however, no provision in the order for adjusting rates to
recover the associated stranded costs. In addition, the divestiture will
eliminate some or all generation-related merger synergies, thereby further
increasing the companies' financial exposure.
These substantial financial risks are not consistent with the
position, endorsed by both DQE and Allegheny at the January 1998 hearings, that
we must appreciate the nature and financial impact of any market power
mitigation conditions prior to closing. Yet, despite this, Allegheny has not
explained to DQE why it has now changed course and informed the PaPUC that it
will accept these conditions. In fact, to the con-
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 8
trary, Allegheny has made false and misleading statements to shareholders
regarding the nature and scope of these conditions.
3. Termination Under Section 8.3(b)(ii). Section 8.3(b)(ii) provides
------------------------------------
that DQE may terminate the Agreement if there has been a material breach by
Allegheny of any representation, warranty or covenant contained in the
Agreement. DQE hereby terminates the Agreement under Section 8.3(b)(ii) for
breach of the representations discussed above and, in addition, because
Allegheny has breached the covenant in Section 6.5(c) to use "all commercially
reasonable efforts . . . to obtain as promptly as practicable all permits,
consents, approvals and authorizations . . . necessary or advisable . . . to
consummate the Merger." DQE has explained in prior correspondence the numerous
instances in which this covenant has been breached. DQE will therefore only
summarize the more notable breaches of this covenant below.
Stranded Cost Recovery. With respect to the PaPUC proceedings,
----------------------
Allegheny has pursued, contrary to our advice, an unreasonable strategy with
respect to stranded cost recovery. This strategy consisted of an unreasonable
and inadequate defense of Allegheny's claim for an administrative determination
of stranded costs. This claim was expected to, and did, fail because the PaPUC,
as in every other restructuring case, rejected the utility's claim regarding
stranded cost recovery and accepted, with certain modifications, the claim of
the Office of Consumer Advocate ("OCA"). Allegheny's defense of its claim was
particularly inadequate, with the PaPUC finding that Allegheny was simply "too
busy" to defend and preserve critical elements of that claim in an adequate,
timely manner. Such a finding, on its face, constitutes a failure to use
commercially reasonable efforts to obtain the authorizations advisable to
consummate the merger.
Allegheny also was unreasonable in failing to protect against such
adverse effects by agreeing, as an alternative to an administrative
determination, to establish stranded costs through a generation auction plan of
the kind filed by Duquesne and approved by the PaPUC. DQE urged Allegheny to
authorize such an auction plan in January 1998 following the Commission's
decision in the PECO restructuring case, the point at which it became clear that
our other proposals, including as to an administrative determination of stranded
costs, would not be accepted by the PaPUC. You stated, in a meeting with me on
January 12, 1998, that you agreed with the "compelling rationale" for such an
auction, but were not prepared to offer such an auction at that time because
management had an "emotional" attachment to West Penn's generation plants. You
promised, however,
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 9
that if settlement negotiations did not succeed during January and February
(prior to issuance of an ALJ decision), you would authorize the filing of such
an auction plan.
When these negotiations failed, on March 5, 1998 DQE forwarded an
auction proposal, including testimony and a motion to reopen the record in the
merger case, to Allegheny for its approval. Allegheny did not, however,
authorize the filing of this proposal at that time or at any time thereafter.
In each instance, Allegheny's officers and attorneys contended that such an
auction proposal would detract from consideration of Allegheny's administrative
claim. The failure to secure approval for an auction has caused Allegheny/DQE
to suffer a $1.2 billion disallowance that could otherwise have been avoided.
The foregoing conduct was commercially unreasonable and, in DQE's
view, also demonstrated a lack of good faith. It now appears, based on recent
correspondence, that during the entire period (January-May 1998) in which
Allegheny was telling DQE that it would offer Duquesne's auction plan as a last
resort, you had never secured authorization from Allegheny's board to submit
such a plan. In recent letters, you have informed me that the Allegheny board,
at an unspecified date, rejected such an auction plan. Given the nature and
course of events during this period, DQE has the right, which it hereby
exercises, to terminate the Agreement for breach of the implied covenant of good
faith and fair dealing.
Finally, I note that, even were Allegheny to be excused for failing to
protect shareholders through such an auction and the favorable results to
Duquesne under its auction plan were ignored, the disallowances associated with
the administrative determination of stranded costs permit DQE to terminate the
Agreement in any event. As indicated, the total disallowance to the merged
company ($1.5 billion, of which $1.2 billion is due to the administrative
determination) is more than sufficient to constitute a Material Adverse Effect
under Section 7.1(c), thereby providing DQE the right to terminate the
Agreement. In addition, even were it relevant to compare the relative
disallowances to Allegheny and DQE under the administrative determination of
stranded costs, Allegheny has conceded that Duquesne received a superior result.
This concession was evident in your repeated statements to DQE that, because of
the favorable result to DQE under its administrative determination of stranded
costs, no appeal of that order would be taken upon consummation of the merger.
By contrast, Allegheny has continued to appeal its own stranded cost
disallowance, claiming that it will cause severe financial harm. Thus, by your
own admission, the adverse effects of the administrative determination of
stranded costs on Alle-
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 10
gheny exceed the effects on DQE, giving DQE the right, which it hereby
exercises, to terminate the Agreement on the foregoing ground as well.
Market Power Mitigation. In addition to stranded cost recovery,
-----------------------
Allegheny has pursued a commercially unreasonable course of conduct with respect
to proposals to mitigate market power. On April 30, 1998, the PaPUC issued a
draft order (later finalized on May 29, 1998) prohibiting Allegheny/DQE from
closing the merger until we could demonstrate that an "independent system
operator" for the regional transmission grid had become operational and had
satisfied a range of conditions relating to market power mitigation. In
response to this order, both companies took the position publicly that the
significant delays associated with satisfying such a condition could not be
satisfied by April 5, 1999 and therefore would cause the merger to fail.
In response to the realization that the merger would likely fail
unless reasonable alternative mitigation measures were proposed, our companies
commenced discussions regarding the appropriate response. Allegheny determined
that it would propose, both to the PaPUC and the FERC, an "interim" market power
mitigation measure that would allow the merger to close if we sold 570 MW of
output from the Cheswick plant into the market. Allegheny submitted this
proposal to the FERC on June 5, 1998 and later to the PaPUC (along with other
proposals). Prior to submission of that proposal, DQE informed Allegheny on
June 4 that this interim mitigation proposal was destined to fail because the
sale of Cheswick capacity was structured in a manner that did not correspond to
the very assumptions regarding its mitigative effects contained in our
economist's (Dr. Pifer) testimony on market power. Dr. Pifer assumed that the
Cheswick capacity would be sold to eleven different purchasers that did not own
any capacity in the relevant market, yet the RFP for the sale of that capacity
submitted to FERC did not require any such result. Because of these obvious and
fatal defects, DQE urged Allegheny to abandon or significantly modify this
proposal, concluding that it was "commercially unreasonable and highly likely to
fail to secure" FERC approval.
Despite our objection, Allegheny filed the proposal in any event and
the FERC, as expected, has now rejected it. The FERC found, as expected, that
"Applicants themselves acknowledge that all the output of the Cheswick
Generating Station may not be sold under their short-term sales proposal."
Because of this, the FERC required Allegheny/DQE to divest the Cheswick plant
prior to consummation of the merger, given that there otherwise "would be no
effective interim mitigation measures in place prior to such time."
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 11
I also note that for similar reasons the PaPUC rejected Allegheny's
mitigation proposals, including the 570 MW sale, as being insufficient to
address its market power concerns. Rather, as indicated, the PaPUC adopted the
open-ended 2500 MW divestiture condition that has the adverse effects described
above. The adverse responses from the PaPUC and FERC as to these mitigation
proposals were due entirely to Allegheny's lack of due diligence, good faith and
commercially reasonable efforts to propose adequate mitigation measures.
Regrettably, since the issuance of the FERC order, Allegheny has
continued to take positions that reflect an absence of due diligence, good
faith, or commercial reasonableness. As discussed above, Allegheny has now
submitted a "trust" arrangement whereby the Cheswick plant would be transferred
to a trustee that would operate and maintain the plant and subsequently auction
it. Allegheny submitted its trust proposal without prior notice to or
consultation with DQE, much less, as required, in cooperation with DQE.
Allegheny's lawyers simply forwarded a signed letter containing such proposal
with a note that it was "being filed" with FERC that same day. Given that this
proposal concerned the disposition of Duquesne's generating assets, the proposal
also violated the covenant that Allegheny not make any characterizations
relating to DQE and its subsidiaries without DQE's prior consent.
Finally, the vagueness of the trust proposal reflected, as discussed
above, an absence of due diligence, good faith or commercially reasonable
conduct. The proposal is a two-page recitation of position that does not
address, among other things, the manner in which labor issues would be addressed
given the existence of the union contract, does not address the manner in which
system reliability would be maintained given the must-run status of the Cheswick
plant, does not address the manner in which Allegheny/DQE would be protected
from liability, whether environmental or otherwise, that could arise during the
period when the trustee was operating the plant, does not address the trust's
responsibilities to auction the plant in a commercially reasonable manner, does
not address fundamental issues relating to organizational structure that would
be a prerequisite to any FERC approval of such a trust arrangement, and does not
address any of the regulatory approvals that would be required before such a
trust arrangement could be implemented. Each of these issues should have been
considered, discussed and resolved between Allegheny and DQE prior to submission
of any such position to ensure that the proposal (assuming the FERC were even to
consider it) could be accomplished in a commercially
<PAGE>
Mr. Alan J. Noia
October 5, 1998
Page 12
reasonable manner that protects shareholders and fully satisfies the FERC's
market power concerns.
In sum, Allegheny's conduct has, and continues to, reflect an absence
of good faith, due diligence and commercially reasonable action, giving DQE the
right, which it hereby exercises, to terminate the Agreement.
For the foregoing reasons, as supplemented by DQE's previous letters
to Allegheny regarding these same matters, DQE hereby terminates the Agreement.
This unilateral termination is necessary because Allegheny declined DQE's
earlier offer to terminate the agreement by mutual consent. Having done so,
Allegheny has now exposed itself to liability for its breach of the Agreement as
described herein. Please be assured that, if circumstances warrant, DQE will
fully exercise its legal rights with respect to these violations of the
Agreement.
Sincerely,
/s/David
Attachment
cc: Thomas K. Henderson
Joseph B. Frumkin
<PAGE>
EXHIBIT A
July 28, 1998
Mr. Alan J. Noia
Chairman, President and Chief Executive Officer
Allegheny Energy, Inc.
10435 Downsville Pike
Hagerstown, MD 21740-1766
Dear Al:
Having reviewed the PaPUC's orders regarding the proposed merger and
associated restructuring plans, DQE's Board of Directors today determined that
the findings contained therein will result in a failure of the conditions to
DQE's obligation to consummate the merger. Specifically, the findings
constitute a material adverse effect under the Agreement and Plan of Merger.
Under the merger agreement, DQE is not required to consummate the merger under
these circumstances and we do not intend to do so.
The PaPUC order on West Penn's restructuring plan disallows approximately
$1 billion in stranded costs. $830 million of that amount relates to the
administrative determination of market value adopted by the PaPUC. Allegheny
has testified that this disallowance will cause severe financial harm.
Duquesne's restructuring plan, by contrast, permits recovery of all but
$140 million of Duquesne's stranded costs. The positive results associated with
this plan are due to the PaPUC's acceptance of divestiture as the means for
determining Duquesne's generation-related stranded costs. All customer
representatives, including the City of Pittsburgh, the Office of Consumer
Advocate, the Industrial Intervenors, and the PaPUC Trial Staff, strongly
supported this proposal as the fairest method for determining and mitigating
stranded costs.
In April 1997, when DQE and Allegheny entered into the merger agreement,
Pennsylvania had recently adopted the Customer Choice Act, which required both
Duquesne and West Penn to file restructuring plans to recover their stranded
costs. The merger agreement provided for the possibility that the PaPUC orders
could adversely affect one company such that the other would not be obligated to
close the transaction. That, unfortunately, has now occurred. DQE cannot,
under these circumstances, proceed with the transaction.
<PAGE>
Mr. Alan J. Noia
July 28, 1998
Page 2
It also is relevant that, in addition to the disallowances incurred by West
Penn, Duquesne would incur an additional $370 million disallowance if the merger
were to be consummated. Together, the stranded cost disallowances applicable to
the merged company under the merger restructuring plan would total $1.5 billion.
Of that amount, $1.2 billion would represent the disallowances associated with
the PaPUC's administrative determination of stranded costs ($830 million for
West Penn; $370 million for Duquesne).
DQE also does not accept the market power mitigation conditions contained
in the PaPUC's July 23, 1998 order on reconsideration. The conditions institute
another trial at the PaPUC on market power in January 2000. The PaPUC will have
the authority, at the conclusion of the trial, to order 2500 MW of divestiture
and to exercise authority over which plants are sold and which purchasers are
eligible to bid on them. This is particularly troublesome given that, once the
plants are sold, there is no provision for adjusting the companies' stranded
cost recovery, including for generation synergies foregone as a result of the
divestiture. Both companies have previously stated that a merger approval
containing such an open-ended condition would be unacceptable.
In consideration of the foregoing, DQE's Board of Directors has concluded
that it cannot, consistent with its fiduciary duty to shareholders, consummate
the merger under these circumstances.
Having now received final PaPUC orders, DQE believes that it currently has
the right to terminate the agreement unilaterally on several grounds. However,
in view of the considerable efforts that both companies have spent on this
project, and out of respect for you and Allegheny's Board of Directors, we
invite Allegheny to join with us in promptly agreeing to a termination by mutual
consent. Such a mutual termination would permit both companies to return to
business in the ordinary course and devote their full attention to a timely
implementation of retail choice in Pennsylvania while avoiding the distractions
that could be associated with a unilateral termination. In the event, however,
that Allegheny is not willing to consider such a termination by mutual consent,
please be advised that DQE will exercise its right to terminate the agreement
unilaterally not later than the October 5, 1998 date set forth in Section 8.2 if
circumstances do not change sufficiently to remedy the adverse effects described
above.
Consistent with its obligations under the securities laws, DQE will
disclose this letter publicly.
Sincerely,
/s/David
