Note 9: Commitments and Contingencies

Commitments

On March 29, 2016, Pennsylvania-American Water Company (“PAWC”) entered into an asset purchase agreement with the Sewer Authority of the City of Scranton (“SSA”) to acquire substantially all of the wastewater collection and treatment system assets of the SSA’s system for a total stated purchase price of $195, which includes approximately $38 in assumed cash to be transferred at closing. The SSA is currently subject to a consent decree with the U.S. Environmental Protection Agency (“EPA”) and the Pennsylvania Department of Environmental Protection (“PaDEP”), which requires the SSA to complete significant upgrades to its sewer system at an estimated cost of $140. As a part of the purchase, PAWC will be required to cause the consent decree to be amended to allow it to assume the obligations and liabilities of the SSA thereunder. The Pennsylvania Public Utility Commission approved the acquisition on October 6, 2016 and will determine recovery of the investment and the related ratemaking treatment in PAWC’s next general rate case proceeding. The amendment of the consent decree is subject to the consent of the EPA, PaDEP, the U.S. Department of Justice and the U.S. District Court for the Middle District of Pennsylvania. The Company is working to close this transaction in the fourth quarter of 2016.

Contingencies

The Company is routinely involved in legal actions in the normal conduct of its business. As of September 30, 2016, the Company has accrued approximately $136 of probable loss contingencies and has estimated that the maximum amount of losses associated with reasonably possible loss contingencies is $48. For certain matters, the Company is unable to estimate possible losses.

West Virginia Elk River Freedom Industries Chemical Spill

Background

On January 9, 2014, a chemical storage tank owned by Freedom Industries, Inc. leaked two substances, 4-methylcyclohexane methanol, or MCHM, and PPH/DiPPH, a mix of polyglycol ethers, into the Elk River near the West Virginia-American Water Company (“WVAWC”) Kanawha Valley Treatment Plant (“KVTP”) intake in Charleston, West Virginia. After having been alerted to the leak of MCHM by the West Virginia Department of Environmental Protection, WVAWC took immediate steps to gather more information about MCHM, augment its treatment process as a precaution, and begin consultations with federal, state and local public health officials. As soon as possible after it was determined that the augmented treatment process would not fully remove the MCHM, a joint decision was reached in consultation with the West Virginia Bureau for Public Health to issue a “Do Not Use” order for all of its approximately 93,000 customer accounts in parts of nine West Virginia counties served by the KVTP. The order addressed the use of water for drinking, cooking, washing and bathing, but did not affect continued use of water for sanitation and fire protection. Over the next several days, WVAWC and an interagency team of state and federal officials engaged in extensive sampling and testing to determine if levels of MCHM were below one part per million (1 ppm), a level that the U.S. Centers for Disease Control and Prevention (“CDC”) and the EPA indicated would be protective of public health. Beginning on January 13, 2014, based on the results of the continued testing, the Do Not Use order was lifted in stages to help ensure the water system was not overwhelmed by excessive demand, which could have caused additional water quality and service issues. By January 18, 2014, none of WVAWC’s customers were subject to the Do Not Use order, although CDC guidance suggesting that pregnant women avoid consuming the water until the chemicals were at non-detectable levels remained in place. In addition, based on saved samples taken on or before January 18, 2014, PPH/DiPPH was no longer detected in the water supply as of January 18, 2014. On February 21, 2014, WVAWC announced that all points of testing throughout its water distribution system indicated that levels of MCHM were below 10 parts per billion (10 ppb). The interagency team established 10 ppb as the “non-detect” level of MCHM in the water distribution system based on the measurement capabilities of the multiple laboratories used. WVAWC continued to work with laboratories to test down to below 2 ppb of MCHM and announced on March 3, 2014, that it had cleared the system to below this level.

To date, there are 73 pending cases against WVAWC with respect to this matter in the U.S. District Court for the Southern District of West Virginia or West Virginia Circuit Courts in Kanawha, Boone and Putnam counties. Fifty-three of the state court cases naming WVAWC, and one case naming both WVAWC and American Water Works Service Company, Inc. (“AWWSC,” and together with WVAWC and the Company, the “American Water Defendants”) were removed to the United States District Court for the Southern District of West Virginia. On December 17, 2015, the federal district court entered orders remanding 52 of the previously removed cases back to the West Virginia Circuit Courts for further proceedings (two of the previously removed cases had been dismissed in the interim). Following that order, seven additional cases were filed against WVAWC in West Virginia Circuit Courts in Kanawha and Putnam counties with respect to this matter, and, as discussed below, on September 16, 2016, four new individual complaints were filed against WVAWC in West Virginia Circuit Court in Kanawha County.

Additionally, investigations with respect to the matter have been initiated by, among other agencies, the U.S. Attorney’s Office for the Southern District of West Virginia, the West Virginia Attorney General, and the Public Service Commission of West Virginia (the “PSC”). As a result of the U.S. Attorney’s Office investigation, Freedom Industries and six former Freedom Industries employees (three of whom also were former owners of Freedom Industries) pled guilty to violations of the federal Clean Water Act.

The Company believes that the causes of action asserted against the American Water Defendants in these cases are without merit. A summary of the proceedings associated with the Freedom chemical spill is set forth below.

Federal Court Litigation

Four of the cases pending before the federal district court were consolidated for purposes of discovery, and an amended consolidated class action complaint for those cases (the “Federal action”) was filed on December 9, 2014 by several plaintiffs who allegedly suffered economic losses, loss of use of property and tap water or other specified adverse consequences as a result of the Freedom Industries chemical spill, on behalf of a purported class of all persons and businesses supplied with, using, or exposed to water contaminated with crude MCHM and provided by WVAWC in Logan, Clay, Lincoln, Roane, Jackson, Boone, Putnam, and Kanawha Counties and the Culloden area of Cabell County, West Virginia as of January 9, 2014. The amended consolidated complaint names several individuals and corporate entities as defendants, including the American Water Defendants.

The plaintiffs seek unspecified damages for alleged business or economic losses; unspecified damages or a mechanism for recovery to address a variety of alleged costs, loss of use of property, personal injury and other consequences allegedly suffered by purported class members; punitive damages and certain additional relief, including the establishment of a medical monitoring program to protect the purported class members from an alleged increased risk of contracting serious latent disease.

On April 9, 2015, the court in the Federal action denied a motion to dismiss all claims against the Company for lack of personal jurisdiction. A separate motion to dismiss filed by AWWSC and WVAWC (and joined by the Company) asserting various legal defenses in the Federal action was resolved by the court on June 3, 2015. The court dismissed three causes of action but denied the motion to dismiss with respect to the remaining causes of actions and allowed the plaintiffs to continue to pursue the various claims for damages alleged in their amended consolidated complaint.

On July 6, 2015, the plaintiffs in the Federal action filed a motion seeking certification of a class defined to include persons who resided in dwellings served by the KVTP on January 9, 2014, persons who owned businesses served by the KVTP on January 9, 2014, and hourly employees who worked for such businesses. The plaintiffs sought a class-wide determination of liability against the American Water Defendants, among others, and of damages to the three groups of plaintiffs as a result of the “Do Not Use” order issued after the Freedom Industries chemical spill.

On October 8, 2015, the court in the Federal action granted in part and denied in part the plaintiffs’ class certification motion. The court certified a class addressing the alleged fault of Eastman Chemical Company, the manufacturer of MCHM, for tort claims and the alleged fault of the American Water Defendants for tort and breach of contract claims, as well as the comparative fault of Freedom Industries. However, the court granted the joint motion by defendants to exclude certain expert testimony, disallowing the testimony of plaintiffs’ economic damages experts, and denied class certification as to any damages, including punitive damages. Thus, determination or quantification of damages, if any, would be made in subsequent proceedings on an individual basis.

On December 17, 2015, the court in the Federal action originally entered a scheduling order that provided for the trial on class issues to begin in July 2016. During the first week of January 2016, three additional cases were filed against one or more of the American Water Defendants, as well as others, in the U.S. District Court for the Southern District of West Virginia with respect to this matter. On March 25, 2016, the court in the Federal action entered an order extending the schedule for events through briefing related to dispositive motions and expert challenges and noting that further events in the case would be set by additional orders to be issued by the court in due course. On May 10, 2016, each of the parties in the Federal action filed motions for summary judgment and motions to exclude experts, followed by responses on June 3, 2016 and final reply memoranda on June 16, 2016. On July 7, 2016, the court in the Federal action rescheduled the trial to begin on October 25, 2016, but the court delayed the start of the trial pending ongoing settlement negotiations between the parties, and has since granted a continuance of the trial until December 5, 2016. See “ – WVAWC Binding Global Agreement in Principle to Settle Claims” below.

Court-directed mediations were held at the end of September 2015 and June 2016 with the assistance of private mediators. Representatives of the American Water Defendants, Eastman Chemical, and the plaintiffs in both the Federal action and the state actions, as well as insurance carriers for certain of the defendants, participated in these mediation sessions. No resolution was reached.

On September 26, 2016, the court in the Federal action granted the Company’s motion for summary judgment and its renewed motion to dismiss all claims against it for lack of personal jurisdiction. The court in the Federal action examined the factual claims asserted by the plaintiffs and held that the plaintiffs failed to provide any evidence that the Company committed a tortious act in connection with the Freedom Industries chemical spill. Also, the court in the Federal action held that it had no personal jurisdiction over the Company, since there was no evidence of a tortious act, and the relationship between the Company and WVAWC was that of a typical parent and subsidiary. As a result of this decision, the Company is no longer a defendant in the Federal action, although the plaintiffs’ claims against AWWSC and WVAWC remain.

On September 27, 2016, the court in the Federal action denied competing motions filed by the plaintiffs and WVAWC for summary judgment on the plaintiffs’ breach of contract claims against WVAWC. The court in the Federal action stated that the implementation of the Do Not Use order and the delivery of water containing MCHM subject to such an order constituted a breach of WVAWC’s contract with customers. However, the court denied the plaintiffs’ motion for summary judgment because the court identified genuine issues of fact to be decided by a jury with respect to WVAWC’s assertion that its contractual performance was impracticable due to the lack of available information as to the contaminants in the water after the Freedom Industries chemical spill, the unexpected nature of Freedom Industries’ criminal negligence and the resulting contamination of the water supply, and WVAWC’s lack of fault for Freedom Industries’ actions in causing the chemical spill.

On October 6, 2016, the court in the Federal action granted the American Water Defendants’ motion for summary judgment related to the members of the class comprised of hourly employees who worked for businesses served by the KVTP on January 9, 2014. The court stated that these class members, who were not customers of WVAWC, did not have a “sufficiently close nexus” to WVAWC to give rise to a “special relationship” that would allow them to recover lost wages absent physical injury or property damage. This ruling does not impact the remaining class members.

On October 25, 2016, the court in the Federal action dismissed all claims against AWWSC, leaving WVAWC as the remaining American Water Defendant in the lawsuit.

West Virginia State Court Litigation

On January 28, 2016, all of the then-filed state court cases were referred to West Virginia’s Mass Litigation Panel for further proceedings. On June 6, 2016, plaintiffs filed a second amended consolidated class action complaint. The second amended consolidated class action complaint names only WVAWC as a defendant and alleges claims of, among other things, negligence, public and private nuisance, trespass, strict liability for abnormally dangerous activity, breach of contract, breach of statutory implied warranty, violation of the West Virginia Consumer Credit Protection Act, strict liability for failure to warn, negligent infliction of emotional distress, medical monitoring and punitive damages. On July 6, 2016, the defendants filed an answer in response to these claims. On July 25, 2016, plaintiffs filed a class certification motion seeking certification for liability and damage classes, including businesses and residents who were customers of the KVTP on January 9, 2014, all West Virginia persons who suffered wage loss as a result of the Freedom Industries chemical spill and personal injury and medical monitoring for West Virginia residents within the affected counties that were exposed to contaminated water as a result of the chemical spill.

On September 14, 2016, WVAWC filed a motion to dismiss the second amended consolidated class action complaint. On September 16, 2016, four new individual complaints were filed in West Virginia Circuit Court in Kanawha County stating the same claims as in the second amended consolidated class action complaint but also seeking a judicial determination as to whether the American Water Defendants and Eastman Chemical have insurance coverage under their respective policies for the claims asserted in the complaints. Plaintiffs have also sought to transfer these complaints to the Mass Litigation Panel. The complaints include as defendants all of the insurance carriers identified by Eastman Chemical and the American Water Defendants. West Virginia law generally permits plaintiffs in civil litigation to seek a determination as to whether insurance coverage exists for claims prior to trial on the merits. The American Water Defendants are currently analyzing and considering their responses to the allegations and claims raised in these four complaints.

WVAWC Binding Global Agreement in Principle to Settle Claims

On October 31, 2016, the court in the Federal action approved the preliminary principles, terms and conditions of an agreed-upon settlement of claims (the “Settlement”) among the American Water Defendants, and all class members, putative class members, claimants and potential claimants (collectively, the “Plaintiffs”), arising out of the Freedom Industries chemical spill. The terms of the Settlement propose a global federal and state resolution of all litigation and potential claims against the American Water Defendants and their insurers. A claimant may elect to opt out of any final settlement agreement, in which case such claimant will not receive any benefit from or be bound by the terms of the Settlement. Under the terms and conditions of the Settlement and any subsequent final settlement agreement, the American Water Defendants have not admitted, and will not admit, any fault or liability for any of the allegations made by the Plaintiffs in any of the actions to be resolved.

The proposed aggregate pre-tax amount of the Settlement is $126, of which $65 would be paid by WVAWC, and the remainder would be paid by certain of the Company’s general liability insurance carriers. The Company has general liability insurance under a series of policies underwritten by a number of individual carriers. Two of these insurance carriers, which provide an aggregate of $50 in insurance coverage to the Company under these policies, were requested, but presently have not agreed, to participate in the Settlement. The Company and WVAWC intend to vigorously pursue their rights to insurance coverage from these non-participating carriers for any losses to be paid by WVAWC in the Settlement. In this regard, WVAWC has filed a lawsuit against one of these carriers alleging that the carrier’s failure to agree to participate in the Settlement constitutes a breach of contract, and the Company will pursue mandatory arbitration against the other non-participating carrier.

As a result of these events, WVAWC has determined that a loss contingency with respect to this matter is probable and in the third quarter of 2016 recorded a charge to earnings of $65 ($39 after-tax), comprised of the aggregate pre-tax settlement amount of $126, net of insurance receivables of $61. Furthermore, under the terms of the Settlement, WVAWC has agreed that it will not seek rate recovery from the Public Service Commission of West Virginia for approximately $4 in direct response costs expensed in 2014 by WVAWC relating to the Freedom Industries chemical spill as well as for amounts that may be paid by WVAWC under the Settlement.

The preliminary terms of the Settlement intend to establish a two-tier settlement fund for the payment of claims, comprised of (i) a guaranteed fund of $76, of which $51 will be contributed by WVAWC, including insurance deductibles, and $25 would be contributed by one of the Company’s general liability insurance carriers, and (ii) a claims-based payment fund of up to $50, of which up to $14 would be contributed by WVAWC and $36 would be contributed by a number of the Company’s general liability insurance carriers. Separately, $25 would be contributed to the guaranteed fund through a settlement by another defendant to the Settlement.

The Company’s insurance policies operate under a layered structure where coverage is generally provided in the upper layers after claims have exhausted lower layers of coverage. The $36 contributed by a number of the Company’s general liability insurance carriers to the claims-based fund, as noted above, were from higher layers of the insurance structure than the two insurance carriers that were requested, but presently have not agreed, to participate in the Settlement. Any recovery by WVAWC or the Company from the non-participating carriers would reimburse WVAWC for its contributions to the guaranteed fund.

The court in the Federal action has given the parties 30 days to finalize, and obtain the court’s preliminary approval of, the terms of the Settlement. As a result, the court in the Federal action has ordered a continuance of the trial date to December 5, 2016. If preliminary approval of the Settlement is obtained, notice of the terms of the Settlement would then be provided to members of the settlement class. Following the notice period, the court in the Federal action would hold a fairness hearing to consider final approval of the Settlement.

PSC General Investigation

On May 21, 2014, the PSC issued an Order initiating a General Investigation into certain matters relating to WVAWC's response to the Freedom Industries chemical spill. Three parties have intervened in the proceeding, including the Consumer Advocate Division of the PSC and two attorney-sponsored groups, including one sponsored by some of the plaintiffs’ counsel involved in the civil litigation described above. WVAWC has filed testimony regarding its response to the Freedom Industries chemical spill and is subject to discovery from PSC staff and the intervenors as part of the General Investigation. Several disputes have arisen between WVAWC and the intervenors regarding, among other things, the scope of the discovery and the maintenance of confidentiality with regard to certain WVAWC emergency planning documents. In addition, the intervenors and PSC staff filed expert testimony in support of their assertions that WVAWC did not act reasonably with respect to the Freedom Industries chemical spill, and WVAWC has asserted that some of the testimony is outside the scope of the PSC proceeding. On May 23, 2016, the PSC entered an order setting a procedural schedule and ruling on outstanding motions related to discovery and the scope of testimony. On October 13, 2016, the PSC entered an order continuing the General Investigation hearings until December 2016. On October 18, 2016, an intervening party in the case requested, with no parties objecting, that the hearings be further continued until the first quarter of 2017.

Missouri Infrastructure System Replacement Surcharge Litigation

On March 8, 2016, the Western District of the Missouri Court of Appeals ruled that the Missouri Public Service Commission (“MoPSC”) did not have statutory authority to issue an order in June 2015 approving an infrastructure system replacement surcharge (“ISRS”) for Missouri-American Water Company (“MAWC”), a wholly owned subsidiary of the Company. The court held that the MoPSC’s June 2015 order authorizing the ISRS increase was invalid because St. Louis County did not have a population of at least one million residents, as required by the statute. MAWC believes that the MoPSC’s June 2015 order authorizing the collection of ISRS revenues was lawful and will continue to challenge the ruling of the Court of Appeals. On June 28, 2016, the Missouri Supreme Court granted MAWC’s application to transfer the case from the Court of Appeals to the Missouri Supreme Court, and as a result of that order, the March 8, 2016 ruling of the Court of Appeals has been vacated. Oral argument in this case was heard on November 1, 2016. As of September 30, 2016, the Company has determined the range of reasonably possible loss associated with this matter to be zero to $26.

Other than as described in the “Contingencies” subsection of this Note 9, the Company believes that damages or settlements to be paid by the Company, if any, in claims or actions will not, individually or in the aggregate, have a material adverse effect on the Company.