Turf War Update: Sixth Circuit Weighs In on Dispute Between Bankruptcy Courts and FERC Over Rejection of Power Contracts
The recent chapter 11 filings by PG&E Corp. and its Pacific Gas & Electric Co. utility subsidiary (collectively, "PG&E") and FirstEnergy Solutions Corp. reignited the debate over the power of a U.S. bankruptcy court to authorize the rejection of contracts regulated by the Federal Energy Regulatory Commission ("FERC"). Only a handful of courts have addressed this thorny issue to date, and with conflicting results, in a controversy that may ultimately need to be resolved by the U.S. Supreme Court or legislative action. The crux of the problem lies in seemingly conflicting jurisdiction conferred by the Bankruptcy Code, 11 U.S.C. §§ 101 et seq., and related statutes upon bankruptcy courts to authorize the rejection of burdensome contracts, on the one hand, and by the Federal Power Act, 16 U.S.C. §§ 791a et seq. (the "FPA"), upon FERC, which is granted the "exclusive authority" to determine the reasonableness of interstate utility rates, on the other.
The U.S. Court of Appeals for the Sixth Circuit is the most recent court to weigh in on the debate, and only the second court of appeals to do so. In FERC v. FirstEnergy Solutions Corp. (In re FirstEnergy Solutions Corp.), 945 F.3d 431 (6th Cir. 2019), a divided panel of the Sixth Circuit ruled that, although the bankruptcy court had "concurrent" jurisdiction to decide whether chapter 11 debtors could reject certain FERC-regulated wholesale power contracts, the bankruptcy court exceeded its jurisdiction by enjoining FERC from requiring the debtors to continue performing under the contracts or from taking any other actions in connection with them. The Sixth Circuit also held that the bankruptcy court incorrectly applied the "business-judgment" standard to the debtors' request to reject the contracts. According to the Sixth Circuit:
[W]hen a Chapter 11 debtor moves the bankruptcy court for permission to reject a filed energy contract that is otherwise governed by FERC, via the FPA, the bankruptcy court must consider the public interest and ensure that the equities balance in favor of rejecting the contract, and it must invite FERC to participate and provide an opinion in accordance with the ordinary FPA approach … within a reasonable time.
Bankruptcy Jurisdiction and Rejection of Executory Contracts
By statute, U.S. district courts are given "original and exclusive" jurisdiction over every bankruptcy "case." 28 U.S.C. § 1334(a). In addition, they are conferred with nonexclusive jurisdiction over all "proceedings arising under" the Bankruptcy Code as well as those "arising in or related to cases under" the Bankruptcy Code. 28 U.S.C. § 1334(b). Finally, district courts are granted exclusive jurisdiction over all property of a debtor's bankruptcy estate, including, as relevant here, contracts, leases, and other agreements that are still in force when a debtor files for bankruptcy protection. 28 U.S.C. § 1334(e). That jurisdiction typically devolves automatically upon the bankruptcy courts, each of which is a unit of a district court, by standing court order. 28 U.S.C. § 157(a).
A bankruptcy court's exclusive jurisdiction over "executory" contracts or unexpired leases empowers it to authorize a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to either "assume" (reaffirm) or "reject" (breach) almost any executory contract or unexpired lease during the course of a bankruptcy case in accordance with the provisions of section 365 of the Bankruptcy Code. Assumption generally allows the DIP to continue performing under the agreement, after curing outstanding defaults, or to assign the agreement to a third party for consideration as a means of generating value for the bankruptcy estate. Rejection frees the DIP from rendering performance under an unfavorable contract. Rejection constitutes a breach of the contract, and the resulting claim for damages is deemed to be a prepetition claim against the estate on a par with other general unsecured claims. See 11 U.S.C. § 365(g).
The power granted to debtors by Congress under section 365 is viewed as vital to the reorganization process. Rejection of a contract "can release the debtor's estate from burdensome obligations that can impede a successful reorganization." N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 528 (1984) (holding that rejection is allowed for "all executory contracts except those expressly exempted"). Typically, bankruptcy courts authorize the proposed assumption or rejection of a contract or lease if it is demonstrated that the proposed course of action represents an exercise of sound business judgment. This is a highly deferential standard akin in many respects to the business-judgment rule applied to corporate fiduciaries.
-The Federal Power Act, the Filed-Rate Doctrine, and the Mobile-Sierra Doctrine
Public and privately operated utilities providing interstate utility service within the United States are regulated by the FPA under FERC's supervision. Although contract rates for electricity are privately negotiated, those rates must be filed with FERC and certified as "just and reasonable" in order to be lawful. 16 U.S.C. § 824d(a). FERC has the "exclusive authority" to determine the reasonableness of the rates. See In re Calpine Corp., 337 B.R. 27, 32 (S.D.N.Y. 2006). The FPA authorizes FERC, after a hearing, to alter filed rates if it determines that they are unjust or unreasonable. 16 U.S.C. § 824e.
On the basis of this statutory mandate, courts have developed the "filed-rate doctrine," which provides that "a utility's right to a reasonable rate under the FPA is the right to the rate which the FERC files or fixes and, except for review of FERC orders, a court cannot provide a right to a different rate." Calpine, 337 B.R. at 32. Moreover, the doctrine prohibits any collateral attack in the courts on the reasonableness of rates—the sole forum for such a challenge is FERC. Id. Applying the doctrine, some courts have concluded that, once filed with FERC, a wholesale power contract is tantamount to a federal regulation, and the duty to perform under the contract comes not only from the agreement itself, but also from FERC. Id. at 33 (citing Pa. Water & Power Comm'n v. Fed. Power Comm'n, 343 U.S. 414 (1952); Cal. ex rel. Lockyer v. Dynergy Inc., 375 F.3d 831 (9th Cir. 2004)).
Although FERC has exclusive authority to modify a filed rate, its discretion is not unfettered. For example, FERC may not change a filed rate solely because the rate affords the utility "less than a fair return" since "the purpose of the power given to the Commission … is the protection of the public interest, as distinguished from the private interests of the utilities." In re Mirant Corp., 378 F.3d 511, 518 (5th Cir. 2004) (citation omitted). In such a case, FERC can change a filed rate only when "the rate is so low as to adversely affect the public interest—as where it might impair the financial ability of the public utility to continue its service, cast upon other consumers an excessive burden, or be unduly discriminatory." Id.
In a series of cases (see United Gas Pipe Line Co. v. Mobile Gas Serv. Corp., 350 U.S. 332 (1956); Fed. Power Comm'n v. Sierra Pac. Power Co., 350 U.S. 348 (1956)), the U.S. Supreme Court articulated what is referred to as the "Mobile-Sierra doctrine." Under this doctrine, FERC must presume that a rate set by a freely negotiated wholesale energy contract meets the "just and reasonable" requirement of the FPA. That presumption may be overcome only if FERC concludes that the contract seriously harms the public interest. See NRG Power Mktg., LLC v. Maine Pub. Utilities Comm'n, 558 U.S. 165 (2010).
If a regulated utility files for bankruptcy, FERC's exclusive discretion in this realm could be interpreted to conflict with the bankruptcy court's exclusive jurisdiction to authorize the rejection of an electricity supply agreement. This thorny issue has been addressed to date by only a handful of courts and, with the Sixth Circuit's recent ruling, two federal courts of appeals.
Mirant
In Mirant, the U.S. Court of Appeals for the Fifth Circuit ruled that the FPA does not prevent a bankruptcy court from ruling on a motion to reject a FERC-approved rate-setting agreement so long as the proposed rejection does not represent a challenge to the agreement's filed rate.
In the case before it, the Fifth Circuit explained, although the chapter 11 debtor's desire to reject a FERC-regulated power supply agreement was motivated in part by its below-market rate, the debtor's business justification was also premised on the existence of excess supply and the consequent lack of any need for the energy covered by the contract. The court accordingly concluded that rejection of the agreement was not a challenge to the filed rate and that the FPA did not preempt a ruling on the rejection motion.
The Fifth Circuit rejected FERC's argument that anything less than full payment would constitute a challenge to the filed rate. According to the court, "[A]ny effect on the filed rates from a motion to reject would result not from the rejection itself, but from the application of the terms of a confirmed reorganization plan to the unsecured breach of contract claims." The court also noted that, although the Bankruptcy Code places numerous limitations on a debtor's right to reject contracts, "including exceptions prohibiting rejection of certain obligations imposed by regulatory authorities," there is no exception that prohibits a debtor's rejection of wholesale electricity contracts that are subject to FERC's jurisdiction. Concluding that "Congress intended § 365(a) to apply to contracts subject to FERC regulation," the Fifth Circuit held that the bankruptcy court's power to authorize rejection of the agreement did not conflict with the authority conferred upon FERC to regulate rates for the interstate sale of electricity.
Citing the U.S. Supreme Court's ruling regarding the standard for rejecting a collective bargaining agreement in Bildisco, the Fifth Circuit in Mirant concluded that, in determining whether a debtor should be permitted to reject a wholesale power contract, "the business-judgment standard would be inappropriate … because it would not account for the public interest inherent on the transmission and sale of electricity." Instead, a "more rigorous standard" might be appropriate, including consideration of not only whether the contract burdens the estate, but also whether the equities balance in favor of rejection, rejection would promote a successful reorganization, and rejection would serve the public interest. Such a balancing exercise, the Fifth Circuit noted, could be undertaken with FERC's input.
Calpine
In Calpine, the U.S. District Court for the Southern District of New York, after withdrawing the reference to the bankruptcy court, dismissed a chapter 11 debtor's motion to reject certain power agreements because the court concluded that FERC had exclusive jurisdiction over the modification or termination of such agreements.
According to the court, the requirement that FERC approval be obtained for any alteration of the "rates, terms, conditions, or duration" of a power agreement is not eliminated merely because the power provider files for bankruptcy. The district court found "little evidence" in the Bankruptcy Code of congressional intent to limit FERC's regulatory authority, remarking that "[a]bsent overriding language, the Bankruptcy Code should not be read to interfere with FERC jurisdiction."
The court wrote that, if a bankruptcy court's broad powers and jurisdiction, including the power to authorize the rejection of a contract, conflict with a federal regulatory regime, "the power of the bankruptcy court must yield to that of the federal agency." The Bankruptcy Code itself supports this conclusion, the court explained, by exempting agency action from the scope of the automatic stay in section 362(b)(4).
As framed by the district court, the dispositive issue was whether rejection of the power agreements directly interfered with FERC's exclusive jurisdiction over wholesale power contracts "or otherwise constitutes a collateral attack on the filed rate." The court concluded that it would—rejection of the agreements, which even the debtor admitted was motivated by its dissatisfaction with their below-market rates, would infringe upon FERC's exclusive prerogative to regulate the rates, terms, conditions, and duration of wholesale energy contracts.
The district court explained that the Fifth Circuit's rationale in Mirant was entirely consistent with its own conclusions because in Calpine, unlike in Mirant, the debtor was seeking nothing more than rate relief—its rejection motion clearly stated that it needed relief from the power agreements because it was being forced to sell energy at far below market rates.
Boston Generating
In In re Boston Generating, LLC, 2010 WL 4616243 (S.D.N.Y. Nov. 12, 2010), the U.S. District Court for the Southern District of New York, after withdrawing the reference of the matter to the bankruptcy court, ruled that, in order to reject a contract for the transportation of natural gas to one of the chapter 11 debtors' power plants, the debtors "must also obtain a ruling from FERC that abrogation of the contract does not contravene the public interest."
The parties to the contract agreed that the debtors should seek FERC approval of the proposed rejection, but they disagreed over whether the bankruptcy court could consider the rejection motion concurrently with FERC or would have to wait until FERC had ruled. According to the district court, the issue was of no consequence. "If either the bankruptcy court or FERC does not approve the Debtors' rejection of the [gas transportation agreement]," the court wrote, "the Debtors may not reject the contract."
PG&E
In PG&E Corp. v. FERC (In re PG&E Corp.), 603 B.R. 471 (Bankr. N.D. Cal. June 7, 2019), amended and direct appeal certified, 2019 WL 2477433 (Bankr. N.D. Cal. June 12, 2019), the U.S. Bankruptcy Court for the Northern District of California ruled that the lack of any exception for FERC in section 365 of the Bankruptcy Code "simply means that FERC has no jurisdiction over the rejection of contracts."
PG&E filed for chapter 11 protection on January 29, 2019, in an effort to manage potential liabilities exceeding $30 billion arising from the alleged role of its equipment in sparking the largest wildfires in California history. At the time of the filing, PG&E was party to $42 billion worth of power purchase agreements (each, a "PPA"), with approximately 350 counterparties covering various electricity projects.
In anticipation of PG&E's bankruptcy filing, two PPA counterparties filed petitions with FERC seeking a declaration that if PG&E filed for bankruptcy, it could not abrogate, amend, or reject the PPAs without first obtaining FERC approval. FERC issued an order in January 2019 concluding that the "Commission and the bankruptcy courts have concurrent jurisdiction to review and address the disposition of wholesale power contracts sought to be rejected through bankruptcy." FERC stated that to "give effect to both the FPA and the Bankruptcy Code," a debtor that is a party to a FERC-regulated power purchase agreement must obtain approval from both FERC and the bankruptcy court to modify the filed rate and reject the contract.
After filing for bankruptcy, PG&E filed an adversary proceeding in the bankruptcy court seeking a declaratory judgment that the bankruptcy court had exclusive jurisdiction to decide whether PG&E could reject the PPAs, as well as an injunction blocking FERC from taking any action that would require PG&E to continue performing under PPAs that PG&E wanted to reject.
The bankruptcy court ruled that FERC exceeded its authority by declaring that it shares jurisdiction with the bankruptcy court over the question of whether PG&E can reject its PPAs. The court rejected FERC's argument that, because wholesale power contracts are not "simple run-of-the-mill contracts," but implicate the public interest in the orderly production of electricity at just and reasonable rates, the modification or abrogation of such contracts by means of rejection should not be subject to a bankruptcy court's exclusive jurisdiction. According to the court, this argument "is completely contrary to the congressionally created authority of the bankruptcy court to approve rejection of nearly every kind of executory contract," including "run-of-the-mill types" as well as power purchase agreements and other contracts that implicate the public's interest, with certain exceptions not relevant in this case (e.g., sections 365(h) (certain leasehold interests), 365(i) (timeshare interests), 365(n) (intellectual property licenses), 365(o) (commitments to federal depository institutions), and 1113 (collective bargaining agreements)). Those provisions, the court reasoned, demonstrate that Congress knows "how to craft special rules for special circumstances." The court added that lawmakers also knew how to condition confirmation of a chapter 11 plan on the approval by a governmental regulatory commission of any proposed rate change but failed to condition rejection of a contract on FERC's approval. See 11 U.S.C. § 1129(a)(6).
The bankruptcy court, concluding that there is no support in either the Bankruptcy Code or the FPA for FERC's assertion of jurisdiction, accordingly granted PG&E's motion for a declaratory judgment that: (i) FERC does not have concurrent jurisdiction over the court's decision to authorize PG&E to reject (or assume) the PPAs; and (ii) FERC's previous rulings involving PG&E are of no force and effect and are not binding on PG&E in its bankruptcy cases. Given its conclusion that FERC exceeded its statutory authority, the court declined to issue an injunction. However, the court wrote that, "[i]f necessary in the future[,] it will enjoin FERC from perpetuating its attempt to exercise power it wholly lacks."
The bankruptcy court stated that, should PG&E move to reject any of the PPAs, the court would consider whether public-policy interests are implicated. At that juncture, the court explained, it could assess whether rejection is warranted, without any "need or right for a second inquiry by a separate non-judicial body to be involved."
The bankruptcy court certified a direct appeal of its ruling to the U.S. Court of Appeals for the Ninth Circuit.
FirstEnergy Solutions
FirstEnergy Solutions Corp. and a subsidiary (collectively, "FES") sells electricity to retail and corporate customers as well as on exchange markets. Prior to filing for chapter 11 protection in 2018, FES entered into several PPAs, in part to satisfy its regulatory obligation to purchase a certain amount of renewable energy credits. The PPAs became financially burdensome to FES after energy prices decreased and energy credits became readily available. After selling its entire retail business, FES had no need for credits from the PPAs, with respect to which FES estimated it was losing $46 million annually.
In 2010, FES entered into a multiparty intercompany power agreement (the "ICPA") under which the signatories were obligated to purchase power from a regional supplier. As with the PPAs, when FES filed for bankruptcy, it no longer needed the electricity, which under the terms of the ICPA cost significantly more than the market rate and, according to FES's estimate, would likely result in a loss of approximately $268 million over the remaining term of the contract.
After filing for bankruptcy, FES commenced an adversary proceeding seeking: (i) a declaratory judgment that the bankruptcy court had the exclusive jurisdiction to decide whether FES could reject the PPAs and the ICPA; and (ii) an order enjoining FERC either from interfering with the intended rejection by ordering continued performance or from conducting any proceedings, hearings, or investigations concerning the contracts.
In opposing the proceeding, FERC argued that, reading the FPA and the Bankruptcy Code together, FERC maintains concurrent jurisdiction with bankruptcy courts over wholesale power agreements. Stated differently, consistent with the district court opinion in Boston Generating, FERC insisted that a debtor must seek both bankruptcy court approval to reject a wholesale power agreement and FERC approval to unilaterally change such an agreement.
The bankruptcy court in FirstEnergy Solutions rejected this argument. It ruled that:
- Any action by FERC to require continued performance by FES in a proceeding commenced before FERC by the counterparty seeking a determination that rejection of the agreements would violate the filed-rate doctrine was subject to the automatic stay.
- In accordance with the Sixth Circuit's ruling in Chao v. Hospital Staffing Services, Inc., 270 F.3d 374 (6th Cir. 2001), the "police and regulatory power" exception to the stay under section 362(b)(4) of the Bankruptcy Code did not apply because the FERC proceeding was "undertaken principally to adjudicate private rights, with only an incidental public interest in the litigation."
- If FERC were nevertheless to proceed on the basis that the section 362(b)(4) exception did apply, "that action would be a fool's errand because any order it might issue to compel the Debtors' performance … would, in substance, be designed to obtain or control the property of the estate and therefore, be void ab initio" under section 362(a)(3) of the Bankruptcy Code.
- In the alternative, to "preserve its jurisdiction" over the agreements, the bankruptcy court had the power to enjoin continuation of the FERC proceeding under section 105(a) of the Bankruptcy Code, which empowers a bankruptcy court to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]."
Notably, the bankruptcy court wrote that "[w]hile given the force of statute or regulation under applicable caselaw, … filed rate contracts remain contracts. They are not actual regulations, subject to notice-and-comment rulemaking processes, let alone actual federal statutes, that would lie outside the ambit of Section 365 simply by virtue of not being 'contracts' at all." Consistent with Mirant, the bankruptcy court in FirstEnergy Solutions also concluded that the filed-rate doctrine, the FPA, and FERC's regulatory authority are not offended by, and do not preempt, the bankruptcy court's exclusive jurisdiction over motions to reject executory power contracts and the treatment of rejection damages claims in bankruptcy cases.
Having concluded that it had exclusive jurisdiction to decide whether FES could reject the PPAs and the ICPA, the bankruptcy court applied the "business-judgment" standard in authorizing the FES to reject the contracts. The court reasoned that rejection was warranted because FES did not need the electricity and the contract rates were significantly above market. Notably, the court refused to "consider any public interest principles potentially implicated by the [FPA] and/or any alleged harm that rejection could cause [FES's] contract counterparties or consumers."
The bankruptcy court certified a direct appeal of its ruling to the Sixth Circuit.
The Sixth Circuit's Ruling
A divided three-judge panel of the Sixth Circuit affirmed the bankruptcy court's decision in part, reversed in part, and remanded the case below for additional findings.
As an initial matter, the Sixth Circuit concluded that the ICPA and the PPAs "are not de jure regulations but, rather, ordinary contracts susceptible to rejection in bankruptcy." This is because "the public necessity of available and functional bankruptcy relief is generally superior to the necessity of FERC's having complete or exclusive authority to regulate energy contracts and markets." However, the court explained, the bankruptcy court's jurisdiction in this context is not exclusive but, rather, concurrent, albeit "primary or superior to FERC's position."
Next, the Sixth Circuit determined that "the bankruptcy court was not necessarily wrong" in ruling that actions that might be undertaken by FERC in connection with the ICPA and the PPAs were not excepted from the automatic stay under the police and regulatory power exception set forth in section 362(b)(4). According to the Sixth Circuit, the bankruptcy court improperly applied the public-policy test set forth in Chao in holding that FERC's interest in preventing rejection of any power contracts is and always will be substantially private and only incidentally public, thereby falling outside the scope of section 362(b)(4). Under Chao, the Sixth Circuit explained in FirstEnergy Solutions, the bankruptcy court should not have imposed an "absolute injunction against any FERC activity." Instead, the Sixth Circuit wrote, "Chao would permit FERC to proceed at its own risk with any actions over which it felt it had jurisdiction [subject to judicial review], such as holding hearings and making findings, and to issue orders that did not violate the bankruptcy stay or conflict with the bankruptcy court's orders."
However, the Sixth Circuit noted, on the basis of the particular facts of this case—i.e., the tiny amounts of energy covered by the contracts relative to the market, FES's small stake in the ICPA, and the lack of damages to the PPA counterparties relative to the anticipated disproportionate harm to other creditors—the bankruptcy court's conclusion that FERC failed the public-policy test necessary to avoid the stay was not in error.
Next, the Sixth Circuit held that the bankruptcy court "went too far" in invoking section 105(a) of the Bankruptcy Code as authority for prohibiting FERC "from taking any action whatsoever or to enjoin all of FERC's regulatory functions." According to the Sixth Circuit, although the Mirant court held that section 105(a) gave it the power to enjoin FERC from countermanding its order authorizing rejection, "Mirant's overall holding is integrated or holistic, meaning that its determination that the bankruptcy court's authority was superior to FERC's factored in the conclusion of public-interest considerations in the standard … as a concurrent limitation on the bankruptcy court's authority."
Finally, taking a cue from Mirant, the Sixth Circuit held that "an adjusted standard," rather than the business-judgment standard, "best accommodates the concurrent jurisdiction between, and separate interests of, the Bankruptcy Code (court) and the FPA (FERC)." It accordingly remanded the case to the bankruptcy court with instructions to reconsider its ruling under this higher standard after giving FERC a reasonable time to provide an opinion on the public interest.
In an opinion concurring in part and dissenting in part, circuit judge Richard A. Griffin agreed with the majority that the bankruptcy court erred by using the business-judgment standard. However, he wrote that the majority's affirmance of the bankruptcy court's order enjoining FERC from issuing an order requiring FES to continue performing under the PPAs and the ICPA or limiting FES to seeking abrogation of the contracts under the FPA was "based on a flawed understanding of how filed rates operate under the FPA" and "conflicts with Congress's decision to deny federal-court jurisdiction over the abrogation or modification of a filed rate." According to Judge Griffin, the majority created a conflict between the Bankruptcy Code and the FPA where none exists, and then declared that the Bankruptcy Code is more important. Such an approach, he wrote, undermines the filed-rate doctrine and would permit "power companies [to] use bankruptcy to evade regulation in an industry for which Congress envisioned close, watchful oversight."
Outlook
Courts have reached mixed conclusions regarding the power of a bankruptcy court to authorize the rejection of a regulated wholesale power contract in bankruptcy. However, although the two courts of appeals that have addressed this question disagree over whether it creates a jurisdictional conflict, they agree that FERC should play some role in determining whether such contracts can be rejected. It remains to be seen whether the Ninth Circuit will also endorse this view or take a different approach in PG&E. Any resulting circuit split may invite resolution of this important issue by the U.S. Supreme Court or legislative action.
On January 27, 2020, FERC filed a petition for rehearing of the Sixth Circuit's ruling in FirstEnergy Solutions. FERC argued that the majority opinion contravenes U.S. Supreme Court precedent that rates filed with FERC carry public-law obligations that are separate from private contractual obligations. FERC also claimed that Mission Products Holdings Inc. v. Tempnology LLC, 139 S. Ct. 1652 (May 20, 2019), in which the Supreme Court ruled that rejecting a contract in bankruptcy is a "breach" with damages to be determined by "non-bankruptcy contract law," indicates that debtors are not exempt from "generally applicable law."
The Sixth Circuit denied FERC's petition for rehearing on March 13, 2020.
