Fifth Circuit Rules that Chapter 11 Debtors May Reject Filed-Rate Contracts Without FERC Permission
In FERC v. Ultra Resources, Inc. (In re Ultra Petroleum Corp.), 2022 WL 763836 (5th Cir. Mar. 14, 2022), the U.S. Court of Appeals for the Fifth Circuit issued a long-awaited ruling on an appeal from a bankruptcy court order authorizing chapter 11 debtor Ultra Resources, Inc. ("Ultra") to reject a filed-rate gas transportation contract as part of its chapter 11 plan. The Fifth Circuit held that, under the circumstances and in accordance with Fifth Circuit precedent, the bankruptcy court properly authorized Ultra to reject the contract without obtaining the approval of the Federal Energy Regulatory Commission ("FERC"), that Ultra was not subject to a separate public-law obligation to continue performance under the rejected contract, and that section 1129(a)(6) of the Bankruptcy Code does not require a bankruptcy court to seek FERC approval before confirming a chapter 11 plan providing for rejection of the contract.
Court rulings to date on the jurisdictional turf war between FERC and the bankruptcy courts have been a mixed bag, although two federal circuits courts of appeals now have concluded that a bankruptcy court has the power to authorize the rejection of a filed-rate contract. Here, we offer a brief discussion of the most notable court decisions addressing this issue to date.
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 "civil proceedings arising under" the Bankruptcy Code as well as civil proceedings "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 debtor, after curing outstanding defaults, to continue performing under the agreement or to assign the agreement to a third party for consideration as a means of generating value for the bankruptcy estate. Rejection frees the debtor from rendering performance under unfavorable contracts. 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.
Accordingly, 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, the Natural Gas Act, and the Mobile-Sierra Doctrine
Public and privately operated utilities providing interstate utility service within the United States are regulated by the Federal Power Act, 16 U.S.C. §§ 791a et seq. ("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)).
The National Gas Act, 15 U.S.C. §§ 717 et seq. ("NGA"), regulates interstate sales of natural gas for resale in much the same way the FPA regulates interstate sales of power. The language in the NGA regarding the requirement to file rates and FERC's power to fix unjust and unreasonable rates is nearly identical to the language in the FPA. Compare 16 U.S.C. § 824(e) (FPA) with 15 U.S.C. § 717c (NGA).
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 NGA and 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 or natural gas agreement. FERC has taken the position that it shares jurisdiction with the bankruptcy courts to determine whether contracts subject to FERC regulation under the FPA can be rejected in bankruptcy. See NextEra Energy, Inc. v. Pac. Gas & Elec. Co., 166 FERC ¶ 61,049 (2019); Exelon Corp. v. Pac. Gas & Elec. Co., 166 FERC ¶ 61,053 (2019), on reh'g, 167 FERC ¶ 61,096 (2019). In addition, in ETC Tiger Pipeline, LLC, 171 FERC ¶ 61,248 (2020), reh'g denied, 172 FERC ¶ 61,155 (2020), FERC determined that a party to a natural gas transportation agreement regulated under the NGA must obtain FERC's approval as well as the approval of the bankruptcy court prior to modifying the filed rate and rejecting the agreement in bankruptcy.
The apparent conflict between the Bankruptcy Code, on the one hand, and the NGA and the FPA, on the other, has been addressed to date by only a handful of courts, including two federal courts of appeals—one of them twice.
Notable Court Decisions
In re Mirant Corp., 378 F.3d 511 (5th Cir. 2004). 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-regulated rate-setting agreement as long as the proposed rejection does not represent a challenge to the agreement's filed rate.
The Fifth Circuit 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.
The Fifth Circuit, however, imposed a higher standard for rejection of such agreements. It 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.
Finally, the Fifth Circuit held that the bankruptcy court exceeded its authority under section 105(a) of the Bankruptcy Code by prohibiting FERC from taking any action against the debtor instead of limiting the scope of its injunction to FERC's attempts to compel the debtor to perform under the particular contract that the court authorized the debtor to reject.
In re Calpine Corp., 337 B.R. 27 (S.D.N.Y. 2006). In Calpine, the U.S. District Court for the Southern District of New York (having withdrawn the reference to the bankruptcy court) denied a chapter 11 debtor's motion to reject certain FPA-governed 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."
In re Boston Generating, LLC, 2010 WL 4616243 (S.D.N.Y. Nov. 12, 2010). In Boston Generating, the U.S. District Court for the Southern District of New York (having withdrawn the reference to the bankruptcy court) ruled that, in order to reject an NGA-governed 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." "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 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), vacated, 829 Fed. App'x 751 (9th Cir. 2020). In PG&E, 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."
The bankruptcy court concluded that FERC exceeded its authority by declaring that it shares jurisdiction with the bankruptcy court over the question of whether PG&E Corp. and its Pacific Gas & Electric Co. utility subsidiary (collectively, the "PG&E debtors") could reject FPA-governed power purchase agreements. 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 they failed to condition rejection of a contract on FERC's approval. See 11 U.S.C. § 1129(a)(6).
The bankruptcy court certified a direct appeal of its ruling to the U.S. Court of Appeals for the Ninth Circuit. However, after the bankruptcy court confirmed PG&E's chapter 11 plan on June 20, 2020, the Ninth Circuit vacated the appeal as moot.
FERC v. FirstEnergy Solutions Corp. (In re FirstEnergy Solutions Corp.), 945 F.3d 431 (6th Cir. 2019), reh'g denied, No. 18-3787 (6th Cir. Mar. 13, 2020). In FirstEnergy, a divided panel of the U.S. Court of Appeals for the Sixth Circuit ruled that the bankruptcy court had jurisdiction to decide whether a chapter 11 debtor could reject its FPA-regulated electricity-purchase contracts because, even though filed-rate contracts may have the force of regulation or statute outside of bankruptcy, they are ordinary contracts susceptible to rejection in bankruptcy. The Sixth Circuit also held that, although the bankruptcy court had "concurrent" jurisdiction with FERC to decide whether a debtor could reject the 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.
In addition, the Sixth Circuit determined that the bankruptcy court incorrectly applied the "business-judgment" standard to the debtors' request to reject the contracts. Instead, the court wrote, "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." FirstEnergy, 945 F.3d at 944. One judge on the panel dissented in part, stating that the majority's holding "conflicts with Congress's decision to deny federal-court jurisdiction over the abrogation or modification of a filed rate." Id. at 945.
The Fifth Circuit revisited a bankruptcy court's power to authorize the rejection of filed-rate contracts in Ultra Petroleum.
Ultra filed for chapter 11 protection for the second time in four years on May 14, 2020, in the Southern District of Texas. It immediately sought court authority to reject an NGA-governed natural gas transportation agreement with Rockies Express Pipeline LLC ("REX"), which transports natural gas through a natural gas pipeline stretching from eastern Ohio to southwestern Wyoming.
REX objected to the motion, arguing that the public interest would be harmed by rejection and that the motion could not be considered until FERC was permitted to "meaningfully participate" on whether rejection would harm the public interest. Otherwise, REX contended, any order approving the rejection motion would contravene the Fifth Circuit's Mirant decision and the "primary jurisdiction doctrine," which applies when a claim is originally cognizable in the courts but involves issues that fall within the special competence of an administrative agency. According to REX:
A rejection standard that does not take into account the importance of stable FERC-regulated agreements, which the U.S. Supreme Court has held to be in the public interest, and the harmful [e]ffect that free-rider activity would have on [Rockies] and the interstate pipeline system as a whole, would create a dangerous discontinuity between the Bankruptcy Code and the NGA, and would be inconsistent with Mirant.
The bankruptcy court denied REX's request to defer consideration of the rejection motion until FERC could weigh in on the question in a formal proceeding. However, the court invited FERC to participate in the bankruptcy case and make its views known. FERC declined to do so outside the context of a FERC proceeding.
On August 6, 2020, the bankruptcy court granted Ultra's motion to reject the REX gas transportation agreement. See In re Ultra Petroleum Corp., 621 B.R. 188 (Bankr. S.D. Tex. 2020), aff'd, 2022 WL 763838 (5th Cir. Mar. 14, 2022). Addressing the standard for rejection, the court noted that Mirant is binding authority in the Southern District of Texas. As a consequence, a bankruptcy court must engage in a fact-intensive analysis of whether the rejection of a transportation agreement would lead to direct harm to the public interest through an "interruption of supply to consumers" or a "readily identifiable threat to health and welfare." According to the court, the evidence submitted by REX had "little to do with the contract at issue," and any identified harm was grounded in market-chilling effects that would stem from a "general ability to reject" FERC-regulated contracts.
Although the general business-judgment standard applicable to contract rejection may be elevated in certain circumstances, the court explained, imposing what would amount to a general bar to rejection (e.g., by requiring that a debtor's reorganization would fail absent rejection) would be a statutory-type exception that only Congress could create (as it has done with respect to certain other kinds of contracts).
The court found that the record overwhelmingly supported rejection. The evidence showed that there would be no interruption to the supply of gas to consumers, there would be no negative macroeconomic consequences, and Ultra would "marginal[ly]" benefit by rejecting the transportation agreement.
The court wrote that "[t]he Court is not authorized to graft a wholesale exception to § 365(a) of the Bankruptcy Code … preventing rejection of FERC approved contracts." It further noted that "[p]ublic policy may, in certain circumstances, be considered when determining whether to authorize the rejection of a FERC approved pipeline contract." According to the court, whether the rejection of an executory FERC contract is "good or bad public policy" must be decided by Congress and not by the court or FERC.
Finally, the court ruled that the rejection of the contract did not violate section 1129(a)(6) of the Bankruptcy Code, which provides that a plan cannot be confirmed unless "[a]ny governmental regulatory commission with jurisdiction … over the rates of the debtor has approved any rate change provided for in the plan, or such rate change is expressly conditioned on such approval," because "FERC's rate setting authority will remain intact following rejection and potential confirmation of the plan."
On August 21, 2020, shortly after the rejection approval, the bankruptcy court confirmed a chapter 11 plan for Ultra. FERC appealed the confirmation order to the extent it provided that the bankruptcy court retained "exclusive jurisdiction" over orders authorizing Ultra's rejection of FERC-regulated contracts.
The Fifth Circuit's Ruling
A three-judge panel of the Fifth Circuit affirmed the confirmation order.
Writing for the panel, U.S. Circuit Judge Carolyn Dineen King noted that "[i]n light of Mirant, what FERC casts as a pitched battle is actually a settled truce." Ultra Petroleum, 2022 WL 763838, at *4. She explained that Mirant, which is binding precedent, "balances the interests of the bankruptcy courts (which are ultimately in charge of the rejection decision) and FERC (by requiring that rejection of a filed-rate contract is considered under a higher standard that considers the public interest and by allowing FERC to participate in the bankruptcy proceedings)." Id.
Judge King emphasized that FERC was not arguing that Mirant allows a bankruptcy court to approve the rejection of a filed-rate contract. Instead, she explained, FERC claimed that any statements in Mirant concerning the consequences of rejection—including the statement that FERC could not enforce post-rejection performance and payment—were nonbinding dicta.
Judge King rejected this argument, stating that the language in Mirant regarding the effects of rejection "was necessary to our holding in Mirant." Id. According to Judge King, "The consequences of rejection of a filed-rate contract are central to the decision to allow rejection of said contracts, and the governing rules of law related to those consequences required explication; that discussion was not dicta." Id. at *5. Otherwise, she wrote, after authorizing rejection, the bankruptcy court "would have been left adrift when considering how to enforce rejection."
Moreover, Judge King explained, the court's determination in Mirant that rejection has only "'an indirect effect upon the filed rate'" and "'is not a collateral attack upon [the filed rate]'" was "a necessary prerequisite" to its ruling that a debtor can reject a filed-rate contract in bankruptcy. Id. (quoting Mirant, 378 F.3d at 519-20, 522).
Noting that the Sixth Circuit came to the same conclusion in FirstEnergy, Judge King ruled that the bankruptcy court properly authorized rejection of the contract with REX under the Mirant standard, based on the bankruptcy court's findings that: (i) rejection did not collaterally attack the rate filed with FERC because that rate was used to calculate the damage award after rejection and Ultra did not seek to reject the contract because the rate was excessive, but because it did not need the capacity; and (ii) the bankruptcy court did not apply the normal business judgment standard in deciding whether to authorize rejection, but the higher standard ("Mirant Scrutiny") that involves consideration of the public interest. Id. at *6-7.
Judge King rejected FERC's argument that it must be permitted to comment on the public-interest ramifications of a proposed rejection in a formal proceeding before rejection can be authorized. Mirant, she noted, does not "include such a requirement," and the bankruptcy court, which was obligated to weigh the public interest in deciding whether to authorize rejection of a filed-rate contract, specifically sought FERC's input on the impact of rejection.
Finally, Judge King rejected FERC's argument that the bankruptcy court erred because rejection of the REX contract amounted to a rate change and the inclusion of a provision in Ultra's chapter 11 plan authorizing rejection violated section 1129(a)(6) of the Bankruptcy Code. According to Judge King, "[s]ince the bankruptcy court did not change the actual rate and used it to calculate the damages claim that would result from rejection of the contract, the confirmation of the plan did not violate [section 1129(a)(6)]." Id. at *8.
In Ultra Petroleum, the Fifth Circuit reaffirmed the vitality of its ruling in Mirant regarding the power of a bankruptcy court to authorize under certain circumstances the rejection of an executory filed-rate contract. The Fifth and Sixth Circuits are aligned on this issue, although they disagree over whether it creates a jurisdictional conflict. The Fifth and Sixth Circuits also agree that, to assist the bankruptcy court in assessing the public interest, FERC should play some role in determining whether such contracts should be rejected. We can only speculate as to whether the Ninth Circuit would also have endorsed this view or taken a different approach in PG&E had it not vacated the appeal as being moot.
A version of this article was published in Lexis Practical Guidance. It appears here by permission.
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