Fifth Circuit Triples Down: Filed-Rate Natural Gas and Power Contracts Can Be Rejected in Bankruptcy Without FERC Approval
In Gulfport Energy Corp. v. FERC, 41 F.4th 667 (5th Cir. 2022), the U.S. Court of Appeals for the Fifth Circuit tripled down on its nearly two-decades-long view that filed-rate contracts regulated under the National Gas Act (the "NGA") and the Federal Power Act (the "FPA") can be rejected in bankruptcy without the consent of the Federal Energy Regulatory Commission ("FERC"). Reaffirming its previous rulings in In re Mirant Corp., 378 F.3d 511 (5th Cir. 2004), and In re Ultra Petroleum Corp., 28 F.4th 629 (5th Cir. 2022), the Fifth Circuit was highly critical of FERC's "bizarre view" that the consequences of rejection of filed-rate contracts should be viewed differently than the consequences of rejection of other types of executory contracts in bankruptcy. According to the court, as in its previous rulings, it rejected FERC's argument because it "patently contradicts the [Bankruptcy] Code's text and established interpretation."
The Fifth Circuit summarized its decision as follows:
FERC can decide whether actual modification or abrogation of a filed-rate contract would serve the public interest. It even may do so before a bankruptcy filing. But rejection is just a breach; it does not modify or abrogate the filed rate, which is used to calculate the counterparty's damage. So FERC cannot prevent rejection. It cannot bind a debtor to continue paying the filed rate after rejection. And it cannot usurp the bankruptcy court's power to decide [the debtor's] rejection motions.
Gulfport, 41 F.4th at 685. With its third such ruling in the last 18 years, the Fifth Circuit has unequivocally staked out its view on this issue, which is aligned with the position adopted by the only other court of appeals that has addressed it—the Sixth Circuit, in In re FirstEnergy Solutions Corp., 945 F.3d 431 (6th Cir. 2019), reh'g denied, No. 18-3787 (6th Cir. Mar. 13, 2020).
In Mirant, 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 in 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.
In Ultra, the Fifth Circuit held that, in accordance with its previous ruling in Mirant, a bankruptcy court properly authorized chapter 11 debtor Ultra Resources, Inc. ("UPC") to reject an NGA-governed natural gas transportation agreement as part of its chapter 11 plan without obtaining FERC's approval. It also ruled that UPC was not subject to a separate public-law obligation to continue performance under the rejected contract, and that 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.
In Ultra, the Fifth Circuit explained that the binding precedent in Mirant "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)."
Noting that the Sixth Circuit came to the same conclusion in FirstEnergy, the Fifth Circuit ruled that the bankruptcy court properly authorized the rejection of the filed-rate contract 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 UPC did not seek to reject the contract because the rate were 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 that involves consideration of the public interest.
The Fifth Circuit 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, it 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, the Fifth Circuit rejected FERC's argument that the bankruptcy court erred because rejection of the contract amounted to a rate change and the inclusion of a provision in UPC's chapter 11 plan authorizing rejection violated section 1129(a)(6) of the Bankruptcy Code. According to the court, "Since 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)]."
Natural gas producer Gulfport Energy Corporation ("GEC") and Rover Pipeline L.L.C. ("Rover") entered into transportation service agreements ("TSAs") whereby Rover agreed to transport GEC's gas through its pipelines.
After the onset of the COVID-19 pandemic crushed demand for energy, GEC disclosed in public filings that its financial outlook was grim. Concerned that GEC might file for bankruptcy and reject its TSAs, Rover petitioned FERC in September 2020 for a declaratory judgment that FERC had exclusive jurisdiction over the TSAs and that GEC would need FERC's approval before rejecting the contracts in bankruptcy. Rover also asked FERC to hold an expedited hearing to determine whether nonperformance of the TSAs would "harm the public interest."
FERC granted Rover's petition for declaratory relief in October 2020. In its order, FERC noted that it asserted "parallel, exclusive jurisdiction" over the filed-rate TSAs. It also stated that rejection of a filed-rate contract in bankruptcy "alters the essential terms and conditions" of that contract. In addition, the order provided that, because "[FERC's] approval is required to modify or abrogate [a] filed rate," GEC could not reject any TSAs with Rover in bankruptcy without FERC's approval. Finally, the order stated that the bankruptcy court could not confirm any chapter 11 plan that rejected a TSA "unless and until [FERC] agrees, or the plan … is made contingent on [FERC] approval."
In November 2020, FERC issued another order in which it found "that the public interest does not presently require the modification or abrogation of the [GEC] TSAs," because the rates "currently on file and in effect remain just and reasonable" under the Mobile–Sierra doctrine, which creates a rebuttable presumption that a rate set by a freely negotiated wholesale-energy contract meets the "just and reasonable" requirement of the NGA and the FPA. FERC also directed GEC to continue performing under the TSAs.
FERC later denied GEC's request for reconsideration of both orders.
On November 13, 2020, GEC filed for chapter 11 protection in the Southern District of Texas. It then filed a motion to reject the TSAs with Rover.
In January 2021, GEC appealed FERC's orders to the Fifth Circuit. See 15 U.S.C. § 717r(b) (permitting the federal circuit court in the circuit where a natural-gas company is located or has its principal place of business to hear an appeal of a FERC order).
In the meantime, GEC pursued its rejection motion in the bankruptcy court. Rover argued that the bankruptcy court "lacked exclusive subject matter jurisdiction over [Gulfport's] rejection request" because FERC had already asserted jurisdiction. It also moved to withdraw the reference of the rejection motion to the district court for an initial decision.
The bankruptcy court blasted Rover for "obtaining an advisory order from FERC" to obstruct and "avoid the Court's proper exercise of its jurisdiction over [the] pure bankruptcy matter" of rejection. "Th[at] tactic and associated arguments," the bankruptcy court wrote, "have been repeatedly rejected and are contrary to established Fifth Circuit precedent."
The district court withdrew the reference of the rejection motion in January 2021.
The bankruptcy court confirmed GEC's chapter 11 plan over Rover's objections in April 2021, and the company emerged from bankruptcy the following month.
Nearly a year later, the Fifth Circuit handed down its ruling in Ultra.
In July 2022, the Gulfport Energy district court returned GEC's motion to reject the Rover TSAs to the bankruptcy court, stating that "the bankruptcy court has authority [under Mirant and Ultra] to reject [the TSAs] without conflicting with FERC's authority to regulate filed rates."
The Fifth Circuit's Ruling in Gulfport Energy
The Fifth Circuit first determined that it had jurisdiction to hear GEC's January 2021 appeal of FERC's orders.
The Fifth Circuit then ruled that, although "FERC did have authority to issue the orders" because it "gave rational reasons for finding that its orders would remove uncertainty," the orders must be vacated because they "rested on an inexplicable misunderstanding of rejection" and were therefore "unlawful."
The Fifth Circuit explained that FERC's "ambitious" orders concluding that rejection could not be authorized without FERC's consent and directing GEC to continue performing under the Rover TSAs were "wrong" because they "assume[d] that rejecting a contract changes or cancels the obligations under that contract." That assumption, the Fifth Circuit wrote, "flouts the Bankruptcy Code, Supreme Court precedent, and the caselaw of every federal circuit."
The Fifth Circuit explained that, in accordance with section 365(g) of the Bankruptcy Code and the U.S. Supreme Court's ruling in Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), the rejection of a contract does not change or rescind it, but results in a breach excusing the debtor's performance and entitling the counterparty to a claim for damages. As such, the breach of the TSAs resulting from GEC's rejection of the contracts would entitle Rover to a claim for damages valued at the filed rate, but did not "change the contracts' terms or the filed rate itself."
According to the Fifth Circuit, "we have twice rejected" FERC's "bizarre view" that the consequences of rejection of filed-rate contracts should be viewed differently than the consequences rejection of other executory contracts, "and we reject it again today" because it "patently contradicts the [Bankruptcy] Code's text and established interpretation.
The Fifth Circuit also rejected Rover's arguments that: (i) Mirant and Ultra do not apply because the court was reviewing FERC, rather than bankruptcy court, orders; (ii) FERC's orders should remain undisturbed because the commission completed its administrative process before GEC filed for bankruptcy; and (iii) the Supreme Court overruled Mirant and Ultra in Mission Product because the Mirant court premised its conclusion that rejecting a filed-rate contract merely breaches the contract upon the "negative inference" that provisions of the Bankruptcy Code governing the rejection of an executory contract do not require the input of regulatory commissions like FERC.
According to the Fifth Circuit, the distinction between FERC and bankruptcy court orders was meaningless given FERC's "powerlessness to require continued performance of a rejected contract." For the same reason, it noted, the timing of FERC's orders was irrelevant. Finally, the court explained, Rover misconstrued Mission Product, which confirmed the rationale in Mirant and Ultra by dismissing a different "negative inference"—that lawmakers, by enumerating exceptions in the Bankruptcy Code to the rule that rejection results in breach rather than abrogation or modification of a contract, abandoned the rule.
Because FERC's action was "not in accordance with law," the Fifth Circuit stated, it vacated all of its orders.
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