It may be fair to say that non-US entities involved in a chapter 15 case, the mechanism through which US courts recognize foreign insolvency proceedings, do not anticipate having to litigate claims raised in the chapter 15 case outside of the bankruptcy court. This may be due in large part to 28 U.S.C. § 1334(c)(1), an abstention statute applicable in chapter 15 bankruptcy proceedings.

Abstention is a doctrine created by both case law and statute that discourages US federal courts from hearing cases or determining specific issues within its jurisdiction and, instead, deferring to the authority of state courts that have a greater interest or expertise in that issue. Put more simply, the doctrine permits (and sometimes requires) a US federal court to refuse to hear a case if doing so would intrude upon the powers of a state court when the state court is capable of rendering a ruling on the issue.

The abstention statute applicable in bankruptcy, 28 U.S.C. § 1334(c)(1), provides that “except with respect to a case under chapter 15 of title 11, nothing in this section prevents a [federal] district court in the interest of justice, or in the interest of comity with State courts or respect for State law, from abstaining from hearing a particular proceeding” in a bankruptcy case. Given the express language of this statute, it appears that a bankruptcy court cannot abstain from a proceeding occurring in a chapter 15 case.

A recent decision from the US Court of Appeals for the Fifth Circuit, however, surprised some observers by rejecting that view. The decision shows that, notwithstanding section 1334, a bankruptcy court may be required to abstain with respect to an issue in a chapter 15 case, resulting in a foreign entity being forced to litigate issues, not in bankruptcy court, but in a state court.

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The decision arises out of the chapter 15 bankruptcy case of Just Energy Group, Inc., a Canadian retail energy provider that was forced to file insolvency proceedings as a result of winter storm Uri’s disruption of electric utilities services in Texas.

For background, Texas’s electric utilities market is governed by and regulated extensively through Texas law – the Public Utility Regulatory Act (PURA). The Public Utility Commission of Texas (PUCT) and the Electric Reliability Council of Texas, Inc. (ERCOT) are the state appointed agencies tasked with overseeing, implementing, and enforcing PURA.

In February of 2021, winter storm Uri incapacitated most of Texas’s power-generating facilities and forced many power plants offline, resulting in an enormous decrease in electricity production. ERCOT intervened in the market by setting prices that were substantially higher than energy providers had expected. As a result of the price hike, Just Energy received invoices from ERCOT totaling approximately $335 million USD for only seven (7) operating days. After paying these invoices, Just Energy commenced an insolvency proceeding under Canadian law. It then sought recognition of the Canadian proceeding in the US by filing a chapter 15 case in the United States Bankruptcy Court for the Southern District of Texas.

Just Energy then brought suit in the bankruptcy court to recover at least $274 million USD in payments made to ERCOT, arguing, among other things, that ERCOT’s setting of prices was unlawful and inconsistent with ERCOT protocols and PURA. ERCOT moved to dismiss the complaint, arguing, among other things, that the bankruptcy court should abstain under the Burford abstention doctrine, which is a doctrine set forth by the Supreme Court of the United States that “allows federal courts to avoid entanglement with state efforts to implement important policy programs.”

While the bankruptcy court found in favor of ERCOT and dismissed some of the claims brought by Just Energy, it nevertheless declined to abstain from hearing the PURA related claims. On appeal before the Fifth Circuit, a three-judge panel considered whether the bankruptcy court abused its discretion by declining to abstain.

The panel first considered whether Burford applied in the bankruptcy context. Just Energy argued that, because it filed a bankruptcy case under chapter 15, abstention was not permitted under section 1334(c).

The panel noted, however, that ERCOT had requested abstention under Burford, not section 1334(c). The panel found that section 1334(c) and Burford are independent abstention doctrines, meaning section 1334(c) does not preclude the application of Burford. Significantly, the panel also found that Burford is applicable in chapter 15 bankruptcy cases.

The panel then considered whether Burford required that the bankruptcy court abstain from considering Just Energy’s PURA causes of action. To make this determination, the panel considered the following factors: (1) whether the plaintiff raises state or federal claims; (2) whether the case involves unsettled state law or detailed local facts; (3) the importance of the state’s interest in the litigation; (4) the state’s need for a coherent policy in the area; and (5) whether there is a special state forum for judicial review.

While the panel found that the first factor weighed against abstention because Just Energy raised claims under Canadian and US federal law, it found that the remaining four factors weighed in favor of abstention.

For the second factor, the panel explained that the consideration was whether the federal court would be required to review a state agency’s decision made in a state law framework where that agency was an expert. The panel found that the merits of Just Energy’s case required the bankruptcy court to review ERCOT’s and PUCT’s decisions in an area in which those agencies are experts. Thus, the panel concluded that this factor supported abstention.

The third factor favors abstention when a state administrative scheme is so pervasive and fulsome over a vital interest to the general public of that state that it guards against federal interference. In such a situation, “the state’s interest is considered paramount.” Applying this factor to Just Energy’s claims, the panel found that Texas’s interest in utility regulation is clear from the face of PURA and because the Texas legislature gave PUCT exclusive original jurisdiction over the rates, operations, and services of an electric utility.” The panel further recognized that “utility regulation” is “one of the most important of the functions traditionally associated with the police power of the States.” Finally, the panel explained that, because the electric grid did not extend beyond the borders of Texas, the management of Texas’s electricity market and resolving disputes in connection therewith “is a matter of particular importance to the state.” Consequently, the third factor favored abstention.

The fourth factor recognizes a state’s need for a coherent policy in an area and favors abstention to “avoid recurring and confusing federal intervention in an ongoing state scheme.” Abstention is proper under this factor when a federal court ruling would necessarily affect not only the parties to the litigation but other parties within the system. The panel found that its intervention would affect all market participants, not solely Just Energy and ERCOT, because if a federal court required ERCOT to refund monies to Just Energy, ERCOT would have to recoup the refunded monies from other market participants. Re-allocation would affect all other market participants “as they would financially bear the burden of an order in favor of Just Energy.” The panel explained that “this kind of domino effect” is exactly the type of federal interference that Burford seeks to prevent. Thus, the fourth factor favored abstention.

Lastly, the fifth factor favors abstention when there is a forum, other than the federal court, that offers timely and adequate state court review. Just Energy argued that its bankruptcy claims could not be adjudicated outside of the bankruptcy court. The panel found this argument unpersuasive because “behind the guise of Just Energy’s bankruptcy action is its challenge to ERCOT’s pricing decisions.” The panel noted that Texas law requires that such challenges be filed with ERCOT and be pursued through the process established under PURA. The panel explained that the state court is well equipped to adjudicate Just Energy’s and ERCOT’s dispute because it regularly adjudicated such disputes. Thus, the panel found that the fifth factor supported abstention because “the root issue falls within the exclusive jurisdiction of the state court” and “the answer central to Just Energy’s claims can only be found in a specific state forum.”

Consequently, the panel concluded that Just Energy’s claims could only be considered by the Texas state court even though the bankruptcy case could not proceed without adjudication of those claims.

Just Energy did request for panel or en banc rehearing on the panel’s decision. But this request was denied on January 31, 2023.

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The Fifth Circuit panel’s decision informs us that there is no guaranty that claims raised by a non-US entity in a chapter 15 bankruptcy case will be adjudicated by the bankruptcy court. The decision is also interesting because Burford is not the only judicially created abstention doctrine. Thus, this decision may open the door for other abstention doctrines to be found applicable in bankruptcy as well.

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