Introduction
On June 7, 2019, the U.S. Bankruptcy Court for the Northern District of California issued a ruling on a matter that has been closely monitored by the power industry. The court issued a declaratory judgment that Pacific Gas & Electric (PG&E) need not seek the prior approval of the Federal Energy Regulatory Commission (FERC), and that the bankruptcy court has exclusive jurisdiction over any decision by PG&E to assume or reject any power purchase agreements (PPAs).1 While PG&E has not yet sought to reject any PPAs, this decision is intended to give the utility clarity with regard to jurisdiction and the applicable legal standard.
Background
The Bankruptcy Code authorizes a chapter 11 debtor to assume, assign, or reject executory contracts, subject to court approval.2 An executory contract is generally defined as a contract in which continued material performance is due on both sides. When a debtor rejects an executory contract, the debtor is relieved from future performance obligations. Rejection is treated as a pre-petition breach, and the counterparty's recourse is limited to asserting an unsecured claim arising out of the so-called "breach." Outside of bankruptcy, FERC has broad jurisdiction to regulate the rates, terms, and conditions of PPAs. The question raised in this case is whether a debtor is required to obtain FERC approval, in addition to bankruptcy court approval, in order to stop performing under an executory PPA.
The case follows several conflicting decisions regarding the rejection of PPAs in bankruptcy. In Mirant, the U.S. Court of Appeals for the Fifth Circuit held that the Federal Power Act does not preempt a bankruptcy court's jurisdiction to authorize the rejection of a PPA.3 Several years later, the district court in Calpine reached the opposite conclusion, finding that it lacked subject matter jurisdiction to authorize rejection of the energy contracts before it.4 More recently in the FirstEnergy bankruptcy, the bankruptcy court concluded that rejection does not intrude on FERC's jurisdiction, and issued a preliminary injunction enjoining FERC from requiring FirstEnergy to continue performing under PPAs that it sought to reject.5 An appeal is currently pending before the U.S. Court of Appeals for the Sixth Circuit.
In January 2019, shortly before PG&E filed for bankruptcy, NextEra Energy and Exelon Corporation filed petitions for declaratory orders from FERC, requesting a finding that PG&E could not abrogate, amend, or reject in a bankruptcy proceeding any rates, terms, and conditions of its FERC-jurisdictional wholesale power contracts without first obtaining approval from FERC. In orders issued on January 25 and 28, FERC concluded that it and the bankruptcy courts have "concurrent jurisdiction to review and address the disposition of wholesale power contracts sought to be rejected through bankruptcy."6
When PG&E filed for bankruptcy on January 29, it also launched an adversary proceeding against FERC in the bankruptcy court, seeking, among other things, a declaration confirming the bankruptcy court's exclusive jurisdiction over rejection of PPAs. PG&E also sought rehearing of the two FERC orders, which FERC denied. In its denial, FERC emphasized that a contract party's bankruptcy filing "does not divest the Commission of its statutory mandate to protect the public interest."7
The Court's Decision
In its June 7 opinion, the bankruptcy court concluded that the rejection of an executory contract is solely within the power of the bankruptcy court. The court emphasized that Section 365 of the Bankruptcy Code, which authorizes the bankruptcy court to approve rejection of executory contracts, creates no exception for PPAs. Rejection constitutes a "breach" of the applicable contract, the court pointed out, citing the U.S. Supreme Court's recent decision in Mission Product Holdings, Inc. v. Tempnology LLC,8 a case dealing with rejection of trademark licenses. Accordingly, if a bankruptcy court approves rejection of a PPA under Section 365, the debtor is authorized to cease performance, leaving the counterparty with a claim for damages as of the petition date. No further approval from FERC is required.
The court reasoned that if FERC successfully orders performance under a rejected PPA, the counterparty would receive an administrative priority claim, meaning that it would be placed ahead of all other unsecured creditors. This would be inconsistent with the Bankruptcy Code's treatment of such a rejected claim.
The appropriate standard to evaluate the rejection of an executory PPA is the business judgment rule—the same standard that is applied to all executory contracts. The court acknowledged that "public interest may need to be considered in the context of a specific rejection of a specific PPA. That outcome will be fact-driven based on the particular motion to reject and the responses of the opposing party." It would be the role of the bankruptcy court, and not FERC, to make that determination.
On June 12, the bankruptcy court certified the matter for direct appeal to the U.S. Court of Appeals for the Ninth Circuit.
Takeaways
Because this decision is one of several conflicting rulings on the issue of PPA rejection, there may be some time before buyers and sellers under PPAs have clarity on the likely impact of a counterparty's bankruptcy. As more courts—including appellate courts—address the issue, a more definitive rule may emerge regarding the relationship between FERC and bankruptcy court jurisdiction. For now, except for the court in the Calpine case, courts' rulings on the issue have concluded that a bankruptcy court may authorize rejection of a PPA without FERC approval, indicating that chapter 11 debtors will only need to satisfy a relatively debtor-friendly business judgment standard in order to stop performing under a PPA.
