September 2020: Bankruptcy and Restructuring Litigation Update

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The Bankruptcy Courts vs. FERC:

A Jurisdictional Clash over the Rejection of Energy Contracts

A jurisdictional conflict has emerged between federal courts overseeing bankruptcy cases and the Federal Energy Regulatory Commission (“FERC”) over the rejection of energy contracts.  Ordinarily, a court’s authority to allow rejection is exclusive and unquestioned.  But when a contract authorized and regulated by FERC is at issue, the court must decide whether permitting rejection impermissibly infringes on FERC’s regulatory domain.  

I.    The Sources of Competing Jurisdictional Authority

Section 365 of the Bankruptcy Code allows a debtor to reject “all executory contracts,” subject to court approval.  The ability to reject an executory contract “is vital to the basic purpose of a Chapter 11 reorganization, because rejection 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).  Rejection is governed by the deferential “business judgment” standard, which requires a court to approve a rejection motion as long as it finds that the debtor exercised its sound business judgment in determining that rejection is in the best interests of its estate.  See, e.g., Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 (2019).

The Federal Power Act and Natural Gas Act vest FERC with exclusive authority to regulate rates for sales of electric energy and transportation and sale of natural gas, respectively.  Ark. La. Gas Co. v. Hall, 453 U.S. 571, 577 n.7 (1981).  In practice, this means that FERC can modify or abrogate a contract if it finds that the agreed-upon rate is not “just and reasonable.”  Id.  However, under the Mobile-Sierra doctrine, FERC must presume that the rate in a freely negotiated contract is “just and reasonable,” which presumption may be overcome “only if FERC concludes that the contract seriously harms the public interest.”  Morgan Stanley Capital Grp. Inc. v. Pub. Util. Dist. No. 1 of Snohomish Cty., Wash., 554 U.S. 527, 530 (2008).  

The statutory powers granted to FERC led to the judicially-created “filed rate doctrine,” under which the “right to a reasonable rate is the right to the rate which the [FERC] files or fixes, and, . . . except for review of the [FERC’s] orders, a court can assume no right to a different one on the ground that, in its opinion, it is the only or the more reasonable one.”  Miss. Power & Light Co. v. Miss. ex rel. Moore, 487 U.S. 354, 371 (1988).  Thus, “the reasonableness of rates and agreements regulated by FERC may not be collaterally attacked in state or federal courts,” and may be challenged only before FERC or a court reviewing the Commission’s order.  Id. at 375. 

II.    Conflicting Decisions in Various Jurisdictions

The apparent overlap in statutory authority conferred to bankruptcy courts and FERC has been addressed by a number of conflicting circuit and district court rulings. 

The Fifth Circuit was the first circuit court to address this issue, holding that FERC cannot “preempt a district court’s jurisdiction to authorize the rejection of an executory contract subject to FERC regulation as part of a bankruptcy proceeding.”  In re Mirant Corp., 378 F.3d 511, 522 (5th Cir. 2004).  The court reasoned that rejection is not modification or abrogation of a filed rate, and that the plain language of Section 365 shows that Congress did not intend to exclude energy contracts from rejection.  Id.  Nevertheless, the court suggested that on remand, the district court should consider applying a more rigorous standard than “business judgment,” to account for the “unique” nature and “public interest inherent in the transmission and sale of electricity.”  Id. at 525.  The court proposed that the district court weigh the public interest impact of rejection, including whether rejection would cause any disruption in the supply of electricity to other public utilities or to consumers, against the burdens of the agreement, and that rejection should be authorized only if “the equities balance in favor of rejecti[on].”  Id.  Significantly, the court also noted that FERC should be welcome to assist in the “balancing [of] these equities.”  Id. at 526.

Decisions from the Southern District of New York have sided with FERC in this jurisdictional debate.  In In re NRG Energy, Inc, the district court held that it lacked jurisdiction to vacate a FERC order requiring the debtor to perform under a contract that the bankruptcy court had subsequently authorized the debtor to reject.  2003 WL 21507685, at *3. (S.D.N.Y. June 30, 2003). The court held that actions taken by FERC “are reviewable only by the federal courts of appeals,” and because FERC had acted first “within its legal authority,” the district court was “not the proper forum for Plaintiff to challenge FERC’s regulatory action.”  Id. at *3-4.  In re Calpine then extended NRG’s expansive view of FERC’s authority, holding that “FERC has plenary jurisdiction over filed rate energy contracts,” and that “neither the jurisdictional grant to the bankruptcy courts, nor the rejection authority limits FERC’s plenary jurisdiction.”  337 B.R. 27, 32-33 (S.D.N.Y. 2006).  The court explicitly refused to adopt what it described as Mirant’s “narrow[]” interpretation of the filed rate doctrine as to only reach modifications of the rate, rather than rejections or terminations.  Id. at 38.

Subsequently, in the second circuit-level decision on this issue, the Sixth Circuit held that even “if the bankruptcy court’s jurisdiction is not exclusive . . . its position in the concurrent jurisdiction is nonetheless primary or superior to FERC’s position.”  In re FirstEnergy Sols. Corp., 945 F.3d 431, 446 (6th Cir. 2019).  The court concluded that “the public necessity of available and functional bankruptcy relief is generally superior to the necessity of [the] FERC’s having complete or exclusive authority to regulate energy contracts and markets.”  Id. at 445-46.  The Sixth Circuit also agreed with Mirant that a heightened standard should apply, concluding that bankruptcy courts must consider “the impact of the rejection of these contracts on the public interest.”  Id. at 454.  Unlike Mirant, however, the court required—rather than invited—FERC to participate in the rejection determination, mandating that FERC provide an opinion on the public interest pursuant to the Mobile-Sierra analysis it ordinarily employs when assessing a rate modification or abrogation.  Id.

The most vigorous defense of the courts’ jurisdiction over rejection came in the Northern District of California, where the court concluded that “the rejection of an executory contract is solely within the power of the bankruptcy court, a core matter exclusively this court’s responsibility.”  In re PG&E Corp., 603 B.R. 471, 486 (Bankr. N.D. Cal. 2019).  Distinguishing its holding from Mirant, the court did not conclude that the public interest needs to be considered every time a party seeks to reject a FERC-regulated agreement, but “may need to be considered in the context of a specific rejection of a specific [energy agreement].”  Id. at 490.  The case is now on direct appeal to the Ninth Circuit, which held oral argument on August 14, 2020.  

The most recent case to address this issue was In re Ultra Petroleum Corp. in the Bankruptcy Court for the Southern District of Texas.  Two weeks before Ultra filed for bankruptcy, Rockies Express Pipeline LLC (“Rockies”) filed a petition with FERC asserting that FERC “has concurrent jurisdiction with U.S. Bankruptcy Courts,” and seeking a ruling that Ultra may not reject its shipping agreement with Rockies in Ultra’s forthcoming bankruptcy “without FERC’s prior approval.”  See FERC Docket No. RP20-822-000.  Following Ultra’s bankruptcy filing and motion to reject, and statements from the court suggesting that pursuit of the petition would violate the Bankruptcy Code’s automatic stay, Rockies voluntarily withdrew the petition.  Nevertheless, the court repeatedly requested that FERC participate in the rejection proceeding as a party-in-interest, while FERC responded that without a formal proceeding, its ability to take a position was limited.  Relying on Mirant, the Ultra court held that because “[r]ejection is, simply, a breach” that does not abrogate, rescind, modify, or terminate a contract, “FERC’s jurisdiction concerning rate setting is unaltered by rejection.”  In re Ultra Petroleum, No. 20-32631, 2020 WL 4940240, at *12 (Bankr. S.D. Tex. Aug. 21, 2020).  Turning next to the public interest analysis it found to be mandated by Mirant, the Court rejected Rockies’ and FERC’s arguments that it should permit rejection only if it found that continuation of the contract would harm the public interest, determining instead that the appropriate analysis was whether rejection would harm the public interest.  Id. at *11  The court concluded that the evidentiary record showed that the impact of rejection on the public interest would be minimal, and granted Ultra’s motion to reject.  Id. at *12-13.

III.    Conclusion

As the energy sector braces for a potential onslaught of bankruptcy filings, the jurisdictional conflict between the federal courts and FERC is far from settled.  Debtors with onerous energy contracts they are hoping to reject, and creditors of such debtors, should thus take great care in choosing the location of a bankruptcy filing, which may mean the difference between a successful or unsuccessful motion to reject.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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