The Turf War Between the Bankruptcy Courts and FERC Escalates

The recent chapter 11 filings by PG&E Corp. and its Pacific Gas & Electric Co. utility subsidiary (collectively, "PG&E") and FirstEnergy Solutions Corp. have reignited the debate over the power of a U.S. bankruptcy court to authorize the rejection of contracts regulated by the Federal Energy Regulatory Commission ("FERC"). Only a handful of courts have addressed this thorny issue to date, and with conflicting results in a controversy that may ultimately need to be resolved by the U.S. Supreme Court or legislative action. The crux of the problem lies in conflicting jurisdiction conferred upon bankruptcy courts by the Bankruptcy Code, 11 U.S.C. §§ 101 et seq., and related statutes to authorize the rejection of burdensome contracts, on the one hand, and by the Federal Power Act, 16 U.S.C. §§ 791a et seq. (the "FPA"), to FERC, which is granted the "exclusive authority" to determine the reasonableness of interstate utility rates, on the other.

The bankruptcy court presiding over PG&E’s chapter 11 cases was the most recent court to weigh in on the debate. In PG&E Corp. v. FERC (In re PG&E Corp.), Adv. Proc. No. 19-3003 (Bankr. N.D. Cal. June 7, 2019), as amended and direct appeal certified, 2019 WL 2477433 (Bankr. N.D. Cal. June 12, 2019), 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 PG&E ruling came on the heels of another bankruptcy court’s decision in FirstEnergy Solutions Corp. v. FERC (In re FirstEnergy Solutions Corp.), 2018 WL 2315916 (Bankr. N.D. Ohio May 18, 2018). In that case, the U.S. Bankruptcy Court for the Northern District of Ohio enjoined FERC from requiring chapter 11 debtors to continue performing under certain wholesale power contracts that the debtors sought to reject. PG&E and FirstEnergy have been certified for direct appeal to the Ninth and Sixth Circuit Courts of Appeals, respectively. Those courts will be the second and third circuit courts to consider this issue.

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 "proceedings arising under" the Bankruptcy Code as well as those "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 DIP to continue performing under the agreement, after curing outstanding defaults, or to assign the agreement to a third party for consideration as a means of generating value for the bankruptcy estate. Rejection frees the DIP 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, and the Mobile-Sierra Doctrine

Public and privately operated utilities providing interstate utility service within the United States are regulated by the 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)).

Although FERC has exclusive authority to modify a filed rate, its discretion is not unfettered. For example, FERC may not change a filed rate solely because the rate affords the utility "less than a fair return" since "the purpose of the power given to the Commission … is the protection of the public interest, as distinguished from the private interests of the utilities." In re Mirant Corp., 378 F.3d 511, 518 (5th Cir. 2004) (citation omitted). In such a case, FERC can change a filed rate only when "the rate is so low as to adversely affect the public interest—as where it might impair the financial ability of the public utility to continue its service, cast upon other consumers an excessive burden, or be unduly discriminatory." Id.

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 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 agreement. This thorny issue has been addressed to date by only a handful of courts and a single court of appeals.

Mirant

In In re Mirant Corp., 378 F.3d 511 (5th Cir. 2004), 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-approved rate-setting agreement so long as the proposed rejection does not represent a challenge to the agreement’s filed rate.

In the case before it, the Fifth Circuit explained, although the chapter 11 debtor’s desire to reject a FERC-regulated power supply agreement was motivated in part by its below-market rate, the debtor’s business justification was also premised on the existence of excess supply and the consequent lack of any need for the energy covered by the contract. The court accordingly concluded that rejection of the agreement was not a challenge to the filed rate and that the FPA did not preempt a ruling on the rejection motion.

The Fifth Circuit rejected FERC’s argument that anything less than full payment would constitute a challenge to the filed rate. According to the court, "[A]ny effect on the filed rates from a motion to reject would result not from the rejection itself, but from the application of the terms of a confirmed reorganization plan to the unsecured breach of contract claims." The court also 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.

Calpine

In In re Calpine Corp., 337 B.R. 27 (S.D.N.Y. 2006) (Casey, J.), the U.S. District Court for the Southern District of New York, after withdrawing the reference to the bankruptcy court, dismissed a chapter 11 debtor’s motion to reject certain 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."

The court wrote that, if a bankruptcy court’s broad powers and jurisdiction, including the power to authorize the rejection of a contract, conflict with a federal regulatory regime, "the power of the bankruptcy court must yield to that of the federal agency." The Bankruptcy Code itself supports this conclusion, the court explained, by exempting agency action from the scope of the automatic stay.

As framed by the district court, the dispositive issue was whether rejection of the power agreements directly interferes with FERC’s exclusive jurisdiction over wholesale power contracts "or otherwise constitutes a collateral attack on the filed rate." The court concluded that it would—rejection of the agreements, which even the debtor admitted was motivated by its dissatisfaction with their below-market rates, would infringe upon FERC’s exclusive prerogative to regulate the rates, terms, conditions, and duration of wholesale-energy contracts.

The district court explained that the Fifth Circuit’s rationale in Mirant was entirely consistent with its own conclusions because in Calpine, unlike in Mirant, the debtor was seeking nothing more than rate relief—its rejection motion clearly stated that it needed relief from the power agreements because it was being forced to sell energy at far below market rates.

Boston Generating

In In re Boston Generating, LLC, 2010 WL 4616243 (S.D.N.Y. Nov. 12, 2010) (Cote, J.), the U.S. District Court for the Southern District of New York, after withdrawing the reference of the matter to the bankruptcy court, ruled that, in order to reject a 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."

The parties to the contract agreed that the debtors should seek FERC approval of the proposed rejection, but they disagreed over whether the bankruptcy court could consider the rejection motion concurrently with FERC or would have to wait until FERC had ruled. According to the district court, the issue was of no consequence. "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."

FirstEnergy Solutions

In FirstEnergy, the U.S. Bankruptcy Court for the Northern District of Ohio enjoined FERC from requiring the chapter 11 debtors to continue performing under certain wholesale power contracts that the debtors sought to reject. In opposing the injunction, FERC argued that, reading the FPA and the Bankruptcy Code together, FERC maintains concurrent jurisdiction with bankruptcy courts over wholesale power agreements. Stated differently, as the district court did in Boston Generating, FERC insisted that a debtor must seek bankruptcy court approval to reject a wholesale power agreement, and FERC approval to unilaterally change such an agreement.

The bankruptcy court in FirstEnergy Solutions rejected this argument. It ruled that:

1. Any action by FERC to require continued performance by the debtors in a proceeding commenced before FERC by the counterparty seeking a determination that rejection of the power agreement would violate the filed-rate doctrine was subject to the automatic stay.
2. The "police and regulatory power" exception to the stay under section 362(b)(4) of the Bankruptcy Code did not apply because the FERC proceeding was "undertaken principally to adjudicate private rights, with only an incidental public interest in the litigation."
3. If FERC were nevertheless to proceed on the basis that the section 362(b)(4) exception did apply, "that action would be a fool’s errand because any order it might issue to compel the Debtors’ performance … would, in substance, be designed to obtain or control the property of the estate and therefore, be void ab initio" under section 362(a)(3) of the Bankruptcy Code.
4. In the alternative, to "preserve its jurisdiction" over the power agreement, the bankruptcy court had the power to enjoin continuation of the FERC proceeding under section 105(a) of the Bankruptcy Code, which empowers a bankruptcy court to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]."

Notably, the bankruptcy court wrote that "[w]hile given the force of statute or regulation under applicable caselaw, … filed rate contracts remain contracts. They are not actual regulations, subject to notice-and-comment rulemaking processes, let alone actual federal statutes, that would lie outside the ambit of Section 365 simply by virtue of not being ‘contracts’ at all." Consistent with Mirant, the bankruptcy court in FirstEnergy Solutions also concluded that the filed-rate doctrine, the FPA, and FERC’s regulatory authority are not offended by, and do not preempt, the bankruptcy court’s exclusive jurisdiction over motions to reject executory power contracts and the treatment of rejection damages claims in bankruptcy cases.

A direct appeal of the bankruptcy court’s ruling is currently pending before the U.S. Court of Appeals for the Sixth Circuit. See In re FirstEnergy Solutions Corp., Case Nos. 18-3787 et al. (6th Cir.) (appeal filed Jan. 17, 2019). Briefing in the appeal concluded in May 2019, and the court heard argument in the case on June 26.

PG&E

PG&E filed for chapter 11 protection in the Northern District of California on January 29, 2019. It was the second chapter 11 filing for Pacific Gas & Electric Co., which emerged from a previous bankruptcy in 2003. With listed assets of $71.4 billion and debts of $51.7 billion, PG&E’s bankruptcy is the largest U.S. utility bankruptcy to date and the sixth-largest U.S. corporate bankruptcy ever. The filing was precipitated by potential liabilities exceeding $30 billion arising from the alleged role of PG&E’s equipment in sparking the largest and most deadly wildfires in California history.

As of December 2017, PG&E was party to $42 billion worth of power purchase agreements (each, a "PPA"), with approximately 350 counterparties covering various electricity projects.

In anticipation of PG&E’s bankruptcy filing, NextEra Energy Inc. and Exelon Corp., which have solar and wind PPAs with PG&E, filed petitions with FERC seeking a declaration that if PG&E filed for bankruptcy, "PG&E may not abrogate, amend or reject in bankruptcy any of the rates, terms and conditions of its wholesale power purchase agreements subject to this Commission’s jurisdiction" without first obtaining approval from FERC. See NextEra Energy, Inc. v. Pac. Gas & Electric Co., 166 FERC ¶ 61,049 (2019); Exelon Corp. v. Pac. Gas & Electric Co., 166 FERC ¶ 61,053 (2019).

On January 25, 2019, FERC issued an order concluding that the "Commission and the bankruptcy courts have concurrent jurisdiction to review and address the disposition of wholesale power contracts sought to be rejected through bankruptcy." FERC acknowledged that "the law in this area is unsettled" and that courts have reached different conclusions in interpreting the FPA and the Bankruptcy Code with respect to the rejection of PPAs in bankruptcy. After reviewing recent court rulings, including Mirant, Calpine, Boston Generating, and FirstEnergy, FERC determined that to "give effect to both the FPA and the Bankruptcy Code, a party to a Commission-jurisdictional wholesale power purchase agreement must obtain approval from both the Commission and the bankruptcy court to modify the filed rate and reject the contract, respectively."

On the day it filed for bankruptcy, PG&E filed an adversary proceeding in the bankruptcy court seeking a declaratory judgment to enforce the automatic stay and an injunction blocking FERC from taking any action that would require PG&E to continue performing under PPAs that PG&E sought to reject in bankruptcy.

On February 6, 2019, FERC filed a motion to withdraw the reference of the adversary proceeding, arguing that only a federal appellate court could resolve the dispute because it involved "substantial and material consideration" of how the FPA gives FERC exclusive authority to oversee rates for interstate transmission and wholesale electricity sales. Certain PPA counterparties also filed motions to withdraw the reference. The U.S. District Court for the Northern District of California denied FERC’s motion to withdraw the reference in March 2019. The district court agreed with the bankruptcy court’s assessment that it could determine the issues presented, writing that "resolving these questions will not necessarily involve the substantial and material consideration of non-[Bankruptcy Code] law so as to mandate withdrawal."

FERC issued an order on May 1, 2019, denying rehearing of its orders asserting concurrent jurisdiction with the bankruptcy court over the PPAs.

The Bankruptcy Court’s Ruling

On June 7, 2019, the bankruptcy court ruled that FERC exceeded its authority when it declared that it shares jurisdiction with the bankruptcy court over the question of whether PG&E can reject its PPAs. "To be blunt," the court wrote, "they were unauthorized acts of the power regulator executing a power play (to use a hockey term) to curtail the role of the court acting within its authorized and exclusive role in these bankruptcy cases."

The bankruptcy court was particularly troubled by two "remarkable" assertions made by FERC in its May 1, 2019, order denying rehearing. First, the court noted, FERC stated that "[w]holesale power contracts are not simple run-of-the-mill contracts between two private parties, rather, these contracts, while privately negotiated, implicate the public’s interest in the orderly production of plentiful supplies of electricity at just and reasonable rates."

Although true, the court explained, this statement "is completely contrary to the congressionally created authority of the bankruptcy court to approve rejection of nearly every kind of executory contract." This authority includes "‘run-of-the-mill types,’ whatever that means, or the other kind, including power purchase agreements and others that implicate the public’s interest, but excluding certain types not relevant here." This fundamental grant of authority over executory contracts, the court explained, is borne out by both the U.S. Supreme Court’s recent ruling in Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 652, 2019 WL 2166392 (U.S. May 20, 2019), and provisions in the Bankruptcy Code dealing with special types of executory contracts (e.g., sections 365(h), 365(i), 365(n), 365(o), and 1113). According to the court, those provisions 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 failed to condition rejection of a contract on FERC’s approval. See 11 U.S.C. § 1129(a)(6).

Second, FERC stated in its order that, "[t]o be clear, [FERC] neither presumes to sit in judgment of rejection motions nor seeks to arrogate the role of adjudicating bankruptcy proceedings." According to the bankruptcy court:

FERC, despite its denial, has chosen to interfere with bankruptcy courts’ decisions. Without statutory or [S]upreme [C]ourt authority to support its position, it in fact "presumes to sit in judgment" and second-guess—no overrule—decisions of the bankruptcy court.

To deal with what it correctly identifies as unsettled law with different court interpretations (one circuit court, one district court and one bankruptcy court now on direct appeal to another circuit court) … FERC purports to settle the law by announcing its own interpretation of bankruptcy law and decree something found nowhere in the statute it interprets. This is not the way that unsettled law is to be developed. That is the role of the courts.

The bankruptcy court concluded that there is no support in either the Bankruptcy Code or the FPA for FERC’s assertion of jurisdiction. Moreover, the court noted, granting FERC jurisdiction would be unfair to PG&E and would threaten the balance of power between the executive branch and judicial branch. The court wrote that "[d]espite FERC’s lip service to what it describes as ‘concurrent jurisdiction’ to carry out differing and perhaps competing policies, the effect of its decision guts and renders meaningless the bankruptcy court’s responsibilities in this area of the law."

The court accordingly granted PG&E’s motion for a declaratory judgment that: (i) FERC does not have concurrent jurisdiction over the court’s decision to authorize PG&E to reject (or assume) the PPAs; and (ii) FERC’s previous rulings involving PG&E are of no force and effect and are not binding on PG&E in its bankruptcy cases. Given its conclusion that FERC exceeded its statutory authority, the court declined to issue an injunction. However, the court stated that, "[i]f necessary in the future[,] it will enjoin FERC from perpetuating its attempt to exercise power it wholly lacks."

The bankruptcy court stated that, should PG&E move to reject any of the contracts, the court would consider whether public-policy interests are implicated. At that juncture, the court explained, it could assess whether rejection is warranted, without any "need or right for a second inquiry by a separate non-judicial body to be involved."

The bankruptcy court certified a direct appeal of its ruling to the U.S. Court of Appeals for the Ninth Circuit on June 12, 2019.

Outlook

 Courts have reached mixed conclusions regarding the power of a bankruptcy court to authorize the rejection of a power contract in bankruptcy. With the issue now teed up before the Sixth and Ninth Circuits, substantial additional guidance on the circuit court level regarding this issue is likely to be forthcoming. Any resulting circuit split may invite resolution of this important issue by the U.S. Supreme Court or legislative action.