Firstenergy Solutions: Ohio bankruptcy court finds that it, not FERC, has jurisdiction on rejection of power contracts

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Publication July 16, 2018

Bankruptcy can be an unfamiliar place. It gives a debtor many tools capable of drastically changing its relationship with creditors, contract counterparties, and other interested parties. Bankruptcy can alter not only debtor-creditor relationships, but also the debtor’s relationship with its regulators. Regulators and bankruptcy courts with potentially competing or conflicting jurisdiction and authority create confusion and unique challenges and opportunities for debtors. These problems can be particularly acute in certain sectors of the energy industry.

The Federal Energy Regulatory Commission (“FERC”) is the federal agency vested with exclusive authority to regulate rates for interstate power transmission and wholesale electric energy. Under the Federal Power Act, power companies are required file certain privately-negotiated power purchase agreements (“PPAs”) and contracts with FERC for its review and approval of the contract’s rates and conditions. FERC’s plenary and exclusive jurisdiction over wholesale power rates, terms, and conditions of service is embodied in the “filed rate doctrine,” which provides that “so long as the filed rate is not changed in the manner provided by the [Federal Power Act] it is to be treated as though it were a statute, binding upon the seller and purchaser alike.” Under the filed rate doctrine, a party “can claim no rate as a legal right that is other than the filed rate ... and not even a court can authorize commerce in the commodity on other terms.” Under the Bankruptcy Code, however, these FERC-approved PPAs are potentially subject to rejection by the debtor.

Bankruptcy Code section 365 generally allows a debtor to assume (and under certain circumstances, assign) or reject executory contracts and unexpired leases. Debtors commonly use rejection under section 365 to shed burdensome contracts and leases or otherwise leverage the threat of rejection to renegotiate terms. Section 365 is particularly important for power companies whose revenues are frequently a function of locked-in, FERC-approved rates under PPAs and other energy contracts. PPA counterparties, however, have argued that rejecting a filed rate contract under section 365 violates the Federal Power Act, the filed rate doctrine, and otherwise interferes with FERC’s exclusive jurisdiction. Various courts have considered these issues, and have reached conflicting conclusions.

In NRG Energy, Inc., the US District Court for the Southern District of New York ruled that FERC’s jurisdiction and authority over approved PPAs is unaffected when a counterparty files for Chapter 11. Thus, FERC could prevent the termination of a PPA and order the debtor to continue to pay the existing rates notwithstanding the imposition of the automatic stay or the debtor’s powers under section 365. In In re Mirant Corp., both the US Bankruptcy Court for the Northern District of Texas and the US Court of Appeals for the Fifth Circuit rejected NRG Energy’s analysis, finding no conflict between FERC’s jurisdiction over power rates under the Federal Power Act and the bankruptcy court’s jurisdiction over the debtor’s estate (including the right to reject under section 365) under the Bankruptcy Code. Thus, the bankruptcy court could enjoin FERC from taking actions in derogation of the bankruptcy court’s jurisdiction, including prohibiting FERC from compelling the debtor to perform under a rejected PPA.

The US Bankruptcy Court for the Northern District of Ohio recently confronted these issues in In re FirstEnergy Solutions Corp. Although these issues remain unsettled, in FirstEnergy, the Court examined Mirant Corp., NRG Energy, and Calpine in detail and determined that there is no jurisdictional conflict between the Bankruptcy Code and the Federal Power Act, and further, that FERC could be subject to the Bankruptcy Code’s automatic stay.

Conflicting decisions: NRG Energy, Mirant Corp. and Calpine

NRG Power Marketing, Inc. (“NRG”), a subsidiary of NRG Energy, Inc., was obligated under a PPA with Connecticut Light & Power Company (“CLP”) to provide energy at a fixed price. CLP defaulted under the PPA when it failed to make certain payments, but NRG continued to perform. In May 2003, shortly before filing for Chapter 11 relief, NRG notified CLP that it intended to terminate the PPA. Later that day NRG filed for bankruptcy in the Southern District of New York and simultaneously moved to reject the PPA pursuant to section 365. The next day, Connecticut’s Attorney General and the Connecticut Department of Public Utility Control petitioned FERC for an order staying the termination to prevent harm to CLP’s customers. FERC then entered an order staying the termination and further requiring NRG to continue to perform under the PPA. Two weeks later, the bankruptcy court approved NRG’s motion to reject the “money-losing” PPA, but declined to interfere with the FERC proceeding or its stay order. NRG then sought declaratory judgment and injunctive relief from the district court to set aside FERC’s stay order and proceed with the PPA’s termination. The district court dismissed NRG’s complaint.

According to the district court, whether NRG could stop performing under the PPA fell squarely within FERC’s regulatory purview. The district court also found that it lacked jurisdiction to review FERC’s stay order as the Federal Power Act provides that only US courts of appeals can review FERC orders. As NRG’s PPA drama unfolded, Mirant Corporation (“Mirant”) was taking notes, and when it filed for Chapter 11 protection just days after the NRG decision, it chose to pursue a different rejection strategy.

In 2000, Potomac Electric and Power Company (“PEPCO”) sold its power plants and assigned its PPAs to Mirant. PEPCO and Mirant entered into what the parties called a “back-to-back agreement,” whereby Mirant agreed to buy power from PEPCO at the same price PEPCO was obligated to pay for it under certain PPAs. The agreement resulted in Mirant paying well above market rates and incurring substantial losses. After Mirant filed for bankruptcy, it sought to reject the back-to-back agreement without notice to PEPCO, and it also sought injunctive relief against PEPCO and FERC to protect the bankruptcy court’s jurisdiction over Mirant’s PPAs and the back-to-back agreement. PEPCO and FERC then sought relief in the district court. The district court disagreed with the bankruptcy court and found that FERC had “exclusive authority to determine the reasonableness of wholesale rates for electricity sold in interstate commerce,” and that the Bankruptcy Code does not except parties from compliance with the Federal Power Act. Mirant appealed, and the Fifth Circuit reversed.

The Fifth Circuit agreed with the bankruptcy court’s holding: there is no conflict between FERC’s regulatory authority and the bankruptcy court’s jurisdiction under section 365. The court found that rejection under section 365 constitutes a breach of contract, but the Federal Power Act does not grant FERC authority over the remedies available for breach of a FERC-approved contract. The court further observed that FERC-approved contracts were not specifically excluded under section 365 even though the Bankruptcy Code does expressly require regulators to approve the rejection of certain other obligations.

Mirant Corp. and NRG Energy are plainly inconsistent. In the years since, neither the courts nor Congress resolved the conflict. In fact, shortly after the Mirant Corp. decision, District Court Judge Richard C. Casey (who also issued the NRG Energy decision) issued an opinion in In re Calpine Corp. that expressly disagreed with the Fifth Circuit and ruled that “rejection based on dissatisfaction with the rates . . . constitute[es] [an impermissible] collateral attack on the filed rate itself.” After analyzing the structure of section 365 and related Bankruptcy Code provisions, Judge Casey found that “[b]ecause there is nothing in the Bankruptcy Code that limits FERC’s jurisdiction, [the debtor] cannot achieve in Bankruptcy Court what neither it, nor any other party . . . nor any other federally regulated energy company in the country could do without seeking FERC approval: cease performance under the rates, terms, and conditions of filed rate wholesale energy contracts in the hopes of getting a better deal.”

FirstEnergy Solutions: the bankruptcy court, not FERC, can reject power contracts

FirstEnergy Solutions Corp. (“FES”) is a power generation company based in Ohio that, among other things, sells energy to regional transmission organizations. FES was party to nine “bundled” long-term PPAs that obligated FES to purchase power, capacity, renewable energy credits, and related services. FES and 13 other power companies are also parties to an intercompany power agreement (the “ICPA”) companies pursuant to which they are obligated to purchase power from the Ohio Valley Energy Corporation (“OVEC”).

In early 2018, FES’s strained balance sheet and declining financial condition were no secret. In anticipation of an FES bankruptcy filing, OVEC initiated a FERC proceeding on March 26 and sought the entry of an order finding that any breach of the ICPA would violate the filed rate doctrine and FERC had exclusive jurisdiction to consider that question. On March 31, FES filed its petition for Chapter 11 relief. Shortly thereafter FES filed an adversary proceeding against FERC seeking declaratory judgment and injunctive relief preventing FERC from taking any action that would interfere with the bankruptcy court’s jurisdiction to consider FES’s motions to reject its bundled PPAs and the ICPA.[1] The court entered a temporary restraining order against FERC pending its decision to grant a preliminary injunction. On May 11, it granted FES’s request for a preliminary injunction against FERC.

In previous cases, courts focused their analysis on the use of Bankruptcy Code section 105—which grants bankruptcy courts broad authority to enter “any order . . . that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code—to protect the bankruptcy court’s jurisdiction. The court’s analysis, however, began with the applicability of the automatic stay under section 362. Section 362 generally operates to stay the commencement or continuation of an array of judicial and administrative proceedings as well as any act to exercise control over estate property. Section 362(b)(4) also provides that the automatic stay does not apply to “the commencement or continuation of an action or proceeding by a governmental unit . . . to enforce such governmental unit’s or organization’s police and regulatory power.” Therefore, the court first considered whether the “police and regulatory power” exception to the automatic stay applied to the FERC proceeding or a similar proceeding where a counterparty to a FERC-regulated power contract seeks to enforce the contract after its rejection under section 365. To determine whether FERC would be exercising its “police and regulatory power,” the court employed two tests: the pecuniary purpose test and the public policy test.

Under the pecuniary purpose test, courts focus on whether a governmental proceeding relates primarily to the protection of the government's pecuniary interest in a debtor's property, and not to matters of public safety. Under the public policy test, courts distinguish between proceedings that adjudicate private rights and those that affect public policy. “[W]hen the action incidentally serves public interests but more substantially adjudicates private rights, courts should regard the suit as outside the police power exception, particularly when a successful suit would result in a pecuniary advantage to certain private parties vis-a-vis other creditors of the estate, contrary to the Bankruptcy Code’s priorities.” Although courts acknowledge that “many cases will be close,” proceedings that relate primarily to public safety or policy are generally excepted from the stay. Therefore, under these tests, only actions instituted to effectuate FERC’s public-policy goals (as opposed to those instituted to protect a pecuniary interest in the debtor’s property or to adjudicate private rights) will be excepted from the stay.

In FirstEnergy, the court concluded that the FERC proceeding passed the pecuniary interest test but failed the public policy test. The court observed that a regulatory proceeding need not be wholly unrelated to the public policy of the legislation administered by the agency to fail the public policy test and fall subject to the automatic stay. Here, however, the court found that “the obvious and dominant purpose of the FERC [p]roceeding” was for the debtor’s counterparties to leap frog similarly situated creditors. If OVEC or other PPA counterparties succeed in obtaining the relief requested in the FERC proceeding, the primary impact would be a pecuniary advantage to those counterparties relative to other unsecured creditors. Further, the court noted that any FERC order compelling performance under “the ICPA or any PPA would, in substance, be designed to obtain or control the property of the estate and therefore, be void ab initio.” Next, the court considered whether—even if the automatic stay did not apply—it still had the power to enjoin FERC under Bankruptcy Code section 105 to preserve its jurisdiction over the debtors’ estates and the rejection motions. Like the court in Mirant Corp., the court ruled that it could enjoin FERC “to avoid the cost and delay of unnecessary proceedings that would ultimately be held void.”

Bankruptcy courts generally apply the “usual rules” in deciding whether to issue an injunction under section 105: whether (i) there is a strong or substantial likelihood of success on the merits, (ii) there would be irreparable injury absent the injunction, (iii) there would be substantial harm to others if the injunction was issued, and (iv) the public interest would be served. The court found that FES would likely prevail in its adversary proceeding to preserve the court’s jurisdiction. FERC argued that it had concurrent jurisdiction with the bankruptcy court and that the bankruptcy court could approve the rejection of a filed rate power contract, but FERC could then conduct a regulatory review and require the debtor to perform anyway. The court rejected that argument as “at best, a costly procedural delay of the final determination of the treatment rejection claims will receive in the bankruptcy case” and “[a]t worst, . . . an inappropriate violation of the Bankruptcy Code’s priority scheme.” The court’s decision relied heavily on the bankruptcy and circuit court decisions in Mirant Corp., including their analyses of section 365 and other Bankruptcy Code provisions that limit “general rejection authority” and “prohibit[ ] rejection of certain obligations imposed by regulatory authorities.” Simply put, no such limitation or prohibition protects energy contracts, whether filed with FERC or otherwise.

The court further held that “rejection, including the attendant cessation of performance, does not intrude on FERC's jurisdiction over filed rates” because, among other things, “that rate is given full effect when determining the breach of contract damages resulting from the rejection.” “The economic disappointment a power contract counterparty experiences in a debtor-party's bankruptcy case cannot be avoided by invoking the Federal Power Act and the filed rate doctrine any more than can the disappointment of any other general unsecured creditor be avoided by invoking the law of contract or tort.” FERC and OVEC argued that FERC’s approval of a privately negotiated power contract is, in effect, a regulation “as it relates to the wholesale power in that area.” If true, such contracts would likely fall outside section 365’s scope (as “regulations” cannot be rejected) and would arguably give rise to “an ordinary course regulatory compliance obligation” that FES would have to satisfy. After noting the argument’s “seductive appeal,” the court disposed of it as largely unsupported by (if not contrary to) FERC-related case law. Accordingly, the court could not agree with Calpine and found that the bankruptcy court had jurisdiction to reject filed rate contracts. The court then found that the remaining factors plainly weighed in favor of granting the injunction.

Conclusion

FERC, OVEC, and other intervening parties have appealed the court’s decision, and on June 8, it approved OVEC’s request to certify its appeal directly to the US Court of Appeals for the Sixth Circuit. The FirstEnergy court’s decision nevertheless adds support for view that bankruptcy courts can use injunctive relief to protect their jurisdiction against a parallel FERC proceeding and also provides new guidance regarding whether such relief is necessary at all given the broad protection of the Bankruptcy Code’s automatic stay. If the Sixth Circuit affirms, the FirstEnergy decision would bolster case law holding that the Federal Power Act and the filed rate doctrine cannot stop a bankruptcy court from approving a debtor’s rejection of a FERC-approved PPA.


[1]       OVEC sought to have the ICPA rejection motion decided by the district court rather than the bankruptcy court. The district court quickly denied OVEC’s request and noted, in dicta, that FERC and the bankruptcy court had concurrent jurisdiction and that both would need to approve the debtor’s rejection. After holding a conference with the parties, the district court reaffirmed its decision not to decide the rejection motion, but deleted from its previous decision the dicta regarding the bankruptcy court and FERC’s concurrent jurisdiction.


 

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