Debtors in bankruptcy have broad authority to shed unfavorable contracts through the executory contract rejection process, subject to approval of the bankruptcy court. The Federal Energy Regulatory Commission (FERC), on the other hand, has exclusive jurisdiction over any request to modify or abrogate a “filed rate” under the Federal Power Act and the Natural Gas Act, which includes certain power purchase agreements and natural gas transportation contracts. For years, debtors and distressed counterparties faced uncertainty as to whether a bankruptcy court’s rejection order could fully relieve the debtor from performing under a filed-rate contract or if further relief from FERC (potentially applying the stringent “public interest” standard set out in the Mobile-Sierra line of cases) may be necessary to excuse future performance.
A recent string of court decisions — including the July 2022 decision from the 5th Circuit Court of Appeals in Gulfport Energy Corp. v. FERC, No. 21-60017 (5th Cir. July 19, 2022) — seems to have brought some clarity to this issue. According to both the 5th and 6th Circuits, notwithstanding FERC’s exclusive jurisdiction over modification or abrogation of filed rates, rejection of such contracts in bankruptcy relieves the debtor of its obligation to perform, and FERC does not have the power to compel performance under such rejected contracts. Accordingly, parties to power purchase agreements and negotiated-rate gas transportation contracts in most jurisdictions cannot rely on a proceeding before FERC to preserve the long-term value of such contracts if the counterparty has commenced bankruptcy proceedings, though it is possible FERC or other counterparties may continue to push the issue in other circuits.
The current judicial trend toward this outcome can be traced at least as far back as 2004, when the 5th Circuit found that FERC could not assert its authority to block Mirant, a power company, from rejecting FERC-jurisdictional contracts in bankruptcy. In re Mirant Corp., 378 F.3d 511, 514-15 (5th Cir. 2004). The Mirant court concluded that contract rejection is distinct from the modification or abrogation of a filed rate because rejection is treated as a breach by the debtor of the contract, which entitles the non-debtor counterparty to file a rejection damages claim, but that claim remains premised on the filed rate. The court reasoned that, unlike modification or abrogation, FERC does not have exclusive jurisdiction over a breach of a FERC-approved contract. But, in Mirant, the 5th Circuit established a standard higher than the general rejection standard for rejection of filed-rate contracts, and the court also suggested that rejection may not be available if the debtor is seeking rejection solely to obtain more favorable rates (rather than shedding unneeded capacity altogether).
Under Mirant, a bankruptcy court should balance a contract’s burden on the bankruptcy estate against whether rejection may harm the public interest or disrupt energy supply, and the bankruptcy court must invite FERC to participate in its consideration of the public interest.
Just two years later, the Southern District of New York found that it lacked jurisdiction to authorize rejection of certain FERC-jurisdictional power purchase agreements in a bankruptcy proceeding because doing so would “directly interfere with FERC’s jurisdiction over the rates, terms, conditions, and duration of wholesale energy contracts.” Cal. Dep’t Water Res. V. Calpine Corp., 337 B.R. 27, 36 (S.D.N.Y. 2006). The Calpine court found that Mirant was distinguishable from the case before it because in Mirant, the debtor was unable to take the energy at all, whereas in Calpine, the debtor was able to take the energy, but seemingly wished to do so at a lower rate. The court determined this constituted an impermissible collateral attack on the filed rate.
More recently, in 2019, the 6th Circuit largely aligned itself with Mirant, finding that bankruptcy court rejection of a filed-rate power purchase agreement relieves the debtor from future performance and does not require subsequent approval from FERC, provided that the bankruptcy court considers the public interest in connection with the proposed rejection based on guidance from FERC. See In re FirstEnergy Sols. Corp., 945 F.3d 431, 449 (6th Cir. 2019). The FirstEnergy decision was followed closely by a similar ruling in the Pacific Gas & Electric Company bankruptcy case regarding the court’s ability to reject a power purchase agreement that constituted a filed rate under the Federal Power Act. See PG&E Corp. v. FERC, Nos. 19-30088-DM, 19-03003, 2019 Bankr. LEXIS 1820 (Bankr. N.D. Cal. June 12, 2019). Chief Bankruptcy Judge Sontchi in Delaware also reached the same conclusion with respect to rejection of filed rate midstream gas transportation contracts. See In re Extraction Oil & Gas, Inc., 622 B.R. 608 (Bankr. D. Del. 2020).
In March 2022, the 5th Circuit reaffirmed its 2004 decision in Mirant (now applying it to a filed rate under the Natural Gas Act), finding that a bankruptcy court can approve rejection of a filed-rate contract without need for separate FERC approval, and confirming that a debtor does not have to continue performance under such agreement once a court approves rejection. In re Ultra Petroleum Corp., 28 F.4th 629 (5th Cir. 2022). The court in Ultra noted that the Mirant principles were satisfied in part because the debtor (Ultra) did not seek to reject the contract because the rates were excessive, but instead had suspended its drilling program, had never shipped gas under the contract at issue, and had been releasing its capacity to other shippers. Therefore, the court found that, unlike Calpine, the rejection was not a collateral attack on the filed rate that would interfere with FERC’s jurisdiction.
Finally, on the heels of Ultra, in July 2022, the 5th Circuit rejected FERC’s assertion that a different outcome is warranted where FERC entered orders requiring continued performance under a filed-rate contract prior to any bankruptcy filing. See Gulfport Energy Corp. v. FERC, No. 21-60017 (5th Cir. July 19, 2022). Rejecting FERC’s efforts to constrain the bankruptcy court’s authority, the 5th Circuit vacated a pair of orders FERC had issued prior to Gulfport’s bankruptcy filing that purported to require the debtor to obtain FERC approval prior to rejecting a gas transportation contract. The court found that the FERC orders rested on an incorrect interpretation of rejection, which Mirant and Ultra clarified, and that FERC is not permitted to require continued performance of a validly rejected contract, whether it does so before, during or after the bankruptcy proceeding.
In sum, the 5th and 6th Circuits, as well as a number of lower courts, have now confirmed that, although FERC has exclusive jurisdiction over the modification and abrogation of filed-rate contracts, that exclusivity does not extend to rejection of such contracts in bankruptcy except where the debtor may be seeking to reject a filed rate based on pricing rather than excess capacity.
If the current trend continues, rejection of power or natural gas contracts in bankruptcy will likely fall within the bankruptcy court’s exclusive jurisdiction in most cases. For parties negotiating long-term power purchase agreements and precedent agreements that give rise to long-term negotiated-rate natural gas firm transportation contracts, these risks associated with potential bankruptcy rejection should be taken into account when evaluating collateral requirements and other credit support.
Note: This client alert reflects only the views of its authors and does not necessarily represent the views of the firm or any of its clients.