Commission Watch
FERC Versus Bankruptcy Jurisdiction:
A Double-Edged Sword
Be careful what you wish for.
November 2004
By John P. Ratnaswamy
Two recent articles in the Fortnightly1 discussed conflicts that have emerged in the last 18 months over the respective jurisdictions of bankruptcy courts under the Bankruptcy Code2 and the Federal Energy Regulatory Commission (FERC) under the Federal Power Act.3 This occurs when a debtor seeks the bankruptcy court's approval under Section 365(a) of the code4 to reject a wholesale electricity sales contract that is a FERC-jurisdictional rate. Another pending high-profile dispute involves the respective jurisdictions of FERC and the bankruptcy courts when a debtor seeks to enforce, rather than reject, such a contract.5
The jurisdictional conflict may have even broader impacts on the electricity and the natural gas industries. While the context of the disputes has been wholesale electricity sales contracts, similar disputes could arise if a debtor were to seek to reject electricity transmission or inter-state natural-gas transportation contracts that are FERC-
jurisdictional rates.
The United States Court of Appeals for the Fifth Circuit, in its opinion issued on Aug. 4, 2004, In re Mirant Corp., et al.,6 ruled in favor of bankruptcy court jurisdiction over requests to reject FERC-jurisdictional wholesale electricity sales contracts. Yet, as discussed below, the court did not resolve-
and arguably magnified-uncertainties about the standard that should be employed by a bankruptcy court in considering such a request, essentially leaving the task of establishing the standard to the lower court, while suggesting but not mandating a hybrid standard.7
The uncertainties that remain in the wake of Mirant mean financially troubled companies and their actual and potential counter-parties in many cases will continue to have difficulty in assessing business, default, and credit risks.
Moreover, the jurisdictional conflict is a blade that cuts both ways for troubled companies. Success in obtaining
a more favorable forum and a more lenient standard for rejecting contracts may come at a significant price-counterparties sometimes might decline to do business with such companies or may be willing to enter into transactions only on terms and conditions, including security requirements, that are more
difficult, more costly, or even impossible for the troubled company to meet.
The Harmony of the Spheres
Disputes about claimed conflicts between federal insolvency statutes and federal regulatory statutes, and how such statutes should be read together, are not a new development. The Supreme Court confronted a claimed conflict between an insolvency-related statute and a banking regulation statute as long ago as 1883.8 More recently, the court has addressed claimed conflicts between the Bankruptcy Code and the National Labor Relations Act (NLRA),9 between the code and other banking regulation statutes,10 and between the code and the Communications Act of 1934.
When two federal statutes claimed to be in conflict are capable nonetheless of "co-existence," the federal courts normally seek to give effect to both, absent clear Congressional intent to the contrary.12 The courts, when they determine that there is a conflict between two statutes, may resolve the conflict in a relatively mechanical fashion based on one or more of the canons of statutory construction, but they also may seek to harmonize the statutes in light of their language and purposes.13
The Code and the FPA
Section 365(a) of the code provides that, subject to certain exceptions, "the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor." A "debtor-in-possession" in
a Chapter 11 (reorganization) bankruptcy case also may employ that provision.14 Section 365 contains no express exception for contracts that are within FERC's jurisdiction.15
Rejection under Section 365 is not nullification of the contract, but a breach that usually entitles the counterparty to file an unsecured damages claim in the bankruptcy.16 Whether or to what extent that claim has value is another question. Other beneficiaries of the contract may have little or no remedy.
It is well established that FERC has exclusive jurisdiction over approval, modification, and termination of most wholesale electricity sale (and transmission) contracts under the FPA.17 FERC employs a public interest standard in assessing requests for termination of FERC-jurisdictional rates, one that generally does not permit unilateral termination based on a private party's financial interests absent unusual facts.18
The Fifth Circuit Decision
In Mirant
The Fifth Circuit in Mirant held that the statutes are not in conflict, essentially on the grounds that rejection is a breach of, rather than a challenge to, FERC-jurisdictional contracts.19 The U.S. Court of Appeals nonetheless then discussed the business judgment standard generally employed by bankruptcy courts in assessing contract rejection requests and the more demanding public interest standard employed by FERC. The Court of Appeals found the former to be "inappropriate" in light of the public interest in such contracts, but then failed to adopt a standard.20 It directed the lower court to "consider" whether to apply a "more rigorous standard" than the business judgment standard.21 The Court of Appeals also remanded the dispute on the additional ground that there were unresolved questions about whether the contracts in question in fact were part of a larger transaction, which might call into question the ability of the debtor to selectively reject the contracts.22
The Court of Appeals-relying heavily on the Supreme Court's decision in the Bildisco case, where Section 365 was claimed to conflict with provisions of the NLRA regarding collective bargaining agreements and where the Supreme Court harmonized the statutes by adopting a hybrid standard23-stated that the lower court "might" adopt a standard that permits rejection only if the debtor shows that the contract burdens the estate, that the balance of the equities favors rejection, and that rejection would further the rehabilitation goal of Chapter 11 of the code.24 The Fifth Circuit also "presum[ed]" that the lower court would let FERC participate in the case and assist in the balancing of the equities.25
The Court of Appeals did appear to impose one criterion as part of whatever standard was to be adopted, stating that the lower court should "ensure that rejection does not cause any disruption in the supply of electricity to other public utilities or customers."26 The Fifth Circuit did not clarify, however, what constitutes a "disruption."
The Road Ahead
The failure of the Court of Appeals in Mirant to adopt a complete standard, especially after having found the business judgment standard to be inappropriate, is somewhat puzzling. The Fifth Circuit, in its opinion, did not explain why it delegated that task to the lower court. The issue of what standard should be applied would seem, on its face, to be a pure issue of law, the kind routinely addressed by appellate courts. The parties' briefs to the Fifth Circuit discussed at length how to read together the code and the FPA. While the opinion remanded the matter for further proceedings consistent therewith, it did not indicate what further steps would be needed or appropriate to establish the standard.27
The scope of the "no disruption" criterion imposed by the Fifth Circuit potentially is a critical issue. The argument has been made, quite persuasively in prior Fortnightly articles,28 that bankruptcy courts should defer to the primary role of FERC when a contract rejection dispute involving a FERC-jurisdictional rate raises issues of health, safety, or reliability. That is consistent with the recognition of regulatory agency police and enforcement powers in Section 362(b)(4) of the code, in the context of exceptions to "automatic stay" provisions, as well as with basic notions of the public interest and the role of FERC. Whether the boundary of the "no disruption" criterion is coextensive with concerns of health, safety, and reliability remains to be seen.
The approach otherwise taken by the Court of Appeals-suggesting, but not mandating a hybrid standard-would appear to heighten, at least in the short term, the uncertainties that face financially troubled energy companies and their actual and potential counter-parties.
This "win" for the side that favors bankruptcy court jurisdiction, even if sustained and adopted by other courts, might be of limited value to that side, moreover, depending on what standard ultimately is adopted and how it is applied. If the "balance of the equities" standard is adopted, and the combination of that approach and the "no disruption" criterion leads to results that are the same as or similar to those that FERC would reach under the FPA, then financially troubled companies might gain relatively little by the change in venue. Also, the transfer of the determination of traditional "FERC issues" from the expert agency to bankruptcy courts acting with the assistance of FERC might be of limited value or inefficient.
Finally, as acknowledged in the more recent article in the Fortnightly,29 for a financially troubled company to have a readily available exit strategy from a contract can be a mixed blessing. Potential counterparties that are considering doing business with financially troubled companies, when assessing performance and credit risks, presumably will analyze the risks that the company may go into bankruptcy and seek to reject a contract. Whether or to what extent energy markets already have or have not internalized those risks is very difficult to ascertain at this point. That risk analysis, in some cases, might result in a decision not to do business, more stringent terms and conditions, or collateral or other security requirements that the troubled company may or may not be able to post or provide in light of its resources, needs, debt covenants, or other constraints. A troubled company may find that it is not well-served by being perceived as an unreliable party due to its potential ability to invoke Section 365 in circumstances other than those entertained by FERC.
John Ratnaswamy is a partner in the Energy Regulation Practice Group in the Chicago office of Foley & Lardner LLP. Contact him at jratnaswamy@foleylaw.com.
Endnotes
1. K. Irvin and R. Loeffler, "The Tyranny of FERC: The Commission's Power Grab Over Bankruptcy Courts Condemns Merchants to a Corporate Netherworld," Public Utilities Fortnightly, May 2004, p. 21; K. Irvin & R. Loeffler, "Restructure or Bust? Why FERC Must Yield to Bankruptcy Law," Public Utilities Fortnightly, Oct. 1, 2003, p. 17.
2. 11 U.S.C. § 101, et seq. (the Code). District courts have original jurisdiction over bankruptcy cases. 28 U.S.C. § 1334. They usually refer the cases to the bankruptcy court, although they may, and sometimes must, withdraw the reference in whole or in part. 28 U.S.C. § 157.
3. 16 U.S.C. § 791, et seq. (the FPA).
4. 11 U.S.C. § 365(a).
5 Bankrupt Enron Power Marketing Inc. is seeking to enforce large judgments (over $300 million in the aggregate) for liquidated damages under wholesale electricity supply contracts entered in its favor by a bankruptcy court against Nevada Power Co. and Sierra Pacific Power Co. The defendants have appealed to the district court (appeals from bankruptcy courts first go to the district court, 28 U.S.C. § 158) and are pursuing relief in a separate proceeding before FERC. The dispute has drawn much public comment, including filings by Nevada's two United States senators with FERC.
6. 378 F.3d 511 (5th Cir. 2004) ("Mirant"). The circumstances of Mirant, and the rulings of the bankruptcy court and, upon withdrawal of the reference, the district court, are amply set forth in the appellate opinion and the more recent Fortnightly article cited, supra, in endnote 1.
7. Mirant, 378 F.3d at 542-526. As of the preparation of this article, the time for parties to seek rehearing in the Fifth Circuit or an appeal to the Supreme Court has not elapsed (no such petition yet has been filed), and the district court has not yet adopted a standard nor sent the matter back to the bankruptcy court, although the parties are skirmishing in the district court over certain related issues.
8. Cook County Nat'l Bank v. United States, 107 U.S. 445 (1883) (banking regulatory statute's insolvency provision requiring ratable distribution superseded general statute giving United States priority as creditor of insolvent persons).
9. National Labor Relations Board v. Bildisco and Bildisco, et al., 465 U.S. 513 (1984) (in effect, construing exceptions to the NLRA and adopting a hybrid standard).
10. Board of Governors of the Federal Reserve System v. MCorp Financial Inc., et al., 502 U.S. 32 (1991) (finding no conflict between relevant provisions of the statutes and rejecting argument that more general provisions of the Code were in conflict with banking regulation statutes).
11. Federal Communications Commission v. Nextwave Personal Communications Inc., et al., 537 U.S. 293 (2003) (finding no conflict).
12. E.g., Morton v. Mancari, 417 U.S. 535, 551 (1974).
13. E.g., United States v. Romani, 523 U.S. 517, 530, 534 (1998). Because statutes are not always clear, court decisions on whether there is a conflict between two statutes also may reflect analysis of how best to read the statutes together in light of their language and purposes.
14. 11 U.S.C. § 1107(a).
15. In contrast, as noted in Mirant, 573 F.3d at 521-522, several of the subsections of the general "automatic stay" provision of the Code, Section 362, are subject to a number of express exceptions, one of which, provided for in Section 362(b)(4), is "the commencement or continuation of an action or proceeding by a governmental unit ... to enforce such governmental unit's police and regulatory power." 11 U.S.C. § 362(b)(4). Also in contrast, as noted in Mirant, 573 F.3d at 521, the central plan of reorganization confirmation provision of Chapter 11 of the code, Section 1129, permits a bankruptcy court to approve the plan only if, among other things, "Any governmental regulatory commission with jurisdiction, after confirmation of the plan, over the rates of the debtor has approved any rate change provided for in the plan, or such rate change is expressly conditioned upon such approval." 11 U.S.C. § 1129(a)(6).
16. 11 U.S.C. § 365(g); e.g., Mirant, 378 F.3d at 519. The claim might have a higher priority in some instances involving damages based on post-bankruptcy petition performance of a contract by the counter-party.
17. E.g., 16 U.S.C. § 824d; Mirant, 378 F.3d at 518-519.
18. Mirant, 378 F.3d at 518.
19. Id. at 517-22 (reviewing the district court's jurisdiction under 28 U.S.C. § 1334, Section 365 of the Code, and several provisions of the FPA).
20. Id. at 524-526.
21. Id. at 524.
22. Id. at 524. The Fifth Circuit also agreed with the district court that the bankruptcy court had erred in entering an overbroad injunction that required FERC to give the bankruptcy court ten days notice before taking any regulatory action with respect to hundreds of FERC-jurisdictional contracts of the debtor. Id. at 523-524.
23. See supra, endnote 9. Bildisco did not use, however, the "harmonization" terminology.
24. Mirant, 378 F.3d at 525.
25. Id. at 526.
26. Id.
27. Id.
28. See, supra, endnote 1.
29. See the first article cited, supra, endnote 1.
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