Commission Watch

The commission's power grab over bankruptcy courts condemns merchants to a corporate netherworld.

Since we last visited the conflict between the Federal Energy Regulatory Commission (FERC) and bankruptcy courts over who decides whether a debtor can terminate unprofitable power contracts,¹ a new district court decision out of Texas has come down tilting the field in favor of FERC's assertion of exclusive authority. For merchant energy companies struggling with dwindling capital and mounting credit risks, this change could mean bankruptcy is no longer a viable option for reorganizing.

This latest decision, from , casts doubt on the ability of merchant energy companies in bankruptcy to reject economically burdensome contracts with load-serving entities without FERC approval. Section 365 of the Bankruptcy Code² ordinarily allows a debtor to reject unprofitable contracts. But for energy merchants that section could lose all meaning as applied to forward wholesale power agreements with load-serving entities if courts elsewhere follow this Mirant decision. Under this new paradigm, FERC would have to bless any rejection even if the bankruptcy court finds the contract is a loser for the energy merchant. Complicating matters, FERC has shown little interest in understanding the balance of debtor and creditor rights in the Bankruptcy Code provisions dealing with rejected contracts.

FERC has, essentially, become the senior partner to the bankruptcy courts for merchant power marketers. Unfortunately, this development comes at a time when many have begun to write epitaphs for energy merchants, further dimming prospects for the sector.³ Utilities, now wary of the volatile electricity markets, are reportedly pulling back from wholesale trading and expanding their own power plant portfolios to meet demand.⁴ The uncertain demarcation of FERC versus bankruptcy court jurisdiction raises serious questions that must be decided wisely. FERC's authority faces challenges ahead, especially as states move toward competitive procurement for standard offer or provider of last resort services.

Ironically, there may be a silver lining even if the decision is widely followed. A load-serving entity would, under the ruling, face less risk that its energy merchant counterparty could reject its wholesale power supply agreement through bankruptcy. That, arguably, should lessen collateral requirements, since the merchant supplier would have inferior bankruptcy rights, compared with those of other businesses.

The Mirant Case

Since the court and FERC rulings regarding NRG Power Marketing Inc. discussed in our earlier column,⁵ the bankruptcy and district courts presiding over the Mirant⁶ bankruptcy have weighed in on whether a merchant company in bankruptcy can discontinue supplying power without FERC approval. The Bankruptcy Court for the Northern District of Texas enjoined FERC from requiring Mirant to perform several of its jurisdictional contracts with Potomac Electric Power Co. (PEPCO) while that court considered pending and forthcoming motions by Mirant to reject those contracts. The Federal District Court for the Northern District of Texas disapproved and went in the opposite direction. The higher court denied Mirant's motion to reject one of those contracts and its request for injunctive relief. The degree to which each court took its reasoning is extraordinary.

The Bankruptcy Court's Mirant Decision

In their bankruptcy, the Mirant debtors sought to reject an agreement called the Back-to-Back Agreement, which resulted from the purchase by Southern Energy Inc. (Mirant's predecessor) from PEPCO of various generation assets sold in connection with restructuring implemented in PEPCO's Maryland and Washington, D.C., service areas. The agreement provided that if certain third parties did not agree to PEPCO's assignment of their power purchase agreements to Mirant, PEPCO would remain liable to pay for power under the unassigned agreements, and Mirant would in turn purchase all that power from PEPCO.

Mirant filed a motion to reject the Back-to-Back Agreement pursuant to section 365 of the Bankruptcy Code, contending it was too burdensome economically and impeded its ongoing business operations. Mirant simultaneously filed a lawsuit against PEPCO and FERC seeking to enjoin them from "taking any action, or encouraging any person or entity to take an action, to require or coerce" Mirant to keep performing the Back-to-Back Agreement it wished to reject or two other agreements with PEPCO, which Mirant contemplated also rejecting.⁷

In September 2003, the Mirant bankruptcy court ruled that, as part of its power to order whatever is "necessary or appropriate" to preserve the debtors' assets, it could restrain FERC and others from taking any action to "require or coerce" Mirant to perform several contracts with PEPCO.⁸

Although stating it did not "wish to test its jurisdictional muscle against" FERC, the bankruptcy court said it issued the preliminary injunction "to serve as a gatekeeper" and to protect "the reorganization process from unfettered interference through initiation of actions in other tribunals," referring to FERC.⁹ The court reasoned that because Congress did not specifically treat energy contracts any differently from executory contracts in general, the PEPCO contracts fell within the ambit of what Congress intended Bankruptcy Code section 365 to cover.¹⁰ From there, the court concluded it possessed the power to enjoin FERC preliminarily to preserve the court's jurisdiction over pending and future rejection motions.¹¹ Notably, the bankruptcy court rested its action on finding that FERC could have utilized its police and regulatory powers, which a governmental unit is ordinarily permitted to do under the Bankruptcy Code. The bankruptcy court, notwithstanding the exception to the automatic stay the Bankruptcy Code affords governmental units, deliberately sought to restrain FERC from exercising its police and regulatory powers, at least temporarily.

The District Court's Mirant Decision

After the district court granted their request to withdraw this dispute from the bankruptcy court, PEPCO and FERC argued the bankruptcy court's preliminary injunction violated the exclusive authority granted to FERC in the Federal Power Act (FPA).¹² In December 2003, the district court agreed with them. The higher court denied Mirant's requests to reject the Back-to-Back Agreement and for injunctive relief prohibiting FERC from requiring Mirant to perform it.

The district court, looking to the August 2003 district court decision in and the Fifth Circuit Court of Appeals decision in ,¹³ ruled FERC alone had the authority to permit a merchant energy company to discontinue performing the wholesale supply agreement at issue, regardless of whether the agreement is unprofitable.¹⁴ The court concluded Mirant's rejection motion was essentially a challenge to the rates of the Back-to-Back Agreement and rejected it on the basis of the "filed-rate doctrine."¹⁵ The district court ruled "the right to a reasonable rate is the right to the rate" FERC approves, and neither the district court, nor the bankruptcy court could set a different rate "on the ground that it is the only or the more reasonable one."¹⁶

The district court dismissed Mirant's arguments that it could reject the contract under the Bankruptcy Code based on its anticipated losses of $300 million through 2005 and its business judgment that the contract was bad for Mirant's creditors and hopes for reorganizing. The court counseled the debtors to plead their cause to FERC based on the Mobile-Sierra doctrine, which allows modification or abrogation of a wholesale power contract in those limited circumstances where it imposes a crushing economic burden on the obligor, among other grounds.¹⁷ The court quoted FERC precedent that "the fact that a contract has become uneconomic … does not necessarily render the contract contrary to the public interest"¹⁸ but did not explain what that means in light of the court's exclusive jurisdiction over the debtors' property.¹⁹ The court demurred, stating only that because of its specialized knowledge, FERC alone is entitled to consider "whether 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."²⁰

The district court also overlooked the fact that the Bankruptcy Code provides an exception from the automatic stay for most energy companies with forward contracts, which (under customary contract terms) allows the non-debtor party to terminate the agreement when its counterparty files bankruptcy.²¹ The court's decision alters the lay of the land in that an energy merchant debtor, which is out-of-the-money in a forward supply agreement, cannot escape that contract through bankruptcy unless FERC consents, but a load-serving entity out-of-the-money in contract with a debtor can terminate without FERC's or the bankruptcy court's involvement.

In all, the district court's decision does not really address the other side of the story, and swings too far in the opposite direction from the bankruptcy court's overly aggressive injunction. The district court barely acknowledged its exclusive jurisdiction over Mirant's bankruptcy estate, and it did not explain how compelling a debtor to supply power under a money-losing contract squares with the rights of other creditors, whose claims are necessarily diminished by continued performance of the energy contract at pre-bankruptcy prices. Nor did the court reconcile with its conclusion the "vital" importance to a debtor of rejecting burdensome contracts under section 365.²²

The district court did limit its ruling to some extent. It suggested a different outcome was possible where a party challenges FERC jurisdictional contracts for reasons other than "rates" (for example, where there is alleged fraud and deceptive trade practices). Citing the Fifth Circuit's decision in , the court mused that if Mirant had sought rejection of the PEPCO contract for reasons not related to rates, the court "would have [had] authority to authorize the rejection."²³ The court also stated that if Mirant had first obtained FERC's permission to discontinue service, then rejection would potentially have been available.

As a consequence of the district court's decision in , and the disposition of similar issues in , an energy merchant in bankruptcy presently has no right in the Northern District of Texas or Southern District of New York federal courts to cease performing an unprofitable wholesale power agreement with a load-serving entity without FERC's imprimatur. Merchants in other courts face an uphill battle, considering the influence these early decisions will have. This limits the ability of an energy merchant to deploy the full spectrum of tools Congress provides debtors under the Bankruptcy Code, which seems incongruent in the absence of some counterbalance.

One such counterbalance could be a limitation on the right of the load-serving entity to exact credit support from merchant counterparties. If, as the highest courts to address the issue so far have announced, the bankruptcy court alone cannot authorize rejection of wholesale power agreements between them, then a load-serving entity buying power from an energy merchant faces less risk and should have to adjust its collateral demands accordingly. Of course, neither FERC nor any state agency has yet condoned this approach, which shows the prevailing construction of the interplay between the Bankruptcy Code and the FPA rests on tenuous grounds.

The Fifth Circuit's Challenging Task

The power struggle over jurisdiction moves next to the United States Court of Appeals for the Fifth Circuit, which already has declined to stay the district court order. If the appeals court upholds the district court's decision in , merchant energy companies will face risks greater than most other commercial enterprises because they will not enjoy the full array of reorganization tools available.

It would then be incumbent on FERC to develop an expedited process similar to that employed by bankruptcy courts for determining when creditors' interests justify freeing a debtor from a money-losing contract. The track record of FERC is not encouraging. A complaint under section 206 of the FPA typically lasts several years and results in FERC (not the real party affected) defending the outcome on appeal.²⁴

Moreover, one cannot reasonably expect to foster investment in the merchant energy sector without a transparent, expeditious process for resolving competing interests of creditors and bankrupt entities. To minimize regulatory risk, that process ought to yield results consistent with the claims priorities established by the Bankruptcy Code. Otherwise, creditors will quickly learn of their disfavored status and direct their capital elsewhere, defeating FERC's policy objective of a stable electric supply at competitive prices.

The Swinging Pendulum

The disparity in between the bankruptcy court's decision and that of the district court illustrates the challenge the appeals court faces. At one extreme of the pendulum swing, the Mirant bankruptcy court injunction against FERC was the first of its kind²⁵ and appears to have overstepped some bounds. Nevertheless, the reasoning of the bankruptcy court regarding why it can authorize rejection of wholesale power contracts rings true: (1) The Bankruptcy Code contains no exception for forward energy contracts to the debtor's general power under section 365 to reject contracts, unlike several expressly stated exceptions covering other types of contracts; and (2) the Supreme Court has ruled that when Congress intended to exempt certain types of executory contracts from section 365, Congress did so explicitly.²⁶

At the other extreme, the district court's decision in goes too far in the opposite direction (along with the district court in ). Those decisions deprive merchant energy companies, and all but a select few of the creditors with whom they deal, of the full panoply of rights under the Bankruptcy Code enjoyed by most other companies (including others regulated under the FPA).

How FERC and Bankruptcy Courts Can Work Together

We see no logical reason why the interests protected by the Bankruptcy Code and those protected by the FPA cannot be served in harmony. When two statutes are capable of co-existence, the Supreme Court instructs that courts must, absent a clearly expressed congressional intention to the contrary, regard each as effective.27 Accordingly, FERC and the courts should read the Bankruptcy Code and the FPA "to give effect to each if [they] can do so while preserving their sense and purpose."²⁸

In this jurisdictional conflict, FERC clearly has a legitimate role in determining whether performance of a supply agreement can and should be discontinued. FERC bears significant responsibilities to ensure a safe and stable power supply, and the bankruptcy court has no right to impede fulfillment of those responsibilities. FERC's powers are at their zenith when it acts within its police and regulatory powers.

However, when one of the parties is bankrupt, a whole new set of interests arises under the Bankruptcy Code. In that case, the authority of FERC must yield to some degree in determining what to do about unprofitable power supply agreements because Congress vested courts with exclusive jurisdiction over a debtor's property and set forth in the Bankruptcy Code the federally prescribed process for dealing with creditors and interest holders. Indeed, exclusive FERC jurisdiction in this arena would repose in FERC responsibility for considering rights of those completely foreign to its mandate. Ordinary general unsecured creditors (e.g., the coffee vendor, the office supply store, and others) will be left holding the proverbial bag if FERC follows its thinking in and compels continued performance of wholesale power supply contracts because the load-serving entity would otherwise "be treated as any other unsecured creditor" in a debtor's bankruptcy.²⁹

The courts' exclusive jurisdiction over property of the debtors and their estates should be respected. At the same time, courts should refrain from over-reaching, such as by enjoining a regulatory agency like FERC from fulfilling its own mandate to protect the public interest.

We hope the Fifth Circuit sees fit to provide a reasoned means for affording comity to the respective authority of FERC and the bankruptcy court. Such an approach would promote stability and becalm (to some degree) the tumultuous seas on which many energy merchants find themselves. Either way, both the present and future will be affected. Looming uncertainty regarding who is the final arbiter (FERC or the bankruptcy court) of whether a debtor can reject unprofitable power contracts means energy merchants have more aspects to consider before filing for bankruptcy. For some, bankruptcy may no longer be meaningful. For the future, a complex and uncertain allocation between FERC and the courts could stunt budding efforts to supply standard-offer-service and provider-of-last-resort services by competitive procurement, as well as other competitive initiatives.

Oral argument in the appeal to the Fifth Circuit is scheduled for May 5, 2004.

Endnotes

1. See Kenneth Irvin and Robert Loeffler, "Restructure or Bust?: Why FERC Must Yield to Bankruptcy Law," , Oct. 1, 2003, at 17.
2. Section 365 gives a debtor the right, upon bankruptcy approval, to breach the contract in question, and makes the debtor liable only for damages (albeit generally as a general unsecured pre-petition claim). Despite a rejection, the debtor is also liable for any and all amounts owed from the creditor's performance after the bankruptcy filing, which is referred to as an administrative expense. See 11 U.S.C. §§ 365, 503.
3. Matt Daily, "Utilities Shunning Power Markets With New Plants," Reuters, March 2, 2004, available at
   http://www.forbes.com/business/energy/newswire/2004/03/02/rtr1283368.html;
   also reported in Energy Central, available at
   pro.energycentral.com/professional/news/power/news_printer_friendly.cfm?id=4680991.
5. , No. 03-3754, 2003 WL 21507685 (S.D.N.Y. June 30, 2003) (District Court's NRG Decision); ), Order Upholding Contract, 104 FERC 61,210 (2003); , 104 FERC 61,211 (2003) (). In its Rehearing Decision issued Aug. 15, 2003, FERC ruled that it could force a merchant generator to continue to perform under a forward power contract even though the bankruptcy judge had already allowed the merchant generator to reject the contract.
6. In , 303 B.R. 304 (N.D. Tex. 2003) (District Court's Mirant Decision); see also (In ), 299 B.R. 152 (Bankr. N.D. Tex. 2003) (Bankruptcy Court's ).
7. District Court's at 307.
8. Bankruptcy Court's , 299 B.R. at 158-63, 169-70 (exercising its authority to enter "necessary or appropriate" orders by entering preliminary injunction preventing FERC from requiring debtors to perform under PEPCO agreements and thereby impairing debtors' ability to reject those contracts).
9. at 170.
10. at 161-62 (noting that there are other particular exceptions to the general authority to reject contracts in section 365, such as those for commodities or collective bargaining agreements).
11. See at 163 (citing decisions "consistently" holding debtors may not be required to perform rejected contracts) (citations omitted).
12. District Court's , 303 B.R. at 310-11.
13. , 824 F.2d 1465 (5th Cir.), amended, 831 F.2d 557 (5th Cir. 1987).
14. District Court's , 2003 WL 21507685, at *3 (finding that wholesale power contract between NRG and Connecticut Light and Power fell within FPA's purview and FERC's exclusive jurisdiction); see also District Court's , 303 B.R. at 313-18 (agreeing with District Court's and holding that FERC has exclusive jurisdiction over wholesale sales of electric energy in interstate commerce).
15. District Court's at 317 ("In effect, Debtors are asking this court to set aside their contract to purchase electric energy on the theory that PEPCO's rates are too high. The court has concluded that it should not entertain such a request and that, if Debtors wish to pursue relief of that kind, they should go to FERC.").
16. at 313 (citing , 341 U.S. 246, 251-52 (1951)).
17. See at 317-18.
18. See at 317.
19. 28 U.S.C. § 1334(e).
20. See
21. 11 U.S.C. § 556.
22. NLRB v. , 465 U.S. 513, 528 (1984).
23. District Court's at 316-17.
24. See, e.g., , Order on Requests for Rehearing and Clarification, 105 FERC 61,185 (2003); , Order on Rehearing and Clarification, 105 FERC 61,184 (2003).
25. See Bankruptcy Court's , 299 B.R. at 158-59 ("Although the court has been cited to no case in which a bankruptcy court has enjoined [FERC] and has found none itself, District Courts have often determined they could provide such injunctive relief.") (citations omitted).
26. at 162 (citing , 465 U.S. at 521-22 for proposition that the fact that one party to an agreement was a public utility and was regulated by the state public utility authority did not preclude rejection since Congress did not legislate special treatment for utility contracts rejected under section 365).
27. , 417 U.S. 535, 551 (1974).
28. , 451 U.S. 259, 267 (1981); see also United States v. Fausto, 484 U.S. 439, 453 (1988).
29. , at 104 FERC 61,046 at 61,189 (2003).

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