Why FERC must yield to bankruptcy law.
How will regulators react if the current trickle of bankruptcies within the debt-laden merchant power sector should suddenly become a torrent? Will they encourage the necessary restrcturing of debt, or will they stand in the way?
PG&E National Energy Group and Mirant recently filed bankruptcy. Exelon just walked away from seven plants near Boston. Speculation abounds that Edison Mission may be a candidate for bankruptcy protection.1 All this suggests that a new set of owners, whether they be creditors or new investors, could well take over the merchant sector, with a likely and perhaps dramatic scaling back of operations.
There is nothing inherently wrong with this looming financial restructuring. The Bankruptcy Code offers a ready road map for the working out of debt. Many insolvent businesses have emerged successfully, including some utilities. The trick lies in balancing the concerns of creditors with ratepayer rights and the public interest, as protected under the Federal Power Act.
Lately, however, the road to solvency has taken a wrong turn. In a recent ruling, the Federal Energy Regulatory Commission (FERC) has upset the delicate balance between creditor and ratepayer. This ruling, known as ,2 does not bode well for maintaining a consistent approach to balancing the competing interests.
In the opinion itself, issued Aug. 15, FERC said it may force a merchant generator to continue to perform under a forward power contract-even if a bankruptcy judge has allowed the petitioner in bankruptcy to reject the contract, as commonly occurs under bankruptcy law. Instead of premising its action on issues of health, safety, and reliability-where the commission's power is at its zenith-FERC has abused its authority by failing to accord respect for the Bankruptcy Code's priority scheme for creditor claims and exclusive jurisdiction over estate assets.
The recent wave of telecom industry failures shows that the process of bankruptcy-though fraught with pitfalls and expense-can work well for companies that serve the public interest, and even for entire industries once considered natural monopolies.
Yet in the most basic sense, FERC's recent opinion raises troubling conflicts with the mandate and authority of the bankruptcy courts. This action threatens to undermine the reorganization efforts not only of NRG Power Marketing Inc. (NRG-PMI), but those of every other wholesale energy merchant currently in bankruptcy.
And even beyond that, FERC's decision also may prove detrimental to energy merchants trying to restructure their financial positions outside of bankruptcy, a process that necessarily includes an analysis of possible bankruptcy scenarios that must be relatively predictable. Rather than focusing on health, safety, and reliability, where its authority is strongest (protecting the power grid, for instance), FERC has focused its analysis on economic matters, where its authority is plainly not exclusive.
The Recent NRG Ruling
FERC's improper focus on economics can be seen in the details of the opinion itself.
In June 2003, the commission had ruled as an initial matter in the same proceeding that, notwithstanding a bankruptcy court order approving a debtor-supplier's rejection of a wholesale power contract, NRG-PMI must continue to honor that contract until it should prove to FERC that terminating performance of the contract would satisfy the public interest.3 So let's examine how the commmission chose to define that term.
In the case in question, FERC ruled that NRG-PMI would meet this requirement-to prove that terminating performance would serve the public interest-only by showing that the contract might "impair the financial ability of the [debtor] to continue its service, cast upon other consumers an excessive burden, or be unduly discriminatory."sup>4 Until then, NRG-PMI would be required to continue supplying wholesale power to its contractual counterparty, Connecticut Light & Power (CL&P).
In its followup order issued Aug. 15, FERC again reviewed NRG-PMI's arguments for why it should be allowed to terminate the CL&P contract. It ruled that terminating the contract did not satisfy the public interest because CL&P would not realize 100 cents on the dollar for each dollar of damages terminating the contract would cause CL&P.
In essence, FERC put itself in the role of a guarantor of CL&P's economic position. In essence, FERC ordered specific performance for a forward contract that expressly provided damages as the sole remedy available for a breach.
FERC's analysis in the NRG Marketing case seems clearly to have applied the wrong metric for the task the commission had to accomplish.
At the heart of it, FERC focused on whether NRG-PMI had met the legal standard for abrogating or modifying a power contract. In applying that standard, known as the doctrine, FERC likened NRG-PMI's right under the Bankruptcy Code to reject a contract to a contractual right-to modify or abrogate the contract.5 Thus, FERC overlooked the distinction long-established that a debtor exercising its right of rejection under the Bankruptcy Code effects not a modification but a breach of contract-a result for which the Bankruptcy Code (never mind the contract) prescribes money damages alone (not specific performance) as the redress of the counterparty.6
To compound the error, FERC chose not to focus on questions most clearly linked to its lawful jurisdiction: namely, whether issues concerned with health, safety, or reliability warranted some kind of action to deny immediate effect to the bankruptcy court's determination that creditors were best served by excusing performance of the contract. Instead, consider where FERC hung its hat. The commission instead chose to preserve the favorable price that CL&P, the retail utility, had and would enjoy under its power purchase contract with NRG-PMI, the merchant generator. For the commission to conscript performance on these terms must contravene the core elements of the Bankruptcy Code. Yet FERC articulated no basis for its decision, other than its desire that CL&P would receive preferential treatment-better treatment than that afforded to all other creditors of NRG-PMI.
What the Law Requires
FERC showed some slight glimmer of hope for not confusing the separate but equally important roles of FERC and the bankruptcy courts when, in a separate and more recent case, it denied a complaint filed by Vermont Public Power Supply Authority (VPPSA) against PG&E Energy Trading (ET) that sought a FERC order directing ET's continued performance of that contract.
The distinction lay in the wording of the contract. Thus, in the Vermont ruling, FERC denied relief and dismissed VPPSA's complaint because the ET contract (unlike CL&P's) contained a clause providing for its automatic termination upon a bankruptcy filing, which ET had filed in July.7
Nevertheless, while the result in Vermont squares with bankruptcy principles, the decision further betrays FERC's apparent confusion about the Bankruptcy Code and what the remedy of contract rejection means as a legal matter. By seizing upon the contractual provision of the VPPSA-ET contract that terminated the contract automatically upon the filing of bankruptcy by either party, and contrasting that with the absence of such a clause in the CL&P contract, FERC erred in viewing rejection under the Bankruptcy Code as a contractual matter, instead of the unique statutory right it truly is.
Rejection under Section 365 of the Bankruptcy Code is not the exercise of a contractual right or the modification of a contract. Rather, it is an exercise of a right, granted by the Bankruptcy Code and approved by the bankruptcy court, which permits the debtor to breach the contract in question and makes the debtor liable only for damages, albeit as a general unsecured prepetition claim (except for amounts owed for the creditor's post-petition performance which is entitled to payment by the debtor as an administrative expense). Despite FERC's decision in NRG Marketing, it seems implausible (except where health, safety or reliability is threatened) that the Federal Power Act authorizes FERC to require continuing performance of a contract rejected by a bankruptcy court since the right to reject contracts is a core element of bankruptcy and exclusive jurisdiction over estate assets is vested in the bankruptcy court.
Faced with this precise question, the U.S. Supreme Court ruled, in ,8 that a bankruptcy debtor did not effect an improper unilateral modification to a collective bargaining agreement in violation of Section 8 of the National Labor Relations Act by partially refusing to perform. The Supreme Court ruled the National Labor Relations Board enforcement proceeding to compel performance was improper because a bankruptcy filing modifies all the debtor's executory contracts by operation of law and renders them unenforceable against the debtor until assumed by order of the court under Section 365 of the Bankruptcy Code. That unenforceability, the court ruled, applies equally to regulated contracts as well as private agreements; absent any express exception set forth in Section 365 for such contracts, the debtor could reject the collective bargaining agreement. Although the court specified a debtor must meet a higher standard before obtaining bankruptcy court approval to reject a regulated contract than for an unregulated contract, the court upheld the debtor's rejection. The linchpin of the court's decision is the principle that the right "to reject an executory contract is vital to the basic purpose to a Chapter 11 reorganization, because rejection can release the debtor's estate from burdensome obligations that can impede a successful reorganization."9
Notwithstanding that ruling, FERC required NRG-PMI to continue performing. As a rationale, the commission insisted that it may take regulatory action that it deems "appropriate" under the Federal Power Act, and so long as that action serves a regulatory purpose, "even if that action conflicts with a course taken by the bankruptcy court."10
In other words, FERC conscripted NRG-PMI's performance despite finding no issue of health, safety, or reliability, and despite the Congress having vested exclusive jurisdiction in the bankruptcy courts-and not the FERC-to oversee the property of a bankruptcy estate (such as in this case, the cash expended to perform the CL&P contract). Thus, the commission's action disregards the court's recent reminder to all that "where Congress has intended to provide regulatory exceptions to provisions of the Bankruptcy Code, it has done so clearly and expressly."11
As a consequence of FERC's decision, NRG-PMI risks running out of cash and potentially faces liquidation. FERC's articulation for why it has done this does not square with its obligation to give effect to the Bankruptcy Code and bankruptcy court decisions.12
Whither Rights of Creditors?
Apart from stripping NRG-PMI of its right to reject burdensome contracts and jeopardizing its reorganization efforts, FERC's action prefers CL&P over other creditors in violation of the non-discrimination provisions of the Bankruptcy Code. Though CL&P is deemed under the Bankruptcy Code to have a prepetition general unsecured claim for damages from NRG-PMI's rejection of the contract, FERC's order prefers CL&P's claim over those of all other unsecured creditors by granting specific performance as a remedy, thus forcing NRG-PMI's creditors and bankruptcy estate to subsidize CL&P's below market rate to the tune (according to NRG-PMI) of $500,000 per day. Indeed, FERC expressly acknowledged its motivation is to prefer CL&P over other creditors-despite bankruptcy's requirement for equal treatment for all creditors in the same class.
The commission explained that it required NRG-PMI to continue because otherwise, CL&P would "be treated as any other unsecured creditor in NRG's Energy's bankruptcy," and would "be unlikely ever to recover the full difference between the rate at which NRG-PMI agreed to supply them with energy and the amount NRG-PMI's cessation will force them to pay." Yet that is exactly what every other creditor of NRG-PMI faces. In short, FERC gave higher priority to CL&P for no reason other than to give CL&P customers a windfall.
FERC's immediate objective might be laudable, but it is not consistent with the law or sound public policy. Yet FERC need not resort to protectionism for parochial interests because the wholesale power sector has the depth and maturity to survive any wave of bankruptcies that might befall it.
As Commodities Futures Trading Commission Chairman James Newsome recently stated, "Deep, liquid markets coped well" following Enron's bankruptcy and "prices did not spike and liquidity did not dry up. … [The] system of financial controls in place was successful. There were no disruptions to the system of clearance and settlement, and each trader met its obligations."17 By mandating specific performance and potentially preventing NRG-PMI from reorganizing, FERC risks frustrating the efficient reorganization of debts and assets the Bankruptcy Code permits. Perhaps more importantly, FERC's decision could have a graver impact by stifling new investment and the deployment of newer, more efficient technologies.
Stated differently, FERC is needlessly injecting increased risk and uncertainty about a debtor's ability to shed burdensome contracts through bankruptcy. This increased uncertainty is unwelcome, and it ultimately sabotages efforts to attain the very stability FERC seeks for the wholesale energy sector.
A Better Role for FERC
To be sure, the Bankruptcy Code recognizes a continuing role for state and federal regulatory agencies with respect to entities in reorganization or liquidation. In the past, FERC has moved cautiously with respect to regulatory actions that might conflict with the jurisdiction of the bankruptcy court. In NRG Marketing, the commission took an aggressive view of its powers and precipitated unnecessarily, in our view, a jurisdictional battle with the bankruptcy court. The commission was quite conscious of the effects of its action; its own chair remarked that the limits of its power were uncertain, but nevertheless the commission "ought to take it on and let the court tell us if we have a right to do it or not."18
FERC's collision course with the Bankruptcy Code can readily be avoided by an equitable approach that affords comity for bankruptcy court decisions and balances the public interest under the Federal Power Act with that under the Bankruptcy Code. In the absence of contractual rights to terminate because of a bankruptcy, the FCC's discontinuance requirements for bankrupt providers offers a useful paradigm which has already worked in the context of telecom bankruptcies. Federal Communications Commission (FCC) regulations ensure customers are given adequate notice of an impending termination of service by mandating notice and an orderly transition commencing with an application to the FCC for permission to discontinue service.19 In its application, the carrier must state that it has given notice to customers of its intent to discontinue service and invite comments by any who think they would be adversely affected by the discontinuance. Applications are granted automatically 31 days after the FCC issues public notice of the application unless the FCC notifies the carrier otherwise. Thereafter, the counter party to the rejected contract can prosecute its claim for damages in the bankruptcy proceeding. The proper inquiry for considering the application is on health, safety, and reliability-not debtor/creditor issues.20
Applied in NRG-PMI and other cases involving FERC jurisdictional contracts where the contract does not terminate because of the bankruptcy, NRG-PMI could have applied for discontinuance to FERC on May 14, 2003, the day it filed its bankruptcy petition and motion to reject its contract with CL&P. Thirty-one days after FERC's issuance of a public notice of the application, NRG-PMI then could have terminated service absent any indication that CL&P could not readily procure substitute power at just and reasonable rates. To the extent a bankruptcy court determined rejection and ceasing performance of a power supply agreement served the best interests of creditors, FERC should not trample on that determination by substituting its own judgment for that of the bankruptcy court. FERC should confine its inquiry to whether issues of health, safety, and reliability are threatened. Such a discontinuance procedure would work an equitable balance between the interests underlying successful reorganizations of energy suppliers and the regulatory concerns of FERC, while avoiding regulatory risk and injury to investor confidence from alteration of the Bankruptcy Code's claims priority and distribution scheme. Yes, not everyone will get to keep their favored contracts, but the overall benefit of allowing debtors a fresh start and the opportunity to reorganize will serve the greater public interest in a deep and robust market.
An expedited procedure, like the FCC's discontinuance process focused on health, safety and reliability issues, strikes just such a balance, and can be effective here. Issues of creditor's rights should be left for the bankruptcy court.
- , Aug. 12, 2003; http://biz.yahoo.com/rf/030812/utilities_exelon_mystic_1.html.
- Order Upholding Contract, 104 FERC 61,214 (2003); Order Denying Rehearing and Late Intervention; 104 FERC 61,213 (2003).
- 103 FERC 61,344 (2003).
- at 29, 63, quoting , 350 U.S. 348, 355 (1956).
- FERC's analysis here raises a number of questions in its own right. Moreover, NRG-PMI's contention that because the CL&P contract at issue was never "filed" with FERC it is not subject to protection under misses the mark too. These issues are left for another day.
- See Commissioner Brownell's dissent, 103 FERC at 61, 344 (The FERC's order "confuses the issue of abrogating a contract with the issue of remedying the breach of contract" effected by rejection under the Bankruptcy Code); , 54 F.3d 406, 408 (7th Circ. 1995 ("Rejection is a device [under the Bankruptcy Code] to avoid specific performance."); , 756 F.2d 1043, 1048 (4th Cir. 1985) ("the legislative history of §365(g) makes clear that the purpose of the provision is to provide for the non-bankrupt party.") (emphasis added).
- , 104 FERC 61,185 (2003).
- 465 U.S. 513 (1984).
- at 528.
- , 103 FERC at 21, 49; FCC v. , 123 S.Ct. 832, 839 (2003).
- 28 U.S.C. § 1334(e).
- See , Docket No. RP99-274-006, et al., 101 FERC 61,374, p. 62, 556 (2002) ("the automatic stay gave Enron the right to determine, at its sole discretion, whether to reject or accept [the contract]"); , Docket no. , 71 FERC 61,194, p. 61,678 (1995) ("the Commission has reiterated its determination that Columbia's decision to reject its contracts is an issue to be resolved before the Bankruptcy Court and ) (emphasis added).
- FERC abdicates its responsibility under the FPA to guard against discrimination by concluding it lacks jurisdiction because supposedly "relief under is not available to redress alleged discrimination as between counterparties to non-jurisdictional contracts. Those interests are outside the scope of interests under Section 206 of the FPA." , 103 FERC at 25, 67.
- , 465 U.S. at 529-30.
- at 7-8, 16.
- 104 FERC 61,213 at 29, 58.
- , Energy Central Professional, July 10, 2003; http://pro.energycentral.com/professional/news/gas/news_article.cfm?id=3978347.
- , The Hartford Courant, June 26, 2003.
- 47 C.F.R. § 63.71
- Indeed, in its recent filings with the United States Court of Appeals, FERC acknowledged that the Supreme Court's decision in required giving credence to a debtor's right to reject even contracts subject to regulatory review. Opposition of Federal Energy Regulatory Commission to Emergency Motion for Stay at 15-16, , (D.C. Cir.) (No. 03-1189).
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