On December 12, 2019, the US Court of Appeals for the Sixth Circuit issued a highly anticipated ruling in the FirstEnergy Solutions Corp. bankruptcy case, regarding the efforts of FirstEnergy Solutions Corp. (FirstEnergy or FES) to reject certain wholesale power purchase contracts. The Sixth Circuit held that the bankruptcy court has sole authority to decide whether FES could reject the executory contracts—which were subject to the Federal Energy Regulatory Commission’s (FERC) regulatory jurisdiction under the Federal Power Act (FPA)—and could enjoin FERC from compelling FES to continue performing under the contracts. The Sixth Circuit also held that the bankruptcy court must apply a heightened standard, which considers whether rejection is in the public interest, when making its determination and that it must also allow FERC a reasonable opportunity to offer its own views on whether rejection is in the public interest.

This decision represents an important benchmark in this still-unsettled area of law. Market participants with wholesale power purchase agreements (PPAs) or other contracts subject to FERC’s FPA jurisdiction (referred to herein, collectively, as “FERC-jurisdictional power contracts”) will likely benefit from staying current on additional legal developments.

Background

The Sixth Circuit’s decision and the related cases discussed below address the relative authority of courts, under the federal law, and FERC, under the FPA, with respect to the ability of a debtor in bankruptcy to reject or abrogate FERC-jurisdictional power contracts.

US law provides federal courts with original jurisdiction over bankruptcy filings and exclusive jurisdiction over the property of chapter 11 debtors-in-possession. It further provides chapter 11 debtors-in-possession with the ability to seek rejection (equivalent to pre-petition breach) of their executory contracts (i.e., a contract where each party has material unperformed obligations), subject to court approval. When deciding whether rejection is appropriate, courts apply a “business judgment” standard, under which a debtor may reject a contract if it is financially burdensome to the debtor’s estate.

The FPA grants FERC exclusive jurisdiction over the rates, terms, and conditions of service for wholesale sales of electricity in interstate commerce. It further requires that all contracts setting forth such rates must be filed with FERC, even if the contracts are privately negotiated. Under the “filed rate doctrine,” once FERC approves or fixes the “just and reasonable” rate, the reasonableness of the rates cannot be collaterally attacked in state or federal courts. Finally, the “Mobile-Sierra doctrine” provides that a rate agreed to through arm’s-length negotiation and filed with FERC takes on the force of regulation or statute, and such rate may be modified only if it is found to be contrary to the public interest (or if the contract expressly provides for a different standard).

Thus, when a party to a FERC-jurisdictional power contract files a petition for chapter 11 bankruptcy protection, questions arise regarding the scope of the court’s authority under the Bankruptcy Code relative to FERC’s authority under the FPA. Courts that have previously addressed these questions have reached varying conclusions. In the Mirant bankruptcy, the US Court of Appeals for the Fifth Circuit held that courts have authority to reject FERC-jurisdictional contracts without FERC’s consent or approval, and may enjoin FERC from requiring a debtor to continue performance at the pre-rejection filed rate. In addition, the Fifth Circuit found that courts should apply a “more rigorous” standard than the ordinary business judgment standard to the rejection of FERC-jurisdictional power contracts, including “carefully scrutiniz[ing] the impact of rejection upon the public interest.” Subsequently, in Calpine, the US District Court for the Southern District of New York held that it lacked jurisdiction to authorize the rejection of the FERC-jurisdictional power contracts at issue, where the debtor sought rejection based on its dissatisfaction with the filed rates. Most recently, in PG&E, the US Bankruptcy Court for the Northern District of California held that it had exclusive jurisdiction to decide whether a motion for rejection should be granted, and that the ordinary business judgment standard would apply to such decisions; however, it later caveated its finding regarding the applicable standard, stating that the “public interest may need to be considered in the context of a specific rejection of a specific PPA.”

As set forth in its recent declaratory orders related to PG&E’s 2019 bankruptcy petition, FERC asserts that it and the courts have “concurrent jurisdiction” to review and address the disposition of wholesale power contracts sought to be rejected in bankruptcy. In FERC’s view, a bankruptcy court’s authorization to reject a FERC-jurisdictional power contract does not relieve a debtor of its separate obligation to obtain FERC’s authorization to cease or modify its performance under such contract.

FirstEnergy, an Ohio-based retail and wholesale power provider, obtains supply to meet its customers’ needs through its own generation fleet and by purchasing the output of its affiliates’ generation facilities. In addition, FES is a party to nine long-term PPAs pursuant to which it purchases additional capacity, power, renewable energy credits, as well as another multi-party power purchase contract.

In March 2018 FES, along with certain of its affiliates, filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code in the US Bankruptcy Court for the Northern District of Ohio. The following day, FES filed motions to reject the nine PPAs and one similar agreement. FES simultaneously initiated an adversary proceeding against FERC, seeking injunctive relief to prevent FERC from taking actions that could interfere with the bankruptcy court’s consideration of FES’s motions to reject the contracts. FERC and other interested parties opposed the requested relief, on the grounds that FES needed FERC’s authorization to modify or abrogate these FERC-jurisdictional power contracts.

In May 2018, the bankruptcy court granted FES’s request for a preliminary injunction. The preliminary injunction prohibited FERC from: (1) “initiating or continuing any proceeding”; (2) “issuing any order, to require or coerce FES to continue performing the contracts or limiting FES to seeking abrogation under the FPA“; or (3) “interfering with the bankruptcy court’s exclusive jurisdiction.” The bankruptcy court found that FERC lacked authority “to prevent a chapter 11 debtor-in-possession who has successfully rejected a power contract from avoiding performance under the contract.” Subsequently, the bankruptcy court authorized FES to reject the contracts under the ordinary business judgment standard.

The FES Decision

The Sixth Circuit affirmed in part and reversed in part the bankruptcy court’s injunction and rejection orders, and remanded the case to the bankruptcy court for further consideration. First, the court held that the bankruptcy court and FERC have concurrent jurisdiction, but that the bankruptcy court’s jurisdiction is “primary or superior to FERC’s position.” Thus, the “bankruptcy court has jurisdiction to decide whether FES, as a chapter 11 debtor-in-possession, may reject the [FERC-jurisdictional power] contracts, meaning that FES can reject the contracts subject to proper bankruptcy court approval and FERC cannot independently prevent it.” The court reasoned that “the public necessity of available and functional bankruptcy relief is generally superior to the necessity of FERC’s having complete and exclusive authority to regulate energy contracts and markets.”

Second, the court held that the bankruptcy court acted within its authority when it enjoined FERC from “issuing any order that would require or coerce FES to continue performing the contracts or limit FES to seeking abrogation under the FPA.” The court explained that this finding was “based on the particular facts and circumstances” before the bankruptcy court, namely, that FES had no need for the power it was obligated to pay for under the FERC-jurisdictional power contracts, and that it was not merely trying to obtain a more favorable rate, as was the case in Calpine. However, the court held the other elements of the bankruptcy court’s injunction were overly broad and exceeded its authority under the Bankruptcy Code.

Finally, the court held that the bankruptcy court should not have applied the ordinary business judgment standard and that, “[o]n remand, the bankruptcy court must reconsider its decision under [the] higher standard [adopted in Mirant].” Specifically, the bankruptcy court must “consider[] and decide[] the impact of rejection of these contracts on the public interest—including the consequential impact on consumers and any tangential contract provisions concerning such things as decommissioning, environmental management, and future pension obligations—to ensure that the ‘equities balance in favor of rejecting the contracts.’” Moreover, the court found, the bankruptcy court must afford FERC a reasonable opportunity to present its views regarding the public interest implications of any such request.

In a partial dissenting opinion, Circuit Judge Richard Allen Griffin espoused FERC’s current position, finding that the “filed rates and power contracts are separate obligations with independent sources of power authorizing their enforcement.” His dissent urged: “[a] decision of whether to grant the rejection of the power purchase contracts lies solely with the bankruptcy court, while the decision of whether to abrogate or modify the filed rates lies solely with FERC.”

Key Takeaways

The Sixth Circuit’s decision is an important benchmark in this area of law, which remains unsettled. To date, two circuit courts—the Fifth and Sixth Circuits—have addressed the interplay of the Bankruptcy Code and FPA with respect to chapter 11 debtors’ requests to reject FERC-jurisdictional power contracts. Both found that the courts have authority to approve such requests, that FERC lacks authority to require a debtor to continue performing at the pre-rejection filed rate, and that the courts must apply a heightened standard when ruling on such requests. At the same time, lower courts in other circuits have reached different results, and the US Court of Appeals for the Ninth Circuit is poised to weigh in on these issues in the near future. If the Ninth Circuit reaches a decision that is starkly opposed to FES and Mirant, the issues could be ripe for review by the Supreme Court of the United States.