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Rejection of FERC-Regulated Agreements: Is In re Ultra Petroleum the Last Word?

By Jarret P. Hitchings and Malcolm M. Bates
February 2021
American Bankruptcy Institute Journal

Rejection of FERC-Regulated Agreements: Is In re Ultra Petroleum the Last Word?

By Jarret P. Hitchings and Malcolm M. Bates
February 2021
American Bankruptcy Institute Journal

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ABI Journal

The ongoing jurisdictional dispute between the Federal Energy Regulatory Commission (FERC) and courts overseeing cases under the Bankruptcy Code has been well featured in this publication.[1] Given the latest uptick in bankruptcy filings by upstream and mid-stream energy market participants,[2] the FERC and the courts have had recent opportunity to stake new ground in the turf war over which has ultimate say as to a debtor's ability to reject a FERC-regulated agreement. While the FERC might not yet concede the field, it is possible that the bankruptcy court in In re Ultra Petroleum Corp.[3] has rendered the last word on this hotly contested issue.

The FERC regulates public and private utilities. Under the Federal Power Act (FPA) and Natural Gas Act (NGA),[4] in order to protect the public interest, contract rates for the interstate transmission of electricity and natural gas, respectively, must be "just and reasonable." The FPA and NGA vest the FERC with the authority to determine the reasonableness of rates.[5] However, when a party to a FERC-regulated agreement files for bankruptcy, the FERC's authority over contract rates comes into conflict with the court's jurisdiction over a debtor's decision to reject an executory contract pursuant to § 365 of the Bankruptcy Code.

This issue has been framed as whether FERC or the courts have "exclusive" jurisdiction to consider rejection of a FERC-regulated agreement, or whether they share some form of "concurrent" authority. According to the FERC, rejection in bankruptcy has the effect of modifying the filed rate with respect to the FERC-regulated agreement. Since under the FPA and NGA such modification can only be authorized by the FERC, before a debtor can reject a FERC-regulated agreement it must first obtain the FERC's approval.

Perhaps unsurprisingly, bankruptcy courts in most instances have disagreed. These courts rely on a number of different theories, including that § 365 (a) makes no exception for FERC-regulated agreements and, more recently, citing the clarification provided by the U.S. Supreme Court's holding in Mission Product,[6] that rejection is deemed only a breach of an executory contract and does not otherwise affect its terms.

In In re Mirant Corp.,[7] the Fifth Circuit Court of Appeals concluded that the FPA does not pre-empt a motion to reject a FERC-regulated agreement in bankruptcy provided that such motion is not a direct challenge to a filed rate. The Mirant court suggested that, on remand, "the district court should consider applying a more rigorous standard" to the rejection of FERC-regulated agreements.[8] Applying such a standard to a FERC-regulated agreement, a court should go beyond the typical "business-judgment" standard. Instead, the court should "carefully scrutinize the impact of rejection upon the public interest" and "ensure that rejection does not cause any disruption in the supply of electricity to other public utilities or to consumers."[9]

Two years later, the Southern District of New York came to the opposite conclusion. In In re Calpine Corp.,[10] the district court held that the bankruptcy court lacked jurisdiction to authorize the rejection of FERC-regulated agreements "because doing so would directly interfere with [the] FERC's jurisdiction over the rates, terms, conditions, and duration" of such agreements. In 2010, the same court, in In re Boston Generating,[11] appeared to soften its stance, recognizing the jurisdiction of both the bankruptcy court and the FERC without giving preference to either: The debtor was required to obtain the approval of both the bankruptcy court and the FERC in order to reject a natural gas transportation agreement.[12]

Fast-forward to more recent history. In a series of cases, courts in the Fifth, Sixth and Ninth Circuits have made plain their authority over a debtor's decision to reject FERC-regulated agreements and affirmed Mirant's heightened-scrutiny standard.

In June 2019, the U.S. Bankruptcy Court for the Northern District of California in In re PG&E Corp.[13] considered the effect of orders that the FERC issued in prebankruptcy administrative actions. In those pre-petition orders, the FERC had ruled that it maintains "concurrent jurisdiction" with the bankruptcy court over the debtors' ability to reject FERC-regulated agreements. Post-petition, the bankruptcy court determined that the FERC lacked authority to declare its own jurisdiction over the rejection of contracts in bankruptcy and explicitly held that such decisions were "unenforceable in bankruptcy and of no force and effect" on the parties once in bankruptcy.[14] Rather, the bankruptcy court forcefully concluded that only the bankruptcy court had authority to rule on the debtors' rejection of the subject agreements.[15]

Exercising that jurisdiction, the PG&E court applied Mirant's "heightened-standard" analysis, reasoning that the "public interest may need to be considered in the context of a specific rejection of a specific" FERC-regulated agreement.[16] The FERC appealed, and the bankruptcy court certified a direct appeal to the Ninth Circuit Court of Appeals. However, while that appeal was pending, the debtors confirmed a chapter 11 plan. As a result, both PG&E and the FERC agreed that the appeal was moot. The Ninth Circuit ultimately vacated both the bankruptcy court's order and the FERC's prebankruptcy administrative orders without reaching the merits.[17]

In March 2020, in In re First Energy,[18] the Sixth Circuit concluded that the bankruptcy court had concurrent jurisdiction with the FERC to determine whether to authorize a debtor's rejection of a FERC-regulated agreement.[19] In addition, the Sixth Circuit determined that the bankruptcy court had incorrectly applied the typical business-judgment standard when weighing the debtors' decision to reject its FERC-regulated agreements.[20] Instead, the Sixth Circuit instructed that, on remand, the bankruptcy court must apply Mirant's "higher standard" and consider the public interest "to ensure that the ‘equities balance in favor of rejecting the contracts.'"[21] The Sixth Circuit further required that the bankruptcy court "invite [the] FERC to participate and provide an opinion in accordance with the ordinary FPA approach ... within a reasonable time."[22]

In August 2020, the U.S. Bankruptcy Court for the Southern District of Texas declared what may become the last word on this issue. In a clear, well-reasoned opinion, the court held that it was bound to apply "Mirant scrutiny" when considering a debtor's request to reject a FERC-regulated agreement.[23] Without expressly stating that it has exclusive jurisdiction over the rejection of executory contracts, the court maintained that the "FERC's jurisdiction concerning rate-setting is unaltered by rejection."[24]Ultra is a natural gas exploration company. Ultra and Rockies Express Pipeline LLC were parties to a negotiated rate agreement pursuant to which Ultra would ship natural gas on Rockies Express's REX Pipeline.[25] Commodity prices dropped precipitously, and Ultra consequently suspended its exploration program and released its REX Pipeline capacity to other shippers.[26] Rockies Express prophylactically filed a petition with the FERC seeking a declaratory ruling barring Ultra from rejecting the agreement in bankruptcy without prior FERC approval.[27] Before the FERC could issue a decision, Ultra filed for bankruptcy and, on the same day, filed a motion to reject the agreement.[28]

Considering the debtors' motion, the bankruptcy court, "[c]onsistent with the Fifth Circuit's teachings in Mirant," invited the FERC to participate in the bankruptcy proceedings as a party-in-interest to "argue and comment on whether rejection of the Agreement would harm the public interest."[29] At the same time, the bankruptcy court cautioned "Rockies Express that pursuing the FERC petition for declaratory order would violate the automatic stay" and subsequently denied Rockies Express's motion for relief from stay.[30] The FERC "fully participated" in the proceedings but ultimately stated that it "would not take a position on the public interest implications of rejecting this specific Agreement."[31]

The court recognized that Mirant was the "controlling authority" on rejection of the agreement and rejected Ultra's arguments that Mirant dictated that the bankruptcy court should "ignore public policy considerations."[32] On the contrary, the court noted that Mirant required the court to apply a "more rigorous standard" than the "usual business-judgment standard."[33]

Noting that the Mirant court did not precisely define this "more rigorous standard," the bankruptcy court articulated the bounds of "Mirant scrutiny" as requiring the court to scrutinize the impact of rejection on both the public interest and on the supply of natural gas to consumers, and after determining the public interest and supply concerns, weigh such concerns against the underlying agreement's burden on the debtor's reorganization.[34] Applying this standard, the bankruptcy court found that Ultra's rejection of the REX Pipeline agreement was warranted.[35]

First, the court found that while rejection would affect "the economic relationship" between Ultra and Rockies Express, there was no evidence that rejection would harm the public interest.[36] Second, the court found that there was also no evidence that rejection would negatively impact the supply of natural gas to public utilities or consumers, since rejection would "neither reduce the volume of natural gas travelling along the REX Pipeline nor decrease the volume of natural gas that Ultra produces."[37] Finally, the court found that the agreement "plainly" burdened Ultra's estate by "requiring substantial monthly payments" and "locking Ultra into above-market shipping rates."[38] Taken together, the court concluded that the Mirant factors established that "the equities plainly favor [ed] approving rejection."[39]

After concluding that Mirant scrutiny favored rejection of the agreement, the bankruptcy court resolved the jurisdictional question by finding that "[r] ejection is, simply, a breach," and therefore neither abrogates, rescinds, nor terminates a contract.[40] Thus, the terms of the underlying agreement remain unchanged. Consequently, the court held that because rejection does not modify the filed rate, "rejection does not implicate 11 U.S.C. § 1129 (a)(6)" and had no effect on the FERC's jurisdiction concerning rate-setting.[41] While the bankruptcy court stopped short of saying that it wields exclusive jurisdiction over rejection of FERC-regulated agreements, the fact that the FERC had previously relied on § 1129 (a)(6) in support of its claim to concurrent jurisdiction means that the court's holding in Ultra may render that argument unavailable.

Given the holdings in First Energy, PG&E and Ultra, we may have heard the last word on this issue, reserving ultimate authority over rejection of FERC-regulated agreements to the bankruptcy court but crystalizing the heightened "public interest" standard articulated in Mirant. Of course, a number of circuits have yet to adopt Mirant, and at least some courts in the Second Circuit have rejected its holding. As noted at the outset of this article, this issue is still at the forefront while the energy market remains roiled by the current economic challenges arising from the COVID-19 pandemic.

Indeed, both Rockies Express and the FERC have appealed the decision in Ultra to the U.S. District Court for the Southern District of Texas.[42] Likewise, the U.S. Bankruptcy Court for the Southern District of Texas is currently considering objections in In re Chesapeake Energy Corp. from both the FERC and ETC Tiger Pipeline LLC in opposition to the debtor's motion for rejection of certain natural gas transportation agreements.[43]

Both of these objections were filed before the bankruptcy court issued its opinion in Ultra. However, given the court's steady application of Mirant in Ultra, it is unlikely that the court will deviate from applying Mirant in Chesapeake. Such a decision would reinforce the application of Mirant's scrutiny analysis and strengthen the growing majority position in this debate.

Notes

[1] For an excellent primer on the history of this turf war, see Risa L. Wolf-Smith, “Rejecting Power-Purchase Agreements in Energy Cases: Do Bankruptcy Courts Have Exclusive Jurisdiction?,” XXXVIII ABI Journal 8, 22-23, 67-68, August 2019. For an insightful analysis on the evolving standards courts have applied when considering a debtor’s attempt to reject a FERC-regulated agreement, see David A. Beck, “Public Interest Must Be Considered: The Rejection of Power Purchase Agreements Examined,” XXXIX ABI Journal 4, 18-19, 70-71, April 2020. Both articles are available at abi.org/abi-journal (unless otherwise specified, all links in this article were last visited on Dec. 22, 2020).

[2] See, e.g., Paul Takahashi, “Oil Bankruptcies Rise in the Third Quarter,” Houston Chronicle (Nov. 18, 2020), available at houstonchronicle.com/business/energy/article/Oil-bankruptcies-rise-in-the-third-quarter-15736171.php.

[3] In re Ultra Petroleum Corp., 621 B.R. 188 (S.D. Tex. 2020); 621 B.R. 188 (Bankr. S.D. Tex. 2020), motion to certify appeal granted sub nom., Rockies Express Pipeline LLC v. Ultra Res. Inc., No. 4:20-CV-2306, 2020 WL 7323356 (S.D. Tex. Dec. 10, 2020).

[4] Federal Power Act, 16 U.S.C. §§ 791a, et seq.; Natural Gas Act, 15 U.S.C. §§ 717, et seq.

[5] See 16 U.S.C. § 824d (as to FPA); 15 U.S.C.§ 717c (as to NGA).

[6] See Mission Prod. Holdings Inc. v. Tempnology LLC, 139 S. Ct. 1652 (2019).

[7] In re Mirant Corp., 378 F.3d 511, 519-20 (5th Cir. 2004).

[8] Id. at 526.

[9] Id.

[10] See In re Calpine Corp., 337 B.R. 27 (S.D.N.Y. 2006).

[11] In re Boston Generating LLC, 2010 WL 4616243 (S.D.N.Y. Nov. 12, 2010).

[12] Id. at *3.

[13] See In re PG&E Corp., 2019 WL 2477433 (Bankr. N.D. Cal. June 12, 2019).

[14] Id. at *4.

[15] Id. at *17.

[16] Id. at *7, *17. The PG&E decision did not address a pending motion to reject an executory contract, but rather merely resolved the underlying jurisdictional question, indicating that the bankruptcy court would apply the Mirant standard if and when a motion to reject an executory contract were filed and opposed. See id. at *17.

[17] See PG&E Corp. v. Fed. Energy Regulatory Comm’n, Case No. 19-71516, Docket No. 164-1 at 7 (9th Cir. Oct. 7, 2020).

[18] In re FirstEnergy Solutions Corp., 945 F.3d 431 (6th Cir. 2019).

[19] Notably, the Sixth Circuit also held that the bankruptcy court exceeded this jurisdiction when it enjoined the FERC from compelling the debtors to continue performing under the agreements at issue. See id. at 452 (finding that bankruptcy court lacked authority to enjoin FERC in this manner “particularly because the bankruptcy court did not have exclusive jurisdiction”).

[20] Id. at 454.

[21] Id. (quoting Mirant, 378 F.3d at 525).

[22] Id.

[23] In re Ultra Petroleum, 621 B.R. at 204.

[24] Id. at 205.

[25] Id. at 193.

[26] Id.

[27] Id. at 194.

[28] Id.

[29] Id. (internal quotations omitted).

[30] Id.

[31] Id.

[32] Id. at 198.

[33] Id. at 199.

[34] Id. at 199-200.

[35] Id.

[36] Id. at 201.

[37] Id.

[38] Id. at 203.

[39] Id. at 203-04.

[40] Id. at 204 (citing Tempnology, 139 S. Ct. at 1657-58).

[41] Id.

[42] On Aug. 26, 2020, Rockies Express appealed the bankruptcy court’s rejection order. See Rockies Express Pipeline LLC v. Ultra Petroleum Corp., Case No. 4:20-cv-03043, Docket No. 1 (S.D. Tex. Aug. 31, 2020). This appeal has been consolidated with Rockies Express’s prior appeals from the bankruptcy court’s orders denying Rockies Express’s motion to proceed with an amended petition for declaratory ruling before the FERC and Rockies Express’s appeal from the bankruptcy court’s order denying relief from stay under lead case, Rockies Express Pipeline LLC v. Ultra Res. Inc., Case No. 4:20-cv-2306 (S.D. Tex. 2020). The district court certified direct appeal to the Fifth Circuit, but on Dec. 11, 2020, Rockies Express moved for reconsideration of that order. The briefing schedule in the FERC’s appeal from the bankruptcy court’s order authorizing rejection of the agreement is, as of this writing, in abeyance pending the Fifth Circuit’s ruling on the parties’ forthcoming petition for direct review.

[43] See In re Chesapeake Energy Corp., Case No. 20-33233, Doc. No. 441 (Bankr. S.D. Tex. July 20, 2020) (FERC); Doc No. 492 (Bankr. S.D. Tex. July 24, 2020) (ETC Tiger Pipeling LLC).

Reprinted with permission from the ABI Journal, Vol. XL, No. 2, February 2021.