Fifth Circuit Reaffirms Jurisdiction of Bankruptcy Court Over Rejection of FERC Regulated Levy Agreement | Pillsbury Winthrop Shaw Pittman LLP
Similarly, the development of renewable power generation facilities is typically funded based on the existence of long-term power purchase agreements (PPAs) with a power utility or end user. PPAs allow the developer to recoup the cost of construction over time based on a fixed electricity price schedule. Without the expectation of long-term revenue streams, many renewable energy projects would never get funded.
The Natural Gas Act (NGA) and Federal Electricity Act (FPA) provide that the business of “transmission and sale of natural gas” and “transmission and sale of electric power” “for final distribution to the public are affected by the public interest”. On their face, the NGA and FPA give the Federal Energy Regulatory Commission (FERC) exclusive authority to protect this public interest by regulating the terms of contracts for the sale and transportation or transmission of natural gas and electricity. Regulated entities must file the contract rate (filed rate) with FERC. Terms must be “fair and reasonable” and not “unduly discriminatory or preferential”. Additionally, the Supreme Court held that the NGA and FPA require FERC to consider “the stabilizing force of contracts” because “uncertainties regarding rate stability and contract sanctity may have a chilling effect on the investments and the willingness of the seller to enter into long-term contracts. and this, in turn, can harm consumers in the long run. Modifications or termination of performance of contracts regulated by FERC require the commencement of proceedings before FERC, in which affected parties may participate.
Bankruptcy can change the FERC process
This process can be bypassed if a counterparty files for bankruptcy protection, as demonstrated by the Fifth Circuit Ultra decision.
Ultra Resources, Inc. (Ultra) has entered into a pipeline capacity agreement with Rockies Express Pipeline LLC (REX) that is expected to run from 2019 through 2026. Ultra’s obligation would have been $169 million over the term of the agreement. Ultra suspended its drilling program and filed for Chapter 11 protection shortly before the deal went into effect, but after REX asked FERC for a statement that Ultra could not reject the contract by bankruptcy.
Notwithstanding the pending FERC proceeding, Ultra has applied to the Texas bankruptcy court for permission to dismiss the contract. REX objected and asked the bankruptcy court to let FERC determine whether the rejection was in the public interest. The bankruptcy court denied the request but invited FERC (but not all affected parties) to comment on whether the denial would harm the public interest. FERC did, but relying on In the Mirant Corp. case, 378 F.3d 511 (5th Cir. 2004), the bankruptcy court allowed the dismissal. (In re Ultra Petro. Corp.621 BR 188 (Bankr. SDTex. 2020)).
In Mirantthe Fifth Circuit held that the authority of the FERC did not prevent a bankruptcy court from allowing the dismissal of a PPA as long as it did not directly affect a filed rate. Mirant also required an increased level of scrutiny to authorize rejection of a FERC-regulated contract. Normally, a debtor’s decision to reject a contract is reviewed under the “business judgment rule”. Under Mirantthe bankruptcy court must “consider carefully the impact of the rejection on the public interest and must, among other things, ensure that the rejection does not lead to any interruption of the supply of [a regulated commodity] to other public services or to consumers.
The bankruptcy court of Ultra (1) held an evidentiary hearing and made the public interest finding required under “Mirant Scrutiny” and (2) found that there was no collateral attack on the rate filed because the rate was still used to set REX’s compensation, which could be filed as a claim in the event of bankruptcy. The Court’s public interest finding focused solely on gas availability and ignored many other factors typically assessed in a FERC proceeding, such as public health and safety. In addition, the High Court ignored the indirect effect on the rate deposited that the market must now integrate: the risk of rejection of the bankruptcy, a cost ultimately borne by consumers.
On March 14, 2022, the Fifth Circuit joined its Mirant decision and affirmed the opinion of the bankruptcy court. (2022 US App. LEXIS 6522 (5th Cir. Tex., March 14, 2022)). To date, only two Circuit Courts of Appeals (Fifth and Sixth) have considered this issue, both reaching similar conclusions. Bankruptcy courts in Delaware came to a similar conclusion regarding the jurisdiction of the bankruptcy court, while courts in the Southern District of New York came to the opposite conclusion and required a review by the FERC.
The ruling emphasized that the filed rate was not indirectly attacked because Ultra was not seeking a lower rate through rejection. Instead, Ultra was suspending its drilling program and releasing its pipeline capacity. Thus, the contract was no longer required for its operations. This distinction still leaves open an argument in a future dismissal case that attempting to dismiss an off-market contract is in fact a collateral attack on the filed tariff if the party seeking dismissal intends to access the pipeline. under a new contract as part of its reorganization.
The Fifth Circuit also strengthened its position in Mirant that a bankruptcy court must invite FERC to participate in a dismissal proceeding as an interested party. However, this requirement creates an awkward situation when a judicial body is required to participate as a party to a dispute. FERC has repeatedly stated that as a regulator, it speaks through its orders.
Finally, the Fifth Circuit reiterated that a bankruptcy court cannot base its decision on the traditional standard of business judgment for the rejection of an enforceable contract, and must instead consider the public interest. The challenge, however, is that FERC and bankruptcy courts have competing sets of public policy concerns. Bankruptcy courts focus, among other things, on (1) ensuring that debtors have a break; (2) exercise jurisdiction over the entire estate of the debtor; (3) enable debtors to exercise good business judgment when reorganizing their business; (4) promote rapid and successful reorganizations; and (5) save jobs. In contrast, FERC must (1) guarantee reliability to keep the lights on and the houses warm; (2) promote investments in infrastructure by respecting contractual clauses; (3) prevent breaches of contract from destabilizing a market; (4) assist in the development of clean energy; and (5) safeguard the general public interest. Another significant concern regarding gas transmission service agreements is public safety and the potential impact of gas flaring following the rejection of a gas transmission agreement. Many shale reservoirs produce both oil and gas, and an operator may be inclined to continue producing these wells for oil even without access to the pipeline to market the gas, which requires the gas to be flared.
The Fifth Circuit was satisfied that the bankruptcy court of Ultra properly balanced competing policies by focusing on whether the rejection would have a negative impact on gas supply and concluding that it would not. He acknowledged the expertise of FERC and its staff, but found that the need for speed in bankruptcy cases weighed in favor of upholding the dismissal ruling in bankruptcy court, with FERC inviting insights . Accordingly, counterparties to FERC-regulated contracts must be prepared to promptly make a public interest argument against any petition to dismiss in the event of a counterparty’s bankruptcy.