Left to right: Andrew Kassner and Joseph Argentina of Drinker Biddle & Reath.

The provisions of the Bankruptcy Code sometimes conflict with other federal laws and regulations. A debtor that operates in a highly regulated industry often faces additional hurdles in administering its bankruptcy case that would be routine in other Chapter 11 proceedings. Conversely, a regulated debtor might find the Bankruptcy Code enables it to avoid an otherwise inevitable regulatory consequence. The U.S. Court of Appeals for the Sixth Circuit Court recently considered whether an energy company debtor could reject a power purchase agreement as an executory contract that had been filed with the Federal Energy Regulatory Commission (FERC). Outside of bankruptcy, the debtor's ability to address the contract would fall under FERC's exclusive jurisdiction. Here, the bankruptcy court ruled that FERC had no jurisdiction, and the bankruptcy court had exclusive jurisdiction to adjudicate the matter. The Sixth Circuit court rejected that position, and ruled that the bankruptcy court and FERC have concurrent jurisdiction. The opinion was issued on Dec. 12, 2019, in the case of In re FirstEnergy Solutions, Case Nos. 18-3787/3788/4095/4097/4107/4110.

Rejection of the PPAs

The debtor, FirstEnergy Solutions (debtor) and a subsidiary filed a bankruptcy case in March 2018. The debtor's business was the purchase of electricity from its subsidiaries and resale to retail clients, corporate affiliates and a wholesale energy market. According to the opinion, regulations from the early 2000s required the debtor to purchase a certain amount of renewable energy. However, the marketplace and regulatory mandates had changed, and regulations had been relaxed resulting from a drop in energy prices and an abundance of available renewable energy. These changes rendered the contracts burdensome on the debtor, which sought to sell its entire retail business. As a result, at the time of its bankruptcy filing, the debtor determined it had no use for the contracts. In fact, it alleged the debtor was losing an estimated $46 million per year under one set of power purchase agreements and another $248 million by the year 2040 under another intercompany power purchase agreement.

One day after the petition date, the debtor and its subsidiary initiated an adversary proceeding that sought to enjoin FERC from interfering with the debtor's planned rejection of the power purchase agreements. The debtor argued that it needed to reject the PPAs because they had become financially burdensome and, in light of the debtor's plan to exit the retail energy market, it no longer had a need for the renewable PPAs. The debtor also argued that the contract counterparties could easily sell their electricity to other wholesale purchasers on into the wholesale marketplace.

FERC had previously approved the contracts under the Federal Power Act and the Public Utilities Regulatory Policies Act. FERC, certain contract counterparties, and an Ohio Consumers Council (appellants) argued that the Federal Power Act (FPA) gave FERC exclusive jurisdiction over energy contracts. Once a contract has been filed with FERC, only FERC can modify or abrogate the terms of the agreement. Further, under these acts, FERC may only modify or abrogate the agreement "… if it finds that the contract is not just and reasonable, in that it seriously harms the public interest." FERC also argued that the Bankruptcy Code's automatic stay did not apply because FERC met the "regulatory powers" exception, which authorizes certain government actions to proceed notwithstanding a bankruptcy filing.

The bankruptcy court held it had exclusive and unlimited jurisdiction over the debtor's request to reject the contracts, and FERC had no jurisdiction. The bankruptcy court enjoined FERC from taking any action relating to the contracts. The bankruptcy court then approved the debtor's rejection of the contracts under Section 365 of the Bankruptcy Code, utilizing the business judgment standard in rejection of executory contracts under the Bankruptcy Code. The appellants were permitted to take a direct appeal to the Sixth Circuit.

Debtor Permitted to Reject

The court began its analysis by noting certain important threshold issues. First, the case was not a liquidation proceeding, but a reorganization. In a liquidation, no one could compel the debtor to keep performing under the PPAs, and the U.S. Supreme Court previously ruled that FERC had authority to compel specific performance of unprofitable, or even illegal contracts. Second, the court noted the debtor's obligations under the agreements included more than just the purchase of electricity. Other terms included contributions towards eventual facility de-commissioning, environmental monitoring, compliance and cleanup, and long-term retiree benefit obligations. Third, the contracts only concerned a "very small" quantity of the total market. The court recognized careful consideration of these issues was needed.

The court then turned to the FERC's argument that the filed PPAs could not be rejected in bankruptcy. The opinion states the act of filing the PPAs with FERC transformed them from contracts to federal regulations and, as such, the bankruptcy court lacked jurisdiction to approve the debtor's rejection of the filed PPAs. The opinion reviewed caselaw governing how negotiated contract obligations become "de jure" regulations after filing with FERC. However, the opinion cites a First Circuit opinion that acknowledged there may be instances where mandating performance might be unconscionable, or where a "striking public necessity should be given overriding effect," see Boston Edison v. FERC, 856 F.2d 361, 372 (1st Cir. 1988). The court reasoned, "the public necessity of available and functional bankruptcy relief is generally superior to the necessity of FERC's having complete or exclusive authority to regulate energy contracts and markets." Consequently, the court reasoned the bankruptcy court had jurisdiction to decide whether the debtor could reject the PPA contracts and FERC could not independently prevent it.

Next, the court considered whether the bankruptcy court was permitted to issue an "overwhelming injunction" preventing FERC from holding proceedings with respect to the PPAs. The court disagreed with the bankruptcy court's decision that the automatic stay prevented FERC from doing anything at all. Instead, the court reasoned that some potential FERC actions would fall into the regulatory powers exception to the automatic stay, which permits commencement or continuation of an action or proceeding by a government unit to enforce such government unit's regulatory power. The court also disagreed with the bankruptcy court's decision that Section 105(a) of the Bankruptcy Code enabled it to enjoin all FERC proceedings. The court reasoned that the bankruptcy court did not have exclusive jurisdiction over the issues, but concurrent jurisdiction with FERC.

Ultimately, the court determined that the competing interests of the FPA and the Bankruptcy Code were best "harmonized" if the bankruptcy court is permitted, based on the particular facts and circumstances before it, to enjoin FERC from issuing an order (or compelling an action) that would directly conflict with the bankruptcy court's orders or interfere with its otherwise-authorized authority, but the bankruptcy court may not enjoin FERC from conducting its business or issuing orders that do not interfere with the bankruptcy court. In the case before it, the bankruptcy court had limited authority to enjoin FERC from requiring the debtor to continue performing the PPAs, but lacked the authority to enjoin FERC from initiating or continuing any other proceedings.

Finally, the court disagreed with the bankruptcy court's use of the business judgment standard to evaluate the debtor's decision to reject the PPAs. The court reasoned that while this case appeared to have limited public impact, other cases might implicate significant public interests. Ultimately, the court articulated a specific standard to apply where a debtor seeks to reject a contract that has been filed with FERC:

We conclude that an adjusted standard best accommodates the concurrent jurisdiction between, and separate interests of, the Bankruptcy Code (court) and the FPA (FERC). On remand, the bankruptcy court must reconsider its decision under this higher standard, considering and deciding the impact of the 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.

Conclusion

This case presents an example where the debtor's business judgment to jettison burdensome executory contracts as part of its reorganization process was not allowed to preempt or override the complex federal regulatory scheme in the energy arena. At the same time, the Sixth Circuit recognized that energy companies are entitled to utilize the Chapter 11 reorganization laws, and established bankruptcy processes should be available to such enterprises. It is interesting to note that one member of the panel issued an opinion "concurring in part but dissenting in part," stating that the bankruptcy court also erred in its injunction by infringing on FERC's exclusive jurisdiction to determine, modify or abrogate rates. In sum, cases like these will continue to be adjudicated in a fact specific manner to balance a debtor's need to reorganize with the public interest served by the federal regulatory scheme.

Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, a national law firm with more than 635 lawyers in 12 offices. He chaired the corporate restructuring group for almost 20 years. He can be reached at [email protected] or 215-988-2554.

Joseph N. Argentina Jr. is a senior attorney in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, Delaware, offices. He can be reached at [email protected] or 215-988-2541.