Fifth Circuit Rules That Chapter 11 Debtors May Reject Filed-Rate Contracts Without FERC Permission

• Published date: 25 May 2022
• Subject Matter: Energy and Natural Resources, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Energy Law, Oil, Gas & Electricity
• Law Firm: Jones Day
• Author: Mr Paul Green and Mark Douglas

In FERC v. Ultra Resources, Inc. (In re Ultra Petroleum Corp.), 2022 WL 763836 (5th Cir. Mar. 14, 2022), the U.S. Court of Appeals for the Fifth Circuit issued a long-awaited ruling on an appeal from a bankruptcy court order authorizing chapter 11 debtor Ultra Resources, Inc. ("Ultra") to reject a filed-rate gas transportation contract as part of its chapter 11 plan. The Fifth Circuit held that, under the circumstances and in accordance with Fifth Circuit precedent, the bankruptcy court properly authorized Ultra to reject the contract without obtaining the approval of the Federal Energy Regulatory Commission ("FERC"), that Ultra was not subject to a separate public-law obligation to continue performance under the rejected contract, and that section 1129(a)(6) of the Bankruptcy Code does not require a bankruptcy court to seek FERC approval before confirming a chapter 11 plan providing for rejection of the contract.

Court rulings to date on the jurisdictional turf war between FERC and the bankruptcy courts have been a mixed bag, although two federal circuits courts of appeals now have concluded that a bankruptcy court has the power to authorize the rejection of a filed-rate contract. Here, we offer a brief discussion of the most notable court decisions addressing this issue to date.

Bankruptcy Jurisdiction and Rejection of Executory Contracts

By statute, U.S. district courts are given "original and exclusive" jurisdiction over every bankruptcy "case." 28 U.S.C. ' 1334(a). In addition, they are conferred with nonexclusive jurisdiction over all "civil proceedings arising under" the Bankruptcy Code as well as civil proceedings "arising in or related to cases under" the Bankruptcy Code. 28 U.S.C. ' 1334(b). Finally, district courts are granted exclusive jurisdiction over all property of a debtor's bankruptcy estate, including, as relevant here, contracts, leases, and other agreements that are still in force when a debtor files for bankruptcy protection. 28 U.S.C. ' 1334(e). That jurisdiction typically devolves automatically upon the bankruptcy courts, each of which is a unit of a district court, by standing court order. 28 U.S.C. ' 157(a).

A bankruptcy court's exclusive jurisdiction over "executory" contracts or unexpired leases empowers it to authorize a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to either "assume" (reaffirm) or "reject" (breach) almost any executory contract or unexpired lease during the course of a bankruptcy case in accordance with the provisions of section 365 of the Bankruptcy Code. Assumption generally allows the debtor, after curing outstanding defaults, to continue performing under the agreement or to assign the agreement to a third party for consideration as a means of generating value for the bankruptcy estate. Rejection frees the debtor from rendering performance under unfavorable contracts. Rejection constitutes a breach of the contract, and the resulting claim for damages is deemed to be a prepetition claim against the estate on a par with other general unsecured claims.

Accordingly, the power granted to debtors by Congress under section 365 is viewed as vital to the reorganization process. Rejection of a contract "can release the debtor's estate from burdensome obligations that can impede a successful reorganization." N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 528 (1984) (holding that rejection is allowed for "all executory contracts except those expressly exempted"). Typically, bankruptcy courts authorize the proposed assumption or rejection of a contract or lease if it is demonstrated that the proposed course of action represents an exercise of sound business judgment. This is a highly deferential standard akin in many respects to the business judgment rule applied to corporate fiduciaries.

The Federal Power Act, the Filed-Rate Doctrine, the Natural Gas Act, and the Mobile-Sierra Doctrine

Public and privately operated utilities providing interstate utility service within the United States are regulated by the Federal Power Act, 16 U.S.C. ' 791a et seq. ("FPA"), under FERC's supervision. Although contract rates for electricity are privately negotiated, those rates must be filed with FERC and certified as "just and reasonable" in order to be lawful. 16 U.S.C. ' 824d(a). FERC has the "exclusive authority" to determine the reasonableness of the rates. See In re Calpine Corp., 337 B.R. 27, 32 (S.D.N.Y. 2006). The FPA authorizes FERC, after a hearing, to alter filed rates if it determines that they are unjust or unreasonable. 16 U.S.C. ' 824e.

On the basis of this statutory mandate, courts have developed the "filed-rate doctrine," which provides that "a utility's right to a reasonable rate under the FPA is the right to the rate which the FERC files or fixes and, except for review of FERC orders, a court cannot provide a right to a different rate." Calpine, 337 B.R. at 32. Moreover, the doctrine prohibits any collateral attack in the courts on the reasonableness of rates'the sole forum for such a challenge is FERC. Id. Applying the doctrine, some courts have concluded that, once filed with FERC, a wholesale power contract is tantamount to a federal regulation, and the duty to perform under the contract comes not only from the agreement itself but also from FERC. Id. at 33 (citing Pa. Water & Power Comm'n v. Fed. Power Comm'n, 343 U.S....