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Reprinted with permission from the December 19, 2019 issue of The Legal Intelligencer. © 2019 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
In complex Chapter 11 cases, practitioners often encounter legal issues that extend well beyond the Bankruptcy Code. The FirstEnergy bankruptcy case, which ultimately was decided by the U.S. Court of Appeals for the Sixth Circuit (Federal Energy Regulatory Commission v. FirstEnergy Solutions, (In re FirstEnergy Solutions), Case No. 18-3897 (6th Cir. Dec. 12, 2019)) is a good example of how a business failure led to a bankruptcy case which directly impacted the energy market, the federal regulation of that market, and the harmonizing of such regulations against the Bankruptcy Code’s goal of providing a “fresh start” to debtors. Ultimately, when faced with these competing interests, the Sixth Circuit exercised a balanced approach in an effort to ensure that policy from all sides was fairly implemented.
FirstEnergy Solutions Corp. (FES), purchased power on the open market for resale to retail customers, affiliates, and in the PJM spot market (a market that coordinates access to wholesale power over 13 states and Washington D.C., covering about 65 million people). Unfortunately, a shift in the regulatory scheme coupled with changing energy prices, led to financial turmoil for FES.
As early as 2003, government regulation required FES to purchase renewable energy credits or RECs, leaving FES with significant REC related obligations by 2011. Since RECs were hard to come by, FES was forced to enter into long-term power purchase contracts to guarantee enough supply to meet its obligations. At that time, electricity prices—and thus, REC prices—were relatively high. What’s more, to mitigate the higher energy prices, FES also entered into a multi-party intercompany power purchase agreement with 12 other peer companies, under which each participant agreed to take a proportionate stake in the production from and management, maintenance and decommissioning of Ohio Valley Electric fossil fuel plants.
Subsequently, government regulations relaxed the number of RECs that FES needed to buy, rendering them more abundant, and less expensive because of the concurrent decline in energy prices. This left FES stuck with long-term power purchase agreements to buy now unnecessary RECs at noncompetitive prices. As with the PPAs, the energy under the ICPA agreements was priced above market. Between the PPAs and the ICPA, FES estimated it would lose $46 million and $268 million per year, respectively, throughout the terms of those contracts.
These changes in the energy market, among others, caused FES and one of its affiliates to file bankruptcy in March 2018 in the Northern District of Ohio in an effort to shed these now-uneconomic contracts. As a result, an epic battle with the Federal Energy Regulatory Commission was commenced. Not surprisingly, immediately upon filing, FES moved to enjoin FERC from interfering with its plans to reject the PPAs and ICPA, all of which FERC had previously approved under the applicable federal statutes. Specifically, FES sought “a declaratory judgment that the bankruptcy court’s jurisdiction is superior to FERC’s and injunctions prohibiting FERC from interfering with its intended rejection of the ICPA and the PPAs (i.e., forbidding FERC from ordering it to continue to perform under those contracts) and prohibiting FERC from even conducting any proceedings concerning those contracts (i.e., preventing FERC’s regulatory mandated hearings about them).”
FES sought to reject the ICPA and PPAs for obvious reasons—the price of energy under those contracts was far above market, a substantial decline in FES’ sales (2018 sales were 50% of 2013 levels), regulatory changes, and the fact that FES was seeking to leave the retail business altogether, FES did not need to buy additional RECs or electricity.
FERC, and four parties to the ICPA, opposed FES and argued that federal law gave FERC exclusive jurisdiction over energy contracts—that applicable law provided only FERC could modify such contracts and can only do so if it found the contract seriously harmed the public interest. The Bankruptcy Court issued a TRO and ultimately entered an order that enjoined FERC from: “initiating or continuing any proceeding; issuing any order, to require or coerce [FES] to continue performing the contracts or limiting [FES] to seeking abrogation … under the [FPA]; or interfering with the bankruptcy court’s exclusive jurisdiction.”
In support of its order, the Bankruptcy Court opined that: FERC was bound by the automatic stay; FERC did not meet the Sixth Circuit’s formulation of the “public policy test” that permits regulators using police power as an exemption from the stay; and the Bankruptcy Court actions were supported by section 105(a) of the Bankruptcy Code. The Bankruptcy Court further concluded that under bankruptcy law, FES was able to reject the PPAs and ICPA under the low bar of the business judgment standard.
On appeal, the Sixth Circuit was presented with several questions: whether the Bankruptcy Court had exclusive jurisdiction—over and above FERC—to decide whether FED could reject the energy contracts; whether the Bankruptcy Code granted the Bankruptcy Court authority to enact such a board injunction over FERC; and whether the business judgment standard properly applied to these heavily regulated contracts.
The battle for jurisdiction between FERC and the Bankruptcy Court raised the critical question of whether FERC’s regulatory control over energy contracts is exclusive and superior to that of the bankruptcy court and its rights under the Bankruptcy Code? The “filed-rate doctrine” provides that under the Federal Power Act, FERC has plenary and exclusive jurisdiction over wholesale power rates, terms, and conditions of service for any such rate filed with FERC—but despite the name, this doctrine extends beyond just rates and includes all contractual provisions, including, ostensibly, termination or abrogation of these contracts. As a corollary, the Mobile-Sierra doctrine provides that all contracts filed and approved by FERC presumptively meet the “just and reasonable” standard required under the FPA and that to abrogate or terminate any such contract, FERC has to show that the contract seriously harms the public interest. Because of this heavy regulatory overlay, many courts have construed them to prevent judicial alteration.
The Sixth Circuit, however, recognized that the Bankruptcy Court’s treatment of such contracts differed from prior matters before other district or state courts—i.e., considering the contract itself or imposing competing state law—because the Bankruptcy Court was simply attempting to permit FES to take advantage of the provisions of the Bankruptcy Code to seek financial relief. The Sixth Circuit reasoned that: 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. This means that, for present purposes, the ICPA and the PPAs are not de jure regulations but, rather, ordinary contracts susceptible to rejection in bankruptcy.
However, the Sixth Circuit made clear that the Bankruptcy Court’s jurisdiction was not exclusive, but rather, concurrent and superior to that of FERC.
The Sixth Circuit then turned its attention to the Bankruptcy Court’s broad injunction against virtually all FERC activity. The Bankruptcy Court premised its injunction on the automatic stay and Section 105(a) of the Bankruptcy Code. With respect to the automatic stay, the Bankruptcy Court found that FERC did not fall within the police power exception to the stay, notwithstanding contrary Fifth Circuit law. The police power exception requires courts to consider whether a regulator is initiating a proceeding to adjudicate private rights or to effectuate public policy—actions advancing public policy are exempt from the automatic stay. The Bankruptcy Court found any action by FERC would fail the test because, ultimately, any such actions would only incidentally touch on public policy and actually focus on “who gets what from the insolvent enterprise.” The Bankruptcy Court also found that the energy contracts were small in comparison to FES’ overall portfolio and that the counterparties to the rejected contracts would be able to quickly resell their energy—the Sixth Circuit commented that this finding suggests that private rights were nearly unaffected and that these facts actually supported the proposition that FERC fell within the public policy exception. Regardless, the Sixth Circuit found that while the Bankruptcy Court was “not necessarily wrong” in determining a FERC action would violate the automatic stay in this case, it found the Bankruptcy Court’s ruling that “FERC’s interest in preventing bankruptcy rejection of any such contracts is and will always be substantially private and only incidentally public” to be overboard.
In addition, the Sixth Circuit took issue with the “overwhelming” breadth of the injunction, preventing FERC from taking any action. The Bankruptcy Court was, in effect, preempting FERC from taking action that might ultimately lead to a stay violation. The Sixth Circuit found this to be a misapplication of the relevant governing case law. The controlling Sixth Circuit case on point, Chao, explicitly held that regulating bodies with concurrent jurisdiction to a bankruptcy court may enter orders consistent with the automatic stay. The Chao court held that federal agencies, of course, run the risk of taking action that is ultimately deemed a stay violation and, thus, void ab initio, but that a conflict between such an agency and a bankruptcy court finding the agency’s actions inviolate of the stay would need to be resolved by an appellate court.
The Bankruptcy Court took nearly the opposite approach. Rather than permitting FERC to act on its concurrent jurisdiction and perhaps “run the risk” of incurring a stay violation down the road, the Bankruptcy Court enjoined FERC from taking any action whatsoever—even holding a hearing—because Bankruptcy Court presumed the ultimate result (i.e., an order from FERC) would be found to have violated the automatic stay and be void.
The circuit court found “the bankruptcy court was not entitled to enjoin FERC from risking its own jurisdictional decision, conducting its business (otherwise mandated by regulation), or issuing orders that would not conflict with the bankruptcy court’s rulings.” Thus, while the Sixth Circuit found that the Bankruptcy Court “was not necessarily wrong” in determining a FERC action did not fit the public policy exception, the automatic stay did not give the Bankruptcy Court the authority to issue such a vast, sweeping injunction. The circuit court entirely rejected the Bankruptcy Court’s alternative justification under Section 105 for the breadth of its injunction, finding that this conclusion was based on a misapplication of a nonbinding Fifth Circuit ruling.
Ultimately, the court sought to harmonize the Federal Power Act and the Bankruptcy Code. Under the FPA, Congress sought to protect energy markets by placing them under control of a commission of experts, yet under the Bankruptcy Code, Congress ought to protect debtors by allowing liberal restructuring, which, to some degree does harm non-debtor parties in practice. The court determined that it would be unreasonable to allow public interest to override restructuring decisions. Indeed, the court recognized that bankruptcy judges “are capable of comprehending public interest.” At the same time, the court declined to give bankruptcy courts full power over the issue. Thus, the court found “the bankruptcy court may, based on the particular facts and circumstances before it, 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 risking its own jurisdictional decision, conducting its (otherwise regulatory mandated) business, or issuing orders that do not interfere with the bankruptcy court.” The Sixth Circuit reversed the Bankruptcy Court’s injunction.
Finally, the circuit court addressed the correct standard to apply when determining if FES could indeed reject the energy contracts. While FES pushed for the business judgment standard, FERC argued in favor of a heightened standard that took into account public interest principles. The Sixth Circuit considered prior U.S. Supreme Court jurisprudence, which took into account the public interest when dealing with the rejection of collective bargaining agreements. It also considered the appellant’s not unreasonable argument that FES’ rejection could adversely affect the energy markets and consumers. Thus, the court found that an adjusted standard best accommodated the concurrent jurisdiction between the Bankruptcy Court and FERC, and the counterbalanced interests advanced by the Bankruptcy Code and the FPA. Thus, the court remanded and ordered the Bankruptcy Court to: consider and decide 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.
The consistent theme throughout the Sixth’s Circuit’s opinion involving all three key issues—jurisdiction, injunctive power and rejection standards—was balance. The court recognized that it was important to place FES, as a debtor, under the protection of the Bankruptcy Code and maintain the integrity of nationwide bankruptcy relief; yet, it also knew that FERC had tools in its toolbox that it could use to advance its important energy policy mandates without running afoul of the automatic stay. Thus, concurrent jurisdiction was the best answer. In terms of injunctive power, the same balance applied—certainly the Bankruptcy Court was right to put a stop to regulatory actions violating the stay, but at the same time, the Sixth Circuit found it was a step too far to preemptively halt all action by FERC. Thus, the court put the risk in FERC’s hands—if it went too far, it might face a stay violation and its work would be undone as being void ab initio. Finally, as for rejection, the court recognized that the rejection impact of energy contracts went far beyond the interests of FES and its counterparties—they affected the market as a whole, and thus, the public good needed to be considered by the Bankruptcy Court, not FERC, to determine if rejection was justified. These solutions provide a possible roadmap for future courts facing the tension of regulatory powers and the underlying policies of the Bankruptcy Code.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.