Fifth Circuit Reaffirms Bankruptcy Court Jurisdiction Over Rejection of FERC-Regulated Offtake Agreement

Similarly, the development of renewable electricity generation facilities is typically financed based on the existence of long-term power purchase agreements (PPA) with an electricity utility or an end user. PPAs allow the cost of construction to be recouped by the developer over time based on a fixed electricity price schedule. Without the expectation of long-term revenue streams, many renewable projects would never secure financing.

The Natural Gas Act (NGA) and Federal Power Act (FPA) provide that the business of “transporting and selling natural gas” and “transmitting and selling electric energy” “for ultimate distribution to the public is affected with a public interest.” On their face, the NGA and FPA vest the Federal Energy Regulatory Commission (FERC) with the exclusive authority to protect that 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 contracted rate (filed rate) with FERC. The terms must be “just and reasonable” and not “unduly discriminatory or preferential.” Additionally, the Supreme Court has held that the NGA and FPA require FERC to consider “the stabilizing force of contracts” because “uncertainties regarding rate stability and contract sanctity can have a chilling effect on investments and a seller’s willingness to enter into long-term contracts and this, in turn, can harm consumers in the long run.” Changes to or cessation of performance under FERC-regulated contracts require the initiation of proceedings before FERC, in which impacted parties can participate.

Bankruptcy Can Change FERC Process

This process can be short-circuited if a counterparty files for bankruptcy protection as demonstrated by the Fifth Circuit’s Ultra decision.

Ultra Resources, Inc. (Ultra) entered a pipeline capacity agreement with Rockies Express Pipeline LLC (REX) slated to run from 2019 until 2026. Ultra’s obligation would have been $169 million over the agreement’s life. Ultra suspended its drilling program and filed for chapter 11 protection shortly before the agreement took effect, but after REX petitioned FERC for a declaration that Ultra could not reject the contract through bankruptcy.

Notwithstanding the pending FERC proceeding, Ultra sought authority from the Texas Bankruptcy Court to reject the contract. REX objected and asked the Bankruptcy Court to let FERC determine whether rejection was in the public interest. The Bankruptcy Court denied the request but invited FERC (but not all the impacted parties) to comment on whether rejection would harm the public interest. FERC did, but relying on In re Mirant Corp., 378 F.3d 511 (5th Cir. 2004), the Bankruptcy Court authorized rejection. (In re Ultra Petro. Corp., 621 B.R. 188 (Bankr. S.D.Tex. 2020)).

In Mirant, the Fifth Circuit held that FERC’s authority did not prevent a bankruptcy court from authorizing the rejection of a PPA so long as it did not directly affect a filed rate. Mirant also required an increased level of scrutiny to authorize the rejection of a FERC-regulated contract. Normally, a debtor’s decision to reject a contract is reviewed under the deferential “business judgment rule.” Under Mirant, the bankruptcy court must “carefully scrutinize the impact of rejection upon the public interest and should, inter alia, ensure that rejection does not cause any disruption in the supply of [a regulated commodity] to other public utilities or to consumers.”

The Bankruptcy Court in Ultra (1) held an evidentiary hearing and made the requisite public interest finding under “Mirant Scrutiny” and (2) found that there was no collateral attack on the filed rate because the rate was still used to set REX’s damages award, which could be filed as claim in the bankruptcy case. The Court’s public interest finding focused on only the availability of gas and ignored numerous other factors typically evaluated in a FERC proceeding, such as public health and safety. Moreover, the Bankruptcy Court ignored the indirect effect on the filed rate that the market must now price in: the risk of bankruptcy rejection, a cost ultimately borne by consumers.

On March 14, 2022, the Fifth Circuit adhered to its Mirant decision and affirmed the Bankruptcy Court’s opinion. (2022 U.S. App. LEXIS 6522 (5th Cir. Tex., Mar. 14, 2022)). To date, only two Circuit Courts of Appeal (Fifth and Sixth) have addressed this issue, both reaching similar conclusions. Bankruptcy courts in Delaware have reached a similar conclusion with respect to bankruptcy court jurisdiction, while courts in the Southern District of New York have reached the opposite conclusion and required FERC review.

The decision stressed that the filed rate was not being collaterally attacked because Ultra was not seeking to secure a lower rate through rejection. Rather, Ultra was suspending its drilling program and was releasing its pipeline capacity. Thus, the contract was no longer required for its operations. This distinction still leaves open an argument in a future rejection case that the attempt to reject an out-of-market contract does in fact constitute a collateral attack on the filed rate if the party seeking rejection intends to access the pipeline under a new contract as part of its reorganization.

The Fifth Circuit also reinforced its position in Mirant that a bankruptcy court must invite FERC to participate in a rejection proceeding as a party in interest. This requirement, however, creates an awkward situation where an adjudicatory body is being required to participate as a litigant. FERC has repeatedly stated that as a regulatory body it speaks through its orders.

Finally, the Fifth Circuit reiterated that a bankruptcy court cannot base its decision on the traditional business judgment standard for rejection of an executory 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 on, among other things, (1) ensuring debtors have breathing space; (2) exercising jurisdiction over the debtor’s entire estate; (3) allowing debtors to exercise sound business judgment in reorganizing their business; (4) promoting swift and successful reorganizations; and (5) saving jobs. In contrast, FERC must (1) ensure reliability to keep lights on and houses warm; (2) promote infrastructure investment by upholding contract terms; (3) prevent contract terminations from destabilizing a market; (4) aid development of clean energy; and (5) safeguard the overall public interest. Another significant concern involving gas transportation services agreements is public safety and the potential impact of flaring of gas following rejection of a gas transmission agreement. Many shale reservoirs produce both oil and gas, and an operator may be inclined to continue to produce these wells for oil, even without pipeline access to market the gas, requiring the gas to be burned off.

The Fifth Circuit was satisfied that the Bankruptcy Court in Ultra properly balanced competing policies by focusing on whether rejection would negatively impact gas supply and concluding it would not. It recognized the expertise of FERC and its staff but found that the need for expediency in bankruptcy cases weighed in favor of keeping the rejection determination with the bankruptcy court, with FERC’s invited insights. As a result, counterparties to FERC-regulated contracts must be prepared to make a public interest case in opposition to any rejection motion quickly in the event of a counterparty bankruptcy.