June 8, 2022

Fifth Circuit Court of Appeals Clarifies and Reinforces Holdings of 2004 In re Mirant Corp. Case

One of the requirements for confirmation of a Chapter 11 reorganization plan by bankruptcy courts is that “any governmental regulatory commission with jurisdiction, after confirmation of the plan, over the rates of the debtor has approved any rate change provided for in the plan, or such rate change is expressly conditioned on such approval.” 11 U.S.C. § 1129(a)(6).

One of the requirements for confirmation of a Chapter 11 reorganization plan by bankruptcy courts is that “any governmental regulatory commission with jurisdiction, after confirmation of the plan, over the rates of the debtor has approved any rate change provided for in the plan, or such rate change is expressly conditioned on such approval.” 11 U.S.C. § 1129(a)(6). Energy companies that transport and sell electricity and natural gas in interstate commerce fall under the jurisdiction of the Federal Energy Regulatory Commission (FERC). These companies are required to file schedules of rates with FERC, and said rates must be just and reasonable. The contracts containing these filed rates are known as “filed rate contracts” and, pursuant to the“filed rate doctrine,” said rates may not be changed without FERC’s approval, even by the bankruptcy courts.

           In the 2004 case of In re Mirant Corp., 378 F.3d 511, the U.S. Court of Appeals for the Fifth Circuit held that a district court (and, by extension, a bankruptcy court) had the power to authorize the rejection of a filed rate contract as an executory contract ⸻ a contract in which performance remains due on both sides ⸻ under 11 U.S.C. § 365,and such authority did not conflict with FERC’s exclusive jurisdiction to regulate wholesale rates for the interstate sale of electricity. The Court reasoned that Congress intended to grant comprehensive jurisdiction to bankruptcy courts to deal with all matters related to the bankruptcy estate. Despite the numerous specific limitations on and exceptions to the courts’ rejection authority in the Bankruptcy Code, there was no exception prohibiting rejection of, or providing other special treatment for, filed rate contracts subject to FERC jurisdiction. The rejection of the filed rate contract was equivalent to a breach of the contract, which did nothing to invalidate or amend the contract in any way. So long as the rejection of the contract was based on other factors beyond the debtor’s desire to pay a lower rate, then the rejection would only have an indirect effect upon the filed rate. Furthermore, rejection of the filed rate contract was not a collateral attack upon the filed rate because any resulting unsecured claim for damages against the bankruptcy estate for breach of the contract would be based on the filed rate, which would be given full effect. While it was certainly possible that the debtor might end up paying less than the full amount of damages due, the amount ultimately paid would depend solely on the terms of the classes under the reorganization plan and not as a direct result of the act of rejection itself.

           Importantly though, the Court in Mirant also ruled that instead of the less stringent “business judgment” standard typically used by courts in consideration of any potential rejection, courts had to utilize a more rigorous standard of heightened scrutiny that both considered the public interest and allowed FERC to participate in the bankruptcy proceedings. The courts would have to examine whether the rejection of the filed rate contract would harm the public interest or disrupt the supply of energy to other public utilities or consumers, and weigh those factors against the contract’s burden on the bankrupt estate.

           Lastly, the Court in Mirant held that FERC could not negate the debtor’s rejection of the filed rate contract by ordering the debtor to continue to perform, and the bankruptcy court was empowered to issue a limited injunction against FERC if it attempted to do so pursuant to 11 U.S.C. § 105(a).

           The Fifth Circuit recently took up the issue of rejection of filed rate contracts again in FERC v. Ultra Res.,Inc. (In re Ultra Petro. Corp.), 28 F.4th 629, which clarified and reinforced the holdings in Mirant in a unanimous opinion of the three-judge panel entered on March 14, 2022. Ultra Resources, Inc. (“Ultra”) is an energy company involved in the production of natural gas that had a filed rate contract with Rockies Express Pipeline LLC (“REX”). The contract included commitments by Ultra to financially assist REX in building a new pipeline; Ultra was required to pay a monthly reservation charge to reserve a fixed amount of space in the pipeline, regardless of how much gas it shipped. In 2016, Ultra failed a credit worthiness check and REX sued for damages in Texas state court,claiming that the contract with Ultra had been terminated due to Ultra’s failure to meet credit worthiness requirements. Ultra filed for Chapter 11 bankruptcy, but subsequently settled with REX, and both parties agreed to a new filed rate contract slated to run from 2019 until 2026 in which Ultra reserved space in the new pipeline and agreed to pay a particular rate over the life of the agreement, whether or not it actually used the pipeline.

           Shortly before the new contract took effect, Ultra once again filed for Chapter 11 bankruptcy. Before the bankruptcy filing, REX had petitioned FERC for a declaration that Ultra could not reject the new filed rate contract without FERC’s approval, but FERC had not yet issued a decision. Ultra filed a motion in the bankruptcy case to reject the new contract. REX objected and requested that the court refrain from ruling on the rejection motion until the conclusion of FERC’s proceedings to consider whether a rejection of the contract would be against the public interest. REX also argued that FERC had exclusive authority to decide whether Ultra should be relieved of its obligations under the new contract.

           The bankruptcy court denied REX’s request, but asked FERC to participate in the case as a party in interest and take a position on the public interest question. FERC filed a motion for reconsideration, contending that it could only speak through orders issued by the Commission after its own proceedings and was prohibited from commenting on the matter via counsel in the bankruptcy case. The bankruptcy court denied FERC’s motion and ultimately authorized Ultra to reject the contract after an evidentiary hearing in which FERC participated.

           In its decision, the bankruptcy court found that based on Mirant, it had the authority to approve of Ultra’s rejection of the contract, even under the heightened public interest level of scrutiny. The bankruptcy court found that rejection would not harm the supply of natural gas and would significantly benefit the debtor’s estate. In addition, rejection of the contract did not modify or abrogate the contract and, therefore, did not amount to a change in the filed rate requiring FERC’s approval under 11 U.S.C. § 1129(a). The bankruptcy court then confirmed Ultra’s reorganization plan over FERC’s objection and FERC appealed.

           The Fifth Circuit panel in Ultra Petro. Corp. had two main questions to consider: 1. did Ultra’s rejection of a filed rate contract in bankruptcy relieve it of its obligation to continue performance absent the approval of FERC?; and 2. under 11 U.S.C. § 1129(a)(6), was the bankruptcy court required to obtain the approval of FERC before confirming Ultra’s reorganization plan?

           FERC argued that the statements in Mirant that FERC could not enforce full performance and payment under a contract post-rejection were dicta. However, the Fifth Circuit panel clarified that those statements in the Mirant decision were not dicta, but instead central to the Court’s analysis and overall decision in Mirant to allow rejection of filed rate contracts by the courts; therefore, they were controlling case law. As such, Ultra was not subject to a separate public-law obligation to continue performance or payment of the filed rate, and FERC did not have the authority to compel Ultra to do either. Moreover, Ultra’s rejection of the contract was valid under Mirant because it was “not just seeking to secure a lower rate, but instead want[ed] out of the contract altogether, given the suspension of its drilling program and its nonuse of the volume reservation,” and the filed rate in the contract was used to set the amount of damages to which REX was entitled as creditor after the rejection.

           The Court also noted that the bankruptcy court considered Ultra’s rejection of the new contract under what it called “Mirant Scrutiny,” the higher standard requiring consideration of the public interest instead of the normal business judgment standard. The Court stated:

We agree with the bankruptcy court that Mirant requires consideration of the public interest before rejection of a filed rate contract can be approved but, to dispel any confusion, we again reiterate that the use of a higher standard is required. A court must determine whether “the equities balance in favor of rejecting” the filed rate contract. Specifically, a court must “ensure that rejection does not cause any disruption in the supply of electricity,” natural gas, or whatever regulated commodity is the subject of the contract under consideration. Because the bankruptcy court did so here, its rejection decision was proper.

           As to the second issue ⸻ whether 11U.S.C. § 1129(a)(6) required the bankruptcy court to seek FERC’s approval before it confirmed Ultra’s reorganization plan ⸻ FERC made two main arguments. First, Mirant required the bankruptcy court to allow FERC to comment on the public-interest consequences of rejection of filed rate contracts, and since FERC could only speak through its official orders after the conclusion of its own proceedings, the only way to satisfy the requirement was for FERC to conduct full proceedings before any rejection. Second, the bankruptcy court erred because the rejection of the REX contract amounted to a rate change, and its inclusion in Ultra’s confirmed reorganization plan violated 11 U.S.C. §1129(a)(6).

           The Court found no requirement in Mirant to allow FERC to conduct proceedings before a court’s decision on rejection of a filed rate contract, emphasizing that Mirant made clear that it was the courts that were charged with examining the effects upon the public interest in rejection of the contract, not FERC. The Fifth Circuit panel clarified that Mirant merely required a bankruptcy court to invite FERC to participate in the bankruptcy case as a party in interest; however, the decision on whether to participate or not was up to FERC. Since the bankruptcy court in this matter did indeed invite FERC to participate as a party in interest, that requirement of Mirant was satisfied. While FERC’s expertise and opinion would be of significant benefit to the courts, the panel declined to expand upon the decision in Mirant to require bankruptcy courts to halt its proceedings and wait for a formal decision by FERC, echoing, “in a Chapter 11 bankruptcy, time is of the essence and delay drains the coffers of all involved (except, of course, for those of the lawyers who would be paid to hurry up and wait).”

           Finally, the Fifth Circuit panel easily dispensed with FERC’s second argument. Mirant held that an impermissible rate change occurred only if the actual filed rate in the contract was changed. REX’s damages due to rejection of the contract by Ultra were calculated using the filed rate. Per the panel, the Mirant decision “made clear that the filed rate itself is separate from full payment of that rate.” Since there was no change to the filed rate, the bankruptcy court did not require FERC’s approval for confirmation of Ultra’s reorganization plan under 11 U.S.C. § 1129(a)(6).

Written by Michael Sturm