Rejecting Executory Power Contracts in Bankruptcy Cases: Jurisdictional
Authority, But Has the Standard Changed?
By Bryan L. Elwood, Greenberg
Traurig, Dallas Office
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On August 4, 2004, a three-judge panel of the Fifth Circuit Court of
Appeals issued an opinion1
in the Mirant Corporation bankruptcy case reversing a federal district court
(the “District Court”) decision holding that it was powerless to approve
Mirant’s proposed rejection of a wholesale contract for the interstate sale
of electricity. The Fifth Circuit ruled that the District Court could authorize
Mirant’s rejection of the executory power contract regardless of the Federal
Energy Regulatory Commission’s (“FERC”) otherwise exclusive jurisdiction
over the rates charged in the contract.2
|"Overruling a district court
decision, the Fifth Circuit opinion issued in Mirant holds that
a Chapter 11 debtor can reject an executory power contract even
if the rates charged in the contract are subject to FERC approval."
The Fifth Circuit remanded the case to the District Court to rule on
the merits of Mirant’s rejection motion. However, in doing so, the District
Court was instructed to seriously consider applying a more stringent standard
than the traditional business judgment test typically used to evaluate a
debtor’s rejection of an executory contract or unexpired lease. Thus, while
the Fifth Circuit made it clear that an executory power contract can be
rejected in a bankruptcy proceeding, one must wonder whether the Fifth Circuit
Court of Appeals has changed the standard for rejecting power contracts?
Mirant Corporation and a number of its affiliates (collectively, “Mirant”)
filed Chapter 11 bankruptcy petitions in July 2003, with the United States
Bankruptcy Court for the Northern District of Texas. One of the largest
public utilities in America, Mirant, in addition to generating electricity,
buys and sells power for use across the United States.
In June 2000, Mirant entered into an asset purchase agreement (the “APA”)
with Potomac Electric Power Company (“PEPCO”) to purchase most of PEPCO’s
electric generation plants and to take assignment of PEPCO’s power purchase
contracts. However, two of these power contracts were not assigned to Mirant
due to the inability to obtain supplier consent. Instead, PEPCO and Mirant
agreed, pursuant to a schedule attached to the APA (the “Back-to-Back Agreement”),
that PEPCO would comply with its obligations under these unassigned contracts
and that Mirant would then purchase, at the rates charged therein, an amount
of electricity from PEPCO equivalent to PEPCO’s obligations under these
contracts. Upon submission, FERC then approved the rates charged in the
Back-to-Back Agreement. These rates are higher than the current market rate
After filing bankruptcy, and due to its continuing losses under the Back-to-Back
Agreement, Mirant filed a motion to reject the Back-to-Back Agreement, but
not the APA itself, as an executory contract. Following a hearing, the bankruptcy
court held that it had the power to authorize the rejection of the Back-to-Back
However, before a final ruling could be made on the merits of whether
Mirant had grounds to actually reject the Back-to-Back Agreement, the District
Court withdrew the case from the bankruptcy court and held a new hearing
on the matter. The District Court then held that FERC has “exclusive” authority
to determine whether wholesale rates charged for electricity sold in interstate
commerce are reasonable and that any challenge to approved rates must be
pursued in a FERC proceeding. As a result, the District Court found that
Mirant could not reject the Back-to-Back Agreement because doing so was
an improper attempt to avoid its contractual obligations at the rates FERC
had previously approved. Finding no exceptions under the Bankruptcy Code,
the District Court stated that Mirant was required to first seek relief
from the rates charged in the Back-to-Back Agreement in a FERC proceeding.
Mirant thereafter appealed this decision to the Fifth Circuit.
The Federal Power Act gives FERC the exclusive responsibility of approving
rates charged in wholesale contracts for the interstate sale of electricity
as being “just and reasonable.” In acknowledging this fact, the Fifth Circuit
noted that the United States Supreme Court previously determined that FERC
“has the ‘exclusive authority to determine the reasonableness of wholesale
[electricity] rates’ under the Federal Power Act.” Mississippi Power
& Light Co. v. Mississippi, 487 U.S. 354, 371 (1988).
|"Unfortunately, the Fifth Circuit
was not entirely clear whether a debtor’s intentions in seeking
to reject a power contract must be for reasons other than due to
the rates charged."
In bringing its motion to reject the Back-to-Back Agreement, Mirant claimed
that it had the right to reject, subject to the bankruptcy court’s approval,
“any” of its executory contracts. FERC countered that its authority under
the Federal Power Act over wholesale rates preempted the District Court’s
jurisdiction to approve the rejection of the Back-to-Back Agreement. Agreeing
with Mirant, the Fifth Circuit concluded that the District Court’s power
to approve the rejection of the Back-to-Back Agreement did not conflict
with FERC’s authority to regulate rates for the interstate sale of wholesale
Specifically, the Fifth Circuit panel determined that because Mirant’s
proposed rejection of the Back-to-Back Agreement would be considered a breach
of contract, the question then became whether the Federal Power Act granted
FERC exclusive authority over breaches of FERC-approved contracts. The Fifth
Circuit held that the Federal Power Act does not give FERC exclusive jurisdiction
over breach of contract claims where the alleged breaches are unrelated
to an approved rate. As a result, the Fifth Circuit found that the rejection
of the Back-to-Back Agreement would only have an “indirect” impact on the
rates charged therein as the amount of damages PEPCO would have as an unsecured
claim for Mirant’s breach would be calculated using the FERC-approved contractual
rate. In this regard, the Fifth Circuit specifically stated:
The [Federal Power Act] does not preempt a district court’s jurisdiction
to authorize the rejection of an executory contract subject to FERC regulation
as part of a bankruptcy proceeding. A motion to reject an executory power
contract is not a collateral attack upon that contract’s filed rate because
that rate is given full effect when determining the breach of contract
damages resulting from the rejection. Further, there is nothing within
the Bankruptcy Code itself that limits a public utility’s ability to choose
to reject an executory contract subject to FERC regulation as part of
its reorganization process.
Unfortunately, the Fifth Circuit was not entirely clear whether a debtor’s
intentions in seeking to reject a power contract must be for reasons other
than due to the rates charged. Specifically, FERC asserted, and the District
Court held, that Mirant’s reason for seeking to reject the Back-to-Back
Agreement was because the rate was higher than the current market rate.
However, Mirant countered by stating that it did not need the electricity
provided under the Back-to-Back Agreement to meet its supply requirements.
In addressing this issue, the Fifth Circuit stated:
A debtor’s use of the filed rate as a criteria to select for rejection
under § 365(a) those contracts which impose the greatest burden upon the
bankruptcy estate does not convert that rejection decision into a prohibited
collateral attack on the filed rate when the electricity purchased under
the rejected contract is not necessary to fulfill a debtor’s supply obligations.
As such, it is unclear from the Fifth Circuit’s comments whether the
District Court has jurisdiction to authorize the rejection of the Back-to-Back
Agreement if Mirant’s sole reason for wanting to reject was due only to
the above-market rates being charged.
Finally, in remanding the case to the District Court for determination
of whether grounds actually exist for rejecting the Back-to-Back Agreement,
the Fifth Circuit noted that the bankruptcy court had previously indicated
that it might choose to apply a more “rigorous” standard in evaluating Mirant’s
rejection motion than the business judgment standard typically used. Agreeing,
the Fifth Circuit noted that because FERC can only approve a rate change
if it is in the public’s interest, the District Court, on remand, “should”
therefore consider applying more stringent standards to Mirant’s motion
to reject than the typical business judgment test. Specifically, the Fifth
Clearly the business judgment standard normally applicable to rejection
motions is more deferential than the public interest standard applicable
in FERC proceedings to alter the terms of a contract within its jurisdiction.
Use of the business judgment standard would be inappropriate in this case
because it would not account for public interest inherent in the transmission
and sale of electricity.
Accordingly, the Fifth Circuit suggested that the District Court adopt
a standard whereby Mirant bore the burden of showing that the Back-to-Back
Agreement “burdens the estate,” that the “equities” are in favor of rejecting
the contract, and that rejection would further Mirant’s reorganization.
In doing so, the Fifth Circuit instructed the District Court to “carefully
scrutinize the impact upon the public interest” and to “ensure that rejection
does not cause any disruption in the supply of electricity to other public
utilities or to consumers.”
While couched as “suggestions,” the Fifth Circuit appears to have made
clear its expectation that the District Court apply more stringent standards
to the rejection of executory power contracts such as the Back-to-Back Agreement.
Although the Fifth Circuit panel did not specifically state what these higher
standards are to entail, “public interest” is to be factored into whether
a debtor is authorized to reject an executory power contract.
Overruling a district court decision, the Fifth Circuit opinion issued
in Mirant holds that a Chapter 11 debtor can reject an executory power contract
even if the rates charged in the contract are subject to FERC approval.
As a result of this opinion, debtors in the Fifth Circuit are not required
to initiate a FERC proceeding to attempt to rid itself of a burdensome power
contract. Instead, these debtors can seek relief before the bankruptcy court
administering their bankruptcy cases, which, in turn, gives them a powerful
tool to assist in their reorganization efforts.
However, in holding that executory power contracts containing rates subject
to FERC approval can be rejected in bankruptcy proceedings, the Fifth Circuit
indicated that a more rigorous standard should be applied than the traditional
business judgment test used in evaluating whether rejection is appropriate.
Instead, the Court stated, without being specific, that the “public interest”
should be considered when a debtor seeks to reject an executory contract
that includes rates approved by FERC.
1 See 378 F.3d 511 (5th Cir. 2004).
As of September 24, 2004, the Fifth Circuit had not issued a final mandate
reversing and remanding the District Court opinion.
2 While this Fifth Circuit opinion appears to
be the first Circuit Court of Appeal's decision directly addressing this
issue, a similar situation arose recently in the NRG Energy, Inc. bankruptcy
case. In that case, and although the United States Bankruptcy Court for
the Southern District of New York determined that the business judgment
standard had been satisfied, it refused to vacate an existing FERC order
requiring NRG to continue providing energy under the contract. In re
NRG Energy, Inc., 2003 WL 21507685, *2 (S.D.N.Y. 2003). NRG then filed
a motion with the United States District Court for the Southern District
of New York requesting authority to cease performance under the contract
and for injunctive relief. That court, much like the District Court in this
case, held that it did not have subject matter jurisdiction to make a decision
on these issues. See id., at 4. This issue was subsequently settled
prior to a ruling by the Second Circuit.
© 2004 Greenberg Traurig
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