The Calpine Case

After withdrawing the reference to the bankruptcy court, Judge Casey rejected Calpine's argument that 11 U.S.C. ' 365 creates jurisdiction for a court to authorize a debtor to cease performance under a power contract. Rather, because the Federal Power Act (the FPA) affords regulatory effect to privately negotiated wholesale power contracts, Judge Casey ruled that only FERC can authorize cessation of performance under the contract outside of the contract's own terms, and this regulatory scheme is not changed by the Bankruptcy Code. Furthermore, the court held that, because FERC has exclusive jurisdiction to review any contest to the rates and terms of a FERC-jurisdictional contract, an effort to reject in bankruptcy a power contract that is premised solely on a uneconomic rate constitutes a collateral attack upon FERC's exclusive domain. Accordingly, Casey dismissed the motion to reject the contracts for want of subject matter jurisdiction and lifted the temporary restraining order against FERC.

Reconciling 11 U.S.C. ' 365 With the FPA

In Calpine, FERC's exclusive jurisdiction over the modification of power contracts ran squarely up against the broad language of ' 365 of the Bankruptcy Code, which, on its face, allows debtors to reject or assume 'any' executory contract upon approval by the court. Calpine pointed to the Supreme Court's expansive interpretation of ' 365 in NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528 (1984), which would allow the rejection of 'all executory contracts except those expressly exempted.' It was not disputed in Calpine that the power contracts fit within the ordinary definition of executory contracts, and that ' 365 does not contain any express exception for such contracts. The issue squarely faced by the Calpine court, then, is how to reconcile the two seemingly conflicting grants of jurisdiction.

Calpine's strenuous efforts to reject the contract in bankruptcy, rather than seeking relief before FERC, are not without strategic purpose. At FERC, parties can only obtain relief from the terms of a power contract if modification is 'in the public interest.' All sides agree that the FERC public interest standard is a difficult one to meet. Calpine argued that rejection of the contract in bankruptcy, however, would entitle Calpine to relief under a less stringent standard than FERC's public interest standard. Therefore, resolution of the jurisdiction issue at the center of the Calpine case is significant not only to define the division of authority between the judicial and executive branches of government, but potentially for Calpine's practical purposes of obtaining relief from the contracts.

FERC's Plenary Jurisdiction over Power Contracts

Perhaps the primary dispute between the parties in the Calpine case revolved around the existence and extent of FERC's exclusive jurisdiction over a party's unilateral cessation of performance under an FERC-jurisdictional contract. According to the Debtors, a party's failure to perform under a power contract results merely in an ordinary breach of the contract, entitling the nonbreaching party to a damages award determined by a court. The Debtors' position was that a party need not obtain permission from FERC before ceasing performance because, according to the Debtors, FERC generally does not hear such requests. To that end, the Debtors cited to a line of cases holding that courts possess subject matter jurisdiction over matters of interpretation of FERC-jurisdictional contracts, including the determination of whether a party is in breach of that contract. Because rejection of a contract in bankruptcy constitutes a breach of the contract pursuant to 11 U.S.C. ' 365(g), the Debtors argued that nothing in the FPA or the Bankruptcy Code prevents the Debtors from breaching the contract via rejection without FERC approval.

The counterparties vigorously contested not only the Debtors' ability to cease performance outside of bankruptcy without FERC authorization, but also disputed their description of the effect and significance of rejection. The FPA grants plenary authority to FERC to ensure that the rates and terms of wholesale power contracts that affect interstate commerce are 'just and reasonable.' Parties entering into any FERC-jurisdictional contract are re-quired to file the contract (or schedules indicating the rates and terms of such contracts) with FERC. When the contract is entered, the rates and terms of the contract are deemed just and reasonable by FERC, subject to any subsequent FERC review. Pursuant to the long-standing 'filed rate doctrine,' the Supreme Court has consistently interpreted the FPA to grant exclusive subject matter jurisdiction to FERC, to the exclusion of courts, concerning requests to modify the rates or terms of contracts that are filed with FERC.

The counterparties thus argued that a regulated entity's obligations arise from more than contract law. Each time FERC accepts the rates and terms of a power contract, the obligations contained therein are transformed from private contractual obligations into public regulatory obligations carrying the force of law unless FERC orders otherwise. As such, each party to the contract is obligated to perform to the terms of the agreement not merely by contract law, but by force of regulation. If performance under an existing agreement becomes so onerous that it threatens the viability of the utility, as Calpine claimed to be the case, the FPA provides the mechanism to redress burdensome regulatory obligations: the party must apply to FERC for modification or abrogation of the rates and terms of the contract.

Application to FERC is not the only means by which a party can limit its obligation to continue performance under a FERC-jurisdictional contract. By virtue of the FPA's unique regulatory framework, the extent and scope of each party's regulatory obligations are defined by the provisions of the contract filed with FERC. Some power contracts authorize unilateral cessation of performance by a party pursuant the terms of the contracts, such as through an ipso facto clause or automatic termination clause. Upon filing such contracts with FERC, the regulatory iteration of that contract would also allow unilateral cessation of performance under the contract's terms because FERC has necessarily determined that such a term was just and reasonable. Therefore, through negotiation prior to filing any power contract, parties have the opportunity to define the scope of their future regulatory responsibilities, including the opportunity to provide for unilateral termination of those responsibilities.

Where a contract does not include any term that permits unilateral cessation of performance, however, any attempt to cease performance by a producer would violate the supply obligations under the contract (and, necessarily, the attendant regulatory obligation). Regardless of any consequences that cessation of performance would have under contract law, each party's regulatory obligations to continue performance remain intact until FERC orders otherwise. Therefore, the counterparties argued, where a supplier does not possess any unilateral right to cease performance of its regulatory obligations, that party must obtain FERC approval to modify such obligations before the supplier can cease performance.

FERC's Role in the Calpine Litigation

Considering that the resolution of Calpine's rejection motion could have profound consequences on the extent and scope of FERC's regulatory jurisdiction both in and outside of bankruptcy, one might expect FERC to play an active role in the ongoing litigation. The ex-parte restraining order obtained by Calpine through a first-day order, however, prevented FERC from actively participating in the early stages of the case. But the restraining order, which, on more than one occasion, was voluntarily extended by FERC, does not appear to be the only reason for FERC's relative silence. In ruling that FERC possessed exclusive jurisdiction relief sought by Calpine, Judge Casey lifted the restraint against FERC. Yet, FERC appears content to let the Calpine appeal resolve itself before taking any action. Accordingly, during the litigation that will decide the extent of FERC's regulatory authority, FERC has largely remained silent.

The only possible indication of FERC's position came in the form of a nonbinding 'Interim Guidance Order,' which was issued soon after Calpine filed its motion to reject the contract (and before Judge Casey withdrew the reference to the bankruptcy court or lifted the restraining order that prevented FERC from challenging the rejection). In its guidance order, FERC indicated that it felt compelled to defer on the jurisdictional issue to the only court of appeals to have ruled on the issue at that time ' the Fifth Circuit in In re Mirant, 378 F.3d 511 (5th Cir. 2004). In following the Mirant decision, FERC stated that it would not challenge the bankruptcy court's jurisdiction to reject the contract and authorize cessation of performance, but rather, pursuant to Mirant, would take comments on rejection's consequences to the public interest so that FERC could represent that interest in the rejection proceedings.

Calpine Court Diverges from Mirant

Despite Calpine's vehement assertion that a wholesale power contract is just like any other executory contract for purposes of rejection under ' 365, the district court ultimately disagreed. Under ' 365(g), the rejection of an executory contract is treated as a pre-petition breach. As Judge Casey recognized, however, a breach arising under ' 365(g) through rejection of a contract is no ordinary breach. Rather, rejection extinguishes the debtor's underlying obligation to perform under the contract and converts any remaining contractual obligations into a prepetition damages claim. In other words, rejection would eliminate Calpine's obligation to perform under the power contracts, which an ordinary breach of that contract could not do.

Thus, ' 365 may provide some authority to excuse a debtor's nonperformance of its contractual obligations. But the Calpine court found that wholesale power contracts represent regulatory obligations, and ' 365 of the Bankruptcy Code provides no authority to eliminate FERC's exclusive control over a debtor's regulatory responsibilities. Absent overriding authority to the contrary, Judge Casey found that the Bankruptcy Code should not be interpreted to usurp express delegations of exclusive jurisdiction to administrative agencies. Rather, the provisions in the Bankruptcy Code contemplate ongoing regulatory activity during the bankruptcy process. Provisions such as the exception from the automatic stay for regulatory authorities under ' 362(b)(4) evince a general Congressional intent to allow administrative agencies to retain jurisdiction over their exclusive domain unless the Bankruptcy Code expressly provides otherwise. There-fore, despite the broad language in
' 365 allowing a debtor to reject any executory contract, the court found that this general language did not constitute sufficient evidence that Congress intended to eliminate the FPA's delegation to FERC of exclusive jurisdiction to modify regulatory obligations of parties to wholesale power contracts.

At the time of Judge Casey's decision, the only court of appeals to squarely address the issue of reconciling ' 365 with the FPA was the Fifth Circuit in Mirant. In that case, the Fifth Circuit reached a different conclusion than Judge Casey. The Fifth Circuit found that courts generally do possess subject matter jurisdiction to reject wholesale power contracts, but not where that rejection constitutes a collateral attack on the filed rate of the contract. In Mirant, the debtor was a purchaser under unprofitable long-term fixed rate contracts for power that exceeded the needs of the debtor. Because the debtor ultimately did not require the power it was purchasing under the uneconomic FERC-jurisdictional contracts, the Fifth Circuit reasoned that the rejection of the contracts was premised not on a rate dispute but on a business decision to eliminate unnecessary power.

Judge Casey agreed with the Mirant decision to the extent Mirant held that the filed rate doctrine prohibits rejection of a power contract solely on the basis of rates. Because the debtor in Calpine sought to reject the contracts exclusively based on uneconomic rate terms, the district court in Calpine interpreted Mirant to require the debtor to obtain relief from FERC in such circumstances because rejection represents a collateral attack on the filed rate. Still, the Calpine decision went beyond Mirant because Judge Casey found that the court lacked jurisdiction to authorize cessation of performance under a power contract for any reason. Reading the Bankruptcy Code together with the FPA, Judge Casey recognized that retaining FERC's exclusive jurisdiction over regulatory matters best reconciled the respective authority granted under the two statutes.

The Aftermath

The Calpine decision does not necessarily prevent rejection of all contracts that arise in any regulated field. Rather, regulation under the FPA is unique because private contracts are transformed into regulatory mandates. Therefore, the holding in Calpine only comes into play in situations where an administrative agency has exclusive jurisdiction over the rates and terms of the contract at issue. Still, the Calpine decision will impact both the Calpine bankruptcy and future reorganizations. If the Second Circuit upholds Casey's decision in Calpine, a split among the circuits would allow debtors in the Fifth Circuit to reject wholesale power contracts under certain circumstances, whereas debtors in the Second Circuit could not. Moreover, if FERC continues to simply defer to federal courts of appeals regarding the extent of its own jurisdiction rather than asserting its own position, FERC is put in the awkward position where the scope of its administrative jurisdiction differs based on geography. Until the split is resolved, potential forum shopping issues loom for energy companies seeking relief under the Bankruptcy Code.

Dion W. Hayes (dhayes@mcguire woods.com), a member of this newsletter's Board of Editors, is a partner, and Joseph S. Sheerin (http://www-lawjournalnewsletters.iproduction.com/Admin/cgi-bin/udt/jsheerin@mcguire%20woods.com) and Aaron G. McCollough ([email protected]) are associates in the Bankruptcy and Restructuring Group at the Richmond, VA, office of McGuireWoods LLP. The views expressed in this article are those of the authors and do not necessarily represent the views of McGuireWoods LLP or its clients.

When is an executory contract not just an executory contract? When it's also a regulation, of course. So ruled Judge Richard Casey of the District Court for the Southern District of New York in In re Calpine, 337 B.R. 27 (S.D.N.Y. Jan. 27, 2006), dismissing Calpine's request for authority to reject under 11 U.S.C.
' 365 certain regulated wholesale power supply contracts that fall within the exclusive jurisdiction of a federal administrative agency. Casey's decision and the subsequent appeal to the Second Circuit Court of Appeals, where the case is currently pending, culminate a 3-month legal sprint through the executive and judicial branches of government in a case that pits the authority of the judiciary against the jurisdiction of the Federal Energy Regulatory Commission (FERC) ' the administrative agency tasked with regulating the wholesale sale and transmission of electric power.

The Case

On Dec. 20, 2005, Calpine Corporation, a large power producer based in California that produces 3.5% of the power in the United States, filed for Chapter 11 relief in the Southern District of New York. The next day, Calpine sought bankruptcy court authority to reject eight fixed-rate wholesale power supply contracts on the sole basis that the contracts included uneconomic rate terms. That same day, Calpine obtained an ex-parte temporary restraining order against FERC that prevented FERC from taking any action to interfere with Calpine's rejection motion. According to Calpine, the company faced losses of over $1 billion under the eight power contracts during the life of those contracts, which losses allegedly threatened Calpine's ability to successfully reorganize. A significant drop in natural gas prices after the petition date has now cast Calpine's estimate into serious doubt.

After withdrawing the reference to the bankruptcy court, Judge Casey rejected Calpine's argument that 11 U.S.C. ' 365 creates jurisdiction for a court to authorize a debtor to cease performance under a power contract. Rather, because the Federal Power Act (the FPA) affords regulatory effect to privately negotiated wholesale power contracts, Judge Casey ruled that only FERC can authorize cessation of performance under the contract outside of the contract's own terms, and this regulatory scheme is not changed by the Bankruptcy Code. Furthermore, the court held that, because FERC has exclusive jurisdiction to review any contest to the rates and terms of a FERC-jurisdictional contract, an effort to reject in bankruptcy a power contract that is premised solely on a uneconomic rate constitutes a collateral attack upon FERC's exclusive domain. Accordingly, Casey dismissed the motion to reject the contracts for want of subject matter jurisdiction and lifted the temporary restraining order against FERC.

Reconciling 11 U.S.C. ' 365 With the FPA

In Calpine, FERC's exclusive jurisdiction over the modification of power contracts ran squarely up against the broad language of ' 365 of the Bankruptcy Code, which, on its face, allows debtors to reject or assume 'any' executory contract upon approval by the court. Calpine pointed to the Supreme Court's expansive interpretation of ' 365 in NLRB v. Bildisco & Bildisco , 465 U.S. 513, 528 (1984), which would allow the rejection of 'all executory contracts except those expressly exempted.' It was not disputed in Calpine that the power contracts fit within the ordinary definition of executory contracts, and that ' 365 does not contain any express exception for such contracts. The issue squarely faced by the Calpine court, then, is how to reconcile the two seemingly conflicting grants of jurisdiction.

Calpine's strenuous efforts to reject the contract in bankruptcy, rather than seeking relief before FERC, are not without strategic purpose. At FERC, parties can only obtain relief from the terms of a power contract if modification is 'in the public interest.' All sides agree that the FERC public interest standard is a difficult one to meet. Calpine argued that rejection of the contract in bankruptcy, however, would entitle Calpine to relief under a less stringent standard than FERC's public interest standard. Therefore, resolution of the jurisdiction issue at the center of the Calpine case is significant not only to define the division of authority between the judicial and executive branches of government, but potentially for Calpine's practical purposes of obtaining relief from the contracts.

FERC's Plenary Jurisdiction over Power Contracts

Perhaps the primary dispute between the parties in the Calpine case revolved around the existence and extent of FERC's exclusive jurisdiction over a party's unilateral cessation of performance under an FERC-jurisdictional contract. According to the Debtors, a party's failure to perform under a power contract results merely in an ordinary breach of the contract, entitling the nonbreaching party to a damages award determined by a court. The Debtors' position was that a party need not obtain permission from FERC before ceasing performance because, according to the Debtors, FERC generally does not hear such requests. To that end, the Debtors cited to a line of cases holding that courts possess subject matter jurisdiction over matters of interpretation of FERC-jurisdictional contracts, including the determination of whether a party is in breach of that contract. Because rejection of a contract in bankruptcy constitutes a breach of the contract pursuant to 11 U.S.C. ' 365(g), the Debtors argued that nothing in the FPA or the Bankruptcy Code prevents the Debtors from breaching the contract via rejection without FERC approval.

The counterparties vigorously contested not only the Debtors' ability to cease performance outside of bankruptcy without FERC authorization, but also disputed their description of the effect and significance of rejection. The FPA grants plenary authority to FERC to ensure that the rates and terms of wholesale power contracts that affect interstate commerce are 'just and reasonable.' Parties entering into any FERC-jurisdictional contract are re-quired to file the contract (or schedules indicating the rates and terms of such contracts) with FERC. When the contract is entered, the rates and terms of the contract are deemed just and reasonable by FERC, subject to any subsequent FERC review. Pursuant to the long-standing 'filed rate doctrine,' the Supreme Court has consistently interpreted the FPA to grant exclusive subject matter jurisdiction to FERC, to the exclusion of courts, concerning requests to modify the rates or terms of contracts that are filed with FERC.

The counterparties thus argued that a regulated entity's obligations arise from more than contract law. Each time FERC accepts the rates and terms of a power contract, the obligations contained therein are transformed from private contractual obligations into public regulatory obligations carrying the force of law unless FERC orders otherwise. As such, each party to the contract is obligated to perform to the terms of the agreement not merely by contract law, but by force of regulation. If performance under an existing agreement becomes so onerous that it threatens the viability of the utility, as Calpine claimed to be the case, the FPA provides the mechanism to redress burdensome regulatory obligations: the party must apply to FERC for modification or abrogation of the rates and terms of the contract.

Application to FERC is not the only means by which a party can limit its obligation to continue performance under a FERC-jurisdictional contract. By virtue of the FPA's unique regulatory framework, the extent and scope of each party's regulatory obligations are defined by the provisions of the contract filed with FERC. Some power contracts authorize unilateral cessation of performance by a party pursuant the terms of the contracts, such as through an ipso facto clause or automatic termination clause. Upon filing such contracts with FERC, the regulatory iteration of that contract would also allow unilateral cessation of performance under the contract's terms because FERC has necessarily determined that such a term was just and reasonable. Therefore, through negotiation prior to filing any power contract, parties have the opportunity to define the scope of their future regulatory responsibilities, including the opportunity to provide for unilateral termination of those responsibilities.

Where a contract does not include any term that permits unilateral cessation of performance, however, any attempt to cease performance by a producer would violate the supply obligations under the contract (and, necessarily, the attendant regulatory obligation). Regardless of any consequences that cessation of performance would have under contract law, each party's regulatory obligations to continue performance remain intact until FERC orders otherwise. Therefore, the counterparties argued, where a supplier does not possess any unilateral right to cease performance of its regulatory obligations, that party must obtain FERC approval to modify such obligations before the supplier can cease performance.

FERC's Role in the Calpine Litigation

Considering that the resolution of Calpine's rejection motion could have profound consequences on the extent and scope of FERC's regulatory jurisdiction both in and outside of bankruptcy, one might expect FERC to play an active role in the ongoing litigation. The ex-parte restraining order obtained by Calpine through a first-day order, however, prevented FERC from actively participating in the early stages of the case. But the restraining order, which, on more than one occasion, was voluntarily extended by FERC, does not appear to be the only reason for FERC's relative silence. In ruling that FERC possessed exclusive jurisdiction relief sought by Calpine, Judge Casey lifted the restraint against FERC. Yet, FERC appears content to let the Calpine appeal resolve itself before taking any action. Accordingly, during the litigation that will decide the extent of FERC's regulatory authority, FERC has largely remained silent.

The only possible indication of FERC's position came in the form of a nonbinding 'Interim Guidance Order,' which was issued soon after Calpine filed its motion to reject the contract (and before Judge Casey withdrew the reference to the bankruptcy court or lifted the restraining order that prevented FERC from challenging the rejection). In its guidance order, FERC indicated that it felt compelled to defer on the jurisdictional issue to the only court of appeals to have ruled on the issue at that time ' the Fifth Circuit in In re Mirant, 378 F.3d 511 (5th Cir. 2004). In following the Mirant decision, FERC stated that it would not challenge the bankruptcy court's jurisdiction to reject the contract and authorize cessation of performance, but rather, pursuant to Mirant, would take comments on rejection's consequences to the public interest so that FERC could represent that interest in the rejection proceedings.

Calpine Court Diverges from Mirant

Despite Calpine's vehement assertion that a wholesale power contract is just like any other executory contract for purposes of rejection under ' 365, the district court ultimately disagreed. Under ' 365(g), the rejection of an executory contract is treated as a pre-petition breach. As Judge Casey recognized, however, a breach arising under ' 365(g) through rejection of a contract is no ordinary breach. Rather, rejection extinguishes the debtor's underlying obligation to perform under the contract and converts any remaining contractual obligations into a prepetition damages claim. In other words, rejection would eliminate Calpine's obligation to perform under the power contracts, which an ordinary breach of that contract could not do.

Thus, ' 365 may provide some authority to excuse a debtor's nonperformance of its contractual obligations. But the Calpine court found that wholesale power contracts represent regulatory obligations, and ' 365 of the Bankruptcy Code provides no authority to eliminate FERC's exclusive control over a debtor's regulatory responsibilities. Absent overriding authority to the contrary, Judge Casey found that the Bankruptcy Code should not be interpreted to usurp express delegations of exclusive jurisdiction to administrative agencies. Rather, the provisions in the Bankruptcy Code contemplate ongoing regulatory activity during the bankruptcy process. Provisions such as the exception from the automatic stay for regulatory authorities under ' 362(b)(4) evince a general Congressional intent to allow administrative agencies to retain jurisdiction over their exclusive domain unless the Bankruptcy Code expressly provides otherwise. There-fore, despite the broad language in
' 365 allowing a debtor to reject any executory contract, the court found that this general language did not constitute sufficient evidence that Congress intended to eliminate the FPA's delegation to FERC of exclusive jurisdiction to modify regulatory obligations of parties to wholesale power contracts.

At the time of Judge Casey's decision, the only court of appeals to squarely address the issue of reconciling ' 365 with the FPA was the Fifth Circuit in Mirant. In that case, the Fifth Circuit reached a different conclusion than Judge Casey. The Fifth Circuit found that courts generally do possess subject matter jurisdiction to reject wholesale power contracts, but not where that rejection constitutes a collateral attack on the filed rate of the contract. In Mirant, the debtor was a purchaser under unprofitable long-term fixed rate contracts for power that exceeded the needs of the debtor. Because the debtor ultimately did not require the power it was purchasing under the uneconomic FERC-jurisdictional contracts, the Fifth Circuit reasoned that the rejection of the contracts was premised not on a rate dispute but on a business decision to eliminate unnecessary power.

Judge Casey agreed with the Mirant decision to the extent Mirant held that the filed rate doctrine prohibits rejection of a power contract solely on the basis of rates. Because the debtor in Calpine sought to reject the contracts exclusively based on uneconomic rate terms, the district court in Calpine interpreted Mirant to require the debtor to obtain relief from FERC in such circumstances because rejection represents a collateral attack on the filed rate. Still, the Calpine decision went beyond Mirant because Judge Casey found that the court lacked jurisdiction to authorize cessation of performance under a power contract for any reason. Reading the Bankruptcy Code together with the FPA, Judge Casey recognized that retaining FERC's exclusive jurisdiction over regulatory matters best reconciled the respective authority granted under the two statutes.

The Aftermath

The Calpine decision does not necessarily prevent rejection of all contracts that arise in any regulated field. Rather, regulation under the FPA is unique because private contracts are transformed into regulatory mandates. Therefore, the holding in Calpine only comes into play in situations where an administrative agency has exclusive jurisdiction over the rates and terms of the contract at issue. Still, the Calpine decision will impact both the Calpine bankruptcy and future reorganizations. If the Second Circuit upholds Casey's decision in Calpine, a split among the circuits would allow debtors in the Fifth Circuit to reject wholesale power contracts under certain circumstances, whereas debtors in the Second Circuit could not. Moreover, if FERC continues to simply defer to federal courts of appeals regarding the extent of its own jurisdiction rather than asserting its own position, FERC is put in the awkward position where the scope of its administrative jurisdiction differs based on geography. Until the split is resolved, potential forum shopping issues loom for energy companies seeking relief under the Bankruptcy Code.

Dion W. Hayes (dhayes@mcguire woods.com), a member of this newsletter's Board of Editors, is a partner, and Joseph S. Sheerin (http://www-lawjournalnewsletters.iproduction.com/Admin/cgi-bin/udt/jsheerin@mcguire%20woods.com) and Aaron G. McCollough ([email protected]) are associates in the Bankruptcy and Restructuring Group at the Richmond, VA, office of McGuireWoods LLP. The views expressed in this article are those of the authors and do not necessarily represent the views of McGuireWoods LLP or its clients.