The bankruptcy code and the Federal Power Act bumped heads in the Fifth Circuit Court of Appeals, and the bankruptcy code won in the Mirant/Pepco decision announced Wednesday. The courts will do the deciding as to whether bankrupt Mirant Corp. should be allowed to breach two power purchase agreements worth hundreds of millions of dollars with the Potomac Electric Power Co. (Pepco), according to an Appeals Court three-judge panel which reversed and remanded the case to a lower court that had earlier deferred to FERC jurisdiction.

The U.S. District Court for the Northern District of Texas had ruled late last year that since the Federal Power Act (FPA) gives the Federal Energy Regulatory Commission the exclusive authority over wholesale electric rates, any attempt to change the Mirant/Pepco contracts was subject to FERC approval. The lower court ruled against Mirant and its creditors who had claimed the company’s move to terminate the power purchase agreements (PPA) was viable under the bankruptcy code and any disputes with the breach of contract action came under the jurisdiction of the courts (see Power Market Today, Dec. 30, 2003).

Under the bankruptcy code, the courts must simply decide whether a decision to abrogate a contract is a good business move in the reorganization of a company. leading to its emergence from bankruptcy. FERC is bound to also consider the public interest.

Standard & Poor’s Ratings Services said the Fifth Circuit decision would not immediately impact the ratings of parent Pepco Holdings or its subsidiaries, although it expects the dispute to be protracted. S&P “conservatively” estimates Pepco would be required to make $160 million in cash payments in the near term if it ultimately loses the case.

Mirant, as part of its Chapter 11 filing in July 2003, sought to reject the PPA’s which required it to purchase power from Pepco at above market prices through 2021. The bankruptcy court argued with Mirant that the courts had jurisdiction. Pepco and FERC said that to allow the contracts to be rejected would infringe on FERC’s jurisdiction and the filed rate doctrine.

The Fifth Circuit said, however, that the FPA does not preempt Mirant’s rejection of the PPAs because it would only have an indirect effect upon the filed rate. Abrogation of the contracts did not constitute an attempt to change the rate of the contracts. If rejection of the contracts is approved by the court, Pepco would receive an unsecured claim against the bankruptcy estate for an amount equal to its damages from the breach. Pepco’s claim would be based on the amount of electricity it would have otherwise sold to Mirant under that agreement at the filed rate. Therefore, the award calculation would be based on the filed rate, even if the actual award was less because of competing creditor claims.

Part of Mirant’s argument in breaching the contract was that it does not need the electricity purchased under the agreement. “In that situation Mirant may choose to reject this agreement as unnecessary to its reorganized business because it represents excess capacity in its system to supply electricity,” the Fifth Circuit said. The court noted that the bankruptcy estate is allowed to select, within certain limits, which contracts to reject and which to continue, based on the greatest benefit to the bankruptcy estate. If it should reject a contract based on a filed rate because it places a greater burden on the estate, that would not be considered a collateral attack on the filed rate doctrine, the court said.

While remanding the case for a court decision based on the bankruptcy code, the appeals court also acknowledged that a contract for wholesale electricity was “unique,” and the public interest was involved. It charged the lower court should 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 electricity to other public utilities or to consumers. The bankruptcy court has already indicated that it would include FERC as a party in interest for all purposes in this case… We presume that the district court would also welcome FERC’s participation, if this case is not referred back to the bankruptcy court. Therefore FERC will be able to assist the court in balancing these equities.”

It will be up to the Texas court to decide whether to hear the case itself or send it back to the bankruptcy court.

Pepco Holdings issued a press release Thursday saying that “whether or not Mirant will be successful in its attempts to reject its obligations to Pepco is yet to be determined. We expect that it will take some time as Mirant, FERC, Pepco and other parties to the case pursue various legal options, including possible efforts to seek review by the Supreme Court.”

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