The U.S. Supreme Court last Wednesday delivered more certainty to parties contracting in wholesale energy markets when it ruled in an 8-1 decision that the venerable Mobile-Sierra doctrine does in fact apply to noncontracting third parties as well as contracting entities. The ruling means third-party challengers to contracts would have to meet the higher “public interest” standard of Mobile-Sierra rather than a merely “just and reasonable” hurdle.

The court’s decision in NRG Power Marketing LLC, et al. v. Maine Public Utilities Commission, et al. reversed an earlier ruling by the U.S. Court of Appeals for the DC Circuit in Maine Public Utilities vs. Federal Energy Regulatory Commission.

“The decision removes uncertainty for investors and customers in the wholesale power contract market that had arisen as a result of the lower court decision reversed in today’s Supreme Court opinion,” said Charles A. Zielinski, a former chairman of the New York Public Service Commission and a lawyer with Bryan Cave LLP in Washington, DC.

The issue before the high court was whether the Mobile-Sierra doctrine — which bars the Federal Energy Regulatory Commission from modifying or abrogating electricity and natural gas contracts unless they are shown to be contrary to the public interest — applies when a contract is challenged by a noncontracting third party. Under Mobile-Sierra, a precedent-setting court decision issued more than 50 years ago, FERC may set aside a contract only for the most compelling reasons.

NRG Power Marketing and the states of Connecticut and Massachusetts had sought reversal of the April 2008 decision by the U.S. Court of Appeals that would allow noncontracting third parties to challenge rates under the more lenient just and reasonable standard rather than the stricter Mobile-Sierra public interest standard (see NGI, Nov. 9, 2009; Oct. 26, 2009).

“We reverse the DC Circuit’s judgment to the extent that it rejects the application of Mobile-Sierra to noncontracting parties,” wrote Justice Ruth Bader Ginsburg in the majority opinion. “Our decision in Morgan Stanley [Capital Group Inc. v. Public Util. District No. 1 of Snohomish County.], announced three months after the DC Circuit’s disposition, made clear that the Mobile-Sierra public interest standard is not an exception to the statutory just-and-reasonable standard; it is an application of that standard in the context of rates set by contract.”

Justice John Paul Stevens wrote the dissenting opinion.

“In this third chapter of the Mobile-Sierra story, the court applies a rule — one designed initially to protect the enforceability of freely negotiated contracts against parties who seek a release from their obligations — to impose a special burden on third parties exercising their statutory right to object to unjust and unreasonable rates,” Stevens wrote. “This application of the rule represents a quantum leap from the modest origin set forth in the first chapter of this tale. As the Court of Appeals correctly concluded in the opinion that the [Supreme] Court sets aside today: ‘This case is clearly outside the scope of the Mobile-Sierra doctrine.'”

The case is related to reliability of New England’s power grid. In 2006 FERC approved a settlement agreement that addressed reliability issues by establishing a forward capacity market with annual auctions to set capacity prices. To cover a transition period, the agreement prescribed a series of fixed payments to generators supplying capacity.

Under the agreement’s Mobile-Sierra provision, challenges to transition-period payments and auction-clearing prices would be adjudicated under the Mobile-Sierra public interest standard.

Several objectors to the agreement sought review by the DC Circuit, which largely rejected their efforts to overturn FERC’s approval of the settlement. However, the DC Circuit held that Mobile-Sierra applies only to contracting parties. Parties in favor of the settlement — including its Mobile-Sierra provision — petitioned the Supreme Court.

“Morgan Stanley did not reach the question presented here: Does Mobile-Sierra’s public interest standard apply to challenges to contract rates brought by noncontracting parties?” Ginsburg wrote. “But Morgan Stanley‘s reasoning strongly suggests that the DC Circuit’s negative answer misperceives the aim, and diminishes the force, of the Mobile-Sierra doctrine.”

Mobile-Sierra‘s public interest standard “defines ‘what it means for a rate to satisfy the just-and-reasonable standard in the contract context,'” Ginsburg wrote, quoting from Morgan Stanley.

“Moreover, the Mobile-Sierra doctrine does not overlook third-party interests; it is framed with a view to their protection. The doctrine directs the Commission to reject a contract rate that ‘seriously harms the consuming public.'”

In his dissenting opinion Stevens wrote, “The court assures respondents that the ‘public interest standard’ does not ‘overlook third-party interests’ and is ‘framed with a view to their protection.’ Perhaps in practice the Mobile-Sierra doctrine will protect third parties’ interests, and the public interest, just as well as the so-called ‘ordinary’ just-and-reasonable standard. But respondents are rightly skeptical. The Mobile-Sierra doctrine, as interpreted by the court in Morgan Stanley, must pose a higher bar to respondents’ rate challenge — that is, it requires them to show greater harm to the public. Otherwise, it would hardly serve to protect contract stability better than the plain vanilla just-and-reasonable standard and the court’s decision in Morgan Stanley would have little effect.”

The petitioners to the high court argued that the auction rates and transition payments “are prescriptions of general applicability rather than ‘contractually negotiated rates,’ hence Mobile-Sierra is inapplicable…FERC agrees that the rates covered by the settlement ‘are not themselves contract rates to which the Commission was required to apply Mobile-Sierra,'” Ginsburg wrote.

“Whether the rates at issue qualify as ‘contract rates,’ and, if not, whether FERC had discretion to treat them analogously are questions raised before, but not ruled upon by, the Court of Appeals. They remain open for that court’s consideration on remand.”

Zielinski noted how the question of whether the rates in the specific case were contract rates or rates prescribed by FERC was left unresolved by the court’s decision. “Ironically, if it were ultimately determined that the rates at issue in the case were prescribed tariff rates instead of negotiated contract rates, the less difficult ‘just and reasonable’ standard could apply to challenges to those rates by noncontracting third parties,” he said.

The lawyer told NGI the case is one “in which FERC won and lost.” While the court affirmed the settlement agreement, FERC had sought a decision “that would leave them a lot of discretion in this area…” Zielinski said. That’s not what happened, though.

“I think [the justices] would have had to probably go along the lines of Justice Stevens to get to where FERC would want to be, or apparently wanted to be based on its argument,” Zielinski said. “FERC would have discretion, say, ‘if these rates are too high, we don’t have to presume that just because they’re freely negotiated contract rates that they’re just and reasonable, we can go behind that.’ And the court really reaffirmed what I think they said in Mobile-Sierra, and that is the presumption of just and reasonable in a freely negotiated contract rate holds. It’s just as good today as it was then and it applies to the contracting parties, to third parties and to FERC.”

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