When the founders of the United States debated the Constitution in the summer of 1787, a primary point of contention was how to strike a proper balance of power between the federal government and the sovereign states. In fact, the founders were nearly obsessed with the concept of power, as demonstrated by James Madison’s words in The Federalist No. 45 that the “powers delegated to the federal government are few and defined [while those] which are to remain in the state governments are numerous and indefinite.” The Federalist supporters of a relatively strong centralized government prevailed, and the Constitution was ratified June 21, 1788.
As adopted, the Constitution included a provision authorizing Congress to enact “uniform Laws on the subject of Bankruptcies.” After a few short-lived attempts at a federal bankruptcy statute, Congress enacted the Bankruptcy Act in 1898 and the modern Bankruptcy Code in 1978.
From 1788 to today, courts and legislatures at both the state and federal levels have struggled with the proper balance of power envisioned by the Constitution. Bankruptcy law has been no exception. In fact, the Supreme Court over the decades has weighed in on landmark decisions related to the breadth of a bankruptcy court’s power, from the foundational decision Northern Pipeline Construction Co. v. Marathon Pipe Line Co. to the more recent decision Stern v. Marshall.
In a decision issued Jan. 5, 2023, the Fifth Circuit Court of Appeals contributed to the debate by addressing the proper balance of power in relation to regulation of electric power. The case – ERCOT v. Just Energy Texas, L.P. – is notable in its own right for addressing critical issues regarding who has authority to regulate a state’s electric utilities.
But the case is even more interesting when considered in the broader mosaic of recent decisions by courts dealing with how and when state regulatory power may be circumscribed by federal bankruptcy courts. The Just Energy decision may be seen as a data point in the broader national movement by federal circuit courts to rein in bankruptcy courts’ ability to assert dominion over regulatory matters reserved to the states. Whether or not this trend continues is unclear, but a convincing argument can be made that the legal winds are blowing in favor of the states and against the broad exercise of bankruptcy court powers.
The Just Energy bankruptcy case was one of several bankruptcy cases resulting from Winter Storm Uri, which struck Texas in February 2021. Hundreds of Texans lost their lives and hundreds of thousands more were subjected to lengthy power outages due to the near failure of the power grid.
The regulation of power in Texas is a relatively complicated affair. In 1999, the Texas Legislature “deregulated” the power industry through a series of amendments to the Public Utility Regulatory Act. The amendments were designed to create competition in the electric power industry by introducing competition through the unbundling of services provided by utilities.
Deregulation, however, does not mean no regulation. While Texas takes a more limited role in power regulation than elsewhere, the state maintains an important role. Regulation is overseen by the Public Utility Commission of Texas which, in turn, oversees a quasi-governmental entity known as the Electric Reliability Council of Texas. ERCOT manages the state’s wholesale electricity market and is generally responsible for ensuring that adequate and reliable power flows through the Texas power grid, which is unique in America because it is located entirely within a single state.
During Winter Storm Uri, the PUCT issued a series of orders requiring ERCOT to set the price for wholesale energy at the then-statutory cap of $9,000 per megawatt-hour. For context, the per-hour price for such power outside of a crisis situation is around $20. The detailed reasoning behind the price increase is outside the scope of this article, but generally speaking it was designed to both incentivize energy production and to disincentivize energy consumption by large customers, such as commercial industrial plants. The price increase was maintained for 33 hours, thus making power very expensive for a relatively extended period.
Just Energy Group and its related companies are retail energy providers that filed Chapter 15 bankruptcy in Houston March 9, 2021. The case was filed under Chapter 15, rather than Chapter 11, because Just Energy separately commenced insolvency proceedings in Canada, and Chapter 15 is designed to provide for U.S. bankruptcy court recognition of foreign proceedings. Just Energy quickly filed an adversary proceeding complaint in the Houston bankruptcy court against several entities, including ERCOT, alleging that $335 million worth of Just Energy’s financial troubles could be traced back to the steps ERCOT took to implement the PUCT’s price increase orders.
In the bankruptcy court, ERCOT argued that Just Energy was directly challenging the lawfulness of actions taken by the PUCT and that therefore the bankruptcy court was required to abstain from hearing the dispute in favor of having the matter handled under the Texas regulatory scheme set forth in PURA. Specifically, PURA requires a party such as Just Energy to first seek redress from ERCOT then appeal to the PUCT. Thereafter any litigation must be commended in the Travis County district court. Just Energy opposed abstention, arguing that it was not directly attacking the lawfulness of the PUCT’s actions but was merely disputing the amount of a claim in a bankruptcy filing, thus making it a core bankruptcy matter that the bankruptcy court had jurisdiction to consider.
ERCOT asserted that the regulation of power was an important matter reserved to the states and that a federal bankruptcy court had no business usurping the role of state regulators as enacted under PURA by the Texas Legislature.
Just Energy, once again, framed the matter as nothing more than a claim dispute without any need to take up the issue of state versus federal power. The issue was framed by the U.S. Supreme Court decision in Burford v. Sun Oil Co. So-called “Burford abstention” is designed to prevent federal courts from becoming “entangled” with a state’s ability to implement important policy programs. Burford mandates that a federal court refrain from hearing a matter where intervention would undermine the uniform treatment of local issues. The court set forth a five-part test for determining when Burford abstention applies. While the specifics of each element need not be analyzed here, the test is generally designed to determine whether there is an important state interest at hand and whether such an important issue can, and should, be handled by state regulators and the state judiciary.
The Just Energy bankruptcy court took the matter up on ERCOT’s motion to dismiss and agreed with Just Energy’s characterization of the dispute. That is, the bankruptcy court framed the matter as a dispute on how much Just Energy owed ERCOT and that therefore the court had a duty to decide. The bankruptcy court denied ERCOT’s motion to dismiss and ERCOT appealed directly to the Fifth Circuit. Following oral argument, the Fifth Circuit issued its opinion Jan. 5, 2023, reversing the bankruptcy court, finding that four of the five Burford abstention elements had been established.
The Fifth Circuit stated that resolving the dispute would require the court to “second guess ERCOT’s decision making and authority during the unusual, emergency circumstances of winter storm Uri [and that such second-guessing] risk[s] reaching a different answer than the state institutions with greater interest and familiarity with such matters.”
The court also found that utility regulation “is one of the most important functions traditionally associated with the police power of the States” and that a federal intervention that could potentially affect all utility market participants would risk a “domino effect [that] is exactly the type of ‘worrisome’ federal court interference with an interdependent administrative scheme that Burford seeks to prevent.”
The court succinctly summarized: “Only one court is permitted to answer Just Energy’s $335-million-dollar question: Travis County district court.” The court thus vacated the bankruptcy court’s order denying ERCOT’s motion to dismiss and remanded “with instructions to determine the appropriate trajectory of [the] case after abstention.”
The Just Energy case demonstrates that state regulatory interests can prevail in bankruptcy cases even if adjudicating the state’s interests will put the bankruptcy case on hold. This is important because the need for a debtor to move through bankruptcy quickly – in order to preserve value and minimize costs – is often placed before bankruptcy courts as the paramount interest trumping all others. While preserving value and minimizing costs are important considerations in every bankruptcy case, those issues cannot override the constitutional scheme of divided power.
The Fifth Circuit’s decision is also notable because it was made notwithstanding the fact that the Constitution’s Bankruptcy Clause specifically empowers the federal government (rather than states) to address bankruptcy issues and also notwithstanding federal courts’ having a “virtual unflagging obligation to exercise their jurisdiction.” (Just Energy, at *10.)
Even with all of those cards stacked against the state’s interests prevailing in bankruptcy court, the Just Energy decision demonstrates that, when critical state regulatory interest are at hand, the state interests come first and federal courts are obligated to step aside.
It is often a risky maneuver to read too much into one circuit court opinion. One data point, after all, does not make a trend. Nevertheless, recent decisions by other circuit and district courts in the bankruptcy context suggest that Just Energy may be one in a grouping of determinations dialing back the power of bankruptcy courts. There are several such recent examples.
On Jan. 20, 2023, the Third Circuit in In re LTL Management, LLC held that the bankruptcy court should not have permitted a reverse merger known as the “Texas Two-Step” to be used for the purpose of putting a newly created subsidiary of Johnson & Johnson into Chapter 11 in order to address talc personal injury claims. And, the Seventh Circuit, in the bankruptcy case In re Aearo Technologies, LLC, is currently considering whether a bankruptcy court has the power to issue broad nationwide injunctions halting personal injury claims against non-debtor entities; that is, entities that did not themselves file bankruptcy and therefore do not enjoy the benefit of the automatic stay.
The issue of a bankruptcy court’s power also has been addressed by federal district courts in relation to the permissibility of nonconsensual third-party releases.
In Patterson v. Mahwah Bergal Retail Group, Inc., a case arising out of the bankruptcy filing of retailer Ann Taylor and related companies, the court issued a lengthy opinion making very clear from the district court judge’s point of view that the bankruptcy court erred in confirming a plan containing nonconsensual third-party releases. In an unusual move, the district court not only remanded the case with instructions to vacate the plan confirmation order but also ordered that the case be reassigned to a different bankruptcy judge in the district. That case was not appealed to the Fourth Circuit Court of Appeals.
However, the issue of a bankruptcy court’s power to approve third-party releases is currently on appeal in the Second Circuit. In 2021, the district court in In re Perdue Pharma, L.P. found that the bankruptcy court had impermissibly approved nonconsensual third-party releases as part of a complicated settlement with the Sackler family related to opioid epidemic. Oral arguments were held before the Second Circuit April 29, 2022. The circuit court has not yet ruled.
Each of these cases – LTL, Aearo Technologies, Patterson and Perdue – differs from the Just Energy case because only Just Energy involves state utility power regulation and Burford abstention. On the other hand, all the cases address the foundational issue of how far a bankruptcy court’s power extends.
It remains to be seen how the Seventh Circuit will rule in the Aearo Technologies matter and how the Second Circuit will rule in the Perdue matter. But if those courts also find fault with the bankruptcy courts’ decisions, the Just Energy case and the LTL case may later be seen as the start of a broader trend indicating that, in certain circumstances, the power of bankruptcy courts is on the wane.
Disclaimer: The author was an assistant attorney general at the Texas Office of Attorney General from 2020 to 2022, where he worked as the manager of the Bankruptcy & Regulatory Team. In that role, he was involved in several of the bankruptcy cases discussed in this article. Nothing in this article contains nonpublic information, and the article constitutes solely the work of the author and does not represent the position of the Texas Office of Attorney General, any state agency or any other party.
Jason B. Binford is a shareholder in the Austin office of the corporate restructuring, bankruptcy, insolvency and mediation firm Ross, Smith & Binford, PC.