Court: United States Bankruptcy Court, N.D. Ohio; January 15, 2019; Us Bankruptcy; United States Bankruptcy Court
On July 3, 2018, the Debtors filed a motion to enforce the automatic stay against Meadville Forging Company, alleging it violated the stay by terminating its power supply agreement with FirstEnergy Solutions Corporation (FES). Meadville argued that its actions were permissible under 11 U.S.C. § 556, claiming it was a forward contract merchant and that the contract included an ipso facto clause allowing termination upon the Debtors' bankruptcy. The Court held a final hearing on September 11, 2018, where both parties presented stipulated evidence and undisputed facts, without live testimony. The Court concluded that Section 365(e) prohibited Meadville from terminating the contract, affirmed the applicability of the automatic stay, and found Meadville in violation of it. The determination of sanctions for this violation was deferred for a future hearing. The Court has jurisdiction over the case under 28 U.S.C. § 1334, with venue proper under 28 U.S.C. § 1409(a), and it classified the matter as a core proceeding. Procedurally, the initial motion and supporting documents were filed on July 3, 2018, and after an emergency hearing, the Court issued a preliminary order on July 10, 2018, restricting Meadville's actions regarding the termination of the agreement. A scheduling order for further litigation was established, which was later amended to allow for more detailed briefing from both parties.
On September 4, 2018, Meadville filed a supplemental response to a motion (Docket No. 1271) and included declarations from James J. Toy, former Director of Purchasing and Materials and Vice President of Operations (Docket No. 1271-2), and Robert A. Lack, current Vice President and CFO (Docket No. 1271-5). The Debtors filed a reply brief on September 10, 2018 (Docket No. 1316) along with a supplemental declaration from Mr. Schmuhl (Docket No. 1317). Collectively, these declarations are referred to as the "Declarations". A final hearing on the motion was held on September 11, 2018, where no party cross-examined the declarants or objected to the evidence presented. The hearing served as both an evidentiary session and oral argument. The Court's Memorandum Decision is based on the docket, joint stipulations (Docket No. 1271 Ex. 1), testimony from the Declarations, and admitted exhibits.
On March 31, 2018, the Debtors filed for chapter 11 bankruptcy, with their cases consolidated for procedural purposes. They are operating as debtors-in-possession under the Bankruptcy Code. Debtor FES engages in the retail electricity market, having 938 large and medium commercial and industrial customers as of July 3, 2018. FES is concerned that Meadville and other customers may unilaterally terminate contracts during the bankruptcy proceedings, potentially impairing the value of a pending sale agreement for those contracts, with Meadville's projected revenue from its contract exceeding $7.2 million. Meadville, a forging business in Pennsylvania, has had a commercial relationship with FES since at least 2010, entering a Customer Supply Agreement for electricity supply for two locations. Meadville requires electricity, natural gas, and industrial metals such as steel for its operations.
Meadville has entered into several forward contracts for commodities essential to its business, with a schedule of thirty-six contracts presented as evidence. Of these, three pertain to electricity, excluding the CSA with FES. One contract with Source Power & Gas, LLC will commence in 2020, while a second contract began on July 1, 2018, likely replacing prior electricity purchases under the CSA. The third electricity-related agreement is an Energy Management Agreement with EnerNOC, Inc., effective March 28, 2014. This agreement involves Meadville curtailing its energy use during high-demand periods identified by PJM, with EnerNOC compensating Meadville for this service. As of September 11, 2018, PJM had not required Meadville to curtail its usage.
Both parties acknowledged that electricity is a "commodity" and the CSA constitutes a "forward contract" as defined in the Bankruptcy Code. Meadville acts solely as an end user of the electricity purchased from FES and does not engage in trading or reselling it. The CSA includes a requirements clause and stipulates defaults related to bankruptcy filings. In the event of default, the non-defaulting party may terminate the agreement with written notice, subject to regulatory compliance.
Additionally, the CSA was amended in September 2014 to include a Fixed Price Pricing Attachment, changing the price structure and adding a service address. In early 2016, FES informed Meadville of new pass-through costs, leading to a "blend and extend" agreement, which adjusted these costs with lower energy prices and extended the CSA term from January 2018 to December 2020. After the Debtors filed for bankruptcy on April 10, 2018, Meadville indicated to FES its consideration of terminating the CSA, citing potential cost savings and its belief that the CSA allowed termination due to the bankruptcy.
On April 11, 2018, FES proposed renegotiation of the CSA price while asserting that Meadville’s unilateral termination would be unlawful. On April 17, Meadville notified FES of its termination of the CSA. In response, on April 27, the Debtors' counsel informed Meadville that this termination violated the automatic stay and was void. Meadville’s counsel countered on May 1, claiming that the termination was permissible under the Bankruptcy Code and the CSA, as both parties recognized each other as forward contract merchants. The Pennsylvania electricity market allows Meadville to unilaterally stop receiving electricity from FES. After switching to a new provider, Meadville notified Penelec, leading to FES being informed on June 28 that Meadville had changed providers at one service address. By June 29, Meadville stopped purchasing electricity at that address. Counsel indicated at a July 5 preliminary hearing that the other two service addresses had yet to switch providers, and the Court subsequently ordered Meadville to make reasonable efforts to retain FES as the supplier for those addresses.
The legal analysis asserts that unless an exception applies, the Bankruptcy Code's automatic stay prohibits Meadville from enforcing the CSA's Ipso Facto Clause. Upon filing for bankruptcy, the Debtors' estates retained the rights to their executory contracts, and the automatic stay generally bars any termination or modification of these rights. Case law supports that a nondebtor’s unilateral termination of such contracts violates the stay. The debtor has until plan confirmation to assume or reject contracts, during which termination by creditors is typically prohibited. Termination can occur only with court permission, and any attempts to terminate executory contracts postpetition, which were not properly terminated prepetition, are also subject to the automatic stay, protecting the debtor’s contractual rights as property of the estate.
The automatic stay in bankruptcy does not alter the terms of executory contracts or prevent their expiration. However, the Bankruptcy Code prohibits terminating or modifying executory contracts based on clauses conditioned on the debtor's insolvency, the initiation of bankruptcy, or possession by a trustee. Paragraph 24 of the CSA contains such an "ipso facto" clause. Meadville argues that an exception in the Bankruptcy Code applies, permitting it to activate this clause and terminate the CSA despite the automatic stay. Specifically, Meadville claims to be a "forward contract merchant," allowing it to liquidate or terminate commodity contracts under Section 556 of the Bankruptcy Code.
To qualify as a forward contract merchant, a party must engage in forward contracts with merchants and deal with commodities or similar goods. The court determined that Meadville does not meet this definition and thus cannot invoke the safe harbor of Section 556. Although the CSA states both parties are forward contract merchants, the court emphasized that this text does not resolve the legal status, and ignoring the contract's terms would unfairly rewrite the agreement to benefit FES from a poor bargain.
Parties cannot agree to confer legal status as a forward contract merchant on Meadville or bind the court to such a conclusion, similar to how they cannot declare Meadville to be a Federal Reserve Bank through mutual consent. Litigation stipulations cannot dictate legal conclusions, as established in cases such as TI Federal Credit Union v. DelBonis and Saviano v. C.I.R. Courts maintain that they are not controlled by the counsel's agreements on legal questions. Allowing parties to stipulate to forward contract merchant status could lead to improper recognition of entities that do not meet statutory definitions, contrary to Congressional intent. The case In re Mirant Corp. exemplifies that a prepetition agreement claiming a governmental entity as a forward contract merchant was ineffective because governmental entities are not classified as "persons" eligible for such status. Although In re Clear Peak Energy, Inc. appeared to suggest that contractual provisions could create forward contract merchant status, the court ultimately determined that the debtor met the definition based on contract nature and that the status of the nondebtor counterparty sufficed under Section 101(26). The interpretation of Clear Peak Energy did not resolve the question of private negotiations conferring such status. Furthermore, Paragraph 41 of the CSA cannot be interpreted as a mere waiver of FES's argument regarding Meadville's status, as a prepetition debtor cannot waive rights granted by the Bankruptcy Code, particularly concerning fundamental rights like the automatic stay. The Bankruptcy Code overrides private contractual rights regarding its essential provisions.
Forward contract merchant status provides certain legal protections under the Bankruptcy Code, including exemptions from the automatic stay as per Section 556. Prepetition efforts to achieve this status are discouraged, rendering efforts by FES and Meadville to bestow such status upon each other in paragraph 41 of the CSA unenforceable. Meadville does not qualify as a forward contract merchant as it is not engaged in profit-driven forward contracting. The court must evaluate whether Meadville meets the statutory criteria to leverage Section 556's safe harbor for terminating contracts with a bankrupt debtor based on an ipso facto clause. Evidence indicates Meadville does not fulfill this role, as its business activities do not involve entering into forward contracts within the electricity market. The bankruptcy court recognized differing interpretations of "forward contract merchant," with some courts favoring a narrow definition that requires a party to be engaged in buying, selling, or trading for profit, as articulated in Mirant Americas Energy Marketing, L.P. v. Kern Oil, which emphasized that the term does not apply to every party in a goods or services contract. Conversely, broader definitions have emerged, incorporating those needing protections related to forward contracts, reflecting a split in judicial interpretation since the 2013 Laurel Valley Oil decision.
The Court is urged by the Debtors to adopt a narrow definition of "merchant" from the Mirant case, which defines a merchant as an entity that engages in buying, selling, or trading in a market, excluding end users and producers. They also advocate for the Mirant definition of "business" as an endeavor aimed at generating profit. Conversely, Meadville supports a broader interpretation based on the Borden decision, arguing that the statutory language allows for a wider range of entities to qualify as forward contract merchants. Meadville points out that Section 101(26) requires only that one party to a contract be a forward contract merchant. The Court acknowledges that the statute mandates a forward contract merchant's business must consist, in whole or in part, of entering into forward contracts. The use of the terms 'business' and 'merchant' in the statute indicates a limited interpretation to avoid allowing an excessive number of parties to bypass the automatic stay in bankruptcy proceedings. Consequently, the Court adopts the narrow definition from Mirant while expressing concern that this definition may be overly restrictive for the Bankruptcy Code's context. The Court notes that if Meadville is to qualify as a forward contract merchant, its business must involve entering into forward contracts for electricity specifically to generate profit, rather than merely being an end user of electricity.
Meadville's involvement with forward contracts for electric power is limited to entering supply contracts as an end user, specifically under a requirements contract (CSA), which only allows Meadville to purchase the amount of power it consumes. Prior to the petition date, Meadville had no additional contracts for purchasing electricity, does not generate its own power, and lacks the capacity to store significant volumes of electricity or acquire resale rights from third parties. Meadville does not engage in selling or reselling electricity, nor does it market itself as a trader or broker of electricity contracts. Its participation in PJM's demand response program through the EnerNOC Agreement is characterized as ancillary to its primary business of manufacturing metal parts for the automotive industry and does not constitute a forward contract. The EnerNOC Agreement, while referred to by Mr. Toy as a "resell agreement," does not allow EnerNOC to purchase electricity from Meadville or access its purchasing rights from FES, Meadville’s sole electricity supplier from 2010 to June 2018. Meadville's electricity contracts and demand response participation are focused on controlling manufacturing costs rather than generating profit from the electricity market. Should Meadville cease its manufacturing operations, it would no longer benefit from its electricity contracts or participate in demand response programs, as such opportunities are typically reserved for large users capable of significantly reducing grid demand. Ultimately, Meadville's business does not involve entering forward contracts, as its electricity dealings are strictly tied to its manufacturing needs.
Meadville's interpretation of the phrase "business consisting in part" is deemed excessively broad, as it would include non-business activities. Consequently, Meadville is not recognized as a forward contract merchant in the electric power market and cannot invoke the ipso facto clause in the CSA to terminate the contract under 11 U.S.C. § 556. The termination by a nondebtor party of a debtor-in-possession's executory contract via an ipso facto clause is barred by 11 U.S.C. § 365(e) and violates the automatic stay under 11 U.S.C. § 362(a)(3), with no applicable exceptions.
The matter of sanctions against Meadville is postponed. Although the parties discussed potential sanctions arising from Meadville's termination of the CSA and its disregard for the Debtor's bankruptcy counsel, detailed arguments and evidence regarding the economic impact of Meadville's actions were lacking. The hearing did not establish a clear standard for sanctions regarding stay violations in corporate bankruptcy cases. Both parties agreed to defer the sanctions issue until after determining the legality of Meadville's contract termination and the violation of the automatic stay.
Meadville is identified strictly as an end user of electricity purchased from FES under a requirements supply contract, with no current capacity to resell electricity. Its contracts are intended solely for its operations in forging metal products for the automotive sector, and participation in demand response programs does not categorize it as a forward contract participant. The language in paragraph 41 of the CSA is unenforceable, as prepetition debtors cannot impose conditions on future debtors-in-possession or the bankruptcy court that contradict the Bankruptcy Code's provisions. A prepetition debtor cannot waive rights that emerge only upon the filing of a bankruptcy petition. A status conference will be scheduled to discuss the sanctioning process for Meadville's violations.
Meadville is not classified as a forward contract merchant and therefore cannot invoke the safe harbor provision of Section 556 to terminate the contract under the ipso facto clause, which would otherwise violate the automatic stay. Meadville's attempt to terminate the contract was a breach of this stay. The Court will hold a status conference to address potential sanctions for this violation, and this Memorandum Decision does not serve as a final order on the related Motion, pending a resolution of the sanctions issue.
The sale agreement concerning FES's retail book and associated contracts is currently involved in both a sale motion (Docket No. 908) and an adversary proceeding (AP No. 18-05081) with Exelon Generating Company, LLC, as the stalking horse bidder. Both matters are still pending.
PJM Interconnection operates as a regional transmission organization managing wholesale electricity movement across several states, including Pennsylvania, and is a key channel for FES's power sales to Meadville. The definition of "forward contract merchant" was broadened by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), now including entities beyond individuals, such as Federal Reserve Banks.
The analysis of safe harbor defenses related to forward contract merchants can be complex, often conflating two distinct defenses. In this case, the Court examines the legality of contract termination by a nondebtor party under an ipso facto clause in light of the automatic stay and 11 U.S.C. 365(e). Section 556 allows a nondebtor forward contract merchant to terminate a contract with a debtor under these circumstances, provided that only the nondebtor party is classified as a forward contract merchant.
Key cases related to the Section 556 safe harbor include Clear Peak Energy, 488 B.R. 647 (Bankr. D. Ariz. 2013), and Mirant, which is represented by two opinions: 303 B.R. 319 (Bankr. N.D. Tex. 2003) and 310 B.R. 548 (Bankr. N.D. Tex. 2004). An additional safe harbor defense is provided under 11 U.S.C. § 546(e), which prevents the avoidance of certain transfers, including fraudulent transfers or preferences, according to 11 U.S.C. §§ 544, 545, 547, 548(a)(1)(B), and 548(b). This defense applies to margin or settlement payments involving a forward contract merchant, allowing either the debtor or the nondebtor transferee to qualify as such.
The definitions and implications of "forward contract merchant" are explored in cases like Laurel Valley Oil Co., 2013 WL 832407 (Bankr. N.D. Ohio, Mar. 5, 2013), and Borden Chemicals, 336 B.R. 214 (Bankr. D. Del. 2006). Clear Peak Energy conflates the Section 546(e) and Section 556 defenses, mistakenly applying the "either party" concept from Section 546(e) to a situation governed by Section 556, which requires the nondebtor to be a forward contract merchant for the defense to be applicable. Although Clear Peak Energy correctly identified the nondebtor as a forward contract merchant, it failed to recognize the distinct requirements of Section 556. In the current case, it is critical that Meadville, the non-party debtor, qualifies as a forward contract merchant for the Section 556 defense to apply, rendering FES's status irrelevant. Meadville, like Clear Peak Energy, misinterprets the distinction between the two safe harbor defenses, although only one party needs to be a forward contract merchant for the Section 556 defense to be relevant.
