5th Circuit Holds that Federal Anti-Assignment Act Doesn't Trigger "Ipso Facto" Termination of Mirant's Energy Contract

For a federal agency, the Bonneville Power Administration (BPA) is surely unique. Unlike most federal agencies, this one is self-funding. It boasts that it "recover[s] all of its costs through sales of electricity and transmission and repay[s] the U.S. Treasury in full with interest for any money it borrows." The story of the origins and growth of the BPA is one worth reading, as it holds many lessons regarding the social, political, and economic development in the Pacific Northwest and the US generally. To take one more extreme example, did you know that the BPA served as the inspiration for some of Woody Guthrie's most famous songs? According to one documentary, entitled Roll on Columbia: Woody Guthrie and the Bonneville Power Administration:

In spring 1941, the cusp of the Great Depression and Pearl Harbor, a 28 year old, unemployed Dust Bowl balladeer, Woodrow Wilson Guthrie took a one month, temporary job with the U.S. Department of the Interior's Bonneville Power Administration (BPA) on the Columbia River. The BPA needed a folksinger to promote the benefits of building dams to produce cheap electricity. Guthrie, and his wife and 3 kids needed the paycheck. He wrote 26 songs in 30 days - classics like Roll on Columbia and Pastures of Plenty. This ... is the ... most prolific moment in Guthrie's extraordinary career.

The BPA also is one of the lesser publicized casualties in the largest bankruptcies ever (Enron, Mirant, Calpine, Kaiser, PG&E, Longview Aluminum, to name a few), and its advocates both internally and at the Department of Justice have fought tooth and nail on behalf of the BPA against some of the best bankruptcy lawyers in the land.

Recently, the Fifth Circuit weighed in on a long-standing split among the circuits in the law regarding assumption and termination of non-assignable executory contracts. It held that the BPA could not unilaterally terminate its executory contract with Mirant for future electric power purchases under the contract's "ipso facto" clause (which excuses the solvent party from performance of the contract when the other party becomes insolvent or goes bankrupt) simply because the federal Anti-Assignment Act prohibited the assignment of the contract. In re Mirant Corp., 2006 WL 33012 (5th Cir., 2/13/06) (pdf).

In reaching this result, the Fifth Circuit stepped into the debate over whether to adopt the "actual" or "hypothetical" approach in determining whether, under Bankruptcy Code section 365(e)(2)(A), the contract can be terminated as a matter of law because --

applicable law [such as the federal Anti-Assignment Act - 41 USC § 15] excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to the trustee or an assignee of such contract or lease, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties.

The Fifth Circuit framed the differing positions of the parties as follows:

BPA asks this Court to hold that under a hypothetical test, § 365(e)(2) permits automatic termination of the Agreement prior to judicial review and prior to the entry of automatic stay, or in the alternative, that § 365(e)(2) requires a bankruptcy court to lift the automatic stay in order for the ipso facto clause to be enforced. Accordingly, BPA challenges both the bankruptcy court's entry of automatic stay and denial of a modification to the stay because the ipso facto clause and the Anti-Assignment Act permit BPA to terminate the Agreement automatically upon Mirant's Chapter 11 filing prior to any review by or approval of the bankruptcy court under § 365(e)(2)(A).


Mirant responds that the automatic stay provision, § 362(a), is violated by BPA's termination of the Agreement, that is, BPA's attempt to exercise control of property of the estate without the oversight of the bankruptcy court. Mirant argues the bankruptcy court did not abuse its discretion in entering the stay because the stay is automatic and either the Anti-Assignment Act does not apply because there was no transfer or, even if the Act does apply, the stay's automatic entry precedes any termination permitted by the combined effect of the Act, § 365(e)(2)(A), and the ipso facto clause of the Agreement. Mirant also argues the bankruptcy court did not err in denying BPA's motion to modify the stay because BPA failed to show the cause required under § 362(d)(1). In support, Mirant urges this Court to adopt an actual, or as-applied, analysis to determine whether the Anti-Assignment Act applies to this case and to conclude that it does not (thereby foreclosing termination via the ipso facto clause) because no assignment occurred here.

The Fifth Circuit then reviewed the split among the circuits, noting that only the 1st Circuit has adopted the "actual" approach, compared with the 3rd, 4th, 9th, and 11th Circuits, which have adopted the "hypothetical" approach:

Under the ... hypothetical approach, ... a court must ask whether BPA could refuse to accept performance of the Agreement from any assignee because the Anti-Assignment Act makes the Agreement unassignable as a matter of law. If so, then irrelevant is the fact that the debtor did not actually assign, intend to assign, or attempt to assign the contract, and consequently the executory contract is terminable by its ipso facto provision under § 365(c)....


The actual test requires on a case-by-case basis a showing that the nondebtor party's contract will actually be assigned or that the nondebtor party will in fact be asked to accept performance from or render performance to a party--including the trustee--other than the party with whom it originally contracted. The actual test contemplates that in a case where no assignment has taken place, § 365(e)(2)(A)'s exception is not available and, as such, an ipso facto clause is invalidated. (Citations omitted.)

The Fifth Circuit provided an important counterweight in the long-raging debate by squarely siding with the First Circuit and establishing that the "actual" test governs based on the "plain text" of § 365(e)(2)(A). In the end, the Court concluded, "we cannot agree with so broad an analysis as permitted by the entirely theoretical approach countenanced by those courts adopting the hypothetical approach."

As noted by the 5th Circuit, this raging debate over the applicability of the "actual" or "hypothetical" test is an important one, as it extends under Bankruptcy Code § 365(c) to the even more important (unresolved) question of whether "applicable law" that prohibits the assignment of certain executory contracts also prohibits their assumption by the trustee or debtor in possession. With the fate in bankruptcy of government contracts, personal service contracts, and patent and other IP licenses hanging in the balance, we can only hope that this split among the circuits will soon be resolved by the US Supreme Court (perhaps even in this case)!

© Steve Jakubowski 2006