In Re Mirant Corp.
332 B.R. 139, 45 Bankr. Ct. Dec. (CRR) 105, 2005 Bankr. LEXIS 1779 (2005)
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Rule of Law:
When calculating a claim for damages from a contract rejected in bankruptcy, the non-breaching party has a duty to make reasonable efforts to mitigate damages, which does not include breaching other contracts, and the future lost payments must be discounted to present value using a rate that reflects the debtor's credit risk at the time the contract was formed.
Facts:
- Kern River Gas Transmission Company ('Kern River') operates a natural gas pipeline system.
- Mirant Americas Energy Marketing, LP ('MAEM'), an energy company, used the pipeline to supply its power plants, including the Apex Facility in Nevada.
- On May 29, 2001, MAEM and Kern River entered into a 15-year contract requiring MAEM to pay for a fixed amount of 'firm' transportation capacity (90,000 decatherms per day) from May 2003 through April 2018, regardless of whether it was used.
- Kern River had pre-existing contracts with 'vintage' shippers that included most-favored-nation (MFN) clauses, obligating Kern River to lower their rates if it sold new long-term firm capacity below a certain price.
- After the contract with MAEM was made, the general market price for gas transportation capacity decreased.
- In December 2004, Kern River more than doubled its price for 'interruptible' capacity (non-guaranteed, short-term) specifically for delivery points in Southern Nevada, where MAEM's Apex Facility was located.
- Following this price increase, MAEM stopped purchasing interruptible capacity from Kern River for its Apex Facility and found alternative suppliers.
Procedural Posture:
- Mirant Americas Energy Marketing, LP, and other affiliated debtors ('Debtors') filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Northern District of Texas.
- Pursuant to a court order, Debtors rejected their long-term gas transportation contract with Kern River Gas Transmission Company ('Kern River'), effective December 18, 2003.
- Kern River filed a proof of claim for approximately $153.6 million in damages resulting from the contract rejection.
- Debtors filed an objection to Kern River's proof of claim, asserting that the amount was excessive due to a failure to properly mitigate and the use of an incorrect discount rate.
- The bankruptcy court conducted an eight-day evidentiary hearing on the Debtors' objection.
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Issue:
In calculating a claim for damages from a contract rejected in bankruptcy, must the non-breaching party's claim be reduced by amounts it could have reasonably mitigated, and must the future damages be discounted to present value using a rate that reflects the debtor's pre-bankruptcy credit risk?
Opinions:
Majority - Dennis Michael Lynn
Yes, a claim for damages from a rejected contract must be reduced for failure to reasonably mitigate, and the appropriate discount rate is one that reflects the debtor’s credit risk when the contract was formed. Under Utah law, the non-breaching party has an active duty to mitigate damages, and Kern River was in the best position to do so after MAEM rejected the contract and relinquished control over the capacity. The court found that reasonable mitigation did not require Kern River to breach its MFN clauses with other customers, as this would be an extraordinary and costly effort. However, the court rejected Kern River's argument that it was a 'lost volume seller,' holding that because its pipeline capacity is finite, it cannot perform an unlimited number of contracts; therefore, revenue from re-selling the rejected capacity must be counted as mitigation. Furthermore, Kern River aggravated its own damages in violation of Utah law by instituting a point-to-point price increase that effectively forced MAEM out of the interruptible capacity market, thus hindering mitigation. Finally, the court determined the correct discount rate to calculate the claim's present value is not a risk-free rate, nor a rate based on the debtor's current bankruptcy, but one reflecting the risk of non-performance at the time of contracting, for which the debtor's pre-petition borrowing rates are a fair proxy. The court set this rate at 8.0%.
Analysis:
This opinion provides a significant framework for calculating complex contract rejection claims in bankruptcy, particularly for service providers with finite capacity. It firmly rejects the application of the 'lost volume seller' doctrine to entities like a pipeline operator, clarifying that if capacity is limited, resale of the breached capacity must count as mitigation. The decision's most influential aspect is its novel approach to selecting a discount rate. By rejecting both the creditor's preferred risk-free rate and the debtor's high-risk bankruptcy rate, the court established a middle-ground 'time of contracting' risk standard, using the debtor's pre-petition borrowing costs as a proxy. This creates a new precedent for ensuring that rejection damage claims are valued on a parity with other pre-petition unsecured claims.
