Utility Divestiture and 366 Is Your Debtor Protected from Utility Discrimination

Utility Divestiture and 366 Is Your Debtor Protected from Utility Discrimination

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Section 366 of the Bankruptcy Code aids a debtor in its post-petition relationships with utility companies. However, the modern-day bankruptcy practitioner must realize that times change, as have certain debtor/utility provider relationships. While this specific issue is not well-developed, bankruptcy practitioners are wise to evaluate the relationship between a debtor and its utility provider, instead of accepting the application of §366 at face value. Upon evaluation, one might find that §366 does not apply.

Section 366

Section 366 states that a utility may not alter, refuse or discontinue service to, or discriminate against, a trustee or a debtor solely on the basis of the commencement of the case or because the debts owed by a debtor for service rendered before the order for relief were not paid when due. 11 U.S.C. §366(a) (West 1998). Consequently, a utility provider cannot quash a debtor's bankruptcy efforts by refusing service or requiring an outlandish deposit. Congress succeeded in its attempts to prevent a monopolistic utility provider from forcing a debtor, who has no choice but to deal with that particular utility provider, to accept the utility provider's terms regardless of the fairness of those terms.

However, some debtors are not typical utility consumers. And some utility providers are not monopolistic whereby a debtor, and the community at large, has no options in utility service. For example, the number of "start-up" long distance phone companies is endless, not to mention the numerous Internet service providers whose businesses revolve around the use of other entities' telephone lines and service. Additionally, if current lobbying efforts are successful, numerous "start-up" electrical companies may also exist.

These atypical utility consumers buy utility service from a utility provider in bulk and typically at a discount, and resell the service to the public. The debtor in this relationship thus takes on the role of a retailer, whereas the utility provider plays the role of a wholesaler. This relationship is quite different from the typical debtor/utility provider relationship in that the debtor is not using the utility as its primary utility provider. In fact, the debtor may buy bulk utility service from one utility provider for resale, e.g. MCI, but use another utility provider for its day-to-day utility service needs, e.g. AT&T.

The refusal to apply §366 to wholesale utility providers preserves the congressional intent and, in fact, bolsters Congress' intent because wholesale executory contracts belong under §365.

Divestiture and competition created a consumer market where "start-up" utility companies not only exist, but also bargain and negotiate for the best terms available from various utility providers. Consequently, the typical debtor/utility provider relationship contemplated by §366 may not exist in every case. However, debtors in this situation will surely argue that §366's anti-discrimination provisions apply, but the legislative history of §366 implies that its anti-discrimination provisions are inapplicable.

Legislative History of §366

Section 366 appears to state that no utility company may discriminate against any debtor, no matter the relationship. However, the legislative history of §366 states that:

This section is intended to cover utilities that have some special position with respect to the debtor, such as an electric company, gas supplier, or telephone company that is a monopoly in the area so that the debtor cannot easily obtain comparable service from another utility.

House Report No. 95-595, 95th Cong., 1st Sess. 350 (1977), U.S. Code Cong. & Admin. News 1978, at 5787, 6306.

Section 366's legislative history contemplates utilities that are "monopolies in the area" and debtors who "cannot easily obtain comparable service." The history therefore implies that if a utility is not a monopoly, and the debtor can easily obtain comparable service, §366 does not apply.

Unfortunately, few cases, if any, address the issue of whether §366 applies to a wholesale utility provider. One court, which apparently recognized this issue, merely stated in dicta that it "temporarily ruled against [the creditor utility provider] on the issue of whether [it] is a "utility" within the meaning of §366." In re Tel-Central Communications Inc., 212 B.R. 342 (Bankr. W.D. Mo. 1997). However, the court in Tel-Central did not expand on this issue, the basis for the "temporary" ruling, or even the facts supporting the "temporary" ruling. Other courts, such as the court in In re Sun-Tel Communications Inc., 39 B.R. 10 (Bankr. S.D. Fla. 1984), where the debtor resold long distance telephone service, have addressed utility deposit issues but not whether the creditor/utility provider was a "utility" for §366 purposes.

These cases are representative of §366 cases in that the issue of whether a wholesale utility provider is a "utility" for §366 purposes is not addressed. Therefore, those arguing this issue will not have much case authority to support their argument, whether they are a debtor or creditor/utility provider. Accordingly, the legislative history's negative implication must control, and §366 should not apply to wholesale utility providers.

This result is logical and fair in that the debtor in these circumstances does not use the utility provider in question as a utility, but as a wholesaler for its retail business of reselling utility service. A wholesale supplier of other products is not bound by §366, so why should a wholesale supplier of utility services be? Additionally, since utility providers are not always monopolies, and competition provides the debtor with a choice in wholesale utility providers, §366 should not apply. If the debtor does not find the utility provider's terms and conditions acceptable, the debtor may negotiate with another utility provider. Congress' intent is preserved because §366 would still apply to the debtor's personal and/or business utility needs, just not its wholesale utility needs. Therefore, due to persuasive legislative history, the parties must prepare themselves for the application of §365 instead of §366.

Section 365

Section 365 provides for the assump-tion or rejection of executory contracts. Assuming §366 is inapplicable, the court must apply §365 as the debtor/utility relationship is an executory contract. Since §366 is a mere counterpart to §365 when a "utility" is the creditor, there are some similarities. Specifically, §365 and §366 both require further adequate assurance. 11 U.S.C. §§365(b)(1)(C), 366(b) (West 1998). The differences between §§365 and 366, however, can prevent the debtor from successfully emerging from bankruptcy.

One difficulty a debtor may experience upon finding that §366 does not apply is that in addition to the adequate assurance of future payments, §365 also requires a debtor to "cure, or provide adequate assurance that the [debtor] will promptly cure, such default" prior to the assumption of an executory contract. 11 U.S.C. §365(b)(1)(A) (West 1998). Section 366, on the other hand, does not require the cure of pre-petition defaults, only the provision of adequate assurance. 11 U.S.C. §366(b) (West 1998). The debtor, therefore, will in all likelihood find it more difficult to cure and/or provide adequate assurance under §365 than under §366. Since adequate assurance is a relative concept, both debtor and creditor may always argue what constitutes adequate assurance and what does not. However, the potential to argue adequate assurance does not guarantee success. Therefore, due to a utility provider's potential to discriminate, a debtor is wise to cure its defaults and provide as much adequate assurance as possible.

Further, since the application of §365 does not prevent the alteration, refusal or discontinuation of service to, or discrimination against, the trustee or the debtor, utility providers have much more leverage against debtors. This additional leverage strains the "start-up" utility/debtor's post-petition dealings. The market now belongs to the utility provider, who may set its terms as it pleases. A utility provider could therefore quash a debtor's bankruptcy efforts by creating difficulties in the debtor's wholesale supply. The debtor is able to enter the utility provider market to find a new wholesale utility provider, but may find other utility providers unwilling or unfair. Remember, once §366 is found inapplicable, notwithstanding a controlling executory contract, both new and old utility providers may set their terms as they please.


The congressional intent behind §366 is now more than 20 years old. During that time, many things have changed. Divestiture created competition and a free market. Further, new "start-up" utility companies arrive every day as large utility providers sell utility service to new "start-up" utility companies for resale. This new form of business changes the "start-up" utility company from a consumer to a retailer and the utility provider to a wholesaler of utility services. Due to such changes in the make-up of utility companies, a change in the application of §366 is imminent.

The refusal to apply §366 to wholesale utility providers preserves the congressional intent and, in fact, bolsters Congress' intent because wholesale executory contracts belong under §365. When a court applies §365 instead of §366, a debtor's case is not over. The debtor is merely put in the position of dealing with its wholesaler pursuant to §365, just as other retailers must do in bankruptcy.

Journal Date: 
Tuesday, December 1, 1998