United States: Tips On How To Protect Yourself In The Event Your Oil And Gas Operator Goes Bankrupt

Advances in production technology have led to an unprecedented supply of natural gas in the United States, putting downward pressure on market prices. Both the Henry Hub cash price and the NYMEX price closed below $2.00/MMBtu at times in the past month and prices continue to hover in the $2.00 range. As the summer approaches, experts believe natural gas prices will remain depressed due to slack demand and the significant inventories that remain in storage from a mild winter. For oil and gas operators heavily invested in natural gas producing assets, these historically low prices raise the risk of insolvency and bankruptcy.

If an operator seeks bankruptcy protection, royalty owners, working interest partners and service providers all bear a risk of non-payment. Outlined below are some steps creditors should consider taking to protect themselves against the bankruptcy of an operator.

TEXAS UCC § 9.343 Statutory Lien

Section 9.343 of the Texas UCC creates a perfected lien in favor of interests owners (e.g. producers, royalty owners and working interest owners) in production, "as extracted minerals," to secure the obligations of the first purchaser to pay the purchase price of the minerals sold. The "First Purchaser" is the first person that purchases oil or gas production from the interest owner after the production is severed. It Includes an operator who receives the production proceeds under a 100% division order from the third-party purchaser. The statutory lien can be helpful to joint interest owners if an operator gets into financial trouble before it distributes production proceeds to the other interest owners.

The security interest created by § 9.343 is perfected automatically without the filing of a financing statement and is treated, for priority purposes, as a purchase money security interest. The security interest exists for an unlimited time in oil and gas production in the hands of the first purchaser (who can be, and many times is, the operator), but is extinguished upon the operator's sale of the production to a buyer in the ordinary course of business. Although the lien in production is extinguished, it attaches to the proceeds from the sale of such production, giving the interest owner a perfected security interest in the operator's bank account containing the cash proceeds from the sale of production. The viability of this lien can be jeopardized by an operator that is squeezed for cash. Although § 9.343 does not technically require any type of notice to the first purchaser or other downstream buyers, providing notice of your § 9.343 lien to the person taking your production from the first purchaser (i.e., a buyer in the ordinary course) could be helpful to put that person on notice your interest in the production, perhaps making the person reluctant to distribute your share of proceeds to a distressed first purchaser.

Even though the §9.343 lien is perfected automatically under Texas law, there is a bankruptcy case from the District of Delaware that holds that §9.343 does not apply to Texas properties if the bankrupt first purchaser is incorporated in a state other than Texas.¹ The rationale of this case is that the Texas statutory lien is non-uniform, so if the other applicable states (i.e., state of incorporation of debtor) do not have a similar provisions, a joint interest owner must perfect its lien under the UCC of the state of incorporation of the debtor/operator.

Chapter 56 - Texas Property Code

Section 56.002 of the Texas Property Code provides mineral contractors and subcontractors with a lien "to secure payment for labor or services related to the mineral activities" that attaches to the materials, supplies and equipment provided, as well as the leasehold, oil or gas well, pipelines, and rights-of way to which the services or materials were provided.

In order to secure its lien, a mineral contractor must file a lien affidavit (it must be sworn to, not just notarized) in the county where the property is located not later than 6 months after the day the last services or goods giving rise to the claim accrued. The lien affidavit must list: (1) the name(s) of the mineral property owner(s) involved, if known; (2) the name and mailing address of the claimant; (3) the dates of performance or furnishing; (4) a description of the land, leasehold interest, pipeline, or pipeline right-of-way involved; and (5) an itemized list of amounts claimed. A mineral subcontractor generally must follow the same rules except that the subcontractor must serve written notice of the lien on the property owner at least 10 days before the affidavit is filed.

A contractor or subcontractor who has perfected its lien per the provisions of Chapter 56 will usually be a secured creditor in any bankruptcy case; however, remember that this is of benefit only if the well or lease subject to the lien is producing; otherwise the contractor or subcontractor is considered an unsecured creditor. Also keep in mind that after a bankruptcy filing, there is a special provision in the Bankruptcy Code allowing the filing of these liens despite the automatic stay provisions.

Other Jurisdictions

These tips focus on liens and security interests created by Texas law. However, other states have similar protections for owners. Additional information for owners with assets in jurisdictions such as Kansas, Louisiana, New Mexico and Oklahoma, amongst others, can be easily obtained and shared.

Filing Reminder

Creditors and owners with recorded rights are, generally, treated better in bankruptcy than creditors who have not recorded their rights. The interest in a lease owned by a working interest owner is usually not treated as belonging to the bankrupt if it has been recorded. Similarly, a recorded mortgage, or UCC filing, typically cannot be ignored in bankruptcy, at least with respect to the property covered by such filing. Accordingly, creditors, fellow interest owners and others should take all steps necessary to file notice of their interests or rights before bankruptcy. Doing so (subject to the specific facts and circumstances of the case) will allow owners to maximize their position in the event of the bankruptcy of an operator, first purchaser, or fellow owner.

Footnote

1. In re Semcrude, L.P., 407 B.R. 112 (Bankr. D. Del 2009)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.