United States: Who Is Responsible For Decommissioning Costs For Oil And Gas Assets Abandoned Or Sold In Bankruptcy?

Lower oil prices have led to an increase in the number of energy companies seeking to sell or abandon interests in oil and gas assets in bankruptcy proceedings. Whether companies are seeking to sell assets or abandon them, concerns regarding the costs of plugging and abandoning or decommissioning those assets arise not just for the debtor and potential purchasers of the assets but also for the debtor's lessors, joint-interest holders, and predecessors in interest. Each of these parties bears potential liability for decommissioning costs that are not paid by the debtor's estate or assumed by a buyer of the debtor's interests.

A debtor's lessors, joint-interest holders, and predecessors in interest faced with potential abandonment will need to learn certain facts to allow them to assess the likelihood that they will have to pay any decommissioning or abandonment costs. What do the relevant lease, operating agreement, or assignment provisions say about such costs? Have decommissioning obligations already arisen, and if not, when are they likely to arise? Are there multiple options for accomplishing decommissioning and what are the costs of each? Are there bonds, trust funds, letters of credit, or escrowed funds set aside to pay for decommissioning, and if so, are those funds sufficient? What is the likelihood that the debtor's estate will have assets sufficient to pay any unfunded decommissioning costs? The answers to these questions, along with various business concerns, will drive decisions about how to proceed when faced with the possibility of having to cover a debtor's share of unfunded decommissioning costs.

There are a number of other legal issues that would also be relevant to anyone advising a company in this situation. A thorough examination of all these issues is beyond the scope of this article, but the following is an introduction to two legal questions often faced by lessors, joint-interest holders, and predecessors in interest confronted with abandonment.

Can the Debtor Abandon the Assets and Leave Unfunded Decommissioning Obligations?

A debtor seeking a discharge from liability for decommissioning costs in bankruptcy may seek to abandon those assets and reject any related executory contracts from which the decommissioning obligations arise. Section 554 of the U.S. Bankruptcy Code allows a debtor or trustee, subject to court approval, to abandon any property "that is burdensome to the estate or that is of inconsequential value and benefit to the estate." 11 U.S.C. § 554(a). Section 365 allows the debtor or trustee to "reject any executory contract or unexpired lease of the debtor." 11 U.S.C. § 365(a). Together, these provisions can allow a debtor to give up oil and gas interests that are no longer sufficiently valuable to cover expected decommissioning costs and to receive a discharge of any liability for those costs.

A debtor's lessors, joint-interest holders, and predecessors in interest that are potentially stuck footing the bill for unfunded decommissioning costs may want to intervene and force the debtor's estate to decommission the assets or at least pay for the debtor's share of any unfunded decommissioning costs from available assets.

The power to abandon assets pursuant to section 554 has certain limitations. A trustee cannot simply abandon any and all uneconomic interests in oil and gas assets. In Midlantic National Bank v. New Jersey Department of Environmental Protection, 474 U.S. 494 (1986), the U.S. Supreme Court held that a "Bankruptcy Court does not have the power to authorize an abandonment without formulating conditions that will adequately protect the public's health and safety." Id. at 507. In other words, the "trustee may not abandon property in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards." Id. What Midlantic requires exactly is a matter of some debate, though.

A minority of courts have found that Midlantic prohibits the abandonment of property in violation of any applicable environmental laws. See In re Howard, 533 B.R. 532, 547 (Bankr. S.D. Miss. 2015). Under this view, any decommissioning obligations that are ripe would need to be met by a debtor before abandonment can occur. The majority of jurisdictions, however, have found that Midlantic only requires a debtor to ameliorateany identified and imminent harm to public health and safety. Id. at 545. Under this view, a party opposing abandonment must prove that there is an imminent harm to public health and safety before the court can require the debtor to address the issue.

Regardless of which interpretation of Midlantic is correct, a bankruptcy court must attempt to ensure that assets are brought into compliance with applicable statutes and regulations, or at least attempt to ensure that there is no imminent threat to public safety, before allowing the assets to be abandoned. Accordingly, courts applying Midlantic have held that decommissioning costs incurred by a third party are entitled to treatment as administrative expenses to the extent necessary to get the property into the condition required for abandonment. Because administrative expenses enjoy a higher priority than unsecured claims—which is how claims for abandonment costs would otherwise be prioritized—such claims are more likely to be paid.

When practicable, a debtor's lessors, joint-interest holders, and predecessors may want to take steps to maximize the amount of decommissioning costs that are paid by the estate. Such steps could include (1) filing a motion with the court requesting that it set aside additional funds for decommissioning costs or (2) paying the costs and then seeking reimbursement as an administrative expense. The preferred course of action will depend on the facts of the particular case.

Are the Debtor's Predecessors in Interest Responsible for Unfunded Decommissioning Obligations?

When funds from the estate and other sources like bonds and trust funds are insufficient to cover the costs of a debtor's decommissioning obligations, co-owners and lessors will want to consider whether the debtor's predecessors in interest are liable for the debtor's share of decommissioning costs. The party that assigned the abandoned interest to the debtor could be liable for unfunded decommissioning costs, as could any other prior owner of those interests, going back to the original contracting or purchasing party. Frequently, interests sought to be abandoned will have been assigned numerous times, and the chain of title for the interests may be complex.

If the operating agreements, leases, or other governing documents specifically address assignor liability, courts will generally enforce the language in the agreements. Where decommissioning obligations are owed to a governmental entity, there may be applicable statutes and regulations that address the issue. See, e.g., 30 C.F.R. § 256.1702. If the relevant agreements and laws do not address assignor liability, different common-law rules may apply. Courts will not ignore clear evidence of the parties' intent, but they will look to common-law rules regarding assignor liability as gap-fillers and in construing agreements without clear assignor liability provisions.

The courts that have considered the issue of assignor liability to date have found that at least some of a debtor's predecessors in interest remain liable for decommissioning or operating costs that an assignee does not pay. These courts have looked to the common-law assignor liability rules applicable to contracts and leases to hold that an assignor of interests in oil and gas assets is liable for costs that accrue while it is in either privity of contract or privity of estate with the obligee.

Seagull Energy E & P, Inc. v. Eland Energy, Inc., 207 S.W.3d 342, 347 (Tex. 2006), is the seminal case holding assignors liable for abandonment costs. In that case, the Texas Supreme Court ruled that an assignor remained liable for abandonment costs "because the operating agreement did not expressly provide that . . . the operating agreement should terminate upon assignment" and there was no express release of the assignor. Id. at 347. Wyoming has recently followed Seagull, and other courts that have considered the issue have reached the same conclusion. See Pennaco Energy, Inc. v. KD Co. LLC, 363 P.3d 18 (Wyo. 2015); Wold v. Diamond Res., Inc., 2011 U.S. Dist. LEXIS 115118 (D.N.D. 2011); Chieftain Int'l v. Southeast Offshore, Inc., 553 F.3d 817 (5th Cir. 2008).

There is some disagreement, however, as to whether the obligee may look to intermediate assignees—those who were assigned interests and then in turn assigned those interests to another party—to cover any unfunded decommissioning costs. Where interests have been assigned multiple times, intermediate assignees generally are liable only for obligations that accrued while they held an interest in the property, absent an express assumption of the obligation (at what point decommissioning costs accrue is a separate issue that is beyond the scope of this article). In other words, if the intermediate assignee is not in privity of contract with the obligee, it must be in privity of estate with the assignee to owe decommissioning obligations under the common law. In Texas, the Seagull court assumed that each assignee was in privity of contract with the obligee as a matter of law, regardless of whether each one signed a contract with the obligee. Texas appears to be in the minority on this issue, though. In other states, an intermediate assignee may not be liable for obligations that arose before the assignment or for obligations that arose after the intermediate assignee further assigned those interests to another party, unless it signed an agreement with the obligee or the obligee can enforce the assignment agreement as a third-party beneficiary. 4 Williams & Meyers, Oil and Gas Law § 403.

Although the courts that have decided issues of assignor liability for operating or abandonment costs to date have found that assignors are liable, there is an alternative common-law rule that some in the oil and gas industry have argued should apply instead. Under the assignor liability rule that applies to conveyances of real property, an assignor or conveyor is liable only for costs that accrue while it owns an interest in the real property.

The American Association of Professional Landmen (AAPL) and the Independent Petroleum Association of America (IPAA) filed an amicus brief with the Seagull court asserting that operating agreements in the oil and gas industry are based on a long-held assumption that assignors will not remain liable after assignment. In other words, they asserted that, prior to Seagull, the oil and gas industry had assumed that decommissioning costs were covenants that would run with the land. The AAPL claimed that each of the early form operating agreements it published was based on this assumption. The AAPL and IPAA also argued that applying the common-law contract or lease rule would

  • chill exploration and production activity;
  • result in an explosion of litigation;
  • result in limitless liability for far removed parties;
  • require expansion of the rights of prior owners to object to costs; and
  • create uncertainty as to financial and risk analyses.

We are not aware of any court to date that has adopted the AAPL/IPAA position, but parties should keep these arguments in mind if they are in one of the many jurisdictions that have not yet decided the issue of assignor liability for decommissioning costs.

Barring a court's adoption of the AAPL/IPAA position and the conveyance rule of assignor liability, at least some of a debtor's predecessors in interest will be on the hook for any unfunded decommissioning costs the estate does not pay. Co-owners and lessors responsible for decommissioning can seek contribution from predecessors in interest after costs are incurred or they can seek a declaratory judgment regarding liability beforehand so anyone ultimately liable can be involved in planning the decommissioning and cannot later claim the costs incurred were unnecessary or otherwise objectionable.

If a debtor seeks to sell assets rather than abandon them, lessors, co-owners, and predecessors in interest should carefully review any related pleadings and sale documents. In a bankruptcy scenario, a debtor or trustee may attempt to sell oil and gas interests to a third party free and clear of all liens, claims, and encumbrances pursuant to section 363 of the Bankruptcy Code. Plugging and abandonment obligations will not be extinguished under applicable law by such a sale. In re Rosbottom, 2010 Bankr. LEXIS 4305 (Bankr. W.D. La. 2010).

Oftentimes a debtor will provide for the treatment of such obligations in its plan of reorganization in a Chapter 11 case. Predecessors in interest should carefully scrutinize these provisions in the plan, however, as they often attempt to limit or discharge such liability. In addition to opposing the limiting or discharging of liability, predecessors should consider requesting that the debtor set aside funds, a letter of credit, or bonds to address current and future liabilities in connection with the implementation of the plan.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.