On May 3, 2016, New York bankruptcy judge Shelley Chapman issued a judgment in In re Sabine Oil & Gas Corporation which could dramatically shift the balance of power in favor of distressed energy and production companies renegotiating gas gathering and treatment contracts with midstream companies. Midstream companies would be well advised to explore restructuring and redrafting their contracts going forward.

Judge Chapman ruled that the dedication of hydrocarbons from specified mineral leases and associated acreage to midstream pipeline companies in gas gathering and treatment contracts at issue are not covenants running with the land under Texas law, despite the parties' agreement that they are. Previously on March 8, 2016, Judge Chapman had ruled that the debtor, Sabine Oil and Gas Corp, could reject, or breach, its gas treatment and gathering contracts with two midstream companies. Together, these decisions mean that Sabine has been released from the contracts and the midstream companies are left with unsecured claims for breach of contract.

What makes this case particularly significant is that the contracts at issue are similar to those used throughout the industry and, until now, were believed to be the type of contracts a debtor could not modify or escape in bankruptcy. Midstream companies collectively invest billions of dollars annually developing the infrastructure necessary to gather, process, and transport oil and gas. In exchange, they receive a promise of payment, if and when oil and gas is produced, and dedications of the hydrocarbons produced from the underlying oil and gas mineral interests and associated acreage. The parties intend the contracts to bind anyone who acquires the mineral rights in the dedicated area, so the contracts expressly provide that the dedications are covenants running with the land, and the contracts are recorded in the real property records. This serves to protect their substantial capital investment and protect the benefit of their bargain even if their counterparty files bankruptcy.

Or so they thought.

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