United States: Deals Considered Bankruptcy-Proof Combust - Uncertainty Heightens for Midstream Gatherers and Processors After the Sabine Decision

Originally published by Metropolitan Corporate Counsel, May 2016

As the oil and gas industry continues to struggle in the face of the ongoing decline of commodity prices, a recent decision of the United States Bankruptcy Court for the Southern District of New York may have offered a glimmer of hope to upstream producers, while creating more uncertainty for midstream gatherers and processors and their lenders and investors.

Key Players and Agreements

Like many other oil and gas companies contemplating or already undergoing a restructuring pursuant to Chapter 11 of the Bankruptcy Code, Sabine Oil & Gas Corporation is an upstream energy company involved in the acquisition, production, exploration and development of oil and natural gas properties in the United States, otherwise known as an E&P company. Typically, an E&P company will enter into a lease with a landowner for the right to search for and extract minerals from the land. The lease may be a traditional surface lease or, in certain states, a subsurface lease giving rights to the underground property only.

After entering into such leases, an E&P company may conduct seismic testing, drill exploratory wells and engage in other exploratory activities to locate and extract minerals. Once extracted, the minerals will be transferred to a "midstream gatherer," which is a company that acts as an intermediary between the upstream gatherers and those "downstream," namely refining, marketing and distribution outlets. Pursuant to a gathering and processing agreement, a midstream gatherer will handle the storage and transportation of the raw oil and gas products.

After suffering significant losses because of continually declining commodity prices, in 2015 Sabine commenced a voluntary Chapter 11 bankruptcy case in the United States Bankruptcy Court for the Southern District of New York. Prior to this case, Sabine had entered into gathering and processing agreements with Nordheim Eagle Ford Gathering, LLC and HPIP Gonzales Holdings, LLC, two midstream gatherers.

Pursuant to the agreements with Sabine, Nordheim and HPIP agreed to build, at their expense, gathering systems of pipelines and treatment facilities for the gathering, treatment, disposal and redelivery of gases, liquid hydrocarbons and other liquids produced by Sabine from certain defined tracts of land owned or leased by Sabine. The agreements obligate Sabine to "dedicate" to the performance of such agreements all of the gas, liquid hydrocarbons and other liquids it produced from such tracts of land. They specify minimum amounts of gas and other minerals that Sabine is obligated to deliver to Nordheim and HPIP and, in the event Sabine does not deliver them, require Sabine to make deficiency payments to Nordheim and HPIP. Sabine is also obligated to pay monthly gathering fees to Nordheim and HPIP. Both gathering agreements have 10-year terms, with automatic renewal subject to termination, and are governed by Texas law. Both agreements expressly provide that they are covenants "running with the land."

Bankruptcy Court's Decision

Having determined that the gathering agreements had become financially burdensome, Sabine filed a motion to reject both agreements pursuant to Section 365(a) of the Bankruptcy Code. Section 365(a) of the Bankruptcy Code allows debtors-in-possession to assume or reject executory contracts to maximize the value of the bankruptcy estate. Thus, to avail itself of the advantages offered by Section 365, Sabine argued that the processing agreements were executory contracts and, therefore, Sabine could exercise its business judgment in rejecting them. In opposition, Nordheim and HPIP argued, among other things, that Sabine's obligations to "dedicate" all of the minerals produced from the designated tracts and to pay processing fees were covenants that "ran with the land" and could not be rejected even if the court found the other provisions of the agreements to be executory and subject to rejection.

On March 8, 2016, the bankruptcy court issued its decision on Sabine's motion, holding that the processing agreements were executory contracts that could be rejected in an exercise of Sabine's business judgment.1 The court analyzed Texas law and concluded that the processing contracts were not covenants running with the land as either real covenants or servitudes. Interestingly, the court found it to be determinative that under Texas law, once minerals are extracted from the ground, they cease to be real property and instead become personal property. Therefore, the products at issue were deemed not to "touch and concern" the land and were open to rejection under the Bankruptcy Code.

Ramifications and Risk

First, it should be noted that the Sabine decision is not binding to the extent that the court recognized that under Second Circuit precedent, it could not decide a disputed factual issue in the context of a motion to assume or reject an executory contract.2 The reason for this prohibition is that resolution of a motion to assume or reject was intended to be only a summary proceeding and does not allow for lengthy discovery or trial.

Second, a decision made by a bankruptcy court for one federal district is not binding on courts in another district and thus, even if it was a precedential decision by its terms, its reach would be limited to the Southern District of New York.

Third, the Sabine decision is based on its interpretation of property law in Texas, and property law varies, sometimes significantly, from state to state. Therefore, a midstream gatherer is well advised to not only compare the terms of its contract with those at issue in Sabine, but also to consider whether the state law governing its contract is materially similar to the Texas law applied in Sabine.

While the bankruptcy court's opinion in Sabine demonstrates that every motion to assume or reject a gathering and processing agreement should be decided on the facts of each specific case, the general structure of the agreements in Sabine is rather typical for gathering and processing agreements. As such, this decision will certainly encourage other E&P companies to follow Sabine's example and minimize their losses by rejecting no-longer-profitable gathering and processing agreements.

In fact, the Sabine decision was no doubt a factor in the recent resolution of a dispute between Quicksilver Resources, Inc. and its midstream partners regarding certain gathering and processing agreements for which rejection was sought in Quicksilver's pending bankruptcy in Delaware. In that case, the parties resolved the outstanding motion by entering into new long-term agreements as part of a sale of Quicksilver assets to BlueStone Natural Resources II, rather than allow the bankruptcy court to potentially follow the example set by the Southern District.

The Sabine decision and others that may adopt its reasoning will very likely influence many an oil and gas company's decision whether to seek bankruptcy relief. Conversely, it increases the likelihood that midstream gatherers will lose the protection of the required minimum payments, further affecting midstream companies' valuations and the credit risk assigned to such companies by their lenders. Thus, to avoid an outright rejection of their contracts in the context of an upstream counterparty bankruptcy, a midstream gatherer would be well advised to evaluate the likelihood of rejection based on the underlying state property law and, should it not be favorable, strongly consider renegotiating a new contract in the manner of Quicksilver.

1 In re Sabine Oil & Gas Corp., 2016 Bankr. LEXIS 1905, Case No. 16-11835 (Bankr. S.D.N.Y. 2016)

2 Orion Pictures Corp v. Showtime Networks (In re Orion Pictures Corp.), 4 F.3d 1095, (2d Cir. 1993).


Inez M. Markovich is a shareholder at Anderson Kill P.C., where she chairs the Banking and Lending practice. | imarkovich@andersonkill.com

Arthur R. Armstrong is an attorney at Anderson Kill P.C., participating in the Banking and Lending and Commercial Litigation practices. | aarmstrong@andersonkill.com


About Anderson Kill

Anderson Kill practices law in the areas of Insurance Recovery, Commercial Litigation, Environmental Law, Estate, Trusts and Tax Services, Corporate and Securities, Antitrust, Banking and Lending, Bankruptcy and Restructuring, Real Estate and Construction, Foreign Investment Recovery, Public Law, Government Affairs, Employment and Labor Law, Captive Insurance, Intellectual Property, Corporate Tax, Hospitality, and Health Reform. Recognized nationwide by Chambers USA for Client Service and Commercial Awareness, and best-known for its work in insurance recovery, the firm represents policyholders only in insurance coverage disputes - with no ties to insurance companies and has no conflicts of interest. Clients include Fortune 1000 companies, small and medium-sized businesses, governmental entities, and nonprofits as well as personal estates. Based in New York City, the firm also has offices in Ventura, CA, Philadelphia, PA, Stamford, CT, Washington, DC and Newark, NJ.

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
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions