One of the hottest issues from 2016 was whether an E&P
debtor can reject, under section 365 of the Bankruptcy Code, an
above-market midstream contract. Given the potential for a
"no-win" situation, in all but one case where the issue
arose E&P debtors and midstream companies were able to settle,
often by entering into new midstream contracts upon mutually
agreeable terms that take into account the changed market
conditions since the downturn in commodity prices.
However, the bankruptcy judge in
Sabine Oil and Gas Corp. held that an E&P debtor could
reject its gas gathering agreements because its midstream
counter-parties could not establish that their agreements were
covenants running with the land under Texas law. The midstream
companies appealed to the U. S. District Court for the Southern
District of New York, hoping for a better answer. They did not get
Many were surprised by the opinions, given the billions of
dollars invested in necessary midstream infrastructure that was
built under the assumption that gathering, processing and
transportation agreements would bind the producer's successors.
The Sabine court was unsympathetic, and last month
affirmed the bankruptcy court's rejection orders. The midstream
companies' primary argument was that the dedication language in
the agreements were analogous to the conveyance of a royalty
interest in minerals "produced and saved". Thus,
Sabine's dedication must have conveyed a real property
interest. The district court was not impressed, and held that the
gathering agreements were mere service contracts, and Texas law did
not support a finding that they constituted a conveyance of mineral
rights or otherwise burdened the underlying leases.
The debate will continue. Sabine is not the end of the
argument that interests created by midstream oil and gas agreements
are covenants running with the land that can survive a
producer's bankruptcy. Why?
A Texas court has not yet ruled on
the issue, although at least one Houston bankruptcy judge has
commented that he would love the opportunity to set the record
straight for his New York colleagues. Given the complex issues of
state law involved in the interpretation of these agreements, there
is reason to believe that a Texas judge experienced in Texas
property law would rule differently.
Energy companies continue to
construct creative arguments that these agreements create real
property interests that cannot be shed in bankruptcy. Most
recently, in the Vanguard Natural Resources Corp. bankruptcy it has
been argued that the right to drill and develop acreage assigned
under a farmout agreement creates a covenant running with the land
that burdens the entirety of the lessee/farmor's undeveloped
acreage (Caveat: This is not a midstream situation).
Stay tuned. Whether these arguments hold water, and in which
contexts, is yet to be seen. What is clear is that midstream
companies will continue to innovate in their effort to protect
agreements in which they have invested millions of dollars, and the
producers will respond.
It's Holy Week, a time for musical interludes, one Jesusy but not churchy, one churchy. See you there.
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