Midstream Executory Contracts in Bankruptcy After Sabine Navigating - - PowerPoint PPT Presentation

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Midstream Executory Contracts in Bankruptcy After Sabine

Navigating Court Treatment of Transportation, Gathering and Processing Agreements; Negotiating Midstream Agreements

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, AUGUST 31, 2017

Eric M. English, Partner, Porter Hedges, Houston Denis A. (Archie) Fallon, Partner, King & Spalding, Houston

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Midstream Executory Contracts in Bankruptcy After Sabine

5 Eric M. English 713.226.6612 eenglish@porterhedges.com

EXECUTORY CONTRACTS IN BANKRUPTCY

• Section 365(a) of the Bankruptcy Code allows a

bankrupt debtor, “subject to the court’s approval,” to “assume or reject any executory contract”

• Three Options:

1)Assume 2)Assume and Assign 3)Reject

• The test for approval of assumption or rejection is a

“reasonable exercise” of its “business judgment”

6

EXECUTORY CONTRACTS

• An executory contract is a contract “under which

the obligations of both the bankrupt and the

• ther party to the contract are so far

unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the

• ther.”
• Shorthand: Both parties have remaining material

performance due under the contract

7

SABINE OIL & GAS CO.

• In Sabine Oil & Gas Co. (Bankr. S.D.N.Y.), Sabine sought to reject its

gas gathering agreements with midstream gathering pipeline companies.

• The agreements provided for the counter-party to gather gas and for

Sabine to pay.

• Sabine’s arguments supporting rejection:

1) rejection was a reasonable exercise of Sabine’s business judgment 2) the agreements required Sabine to deliver the minimum amounts of gas and, which they could not do, or pay certain deficiency payments

• The counterarguments against rejection:

1) the agreements couldn’t be rejected 2) even if they could be rejected, the gathering agreements contained “covenants that run with the land” which survive rejection

8

• On March 8, 2016, the Bankruptcy Court granted

Sabine’s motion and held that Sabine may reject the agreements because the gathering pipeline companies presented no evidence challenging Sabine’s business judgment

• The Court issued a non-binding opinion that the

gathering agreements should not be considered “covenants running with land” under Texas law

9

SABINE OIL & GAS CO. (CONT.)

SABINE OIL & GAS CO. (CONT.)

• Under Texas law, a covenant runs with land when:
• (1) it touches and concerns the land;
• (2) it relates to a thing in existence or specifically

binds the parties and their assigns;

• (3) it is intended by the original parties to run with the

land; and

• (4) the successor to the burden has notice.
• Some courts have also required “horizontal privity
• f estate,” which generally means “‘simultaneous

existing interests or mutual privity’ between the

• riginal covenanting parties either as landlord and

tenant or grantor and grantee.

10

• The Bankruptcy Court stated that the covenants at issue do not run with the

land for the following reasons:

• First, there was no horizontal privity of estate because Sabine did not

“reserve any interest” for the gathering pipeline companies; rather Sabine engaged the gathering pipeline companies to “perform certain services related to the hydrocarbon products produced by Sabine from its property.” Moreover, the gathering agreements did not grant any property rights in Sabine’s property, as a right to gather gas is not a fundamental property right under Texas law.

• Second, the covenants do not “touch and concern” the land because the

covenants do not “affect the owner’s interest in the property or its use.” Rather, the covenants concern Sabine’s interest in the products produced from the land. – The Bankruptcy Court later confirmed this ruling in an adversary proceeding.

11

SABINE OIL & GAS CO. (CONT.)

QUICKSILVER RESOURCES ; MAGNUM HUNTER

• Quicksilver Resources (Bankr. D. Del.)
• Buyer conditioned the acquisition of debtor Quicksilver’s assets on rejection of midstream

gathering agreements

• Rejection of midstream gathering agreements, if successful, would have resulted in

substantial unsecured claim of midstream companies against the estate

• The acquirer agreed to enter into a new contract with the debtor’s midstream pipeline
• perator, averting the need for the Bankruptcy Court to rule on the motion to reject
• Magnum Hunter Resources (Bankr. D. Del.)
• On March 10, 2016, the debtors in the Magnum Hunter Resources reached an agreement

to terminate gas transportation and credit support agreements between one of the debtors and its midstream pipeline partner

• Pursuant to the agreement, the gas transportation and credit support agreements will

be rejected and the midstream gathering company will be allowed a $15 million claim in the debtor’s chapter 11 case on account of the unfulfilled credit support agreement to provide letters of credit totaling $65 million

• On April 13, 2016, Magnum Hunter indicated that it reached an agreement to reject

agreements with another midstream pipeline partner. The terms of the resolution were not

• disclosed. On April 14, the Bankruptcy Court authorized the rejection.

12

IMPACT OF THE SABINE DECISION

• Impact on Midstream Companies: adversely impacts midstream gathering

pipeline companies that have contracted with exploration companies facing insolvency

– The value of pipeline and gathering facilities construction would be jeopardized if the agreements governing their use were rejected by the upstream exploration companies in bankruptcy

• Impact on E&P Companies: provides leverage to financially troubled

upstream exploration companies as they attempt to renegotiate agreements with gathering pipeline companies, giving them the leverage of a bankruptcy threat if their demands are not met

• Note: The applicability of the Sabine decision is somewhat limited where

non-Texas state law governs the relevant contract and related property rights.

13

The Impact of In re Sabine Oil & Gas Corp. and the Rejection of Agreements of Midstream Companies in Bankruptcy

Presentation by

Archie Fallon afallon@kslaw.com

August 31, 2017

King & Spalding LLP 1100 Louisiana, Suite 4000 Houston, Texas 77002

In re Sabine Oil & Gas Corporation, et al. Case

• No. 15-11835 (Bankr. S.D.N.Y.) – Pertinent Facts
• Sabine entered into Gathering Agreements with Nordheim Eagle Ford Gathering,

LLC (“Nordheim”) in 2014

―

Gathering Agreements state they are “covenant[s] running with the [land]” and are enforceable by Nordheim against Sabine, its affiliates, and their successors and assigns

―

Privity Issue – Gathering Agreements with Sabine, but mineral rights located in a specified geographical area in DeWitt County, Texas and owned by Sabine South Texas LLC, who was not a party to the Gathering Agreements

• Sabine did not convey any portion of its real property interests to

Nordheim through the Gathering Agreements

• The property subject to the Gathering Agreements was subject to preexisting liens

held by Sabine’s secured lenders

• Nordheim’s gathering fee was not secured

15

Sabine – Opinion Takeaways

• Gathering Agreements must be reviewed on a case-by-case, fact-

intensive basis

― Do covenants “touch and concern” or affect the

land?

• Is land “unburdened” by alleged covenant (e.g.,

minimum volume commitment)?

― Is there horizontal privity? ― What was the intent of the parties? ― Was the notice properly recorded? ― Is a conveyance of oil and gas interests necessary?

16

In re Quicksilver Resources Inc., Case No. 15-10585 (Bankr. D. Del.)

• Bluestone conditions $235 million acquisition of Quicksilver’s

Barnett Shale assets (mostly gas and NGL wells) on rejection of Crestwood gathering agreements

• Rejection of Crestwood gathering agreements, if successful, would

have resulted in substantial unsecured claim of Crestwood against debtor estate

• Quicksilver affiliates had developed gathering systems for three

formations, and Crestwood acquired those three gathering systems from Quicksilver affiliates for over $700 million in 2010

• Prior Quicksilver filings with SEC indicated that G&P contracts

would “survive any transfer” by Quicksilver

17

Quicksilver - Benefits of Structuring a Deal

Quicksilver / Blue Stone Benefits Crestwood Benefits Quicksilver closes sale - not forced to further delay closing through legal process for challenging property interest represented by dedication. Quicksilver withdraws motion to reject Crestwood’s legacy gathering agreements. Crestwood relationship continues - Substantial amount of Quicksilver revenue from nat gas and NGL production on acreage dedicated to Crestwood. Bluestone is financially sound, experienced Barnett Shale gas operator, known for growing production from existing wells at low costs Presumably, gathering fees are reduced “Production Assurance” – all shut-in wells return to production by 7/1/16 and will not shut-in or choke production through 2018 Gathering agreement terms extended from 2020 through 2026 No continuing credit exposure to Quicksilver

• Upside potential over long-term through

hybrid fixed fee / POP payment structure

18

Strategic Takeaways from In re Quicksilver for Asset Sales

• Post-Sabine, conditioning an asset sale on the rejection of

midstream contracts is a more powerful strategy for an E&P debtor, but fraught with dilutive risk for creditors

• E&P debtor should seek non-reimbursable deposit from

“conditional” asset bidder, discourages “wait & see”

• A robust process can generate backup bidders with

different views on G&P contract economics – backup bidder to Bluestone would buy assets subject to Crestwood contracts – more flexibility for E&P debtor and creditors

• G&P potentially willing to exchange short term MVC

economics for production growth, alignment in upside

19

In re Energytec, Inc., 739 F.3d 215 (5th Cir. 2013)

• Factually distinguishable from Sabine
• Pipeline system owner assigned its property rights to one

party but reserved “by covenant” for another party (an affiliate) the right to receive a fee for product transported through the pipeline and a right to consent to any assignment of that property

• Original seller sought to ensure the transfer of its property

interests did not eliminate an interest in the property of a third party

20

Energytec – The “Traditional Paradigm”

Mescalero (Original Owner)

Reservation of Rights/Covenant -- “Subject to” Transportation Fee & Right to Approve Future Assignments of Pipeline

Producer’s Pipeline Energytec/ Debtor NEWCO

Pipeline & Plant Sale

Red Water / Buyer

§ 363 Sale Are Transportation Fee and Assignment Approval Rights Covenants That Cannot Be Stripped in § 363 Sale? Sale Objection

21

Covenant Must “Run with the Land” – Tactics Based on Texas Case Law Element 1: Touches & Concerns Land

― Direct impact on land value and use ― Burden necessary, but not benefit ― Energytec: Agreement required beneficiary of

fee/burden to approve subsequent transfers – T&C element met

― Wimberly: Landowner’s contract to sell water to

• perator for gas compressor station lasted “so long as
• perator operated the plant” – T&C element met

― American Refining: Gas sales from “dedicated wells”

were sale of in situ minerals – T&C element met

22

“Run with the Land” Analysis

• Element 1: Touches & Concerns Land (Continued)

Energytec Sabine Considerations post-Sabine Security Transport fee secured by lien on pipeline system No security G&Pco seeks (subordinated) lien & files notice in county records Consent Rights on Transfers Beneficiary of pipeline fee had right to approve transfer of pipeline assets G&Pco did not have right to approve transfers

• f mineral estate

G&Pco has right to approve contract assignment Fee Trigger “Tied to Land” Payment of transport fee tied to gas flow directly from well Gathering fee trigger - “receipt

• f gas…into

Nordheim’s own facilities” A fee trigger “at the wellhead” might help legal analysis, but is it the business deal?

23

“Run with the Land” Analysis

Element 2: Relation to Thing in Existence (in esse) or Specifically Binds Parties & Assigns

• Beckham: Promise to construct

flume for irrigation, which was constructed, but not maintained

• But see Gulf: Fence that was to built,

but was never built

• Include schedule with particular

description of relevant facilities

24

“Run with the Land” Analysis

Element 3: Original Intent to Run with the Land

• Energytec: Include statement parties intend

for covenant to “run with the land”

• Include contract language that contract is

binding upon parties’ “successors and assigns”

• Evidence of intent is bolstered by filing the

agreement in county deed records

25

“Run with the Land” Analysis

Element 4: Successor to Burden Has Notice

• Constructive Notice – filing in

County records

• Actual Notice - acknowledgement

letter agreement between successor and G&P company, potentially addressing indemnity and release issues

26

THE “FIFTH” ELEMENT

Vertical / Horizontal Privity of Estate

• The “Traditional Paradigm” –

conveyance of real estate (surface, mineral, water rights), subject to reservation of interest

• On the other hand, a personal covenant,

such as a promise to provide utility service or environmental indemnity, does not involve a transfer of real estate, does not survive bankruptcy challenge

27

“Further Assurances”

• Many gathering agreements entitle G&P companies

to request producers provide further assurances related to creditworthiness and dedication of assets.

• Further assurances of creditworthiness –

information rights, parent guaranty, notices from lenders, approval of successors.

• Producer grant of security (liens, mortgages) in

mineral estate or other assets to G&P not historically market, but may be possible in some limited circumstances (see Energytec).

28

Williams / Chesapeake G&P Renegotiation in 4Q 2015

Utica Haynesville Fee Change Cost of services fee changed to fixed fee with minimum volume commitments Cost of services fee changed to fixed fee with minimum volume commitments achievable by collapsing two contract areas New Acreage / Wells 50,000 new acres – total of 190,000 net acres 140 new wells by end of 2017, Price Savings $.25 mmbtu $.20 per Mcf in 2016-17 $.30 per Mcf in 2018… Other published terms 250 mmbtu per day through Williams pipelines beginning in 2017 Term to last to 2035 Allows Williams to gather third party volumes and build scale in Utica dry gas areas

29

MVC - Further Questions to be Addressed

• MVCs are dilutive to creditors, and may

make a Midstream Contract more prone to rejection.

• Crestwood emphasized that its gathering

agreements with Quicksilver did not contain MVCs.

• MVCs without production risk may be

viewed as inconsistent with a real property interest or covenants running with land, may be viewed as unsecured borrowing and attacked by other creditors.

30

Forward Contract Issues

• Gas Purchase Contracts between producers

and midstream companies are typically “forward contracts”.

― future purchase of gas from leases

― midstream companies are “industry participants” ― delivery occurs on specified dates ― monthly account settlement

• Safe harbor under Bankruptcy Code for

settlement payments under Section 546(e).

• Drafting suggestions: payment settlement,

monthly setoff, liquidation clauses

31

Liability Continuation /Assignment Considerations

• Producer A assigns working interests in lease &

related gathering contract with G&P to Producer B

• Producer A does not obtain release of liability from

G&P

• Producer B files for bankruptcy
• Producer A potentially has continuing liability for

pre- and post assignment activities despite Producer B’s bankruptcy

• Seagull Energy E&P, Inc. v. Eland Energy, Inc., 207 S.W.3d 342 (Tex. 2006);

but note that certain federal bankruptcy courts have prevented litigation against co-

• bligors of bankruptcy estate, see e.g., In re Lazarus Burman Associates, 161 B.R.

891, 899-900 (Bankr. E.D.N.Y. 1993)

32