Oil and Gas E&P Bankruptcies: Tackling the Unique Complexities - - PowerPoint PPT Presentation

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Presenting a live 90-minute webinar with interactive Q&A

Oil and Gas E&P Bankruptcies: Tackling the Unique Complexities of E&P Restructuring

Navigating Characterization of Oil and Gas Leases Under Sec. 365, Treatment of JOAs in Bankruptcy, Lien Priority, and DIP Financing

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNESDAY, AUGUST 31, 2016

Sarah Link Schultz, Partner, Akin Gump Strauss Hauer & Feld, Dallas Randy W. Williams, Partner, Thompson & Knight, Houston

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TREATMENT OF OIL AND GAS LEASES IN BANKRUPTCY

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The Foundation of All Other Rights: the Oil and Gas Lease

 As a general rule, oil and gas leases are the foundation of all other rights an

• il and gas company has to explore for, produce, own, and sell the oil and

gas.

• The one exception to this general rule is that, occasionally, an oil and gas company

will own the actual mineral interest in the ground.

 In a typical acquisition agreement or mortgage, the oil and gas leases of the seller or mortgagor may be defined as follows:

• “Leases” – the oil, gas, and mineral leases described on Exhibit “A”, and any other
• il, gas, or mineral leases that are pooled or unitized with any of the Leases

described on Exhibit “A,” and any amendments, extensions, and/or ratifications affecting such leases, whether or not such instruments are described on Exhibit “A”, together with the leasehold estates (including all royalty interests,

• verriding royalty interests, net profits interests and similar interests) created

thereby and all interests derived from such leases in or to any pools or units that include any lands covered by any such leases or all or a part of any such leases or include any Wells, and all tenements, hereditaments, and appurtenances belonging to such leases and such pooled areas or units.

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The Oil and Gas Lease -

The primary transaction document precedent to virtually all U.S. oil and gas exploration and production activity

 Nature and Purpose

• Oil and gas leases are the foundation on which an E&P company’s house is built.

There is no “standard” form, and even those using preprinted “Producers 88” forms

• ften include amendments and/or addenda. Although there is great variance among

the specific terms of oil and gas leases, all share the same fundamental business purposes and are treated similarly in a bankruptcy.

• In an oil and gas lease transaction, the lessee seeks the right to develop the leased

land for an agreed term, with a right to develop, but as little obligation to develop as the law will allow.

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The Oil and Gas Lease -

Basic Economic Terms

 Bonus

• A bonus is an upfront payment for granting the lease – typically based on the number of net

mineral acres covered by the lease, but usually stated as a price per net mineral acre .

 Royalty

• Royalty is a cost-free fraction of the production sold from the lease.
• It generally ranges from 1/8 to 1/4, depending on market terms and competition, proximity to

known reserves, etc.

 Length of Term

• Primary and secondary terms
• If production is established during the primary term, the lease continues for so long thereafter as

it continues to produce in paying quantities. This is known as the “secondary term.” A lease that is being continuously maintained by commercial production is commonly referred to as “HBP” (meaning “held by production”).

• Delay rentals: Even in the primary term, some leases provide for an annual rental payment,

known as a “delay rental,” in order to maintain the lease in force if drilling has not been commenced during the preceding year. The delay rental is a special limitation on the grant – if not timely paid, the lease automatically terminates. Leases that do not include a delay rental provision are referred to as “paid-up leases.”

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The Oil and Gas Lease -

Other Key Terms

 Termination

• As a general rule, the oil and gas lease remains in effect for so long as there is

continuous commercial production from the leased premises.

 Commercial Production

• As a general rule, in order to continue a producing lease in force beyond its primary

term, the production must meet a “paying quantities” test.

• In the absence of express language in the lease, the standard for what constitutes

paying quantities is a matter of state law, and there are minor variances among the producing states; however, the basic rule is that operating the well must yield a profit to the lessee over a reasonable period of time (i.e., the production revenues must exceed the operating costs, without any regard to the capital expenditures made by the lessee in drilling the well).

 Savings Clauses

• Dry-hole or Operations Clause – gives the lessee a grace period to commence
• perations to restore production or drill a new well
• Shut-in Royalty Clause – allows the lessee to make a “shut-in” payment to keep the

lease in force when there is no market available for production (typically applies only to gas production)

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Classification of Interests Under an Oil and Gas Lease -

The Leasehold Interest, or “Working Interest”

 The leasehold interest refers to the interest granted to the oil company-lessee.

• It is similar to a mineral interest in that the lessee receives all incidents of the mineral interest,

except those reserved to the mineral owner (lessor).

 During the term of the lease, the lessee holds the right to use the surface, incur costs, and retain profits (subject to the lessor’s royalty).

• If unexpired lease of non-residential real property – be aware of time frame for assumption under

§ 365(d)(4).

• Frequently see prophylactic motions assuming oil and gas leases to avoid risk the oil and gas

lease is considered an executory contract

 Due to the cost-bearing nature of the leasehold interest, it is sometimes also called the “working interest” (or less commonly, the “operating interest”).

• One subtle distinction is that it is possible to have a contractual “working interest” without

actually owning title to the leasehold interest – that is, a lessee can bring in partners to share in the drilling of a well. Usually, the partner will get an assignment of an interest in the lease equivalent to its contractual interest in the costs, but not always.

 “Working Interest” – for any well or lease, that share of costs and expenses associated with the exploration, maintenance, development, and operation of such well or lease that the company is required to bear and pay.  In the simplest case where there are no co-owners or partners, the oil company is said to own a “100% working interest,” or “WI.”

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Classification of Interests under an Oil and Gas Lease - The Royalty Interest

 A royalty interest, or “RI,” is a right to receive a percentage of minerals produced from a property.  Generally, royalty interests are created when they are reserved by the lessor under the oil and gas lease.

• A lease may provide an owner with the right to take production in-kind, but most owners take their royalty in cash

based on revenues received for production.

• The royalty proceeds may be calculated on either actual proceeds received by the lessee, or market value (or in

some cases, whichever is greater).

 Royalty interests are non-possessory interests in real property.

• Real Property - Royalty interests are burdens on the operator’s leasehold estate (i.e., the operator’s right to

revenues attributable to production of minerals is subordinate to the rights of royalty owners). They are not simply contractual claims for revenues, and, as third party real property interests, they are not part of a debtor-

• perator’s estate.
• Non-possessory – However, because royalty interests are non-possessory, a royalty owner is dependent on an
• perator to account to the royalty owner for his or her share of revenues.

 Production in Paying Quantities:

• During the primary term of a lease, there is no obligation for the operator to produce minerals.
• During the secondary term, the operator must pay royalties when a property is producing in paying quantities

(i.e., when the operator can produce at a profit)

• The term of the lease continues if and for so long as there is production in paying quantities.
• If there is not production in paying quantities, the lease may terminate automatically, and possibly

without obtaining relief from the automatic stay

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Classification of Interests under an Oil and Gas Lease - NPRIs, NEMIs, ORRIs, NRI

 A “nonparticipating royalty,” or “NPRI,” is created when a mineral owner conveys away a portion of his royalty interest, but retains the executive right and the right to other lease benefits, such as bonus and delay rentals.

• Alternatively, he can retain only the executive rights, creating what is known as a

“nonexecutive mineral interest” or “NEMI.”

• Since NPRIs are carved out of the royalty estate, they generally have no economic

impact on the oil company’s interest.

 An “overriding royalty interest,” or “ORRI,” is like a royalty interest, except that it is carved out of the leasehold/working interest.

• Thus, unlike a nonparticipating royalty interest, an ORRI does reduce the economic

interest of the company.

• ORRIs are commonly created when a company sells a lease to another company,

but reserves an ORRI as part of the consideration.

 The “net revenue interest,” or “NRI,” refers to the oil company’s net share of production after the satisfaction of all royalties, overriding royalties, nonparticipating royalties, net profits interests or other similar burdens on, or measured by, production.

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Treatment of Royalty Interests in Bankruptcy

 Due to a royalty interest’s classification as a non-possessory interest in real property, a royalty owner’s interest survives a debtor-operator’s bankruptcy, but the royalty owner’s right to receive payment is subject to the bankruptcy process.  § 9.343 of Texas’ Uniform Commercial Code (“UCC”) provides that royalty

• wners are automatically-perfected secured creditors as to the proceeds of

production (which are considered personal property). The lien is treated as a purchase money security interest for priority purposes.

• The statutory lien typically attaches initially to the production possessed by the
• perator. When the operator sells the production in the ordinary course of business,

the lien attaches to the cash proceeds from the sale.

• However, at least one Delaware court has held that the security interest granted

under the Texas UCC does not apply to debtor-operators based in Delaware. As a result, royalty owners in such cases would be treated as unsecured creditors. See In re Semcrude, L.P., 407 B.R. 112 (Bankr. D. Del 2009).

 Because the royalty interest itself cannot be extinguished in bankruptcy, it will continue to burden the debtor-operator’s interest after it emerges (or, alternatively, the interest of a purchaser who acquires the applicable properties from the debtor-operator).

MIDSTREAM CONTRACT ISSUES

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Why Is There Uncertainty on This Issue?

 In prior downturns, the midstream space was largely owned and run by the producers.  There were long-term gas sales agreements, but largely at market prices.

• But, there were a few rejections in some take-or-pay settings.

 The rise of the MLP structure, along with the relatively cheap capital available for development of midstream assets, created opportunities for producers.  Midstream assets were developed by the producers where long-term volume commitments drove significant value creation for spinoff opportunities.  Thus, we now have a well-developed midstream sector that did not exist in prior downturns.  The foregoing factors and the significant drop in commodity prices created the perfect storm.

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Gathering Agreements – Main Features

 Seller commits to deliver gas from specified wells, leases, or areas at agreed delivery points to gatherer, and gatherer agrees to transport the gas to agreed redelivery/sales points. Issues like quality, pressure, and methods of measurement are specified.  Sometimes seller agrees to ship a minimum quantity over agreed time periods in order to assure gatherer of sufficient cash flow to amortize the construction costs of the pipelines and other facilities. If there is a shortfall in such minimum quantity, the seller pays the deficiency and sometimes is allowed to recoup that via ‘over deliveries’ in the future.

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Marketing Contracts

 Oil - Generally sold on short-term contracts. Can be marketed by trucking oil from tanks installed at or near the well or field, or via pipelines where there are significant quantities

• involved. Price is usually Platts with location and quality differentials.

 Gas - Generally sold on longer-term contracts, often to the end user or public utilities. Can be sold at any location around the United States, with the delivery to the buyer via intrastate or interstate pipeline systems. Even if contracts are longer term, price fluctuates based on spot (e.g. Henry Hub plus or minus X).  Processing - Gas often contains natural gas liquids (“NGLs”), which, if removed from the gas stream by processing and sold separately, result in greater realization to the producer (i.e., the value of the NGLs plus the residue gas stream is greater than just the value of the “wet” gas, even adjusted for heating (BTU) value adjustments).  Marketing contracts are often entered into by the “operator” of the well or field on behalf of the other working interest owners. The operator then collects the sales proceeds and distributes them to the other working interest owners, royalty owners, etc., after deducting taxes and sales expenses. [Note: There are significant hotly contested legal issues regarding what marketing expenses, if any, can be deducted from the royalty share of sales proceeds.]

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Purpose and Extent of Dedication

 Historically, the primary purpose of the “dedication” was to ensure that anyone who succeeded to the producer’s wells or leases would be burdened by the gathering agreement and would continue to perform under it.  Sometimes this “dedication” was reflected in a document filed in the real property records of the relevant county or parish in order to put any possible successor on notice of the dedication.  In some cases, this dedication language was said to be a “covenant running with the land.” In legal terms, a covenant running with the land is said to be a right and obligation that passes automatically when title to the land passes to a third party (i.e., it is not personal to only the party who originally was bound by it).

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Commitment/Dedication

 Seller’s commitment can be expressed in a number of ways:

• From specified wells
• From all wells on specified leases
• From all wells on specified leases, plus any other, or new, leases within a specified

area

• With a promise not to transport gas from such wells or areas to anyone else

 The language around this commitment is sometimes called a “dedication.”

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Introduction to Midstream Contract Issues in Bankruptcy

 Section 365(a) of the Bankruptcy Code provides that a debtor in a Chapter 11 proceeding has the right to reject executory contracts and unexpired leases, subject to certain exceptions.  The Countryman Rule provides that executory contracts are generally agreements that have continuing performance obligations for both parties to the contract (i.e., they have not been fully performed by both sides).  This presentation will examine whether midstream contracts, such as the typical oil and gas gathering and processing agreements are executory contracts that are subject to rejection by a bankrupt producer, or instead create real property-like interests “owned” by the midstream company (outside of the debtor’s estate) such that the rights of the midstream company cannot be avoided via a rejection action.

 See William Wallander, Bradley Foxman, John Napier & Casey Doherty, Energy Restructuring and Reorganization, Tex. Journal of Oil, Gas, and Energy Law, Vo. 10:1, App. B (2014-2015) (50-state survey on oil and gas leases as excutory contracts or unexpired leases).

• Texas: Fee interest
• Oklahoma: Real property interest (incorporeal hereditament)
• Pennsylvania: Executory contract (lease is a license; once minerals are found, it is a fee interest)
• North Dakota: Real property interest

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Bankruptcy Principles

 Assumption or rejection of an executory contract is typically accomplished by motion of the debtor- in-possession or trustee, subject to objection by other creditors and court approval. A motion to assume or reject an executory contract creates a contested matter, but it is typically handled more expeditiously than an adversary proceeding.  A debtor’s decision to assume or reject an executory contract is subject to review under the business judgment standard. Bankruptcy courts must approve a debtor's decision to assume or reject an executory contract, unless there is bad faith or a gross abuse of discretion. In other words, the court must decide whether the decision of the debtor is so manifestly unreasonable that it could not be based on sound business judgment, but only on bad faith, whim, or caprice.  However, other factors that courts may consider include whether (a) the contract burdens the estate financially; (b) rejection would result in a large claim against the estate; (c) the debtor showed real economic benefit resulting from the rejection; and (d) upon balancing the equities, rejection will do more harm to the other party to the contract than to the debtor if not rejected. However, absent a showing of bad faith or an abuse of business discretion, the debtor's business judgment will not be altered.  The debtor may assume or reject at any time before plan confirmation, provided that the bankruptcy court may order the debtor to act within a shorter time period. The debtor may reject an executory contract through a motion to reject under § 365(a) or through a provision in the plan of reorganization pursuant to § 1123(b)(2).  A party that assumes an executory contract must assume it in its entirety; it may not be assumed in part or rejected in part.

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Relevant Features of Midstream Contracts

 Midstream contracts often contain one or more of the following provisions

• Acreage, lease, or production dedications
• Statements that they create “covenants running with the land”
• Provisions for execution and recordation of a memorandum of the agreement

(assuming that they contain legally sufficient descriptions of the land covered)

• Minimum volume commitments (i.e., ship or pay)
• Provisions that they are binding on successors
• Obligations of the producer to grant the midstream company easements on or

across its oil and gas leases to facilitate laying of gathering pipelines or construction

• f other facilities

 Historically, one principal purpose of the “dedication” was to ensure that any successor to the producer’s wells or leases would be burdened by the midstream contract and would continue to perform under it.

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Texas Law on Covenants Running with the Land

 In Texas, there are several requirements of a “covenant running with the land” that have been set down in case law.

• The covenant must “touch and concern” the land.
• The covenant must be intended by the original parties to run with the land.
• The covenant must relate to something in existence or must specifically bind the parties and

their assigns.

• The successor to property burdened by the covenant must have notice of the covenant.

 Although there is some debate on the issue, generally there must be privity of estate between the parties to the agreement at the time the covenant is made – sometimes referred to as “vertical privity.”  Note: Some states follow the Texas rule; others do not require that all of the above factors be present.

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Circumstances Affecting the Analysis –

Examination of the exact language in the midstream contract is required

 What is dedicated—acreage, leases, land, wells, gas, or other rights? This is important because, for example, “gas,” after it is brought to the surface, is “severed” from the ground and is capable of delivery at a delivery point. Therefore, it is generally considered personal property, not real

• property. So, a mere dedication of gas or wells might not be sufficient to create a real property
• interest. In some states (including Texas), acreage or rights in oil and gas leases are considered

real property if properly described.  Does the language say that the dedication is intended to be a “covenant running with the land”? While not determinative alone, an affirmative statement on the point may assist the midstream company’s argument, while its absence may lead to an inference that the parties did not intend to create an interest in real property. Even if the statement is present, courts have examined several features of the issue to determine whether such a clause in a contractual setting does indeed create a covenant running with the land.  Is the midstream contract, or a short form/memorandum thereof, recorded in the real property records of the relevant county or counties?  Does the contract contain a legally sufficient description of the land “dedicated” under applicable state law in order to provide a valid property right?  Is there any language in the contract indicating an intent to “convey,” “grant,” or “transfer” any property right, given that, to create a property right, words indicating the presence of a grant are generally necessary?

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The State of the Law Before Sabine

 Normally, in the case of a midstream contract without a “dedication” and with no overt transfer of property rights, the contract would be executory in nature and could be rejected by the debtor in bankruptcy.  However, if a midstream company can successfully argue that its contract creates a dedication that qualifies as a covenant running with the land, what is the basis on which it can argue that its contract cannot be rejected?

• Prior Bankruptcy Cases: Midstream companies have relied on bankruptcy cases where

restrictive covenants (or deed restrictions) covering real estate were held to be rights in real property that were not subject to rejection in bankruptcy. The bankruptcy courts characterized the restrictive covenants as “covenants running with the land,” but that does not appear to be the sole basis on which the courts made their rulings—rather, they found that the restrictions were created at the time of, and as part of, a conveyance of real property and therefore were in the nature of real property interests.

• Therefore, the question is: Are the “dedications” in midstream agreements considered property

rights of the midstream company, which are not part of the debtor’s estate and therefore not capable of being rejected in bankruptcy?

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The Energytec Case

 The case of Newco Energy v. Energytec Incorporated (2013) concluded that a sale of a pipeline system and processing plant out of bankruptcy by the debtor, Energytec, was not free and clear of a transportation fee to be paid to a predecessor owner of the pipeline system because the right to the transportation fee was a covenant running with the land. The 5th Circuit Court of Appeals (applying Texas law) found that:

• The agreement to pay the fee satisfied the five-part test of a covenant running with the land, partly because it

affected the value of the land sold as part of the pipeline system.

• Requisite privity was found to exist between the buyer and the holding of the right to the transportation fee (i.e.,

the agreement to pay the fee was not personal to the original owner) due, in part, to the fact that the agreements creating the fee had all been recorded in the real property records.

 However:

• The case involved the creation of the right at the time of the sale of a pipeline system itself, which is, in part,

made up of right-of-way and real property interests.

• Although not mentioned in the opinion, the holder of the right to the fee also had recorded a lien and security

interest to secure the payment of the fee.

• The payment obligation relating to the fee for transportation burdened the pipeline owner, and the payment
• bligation was as partial consideration given for, and at the time of, the conveyance of the pipeline system, which

included real property, from the payee to the pipeline owner/payor.

• Energytec was not faced with a “rejection” situation, but rather a “sale free and clear” situation under Section 363
• f the Bankruptcy Code.
• It did not involve an upstream acreage “dedication” situation, so it is not directly on point.
• Finally, the 5th Circuit remanded the case to determine whether the right to the transportation fee could be

extinguished in a qualifying proceeding where a determination would need to be made of the value required to extinguish the holder of the right to the fee under Section 363(f)(5) of the Bankruptcy Code.

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The Sabine Case

 In early 2016, the debtors in Sabine sought to reject midstream contracts with HPIP Gonzales Holdings LLC and Nordheim Eagle Ford Gathering LLC.  In March 2016, Judge Shelley Chapman entered an order rejecting the Sabine midstream

• agreements. However, she declined to opine as to whether the midstream agreements created a

covenant running with the land, noting that applicable 2nd Circuit law required an adversary proceeding for such declaratory relief.  This left the debtor in a quagmire regarding future production—with the current midstream contracts rejected, but no ruling on whether the dedications contained in the agreements continue or were terminated along with the rejection, it was impossible to enter into new midstream contracts with a third party. Recognizing this, Judge Chapman provided a preliminary or advisory opinion indicating that the debtors were not in horizontal privity with the midstream companies. Additionally, Judge Chapman found that, because the agreements provided that the midstream companies would receive the gas at certain points located away from the wells and that the fee for their services would be triggered at these receipt points, the subjects of the agreements were minerals that had already been severed from the ground (i.e., personal property). As a result, she held that the agreements did not touch and concern the land and did not create real property interests. In May 2016, Judge Chapman issued a final ruling in the Sabine proceedings consistent with her preliminary ruling.  The midstream providers appealed Judge Chapman’s final ruling and sought to stay the bankruptcy court’s order, arguing that these are unsettled issues of state law with the potential for significant repercussions in the oil and gas industry. Both the debtors and the midstream providers are seeking direct appeal to the 2nd Circuit, and the midstream providers have requested certification

• f the legal issues of state law to the Texas Supreme Court. These requests remain pending as of

the date of writing.

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Other Bankruptcy Issues

 Rejection of a contract not assumed constitutes a “breach” immediately before the date of filing of the petition.  Rejection makes the other party to the contract simply an unsecured creditor. The nondebtor party has (1) a claim against the debtor for damages for breach of contract, which claim is deemed to have arisen immediately before the filing of the petition and is a prepetition claim, and (2) an expense of administration claim for any benefits received by the debtor-in-possession prior to rejection.  The amount of the damages may be controlled by state law and/or the remedies specified in the contract.

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Rejection Risks

 To the extent that a producer successfully rejects a midstream contract, the producer may find itself in a dangerous situation vis-à-vis its ability to continue to hold its oil and gas leases. For example, even if the producer can access another market, doing so may take time, during which it may be shut-in.  Most leases provide that, once production is obtained, it must continue without interruption with certain limited exceptions, usually for only events beyond the control

• f the producer.

 Therefore, a rejection that results in a loss of a market for the producer’s gas, even for a short period of time, creates a substantial risk that the producer may forfeit its oil and gas leases where its reserves are located.  The automatic stay, which prevents counterparties from terminating agreements pre- emptively, does not apply to the typical oil and gas lease that terminates by operation

• f law (i.e., automatically, without any action by the oil and gas lessor).

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Commercial Considerations

 Given the unique nature of many of these gathering and processing systems, it is likely that the counterparties will still be incentivized to work together due to the critical need for cash flow on both sides.  Contract renegotiations will turn on the leverage of the parties involved, particularly whether the producer can survive a shut-in (harming cash flow and potentially putting its oil and gas leases at risk) or has another way to move or process its hydrocarbons.  Practically speaking, it is important to analyze what alternative a producer has to continue its production if the midstream contracts are rejected and how likely is it that another midstream company could offer midstream services at a more competitive rate for a new build system vs. existing (sunk cost) infrastructure.  Finally, it is likely that midstream companies and their financing partners will start to think about ways to mitigate this rejection risk on a going-forward basis via security requirements and contract structuring.

FINANCING ISSUES AND LIEN PRIORITIES

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Valuing the Collateral Package – Reserves and Reserves Reports

 Reserves: oil and gas that is yet to be produced, but that is viable to produce under existing economic and technological conditions.  Reserve reports: estimates of a company’s reserves put together by petroleum engineers and geologists (either the company’s or a third party’s) in accordance with industry standards; reserves are categorized based on the degree of uncertainty related to their ultimate recoverability.  Reserves report vs. reserves audit  When are reserve reports required?

• Common for public companies to include with annual report on Form 10-K
• Reserve-based loans and borrowing base-determinations
• In connection with transactions

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Valuing the Collateral Package – Reserves and Reserves Reports

 Basic contents of reserves reports:

• Estimated quantities of oil and gas (and NGLs)
• Discounted cash flow analysis of future income stream expected to be generated from a

sale of the reserves

 What a reserve report is not:

• An exact quantity or precise measurement of volumes or net cash flow
• A valuation report, fairness opinion, or appraisal of fair market value

 Factors that can impact values shown in reserves reports:

• Estimates and judgment
• State of technology
• Price deck used for DCF analysis
• Discount rate used for DCF analysis
• Any value given for undeveloped acreage/“upside”?

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Valuing the Collateral Package – Reserves and Reserves Reports

 Two basic categories of reserves  Proved reserves and unproved reserves

• Types of proved reserves:

■ Proved Developed Producing (“PDPs”): most valuable type of reserves ■ Proved Developed Non-Producing (“PDNPs”): additional completion work required before these reserves can be produced ■ Proved Undeveloped (“PUDs”): proved, but major capital expenditures required to convert to producing reserves

• Types of unproved reserves:

■ Probable Reserves: “more likely than not” (>50%) ■ Possible Reserves: “low probability of recovery” (>10%)

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Oil & Gas Debt Financing - Overview

 Financing Alternatives/Arrangements

• Revolving credit facilities
• Term loans
• Bonds
• Hedges

 Syndicated Credit Facility

• Parties: administrative agent/bank group/loan parties
• Borrowing base (reserves), usually determined twice per year, with an optional

redetermination; based off reserve report.

• Typical Covenant Package: credit agreements usually include affirmative, negative, and

financial covenants that, without consent of banks, may restrict refinancing options.

• Hedging: E&P Debtors hedge production to reduce commodity price risk; usually the

hedge counterparties are part of the bank group and share in the collateral.

 High Yield Bonds

• Parties: trustee/noteholders/issuer(s) and guarantee obligors
• Typical covenant pckage: indentures usually include only negative covenants, making them

more flexible (from the debtor’s perspective).

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Oil and Gas Debt Financing – Overview

 Security Package

• Pure Reserve Backed Loans vs. “All Assets” Loans: The collateral supporting the loans may

be limited to reserves (and property deriving from the reserves) or include substantially all personal property of the Debtor.

• Mortgages and Security/Pledge Agreements: To create the security interest, the debtor and

the administrative agent will enter into an agreement specifying the collateral and the secured

• bligations.
• Perfection/Recording: To complete the securitization process, the security interests must be

perfected or, in the case of real property security interests, recorded.

 Intercreditor Arrangements

• First-Lien/Second-Lien; Pari Passu Intercreditors: Rather than relying on priority rules under

the UCC or state law, creditors will contractually agree on lien priority (and other issues arising with respect to the collateral).

• Subordination: Typically, creditors will agree that the liens supporting the junior debt are

subordinated to the senior debt, but not that the right to payment is subordinated.

• Typical Provisions: Intercreditor agreements usually provide for a standstill period and certain

rights and obligations in insolvency proceedings, and they may also provide for caps on priority debt and debt purchase rights.

37

Oil and Gas Financing – Restructuring/Insolvency

 Current Topics

• Liability Management: retiring or refinancing debt to reduce debt on the balance sheet,

lower interest payments, or take advantage of deep discounts in debt trading prices

• Exposure Management: lenders looking to curtail drawdowns by introducing anti-hoarding

provisions as part of amendments

 Refinancing

• Cleaning up the balance sheet (a/k/a capturing the discount)
• Lengthening the runway
• Strategies/issues

■ Purchasing debt in the market/tender offers ■ Asset sales ■ Exchange offers (up-tier) ■ Cancellation of debt income

 Petition Filed: Who is secured with what?

• Personal Property (UCC): lien review memorandum, review security agreement, and

perfection requirements, including UCC filings

• Real Property (state law): review mortgage and recordings

38

Oil and Gas Debt Financing - Deficient Mortgage Issues

 At the outset of the bankruptcy process of an oil and gas company, interested parties undertake a comprehensive review of all mortgages executed by the debtor.  The most valuable properties owned by an oil and gas company are real property interests (i.e., oil and gas leases, mineral fee interests, wellbore interests, surface interests, rights-of-way, and fixtures). All of the debtor’s rights to oil and gas stem from these real property interests.  Bankruptcy Code section 544(a) gives a debtor special powers to defeat the secured-party status of certain creditors (such powers are typically referred to as “strong arm powers”).

• Specifically, § 544(a)(3) gives the debtor the ability to assume the status of a

hypothetical bona fide purchaser of real property owned by such debtor who has constructive notice of all matters of record affecting such real property.

 In essence, a hypothetical bona fide purchaser under § 544(a)(3) is a purchaser who, under state law, is deemed to have conducted a title search (but does not have actual notice of any unrecorded interests), paid value for the property, and properly recorded an instrument setting forth its ownership interest as of the date of the commencement of the case.

39

Deficient Mortgage Issues

 Based on the debtor’s status as a hypothetical bona fide purchaser, the debtor will have superior title to lienholders who did not properly record or perfect their liens as of the bankruptcy filing date and thus will be allowed to avoid any such unrecorded or unperfected liens as of the bankruptcy filing date.  The determination of whether a creditor has properly perfected its liens is governed by state law. See, e.g., Stanton v. Texas Drug Co. (In re Stanton), 254 B.R. 357, 361-62 (Bankr. E.D. Tex. 2000).  Thus, a threshold question under § 544(a)(3) is whether, under the property law of the state where the properties are located, the liens in question may be defeated by the hypothetical bona fide purchaser.  As part of its preparation for the filing of a voluntary case under Chapter 11, a debtor often analyzes its debt instruments, mortgages, and other instruments of record-creating liens on its properties in order to make an informed decision as to whether to exercise its § 544(a) strong-arm powers.  The debtor will then prepare a report setting forth its conclusions.

40

Deficient Mortgage Issues

 Since the unsecured creditors usually stand to benefit from the avoidance of any liens under § 544(a), the creditors’ committee often requests access to the report prepared by the debtor; undertakes its own independent review of the debt instruments, mortgages, and other instruments of record; and shares its conclusions with the debtor.  If the debtor does not exercise its § 544(a) powers, the Bankruptcy Court may, at the request of the committee, grant authority and standing to such Committee to prosecute claims under § 544(a) on behalf of the debtor’s estate.  Typically, the lienholders will also undertake their own independent review of the mortgages and other instruments of record in order to identify weaknesses and strengths in their lien packages and prepare for a potential dispute.

41

Examples of Liens that Could Be Defeated under Texas law

 Mortgages that were not recorded in the county in which the property is located:

• § 13.001(a) of the Texas Property Code states that “a mortgage or deed of trust is

void as to a creditor or to a subsequent purchaser for a valuable consideration without notice [i.e. a bona fide purchaser for value] unless the instrument has been acknowledged, sworn to, or proved and filed for record as required by law.” TEX.

• PROP. CODE ANN. § 13.001(a).
• Generally, an instrument that is properly recorded in the proper county is notice to

all persons of the existence of the instrument. TEX. PROP. CODE ANN. § 13.002.

• Thus, a mortgage that was properly recorded in the county where the property is

located and properly identifies the property in question will defeat the hypothetical bona fide purchaser.

• However, a mortgage that was not filed in the applicable county will be subject to

attack under § 544(a)(3) even if it properly describes the properties in question.

42

Examples of liens that could be defeated under Texas law

 Mortgages that were recorded in the applicable county, but did not properly describe certain properties:

• Generally applicable conveyancing rules govern mortgages and deeds of trust.
• A mortgage, deed of trust, or other contractual lien on real estate falls within the

statute of frauds. TEX. BUS. & COM. CODE ANN. § 26.01(a), (b)(4); West v. First Baptist Church, 71 S.W.2d 1090, 1100 (Tex. 1934); Edward Scharf Assocs., Inc. v. Skiba, 538 S.W.2d 501, 502–503 (Tex. Civ. App.–Waco 1976, no writ).

• To satisfy the statute of frauds, a mortgage or deed of trust must furnish within itself,
• r by reference to some other existing writing, the means or data by which the

property to be mortgaged may be identified with reasonable certainty. See Long Trusts v. Griffin, 222 S.W.3d 412, 416 (Tex. 2006).

• A legal description affords the means of identifying the land. Morrow v. Shotwell,

477 S.W.2d 538, 539 (Tex. 1972).

• A mortgage in the chain of title that does not sufficiently identify the property made

subject to the lien is ineffective to create a mortgage lien on the property. See Greer v. Greer, 191 S.W.2d 848 (Tex. 1946); Holloway’s Unknown Heirs v. Whatley, 131 S.W.2d 89 (Tex. 1939).

• The intent of the parties concerning the identification of the land conveyed and its

boundaries is determined from the face of the mortgage in light of surrounding

• circumstances. Stafford v. King, 30 Tex. 257 (Tex. 1867).

43

Deficient Mortgage Issues – Blanket Lien Clauses

 Many mortgages contain “blanket” provisions that attempt to create a lien on all real property interests of the mortgagor in a county, state, or other clearly defined area.  In Texas, global or blanket descriptions of all of the grantor’s real property, wherever located in a specified city, county, or state, are sufficient to satisfy the statute of frauds, even if other tracts are also specifically described. Witt

• v. Harlan, 2 S.W. 41 (Tex. 1886).

 Specifically in the context of oil and gas leases, under Texas law, a grant of all of a transferor’s interests located within a clearly defined area, such as a named state or county, is sufficiently descriptive to effect a conveyance. Texas Consol Oils v. Bartels, 270 S.W.2d 708, 712 (Tex. Civ. App. 1954).  A blanket provision should be carefully drafted.  Not all mortgages executed in connection with oil and gas loans contain blanket provisions. If a mortgage does not contain a blanket provision or if the blanket provision is deficient, such mortgage may be subject to attack under § 544(a) if the mortgage does not expressly describe certain oil and gas leases and/or other real property interests.

44

Deficient Mortgage Issues – Blanket Lien Clauses

 Oil and gas mortgages typically include express descriptions of the oil and gas leases and, in some but not all cases, the wells drilled on such leases.  However, it is not uncommon for parties to have inadvertently missed some oil and gas leases owned by the debtor.  Also, mortgages may become outdated if the debtor acquires new oil and gas leases after the mortgage is filed.

 Such new leases would not be subject to the mortgage.  Although mortgages commonly contain “after acquired” property provisions (i.e., provisions that attempt to capture all properties acquired by a mortgagor after the execution of the mortgage), it is not clear whether such provisions are enforceable, since they may not satisfy the statute of frauds.

 Furthermore, some mortgages do not expressly describe surface interests, rights-of- way, and fixtures associated with the gathering lines and facilities used by the debtor.  Finally, a mortgage will be subject to attack under § 544(a) if the mortgage incorrectly describes the oil and gas and other interests (e.g., if the mortgage sets forth incorrect recording references, instrument dates, lessor/lessee or grantor/grantee information,

• r incorrect or conflicting descriptions of the underlying properties subject to the oil and

gas leases or mineral or surface fee interests owned by the debtor).

45

M&M Liens

 Mechanic’s and materialman’s (M&M) liens are granted by state statute to parties who provide work or materials to upstream companies

• Characteristics, duration, perfection requirements, scope, and other features vary by

state.

• See William Wallander, Bradley Foxman, John Napier & Casey Doherty, Energy

Restructuring and Reorganization, Tex. Journal of Oil, Gas, and Energy Law, Vol. 10:1, App. D (2014-2015) (50 state survey on M&M liens).

 Some states have adopted statutes that specifically grant M&M liens to oil and gas vendors (e.g., Colorado), while others apply general M&M lien statutes to such parties (e.g., Texas).  The scope of the liens that encumber a property varies

• For example, in Texas and Colorado, M&M liens attach to a working interest owned

by the operator, but not to a well’s production.

• Other states provide that M&M liens attach to the oil and gas produced (e.g., Utah,

Oklahoma, and Nebraska).

46

M&M Liens - Perfection

 In all cases, M&M liens must be perfected to have priority over liens attaching to property interests held by other creditors.

• Lien indices vary by state. Most have a grantor/grantee system that can be searched by owner name, but some states

have a tract system, which must be searched by property description.

 Bankruptcy Code section 546(b) permits perfection:

• Against an entity that acquires rights in such property before the date of perfection
• To maintain or continue perfection, against an entity that acquires rights in the property before the date on which

action is taken

 A § 546 notice should be filed by M&M lien creditors to perfect the lien where seizure of property or commencement of an action is required for perfection.  Post-petition perfection of M&M liens is permitted under an exception to the automatic stay under § 362(b)(3).

• Most M&M statutes provide that perfection looks back to the time that work began or supplies were delivered if

the lien is filed correctly and within the statutory period.

• But ONLY if state law provides that an intervening BFP for value would be subject to such liens.
• In Texas, that is the case. In Mississippi, for example, it is not.

 Texas and Louisiana “relation back” statutes provide an opportunity to prime competing perfected interest in that the M&M lien priority relates back to the time that the M&M claimant first provided work on the well.  Lawsuit to foreclose a lien need not be filed (in most jurisdictions).

• Time to foreclose is tolled by 11 USC § 108(c).
• But see In re Warren, 192 F.Supp. 801 (W.D. Wash. 1961) (probably not good law).

47

JOA and First Purchaser Liens

 Parties to a JOA (joint operating agreement) often seek to have their rights secured by contractual liens.

• The form JOA promulgated by the AAPL (American Association of Professional Landmen) provides for such

consensual liens.

 These contractual liens are not automatically perfected.

• Such liens must be perfected under applicable state law.

■ Realty: Record an Executed, Acknowledged Memorandum of the Operating Agreement in the Appropriate Land / Mortgage Records. Exhibit to AAPL Form JOA ■ Record in All Counties Where the Property is Located ■ Personalty: File a UCC-1 Financing Statement with the Secretary of State in the Counterparty’s State of Incorporation

• As a result, other liens may pre-date or otherwise be superior to JOA liens.

 The “first purchaser” is typically the midstream company that purchases the oil and gas at the wellhead so that it can process and resell to a downstream company

• First purchaser lien statutes provide that a producer or royalty interest owner has a statutory lien against the oil

and gas transferred to the first purchaser until the producer or royalty owner has been paid.

■ See William Wallander, Bradley Foxman, John Napier & Casey Doherty, Energy Restructuring and Reorganization, Tex. Journal of Oil, Gas, and Energy Law, Vo. 10:1, App. C (2014-2015) (50-state survey on first purchaser and royalty liens).

• The Kansas and Texas first purchaser lien statutes were challenged in Arrow Oil & Gas, Inc. v. SemCrude, L.P.

(In re SemCrude, L.P.), 407 B.R. 112 (Bankr. D. Del. 2009), where the court held that the debtors’ secured lenders had priority over first purchaser liens, because, as a result of conflicts of law issues, the first purchaser liens were not automatically or properly perfected under Delaware or Oklahoma law (the states in which the debtors were formed)

■ Practice Tip: File UCC to perfect statutory producers lien in the producer’s state of incorporation.

48

The Perfection of JOA Rights Also Perfects Your Relinquished (Non–Consent) Interests

 Other Rights Under the JOA (if Recorded) May Qualify as Burdens on Title, Not Subject to Rejection

• Important to do to Recover Non-Consent Penalties and to Prime Bank

Liens on such Relinquished Interest (May also Work if JOA Referenced in Assignment to Counterparty). Determined according to applicable non- bankruptcy law, character of O&G lease

• TransTexas Gas Corp. v. Forcenergy Onshore, 2012 WL 1255218 (Tex.
• App. – Corpus Christi); April 12, 2012 (No. 13–10–00446–CV), review

denied (Nov. 16, 2012) (non–consent interest not part of debtor’s estate).

• Merely “Personal” Contractual Rights or Burdens on the Debtor’s Title to

Real Property i.e. covenants running with the land

• TX – Real Covenants Touch and Concern the Land and Are in the Chain
• f Title 365, 363

49

Perfect Your Producers Liens

• Following bankruptcies of Basin, Inc., Brio Petroleum, Inc., Compton

Petroleum Corp., and Gratex Corp. in 1982. The states of Texas, Oklahoma, Kansas and Wyoming enacted statutory producers’ liens. These liens protect sellers so that the seller will have a secured claim for hydrocarbons sold but not paid as of the filing. (New Mexico had previously enacted one in 1973).

• Importantly certain states allow these security interests to be treated as

purchase money security interests (“PMSI”). As you may recall from law school, a PMSI is a security interest or claim on property that enables a lender who provides financing for the acquisition of goods or equipment to

• btain priority ranking ahead of other secured creditors. Since the producer

is the one actually furnishing the goods in this case the oil or gas, it is logical that producer have a PMSI in such goods and the proceeds of their sale.

50

Perfect Forced Pool Unit Liens

 Certain States Grant Operators Statutory Liens on Participating Interests in Forced Pooled Units e.g. Oklahoma  Must Perfect Statutory Liens in Accordance with Applicable Law

• For Statutory Liens on Force - Pooled Units, Usually Requires the Filing of

Record the Order Approving the Unit

51

A mineral contractor’s lien may or may not provide a defense to a preference action

 Rule: Payments to secured creditors are not preferences.  If contractor receives payment PRIOR to filing the lien, is it a preference?

• No. Cimmaron Oil Co. v. Cameron Consultants, Inc., 71 B.R. 1005 (N.D.
• Tex. 1987).
• Cimmaron criticized but followed in Rand Energy Co. v. Strata Directional

Tech., Inc. (In re Rand Energy Co.), 259 B.R. 274 (Bankr. N.D. Tex. 2001).

• BUT see Baker Hughes Oilfield Operations, Inc. v. Cage (In re Ramba,

Inc.), 416 F.3d 394 (5th Cir. 2005) (rejecting Cimmaron as being contrary to the statute). ■Might be dicta?  If you file the lien PRIOR to accepting payment, it is NOT a preference.

52

How to View Bankruptcy Pleadings

53

Reservation of Rights Language

 Notwithstanding any other provision of the Plan, Plan Related Documents or this Confirmation Order, (i) the “Eagle Point Agreements” and the “Trout Point Agreements,” as such terms are defined in this Court’s Order (1) Pursuant to Motion filed July 28, 1999, Authorizing the Transfer and Conveyance to Bluegrass Petroleum of Certain Assets Free and Clear of Liens and Encumbrances; and (2) Pursuant to Motion filed October 18, 1999, (a) Approving the Amendment and Assumption of Certain Operating Agreements and Exploration Corp; (b) Ratifying the Termination of Certain Operating Agreements and Exploration Agreements with Bluegrass Petroleum; (c) Approving an

54

 Agreement with Bluegrass Petroleum Concerning the Drilling of the Trout Point Prospect; (d) Authorizing the Transfer, Conveyance and Assignment of Certain Properties to Bluegrass Petroleum Free and Clear of Liens, Claims, Charges and Encumbrances; and (e) Directing Turnover of Pre-Petition Funds owed by Bluegrass Petroleum, dated November 30 1999 (the “November 30 Order”), and, and (ii) the “Amended Agreements,” as such term is defined in the Order Authorizing ________ Corporation to Sell Certain Assets Free and Clear of Liens and Encumbrances Pursuant to 11 U.S.C. § 363 and to Enter into Certain Related Transactions, dated February 2, 2000 and (iii) the rights set forth in the Eagle Point Agreements, the Trout Point Agreements and the Amended Agreements shall be unaffected by the terms of the Plan, the Plan Related Documents or this Confirmation order. In the event of any inconsistency between the November 30 Order and the Plan, the Plan Related Documents or this Confirmation Order, the November 30 Order shall be controlling. In the event of any inconsistency between this Paragraph 22(J) and any other provision of this Confirmation Order, this Paragraph 22(J) shall be controlling.

55

But that’s illegal

Republic Supply v. Shoaf, 815 F2d 1046 (5th Cir. 1987) Bankruptcy court confirmed a plan that released a third party guaranty in favor of Republic Bank. Republic Bank sued guarantor and guarantor argued res judicata barred the claim. Fifth Circuit admitted release of guaranty exceeded statute’s authority but Republic Bank did not object or appeal confirmation order. Res judicata.  If fail to object to motion, waive your rights.  Short appellate period – After 14 days, order is final.  If fail to timely appeal, waive your rights.  If fail to obtain a stay and plan is consummated or sale closed, appeal may be moot.

56

Operating Agreements are (usually) Executory Contracts

 OA is almost always an executory contract under § 365.

• Must be assumed or rejected by the debtor.

 OA usually includes contractual liens.

• Effect of lien cannot be avoided by rejection.
• BUT lien can be avoided if not recorded.
• ALWAYS record the OA (or a memorandum of it).
• If not recorded, all is not lost:

■May be in chain of title ■May argue recoupment  Timing of assumption or rejection?

• Not addressed by the Code.
• “Twilight zone” is time between filing and assumption or rejection.

■Wilson v. TXO Production Corp. (In re Wilson), 69 B.R. 960, 963 (Bankr. N.D. Tex. 1987)

57

 Is the OA operative during the Twilight Zone?

• Rule of law: Enforceable by the Debtor but not against the Debtor.

■NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984). ■But Debtor must pay the reasonable value of services received prior to assumption or rejection. 465 U.S. at 531. ■Bildisco rule is unworkable in context of oil & gas property.

• Perhaps governed by “rule of co-tenancy” during Twilight Zone.

■Wilson at 966. ■Also unworkable.

• Those who take the benefit of operations must also allow the non-debtors

the benefit of the OA.

58

 Proposal: Interests that go into non-consent status during Twilight Zone

• ught not be exempt from that status if the OA is later rejected by the debtor.
• Relinquished interest is a real property interest.
• OA is farmout agreement under bankruptcy code definition
• Outcome uncertain.

59

 Practice Tip: Preserve Your Operators and Non-Operators Liens

• In jurisdictions other than Louisiana (and even in Louisiana, though it

supplements the statute), the operating agreement often grants the

• perator a contractual, consensual lien on the non-operator’s interest in

the minerals to secure the non-operator’s obligations under the OA.

• A contractual operator’s lien is generally not binding on third parties unless

the OA or a memorandum of it, with a sufficient description of the lien rights, is filed of record.

• Make sure you have procedures in place to record operator or non-
• perator’s lien by filing a memorandum of the OA with reference to the lien.
• Revise OA to reflect no assignment other than relinquished interest.

60

Reclamation Rights / Producers Liens

 Hydrocarbons are goods under the UCC.  The seller of oil and gas has reclamation rights under both the UCC and the Bankruptcy Code.  Outside of bankruptcy, the seller can reclaim goods for a ten-day period after

• delivery. That time limit does not apply if a misrepresentation of solvency

has been made by the seller in writing. One example of a solvency representation that may be included in a sales contract or purchase order: Buyer hereby represents that it is solvent and that on each delivery this representation shall be deemed renewed unless notice to the contrary is given in writing by the buyer to the seller at or before delivery of goods.

61

 Since the seller generally will not know on the date of filing whether or not a written misrepresentation has been made, better practice is to send a notice reclaiming all unpaid goods. The UCC form letter states: To: [Name of Buyer] I hereby reclaim from you the following goods sold to you on credit and received by you on [date of receipt]: [description of goods]. I reclaim the goods because of your insolvency. __________________ [Name of Seller]  Simplest to attach the invoices to the reclamation demand.

62

 BAPCPA expanded the time period during which sellers can exercise their reclamation rights. ■not later than 45 days after the date of receipt of such goods by the debtor; or ■not later than 20 days after the date of commencement of the case, if the 45-day period expires after the commencement of the case.  In addition, many states have granted statutory liens to protect sellers so that the seller will have a secured claim for hydrocarbons sold but not paid as of the filing. ■Texas – Automatic ■New Mexico – Need filing with county clerk

63

How do you know when oil and gas bankruptcy filed?

• Friends List –Send us an e-mail and we will put you on the list

 Practice Tip.

• send a reclamation demand
• take steps as necessary to perfect any applicable producer’s lien
• Goal is to try to have secured claim, reclamation claim and administrative

claim

64

Priority of Claims

[Owner]  Secured  Administrative  Priority Unsecured  Unsecured  Equity

65

20 Day Claims

 Section 503(b)(9) entitles a seller to an administrative expense claim for the value of goods that were received by the debtor within 20 days of the commencement of the case and sold in the ordinary course of the debtor’s business  The seller need not demand reclamation under §546(c)(1) to be entitled to an administrative expense under §503(b)(9).  Administrative expense claims come ahead of unsecured claims.  In many cases, first day procedures order in place on where and when to file 20 day claims.

66

§ 544(a)(3) versus § 541(d) – Owners with unrecorded assignments can win (in 5th Cir.), if . . . .

 They own “equitable title.”

• Because § 541(d) prevails over § 544(a)(3).

■“section 541(d) prevails over the trustee’s strong-arm powers.”

 Vineyard v. McKenzie (In re Quality Holstein Leasing), 752 F.2d 1009,

1013 (5th Cir. 1985)

• “Equitable” means “true” title.

■Title to property is governed by non-bankruptcy law.

 Butner v. United States, 440 U.S. 48, 54-55 (1979)

■Statute of frauds can be a problem.

 § 5.021, TEX. PROP. CODE.

 Note: Circuits are split over § 541(d) v. § 544(a)(3). Fifth, Tenth and Eleventh hold § 541(d) prevails. Majority approach is that the sections

• perate independently.

67

And the owners with unrecorded assignments can win, if . .

. .

 They can establish a constructive trust under state law.

• Texas requires (i) breach of informal relationship of special trust or

confidence arising prior to and apart from the transaction or actual fraud, (ii) unjust enrichment, and (iii) tracing to an identifiable res. ■Meadows v. Bierschwale, 516 S.W.2d 125, 128 (Tex. 1974) ■Thigpen v. Locke, 363 S.W.2d 247 (Tex. 1962)

• This seldom works.

■E.g., Haber Oil Co., Inc. v. Swinehart (In re Haber Oil Co., Inc.), 12 F.3d 426, 435-37 (5th Cir. 1994)

68

§ 541(b)(4) Safe Harbor for farmees from Debtors

 § 541(b)(4)(A) safe harbor:

• Property of the estate does NOT include interests in hydrocarbons where

the debtor has agreed to transfer interests pursuant to a farmout agreement.  Farmouts defined: § 101(21A) - Any agreement for assignment of an interest in an oil and gas lease that includes, as consideration, operations upon the property.

• Contemplates debtor as farmor rather than farmee.

 When Debtor is farmor –

• The farmee is protected.

69

 Applicability of § 365 to farmouts?

• Farmout is usually an executory contract.
• § 541(b)(4)(A) prevents farmor/debtor from rejecting and depriving farmee
• f title.

 Status prior to assignment of farmout interest?

• Under § 541(b)(4)(A), NOT property of the estate!
• Presumably the Debtor’s rights under the farmout agreement ARE property
• f the estate.

 What if farmee fails to earn the farmout?

• Statute makes no provision for interests to become property of the estate.
• What to do? No one knows.

 Problem of the “fat” farmout agreement – with multiple locations.

70

§ 541(b)(4)(B) Safe harbor for production payments

 Production payments are a hybrid, part ownership and part financing device.  Typically the cash payments by the debtor are NOT property of the estate.

• Terry Oilfield Supply Co., Inc. v. American Sec. Bank, N.A., 195 B.R. 66,

74 (S.D. Tex. 1996)  Attempted codification in § 541(b)(4)(B).

• Safe harbor: carved OUT of debtor’s estate.
• But ONLY if the assignee does NOT participate in operations.

 What if the assignee participates in operations?

• No one knows.

 Recharacterization issue

• Is it really a production payment? Disguised loan?
• The more it looks like a loan . . .
• Matter of Senior – G&A Operating Co., Inc., 957 F.2d 1290 (5th Cir. 1992).

71

Plugging, abandonment, and site restoration

• bligations may (or may not) be administrative claims

 Texas state law: P&A must be commenced within 1 year from cessation of

• perations.
• P&A liabilities that “accrue” post-petition are administrative priority.

■State v. Lowe (In re H.L.S. Energy Co., Inc.), 151 F.3d 434 (5th Cir. 1998). ■Thus, admin claim ONLY if operations cease within 1 year prior to date of filing or thereafter.

72

Plugging Liability in Other States

 Who is liable?

• OK - all current working interest owners and operators
• CA, CO, KS, NM, ND – operator
• LA, PA, WY – owner or operator

 Implication is that prior owners and operators are not liable, but unlike Texas there is no express language

73

 Pennsylvania law.

• Upon the abandonment or ceasing to operate or use any well which shall

have been drilled for oil or gas, it shall be the duty of the person or persons interested in such well to plug the same… ■58 P.S. ' 1(2009)

• Within 9 months after plugging well, operator shall restore the well site.

■58 P.S. ' 601.206

• Arguably not administrative claim if cease to operate or use prior to petition

date.

74

US Offshore Abandonment Requirements

 Outer Continental Shelf (OCS) Gulf Leases  Codified in federal regulations (30 CFR §§ 250.1700-1754)  OCS decommissioning regulated by BOEM and BSEE

75

Some Federal Agencies with Possible Roles Regarding Abandonment

 BOEM  BSEE  US Coast Guard  US Environmental Protection Agency  US Army Corps of Engineers  US Fish and Wildlife Service  National Marine Fisheries Service (Department of Commerce)  US Department of Transportation  In some instances, federal agencies may also delegate certain functions to adjacent state authorities, as well

76

General US Abandonment Requirements

 Who must meet the decommissioning obligations?

• For leases, lessees and owners of operating rights are jointly and severally

liable

• For pipelines, all holders of a right-of-way are jointly and severally liable

 30 CFR § 250.1701

77

When Does Abandonment Liability Accrue?

 You accrue decommissioning obligations when you: (a) drill a well; (b) install a platform, pipeline or other facility; (c) create an obstruction to other users of the OCS; (d) are or become a lessee or owner of operating rights of a lease on which there is a well that has not been permanently plugged according to this subpart, a platform, a lease term pipeline or other facility or

• bstruction;

(e) are or become the holder of a pipeline right-of-way on which there is a pipeline, platform, or other facility, or an obstruction; (f) re-enter a well that was previously plugged  30 C.F.R. §250.1702

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Bankruptcy – Administrative Expenses

 P&A costs are generally entitled to administrative expense priority. P&A liabilities are entitled to administrative claim priority if the liability accrued under state law (that is, if operations ceased either after the date of filing or less than one year prior to the date of filing). State v. Lowe (In re H.L.S. Energy Co., Inc.), 151 F.3d 434 (5th Cir. 1998)(applying Texas law).  Applying the test of Reading Co. v. Brown, 391 U.S. 471 (1968) (“actual and necessary cost”), the court held that the plugging and abandonment was actual, necessary, and also “benefited” the estate. In re Transamerican Natural Gas Corp., 978 F.2d 1409, 1416 (5th Cir. 1992) (must benefit the estate). The court reasoned that a debtor (and trustee) must comply with state law, 28 U.S.C. § 959(b), and may not abandon property in contravention of a state law reasonably designed to protect public health and

• safety. Midlantic Nat’l Bank v. New Jersey Dep’t of Envtl. Protection, 474

U.S. 494 (1986).

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Bankruptcy – Status of Administrative Claims

 One possible problem is that administrative claims come behind secured claims and debtor-in-possession financing. Typically by the time a debtor files bankruptcy it has liened up all up all of its assets. So there may be insufficient funds to pay large administrative claims.  If estate has no money to pay administrative expenses, (i) the bankruptcy Debtor may abandon the assets and leave plugging obligations to predecessors in interest (for example, in re ATP Oil and Gas Corp., No. 12- 36187, 2013 WL 3157567 (Bankr. S.D. Tex. June 19, 2013, the Government asked for an order abandoning offshore leases so they could seek reimbursement from Anadarko, a former owner); or (ii) the Court may allow the administrative expense claim, but deny payment because of lack of

• funds. In re ATP Oil and Gas Corp., No. 12-36187, 2014 WL 1047818

(Bankr. S.D. Tex. March 18, 2004).

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Bankruptcy – Status of Bonds, Letters of Credit, and other Collateral Support

 Escrow funds to pay P&A costs will work in bankruptcy so long as they are carefully set up so that they are not considered property of the Debtor’s

• estate. (for example, the bankruptcy Debtor was not able to invade the

escrow account set up to pay P&A costs in the Pacific Energy Resources bankruptcy).  Likewise, filing bankruptcy generally will not give the Debtor any greater rights to third party bonds and certain other collateral support established to fund P&A obligations.

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Bankruptcy – Claims by Predecessor in Title

 If a successor in interest files bankruptcy, consideration should be given to filing a contingent, unliquidated claim for P&A obligations. In re ATP Oil and Gas Corp., No. 12-36187, 2013 WL 3157567 (Bankr. S.D. Tex. June 19, 2013). (“A party paying decommissioning costs may be subrogated to the economic rights of the United States. In re Tri-Union Development Corp., 314 B.R. 611 (Bankr. S.D. Tex. 2004). …if it is subrogated to the economic rights

• f the United States, Anadarko may be entitled to enforce an administrative

claim for the costs of the cleanup.”)

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Mineral contractor liens

Texas  Lien (in Texas) must be filed six months from date of last work (services or materials).  The priority of the lien is determined by the date of first work.  All lien claimants (in Texas) share pro rata.  The mineral contractor’s lien attaches to the greater of the customer’s legal

• r equitable title.

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Whether the mineral lien contractor has an interest in production proceeds as cash collateral?

 Lien attaches to minerals but NOT proceeds.

• Wilkins v. Fecht, 356 S.W.2d 855 (Tex. Civ. App. – San Antonio 1962, writ

ref’d).

• Creates a problem in bankruptcy for lien claimant.

 Lien claimant may seize proceeds pending foreclosure.

• TEX. PROP. Code, § 53.154, 56.041.
• Includes appointment of a receiver. TEX. CIV. PRAC. & REM. CODE §

64.092.  Bankruptcy Code allows notice that is equivalent to seizure. § 546(b)(1) and § 362(b)(3).

• This notice turns the cash into cash collateral.

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 Alternatively, seek “adequate protection” to protect against depletion of the lien claimant’s collateral.

• The lien claimant is entitled to “adequate protection.”
• § 362 is the vehicle to require the debtor to give the lien claimant

“adequate protection” against depletion. ■If no “adequate protection,” then the stay should lift to allow foreclosure.

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Follow Good Credit Risk Management Practices

 Review and Analyze your Rights under the JOA for Best Practices

• Cash call rights as Operator? Drilling and completion?
• Escrow rights as to pre-payments as non-operator?
• Identify any applicable non-consent penalties and deadlines relating

thereto

• As Non-Operator, consider the character of pre-payments for operations in

the event of a bankruptcy filings

• If appropriate, consider requesting amendments to the JOA in order to

clarify ambiguities or address risk exposure

• Consider Third Party Guaranties
• Consider “Bad Boy” (and “Bad Girl”) Guaranties aka Springing Guaranties.

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Bankruptcy Sales Beware Cure Schedules

• Key executory contracts can be assumed and assigned by the Debtor

company ■JOAs, management agreements, development agreements ■these contracts are assumed or rejected as part of the sale process ■buyer will elect contracts to be assumed and assigned and debtor may be required to assume certain contracts as a condition of the sale ■debtor is required to cure any defaults and provide adequate assurance

• f future performance

 cost to cure may be accounted for in the sale price  anti-assignment clauses not enforceable  ipso facto clauses – which provide that rights terminate upon

bankruptcy filing – are unenforceable

 be sure cost to cure is accurate. If Debtor lists zero and then cost to

cure is $200,000 – need to object or lose $200,000.

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Bankruptcy Sales

 Sale is free and clear of all liens ■liens and encumbrances eliminated ■covenants running with land will continue ■successor liability is minimized  Secured creditor can credit bid  Court approves highest and best bid ■parties receive notice and opportunity to object ■Court enters order authorizing the sale ■Beware Res Judicata Effect – can lose AMI or preferential right to purchase