Oil and Gas Bankruptcies: Oil and Gas Bankruptcies: Selected IssuesSelected Issues

May 7, 2015

Marvin E. Sprouse IIImsprouse@jw.com • (512) 236-2088Matthew D. Cavenaughmcavenaugh@jw.com • (713) 752-4284

Presented by Marvin E. Sprouse III – Austin

Matthew D. Cavenaugh – Houston

Today’s PresentationToday’s Presentation

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What is the Source What is the Source of Bankruptcy Law?of Bankruptcy Law?

• US Constitution

• Article 1, § 8, cl. 4:– Congress shall have the power to. . . Establish uniform Laws on

the subject of Bankruptcies throughout the United States. . .

• Constitutional basis gives Bankruptcy Courts the benefit of the Supremacy Clause

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What is the Source What is the Source of Bankruptcy Law?of Bankruptcy Law?

• Bankruptcy Code– Federal Rules of Bankruptcy Procedure, local rules

• Federal Rules of Evidence

• Bankruptcy Reporter

• Non-bankruptcy law still applies to many issues (liens, perfection, priority, many contract issues)

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What Starts a Bankruptcy Case?What Starts a Bankruptcy Case?

• An eligible person files a “Petition”– “Involuntary” cases are possible

• The filing date is often referred to as the “Petition Date”

• The Petition Date is important: the Petition Date determines many of the debtor’s rights, and the rights of creditors as well

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Property of the EstateProperty of the Estate• The filing of a petition creates an estate – largely defines

bankruptcy court jurisdiction

• Bankruptcy Code § 541(a) – the estate is “all legal and equitable interests of the debtor as of the commencement of the case”

• Bankruptcy Code § 541(b) excepts some property from the estate, including certain oil and gas interests the debtor “has transferred or agreed to transfer”– Oil and gas exception is strictly construed

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Pre v. PostPre v. Post

• The distinctions between pre-petition and post-petition obligations are critically important in bankruptcy

• Pre-petition unsecured claims may receive a pro-rata distribution – a debtor will remain fully liable for most post-petition claims

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What is the “automatic stay”?What is the “automatic stay”?• Upon filing of a petition, the debtor obtains protection from

certain actions by creditors (including most terminations and set off rights)

• The stay is automatic – service of formal notice is not required

• Sanctions are possible for willful violation of the stay

• Certain acts are “excepted” from the automatic stay– Liquidation, termination, set off, or netting under certain oil and

gas, commodity, or forward contracts are excepted

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Relief from the Automatic Stay Relief from the Automatic Stay

• When in doubt, and in most other circumstances, obtain relief from the automatic stay before acting– Motion must be filed with the bankruptcy court

– “comfort orders”

• In most cases, preliminary hearings on motions for relief from stay will be heard within thirty (30) days

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Filing ChaptersFiling Chapters

• Chapter 7 Liquidation (Individual or Business)– “means test” applies to individuals

– A Chapter 7 trustee is appointed

• Chapter 9 – Municipality

• Chapter 11 – Reorganization/Liquidation (Mainly Business)– Individuals with large debt may have to use Chapter 11

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Filing Chapters (cont’d)Filing Chapters (cont’d)

• Chapter 12 – Family Farmer

• Chapter 13 – Individual with Regular Income– Requires repayment plan with “disposable income” for three to

five years

• Chapter 15 – Cross-Border Cases

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Bankruptcy ClaimsBankruptcy Claims

• “Allowance” is the creditor’s goal

• Types of Claims– Secured – secured only to the extent of the value of the collateral

(deficiency usually unsecured)

– Non-bankruptcy rules regarding attachment, perfection, and priorities apply

• Priority – certain wage and tax claims

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Bankruptcy Claims (Cont’d).Bankruptcy Claims (Cont’d).

• Administrative – post petition claims– In a converted case, Chapter 7 administrative claims have priority

over Chapter 11 administrative claims

• Unsecured (includes most pre-petition attorneys’ fees)

• Equity Interests

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11 U.S.C. § 36511 U.S.C. § 365• Section 365 of the Bankruptcy Code deals with the

treatment of executory contracts and unexpired leases in the bankruptcy context

• Section 365 applies to contracts and leases in place as of the bankruptcy filing – it does not serve to “revive” expired or terminated agreements

• The Bankruptcy Code contains deadlines for a debtor (or trustee) to deal with unexpired leases and executory contracts

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What exactly is an “executory contract?”What exactly is an “executory contract?”

Is this contract executory?

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Countryman’s Definition:Countryman’s Definition:

• “A contract under which the obligations of both the bankrupt and the other party are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.”

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What Can a Debtor Do With an What Can a Debtor Do With an Unexpired Lease or Executory Contract?Unexpired Lease or Executory Contract?

• Reject

• Assume – generally, must assume the whole lease or contract, the “good” with the “bad”

• Assume and assign lease or contract to another entity (even if the agreement says you cannot)

• Different rules apply to agreements to make loans, IP contracts, and personal services contracts

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Rejection:Rejection:

• Entire contract or lease must be rejected

• Rejection must be approved by the bankruptcy court

• Most courts apply the “business judgment test” to evaluate motions to reject

• Rejection constitutes breach (result is unsecured claim – capped for real property leases)

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Assumption of Contracts and Leases:Assumption of Contracts and Leases:

• Upon court approval, a debtor may assume a contract or lease (even if the agreement says the debtor cannot)

• To assume, the debtor must cure monetary defaults and provide adequate assurance of future performance

• Defaults based solely upon insolvency or filing bankruptcy do not have to be cured

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Is an Oil and Gas Lease Executory?

• Texas – no– Under Texas law, an oil and gas “lease” is a “fee simple

determinable” – a real property interest• Oklahoma – no

– Under Oklahoma law, an oil and gas lease is a “profit à prendre” – another real property interest

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Is an Oil and Gas Lease Executory? (cont’d.)(cont’d.)

• Kansas – yes– Under Kansas law, an oil and gas lease is executory

and subject to § 365 of the Bankruptcy Code• Pennsylvania – yes and no

– Under Pennsylvania law, a lease to explore for minerals is executory, but it becomes a fee-type interest once minerals are found

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Royalty ClaimsRoyalty Claims

• Typically, failure to pay royalties does not result in automatic termination of the lease– The lease may provide for termination, however• Texas – royalty interest holders have a statutory

lien upon production and proceeds to secure obligations of “first purchasers”

• Tex. Bus. & Comm. Code § 9.343

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Royalty Claims (cont’d.)Royalty Claims (cont’d.)

• Texas § 9.343 only requires recordation of interest in real property records – UCC financing statement not required for perfection

• Different outcomes may result if the laws of other jurisdictions are involved (i.e. non-Texas law)

• In re SemCrude, L.P.– Chapter 11 case filed in Delaware involving production

from Texas, Oklahoma, and Kansas

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Royalty Claims (cont’d.)Royalty Claims (cont’d.)

• Safe harbor for Overriding Royalty Interests (ORRIs)• Bankruptcy Code § 541(b)(5)(B) excludes “true” ORRIs

from property of the bankruptcy estate• NGP Capital Resource Co. v. ATP Oil & Gas

– Bankruptcy court applying LA law, determined transaction might be “disguised financing” and not a “true sale” of the ORRI

– If not a “true sale” of the ORRI, the interest might be property of the bankruptcy estate, leaving the counter-party an unsecured creditor

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Mechanic and Materialmen’s LiensMechanic and Materialmen’s Liens

• Oil and gas M&M liens• M&M liens may “relate back” to the time work

commenced• Under the Bankruptcy Code, as exception to the

automatic stay exists to permit perfection of a lien, even after a bankruptcy case is filed.

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Mechanic and Materialmen’s Liens (cont’d)

• Mechanic and Materialmen’s lien rights vary from state to state– Some statutes allow M&M liens to attach to production– Some statutes allow M&M liens to encumber working

interests– Some statutes allow M&M liens to attach to the entire

leasehold

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Oil and gas M&M liens in Texas

• Texas Property Code § 56.002 provides: “a mineral contractor or subcontractor has a lien to secure payment for labor or services related to mineral activities”

• The M&M lien claimant must follow affidavits, timing, and recordation rules set forth in the Texas Property Code

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Oil and gas M&M liens in Texas (cont’d)

• A Texas M&M lien attaches to the land, leasehold, and equipment, but not to production or proceeds (But see Abella v. Knight Oil Tools 945 S.W.2d 847, 851 (Tex.App. Houston [1st Dist.] 1998, no writ))

• M&M lien is not a priming lien• The Bankruptcy Code allows for perfection of M&M

liens as an exception to the automatic stay

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Bankruptcy § 363 SalesBankruptcy § 363 Sales

• Bankruptcy Code permits sale of debtor assets free and clear of liens and claims

• Bankruptcy courts will require evidence that any proposed sale is consistent with the market – an auction may be required

• Sales through the bankruptcy process are transparent – deal terms may be public record

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Bankruptcy § 363 Sales (cont’d)Bankruptcy § 363 Sales (cont’d)

• (f) the trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate only if:– (1) applicable non-bankruptcy law permits sale of such property

free and clear of such interest;– (2) such entity consents;– (3) such interest is a lien and the price at which such property is

to be sold is greater than the aggregate value of all liens on such property;

– (4) such interest is in bona fide dispute; or – (5) such entity could be compelled, in a legal or equitable

proceeding, to accept a money satisfaction of such interest

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Bankruptcy § 363 Sales (cont’d)Bankruptcy § 363 Sales (cont’d)

• Executory contract issues• Partitioning• Rights of first refusal• Sales by motion or plan• Good faith purchases under the Bankruptcy Code

will not be set aside upon appeal (unless the sale itself is stayed during the appeal)

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Oil and Gas IssuesOil and Gas Issues

• Joint Operating Agreements• Plugging and abandonment

– Administrative claims• Bankruptcy Code § 503(b)(9) claims• “Safe harbor” for certain derivative contracts

– Exempted from avoidance action liability

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Other IssuesOther Issues

• Evidence

• Discovery

• Certain causes of action become property of the bankruptcy estate

• Stern v Marshall

• Jury trial

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Other IssuesOther Issues

• Due process/notice issues

• Plans of reorganization/liquidation

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When Should I Talk When Should I Talk to a Bankruptcy Lawyer? to a Bankruptcy Lawyer?

• When considering the purchase of assets from a bankruptcy case

• Party threatens to file bankruptcy

• Party files bankruptcy

• Pre-bankruptcy planning for creditors

• Pre-bankruptcy planning for debtors

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FINIS

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