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Texas Showdown in Bankruptcy Court: How Texas Judges May Challenge New York Decisions That Have Proved Friendly for Oil and Gas Drillers

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Written by: Katy Pape

Click HERE to Read the Article by the Publisher.


Earlier this summer, Judge David Jones from the bankruptcy court for the Southern District of Texas said in the SandRidge bankruptcy case that he has “been looking for an opportunity to correct the state of New York.”

This issue has been addressed by only a single court – Judge Shelley Chapman in the bankruptcy court for the Southern District of New York in the Sabine Oil & Gas Corp. case. The dispute before Judge Jones ultimately settled, so he will have to wait for another opportunity to “correct” the decision – something that could play out shortly.

Amid the world’s oil and gas glut, U.S. energy companies are struggling to shrink their financial losses in any way possible, including by either consensually restructuring or litigating their contracts with their oil or gas transporters via the chapter 11 process. One of the most critical developments in the latest round of exploration-and-production company bankruptcies is the potential for E&P debtors to use the bankruptcy process to adjust their gathering agreements with midstream counter parties, even though the midstream parties argue that their contracts carry property rights that ought to survive the bankruptcy process.

Gathering agreements provide the mechanism by which debtors or producers agree to dedicate the production of their interests in oil, gas and mineral leases to a gas gatherer – the counter party to the agreement – for the purpose of gathering the commodity for a certain number of years. The commodity is often transported through pipelines that the counter party builds, and these contracts form one of the basic building blocks of the midstream industry.

In many ways the bankruptcy treatment of these agreements is a binary outcome for E&P producers and midstream gatherers: Either the gathering agreements contain a sufficient connection to the real property involved that they cannot be modified by the bankruptcy process, or debtors are free to “reject” the contracts and midstream gatherers are left to seek any damages via the bankruptcy process. If the contract is allowed to be rejected, the gatherer faces the prospect of losing its customer on a custom-built infrastructure, with damages paid side by side with those of other unsecured creditors, often at a steep discount.

Sabine Decisions

The Sabine debtors requested to reject certain gathering agreements with Nordheim Eagle Ford Gathering and with HPIP Gonzalez Holdings as part of an effort to right-size its contracts in the Eagle Ford area. All contracts were governed by Texas state law.

The Nordheim agreements obligated Sabine to “deliver certain minimum amounts of gas and condensate to Nordheim on an annual basis, pay annual gathering fees to Nordheim for the services provided thereunder, and, to the extent that Sabine does not deliver certain minimum amounts of gas or condensate each year, make deficiency payments to Nordheim on an annual basis.” The debtors argued that they would “likely be unable” to deliver the minimum amounts of gas and condensate required under the agreements and, absent rejection of the agreements, would be obligated to make certain deficiency payments. The debtors estimated that rejection of both the Nordheim and HPIP agreements would save them more than $30 million to $40 million in deficiency payments over the course of the gathering agreements. This savings would ultimately be made available to unsecured creditors. At oral arguments made in February, HPIP’s counsel disclosed that HPIP invested approximately $80 million to build a pipeline system.

In their filings related to the motion to reject, the debtors disclosed that they planned to enter into an agreement with an alternative gatherer to provide services substantially similar to those contracted for under the Nordheim agreements at market rates and with no minimum volume obligations. In pleadings and at oral argument, Nordheim and HPIP asserted that the debtors could not show that rejection of the gathering agreements would benefit Sabine because under Texas state law, the terms of the agreements that encumber the oil and gas real property assets are covenants that run with the land that cannot be terminated or avoided under section 365 of the Bankruptcy Code.

Ultimately, in March, Judge Chapman issued a non-binding decision in Sabine on the issue of whether covenants in the agreement run with the land. Judge Chapman’s non-binding decision turned largely on procedural points, relying on the Second Circuit’s decision in Orion Pictures, finding that the court could not decide substantive legal issues involving the interpretation of the agreement’s covenants in the context of Sabine’s motion to reject the gathering agreements. Judge Chapman instead concluded that an adversary proceeding, which afford litigants additional procedural protections beyond those in normal motion practice, or a separate contested matter, would be required with respect to a dispute over whether covenants run with the land, and that the Bankruptcy Code requires that such additional protections be afforded when a debtor is challenging a property interest of a non-debtor. Accordingly, Judge Chapman bifurcated the process and ruled to grant the motion to reject the gathering agreements but issued a non-binding ruling on the substantive underlying substantive issues.

Subsequently, in May, Judge Chapman issued her binding decision, which confirmed her prior ruling and permitted Sabine to reject the Nordheim and HPIP agreements. Specifically, Judge Chapman found that the covenants do not run with the land under Texas law as real covenants or as equitable servitudes.

In June, Judge Chapman denied Nordheim’s request to directly certify its appeal of her decisions to the Second Circuit and denied its request for a stay pending appeal. As a result, both Nordheim’s and HPIP’s appeals of Judge Chapman’s decisions are pending in the District Court for the Southern District of New York.


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Written by: Katy Pape

Click HERE to Read the Article by the Publisher.

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