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vol 16, num 3 | October, 2019 |
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Ignoring the Labels: Oil and Gas Gathering Agreements as Executory Contracts |
Although 11 U.S.C. § 365(a) allows for rejection of executory contracts, determining whether a contract is, in fact, executory can be challenging. As illustrated by a recent Second Circuit case, whether an oil and gas gathering agreement can be fully rejected as an executory contract depends on the state law governing the dispute and the relationship of the covenants to real property.
In an unpublished decision issued in May 2018, the Second Circuit Court of Appeals affirmed a bankruptcy court decision finding that certain oil and gas gathering agreements were not covenants that “run with the land” and therefore could be rejected as executory contracts. While the Second Circuit’s decision was premised on a finding of a lack of horizontal privity, that finding is of limited value given that the requirement is being abolished in a growing number of jurisdictions. The analysis afforded by the bankruptcy court and district court, however, suggest that elimination of the horizontal privity requirement would not necessarily change the result unless the covenants can be shown to have a beneficial impact on the land itself, not merely on the product derived from the land.
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Oil and Gas Lease, or Farmout Agreement? Section 541(b)(4)(a)’s Exclusion of Farmout Agreements from Property of the Estate |
Since 2015, bankruptcy courts have seen a steady flow of oil and gas bankruptcies — totaling around $106.8 billion in aggregate debt — with no slowdown in sight. These cases bring along the complex transactions common in the industry, governed by differing state laws and raising novel issues under the Bankruptcy Code. One such issue is the application of 11 U.S.C. § 541(b)(4)(A) to oil and gas agreements. That section excludes from property of the estate a debtor’s interest in oil and gas that has been transferred under a “farmout agreement.” But what constitutes a farmout varies according to state law and the agreement itself.
Whether the interests underlying these agreements are property of the estate has important consequences in a bankruptcy case.
The quintessential oil and gas transaction is the lease. In its most basic form, a mineral owner conveys its right to explore, develop and produce oil and gas to an operating company in exchange for a royalty. A lease typically lasts for a primary term but will continue beyond the primary term if a producing well is drilled. If the operating company fails to drill a producing well by the end of the primary term, the lease terminates, and the interest reverts to the mineral owner. While termed a “lease,” the agreement typically conveys title of the subsurface rights to the lessee during the term. And so, in most states, the lease conveys a real property interest subject to divestiture.
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Register Now for Winter Leadership Conference |
Join the Bankruptcy Litigation Committee at ABI's Winter Leadership Conference. The Terranea Resort in Rancho Palos Verdes, California is the setting for this year's annual program, which features topics designed for consumer and business practitioners, as well as financial advisors. As always, the conference provides numerous social and fun events to network and renew friendships with your colleagues from around the nation and
overseas. We look forward to seeing you in December!
This year, the Committee will be pairing with the Health Care Committee to host a session titled, “Litigating Issues in a Health Care Case."
Speakers for this session include:
- Tania Moyron
Dentons; Los Angeles
- David Gordon
Polsinelli; Atlanta
- Andrew Sherman
Sills Cummis & Gross P.C.; Newark, NJ
- Margaret Newell
Department of Justice Civil Division, Commercial Litigation Branch; Washington DC
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