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The oil and gas industry in the United States is highly
dependent upon an intricate set of agreements that allow oil and
gas to be gathered from privately owned land. Historically, the
dedication language in oil and gas gathering
agreements—through which the rights to the oil or gas in
specified land are dedicated—was viewed as being a covenant
that ran with the land. That view was put to the test during the
wave of oil and gas exploration company bankruptcies that began in
2014. A shockwave was sent through the oil and gas industry in
2016, when the United States Bankruptcy Court for the Southern
District of New York in the In re Sabine Oil & Gas
Corp.
1 bankruptcy case held that, under Texas law,
the dedication language in the applicable midstream contract did
not create a covenant running with the land, but instead amounted
only to a right involving personal property that could be
separately assumed or rejected in a bankruptcy case.

Since the Sabine decision, there has been a developing split
between bankruptcy courts regarding the enforceability of gathering
agreements as real property covenants. The United States Bankruptcy
Court for the District of Colorado, applying Utah law, held in
In re Badlands Energy, Inc.2 that certain
midstream gas gathering and processing and saltwater disposal
contracts constituted covenants running with the land.3
The Bankruptcy Court for the Southern District of Texas reached
different results in two subsequent cases, holding in In re
Alta Mesa Resources, Inc.
4 that certain dedications
in gathering agreements created covenants that run with the land,
while reaching the opposite conclusion in In re Chesapeake
Energy Corp.
based on the unique language in that
agreement.5 Not to be left out, the Delaware Bankruptcy
Court, in Extraction Oil and Gas,
Inc.,6 determined that certain oil, gas and
water gathering agreements did not create covenants running with
the land under Colorado law. Most recently, on November 13, 2020,
Delaware Bankruptcy Court Judge Karen B. Owens held that a certain
gas gathering agreement did not create a covenant running with the
land under Wyoming law. As this landscape develops, midstream
companies are being required to adjust and evolve their approach to
dedications in order to get the best possible treatment in the
event of a producer bankruptcy.

Background

Southland Royalty Company (“Southland”) is a
Texas-based independent oil and gas exploration and production
company focused on developing plays in Wyoming, Utah, Colorado and
New Mexico. Prior to the recent collapse in energy prices,
Southland planned to increase production of its natural gas assets
in Wyoming through horizontal drilling. A midstream company
affiliated with The Williams Companies (“Williams”)
provided exclusive gathering services in connection with
Southland’s Wyoming assets, and, in 2018, the parties entered a
new gas gathering agreement under which Williams agreed to expand
its pipeline system to accommodate the anticipated increase in
volumes (the “Agreement”). Among other obligations, the
Agreement included long-term minimum volume commitments requiring
Southland to transport fixed quantities of gas on Williams’
pipelines or make deficiency payments. As is common in such
midstream agreements, the contract contained a provision in which
Southland “dedicated” its mineral interests within a
specified geographic area to the performance of the Agreement.

In January 2020, Southland filed for chapter 11 protection and
in March 2020, it filed an adversary proceeding against Williams
seeking a ruling that the Agreement could be rejected under Section
365 of the Bankruptcy Code and that the properties could be sold
free and clear of Williams’ dedication. Williams argued that,
as a real property covenant, the Agreement could not be rejected
and was thus binding on any subsequent purchaser.

Decision

The Bankruptcy Court looked to Wyoming law to determine that the
Agreement did not contain a real property covenant and that, even
if it did, it could be rejected under the Bankruptcy Code and sold
free and clear of Williams’ interests. Under Wyoming law,
covenants running with the land must satisfy four elements: (i) the
original covenant must be enforceable; (ii) the parties must intend
that the covenant run with the land; (iii) the covenant must touch
and concern the land; and (iv) there must be privity of estate
between the parties. The first element was not at issue in the
case, but the Bankruptcy Court found that the dedication failed to
satisfy each of the other three elements.

Intent of the Parties

To determine the intent of the parties, the Bankruptcy Court
looked to the specific language of the Agreement and also
considered extensive testimony from the parties over a week-long
trial. The Agreement provided: “This Dedication shall be a
covenant running with the land under applicable law and binding on
the respective successors and assigns of the interests of the
Shipper and its Affiliates in and to the Dedicated Properties and
Dedicated Gas.” The Court’s opinion focused on the absence
of this language in other parts of the Agreement—including
the minimum volume commitment section—and also drew on
conflicting testimony about whether parties thought the MVC was
intended to be a part of the dedication.

The Bankruptcy Court found that, based on the absence of
evidence or witness testimony that Southland intended the entire
Agreement, and not just the dedication, to run with the land, that
element was not satisfied.

The Covenant Must Touch and Concern the Land

To analyze whether the covenant touched and concerned the land,
the Bankruptcy Court examined whether the dedication alters
Southland’s legal rights in its real property. It found that
even though the Agreement “dedicates” or commits
Southland’s “Dedicated Properties” and
“Dedicated Gas” to Williams, the covenant merely gives
Williams an exclusive right to “Gather, Process, Dehydrate and
treat [Southland’s] Produced Dedicated Gas.” The Agreement
does not convey any right, title or interest in the “Dedicated
Gas” or “Dedicated Properties” to Williams, and it
places no restrictions or any other burden on such property.

The Bankruptcy Court went on to explain that Southland is free
to do what it likes with its unproduced gas reserves, including
decreasing or ceasing further exploration, drilling and production,
and that Williams has no right to enter the underlying area and
access or control Southland’s unproduced reserves. The
Dedication, in fact, does not take effect, and the property was not
benefited or burdened by the dedication, until the gas is produced.
At the point the gas is produced, such property is personal
property and not real property.

The Bankruptcy Court therefore concluded that the Agreement does
not touch and concern the real property.

Privity of Estate

The Bankruptcy Court found that under Wyoming law, privity of
estate can only be created in connection with a grant of “the
land sought to be charged, or an estate therein, or the equivalent
thereof.” Even though Southland granted Williams a floating
easement on the surface estate along with various other easements
to facilitate the midstream operations, the Bankruptcy Court
concluded that these did not sufficiently establish privity in the
mineral estate. The Bankruptcy Court found that “the estate
burdened by the various easements and other rights of access -
Southland’s surface lands – is not the same estate allegedly
burdened by the [dedication] – Southland’s mineral
interests.” The Bankruptcy Court distinguished between the
mineral estate (which was the estate burdened by the dedication)
and the surface estate (which was unburdened). Southland’s
contemporaneous grant of an interest in the surface estate (through
easements) was insufficient to satisfy the privity requirement at
the burdened mineral estate.

Rejection of Real Covenant

Breaking new ground, the Bankruptcy Court held that, even if the
dedication under the Agreement were a real covenant, Southland
could still reject the agreement as an executory contract,
relieving Southland of future performance. The Bankruptcy Court
explained that the relevant inquiry is whether the Agreement is an
executory contract (i.e., whether there are material unperformed
obligations by both Southland and Williams), including with respect
to the dedication. Finding that both parties have material
unperformed obligations, the Bankruptcy Court found that even if
real covenants exist, nothing in the Bankruptcy Code prevents
rejection of the Agreement. Going even further, the Bankruptcy
Court reasoned that Williams’ exclusivity portion of the
covenant would continue to burden the land in that scenario, but
that the minimum volume commitment would not burden either
Southland or any successor. Instead, Williams may file a
prepetition claim for damages resulting from Southland’s
rejection of the agreement, and Williams would be prohibited from
enforcing the MVC obligations against future owners on principles
of equity and fairness. The harsh reality that Williams would
collect only a fraction of its damages from Southland was not
relevant to the Court’s analysis.

Application of Sections 363(f)

Under Section 363(f) of the Bankruptcy Code, assets can be
purchased from a debtor free and clear of all liens, claims and
interests relating to the assets if certain elements are satisfied.
The Bankruptcy Court held that, even if the dedication under the
Agreement were a real covenant, it could still be rejected by
Southland under Section 363(f)(1) and (5) of the Bankruptcy Code.
The Bankruptcy Court found that Section 363(f)(1) allows a sale
free and clear of even enforceable dedications where the
debtor’s RBL lenders perfected their liens before the midstream
company received its dedications. Additionally, the Bankruptcy
Court found that Section 363(f)(5) allows the sale free and clear
because the Agreement included a payoff clause with respect to the
MVC, thereby satisfying one of the scenarios where bankruptcy can
compel a sale free and clear of interests.

Discussion

The Bankruptcy Court openly acknowledged that a split is
developing regarding the enforceability of gathering agreements as
real property covenants. Though only some of the recent holdings
offer precedent for the proposition that dedication covenants run
with the land under applicable state law, they all provide valuable
insight into how to best craft dedication provisions that are most
likely to be enforceable in bankruptcy.

While recent decisions trend against enforcing midstream
agreements as covenants that run with the land, these agreements
can still be improved upon to avoid the problems cited by the
courts. For example, midstream companies need to search for
existing liens and negotiate for non-disturbance agreements with
the producer’s lenders. In addition, parties need to find
creative and commercial solutions to (i) create horizontal privity
at the mineral estate (e.g., a capped ORRI), (ii) satisfy the touch
and concern element (e.g., limited specific performance right) and
(iii) evidence intent more clearly. Midstream transporters and
service providers are well advised to take note of this decision
and the decisions that have come before it. They offer guidance on
how to structure dedication covenants to avoid the pitfalls.

We are available to assist clients in crafting solutions that
cater to applicable state law and to the particulars of a specific
contract.

Footnotes

1. Sabine Oil & Gas Corp. v. HPIP
Gonzales Holdings, LLC
(In re Sabine Oil & Gas
Corp.
), 550 B.R. 59 (Bankr. S.D.N.Y. 2016) (applying Texas law
to find that the certain covenants within a gas gathering agreement
were neither covenants running with the land nor equitable
servitudes), aff’d, 567 B.R. 869 (S.D.N.Y. 2017),
aff’d, 734 Fed. App’x 64 (2d Cir. 2018).

2. Midlands Midstream, LLC v.
Badlands Energy, Inc.
(In re Badlands Energy, Inc.),
608 B.R. 854, 869 (Bankr. D. Colo. 2019).

3.
Midstream Companies Have Renewed Hope: Running-with-the-Land Oil
and Gas Dedication Survives a Bankruptcy Challenge, Offering
Precedent in Contra to Sabine
.

4. Alta Mesa Holdings, LP v.
Kingfisher Midstream, LLC
(In re Alta Mesa Res.,
Inc.
), 613 B.R. 90, 96 (Bankr. S.D. Tex. 2019).

5. In re Chesapeake Energy
Corp.
, No. 20-33233, docket no. 27 (Bankr. S.D. Tex. Oct. 28,
2020).

6. See, e.g., Extraction Oil & Gas,
Inc. v. Platte River Midstream, LLC (In re Extraction Oil &
Gas, Inc.), No. 20-50833, slip op. at 19-44 (Bankr. D. Del. Oct.
14, 2020); In re Extraction Oil & Gas, No. 20-11548, 2020 WL
6389252, at *7 & n.34-36 (Bankr. D. Del. Nov. 2, 2020).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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