After extensive briefing and hearing oral arguments related to Sabine's motion to reject two gathering agreements with Nordheim Eagle Ford Gathering as well as two gathering and handling agreements with HPIP Gonzales Holdings, U.S. Bankruptcy Judge Shelley Chapman ruled that the four agreements may be rejected by Sabine.1 Furthermore, Judge Chapman pronounced a "non-binding" ruling that, under Texas law, such agreements do not constitute or contain covenants running with the land. As a result, Sabine will be permitted to reject the contracts and the counterparties would be treated as unsecured creditors, thus saving the debtors more than $30 million to $40 million. A final, binding ruling on whether or not the gathering agreements contain covenants running with the land will be reserved for later determination through an adversary proceeding. In any event, this "non-binding" ruling could negatively affect some midstream pipeline owners who have relied on the Fifth Circuit jurisprudence that transportation agreements contain or constitute covenants running with the land under Texas law.
In her decision, Judge Chapman focused on the Fifth Circuit's 2013 decision in Newco Energy v. Energytec Inc., ("Energytec")2. Energytec involved a pre-bankruptcy sale to Newco that included a carve-out for a "Transportation Fee" as well as the right to consent to future assignments of the pipeline. In a subsequent post-bankruptcy sale, the debtor attempted to convey its interest in the pipeline to Red Water free and clear of any liens, claims or encumbrances. Newco objected to the proposed sale, arguing that the pipeline could not be sold free and clear of its lien or its property interests – namely, the Transportation Fee and the right to consent to any assignment of the pipeline. On appeal, the Fifth Circuit held that the Transportation Fee and consent rights were property rights that did run with the land. Recognizing that Texas case law contained variations on the specific requirements to determine whether a covenant runs with the land, the Fifth Circuit adopted a five-factor test as "controlling," holding that "a covenant that runs with the land exists when (1) it touches and concerns the land; (2) it relates to a thing in existence or specifically binds the parties and their assigns; (3) it is intended by the original parties to run with the land; and (4) when the successor to the burden has notice" and (5) there exists privity of estate between the parties when the covenant was made.3
The gas gathering agreements at issue in Sabine all contained dedications of hydrocarbons to the pipeline, as well as an agreement to pay a gathering fee to the pipeline owner. In particular each gas gathering agreement at issue provided the following language with respect to mineral rights:
So long as this Agreement is in effect, the Agreement shall (i) be a covenant running with the Interests now owned or hereafter acquired by [Sabine] and/or its Affiliates within the Dedicated Area and (ii) be binding on [Sabine] and enforceable by [Nordheim] and its successors and assigns against [Sabine], its Affiliates and their respective successors and assigns.
At an earlier hearing, Judge Chapman noted that the gas gathering agreement provides that Sabine "dedicates and commits" gas production from certain oil and gas leases "to the performance" of the gas gathering agreement, not the underlying leases themselves. Such language, Judge Chapman said, does not likely constitute a conveyance. Judge Chapman also addressed her view regarding the difference between a gatherer and a producer, stating that "gathering starts at a non-real property level while the production is the real property interests." Further, she said that in her view, the HPIP agreement "is a service agreement and not a covenant running [with the land] because it does not burden the land, it is a right to do something with the debtors' land."
At a subsequent hearing on March 8, 2016, Judge Chapman definitively ruled4 that Sabine had satisfied its "business judgment" requirement, and allowed the rejection of all four agreements. Since there had been no evidence presented that Sabine was acting in "bad faith, whim or caprice," it had met the requisite showing that the contracts should be rejected as burdensome. Judge Chapman also ruled that, in her view, since the covenants at issue were not covenants running with the land, the covenants could not be enforceable as equitable servitudes. The portion of her ruling related to whether the covenants at issue are covenants running with the land or equitable servitudes is "non-binding" due to Bankruptcy Rule 7001 and 2nd Circuit jurisprudence.5
Similar briefing is taking place in the Quicksilver bankruptcy case, with oral arguments haven taken place on Friday, March 4, 2016, and rulings to follow in the future. Amicus briefs have been filed by several midstream players, emphasizing the importance of this issue on the industry. In each case, local real estate law will apply.6 This will be an ongoing question in oil and gas bankruptcies that will turn on specific facts, the language of each contract, applicable state law regarding property rights and covenants running with the land, and how the particular presiding court construes applicable law.
1 Bench Ruling, March 8, 2016.
2 739 F.3d 215 (5th Cir. 2013).
3 Id. At 221.
4 https://cases.primeclerk.com/sabine/Home-DownloadPDF?id1=MjkwNDg4&id2=0
5 Under Rule 7001(2), an action to determine the validity of a party's interest in property must be pursued as an adversary proceeding. The same is true of an action seeking a declaratory judgment regarding the validity of a party's interest in property. See Rule 7001(9). Orion Pictures Corp. v. Showtime Networks (In re Orion Pictures Corp.), 4 F. 3d 1095, 1098 (2d Cir. 1993).
6 The purpose of this e-Alert is to inform readers of relevant information in bankruptcy law, oil & gas law, and related areas. It is not intended nor should it be used as a substitute for legal advice or opinion which can be rendered only when related to specific fact situations. The statements contained herein are not intended to and do not constitute an opinion as to any bankruptcy or other matter. They are not intended or written to be used, and may not be relied upon, by any person for the purposes of avoiding penalties that may be imposed under any law, ruling, or otherwise.
