Coming Down the Pipeline: Mitigating the Payment Risk in Oil and Gas Construction Through Lien Claims

Pepper Hamilton LLP
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This article was published in the January 2017 issue of AGC Law in Brief (Volume 3, Issue 1). It is reprinted here with permission.

Since 2015, the oil and gas market has experienced significant distress. Recent reports have tracked at least 114 North American oil and gas producers and 16 midstream companies that have filed for bankruptcy since the beginning of 2015, involving a total of approximately $91.4 billion in cumulative secured and unsecured debt.

Projects throughout the country have been stalled, suspended or terminated. While outfield service companies have felt the pinch, pipeline contractors, subcontractors and suppliers are increasingly faced with the risk of nonpayment.

So how do pipeline contractors, subcontractors and suppliers mitigate this risk of nonpayment?

For subcontractors or suppliers, payment bonds are the best form of protection when facing upstream insolvency. But payment bonds are not required and are often not secured in the private project setting. Nevertheless, subcontractors and suppliers should ask at the outset of the project whether a payment bond has been secured so they are prepared to make a claim if need be.

Making claim in bankruptcy court is another avenue of recovery. While bankruptcy court affords contractors, subcontractors and suppliers the opportunity to make a claim for payment, bankruptcy poses challenges. Once bankruptcy has been filed, contractors, subcontractors and suppliers typically find themselves at the end of a long list of debtors, with rights subordinate to those of lenders and other secured creditors. The best-case scenario is often a recovery of pennies on the dollar.

Mechanics’ lien laws offer contractors, subcontractors and suppliers another avenue of recovery. With payment bonds often not secured, and the prospect of diminished returns in bankruptcy court, contractors, subcontractors and suppliers commonly turn to mechanics’ liens to secure their right to payment. In general terms, a mechanics’ lien affords contractors, subcontractors and suppliers statutory protection from nonpayment for goods or services furnished on certain projects. In the event of nonpayment, a mechanics' lien can be filed against the property on which the project is located. This gives the lien holder an actual interest in the real estate or other property interest that their labor or materials improved. The mechanics’ lien must be filed within a particular period of time, and, if the lien is not paid, the lien holder can foreclose upon the lien to obtain payment.

The nature of pipeline, however, poses a unique challenge for parties’ making mechanics’ lien claims. Mechanics’ lien laws in many jurisdictions are drafted to address traditional vertical construction on a single plot of land. Because pipelines snake through miles of public and private property on rights-of-way secured for the pipeline, mechanics’ lien laws in many jurisdictions are not equipped to address pipeline construction.

Mechanics’ lien laws are jurisdiction-specific and vary widely from state to state. What projects are covered, who is entitled to file a lien, the property interest the lien attaches to, and the process and requirements to perfect a lien depend on the jurisdiction in which the project is located. This is particularly true for pipeline projects. One of the fundamental distinctions between oil and gas development and vertical construction is the nature of the improvement and property interest to which the lien attaches. On most construction projects, the lien attaches to the project owner’s real estate. In oil and gas development, however, the project “owner” (i.e., the company constructing the well or pipeline) often has obtained a right-of-way on the property and is not the fee owner. The question of whether a pipeline constitutes a lienable improvement for purposes of the state’s mechanics’ lien law is unsettled in many jurisdictions.

This is the case in Pennsylvania and many other jurisdictions where the general mechanics’ lien laws, despite the Marcellus Shale play, do not mention oil and gas projects at all. This presents the question as to whether the installation of the pipeline qualifies as an “improvement” for purposes of the state’s general mechanics’ lien laws, and whether an easement interest in the land is even subject to a lien.

The statutory language under the Pennsylvania mechanics’ lien law defines an “improvement” to include “any building, structure or other improvement of whatsoever kind or character erected or constructed on land, together with the fixtures and other personal property used in fitting up and equipping the same for the purpose for which it is intended.” 49 P.S. § 1201(1). The definition is silent as to the specific types of projects that it includes, and the Pennsylvania courts have yet to provide definitive guidance.

In Yellow Run Coal Co. v. Yellow Run Energy Co., 420 A.2d 690 (Pa. Super. Ct. 1979), the Pennsylvania Superior Court analyzed whether mining is an improvement to real property under the Pennsylvania mechanics’ lien law. In that case, the court drew a distinction between strip mining (which involved only activities associated with the excavation of top soil and coal) and underground mining (which also included the erection and construction of permanent improvements). The court held that strip mining coal and backfilling, unconnected with the construction of a building or other permanent structure, could not be the basis of a mechanics’ lien. With respect to pipeline construction, one might argue that, unlike Yellow Run, a pipeline includes the erection and construction of permanent improvements and thus is subject to lien. But Pennsylvania courts have not specifically resolved the issue of whether the installation of a pipeline falls within the definition of “improvement" on all projects.

Likewise, while Pennsylvania courts have extended lien rights to the “owner’s” leasehold or other equitable interests in the land, the courts have yet to resolve whether this extends to easements secured for the installation of the pipeline.

In other jurisdictions, however, state legislatures have eliminated the uncertainty by enacting specific lien laws addressing oil and gas projects. For example, Ohio’s mechanics’ lien law includes a separate section that provides for the right to lien upon oil or gas well facilities and pipelines. See Ohio Rev. Code Ann. § 1311.021. That section states:

Every person who performs any labor or work upon or furnishes material for digging, drilling, boring, operating, completing, or repairing, any well drilled or constructed for the production of oil or gas or any injection well which furthers the production of oil and gas or which disposes of waste products generated by oil and gas operations, or for altering, repairing, or constructing any oil derrick, oil tank, or leasehold production pipe line by virtue of a contract, express or implied, with the owner or part owner, or the owner’s or part owner’s authorized agent, of any oil and gas lease or leasehold estate or, in the event there is no lease or estate, any mineral estate, and every subcontractor, laborer, and material supplier who performs any labor or work or furnishes material to an original contractor or any subcontractor, in carrying forward, performing, or completing the contract, has a lien to secure the payment thereof upon the oil and gas lease or leasehold estate or, in the event there is no lease or estate, any mineral estate, the oil or gas produced therefrom and the proceeds thereof, and upon all material located thereon or used in connection therewith.

Importantly, this section also sets forth a process for actually filing a lien on a pipeline and the security interests that are attached. In the event there is no oil and gas lease to lien against, the statute extends lien rights to the proceeds of the oil and gas produced by the pipeline. Other states, such as Arkansas, Florida, Illinois, Iowa, Michigan, Nebraska, New Mexico, Ohio, Texas and Utah, have taken a similar approach by enacting statutes specifically addressing a contractor, subcontractor or supplier’s lien rights in the context of oil and gas development.

Whether a contractor, subcontractor or supplier can rely on mechanics’ liens for protection in the event of upstream insolvency depends on the jurisdiction. It is therefore important to understand the mechanics’ lien laws and any other applicable statutes in the state where the project is located, as well as how the courts have interpreted those laws.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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