In consideration of the recent decline in oil prices and more widespread concerns throughout domestic and global markets related to the spread of COVID-19, oil and gas producers should review their marketing arrangements to ensure that they are protected if the first purchaser of their production becomes insolvent or files for bankruptcy.
As articulated in In re SemCrude, L.P.1 and re-affirmed in a recent case, In re First River Energy, LLC,2 the Texas First Purchaser Statute will often provide inadequate protection to the producers of oil and gas properties located in Texas, and therefore, a producer in Texas needs to take extra precautions to protect itself and to receive payments that it is owed in the event that the first purchaser of its production goes bankrupt.
Application of Texas First Purchaser Statute
The Texas First Purchaser Statute, found in Section 9.343 of the Texas Business and Commerce Code, provides to an “interest holder” a security interest that covers its oil and gas production and the identifiable sales proceeds owned, received or due on such production, and such security interest is intended to be automatically perfected without the need to file a separate financing statement.3
If the first purchaser of production files for bankruptcy, whether that first purchaser is a co-working interest owner that is marketing production on behalf of other working interest holders or is a midstream marketer, having a perfected security interest in such production is crucial to the recovery of proceeds owed to the interest holder. Unfortunately, following SemCrude, the Texas legislature failed to revise its First Purchaser Statute to ensure that Texas oil and gas production would be treated as real property and governed by Texas law, rather than personal property subject to the Uniform Commercial Code’s choice-of-law rules.
By contrast, the Oklahoma legislature took action to fix this problem. As reiterated in First River Energy, the law of a debtor’s organizing jurisdiction governs the perfection, effects of perfection, and priority of a security interest in personal property, including goods, inventory, accounts and proceeds.4 Therefore, a producer’s security interest in oil and gas produced in Texas and the proceeds from such production owed by a bankrupt purchaser organized in a different state, such as Delaware, for example, will not be automatically perfected by the Texas First Purchaser Statute.
Because Delaware law was discussed and applied in both SemCrude and First River Energy, Delaware law provides a good initial example of the extra steps a producer in Texas may need to take to protect itself. Under Delaware law, perfection of a security interest in a Delaware entity’s goods, inventory, accounts, and proceeds requires that a UCC-1 financing statement be filed in Delaware.5 Additionally, Delaware follows the first-to-file-or-perfect rule, which, as a practical point, means that filing a financing statement sooner rather than later will benefit a producer of oil and gas in Texas claiming priority over another security interest holder who files a financing statement at a later time.6
Other considerations may include whether additional filings in Texas or in other states where property may be located are necessary and whether another secured party may have a superior claim to deposit accounts containing oil and gas proceeds or other property of the debtor. In any case, reviewing existing marketing arrangements and proactive decision making will allow a producer of oil and gas in Texas to put itself in a better position to recoup proceeds of production if its midstream buyer becomes insolvent or declares bankruptcy.
Takeaway for Oil and Gas Producers
Following SemCrude, the Oklahoma legislature took action to revise its First Purchaser Statute to better protect producers with oil and gas properties in Oklahoma, but Texas is still operating under an inadequate First Purchaser Statute. This contrast between Texas and Oklahoma shows that a producer cannot simply assume its interests are protected, even in a large oil-producing state.
Because the protections afforded to oil and gas producers vary from state to state, the actions a producer must take to protect itself will also depend on where its oil and gas properties are located.
Porter Hedges is a full-service law firm representing diverse interests across the energy sector with the expertise to help you navigate complex energy issues. Whether your interests are in Texas, Oklahoma, or any other jurisdiction, we have the experience to help ensure that your interests are protected.
1 407 B.R. 1112 (Bankr. D. Del. 2009).
2 2019 WL 1103294 (Bankr. W.D. Tex. 2019).
3 Tex. Bus. & Com. Code Ann. § 9.343.
4 Id. § 9.301.
5 Del. Code Ann. tit. 6, § 9.310.
6 See Id. § 9.317.