In a significant opinion for oil and gas industry bankruptcies, the Fifth Circuit in In re Whistler Energy II, LLC., No. 18-30940, 2019 WL 3369099 (5th Cir. July 26, 2019), issued a ruling setting forth the circumstances regarding whether an offshore drilling contractor is entitled to an administrative claim after rejection of its drilling contract.

Facts

The debtor operated an offshore drilling and production platform. Prior to the bankruptcy, the debtor hired a drilling contractor to install a drilling rig and associated equipment on the platform and provide workers to drill a new well from the platform.

Prior to the bankruptcy filing, a worker was killed in an accident on the platform. Federal regulators then shut down the drilling project. Two weeks later, an involuntary petition was filed against the owner of the platform.

The debtor filed a motion to reject the contract with the creditor, which was granted by the bankruptcy court and effective as of the date the creditor abandoned the platform. Thereafter, the federal regulators approved a plan for the drilling contractor to remove the drilling rig and its other equipment from the platform, which the drilling contractor adhered to. The drilling contractor filed an administrative claim for approximately $7 million, covering the period from the effective date of rejection until it had removed its equipment from the platform.

The bankruptcy judge allowed an administrative claim for some a mere fraction of that amount—$900,000—holding that the contractor was entitled to a priority claim only for services specifically requested by the debtor after the effective date of rejection. The district court affirmed and the drilling contractor appealed to the Fifth Circuit.

The Fifth Circuit’s Decision

The Fifth Circuit began by distilling to its essence the law on the allowance of administrative claims under section 503(b)(1)(A). To qualify as “actual, necessary costs and expenses of preserving the estate” the claim must have arisen post-petition and as a result of actions taken by the debtor in possession that benefitted the estate, and that the claim must have arisen from a transaction with the debtor in possession, as opposed to the pre-bankruptcy debtor. The court then explained how a creditor can make such a showing: “[A] creditor can establish that its expenses are attributable to the actions of the bankruptcy estate through evidence of either a direct request from the debtor-in-possession or other inducement via the knowing and voluntary post-petition acceptance of desired goods or services.”  Id. at *5.   According to the court, “[i]f a debtor-in-possession decides to rent equipment for its business, for example, it cannot later evade those rental payments by asserting that it did not end up needing the equipment after all.” Id. at *5.

Applying the facts to the law, the court broke the claim into two separate parts: (1) the pre-demobilization period after rejection up until the contractor was authorized by regulators to begin removing its equipment from the platform, and (2) the demobilization period during which time the contractor removed the equipment from the platform.  Id. at *7-8.

As to the pre-demobilization portion of the claim, the court stated that the bankruptcy court’s denial of most of the claim for administrative status “appears to have been influenced by [the bankruptcy court’s] stated view that [the drilling contractor’s] mere availability on the platform did not warrant administrative priority.”  Id. at *7. In the Fifth Circuit’s view, however, waiting for regulatory approval “can benefit the debtor in possession,” because the debtor asked the contractor to prepare a demobilization plan and wanted the contractor to await regulatory approval before removing its equipment. Id.

Accordingly, the court held that the contractor would have a priority claim “for the actual and necessary cost of its presence on the platform for the period of time required to satisfy [the debtor’s] logistical and regulatory requirements.” But the contract would not qualify for a priority claim “for the costs of its presence on the platform for any time attributable to its own unnecessary delay.” Id.

The Fifth Circuit remanded the case to the bankruptcy court to determine: (1) whether the debtor induced the contractor to remain on the platform; (2) the length of time the contractor was on the platform “because of [the debtor’s] post-petition needs,” and (3) “the actual and necessary costs of staying on the platform during this time period.”  The court held that “actual and necessary” includes the costs of “remaining on the platform” and “the full and ordinary costs of providing a service, including overhead costs and other indirect expenses.”  Id.

With respect to the demobilization portion of the claim, the Fifth Circuit upheld the bankruptcy court by denying administrative status for everything, reasoning that demobilization “was simply the consequence of [the debtor’s] rejection of the contract and did not benefit the estate.” Id. at *8-9.

Given the increasing number of oil and gas industry bankruptcies, this opinion is likely to have far reaching import.