Fifth Circuit Issues Decision Concerning Overriding Royalty Interests and Louisiana Oil Well Lien Act Claims

by King & Spalding

The ATP Oil & Gas Corporation bankruptcy case (Case No. 4:12-bk-36187, S.D. Texas) (“ATP”) involved the intersection of energy and bankruptcy law on a variety of issues. Most recently, the Fifth Circuit Court of Appeals rendered a decision arising from that case dealing with the relative rights or priorities between the holder of overriding royalty interests (“ORRI”) and parties asserting lien claims or privileges under the Louisiana Oil Well Lien Act (“LOWLA”) (La. Rev. Stat § 9:4861) in a case titled OHA Investment Corporation f/k/a NGP Capital Resources Company v. Schlumberger Technology Corporation, et. al (No. 17-20224: April 17, 2018).

The underlying facts before the Court were fairly straightforward. Before its bankruptcy filing, to raise money, APT sold what were described as ORRI to a third party, OHA Investment Corporation (“OHA”), in the aggregate amount of $65 million starting in June 2011 and completing the ORRI sale in July 2012. The ORRI entitled OHA to receive a cost-free percentage of the hydrocarbons “produced, saved and sold from or attributable” to a mineral lease until it received a certain sum. In August 2012, ATP filed a voluntary chapter 11 bankruptcy case. OHA filed a declaratory judgment (i) that it, not the bankruptcy estate, owned the ORRI and (ii) that the ORRI was not an executory contract that could be rejected. The LOWLA lien creditors intervened in the declaratory judgment action and sought recovery against OHA. The bankruptcy court presided and ultimately made a report and recommendation to the District Court which after its decision, was appealed to the Fifth Circuit.

Initially, the bankruptcy court bifurcated the matter into two phases: first, whether OHA owned the ORRI, and if the ORRI were capable of being rejected as executory contracts under Bankruptcy Code section 365. The second phase would determine the priority or LOWLA issues. The parties resolved the first phase by an agreed judgment. For the second phase, OHA sought dismissal under Fed. R. Civ. Pro. 12(b)(6) arguing that (i) LOWLA liens could not attach to ORRI, and, alternatively (ii) if the liens did attach, they were extinguished by LOWLA’s “safe harbor” provisions which protect a “bona fide onerous transaction by the lessee or other person who severed or owned them at severance.” The issues on appeal involved this second phase.

The bankruptcy court determined that LOWLA liens could attach to an ORRI but that the LOWLA safe harbor provisions protected OHA. As such, under LOWLA §9:4869(A)(1)(a), OHA would prevail unless the LOWLA lien claimants had provided notice to OHA before it purchased its ORRI. The bankruptcy court went on to conclude that the safe harbor provisions required actual notice by the claimants. The LOWLA lien claimants did not make any such allegation of notice and thus the bankruptcy court recommended that OHA’s motion to dismiss be granted. The District Court largely agreed with the bankruptcy court’s report and recommendation save that because the lien claimants failed to allege they provided any notice, it was not necessary to decide whether actual notice is required. The LOWLA lien claimants appealed.

The Fifth Circuit identified three potential issues but stated that it was only deciding a single issue – does the LOWLA safe harbor provisions cover OHA’s purchase of the ORRI? While it generally used normal principles of statutory interpretation, the Fifth Circuit did have to rely on substantive Louisiana oil and gas law as LOWLA does not define all the terms necessary to answer the single issue addressed. Initially, the Court rejected the lien claimants argument that ATP could not sell to OHA the hydrocarbons in the ground, noting that a lease not only provides ownership of the minerals after production, but also gives the lessee the right to produce hydrocarbons and thus OHA’s ORRI attached to the to-be-produced hydrocarbons.[1] Further, the Court rejected the argument that the ORRI could only attach to proceeds noting that an ORRI, like the one at issue, could be paid in cash or in kind and by definition, was a percentage free of drilling and production costs.[2]

Then, turning to the safe harbor language, the Court reviewed but rejected the LOWLA lien claimants main argument that the safe harbor language covered not an interest in shares of production but only the already-severed hydrocarbons. The Court held that the term “hydrocarbons” encompasses both those in the ground as well as that produced and, as such, those hydrocarbons (including in the ground) can be sold to and owned by an overriding royalty owner.[3] And, because the text of the safe harbor language extinguishes liens in a conveyance to a purchaser, OHA’s ORRI “fit squarely within that [safe harbor] category.”[4] Because the LOWLA claimants failed to provide pre-purchase notice of their liens, the safe harbor provisions extinguished those liens.

This case makes clear that absent notice by LOWLA lien creditors, a party purchasing an overriding royalty interest, or a production payment, should be protected from those lien claims. As noted at the outset, an important question not answered by this decision is what type of notice is necessary to remove the safe harbor protections. Stated in another way, how would LOWLA lien claimants provide notice to anyone considering entering into a transaction with a lessee to put those persons on notice? The flip side of this issue is what type of diligence should a party negotiating the purchase of an ORRI undertake, in order to be covered by the safe harbor provisions? These important questions await further clarification, and at least one bankruptcy court in Houston believes that actual notice by the claimants is necessary.

 [1] Opinion at 9.

[2] Opinion at 8, citing Total E&P USA Inc. v. Kerr-McGee Oil and Gas Corp., 719 F.3d 424 (5th Cir. 2013).

[3] Opinion at 11.

[4] Opinion at 10.

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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