Keeping Score in Midstream Dedications in Bankruptcy: Midstreams 2, Producers 1

Gray Reed

Gray Reed & McGraw

Ever since the Sabine Oil and Gas Corp. bankruptcy (the top of the first, If it were baseball), where a New York court construed Texas property law to hold that a gathering agreement was not a covenant running with the land, we at Gray Reed, and you if you’re following, have speculated whether a Texas court faced with the question would have come to a different conclusion (see here and here). In Alta Mesa Holdings v. Kingfisher Midstream, a Texas court finally had its say (albeit applying Oklahoma law). For midstream entities, the court did not disappoint.

As we approach the middle innings (47 states to go!), the Alta Mesa court went against Sabine, holding that the dedication in question was a real property interest that could not be rejected in bankruptcy. Along with Badlands Energy, midstream companies have gone from being shut out to being up 2-1 on producers.

Distinguishing Sabine

E&P debtor Alta Mesa contracted with its affiliate, Kingfisher Midstream, to build a gathering system and to transport Alta Mesa’s gas. Once in bankruptcy, Alta Mesa sued Kingfisher for a declaration that the gathering agreement did not constitute a covenant running with the land and thus, could be rejected.

Because the dedicated acreage was in Oklahoma, Oklahoma law governed, although noting that real covenant law in Oklahoma is functionally the same as in Texas. The same two elements at issue in Sabine were at issue: “touch and concern” and “horizontal privity”. But the court was quick to recognize that Sabine was limited to its unique facts and should not be generalized.

The Alta Mesa gathering agreement dedicated all producer’s interest in, among other things, its oil and gas leases within the dedication area. The court held that the dedication satisfied touch and concern because both its benefits and burdens impacted the value of the real property leases. In contrast, in Sabine, the dedication only related to gas “produced and saved,” which the court construed as only affecting personal property interests.

The Alta Mesa court also found that Alta Mesa’s conveyance of a surface easement to Kingfisher satisfied horizontal privity between the parties. The court distinguished Sabine, which held that a related surface easement did not satisfy horizontal privity. Looking again to the dedication of leases, the court noted that the easements at issue were implied in Alta Mesa’s leases. By dedicating the leases to Kingfisher, it was simultaneously conveying the associated easements as well.

And the moral of the story …

It’s all about the dedication language. Since Sabine, midstream companies have tried to draft gathering agreements to get around the problem of gas “produced and saved” by getting a dedication of producer’s interest in the underlying leases. In light of Alta Mesa, in which a dedication of leases satisfies both contested elements of a covenant running with the land, those efforts were not in vain.

As gathering agreements go, so goes our musical interlude.

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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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