New Bankruptcy Ruling Could Impact Future Midstream Contracts

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On Oct. 28, 2020, the U.S. Bankruptcy Court for the Southern District of Texas delivered a key ruling affecting: (1) purchase and sale agreements for produced gas and severed minerals; and (2) agreements with “exclusive remedy” provisions and liquidated damage clauses. See Mem. Op., In re: Chesapeake Energy Corp., et al., Cause No. 20-33233 (Bankr. S.D. Tex. Oct. 28, 2020).

In June 2020, Chesapeake Energy Corporation and related entities (Chesapeake) filed for Chapter 11 bankruptcy. Thereafter, Chesapeake filed a motion to reject a gas purchase agreement with ETC Texas Pipeline, Ltd. (ETC). The agreement was published by the North American Energy Standards Board (NAESB) and titled “Base Contract for Sale and Purchase of Natural Gas.”

[Note: Under 11 U.S.C. § 365(a), a debtor “may assume or reject any executory contract ....” 11 U.S.C. § 365(a). “A contract is executory ‘if performance remains due to some extent on both sides.’” Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 (U.S. 2019).]

ETC claimed the NAESB agreement included a covenant “running with the land” and thus could not be rejected as an executory contract. Chesapeake countered that: (1) the NAESB agreement did not create a covenant running with the land; and (2) if it contained a covenant running with the land, the agreement’s exclusive remedy provision allowed rejection.

In its memorandum opinion, the bankruptcy court held that a contract could be subject to rejection, even if it contained a covenant running with the land. According to the court, “It [did] not stretch the imagination to envision a contract that both contains a covenant that runs with the land and is executory.”

Regardless, the bankruptcy court held that, while the NAESB agreement stated the obligation to sell gas would “run with the land,” Chesapeake and ETC did not truly intend to create a real property covenant. In the event of a breach, the “sole and exclusive remedy of the parties” was payment of liquidated damages (rather than enforcing the purchase and sale of gas). Thus, the parties had excluded specific performance and injunctive relief related to real property remedies, instead opting for personal compensatory remedies. Notably, ETC also never obtained interests in Chesapeake’s leases and had agreed only to buy produced gas (after it was severed from the mineral estate and became personal property).

Ultimately, the bankruptcy court granted Chesapeake’s motion to reject its midstream contract with ETC — but only after reminding the energy industry, “Simply put, the parties’ words matter.” In the future, this decision could affect bankruptcies and restructurings around the nation, including the ability to reject certain midstream contracts that allegedly “run with the land” and contracts with exclusive remedy provisions.

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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