Texas Bankruptcy Court – Applying Oklahoma Law – Concludes That Gathering Agreements Created Covenants Running With the Land and Cannot be Rejected by the Alta Mesa Resources Debtors

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On December 20, 2019, the United States Bankruptcy Court for the Southern District of Texas (Marvin Isgur presiding) entered a memorandum opinion and order finding that midstream gathering agreements created covenants running with the land under Oklahoma law that could not be rejected by bankrupt debtors. This decision reached the same conclusion as a Colorado bankruptcy court in September 2019.[1] Both decisions depart from the widely-reported 2016 decision in Sabine Oil & Gas Corp. v. Nordheim Eagle Ford Gathering, LLC, which held that a debtor could reject a midstream gathering agreement pursuant to section 365 of the Bankruptcy Code because it did not create a real covenant that ran with the land under Texas law.[2]

On September 12, 2019, Debtors Alta Mesa Resources, Inc. and Oklahoma Energy Acquisitions, LP (the “Debtors”) filed their Complaint against Defendants Kingfisher Midstream, LLC and Oklahoma Produced Water Solutions, LLC (together, “KFM”), initiating Adversary Case No. 19-03609 (the “Adversary Proceeding”). Among the various causes of action asserted in the Adversary Proceeding, the Debtors sought a declaration that certain gathering agreements were subject to rejection pursuant to sections 365(a) and 363(f) of the Bankruptcy Code. Under section 365 of the Bankruptcy Code, a debtor may, subject to the court’s approval, “assume or reject any executory contract or unexpired lease of the debtor.” The declaratory relief requested by the Debtors directly implicated whether a gathering agreement constitutes a covenant running with the land. Significantly, covenants running with the land do not qualify as executory contracts that a debtor can reject under the Bankruptcy Code.

On November 8, 2019, the Debtors and KFM filed competing motions for summary judgment with respect to the issue of whether the gathering agreements were subject to rejection under section 365 of the Bankruptcy Code.[3] The motions detail the complex facts specific to the underlying transactions. The Debtors argued, among other things, that the gathering agreements constituted executory contracts subject to rejection under the Bankruptcy Code and pursuant to the holding in Sabine Oil. KFM, on the other hand, argued that the gathering agreements were covenants running with the land in favor of KFM that could not be rejected by the Debtors.

On December 6, 2019, Judge Marvin Isgur of the United States Bankruptcy Court for the Southern District of Texas announced in a telephonic hearing that certain gathering agreements constituted covenants running with the land that could not be rejected by a debtor under the Bankruptcy Code.

On December 20, 2019, Judge Isgur issued his written opinion confirming that announcement. In his memorandum opinion, Judge Isgur noted that the Court could assume that rejection of the gathering agreements would be in the “best interest of the estate,” but commented that the Court’s role is not to “assist the estate by allowing the rejection of a contract that is not executory.”

The Court also analyzed the differing decisions in this area; Judge Isgur specifically noted that “unique facts in Sabine Oil led to that court’s conclusions,” and “[t]o the extent that the pronouncements in Sabine Oil were intended to be generalized, this Court must reject them.” While the Sabine Oil decision found that the agreements failed to satisfy both the touch and concern and privity elements, Judge Isgur found that both of those elements were present in the Debtors’ midstream agreements with KFM. The court explained that a covenant touches and concerns the land when it requires the performance of a physical act upon the land that directly benefits the landowner. The gathering agreements met that requirement because KFM used its surface easement to build a modern gathering system, which enhanced the value of the leases. On the other hand, the agreements imposed costs and restrictions on the hydrocarbons. Regarding the privity element, Judge Isgur observed that the Debtors’ leases granted them easements to develop hydrocarbons and that the Debtors granted a portion of those easements to KFM to provide gathering services. In holding that the easements directly burden the Debtors’ interests, Judge Isgur noted that, “[c]ontrary to the holding in Sabine, the surface easements directly affect the lessee’s underlying mineral interest” because “[w]ithout the surface easement, the lessee cannot capture reserve hydrocarbons.” Finally, based on the express language of the agreements, the parties intended the agreements to run with the land.

Thus, Judge Isgur found that the Debtors’ gathering agreements with KFM satisfy all elements required to form real property covenants under Oklahoma law and the precedent set by other federal courts, specifically, Sw. Pipe Line Co. v. Empire Nat. Gas Co., 33 F.2d 248 (8th Cir. 1929) and Monarch Midstream v. Badlands (2019), discussed above in footnote 1. Accordingly, Judge Isgur ordered that the midstream contracts qualified as covenants running with the land under Oklahoma law that could not be rejected pursuant to section 365 of the Bankruptcy Code.

[1] For more information, see “Major Decision in Energy-Related Bankruptcies: Colorado Court in Monarch Midstream Case Departs from Sabine Oil and Finds Gathering Agreement Established a Covenant Running with the Land” discussing Monarch Midstream, LLC v. Badlands Production Company, Adversary Case No. 17-01429 in the United States Bankruptcy Court for the District of Utah, which was decided on Sept. 30, 2019 and applied Utah law.

[2] See Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC (In re Sabine Oil & Gas Corp.), 550 B.R. 59 (Bankr. S.D.N.Y. 2016); aff’d, 567 B.R. 869 (S.D.N.Y. 2017); aff’d, 734 Fed. Appx. 64 (2d Cir. 2018).  Jackson Walker’s Energy section chair Mike Pearson had addressed the issue of covenants running with the land and the Sabine case in detail in his paper titled, “Covenants Running with the Land.” 

[3]  KFM also sought summary judgment on the remaining causes of action asserted in the Debtors’ Complaint.

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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