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Presenting a live 90-minute webinar with interactive Q&A
Midstream Executory Contracts
in Bankruptcy After Sabine Navigating Court Treatment of Transportation, Gathering and
Processing Agreements; Negotiating Midstream Agreements
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
WEDNESDAY, JUNE 1, 2016
Denis A. (Archie) Fallon, Partner, King & Spalding, Houston
Vince Slusher, Partner, DLA Piper, Dallas
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Executory Contracts in Bankruptcy
Section 365(a) of the Bankruptcy Code allows a bankrupt
debtor, “subject to the court’s approval,” to “assume or reject
any executory contract”
This section allows a bankrupt debtor to evaluate its executory
contracts and seek to assume those that are most beneficial to
its business and to reject those agreements that are
burdensome
The test for approval of assumption or rejection of an
executory contract is whether the debtor’s decision to do so is
a “reasonable exercise” of its “business judgment”
6
Sabine Oil & Gas Co.
In Sabine Oil & Gas Co. (Bankr. S.D.N.Y.), Sabine sought to reject its
gathering agreements with midstream gathering pipeline companies.
Sabine argued that rejection was a reasonable exercise of Sabine’s business
judgment and in the best interests of its estate because the agreements
required Sabine to deliver the minimum amounts of gas and condensate set
forth in the agreements, which they could not do, or pay certain deficiency
payments
The gathering pipeline companies argued that whether such agreements
could be rejected or not, the gathering agreements or certain terms therein
were “covenants that run with the land” which survive rejection by a bankrupt
debtor.
On March 8, 2016, the Bankruptcy Court held that Sabine may reject the
agreements because the gathering pipeline companies presented no
evidence challenging Sabine’s business judgment and issued a non-binding
analysis that the gathering agreements should not be considered “covenants
running with land” under Texas law
7
Sabine Oil & Gas Co. (cont.)
Under Texas law, a covenant runs with land when “(1) it touches and concerns the
land; (2) it relates to a thing in existence or specifically binds the parties and their
assigns; (3) it is intended by the original parties to run with the land; and (4) the
successor to the burden has notice.”
Some courts have also required “horizontal privity of estate,” which generally means
“‘simultaneous existing interests or mutual privity’ between the original covenanting parties
either as landlord and tenant or grantor and grantee.”
The Bankruptcy Court stated that the covenants at issue do not run with the land for
the following reasons:
First, there was no horizontal privity of estate because Sabine did not “reserve any interest” for
the gathering pipeline companies; rather Sabine engaged the gathering pipeline companies to
“perform certain services related to the hydrocarbon products produced by Sabine from its
property.” Moreover, the gathering agreements did not grant any property rights in Sabine’s
property, as a right to gather gas is not a fundamental property right under Texas law.
Second, the covenants do not “touch and concern” the land because the covenants do not
“affect the owner’s interest in the property or its use.” Rather, the covenants concern Sabine’s
interest in the products produced from the land.
The Bankruptcy Court later confirmed this ruling in an adversary proceeding.
8
Quicksilver Resources ;
Magnum Hunter
Quicksilver Resources (Bankr. D. Del.)
Buyer conditioned the acquisition of debtor Quicksilver’s assets on rejection of midstream
gathering agreements
Rejection of midstream gathering agreements, if successful, would have resulted in
substantial unsecured claim of midstream companies against the estate
The acquirer agreed to enter into a new contract with the debtor’s midstream pipeline
operator, averting the need for the Bankruptcy Court to rule on the motion to reject
Magnum Hunter Resources (Bankr. D. Del.)
On March 10, 2016, the debtors in the Magnum Hunter Resources reached an agreement
to terminate gas transportation and credit support agreements between one of the debtors
and its midstream pipeline partner
Pursuant to the agreement, the gas transportation and credit support agreements will
be rejected and the midstream gathering company will be allowed a $15 million claim
in the debtor’s chapter 11 case on account of the unfulfilled credit support agreement
to provide letters of credit totaling $65 million
On April 13, 2016, Magnum Hunter indicated that it reached an agreement to reject
agreements with another midstream pipeline partner. The terms of the resolution were not
disclosed. On April 14, the Bankruptcy Court authorized the rejection.
9
Impact of the Sabine Decision
Impact on Midstream Companies: adversely impacts midstream gathering
pipeline companies that have contracted with exploration companies facing
insolvency
The value of pipeline and gathering facilities construction would be jeopardized if
the agreements governing their use were rejected by the upstream exploration
companies in bankruptcy
Impact on E&P Companies: provides leverage to financially troubled
upstream exploration companies as they attempt to renegotiate agreements
with gathering pipeline companies, giving them the leverage of a bankruptcy
threat if their demands are not met
Note: The applicability of the Sabine decision is somewhat limited where
non-Texas state law governs the relevant contract and related property
rights.
10
The Impact of In re Sabine Oil & Gas Corp. and the Rejection of Agreements of
Midstream Companies in Bankruptcy
Presentation by Archie Fallon [email protected]
June 1, 2016
King & Spalding LLP 1100 Louisiana, Suite 4000
Houston, Texas 77002
In re Sabine Oil & Gas Corporation, et al. Case No. 15-11835 (Bankr. S.D.N.Y.) – Pertinent Facts
• Sabine entered into Gathering Agreements with Nordheim Eagle Ford Gathering,
LLC (“Nordheim”) in 2014
― Gathering Agreements state they are “covenant[s] running with the [land]” and
are enforceable by Nordheim against Sabine, its affiliates, and their successors
and assigns
― Privity Issue – Gathering Agreements with Sabine, but mineral rights located
in a specified geographical area in DeWitt County, Texas and owned by
Sabine South Texas LLC, who was not a party to the Gathering Agreements
Sabine did not convey any portion of its real property interests to
Nordheim through the Gathering Agreements
• The property subject to the Gathering Agreements was subject to preexisting liens
held by Sabine’s secured lenders
• Nordheim’s gathering fee was not secured
12
Sabine – Opinion Takeaways
• Gathering Agreements must be reviewed on a case-by-case, fact-
intensive basis
― Do covenants “touch and concern” or affect the
land?
Is land “unburdened” by alleged covenant (e.g.,
minimum volume commitment)?
― Is there horizontal privity?
― What was the intent of the parties?
― Was the notice properly recorded?
― Is a conveyance of oil and gas interests necessary?
13
In re Quicksilver Resources Inc., Case No. 15-10585 (Bankr. D. Del.)
• Bluestone conditions $235 million acquisition of Quicksilver’s
Barnett Shale assets (mostly gas and NGL wells) on rejection of
Crestwood gathering agreements
• Rejection of Crestwood gathering agreements, if successful, would
have resulted in substantial unsecured claim of Crestwood against
debtor estate
• Quicksilver affiliates had developed gathering systems for three
formations, and Crestwood acquired those three gathering systems
from Quicksilver affiliates for over $700 million in 2010
• Prior Quicksilver filings with SEC indicated that G&P contracts
would “survive any transfer” by Quicksilver
14
Quicksilver - Benefits of Structuring a Deal
Quicksilver / Blue Stone Benefits Crestwood Benefits
Quicksilver closes sale - not forced to
further delay closing through legal process
for challenging property interest represented
by dedication.
Quicksilver withdraws motion to reject
Crestwood’s legacy gathering agreements.
Crestwood relationship continues -
Substantial amount of Quicksilver revenue
from nat gas and NGL production on acreage
dedicated to Crestwood.
Bluestone is financially sound, experienced
Barnett Shale gas operator, known for
growing production from existing wells at
low costs
Presumably, gathering fees are reduced “Production Assurance” – all shut-in wells
return to production by 7/1/16 and will not
shut-in or choke production through 2018
Gathering agreement terms extended from
2020 through 2026
No continuing credit exposure to Quicksilver
- Upside potential over long-term through
hybrid fixed fee / POP payment structure
15
Strategic Takeaways from In re Quicksilver for Asset Sales • Post-Sabine, conditioning an asset sale on the rejection of
midstream contracts is a more powerful strategy for an E&P debtor, but fraught with dilutive risk for creditors
• E&P debtor should seek non-reimbursable deposit from
“conditional” asset bidder, discourages “wait & see” • A robust process can generate backup bidders with
different views on G&P contract economics – backup bidder to Bluestone would buy assets subject to Crestwood contracts – more flexibility for E&P debtor and creditors
• G&P potentially willing to exchange short term MVC
economics for production growth, alignment in upside
16
In re Energytec, Inc., 739 F.3d 215 (5th Cir. 2013)
• Factually distinguishable from Sabine
• Pipeline system owner assigned its property rights to one party but reserved “by covenant” for another party (an affiliate) the right to receive a fee for product transported through the pipeline and a right to consent to any assignment of that property
• Original seller sought to ensure the transfer of its property interests did not eliminate an interest in the property of a third party
17
Energytec – The “Traditional Paradigm”
Mescalero (Original
Owner)
Reservation of Rights/Covenant -- “Subject
to” Transportation Fee & Right to Approve
Future Assignments of Pipeline
Producer’s
Pipeline
Energytec/
Debtor
NEWCO
Pipeline & Plant Sale
Red Water / Buyer
§ 363 Sale
Are Transportation Fee and
Assignment Approval Rights
Covenants That Cannot Be
Stripped in § 363 Sale?
Sale Objection
18
Covenant Must “Run with the Land” – Tactics Based on Texas Case Law Element 1: Touches & Concerns Land
― Direct impact on land value and use ― Burden necessary, but not benefit ― Energytec: Agreement required beneficiary of
fee/burden to approve subsequent transfers – T&C element met
― Wimberly: Landowner’s contract to sell water to operator for gas compressor station lasted “so long as operator operated the plant” – T&C element met
― American Refining: Gas sales from “dedicated wells” were sale of in situ minerals – T&C element met
19
“Run with the Land” Analysis
• Element 1: Touches & Concerns Land (Continued)
Energytec Sabine Considerations
post-Sabine
Security Transport fee
secured by lien on
pipeline system
No security G&Pco seeks
(subordinated)
lien & files notice
in county records
Consent Rights on
Transfers
Beneficiary of
pipeline fee had
right to approve
transfer of
pipeline assets
G&Pco did not
have right to
approve transfers
of mineral estate
G&Pco has right
to approve
contract
assignment
Fee Trigger “Tied
to Land”
Payment of
transport fee tied
to gas flow
directly from well
Gathering fee
trigger - “receipt
of gas…into
Nordheim’s own
facilities”
A fee trigger “at
the wellhead”
might help legal
analysis, but is it
the business deal?
20
“Run with the Land” Analysis
Element 2: Relation to Thing in
Existence (in esse) or Specifically
Binds Parties & Assigns
- Beckham: Promise to construct
flume for irrigation, which was
constructed, but not maintained
- But see Gulf: Fence that was to built,
but was never built
- Include schedule with particular
description of relevant facilities
21
“Run with the Land” Analysis
Element 3: Original Intent to Run
with the Land
- Energytec: Include statement parties intend
for covenant to “run with the land”
- Include contract language that contract is
binding upon parties’ “successors and
assigns”
- Evidence of intent is bolstered by filing the
agreement in county deed records
22
“Run with the Land” Analysis
Element 4: Successor to Burden
Has Notice
- Constructive Notice – filing in
County records
- Actual Notice - acknowledgement
letter agreement between successor
and G&P company, potentially
addressing indemnity and release
issues
23
THE “FIFTH” ELEMENT
Vertical / Horizontal Privity of
Estate - The “Traditional Paradigm” –
conveyance of real estate (surface,
mineral, water rights), subject to
reservation of interest
- On the other hand, a personal covenant,
such as a promise to provide utility
service or environmental indemnity, does
not involve a transfer of real estate, does
not survive bankruptcy challenge 24
“Further Assurances”
- Many gathering agreements entitle G&P companies to request producers provide further assurances related to creditworthiness and dedication of assets.
- Further assurances of creditworthiness –
information rights, parent guaranty, notices from lenders, approval of successors.
- Producer grant of security (liens, mortgages) in
mineral estate or other assets to G&P not historically market, but may be possible in some limited circumstances (see Energytec).
25
Williams / Chesapeake G&P Renegotiation in 4Q 2015 Utica Haynesville
Fee Change Cost of services fee changed
to fixed fee with minimum
volume commitments
Cost of services fee changed to
fixed fee with minimum
volume commitments
achievable by collapsing two
contract areas
New Acreage /
Wells
50,000 new acres – total of
190,000 net acres
140 new wells by end of 2017,
Price Savings $.25 mmbtu $.20 per Mcf in 2016-17
$.30 per Mcf in 2018…
Other published
terms
250 mmbtu per day through
Williams pipelines beginning
in 2017
Term to last to 2035
Allows Williams to gather third
party volumes and build scale
in Utica dry gas areas
26
MVC - Further Questions to be Addressed
• MVCs are dilutive to creditors, and may make a Midstream Contract more prone to rejection.
• Crestwood emphasized that its gathering agreements with Quicksilver did not contain MVCs.
• MVCs without production risk may be viewed as inconsistent with a real property interest or covenants running with land, may be viewed as unsecured borrowing and attacked by other creditors.
27
Forward Contract Issues
• Gas Purchase Contracts between producers and midstream companies are typically “forward contracts”. ― future purchase of gas from leases ― midstream companies are “industry participants” ― delivery occurs on specified dates ― monthly account settlement
• Safe harbor under Bankruptcy Code for settlement payments under Section 546(e).
• Drafting suggestions: payment settlement, monthly setoff, liquidation clauses
28
Liability Continuation /Assignment Considerations • Producer A assigns working interests in lease &
related gathering contract with G&P to Producer B • Producer A does not obtain release of liability from
G&P • Producer B files for bankruptcy • Producer A potentially has continuing liability for
pre- and post assignment activities despite Producer B’s bankruptcy
• Seagull Energy E&P, Inc. v. Eland Energy, Inc., 207 S.W.3d 342 (Tex. 2006);
but note that certain federal bankruptcy courts have prevented litigation against co-obligors of bankruptcy estate, see e.g., In re Lazarus Burman Associates, 161 B.R. 891, 899-900 (Bankr. E.D.N.Y. 1993)
29