Journal of
Corporate
Renewal
October
2016
adversary proceeding was needed
to determine the asserted “validity,
priority, or extent of [Nordheim’s
and HPIP’s] interest in property.”
After Chapman’s initial, nonbinding
ruling, Sabine commenced an
adversary proceeding pursuant to Rule
7001 to determine the validity of the
asserted property interest. Chapman,
ratifying her earlier decision, held
that Sabine’s covenants that were
asserted to run with the land were
not enforceable. In broad strokes,
Chapman, applying Texas law, found
that the covenants did not “touch and
concern” the debtors’ real property
because the only interest governed
by the midstream agreements were
“minerals extracted from the ground,”
which the court found “indisputably
constitute personal property, not real
property, under Texas law.” Among
other things, Chapman found that had
the midstream agreements operated
as insisted by Nordheim and HPIP,
Sabine would have violated the terms
of its existing credit agreement.
Uncertain Fallout
The Sabine dispute was extremely
fact-specific, and the Bankruptcy
Court’s decision is not binding on
other courts. Moreover, Chapman
was applying Texas law. Other oil and
gas debtors have filed in Delaware,
Texas, and other jurisdictions, and
different state laws, such as those
of North Dakota or Oklahoma, may
govern their midstream gathering
contracts. Nevertheless, the decision
is informative in a number of ways.
On the one hand, the Sabine dispute
stands for the proposition that contracts
don’t always provide the protections the
parties may have intended or assumed—
especially when the protections are
intended to avoid consequences of
rejection in bankruptcy. The dispute
involving Sabine, Nordheim, and
HPIP highlights how difficult it is
to immunize an agreement from
the protections afforded a debtor in
bankruptcy. The structure intended to
make Sabine’s obligations rejection-proof—a structure repeated in many
midstream gathering contracts—would
not withstand scrutiny. And that’s
enough to make the case interesting.
On the other hand, the decision
is instructive strategically. The
“dedication/covenant” construct
in the midstream agreements was
fairly standard (if not uniform)
in the industry for midstream
gathering contracts. While the facts
are unique in every case and the
governing law may vary from state
to state, upstream debtors burdened
by improvident and burdensome
midstream contracts now have a
roadmap for getting their midstream
counterparties to the negotiating table.
Other upstream and E&P debtors
that have moved to reject midstream
contracts in the wake of Sabine have
largely renegotiated their contracts
or otherwise settled their disputes
without the court rendering a
decision. However, some disputes
have not been amicably resolved.
A nonexhaustive list of debtors in the
oil and gas industry that have sought to
reject midstream contracts subsequent
to the Sabine decision includes
Triangle USA Petroleum Corp. (motion/
complaint filed July 5, 2016, to reject six
midstream contracts, and answer was
due August 19, 2016); Magnum Hunter
Resources Corp. (matter settled);
Penn Virginia (settled); Quicksilver
Resources (settled); Swift Energy Co.
(settled); SandRidge (contract rejected
without opposition); and Emerald Oil
Inc. (Hearing scheduled for September
23. The Bankruptcy Court issued a
temporary restraining order August 1,
2016, to “maintain status quo” when
debtor began transporting oil and
water by truck and “flaring excess
oil.” The order stated that “
[non-debtor] Dakota stood the likelihood
of prevailing on the merits of the
adversary proceeding in which Debtors
seek a ruling from the Court that the
dedication agreements do not run with
the land.”). More will likely follow.
Initial Test
Sabine is interesting because it was
the first major oil and gas case to test
whether a debtor could effectively
reject a contractual agreement
coupled with a “covenant” or “equitable
servitude.” Once it became clear that
the structure was vulnerable and
the contractual obligations could
be rejected, other debtors moved to
reject their midstream contracts and
have largely been able to renegotiate
or settle with their counterparties.
Perhaps more interesting is the
situation in which a debtor can
reject a midstream contract but has
no better available alternatives. For
some debtors there may be no other
alternative to move their product
from upstream to downstream than
the contract they currently have, or
the available alternatives are even
more expensive. What then?
If the company’s very survival
depends upon the midstream
provider’s cooperation to move its oil
and gas, the debtor has less leverage
but can still seek to renegotiate the
contract. The reality may be that the
debtor will have to cease operations
and liquidate unless it can obtain
concessions from the midstream
counterparty. If this is the case, the
rational midstream counterparty likely
realizes that it’s better to do some
business then no business at all. And
the sooner the parties can strike a
deal, the better it is for all involved.
But the debtor’s leverage is certainly
greater if there are feasible alternatives.
For example, a debtor may be able to
successfully renegotiate a midstream
pipeline contract if the debtor can
use another method or provider to
gather, transport, and/or treat the
debtor’s oil and gas. In Sabine the
debtors did not renegotiate. On May
19, 2016, the Sabine debtors entered
into an agreement with an alternative
provider to replace the services
previously provided by Nordheim. J
Timothy Karcher is a partner in the New York
office of Proskauer Rose LLP, where his practice
concentrates on complex restructuring and
insolvency law, as well as financial reform and
regulation. He is a co-author of the “Consumer
Financial Protection Bureau Reporter” (Wolters
Kluwer) and editor of “CFPB Watch,” a monthly
newsletter on matters related to regulation
and reform of the financial industry.
