Midstream Executory Contracts in Bankruptcy After Sabine

Transcription

1 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 WEDNESDAY, JUNE 1, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Denis A. (Archie) Fallon, Partner, King & Spalding, Houston Vince Slusher, Partner, DLA Piper, Dallas The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Midstream Executory Contracts in Bankruptcy After Sabine Vince Slusher

6 6 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

7 7 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

8 8 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.

9 Quicksilver Resources ; Magnum Hunter 9 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.

10 10 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.

11 The Impact of In re Sabine Oil & Gas Corp. and the Rejection of Agreements of Midstream Companies in Bankruptcy Presentation by Archie Fallon King & Spalding LLP 1100 Louisiana, Suite 4000 Houston, Texas June 1, 2016

12 In re Sabine Oil & Gas Corporation, et al. Case No (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

13 Sabine Opinion Takeaways Gathering Agreements must be reviewed on a case-by-case, factintensive 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

14 In re Quicksilver Resources Inc., Case No (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

15 Quicksilver - Benefits of Structuring a Deal Quicksilver / Blue Stone Benefits Quicksilver closes sale - not forced to further delay closing through legal process for challenging property interest represented by dedication. Crestwood Benefits 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. Presumably, gathering fees are reduced Gathering agreement terms extended from 2020 through 2026 Bluestone is financially sound, experienced Barnett Shale gas operator, known for growing production from existing wells at low costs Production Assurance all shut-in wells return to production by 7/1/16 and will not shut-in or choke production through 2018 No continuing credit exposure to Quicksilver - Upside potential over long-term through hybrid fixed fee / POP payment structure 15

16 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

17 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

18 Energytec The Traditional Paradigm Mescalero (Original Owner) Pipeline & Plant Sale Producer s Pipeline Reservation of Rights/Covenant -- Subject to Transportation Fee & Right to Approve Future Assignments of Pipeline Energytec/ Debtor 363 Sale Red Water / Buyer Sale Objection Are Transportation Fee and Assignment Approval Rights Covenants That Cannot Be Stripped in 363 Sale? NEWCO 18

19 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

20 Run with the Land Analysis Element 1: Touches & Concerns Land (Continued) Security Energytec Sabine Considerations post-sabine 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

21 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

22 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

23 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

24 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

25 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

26 Williams / Chesapeake G&P Renegotiation in 4Q 2015 Utica Haynesville Fee Change New Acreage / Wells Cost of services fee changed to fixed fee with minimum volume commitments 50,000 new acres total of 190,000 net acres Cost of services fee changed to fixed fee with minimum volume commitments achievable by collapsing two contract areas 140 new wells by end of 2017, Price Savings $.25 mmbtu $.20 per Mcf in $.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

27 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

28 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

29 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 coobligors of bankruptcy estate, see e.g., In re Lazarus Burman Associates, 161 B.R. 891, (Bankr. E.D.N.Y. 1993) 29