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Midstream Agreements: The Door is Open for 365 Rejection

Posted on: April 12th, 2016 by | No Comments

On March 8, the Bankruptcy Court for the Southern District of New York issued a bench decision in the Sabine Oil & Gas Corp. Chapter 11 case that may have a dramatic impact on the relationships between producers and midstream (pipeline transportation) companies in the troubled oil and gas sector. (In re Sabine Oil & Gas Corp., 15-11835 (Bankr. S.D.N.Y. 2016)).

The opinion—which opened the door to the possibility of rejection of midstream agreements under Bankruptcy Code section 365—has the potential to catalyzing a wave of rejections or renegotiations of these contracts, which the industry had long presumed to be otherwise bankruptcy-proof.

In September 2015, debtor-producer Sabine moved to reject gathering agreements with Nordheim Eagle Ford Gathering, LLC and HPIP Gonzales Holdings, LLC under Bankruptcy Code section 365’s “business judgment” standard.  The midstream companies opposed rejection on various grounds ranging from a challenge to the business judgment rule (which lost) to an argument that the contracts’ conveyance of a portion of the interests in the transported gas was an indefeasible conveyance of an interest in real estate that could not be rejected under 365 (which was left to open to future litigation via adversary proceeding).

While the Southern District held that the business judgment standard for rejection had been met, it declined to rule on the question of whether the contracts conveyed interests in real property (or, as Sabine, argued, only transfers of minerals “as produced”).

In “non-binding” analysis, the court sided with Sabine on this question, concluding that the mineral conveyances would not amount to covenants that run with the land under applicable (Texas) state law.  The court pointed out that the contracts’ reference to specific Sabine mineral leases was only an identification of the property subject to the contracts, versus a grant of an interest in the leases themselves.

The impact of this decision remains to be seen, but there is certainly the potential for a two-way street: on-the-brink distressed producers, on the one hand, filing Chapter 11 cases to take advantage of 365 to shed burdensome midstream agreements, and midstream companies, on the other hand, being forced into their own bankruptcies as a result of losing revenue from rejected (or painfully renegotiated) midstream agreements.  Of course, midstream agreements are not form agreements, and, down the road, a fact-intensive, case-by-case environment may evolve on the question of how mineral interest conveyances affect the bankruptcy treatment of these contracts.

The 75% plunge in global crude prices in the last 18 months has not been kind to U.S. oil and gas producers.  Despite OPEC’s announcement in February that it would cap production and a mid-March rally to around $40 per barrel, the climate remains dubious for U.S. producers, whose shale-based extraction methods are much costlier than those of OPEC producers.  With no credible respite in sight, producer Chapter 11 filings have spiked in recent months, and the foreseeable trend is one of continued strife.  Safe to say, the precedent is evolving in real time as the market downtrend shows no sign of truly easing.

Stuart A. Laven, Jr.
Cavitch, Familo & Durkin Co., LPA

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