Bankruptcy Judge Authorizes Rejection of Gas Gathering Agreements

Bankruptcy Judge Authorizes Rejection of Gas Gathering Agreements

On Tuesday, March 8, 2016, U.S. Bankruptcy Judge Shelley C. Chapman in New York permitted Sabine Oil & Gas Corporation to reject three gas gathering and handling agreements with Nordheim Eagle Ford Gathering, LLC and HPIP Gonzales Holdings, LLC. All of the agreements are governed by Texas law.

In connection with Sabine's effort to restructure, Sabine filed a motion to reject the gathering agreements with Nordheim and HPIP. Sabine argued that it could not deliver the required minimum amounts of gas and condensate, and that rejection would save Sabine as much as $115 million. Nordheim opposed the motion to reject, arguing that rejection was not a proper exercise of Sabine's business judgment because the agreements included dedications that were stated to be covenants running with the land, which would continue to burden the debtor's interests following rejection. While HPIP did not oppose rejection, it also argued that the relevant hydrocarbon dedications were covenants running with the land that would survive rejection. Sabine's response to the objections was that, among other things, the purported dedications lacked the requisite intent and privity to establish covenants running with the land and were not consistent with real property conveyances under Texas law, as they lacked traditional real property terms and were instead more consistent with services agreements.

Judge Chapman held that Sabine's rejection of the midstream agreements was a proper exercise of Sabine's business judgment but determined that the questions of Texas real property law were not properly before the court. In a nonbinding portion of the court's analysis of applicable Texas law, however, the court noted that the agreements fail to meet Texas's five-part test for covenants running with the land, remarking that "none of the covenants run with the land either as a real covenant or as an equitable servitude." In particular, the court explained that the covenants merely identify the rights and obligations related to the services to be provided under the agreements and do not convey interests in the underlying real property. The court recognized that, in the event that the agreements are later determined to include covenants running with the land, the producer will likely be required to work out a deal with existing gatherers on terms consistent with the dedications, notwithstanding Sabine's rejection of the agreements. If, however, it is ultimately determined that the agreements do not contain covenants running with the land—which, as noted, the court indicated in dicta was its understanding of Texas law—the producer will be free to seek other providers of midstream services.

After reading her bench decision to the parties at the hearing on Sabine's motion to reject the agreements, Judge Chapman stated that "[i]t might be time to talk about a commercial resolution of some of these issues, but that's for you and your clients to decide."

The treatment of covenants running with the land and similar rights that parties have historically incorporated into midstream gas and handling agreements varies from state to state. The court's statements with respect to dedications in such agreements that do not qualify as real property interests under Texas law, although not binding precedent, could have a significant impact on the oil and gas industry moving forward. The potential that the existence of such dedications will not be deemed to be an impediment to rejection of the underlying agreements, and that such dedications themselves might not be protected in a bankruptcy, may affect other oil and gas producer bankruptcies in the near term and may deter other midstream companies from building infrastructure in the future in reliance on long-term producer dedications on similar terms.

In another closely watched case pending before a Delaware bankruptcy court involving the attempted rejection of midstream agreements (also subject to Texas law)—Quicksilver Resources Inc. v. Crestwood Midstream Partners case—the court is expected to hand down its ruling during the week of March 14, 2016. The decision is likely to provide further guidance on how these agreements will be treated by bankruptcy courts.

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Jeffrey A. Schlegel

Omar Samji

Paul M. Green, Alexandra L. Wilde, and Katie A. Oldham, associates in the Houston Office, assisted in the preparation of this Alert.

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