In a highly anticipated ruling in the Sabine Oil & Gas bankruptcy case pending in the Bankruptcy Court for the Southern District of New York, Judge Shelley Chapman granted Sabine’s motion to reject certain gathering, transportation, and processing agreements with Nordheim Eagle Ford Gathering and HPIP Gonzales Holdings. In reaching this conclusion, the court focused on Sabine’s business judgment in rejecting the economically burdensome agreements. Sabine successfully argued that the agreements were unnecessarily burdensome and not financially viable. However, the court declined to address substantive legal issues regarding the scope of the rejections, holding simply that rejection “relieves [Sabine] of those terms that are subject to rejection.”
The court declined to decide whether certain payment obligations within the agreements were “covenants running with the land,” or subject to rejection. Therefore, whether Sabine will be bound by such covenants within the existing agreements will be determined in future proceedings, unless the parties resolve the issue by agreement.
Although Judge Chapman did not issue a definitive ruling on the covenant issue, she telegraphed how she may likely rule in any such future proceedings in a “non-binding” section of the opinion, concluding that the rights contained in the agreements did not run with the land and therefore were not real property interests under Texas law. The ruling is non-binding based on Second Circuit precedent, which limits the scope of rulings in connection with determinations regarding assumption or rejection of contracts.
In general, under Texas law, a covenant will run with the land if: (i) the covenant touches and concerns the land; (ii) the covenant relates to a thing in existence or specifically binds the parties and their assignees; (iii) the original parties intended the covenant to run with the land; and (iv) the successor to the burden has notice. Additionally, Judge Chapman noted that certain courts have also required that the parties have horizontal privity of estate between the original parties to the covenant.
The non-binding portion of Judge Chapman’s ruling distinguishes the decision of the Fifth Circuit Court of Appeals in Newco Energy v. Energytec, Inc. (In re Energytec, Inc.), 739 F.3d 215 (5th Cir. 2013), which was also based on Texas law. In Energytec, the Fifth Circuit held that the right to a transportation fee and the right to consent to pipeline assignments were covenants running with the land. Judge Chapman distinguished Energytec by explaining that the rights to payment of the fees in Sabine constitute contractual agreements between the parties with respect to services to be provided, while the right to payment in Energytec was reserved for a third party as part of a conveyance of real property. Accordingly, Judge Chapman found that the covenants in Sabine lacked horizontal privity, whereas the covenant in Energytec did not.
Judge Chapman concluded that the agreements did not impact the value of the land or the real property itself, but rather concerned personal property rights because the covenants were focused on the processing of minerals after extraction from real property and therefore became legally transformed from a real property to personal property right.
Debtors in other large bankruptcy cases, including Quicksilver Resources Inc. and Magnum Hunter Resources Corporation, have made similar requests to reject dedicated gas gathering agreements or similar arrangements. As in Sabine, the key issue in these cases will be whether the agreements implicate real property interests running with the land under state law, and the resolution of these issues will be highly fact-specific.
Haynes and Boone’s Energy and Bankruptcy practice lawyers have been helping clients navigate the ups and downs in the oil and gas sector for more than four decades. With the slump in commodity prices persisting, our lawyers are closely following recent industry developments and have prepared several useful reports for industry participants, including borrowers, lenders, private equity firms and investment funds, and others. The reports are available for download here.