CHAPTER 4 OPERATIONAL ISSUES IN TIMES OF DISTRESS

• Jurisdiction: United States

Bankruptcy and Financial Distress in the Oil & Gas Industry: Legal Problems and Solutions (Oct 2020)
CHAPTER 4
OPERATIONAL ISSUES IN TIMES OF DISTRESS
Eli Columbus
Tom Zavala

[Page 4-1]

ELI COLUMBUS is a partner in the Bankruptcy and Business Restructuring section at Haynes and Boone, LLP. Mr. Columbus specializes in business and commercial bankruptcy and restructuring representations. Mr. Columbus has represented a variety of clients in commercial workouts and bankruptcy cases, including financial institutions, secured creditors, purchasers, unsecured creditors, debtors, creditor committees, and trustees. Mr. Columbus received a Bachelor of Arts, magna cum laude, from Texas Tech University in 1996 and a Doctor of Jurisprudence, magna cum laude, from Texas Tech University School of Law in 2000. Prior to joining Haynes and Boone, Mr. Columbus was the Chair of the Business Restructuring and Bankruptcy practice group at Winstead PC where he practiced for more than 16 years. Mr. Columbus is a member of the American Bankruptcy Institute and Bankruptcy Sections of the State Bar of Texas and the Dallas Bar Association. Mr. Columbus served as the Chair of the Bankruptcy & Commercial Law Section of the Dallas Bar Association in 2011.

[Page 4-2]

TABLE OF CONTENTS

I. Introduction

II. Protecting the Debtor's Assets and Operations During Reorganization

A. The Automatic Stay and Property of the Estate

B. Funding Operations and Protections for Vendors in the Ordinary Course

C. First Day Motions

1. Motion for Use of Cash Collateral ("Cash Collateral Motion")

2. Motion to Obtain Debtor-in-Possession Financing ("DIP Financing Motion")

3. Motion for Authority to Continue Debtor's Existing Cash Management System ("Cash Management Motion")

4. Motion for Authority to Pay Certain Prepetition Claims of Critical Vendors ("Critical Vendor Motion")

5. Motion to Establish Reclamation/Section 503(b)(9) Procedures

6. Motion for Authority to Pay Prepetition Interest Owner Obligations, Joint Interest Billings, and Exploration and Production ("E&P") Operating Expenses

7. Motion for Authority to Pay Prepetition Wages ("Employee Wage Motion")

8. Motion Prohibiting Utility Companies from Discontinuing Service and Approving Debtor's Proposed form of Adequate Assurance ("Utilities Motion")

9. Motion for Authority to Continue Existing Insurance Policies and Pay All Insurance Obligations Thereunder ("Insurance Motion")

10. Motion for Authority to Continue Surety Bond Program and Pay All Obligations Thereunder ("Surety Bond Motions")

11. Motion for Authority to Pay Certain Prepetition Taxes and Fees

12. Motion for Authority to Perform Prepetition Hedge Contracts and Enter into New Hedge Contracts

[Page 4-3]

III. Keeping Contracts Alive in Bankruptcy and the Debtor's Power to Reject Executory Contracts

A. The Debtor's Power to Assume or Reject Executory Contracts

B. Oil and Gas Leases and Mineral Leases

1. Mineral Leases in Texas, Colorado, Oklahoma and New Mexico

2. Mineral Leases in Louisiana

3. Mineral Leases in Other States

4. Offshore Exploration and Production

C. Farmout Agreements and Section 541(b)(4) of the Bankruptcy Code

1. The Debtor as Farmor

2. The Debtor as Farmee

3. Better in Bankruptcy: Agreements to Transfer or Term Assignments?

D. Joint Operating Agreements

E. Gathering Agreements

1. Covenants Running with the Land

a) Sabine

b) Badlands

c) Alta Mesa

2. The Upshot for Debtors and Midstream Service Providers

3. Pending Cases Regarding Midstream Service Contract Disputes

a) In re Southland Royalty Company, LLC ("Southland Royalty")

b) In re Sanchez Energy Corporation ("Sanchez")

IV. Effect of the Automatic Stay on State Proceedings

A. The Police Power Exception

B. Public Utility Actions and Environmental Actions

C. Actions to Enforce Spacing Rules, Force Pooling, and Unitize Tracts

[Page 4-4]

D. FERC Proceedings: Analyzing In re Extraction Oil and Gas, Inc.

V. Treament of Tax Liens and Past-Due Royalties Owed to Government Entities

A. Tax Liens and Priority Treatment Under the Bankruptcy Code

B. Ad Valorem Property Tax and Severance Tax Issues

C. Federal Tax Liens

D. Past-Due Royalties Owed to Government Entities

VI. What Bankruptcy Counsel Needs to Know About the Debtor's Operations

[Page 4-5]

I. INTRODUCTION

Since oil prices dropped into negative territory in April of 2020, energy companies have begun filing for bankruptcy at a rapidly increasing rate. Although the price of American oil has rebounded to around $40/bbl as of early October, the relatively flat price curve for future periods may not be a sufficient clearing price for many highly leveraged producers.¹ As the United States enters a new school year while COVID-19 cases linger domestically (and abroad), we can likely expect oil prices to remain stagnant, demand levels to remain depressed, and more companies seek Chapter 11 relief.

The goal of this paper is to provide the reader with a basic understanding of how bankruptcy affects debtors and their vendors and contractors. This paper covers only some of the major issues that are likely to arise in a typical oil and gas bankruptcy case. There are countless other issues one may encounter in bankruptcy that are not discussed here.² Prudent debtors and creditors should consult their bankruptcy counsel to ensure they protect their property interests and rights under the Bankruptcy Code.

II. PROTECTING THE DEBTOR'S ASSETS AND OPERATIONS DURING REORGANIZATION

The purpose of a Chapter 11 reorganization is to provide a single forum in which the company that files bankruptcy—the "debtor-in-possession"³ —can pursue a reorganization plan while continuing to operate. A Chapter 11 case provides an orderly process to preserve going concern value and maximize value for all stakeholders.

A. The Automatic Stay and Property of the Estate

One of the core tenets of bankruptcy is to provide the debtor with a breathing spell from creditors, and the automatic stay does just that.⁴ The automatic stay is an injunction that arises automatically as soon as a company files a Petition,⁵ prohibiting creditors, litigants and anyone who wants to control or interfere with property of the bankruptcy estate from taking actions outside of the bankruptcy court. The automatic stay is so powerful that it can prevent foreclosures scheduled the next day and even stop ongoing litigation in other courts from proceeding.

The automatic stay not only protects the debtor by providing a breathing spell, but it also protects creditors with an interest in the debtor's property, like a bank with a lien on the debtor's cash or other assets. Specifically, the automatic stay prevents creditors that might be worried about a distressed company's ability to pay from racing to the state courthouse to sue the debtor, collect a judgment, and seize cash or other property in satisfaction of that judgment. Instead, because of the automatic stay, the bankruptcy court can oversee a fair and equitable distribution of all of the

[Page 4-6]

debtor's property and, in the context of a Chapter 11, ensure that creditors do not seize capital that could be used in operations to generate revenue and pay back creditors over time.⁶

But what property, exactly, does the automatic stay protect? The answer is pretty much everything. For purposes of the automatic stay, property of the estate is interpreted broadly and encompasses "all legal or equitable interests of the debtor in property as of the commencement of the case."⁷ That means immediately upon the filing of the bankruptcy Petition, all estate property, including, real property and improvements thereon, equipment, materials, cash, and even intangible property like deposit accounts and letter of credit rights,⁸ is subject to the automatic stay. Moreover, creditor actions to enforce rights, or interfere with the debtor's interests, in that property could violate the stay resulting in actual damages or, in some cases, punitive damages.⁹

One truly important aspect of the automatic stay worth noting is the timing: it arises automatically as of the commencement of the case (e.g., when the bankruptcy Petition is filed) and protects the debtor's interests in property as of the commencement of the case. In other words, the Bankruptcy Code takes a snapshot of everything the debtor has an interest in at the time the Petition is filed. But what if the debtor acquires a legal or equitable interest after the bankruptcy Petition is filed? Treatment depends on the nature of the property but, generally, the Bankruptcy Code brings into the bankruptcy estate any "[p]roceeds, product, offspring, rents, or profits of or from property of the estate."¹⁰ Thus, proceeds from the sale of estate property, such as hydrocarbons, become property of the estate. Likewise, royalty income generated from a bankruptcy estate's interests in mineral leases also become property of the bankruptcy estate.

B. Funding Operations and Protections for Vendors in the Ordinary Course

The Bankruptcy Code permits debtors in possession to use, sell, or lease property of the estate in the ordinary course of business—subject to certain limitations, and depending on the nature of the proposed use and whether the property is subject to a lien.¹¹ Operating in the ordinary course means the debtor may engage in transactions without any notice, hearing, or court order authorizing the transaction. For example, debtors may enter into transactions, "including the sale or lease of property," so long as they are carried out in the ordinary course of the debtor's business.¹² Naturally, third-party vendors might be reticent to deal with bankruptcy debtors in the ordinary course even if they have a longstanding business relationship. So, the Bankruptcy Code helps debtors continue to operate in bankruptcy by offering a means of securing financing and protecting vendors that deal with...