CHAPTER 7 BANKRUPTCY PROBLEMS IN MINERAL AGREEMENTS

• Jurisdiction: United States

Mining Agreements Institute
(May 1979)
CHAPTER 7
BANKRUPTCY PROBLEMS IN MINERAL AGREEMENTS
Craig A. Christensen
Dawson, Nagel, Sherman & Howard
Denver, Colorado

The excitement generated by a rising market for mineral products unfortunately tends to anesthetize the caution which should proceed from the speculative nature of any such endeavor. All too often mineral exploration companies seem not to consider that property interests may often be freely conveyed, and the interest presently owned by a financially sound company may someday be conveyed to a company with fewer financial resources. Thus the mining lawyer ought not merely to ignore the problems to be encountered by a mining venture in distress. Specifically, the impact on mining ventures of federal bankruptcy law with its intensely equitable and debtor-oriented objectives ought to be considered while the venture is being structued so that future problems may at least be assessed, if not prevented. There is some immediacy to this consideration with the adoption on November 6, 1978, of the Bankruptcy Reform Act of 1978.¹ This is the most comprehensive revision of the Bankruptcy Act since the Chandler Act of 1938 and indicates a 40-year cycle in the restructure of bankruptcy laws in this country.²

The frustration of a non-bankruptcy specialist in obtaining a feel for the practical problems of this field is compounded by the difficult access to decisions. Bankruptcy decisions are both selectively and unofficially reported in three general sources. These are CCH Bankruptcy Law Reports, The Bankruptcy Court Decisions Reporter, and Collier's Bankruptcy Cases. Unfortunately, these compilations of cases

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tend to reflect those submitted by the various judges rather than a considered reporting of all aspects of bankruptcy law.

The purposes of this article is to highlight problems posed by the new bankuptcy code. A complete understanding of the code is far beyond the scope of this article and, since its provisions are not yet effective, any proposals claiming to effect a prevention of problems posed by the code can only be taken with a grain of salt. It is not the purpose of the author to either suggest or recommend any particular type or structure for a mining transaction, but to indicate some of the problems that may befall the parties in any of the four following typical mining transactions: 1) mining leases, 2) cotenancies with operating agreements disclaiming partnership, 3) mining partnerships, and 4) general partnerships. Before considering the affect of the code on these four types of transactions, a very brief and cursory summary of the major changes in the new code would be appropriate.

GENERAL BANKRUPTCY CONSIDERATIONS

The Bankruptcy Reform Act of 1978 becomes effective with respect to its substantive provisions on October 1, 1979.³ Any cases filed or pending prior to that date will still be governed by the old Bankruptcy Act, while cases filed subsequent to that date will be governed by the new code.⁴ The code creates a new court entitled the United States Bankruptcy Court, which will be an "adjunct" court of the United States District Court for the district in which the United States Bankruptcy Court sits.⁵ While the substantive provisions of the bankruptcy code become effective October 1, 1979, the provisions establishing this new court do not become effective in the main until April 1, 1984.⁶ During the interim period of

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time, labeled a "transition period" the currently sitting bankruptcy judges will continue in office.⁷

The new Bankruptcy Court is granted original and exclusive jurisdiction of all cases arising under Title 11.⁸ In addition to that jurisdiction, the Bankruptcy Court is also given original but not exclusive jurisdiction over civil proceedings arising under or related to Title 11.⁹ This means essentially that all litigation involving either the estate or the debtor, whether it is a bankruptcy cause of action or a cause of action which involves some asset or liability of the state, may be filed in the Bankruptcy Court. This will eliminate once and for all the complex and confusing litigation involving a distinction between "summary" and "plenary" jurisdiction. All of this jurisdiction is, of course, coupled with exclusive jurisdiction over all of the property of the debtor, wherever located.¹⁰ As a corollary to this all encompassing and pervasive jurisdiction, the Bankruptcy Court is granted a non-appealable right to abstain "in the interests of justice" from a particular proceeding either arising under Title 11 or arising in or related to a case under Title 11.¹¹ Finally, in addition to other provisions related to jurisdiction, there is a provision for the removal of any case pending at the time of the filing of a bankruptcy proceeding.¹² Removal is to the Bankruptcy Court and the Court is again given the non-appealable right to remand and abstain from hearing the matters.¹³

Venue provisions remain relatively unchanged with respect to cases under Title 11.¹⁴ With respect to proceedings, meaning a lawsuit, venue is always proper in the forum where the case is pending with one important exception insofar as mining agreements may be concerned. Where the trustee is

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the statutory successor to the debtor or to creditors, the venue of the proceedings is the Bankruptcy Court for the district where the state or federal court sits and in which the debtor or creditors, without intervention of bankruptcy, would have been entitled to commence the action upon which the proceeding is based.¹⁵

Another very important aspect of the provisions of the bankruptcy code is the ease with which involuntary bankruptcy may now be pursued. The old acts of bankruptcy are abolished, and now the requisite number of petitioning creditors may bring their involuntary petition based upon the appointment of a custodian or receiver within 120 days before the date of filing the petition or simply upon the fact that the debtor is generally not paying his debts as the debts become due.¹⁶ The elimination of the old acts of bankruptcy and the necessity to prove the same may well result in a greater number of involuntary petitions being filed.

Finally, the old rehabilitation Chapters VIII, X, XI, and XII under the present Bankruptcy Act are combined into one new chapter to be known as Chapter 11, but with provisions vastly different from the present Chapter XI.¹⁷ The single chapter eliminates the old technical differences under the separately administered chapters and, hopefully, will eliminate litigation over which chapter better serves the debtor's or creditor's purpose. The new Chapter 11 may be either a voluntary or involuntary proceeding.¹⁸

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I. MINING LEASES

A. Lessor's Bankruptcy

Only private leases are considered in this paper since leases involving state or federal land will not involve a bankrupt lessor. The problems posed by the bankruptcy of the lessor are primarily real property title problems and the accompanying problems posed by the trustee's right to assume or reject unexpired leases. The general rules related to a bankrupt lessor should be similarly applicable to a bankrupt optionor.

As an initial matter, the lessor's title in the underlying land will pass to the trustee as property of the estate. Historically the trustee has not only been given title to the debtor's property but has been accorded special additional rights which he¹⁹ may assert.²⁰ The Bankruptcy Act essentially gave the trustee the status of a judgment and execution lien creditor.²¹ In addition to maintaining the trustee's rights and powers as a creditor with a judicial lien, the bankruptcy code bestows on the trustee the rights of a bona fide purchaser with respect to real property.²² This means that if the mining lease is not recorded or if it is otherwise subject under state law to attack or avoidance by a judgment lien creditor or a bona fide purchaser, the trustee will take the lessor's property free and clear of the lease.

If the lease is properly recorded and not subject to attack by a judgment lien creditor or bona fide purchaser, the trustee will take the property subject to the lease. However, the trustee is given the statutory right to either assume or reject the unexpired lease.²³

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The unexpired lease is to be assumed or rejected by the trustee, subject to approval of the court, within 60 days after entry of an order for relief (i.e., after the filing of a voluntary petition or the entry of an order after trial on an involuntary petition), which time period may be extended "for cause" upon motion made within the 60-day period.²⁴ Contacts not assumed within the applicable time period are deemed rejected.²⁵ As a practical matter, the trustee will reject otherwise valid leases only when there remain affirmative covenants in the lease constituting a burden on the estate (i.e., payments on an underlying mortgage, or payments of taxes or other obligations which the trustee seeks to avoid).

If the trustee rejects the lease, the lessee may treat the lease as terminated by such rejection or, in the alternative, may remain in possession for the balance or term of the lease and any renewal or extension that is enforceable by the lessee under applicable non-bankruptcy law.²⁶ If the lessee remains in possession, the lessee may offset against the rent, advance royalties, or production royalties reserved under the lease damages occurring after rejection caused by the non-performance of any obligation of the debtor.²⁷ But, the lessee will not have any rights against the estate on account of any damages arising out of the rejection other than this right of offset.²⁸

B. Lessee's Bankruptcy

Again, the lessee's (or optionee's) interest in the property will pass to the trustee.²⁹ This is true even if the lease is unrecorded, as the provisions making the trustee a judgment lien creditor and a bona fide...