CHAPTER 8 CLAIM PRIORITIES IN BANKRUPTCY AND FAVORABLE CLAIM TYPES
| Jurisdiction | United States |
CLAIM PRIORITIES IN BANKRUPTCY AND FAVORABLE CLAIM TYPES
Reed Smith LLP
Dallas, TX
[Page 8-1]
MICHAEL P. COOLEY is a partner at Reed Smith LLP in Dallas, where he has a comprehensive bankruptcy and creditors' rights practice centered on all matters of federal bankruptcy law, business reorganization and liquidation, and bankruptcy litigation in cases and restructurings ranging in size from a few million dollars to several billion dollars. Specializing in the representation of middle-market companies, he also regularly advises prepetition and postpetition lenders, and asset purchasers, commercial landlords, and real estate investments trusts. Michael is the author of 26 original chapters for the Bloomberg Law: Bankruptcy Treatise on the procedural rules governing bankruptcy litigation and the rules of statutory construction, and has also been recognized for his work representing Central American women and children seeking asylum in the United States, including in two contested trials that resulted in affirmative grants of asylum for his clients. Prior to law school, Michael spent four years as a commissioned officer in the United States Navy, where he served as a Naval Flight Officer with Fleet Air Reconnaissance Squadron Four (VQ-4).
Table of Contents
I. Introduction
II. Overview of Claims and Interests
A. Secured and Unsecured Claims
B. Administrative Expenses and Other Priority Claims
C. Is It Even Property of the Estate?
D. Production Payments, Royalties, and Net Profit Interests
E. Farmout Agreements
F. Plugging and Abandonment Claims
III. Special Issues Concerning Lien Rights
A. The Avoidability of Unperfected Liens
B. The Perfection of Statutory Liens
IV. Special Situations in Bankruptcy
A. First Day Relief
B. Reclamation Claims
C. Executory Contracts
V. CONCLUSION
[Page 8-2]
I. Introduction
Oil and gas law revolves around a multitude of unique business relationships, including terms and definitions that have evolved over time from the earliest days of the oil and gas industry. From mineral rights to leases and working interests, which in turn beget royalties, overriding royalties, net profits interests, and other slices of the original stake. Bankruptcy has its own universe of esoteric terms, including assumption and rejection, cramdown, "critical vendors," and something nobody understands called the "1111(b) election." But when claimants and contract counterparties are presented with the bankruptcy filing for someone on the other side of a past or present transaction, their questions are very simple ones: Do I have a claim or don't I? Is it secured or isn't it. This paper attempts to connect the dots between some of the fundamental relationships that arise in the oil and gas industry and the treatment of those interests under the bankruptcy laws governing the allowance of claims, the perfection of liens, and the delineation of property of the estate.
II. Overview of Claims and Interests
A proper understanding of the treatment and priority of the claims and interests in an oil and gas case begins with an understanding of the claims and interests that the Bankruptcy Code recognizes. The Bankruptcy Code defines a "claim" to include any "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured."1 The definition is intentionally broad and far-reaching.2 Rights to equitable remedies for breach of performance also give rise to a claim if the breach would give rise to a right to payment.3 Boiled down to its essence, however, there are really only two types of claim in a bankruptcy case: secured claims and unsecured claims. Certain unsecured claims are entitled to priority of payment over other claims, but all of them are unsecured, and all of them are subordinate to the in rem rights of a secured creditor in respect of collateral that secures their repayment.
[Page 8-3]
A. Secured and Unsecured Claims
Under Bankruptcy Code § 506, a claim secured by a lien on property in which the estate has an interest is a secured claim, but only to the extent of "the value of such creditor's interest in the estate's interest in such property."4 In plain English, a $100 debt secured by a lien on property worth only $60 yields a secured claim of only $60, and a residual unsecured claim equal to the remaining $40 of the debt owed. This latter "deficiency" claim is treated for substantially all purposes under the Bankruptcy Code as an ordinary unsecured claim.5 If a $100 debt is secured by a lien on property worth $150, then the entire $100 is a secured claim; if a second $100 debt is secured by a second lien on the same property, that second debt yields a $50 secured claim and a $50 unsecured claim.6 For this reason, it is commonly more effective (and more accurate) to approach the Bankruptcy Code in terms of secured and unsecured claims rather than secured and unsecured creditors, because even a secured creditor may also hold an unsecured claim in addition to its secured claim.
Assuming they are supported by properly perfected liens on property of the debtor's estate, secured claims afford their holders special rights under the Bankruptcy Code. Consistent with their priority under nonbankruptcy law, secured claims are entitled to be repaid from the proceeds of their collateral ahead of all other creditors.7 The holders of secured claims are entitled to adequate protection of their interest in collateral that a debtor proposes to use during the case,8 they are entitled to relief from the automatic stay to foreclose their interest in collateral in which the debtor has no equity value,9 and they are entitled to special protections against the confirmation of a plan over their objection.10
The Bankruptcy Code itself does not establish any priority among the holders of secured claims, nor imposes any distinction in the priority of
[Page 8-4]
consensual versus nonconsensual liens.11 Instead, the priority of competing liens, whether consensual or nonconsensual, is generally governed by state law.12
All other claims that are not secured claims are unsecured claims. The unsecured claim represents the baseline entitlement of a creditor to a ratable share of all property of the debtor's estate not encumbered by another creditor's properly perfected lien.13 Certain unsecured claims may be subordinated to others under Bankruptcy Code § 510 or granted priority ahead of other claims under Bankruptcy Code § 507, but they are all unsecured claims.
B. Administrative Expenses and Other Priority Claims
Bankruptcy Code § 507 established a ten-tier hierarchy of claims that are entitled to priority of repayment ahead of other unsecured claims. The categories of priority claims are described and ranked in § 507(a)(1)-(10) and include domestic support obligations (first priority), employee wages (third priority), certain claims of grain producers and fishermen (sixth priority), and personal injury and wrongful death claims caused by drunk driving (tenth priority). Among the ten ranks of priority claims, however, three stand out as particularly relevant to oil and gas cases.
Administrative Expenses. First are the "costs of administration," or administrative expenses, allowed under Bankruptcy Code § 503(b).14 Although technically the second-ranked category of priority claim (behind domestic support obligations), in most chapter 11 cases administrative expenses comprise the senior-most priority claim and are defined in the Bankruptcy Code as the "actual, necessary costs and expenses of preserving
[Page 8-5]
the estate."15 Administrative expenses are those "costs ordinarily incident to operation of a business, and not [ ] limited to costs without which rehabilitation would be impossible.16 In the course of a typical bankruptcy case, employee wages for services rendered during the bankruptcy case17 utility services, and maintenance costs, for example, are all afforded administrative expense priority and generally payable on a current basis during the course of the bankruptcy case. They also include most taxes incurred by the estate18 and the fees and expenses of debtor's counsel, committee counsel, and other estate-paid professionals under Bankruptcy Code § 330(a).19 The debtor's obligations under executory contracts and unexpired leases that are assumed during the bankruptcy case are entitled to administrative expense priority treatment.20 In addition, reclamation claims for the value of goods received by the debtor in the 20 days prior to filing bankruptcy are entitled to administrative expense priority.21
Wage Claims. In most chapter 11 cases, the next-highest priority is granted to claims for wages, salaries, and commissions (including certain other employee benefits) earned by the debtor's employees within 180 days before the commencement of the case, subject to a cap of $13,650 per individual.22 These claims are commonly paid in full at the outset of the case (up to the statutory cap) in recognition of both their priority status and the critical role that rank-and-file employees play in the continued viability and success of any business undertaking.
Tax Claims. Finally, although ranked eighth by statute, the third-highest priority in most chapter 11 cases goes to certain prepetition tax claims, including certain income taxes, property taxes, and trust fund taxes (such as sales tax and employee withholding).23 The "window" for income tax eligibility is complex, but generally includes any tax on prepetition income if either (i) the required tax return was last due within three years of
[Page 8-6]
the petition date, (ii) the tax was assessed within 24 days before the petition date, or (iii) the tax was not yet assessed, but is assessable after the...
To continue reading
Request your trial