Minimizing Counterparty Bankruptcy Risk

Author:Mitchell E. Ayer
Position:Mitchell Ayer is an attorney with the law firm of Thompson & Knight LLP in Houston, Texas. His practice includes disputes with royalty owners, working interest owners, and a variety of oil and gas bankruptcy matters. He represented Davis Petroleum Corp. in a pre-packaged bankruptcy that was confirmed within 96 hours of filing the bankruptcy...
Pages:863-887
 
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Minimizing Counterparty Bankruptcy Risk
Mitchell E. Ayer
TABLE OF CONTENTS
Introduction .................................................................................. 864
I. Priority of “Claims” in Bankruptcy .............................................. 866
II. Sales Contracts For Oil and Gas Production ................................ 867
III. Joint Operating Agreements ......................................................... 871
A. Mitigating Credit Risk by Obtaining and Perfecting a
Security Interest or Lien ......................................................... 872
1. Avoiding Common Pitfalls When Perfecting a
Security Interest or Lien .................................................. 872
a. Failure to Perfect a Security Interest or Lien ............ 873
b. Perfecting a Security Interest or Lien Against
the Wrong Counterparty ............................................ 873
c Failure to Perfect a Security Interest or Lien
as Soon as Possible ................................................... 874
2. Perfecting Oil and Gas Liens ........................................... 875
B. Mitigating Risk Through Setoff and Recoupment ................. 877
Copyright 2016, by MITCHELL E. AYER.
* Mitchell Ayer is an attorney with the law firm of Thompson & Knight
LLP in Houston, Texas. His practice includes disputes with royalty owners,
working interest owners, and a variety of oil and gas bankruptcy matters. He
represented Davis Petroleum Corp. in a pre-packaged bankruptcy that was
confirmed within 96 hours of filing the bankruptcy petition.
Mr. Ayer is Board Certified in Oil, Gas, and Mineral Law by the Texas
Board of Legal Specialization and Board Certified in Business Bankruptcy Law
by the American Board of Certification. He has served as past chair of the Houston
Bar Association Oil, Gas & Mineral Law Section. He is a member of the American
Bankruptcy Institute and American Inns of Court. Additionally, Mr. Ayer has
been named to Texas Super Lawyers in the Bankruptcy & Creditor/Debtor Rights
and Energy & Natural Resources areas, and is the author of numerous publications
and presentations. He has a B.A. from Wittenberg University, an M.B.A. from
Cleveland State University, and a J.D. magna cum laude from the University of
Houston Law Center (first in class). He served on board the legendary Coast
Guard Cutter Bibb from 1971 through 1974.
The Author wishes to thank Steve Levitt, Cassandra Shoemaker, and Ayo
Shittu for their research assistance as well as acknowledge the advice of David
Bennett and Rhett Campbell.
864 LOUISIANA LAW REVIEW [Vol. 76
IV. Treatment of Executory Contracts and Oil and Gas Leases ............ 879
A. Characterization of Oil and Gas Leases ................................. 879
B. Assumption and Assignment of Oil and Gas Leases ............. 881
V. Purchase and Sale Agreements ..................................................... 882
VI. Mitigating Risks Related to Farmouts and
Production Payments .................................................................... 883
VII. Include Bad Boy Guaranties in the “Credit Toolkit” When
Conducting Oil and Gas Deals. .................................................... 884
VIII. Mitigating Regulatory Risks ................................................................ 886
Conclusion .................................................................................... 887
INTRODUCTION1
In 2014, price shocks sent waves of financial distress throughout the
oil and gas industry, as the price of crude oil plummeted from a high of
$100.36/bbl in June to a low of $31.62/bbl by the beginning of February.2
This drop in prices hit many American producers especially hard because
a growing share of production in the United States has been sourced from
“unconventional” deposits with limited permeability, which involve
higher production costs relative to traditional sources of petroleum.3
Consequently, there is growing concern over bankruptcy in the industry,
with prices continuing to be suppressed over a year after their initial fall.4
1. This Article is based on a presentation by our firm at the 2014 Texas
Bench Bar Conference titled “Today’s Oil and Gas Market: Managing and
Mitigating Bankruptcy Risk.” David M. Bennett, Today’s Oil and Gas Market:
Managing and Mitigating Bankruptcy Risks (2014) (unpublished manuscript),
available at http://www.tklaw.com/files/Publication/6bd977c5-ad04-4a0a-a4a3-
575e4dd4b242/Presentation/PublicationAttachment/ab5898d2-0fca-455f-a285-5a
b58228cd3e/Today's%20Oil%20and%20Gas%20Market%3B%20Managing%20a
nd%20Mitigating%20Bankruptcy%20Risks.pdf.
2. Crude Oil, NASDAQ, http://www.nasdaq.com/markets/crude-oil.aspx
(last visited Feb. 2, 2016).
3. Ed Crooks, US Shale Industry Braced for Bankruptcy, FIN. TIME S (Sept.
6, 2015, 1:37 PM), www.ft.com/cms/s/0/5974a3ce-52e0-11e5-b029-
b9d50a74fd14.html#axzz3wSuE689J; see also Jennifer Cruz, Peter W. Smith &
Sara Stanely, The Marcellus Shale Gas Boom in Pennsylvania: Employment and
Wage Trends (U.S. Bureau of Statistics Monthly Labor Report, Feb. 2014); U.S.
GOVT ACCOUNTABILITY OFFICE, REP. NO. GAO-12-732, OIL AND GAS:
INFORMATION ON SHALE RESOURCES, DEVELOPMENT, AND ENVIRONMENTAL AND
PUBLIC HEALTH RISKS (2012).
4. Crooks, supra note 3.

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