In re Chesapeake Energy Corporation and In re Extraction Oil & Gas, Inc.: New Rulings Against Midstream Gatherers Further Dividing the Courts Regarding Covenants Running with the Land
It is common for E&P companies in chapter 11 to seek to reject burdensome midstream contracts under Bankruptcy Code § 365. Rejection has not been permitted by bankruptcy courts where such agreements create enforceable covenants running with the land (“CRWL”) because a CRWL is a real property interest of the midstream gatherer, not just a contract right. Accordingly, before a debtor can seek to reject midstream agreements, the bankruptcy court must first determine whether an enforceable CRWL exists. However, the recent ruling in In re Chesapeake Energy Corporation from the Southern District of Texas Bankruptcy Court, in dicta, casts some doubt on whether a valid CRWL could save a midstream contract from rejection (although the CRWL, a real property interest, would presumably remain intact following rejection).
Whether a purported CRWL is enforceable is determined by applicable state laws, which tend to be similar but which may be subject to differences in interpretation. The recent trend in this area had been toward finding enforceable CRWL in midstream agreements by analyzing applicable CRWL elements in the context of a debtor’s leasehold interests. In three new rulings in adversary proceedings relating to In re Extraction Oil & Gas, Inc., the Bankruptcy Court for the District of Delaware has upset this recent trend when it analyzed the purported CRWL in the context of the debtor’s mineral estate and found no enforceable CRWL in the applicable midstream agreements under Colorado law. The court’s focus on the debtor’s mineral estate led it to conclude that the purported CRWL related only to the debtor’s personal property interests, on the one hand, and rights relating to a separate surface estate, on the other hand. As discussed more fully below, this approach is in sharp contrast to other courts’ analysis of CRWL analyzing a debtor’s leasehold interests, which focus on a broader bundle of rights to which a purported CRWL may attach.
The Ruling in In re Chesapeake Energy Corporation and its Likely Ripple Effects
On October 28, 2020, the Bankruptcy Court for the Southern District of Texas in In re Chesapeake Energy Corporation (Case No. 20-33233) approved the debtor’s request to reject a gas purchase agreement with ETC Texas Pipeline, Ltd. (“ETC”) (the “Chesapeake Ruling”).1 ETC argued that the agreement was not executory because it contained a CRWL and could not be rejected. The debtors argued that the agreement failed to comply with Texas CRWL law and that, even if it did, rejection would not be pro se prohibited.
The court applied Texas law to determine whether a CRWL existed, which looks to the following five elements: (1) the obligation touches and concerns the land, (2) the obligation relates to a thing in existence or specifically binds the parties and their assigns, (3) the original parties intended for the obligation to run with the land, (4) the successor to the burden has notice of the obligation, and (5) there must be privity of estate or vertical privity between the parties at the time the covenant was created (though the Texas Supreme Court has yet to rule on whether privity is required). The court examined the agreement and found no CRWL because intent to create a CRWL was lacking; therefore, the covenant did not touch and concern the debtor’s land, and horizontal privity (to the extent required under Texas law) was not satisfied.
As to intent, although the agreement contained an express statement of intent to create a CRWL, the court found intent to be lacking because the agreement was a forward contract that contained a liquidated damages provision that was the exclusive personal remedy for breach of the agreement, which was “unrelated to any real property interest held by Chesapeake.” Chesapeake Ruling, at 7.
As to touch and concern, the court found that the dedication in the agreement was of produced gas, which, under Texas law, “necessarily means gas severed from the mineral estate and collected at the wellhead” which “is personal property.” Id. The court found that the debtor’s “ability to use and enjoy its property rights is unaffected.” Id. at 8. Importantly, the court noted that “[h]ad the agreement between the parties included a dedication of ‘all of the Debtors’ right, title, and interest in and to the leases,” the court’s analysis might have been profoundly different.” Id. at n.5.
As to privity, the court found no simultaneous interest in real property at the time of entry into the agreement and, consequently, an absence of horizontal privity. Id. at 9.
One aspect of the Chesapeake Ruling that is likely to materially impact future case law in this area is dicta the court provided on the issue of whether a midstream contract may be rejected by a debtor in the event it does contain an enforceable CRWL. The court opined that Bankruptcy Code § 365 contains no exclusion regarding CRWL, and no known rule or law prohibits the mutual existence of an executory contract and a CRWL. Id. at 6. The court posited that “[i]t does not stretch the imagination to envision a contract that both contains a covenant that runs with the land and is executory.” Id. In such a circumstance, the court suggests that “the appropriate analysis is what benefit was previously bestowed by the debtor on the non-rejecting party that remains post-rejection and what future performance by the debtor is excused by the rejection.” Id. The court foreshadows that “[d]epending on the particular language of the subject agreement, a plethora of outcomes are possible.” Id. While this issue was not before the court, given that it determined the agreement before the court contained no enforceable CRWL, this language is likely to fuel arguments by debtors in future cases supporting rejection of midstream agreements and the correlative excuse of future performance by the debtor as to certain obligations in those agreements. It remains to be seen how successful such arguments will be, and the CRWL language in individual agreements tying contract obligations to the CRWL will be of critical importance in this analysis.
The Rulings in the Extraction Oil & Gas, Inc. Adversary Proceedings
On October 14, 2020, in three adversary proceedings relating to In re Extraction Oil & Gas, Inc. (Case No. 20-11548, Bankr. D. Del.), the Bankruptcy Court for the District of Delaware addressed whether midstream agreements contained an enforceable CRWL and concluded in all three cases that they did not. Those adversary proceedings involve the following midstream gatherers: (1) Elevation Midstream, LLC (“Elevation”), (2) Grand Mesa Pipeline, LLC (“Grand Mesa”), and (3) Platte River Midstream, LLC (“Platte River”) and DJ South Gathering, LLC (“DJ South”).2
The court applied Colorado law, which requires that the following three elements be satisfied: (1) the parties must intend to create a covenant running with the land; (2) the covenant must touch and concern the land with which it runs (which means the CRWL must closely relate to the real property with which it is intended to run and must benefit or burden the physical use of that real property); and (3) there must be privity of estate between the covenanting parties (which means that any CRWL must be accompanied by a contemporaneous conveyance of some interest in the real property with which the covenant runs).3
Extraction Oil & Gas, Inc. v. Elevation Midstream, LLC, Adv. Pro. No. 20-50839 (Bankr. D. Del.) (“Elevation Ruling”)4
In the Elevation Ruling, the Bankruptcy Court for the District of Delaware addressed whether certain midstream agreements included enforceable CRWL and found: (1) the agreements sufficiently expressed that the parties intended for certain covenants therein to run with the land; (2) there was no privity of estate among the parties because no real property interest in the debtor’s mineral estate was conveyed to the midstream provider; and (3) only one of the covenants at issue touched and concerned the land — a certain “Drilling Commitment” — but the remaining covenants did not. Elevation Ruling, at 2. Because not all of the CRWL elements were satisfied, no enforceable CRWL was created. Id. at 69. Critically, the court applied the CRWL analysis from the vantage point of the debtor’s mineral estate despite the fact that the agreements at issue purported to include a CRWL relating to much broader interests of the debtor, including its interests in lands, mineral interests, easements, leases, wells, and minerals in and under the land.
The court determined that the conveyance of easements and rights-of-way granted in the agreements did not satisfy the privity of estate requirement because they did not convey any interests in the debtor’s mineral estates, but rather only conveyed rights in the surface estate and determined that rights of ingress and egress incidental to the mineral estate were not property interests that could satisfy the privity of estate requirement because they did not create an ownership right, merely a right of access. The court further considered whether the dedications and commitments themselves constituted any kind of conveyance of a real property right and found they did not. Id. at 32-43.
As to the touch and concern requirement, again, the court’s focus on the debtor’s mineral estate is the key to its conclusions. The court examined many different commitments and dedications and other contract provisions to determine whether they touched and concerned the debtor’s mineral estate and found they did not, other than a commitment to drill, complete, and equip a defined number of wells in a dedicated area within a particular timeframe, which the court found to directly affect the debtor’s physical use and enjoyment of its mineral estate. As to the other purported CRWL in the agreements (such as volume commitments, delivery obligations, obligations relating to the gatherer’s construction of midstream facilities, and fixed fee provisions), the court determined that such commitments related to personal property of the debtor (severed minerals) and not its mineral estate. Finally, easements and rights-of-way could not satisfy the touch and concern requirement because they related to a surface estate, not the debtor’s mineral estate. Id. at 44-68.
Extraction Oil & Gas, Inc. v. Grand Mesa Pipeline, Adv. Pro. No. 20-50816 (Bankr. D. Del.) (“Grand Mesa Ruling”)5
In the Grand Mesa Ruling, the Bankruptcy Court for the District of Delaware similarly concluded that the midstream agreement at issue did not include an enforceable CRWL because it failed to touch and concern the debtor’s mineral estate and there was no privity of estate among the parties. Grand Mesa Ruling, at 3, 42. Although the court in the Grand Mesa Ruling found that intent to create a CRWL existed, it determined that the relevant real property interest of the debtor was its mineral estate, (notwithstanding the fact that the agreement provided that the dedication at issue “shall be deemed to touch and concern all of [the debtor’s] oil and gas leasehold interests in the lands within the Dedication Area”). Id. at 18 (emphasis added).
The court also found that the commitment to pay a contractual fee in exchange for the gatherer’s commitment to transport a certain volume of crude did not touch and concern the debtor’s mineral estates because it concerned only personal property — severed minerals — and where the debtor retained its rights to use its mineral estate. Id. at 21, 24-25.
As to privity, the court found that there was no conveyance of a real property interest in the midstream agreement and further found that the dedication itself did not constitute a conveyance because it “simply identifie[d] the particular produced crude petroleum that is subject to the parties’ contractual obligations.” Id. at 32-33.
Extraction Oil & Gas, Inc. v. Platte River Midstream, LLC and DJ South Gathering, LLC, Adv. Pro. No. 20-50833 (Bankr. D. Del.) (“Platte River and DJ South Ruling”)6
In the Platte River and DJ South Ruling, the Bankruptcy Court for the District of Delaware found intent to create a CRWL lacking in certain agreements and present in others but, like the Elevation Ruling and Grand Mesa Ruling, found the touch and concern and privity of estate elements to be lacking. Id. at 2-3.
As to touch and concern, the court found that the dedications did not limit the debtor’s use or enjoyment of, nor increase the midstream provider’s rights respecting, the debtor’s mineral estates where they only concerned severed minerals, which are personal property. The court further found that provisions permitting the debtor to satisfy its shipping requirements through minerals produced from the land of third parties or by payment of a fee to support a finding that the dedications did not touch and concern the debtor’s mineral estate. Id. at 28-34.
As to privity of estate, the court found that easements and rights-of-way did not satisfy this requirement because they related to a surface estate and not the debtor’s mineral estate. The court also found that other conveyances were insufficient to satisfy privity, including the grant of an equity interest in an above-ground pipeline transportation system, the grant of equity interests in a subsidiary of the debtor, and the dedication itself in the agreements. Id. at 35-44.
Contextualizing the Extraction Rulings Within the Evolving Bankruptcy Law on CRWL
The Elevation Ruling, Grand Mesa Ruling, and Platte River and DJ South Ruling (collectively, the “Extraction Rulings”) depart from a recent duo of cases enforcing CRWL in midstream agreements. While the Extraction Rulings focus on a debtor’s mineral estate, recent cases finding valid CRWL have concentrated on a debtor’s leasehold interest.
A recent ruling from the Bankruptcy Court for the Southern District of Texas exemplifies the leasehold interest view. In In re Alta Mesa Resources, Inc., the upstream debtor and midstream counterparty entered into certain gathering agreements containing purported CRWL. Alta Mesa Holdings, LP v. Kingfisher Midstream, LLC (In re Alta Mesa Res., Inc.), 613 B.R. 90, 96 (Bankr. S.D. Tex. 2019). The court found the gathering agreements there contained CRWL under Oklahoma law, which applies the same three-prong test as Colorado law: (1) touch and concern, (2) privity of estate, and (3) intent that the covenant pass to successors. Id. at 100.
As a threshold question, the court examined which of a debtor’s property interests are relevant to the CRWL analysis and determined the debtor’s leasehold interest to be the appropriate focus for its inquiry. The court explained that a debtor’s leasehold interest is comprised of “a bundle of rights that include[s] the right to search for and reduce hydrocarbons to possession, surface easements for exploration and production, and other rights and privileges necessary for profitable production.” Id. at 102–03 (citations omitted). “Those leasehold interests, targeted at the production of hydrocarbons, are the real property interests which the [debtor’s] gathering agreements involve.” Id. at 103. “[I]n the context of an oil and gas lease, the surface easement is integral to the lessee’s ability to realize the value of its mineral reserves. Without the surface easement, the lessee cannot capture reserve hydrocarbons.” Id. at 104. By analyzing the elements of the purported CRWL relative to the debtor’s leasehold interest (rather than separate mineral and surface estates), the court concluded that both the touch and concern and horizontal privity elements were satisfied.
Similarly, in Midlands Midstream, LLC v. Badlands Energy, Inc. (In re Badlands Energy, Inc.), 608 B.R. 854, 869 (Bankr. D. Colo. 2019), the Bankruptcy Court for the District of Colorado, applying Utah law, found the touch and concern element satisfied when it considered the dedication’s effect on the use and enjoyment of the debtor’s leasehold interest.
The agreements at issue in the Elevation Ruling contain dedication language that relates to interests of the debtor that are much broader than its mineral estate alone, including lands, mineral interests, easements, leases, wells, and gas, oil, and water therein and thereunder. Similarly, the dedication at issue in the Grand Mesa Ruling also broadly relates to the debtor’s leases, wells, dedicated reserves, and crude petroleum within or produced from the dedication area. The dedication and commitments in the Platte River and DJ South Ruling relate to interests that are more narrow, limited to the debtors’ or its affiliates’ crude petroleum and wells in the dedicated area. Nevertheless, the Delaware Bankruptcy Court examined the purported CRWLs in all of the Extraction Rulings narrowly — in the context of only the debtor’s mineral estate — notwithstanding the explicit breadth of the debtor’s real property interests dedicated in many of the relevant midstream agreements.
The distinction observed in Alta Mesa between a mineral estate and a leasehold interest of the debtor was not addressed in the Extraction Rulings. As indicated above, the Extraction Rulings are presently on appeal before the Delaware District Court. In the event that following the appeals this divergence in case law persists, it will likely provide ground for future disputes and more conflicting case law in this area of bankruptcy law.
1 The Memorandum Opinion is at Docket No. 1579, and the related Order is at Docket No. 1580.
2 All three Extraction Rulings (defined below) discussed herein have been appealed. See Elevation Midstream, LLC v. Extraction Oil & Gas, Inc. (In re Extraction Oil & Gas, Inc.), Civ. A. No. 1:20-cv-1456-UNA (D. Del.) (docketed October 28, 2020); Grand Mesa Pipeline, LLC v. Extraction Oil & Gas, Inc. (In re Extraction Oil & Gas, Inc.), Civ. A. No. 1:20-cv-1458-UNA (D. Del.) (docketed October 28, 2020); Platte River Midstream, LLC and DJ South Gathering, LLC v. Extraction Oil & Gas, Inc. (In re Extraction Oil & Gas, Inc.), Civ. A. No. 1:20-cv-1457-UNA (D. Del.) (docketed October 28, 2020) (collectively, the “Extraction Appeals”). In each of the Extraction Appeals, in oral orders docketed October 28, 2020, the bankruptcy court has ordered the parties to mandatory mediation in accordance with a standing order of the court and has directed the parties to advise in joint written submissions as to the parties’ respective positions regarding mediation by November 18, 2020, or, alternatively, if the parties request to be removed from the mandatory mediation requirement, they may propose a joint briefing schedule.
3 Other state CRWL laws often include these three requirements and also may incorporate additional factors, such as those articulated under Texas law in the Chesapeake Ruling.
4 The Elevation Ruling refers to the Findings of Fact and Conclusions of Law on Plaintiff’s Motion for Summary Judgment Against Elevation Midstream, LLC, which is at Docket No. 51; the related Order is at Docket No. 52, and the Judgment is at Docket No. 53.
5 The Grand Mesa Ruling refers to the Findings of Fact and Conclusions of Law on Plaintiff’s Motion for Summary Judgment Against Defendant, Grand Mesa Pipeline, LLC; and Defendant’s Motion for Permissive Abstention, which is at Docket No. 45; the related Order is at Docket No. 46, and the Judgment is at Docket No. 47. Note, the court in the Grand Mesa Ruling also denied Grand Mesa’s motion for permissive abstention.
6 The Platte River and DJ South Ruling refers to the Findings of Fact and Conclusions of Law on Plaintiff’s Motion for Summary Judgment Against Platte River Midstream, LLC and DJ South Gathering, LLC, which is at Docket No. 54; the related Order is at Docket No. 55, and the Judgment is at Docket No. 56.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.