Acreage dedications in midstream oil and gas contracts have been subject to considerable scrutiny and legal debate in recent years. This article provides an overview of the current state of acreage dedications, examining key legal cases such as In re Sabine Oil & Gas Corp., In re: Extraction Oil & Gas et al.; In re Southland Royalty Company, LLC et al, and ETC Texas Pipeline, Ltd. vs. Chesapeake Energy Corporation, et al. The discussion highlights the implications of these cases for parties involved in midstream transactions, particularly those with acreage dedications, and offers insights into emerging trends and considerations in this complex area of law.
Background on Acreage Dedications in Midstream Contracts
Midstream oil and gas contracts play a crucial role in the energy industry, facilitating the transportation and processing of hydrocarbons from production fields to end consumers. Acreage dedications, wherein producers commit certain acreage or production volumes to midstream operators, are a common feature of these contracts. Acreage dedications typically involve producers committing specific areas of land or production volumes to midstream operators in exchange for transportation, processing, and other services. These dedications are often essential for midstream companies to secure financing and develop infrastructure. However, disputes and legal challenges surrounding acreage dedications have intensified in recent years, leading to significant judicial scrutiny and evolving legal precedent.
For a more fulsome explanation of acreage dedications, and their important to midstream contracts, please see our prior article on this topic – Acreage Dedications in Midstream Contracts.
The Sabine Case
The landmark Sabine case, decided by the United States Bankruptcy Court for the Southern District of New York in 2016, fundamentally altered the legal landscape surrounding acreage dedications. Sabine Oil & Gas Corporation filed for bankruptcy and sought to reject gathering agreements with midstream operators
Sabine Oil & Gas Corporation, facing financial distress, filed for Chapter 11 bankruptcy protection and sought to reject certain gathering agreements with midstream operators, including Nordheim Eagle Ford Gathering, LLC. These agreements contained acreage dedications, requiring Sabine to deliver a minimum volume of hydrocarbons from specified acreage to the midstream facilities for transportation and processing.
Sabine argued that these contracts were executory and burdensome, hindering its ability to reorganize effectively under Chapter 11. The company sought approval from the bankruptcy court to reject these contracts, thereby relieving itself of the associated obligations, including the acreage dedications.
The court’s decision in the Sabine case was groundbreaking, as it marked the first time a bankruptcy court allowed a debtor to reject midstream contracts with acreage dedications. The court held that the contracts were indeed executory and could be rejected under Section 365 of the Bankruptcy Code. This decision fundamentally altered the landscape of midstream contracts by introducing uncertainty regarding the enforceability of acreage dedications in bankruptcy proceedings.
The court’s rationale for allowing rejection centered on several key factors. Firstly, it determined that the agreements imposed significant financial burdens on Sabine, impairing its ability to reorganize effectively and maximize value for its stakeholders. More importantly, under Texas law, the court found that the agreements did not constitute real property covenants that run with the land, because the agreement did not “touch and concern the land” and there was lack of “horizontal privity,” which remained a part of the legal test for determining whether a real property covenant run with the land in Texas. Importantly, the court did not determine whether the acreage dedications were, in fact, executory contracts subject to rejection under Section 365(a) of the Bankruptcy Code but rather that no covenant running with the land existed.
The Sabine case sent shockwaves throughout the energy industry, raising concerns among midstream operators and investors about the stability and enforceability of their contracts. It highlighted the need for parties to carefully review and negotiate contractual provisions, including acreage dedications, to mitigate risks and uncertainties in the event of financial distress or bankruptcy.
Post-Sabine, midstream companies took care to draft acreage dedications that clearly indicated the parties’ intent to cover real property interests, including references to the real property interests themselves and the oil and gas in the ground rather than as produced. In addition, midstream companies added express provisions of horizontal privity, typically through a producer’s express grant of an easement over land on which it holds surface rights. Finally, to ensure that third parties were put on notice of the dedication, midstream companies filed memorandums of dedication in the real property records of the appropriate county.
Alas, for midstream companies, it was not enough.
In Re: Extraction Oil & Gas et al.
In the aftermath of Sabine, the case of In re: Extraction Oil & Gas et al., decided by the United States Bankruptcy Court for the District of Delaware in 2020, confronted the complex issue of whether contracts containing acreage dedications could be deemed executory, even if they also included covenants running with the land.
Traditionally, covenants running with the land are contractual provisions that bind successors in interest to the original parties to the contract. These covenants are typically associated with real property interests and are intended to ensure that certain obligations and rights endure beyond the initial parties to the contract, even through bankruptcy.
In the context of bankruptcy law, the characterization of contracts as executory plays a pivotal role in determining whether they can be rejected by the debtor. Section 365 of the Bankruptcy Code provides debtors with the authority to reject executory contracts, relieving them of ongoing obligations and liabilities.
The midstream providers for Extraction, including parties represented by the author of this article, argued that contracts containing acreage dedications create real property interests through covenants running with the land and therefore cannot be considered executory and subject to rejection in bankruptcy.
Judge Sontchi, while acknowledging the presence of covenants running with the land in contracts drafted post-Sabine, focused on the law school concept of property as a “bundle of sticks.” The metaphorical bundle of sticks represents the various rights and interests inherent in property ownership. According to this model, ownership of real property is akin to holding a bundle of individual rights, each resembling a “stick” within the bundle. These rights can include the right to possess, use, transfer, exclude others, and encumber the property. Just as a bundle of sticks can be broken apart or rearranged, property rights can be divided, transferred, or modified among different parties. For Judge Sontchi, an acreage dedication (the obligation to deliver hydrocarbons produced from certain acreage to certain midstream infrastructure) is not one of the sticks.
The court’s decision underscored the pragmatic approach taken in bankruptcy proceedings, where the focus is often on maximizing value for creditors and stakeholders over contractual counterparties. By allowing the rejection of contracts containing acreage dedications, the court prioritized the need for flexibility and efficiency in the reorganization process.
The Extraction case set an important precedent regarding the treatment of contracts with acreage dedications in bankruptcy proceedings. It highlighted the bankruptcy courts’ willingness to look beyond traditional legal classifications and focus on the practical implications of contractual obligations in the context of the financial distress of the debtor.
In Re: Southland Royalty Co. LLC et al.
In Southland Royalty Co. LLC, Judge Owens, deciding the case shortly after Judge Sontchi, reached a similar outcome but for different reasons. Judge Owens’ decision centered on the nature of the gas produced from the dedicated acreage, asserting that once extracted, the gas transformed from real to personal property. This distinction was crucial in determining the enforceability of the acreage dedications, as covenants running with the land pertain to interests in real property. By characterizing the produced gas as personal property, Judge Owen challenged the notion that the acreage dedications created real property interests, thereby undermining the argument that they constituted covenants running with the land.
In win for midstream companies, Judge Owen’s ruling also addressed Southland’s attempt to reject only the minimum volume commitment portion of the agreement while retaining the remainder of the contract. Refusing this request, the court emphasized the indivisibility of the agreement, highlighting the interconnectedness of its various provisions. By rejecting Southland’s selective rejection proposal, the court affirmed the principle that parties cannot cherry-pick contractual obligations in bankruptcy proceedings, underscoring the importance of honoring the entirety of contractual commitments. This aspect of the decision reinforced the notion that parties to a contract must adhere to all its terms, particularly in situations involving bankruptcy or financial distress, to uphold the integrity and enforceability of the agreement.
Etc Texas Pipeline, Ltd. vs. Chesapeake Energy Corporation, et al.
In June 2020, Chesapeake Energy Corporation filed for Chapter 11 bankruptcy. Following the pattern of Extraction and Southland, Chesapeake sought to eject a gas purchase agreement with ETC Texas Pipeline, Ltd. The purchase agreement used the standard “Base Contract for Sale and Purchase of Natural Gas” published by the North American Energy Standards Board (NAESB) and contained a covenant running with the land.
In his opinion, Judge Jones held that the NAESB agreement could be subject to rejection, even containing a covenant running with the land. “It [did] not stretch the imagination to envision a contract that both contains a covenant that runs with the land and is executory.”
Unlike the Court in Extraction, however, Judge Jones ruled that merely stating that the covenant is intended to “run with the land” is not enough to show intent to create a real property covenant. In fact, the agreement stated that the sole and exclusive remedy of the parties in the event of breach was payment of liquidated damages.
Conclusion
The legal landscape surrounding acreage dedications in midstream oil and gas contracts continues to evolve, shaped by judicial decisions and emerging market trends. The pendulum has swung significantly in favor of allowing producers to reject acreage dedications in midstream contracts. While the courts take different paths, each of Judge Sontchi’s, Judge Owen’s and Judge Jone’s decisions reach the same conclusion – acreage dedications are not an interest in real property. Is there a solution for midstream providers? Stay tuned for our next article to find out! Spoiler alert – the answer is yes but you need a skilled midstream attorney to pull it off.
Ryan Newburn has been representing, and starting, companies in the midstream space since since 2010. Ryan managed the seminal Sabine bankruptcy case for HPIP Gonzales Holdings, LLC, which had its acreage dedication rejected in the case. Ryan went on to represent ARB Midstream, LLC, and serve as Co-Chairman of the Unsecured Creditors Committee, for the bankruptcy case of Extraction. Ryan utilizes that experience in crafting midstream agreements for dozens of midstream and upstream companies around the US. If you need expert guidance with your midstream agreements, contact Ryan directly.
