Oil and gas producers and suppliers hit with lower prices, oversupply of their product and the pandemic have been filing bankruptcy petitions at historically high levels. The filing numbers for April through June of this year are almost twice the fling numbers of the first quarter of 2020.
Whiting Petroleum, a big producer in the Bakken, filed for Chapter 11 in April and Chesapeake in June. They will not be alone on the bankruptcy docket. A bankruptcy filing, however, is not the same as a “funeral.” People believe what they want to believe. When I taught bankruptcy law, one of the harder things to get across to the students was the fact that a bankruptcy filing is not automatically “the end.” Nevertheless, several of the students came into the class carrying that attitude. One should keep in mind even if a liquidation bankruptcy case is filed, unless there is an abandonment of the wells, oil and gas production often continues. The particular chapter of the bankruptcy code filing, state property law, as well as state and federal regulations all affect a bankruptcy case. You have as many facets to a bankruptcy case as there are facets on a movie star’s wedding ring.
In this piece I discuss the impact of a bankruptcy filing on the typical lessor (usually property owner) and royalty holder. First let us review a couple of things to watch for. If you are the lessor or royalty holder and think a producer may be a bankruptcy candidate, there are steps that can be taken. Your attorney can access the so-called watch list as well as access public records for delisted public companies. And a slow or nonpayment of royalties is also a red flag. Do not panic if a bankruptcy filing occurs. A lessor and royalty holder should put his energy into keeping good paperwork and records. This will make a bankruptcy experience somewhat more tolerable.
Property rights created by an oil and gas lease are treated differently in the various states. In North Dakota the oil and gas lease give the lessor a real property interest with real property rights. According to the 1986 North Dakota Supreme Court case Nantt v. Puckett Energy Company, “[o]il and gas leases are interests in real property” and have been considered such since 1951. Although an oil and gas lease is not a lease in a typical landlord and tenant sense, in North Dakota, an oil and gas lease is treated under bankruptcy law as an “unexpired lease.”
Many operators who file for bankruptcy are in arrears on royalty payments. A recent North Dakota law allows a royalty holder to file a security lien when the royalty has not been paid when due. The royalty owner must file the lien with the state and record the lien in the county where the well is located within 90 days of production to claim the lien. With good records and timely filing and recording, mineral interest owners can gain a secured position in a bankruptcy proceeding. This increases a royalty holder’s chances of a recovery because secured creditors are paid before unsecured creditors.
In a reorganization bankruptcy, the filing debtor must either assume (agree to be obligated under) or reject an unexpired oil and gas lease as is. A debtor may not accept only the favorable parts of a lease. If the oil and gas lease is assumed and not in default, the royalty holder in assured under the law that the terms of the lease are to be followed. If an oil and gas lease is in default, the debtor must cure the default in order to keep the lease. Therefore, if a bankrupt debtor is delinquent on royalty payments, the debtor must pay the back royalties if they want to assume the lease. However, the bankruptcy court must approve any assumption of a lease. A bankruptcy court will look to whether the lease is a valuable asset to the debtor and whether its preservation is sufficiently important. A royalty holder or lessor may also request that the court order the debtor to decide whether to accept or reject an oil and gas lease within a specified time.
If a debtor elects to reject an oil and gas lease, the lease is no longer valid, and the mineral interest is again available on the open market. Following a bankruptcy filing, a royalty holder or lessor may find themselves with the new option of leasing to a different producer who bought the assets of the bankrupt debtor. Sometimes good. Sometimes bad. Another way this could happen is if a producer is in default of the lease agreement. Under North Dakota law the obligation to pay royalties is “of the essence” in an oil and gas lease and that breach of the obligation “may constitute grounds for cancellation of the lease.” If a mineral owner shows a bankruptcy court that equity requires it, the court may cancel the contract and the mineral owner may then lease to another party. In addition to the statute, some lease agreements contain a provision allowing a landowner to terminate the lease under certain conditions. When I look at a good number of leases that owners, farmers and ranchers bring in I do not often find such a clause. But the clause gives the lessor more control regarding cancellation
David Ganje practices law in the area of natural resources, environmental and commercial law with Ganje Law Office. His website is Lexenergy.net.
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