Editor’s Note: On June 16, 2016, The Bankruptcy Cave gave you our previous summary of the controversial Sabine decision. When Bankruptcy Judge Chapman determined there was no reason to expedite review of her decisions in the case, we brought you Sabine Lives On (and On) detailing the struggles of Sabine’s midstream adversaries. Like Hollywood, Bankruptcy Cave knows that sequels sell (with some notable awful exceptions, such as here and here). We now bring you the third installment of Sabine. If it sounds like a horror film or slasher flick, it was for the midstream sector.
The bankruptcy court was right! Judge Rakoff of the United States District Court for the Southern District of New York stated starkly: “[T]he bankruptcy court did not err in authorizing the rejection of the Agreements pursuant to 11 U.S.C. § 365(a). Nordheim challenges the decision only on the ground that the Agreements are real covenants that run with the land, and, since the Court reaches the contrary conclusion; Nordheim’s argument in this regard has no merit.”[i]
Backing up almost a year, on March 9, 2016, Bankruptcy Judge Chapman of the Southern District of New York issued her decision on the Debtor’s motion to reject certain contracts in Sabine Oil & Gas Corporation’s Chapter 11 case. The decision allowed Sabine to reject “gathering agreements” between it and two “midstream operators” [for more info on these technical terms see my prior blog post here] Nordheim Eagle Ford Gathering, LLC and HPIP Gonzales Holdings, LLC, under Section 365(a) of the Bankruptcy Code. In June, 2016, Judge Chapman refused to allow the midstream operators to appeal her decision to the Second Circuit Court of Appeals and rejected requests to stay her decision.[ii] These decisions sent shockwaves through the midstream energy sector and leveled the playing field for bankrupt production companies.
Judge Rakoff’s opinion (full copy Here) turns immediately to the question of “whether the Agreements run with the land and therefore cannot be rejected pursuant to § 365(a).”[iii] Relying on Texas law and citing Inwood N. Homeowner’s Ass’n v. Harris, the Court notes that
In Texas, a covenant runs with the land when it touches and concerns the land; relates to a thing in existence or specifically binds the parties and their assigns; is intended by the original parties run with the land; and when the successor to the burden has notice.[iv]
It is the first requirement, that a covenant touch and concern the land, which drew the Court’s attention.
Judge Rakoff rejected Nordheim’s argument that the dedication of gas and condensate “produced and saved” under the Sabine contract was an interest that touched and concerned the land.[v] Instead, Judge Rakoff reasoned that the Sabine contract had not granted Nordheim a royalty interest or any other mineral rights or interests recognized by Texas law. The Court also noted that the Agreements “did not decrease Sabine’s legal relation to its real property interests.”[vi] In other words, Sabine did not convey real property interests to the appellants, only personal property interests in the oil and condensate after it was produced.
Judge Rakoff’s reasoning followed Judge Chapman’s previous decision very closely and directly rejected any contrary interpretation of Texas law. Specifically, both rejected Nordheim’s argument that In re Energytec, Inc. applied to the circumstances of the case.[vii]
The latest Sabine ruling has three immediate impacts. First, the ruling expands the precedential value of the bankruptcy court’s decision. While technically the District Court’s ruling is only binding in the Southern District of New York, its practical implications are far broader. Sabine is no longer a rogue decision; it has been upheld on a de novo review by a very well-regarded Judge Rakoff. Second, the District Court’s ruling places additional pressure on midstream operators to settle and renegotiate their gathering agreements with bankrupt producers, as has been the case in multiple cases with gathering agreements similar to those at issue in Sabine.[viii] [Of course, this is exactly what Congress had in mind with Section 365 – forcing parties with above-market contracts to come to the table and negotiate with a debtor-in-possession.] Finally, attorneys for midstream operators will need to devise new contract language if they want to protect their clients’ interests by attaching them to the land. It is no longer enough for a gathering contract to simply say that it is a covenant running with the land; the language and reach of the contract must be broad enough to actually provide the midstream operator with a property right.