Oil and gas producers in Texas and a handful of other states have had the comfort of believing that they held purchase money security interests against the production in the hands of first purchasers and proceeds of that production. Now, the law supporting that belief has come under fire.

On June 19, 2009, the bankruptcy judge in the SemCrude cases in Delaware issued three opinions in three different adversary proceedings filed by oil and gas producers in Texas, Kansas, and Oklahoma. These opinions addressed the question of whether prior perfected article 9 security interests asserted by SemCrude's lenders are superior to the security interests of producers who had sold oil and/or gas to SemCrude prior to its bankruptcy.

In the lawsuit filed by the Texas oil and gas producers, the producers argued that section 9.343 of the Texas Business & Commerce Code (TBCC), which provides interest owners with an automatically-perfected purchase money security interest in oil and gas or its proceeds, automatically perfected their security interests and gave them priority over the prior-perfected security interests of the banks in production sold to first purchasers and the proceeds of that production.

Because SemCrude is organized in Delaware, the Bankruptcy Court held that Delaware law applied. Relying on both Oklahoma (the state of formation of one of SemCrude's subsidiaries) and Delaware perfection rules, the Court held that the producers' security interests were junior to the perfected security interests of the banks. It reasoned that since neither the Oklahoma nor Delaware UCC contained a provision analogous to TBCC section 9.343, the producers could not rely on that provision for automatic perfection of their security interests. Because the producers had not taken affirmative steps to perfect their security interests in Oklahoma or Delaware, as the case may be, pursuant to that state's UCC provisions, their security interests were unperfected and therefore junior to prior-perfected security interests. Thus, Texas producers who sold and delivered oil and gas, in Texas, to SemCrude or its Oklahoma subsidiary could not rely on the Texas law governing liens on production and proceeds.

The court's decision in the adversary proceeding filed by the Kansas producers reached essentially the same result, leaving the producers unperfected.

In the Oklahoma producers' case, the Oklahoma producers argued that a provision of Oklahoma's Production Revenue Standards Act imposed a trust in their favor over the production and proceeds. But the court observed that the intent to create a trust must be "clear, decisive, and unequivocal" and the language of the Oklahoma statute simply did not provide the requisite intent. In response to the Producers' argument that the Oklahoma Lien Act provided them with a lien in the production and proceeds, the Court held that any such lien was junior to the prior-perfected interests of the banks.

The bankruptcy court has certified all three related matters for direct appeal to the Third Circuit Court of Appeals. It is uncertain whether the Third Circuit will accept the appeals. Unless and until the Third Circuit overturns the Bankruptcy Court's decision, the perfection and priority of producers' liens securing the obligations of out-of-state first purchasers under non-uniform provisions of the UCC are now in doubt.

Oil and gas producers seeking to insulate themselves from the effects of this holding will have to:

  1. Require first purchasers to provide, and their lenders to consent, to a first priority security interest on production and proceeds to the extent of unpaid invoices for that production; and
  2. File financing statements and similar instruments and give required notices that conform to the state of incorporation or formation of your first purchaser.

OR

  1. Require evergreen letters of credit or other collateral sufficient for oil and gas nominated to each first purchaser equal to or greater than the highest expected monthly or spot purchase; and
  2. Monitor collections to access collateral if runs are not paid for on time; and
  3. Halt further deliveries until paid.