Williams: Protection for Royalty Owners

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What can land owners do in oil and gas operator bankruptcies?

It’s no secret that the past couple of years have been tough on the oil and gas industry. Sustained low prices in the commodity markets have driven a considerable number of operators into Chapter Eleven bankruptcy. A numerous and more widespread class of creditors has frequently been forgotten in all the excitement and agitation: the class of royalty owners, who are owed a percentage of the value of every barrel of oil or cubic foot of gas produced from their property.

When a company files for bankruptcy, it is obligated to provide notice of the filing to all of its creditors — including all persons to whom it owes royalty payments. Many royalty owners will receive the required notice, but because the class of royalty owner creditors is often so large, it is always possible that some royalty owners will be overlooked. If your royalty payments stop suddenly and without explanation, it would be worthwhile to do a quick search online to determine if your operator filed for bankruptcy.

The required notice of a Chapter Eleven bankruptcy will set forth a lot of basic information about the bankruptcy proceeding, but often will not contain the deadline for creditors to file a proof of claim with the bankruptcy court, because this deadline may be fixed by the court at a later date. Royalty owners affected by an operator bankruptcy should consult with legal counsel as soon as possible, and well in advance of this deadline, to determine whether it is prudent and cost-effective to file a proof of claim and become an active participant in the proceeding.

Section 365 of the Bankruptcy Code gives a bankrupt debtor the option to “reject” certain kinds of contracts, and thus to get out from under the obligations arising from them. The types of contracts that are subject to rejection are referred to in the Code as “executory contracts” and “unexpired leases.” Perhaps surprisingly, however, it remains an open question whether a Louisiana oil and gas lease can be rejected by the debtor under Section 365. In one case, the court held that a Louisiana oil and gas lease was an executory contract and was therefore subject to rejection under Section 365. Texaco, Inc. v. Louisiana Land and Exploration Co., 136 B.R. 658 (M.D. La 1992). A later court declined to follow the decision in the Texaco case, opining that because of the unique suite of rights and duties that arise from it, a Louisiana oil and gas lease cannot be classified as either an executory contract or an unexpired lease within the meaning of Section 365. In re Energy Corp., 202 B.R. 579 (Bankr. W.D. La. 1996).

A bankrupt debtor has a 120-day exclusivity period during which it may assume or reject an executory contract or unexpired lease, after which the contract or lease is deemed rejected. Thus, if a Louisiana oil and gas lease is properly classified as an executory contract or unexpired lease for purposes of the Bankruptcy Code, it will be deemed rejected by the debtor unless the debtor expressly elects to assume it. The proper classification of the oil and gas lease is therefore a high-stakes matter for both the bankrupt operator and the royalty owner.

In this climate of legal uncertainty, royalty owners will need to be assertive in order to protect their leases from rejection in the event that their operators file for bankruptcy protection.

Ryan C. Williams is an Attorney for Cook, Yancey, King & Galloway, APLC