March 20, 2017 - Over the past year, a once obscure issue took on huge significance in the oil patch.  To wit, do gas-gathering contracts between “midstream” service companies and production companies (E&Ps) constitute real property interests?  As Reed Smith notes in a recent client memo, a “gathering agreement refers to a contract that provides for collecting gas or other commodities at the point of production, and for moving it through a pipeline system to a junction with a pipeline’s primary transmission system”.  Why is this important?  In a Chapter 11 bankruptcy, contracts to provide goods or services may be rejected by the debtor, resulting only in an unsecured claim for damages for breach of contract.  However, if the covenants in the agreements “run with the land”, they convey a real property interest which cannot be rejected in bankruptcy.  Last year, in a controversial and impactful ruling, bankruptcy judge Shelly Chapman ruled that under the governing Texas law Sabine, an E&P, could “reject” gathering contracts with midstream pipeline companies because they were executory contracts that were not related to the land. Now, as reported in Law 360, Judge Jed Rakoff of the District Court for the Southern District of New York affirmed.  The court noted that the preliminary issue under Texas law in determining whether the covenants under the gathering agreements run with the land is whether they touch and concern the land.  It ruled that the contracts did not because they did not increase the midstream pipeline companies’ relationship to the property or decrease the debtor’s.  He concluded that the contracts did not convey a real estate interest to the midstreams and did not decrease the debtor’s relationship to the land because Sabine was free to produce as much or as little gas as it chose and that its obligations were only triggered once it produced gas.

As King & Spaulding points out in a recent client memo, the District Court’s decision “cements a much maligned ruling that has negatively affected many midstream companies and caused further distress and disruption in the oil and gas industry.”  Since the bankruptcy court’s decision, many similar disputes have been resolved through negotiation and the District Court’s decision is likely to continue that trend.  Finally, the structure of future gathering contracts between midstream pipeline companies and E&Ps are likely to be influenced by this decision – at least unless and until another court reaches a different conclusion.

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