My Producer has Filed Bankruptcy - Now What?

By:      Wade Caldwell (gcaldwell@beclaw.com) & Zach Fanucchi (zfanucchi@beclaw.com)

As the dreaded packet arrives in the mail from a Bankruptcy Court, many mineral owners are being introduced to the third “B” of the oil business — Boom, Bust, Bankruptcy.  This article is a quick primer for Texas mineral owners.  It is not a legal treatise nor does it address all issues.  As with any legal issue, see an attorney for advice.

A mineral owner should usually look at bankruptcy issues in the following order:

  • What kind of bankruptcy has been filed?

  • What kind of legal relationship do I have with the bankrupt company?

  • What can I do in response to the bankruptcy filing?

  • How does this affect the royalties I am owed, or that will become due?

  • How does this affect my lease?

What Type of Bankruptcy has Been Filed?

When an oil and gas company (the “Debtor”) files for bankruptcy, it is supposed to submit a list of its creditors so the Court can send a “Notice of Filing” to each creditor named by the Debtor.  11 U.S.C. Section 342.

The Notice of Filing tells you which type of Bankruptcy has been filed by the Debtor.  There are three main Chapters in the Bankruptcy Code (Chapters 7, 11 and 13).

 

1.         Chapter 7.

Chapter 7 is a liquidation.  For mineral owners it usually means:  (1) your lease is going to be sold; and (2) you may not receive all of the royalties you are owed.  The Debtor ceases doing any business, after selling all of the assets of the company, and the bankruptcy Trustee makes payments to the creditors of the bankruptcy “estate” if there is money available.

 

2.         Chapter 11.

Chapter 11 is the most complex type of bankruptcy filing and is commonly used by oil and gas companies.  A Chapter 11 is also referred to as a “reorganization,” because it allows the Debtor to try to reorganize the business and keep it going.  It is not uncommon for the shareholders to lose their equity in the company.

Under Chapter 11, the Debtor submits a “plan of reorganization” which details how the Debtor plans on repaying the creditors of the bankrupt company.  The plan will list the different categories of debts, and propose how each of which is to be paid a different proportion from the assets of the Debtor.  Generally speaking, the categories are divided into priority claims, secured claims, priority unsecured claims, and general unsecured claims.

However, Chapter 11 can have a very wide variety of outcomes.  If the court becomes convinced the debtor cannot reorganize, it can be converted to a Chapter 7.  Sometimes the reorganization is radical, with major assets being sold off as part of the reorganization, including your leases.  Some debtors go into Chapter 11 with a prepackaged deal arranged with the creditors to reorganize the company.  In some Chapter 11’s, the court will allow the Debtor to primarily run the company during the reorganization, while others may have a Chapter 11 trustee running the Debtor.  In short, the variety of outcomes in a Chapter 11 is varied and unpredictable.

 

3.         Chapter 13.

Chapter 13 bankruptcies are rarely used by operators.  Chapter 13 is different from Chapter 7 in that the debts are not discharged entirely.  Under Chapter 13, a repayment plan is created to pay back some or all of the debt owed by the Debtor.  Chapter 13 is typically used by individuals with a mix of secured and unsecured debt.  Chapter 13 has also been referred to as a form of debt consolidation.  Chapter 13 is usually only used by small operators with a few leases, and is really as much of a bankruptcy by the individual as it is by their business.

Like Chapter 11, Chapter 13 requires that a plan be filed with Court articulating how (and in what percentage) the Creditors are to be paid.

 

What is My Legal Relationship to the Bankrupt Operator?

A lot of mineral owners receive bankruptcy notices from companies whose names they do not recognize.  This may be because:  (1) the operator stopped paying royalties a long time ago; or (2) the operator has some other type of relationship with you other than as a royalty owner under a lease.  Many operators take a cautious approach when they file bankruptcy and send notices to everyone that they have legal relationships with, whether it be a royalty owner under a lease, a co-royalty owner, a non-participating royalty owner, operators, and many other types of relationships.  Therefore, it is important to know who the company is and what your relationship to them is, legally.

If you do not recognize the company, you can go online and go through the bankruptcy “schedules” to see why you were listed as someone receiving notice.  You should sign up for notices to get documents by e-mail filed in the bankruptcy cases.  However, it is not an easy process to register or request notices, and bankruptcy courts have mandatory electronic filing rules.  After you know what your relationship is to the company that filed bankruptcy, you are ready to decide what your response should be.

 

What Can I Do In Response?

There are a few general rules in dealing with operator bankruptcies:

 

1.         Read the notice carefully, calendar all of the deadlines in the notice and send in a notice of appearance so you will get mailings or e-mail notices of proceedings in the bankruptcy.  A list of the common forms used in bankruptcy is here.

2.         Calling the debtor attorney listed in the notice, or the bankruptcy court, is usually a waste of time.  Bankruptcy clerk personnel do not give out advice, and the attorney for the debtor is not there to help you either, if he/she even returns the phone call.

3.         Research production on the wells that you have with that operator and go through your recent royalty statements to see if it looks like your payments are up to date and you are being paid on your share of the production.

4.         If you are owed money, start collecting the documents that you may need to file a proof of claim, such as your lease, division order, and past royalty statements.

  

The Automatic Stay.

The automatic stay prohibits a creditor from taking action against the Debtor.  These actions include filing a lawsuit against the Debtor, continuing with a lawsuit that has previously been filed, or attempting to collect on a debt owed.  The automatic stay provision can be found at 11 U.S.C. Section 362.  The automatic stay takes effect immediately upon the filing of the Bankruptcy Petition (not when the creditor receives notice), and the only way the stay can be lifted is to file a motion with the Bankruptcy Court requesting that the stay be lifted for a specific purpose.  Oil and gas royalty creditors would typically have no right to seek to lift the automatic stay.  But if the oil and gas lease provides for termination of the lease upon filing bankruptcy or stopping payments, a royalty creditor may want to lift the automatic stay, or reject the lease, especially if it is an old, unfavorable lease.

However, there are instances where there are other issues besides royalties owed that you may want to lift the stay.  For example, if a lease got signed but the bonus check never got paid, you may want to try to lift the stay to get the lease terminated for failure of consideration.

 

Filing A Proof of Claim.

Oil and gas royalty owners are usually one of the largest groups of creditors in oil and gas company bankruptcies.  In Texas, royalty creditors are afforded more security. Royalty creditors are provided a security interest in production from the well, and as such, are perfected secured creditors.  Tex. Bus. & Comm. Code Section 9.343.  Under this Section, royalty creditors are also granted a security interest in the proceeds from the sale of the oil and/or gas to secure payment of their royalties.  Practically speaking, this means that, if the oil and gas company has funds in its account that can be traced to the sale of oil and/or gas from a certain well, the royalty owner would have a claim to those funds superior to other unsecured creditors.

 

Going to Hearings.

Particularly in a Chapter 7, if you have dealt with a dishonest operator, it may be worth going through the Bankruptcy Schedules filed by the debtor to see if there are any untruthful statements on the schedules.  If so, it may be worthwhile to go to the meeting of creditors, where you can ask questions of the debtor under oath and bring to light any suspicious transfers or other absconding with money that the bankruptcy trustee may want to know about.  The bankruptcy trustee usually has the authority to go after improper transfers or false statements on bankruptcy schedules, although a mineral owner as a creditor can also make claims under certain circumstances.

 

Terminating the Lease.

Generally, the operator filing bankruptcy is not likely to create an opportunity to terminate a bad lease.  This is because oil and gas leases are the major asset of most operators, and they will usually try to keep royalty payments current to prevent arguments that leases can be terminated.  This, coupled with the fact that in Texas royalty owners have a security interest in royalty proceeds, means it is less common these days that royalty owners do not get paid during the bankruptcy.

More common is royalty owners who do not receive payments before the filing of bankruptcy.  These “pre-petition” debts would have to be pursued through a proof of claim.  As far as using the failure to pay royalties as a basis for terminating a lease, see an attorney.  The issue is too complex to address in this paper.  However, if you want to look at terminating your lease, there are some general principles.  In Texas, oil and gas “leases” are actually real property interests (a fee simple determinable interest) and not lease interests.  It is critical to determine whether the oil and gas lease contains a termination clause.  If so, the nature of the lease as a fee simple determinable interest would arguably allow the royalty creditor to terminate the lease.  Debtors are aware of this, and, in an effort to protect the asset, oftentimes inform the Bankruptcy Court of leases which they believe are valuable and in danger of termination for non-payment.  If this occurs, the Bankruptcy Court has the authority to pay the royalty owners for both unpaid royalties prior to and after bankruptcy is filed.  This action would prevent the lease from being terminated and protect the asset on behalf of the Debtor.

First, look to terms of your lease for specific remedies you may have when royalty payments are missed.  For example, the lease may provide a termination clause for failure to pay royalties.  Second, if the lease language is unclear, you may want to consider seeking a “comfort order” that declares the lease terminated so you can lease to another company.  You will need to lift the automatic stay to terminate the lease, in most cases.

 

How Long Does It Take And What Should I Expect?

You may be inundated with correspondence from the Court. It is imperative that you review all correspondence, as important deadlines are contained in them.  The most important deadline for the royalty creditor is the filing deadline of the proof of claim.  Prior to the deadline, you will need to collect proof of your claim and the amounts owed by the debtor.  In any event, the best advice upon receipt of the dreaded Notice of Claim would be to contact an attorney for help.  Most people find that just reading the bankruptcy notices is overwhelming, much less figuring out how to find the bankruptcy schedules online, and how to register for, and receive, notices.  Your adversaries are highly trained, and most people are at a severe disadvantage to try to handle it themselves.  “I hesitate not to pronounce, that every man who is his own lawyer, has a fool for a client.”  The flowers of wit, or a Choice Collection of Bon Mots, by Henry Kett, 1814.

The amount of time that the bankruptcy process takes depends greatly on whether it is a Chapter 7, 11 or 13.  Chapter 7 liquidations usually move pretty quickly, and are often completed within about six months.  This does not mean you get paid in 6 months, however.  Generally, creditors are not paid until all the claims are resolved, which can go on for some time.

Chapter 13s take longer, as the reorganization has to be proposed and approved by the court.  Chapter 11s usually take the longest, unless it is a “pre-packaged” bankruptcy.  Payment from a Chapter 11 can take up to a year or much longer.

As with any court proceeding, there are the potential for great delays.  Objections can be filed, and appeals taken from court rulings.  If appeals are filed, bankruptcy proceedings can drag on for several years.

 

How Does This Affect my Royalties?

Because Texas royalty owners may have a secured claim to sales proceeds, and because of the possibility of terminating the lease if it is worded properly, the effect on royalty payments is often not as large as many would fear.  Particularly in a Chapter 11, the operator usually quickly gets permission from the court to continue to pay royalty owners during the bankruptcy.  However, there is no one-size-fits-all outcome on royalty payments, and it can vary from a complete stop of payments, if they have not stopped already, to proportional payments, to full payments.  The payment for any royalties overdue at the time the bankruptcy is filed are considered claims against the bankruptcy estate, and may take a substantial amount of time to collect, if at all.  If your operator has stopped paying royalties and eventually files a voluntary Chapter 7, your chance of getting 100 cents on the dollar is poor.

 

How Does This Affect my Lease?

As discussed above, since leases are the major assets of most operators, they try to preserve them as best they can, whether to be sold, or to try to reorganize the company.  Therefore, most bankruptcies are structured to try to prevent lease terminations as much as possible.

However, this does not mean you should not look at the possibility of a lease termination.  As discussed earlier, look at your lease, and consult an attorney.  Lease termination is a potential avenue in a bankruptcy if your lease is worded correctly.

Welcome to the third “B” — Bankruptcy.

Views: 1483

Comment by Leo Schumacher on January 30, 2016 at 1:21pm

Thanks for posting this helpful article....one subject I did not find mentioned, is what happens to production of the well once a bankruptcy is filed, especially a chapter 7.  It seems production should automatically be terminated, otherwise, the debtor would in esssence be stealing the minerals since it cannot pay the royalties.  Also, I thought some states require royalty monies can be used only for the purpsoe to pay royalties, and other creditors had no rights to the royalty monies.      This was a very helpful article.

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