R&I Update: Hot Topics in Oil and Gas Restructurings, Volume 5

Delaware Bankruptcy Court Sends Covenant Question to North Dakota

December 14, 2016

Like the wild prairie rose that punctuates the North Dakota plains, the issue of whether a debtor can reject its midstream agreements is back after a brief period of dormancy. In Hot Topics in Oil and Gas Restructurings, Volume 3, we described how the U.S. Bankruptcy Court for the Southern District of New York interpreted Texas law to authorize a debtor’s rejection of midstream gas-gathering contracts in Sabine Oil & Gas Corporation. On November 21, 2016, the U.S. Bankruptcy Court for the District of Delaware took a notably different tack. In Triangle USA Petroleum Corporation, the court lifted the automatic stay to allow a North Dakota court to determine whether gas-gathering agreements constitute covenants that run with the land under North Dakota law — a question of first impression. 

Triangle USA Petroleum Corporation (TUSA) is an exploration and production energy company based in Colorado. Its operations focus on shale oil and natural gas and are located primarily in the Williston Basin of North Dakota and Montana. Because those plays are isolated and underdeveloped, TUSA previously relied on truck and rail transportation to get its product to market.  But truck and rail transportation is costly. So, in 2012, TUSA entered into a joint venture to form Caliber Midstream Partners L.P. Caliber, in turn, constructed and currently operates a 300-mile pipeline system in the Williston Basin. Of note, Caliber also provides TUSA with gathering and related services for crude oil, gas and water pursuant to several long-term agreements that the companies executed.

Citing dismal, unpredictable macroeconomic conditions and a standalone plan of restructuring to which its lenders consent, TUSA and its affiliates filed for Chapter 11 bankruptcy protection in Delaware on June 29, 2016. Less than a week later, TUSA asked the bankruptcy court to authorize the rejection of six of its agreements with Caliber — which TUSA contends are executory contracts. In support of its motion, TUSA argued that the agreements are “an albatross” on its business: They commit TUSA to Caliber’s services for 15 years and were negotiated in a strong commodities market. Attempts to renegotiate rates with Caliber failed, and TUSA believes that it can obtain cheaper midstream services from another provider.

TUSA also filed an adversary proceeding in conjunction with its rejection motion. In that action, TUSA argued that certain of its agreements with Caliber do not provide a direct benefit to the properties they burden, nor do they purport to grant Caliber any title or estate in real property. Accordingly, TUSA asked the bankruptcy court to declare that the agreements “do[] not contain covenants or equitable servitudes that run with the land.”

Caliber beat TUSA to the punch, though. On May 27, 2016 — about a month before TUSA’s bankruptcy filing — Caliber filed a declaratory judgment action in North Dakota state court. There, Caliber seeks a determination that its agreements with TUSA are valid and enforceable covenants that run with the land under North Dakota law. In support, Caliber cites provisions in its agreements in which TUSA: (1) commits to providing Caliber with minimum revenues and (2) dedicates to Caliber rights in oil, gas, and mineral leases and interests in various wells. Caliber further notes that the parties’ agreements state that the dedications are covenants that run with the land. And if that weren’t enough, Caliber cites to four “Memoranda of Midstream Services Agreement” that the parties recorded in land offices where the burdened property is located.

Then, on October 21, 2016, Caliber moved the bankruptcy court to lift the automatic stay so it could continue to prosecute the North Dakota declaratory judgment action (which TUSA had since removed to the federal district court, and which the district court stayed in light of TUSA’s bankruptcy proceeding). 

The parties’ briefing on these matters focused on the level of prejudice that TUSA would suffer by litigating in North Dakota. In short, Caliber asserted that TUSA would suffer no prejudice, as the parties “irrevocably submit[ted]” to the jurisdiction of North Dakota courts through forum selection clauses in their agreements. Caliber further argued that resolution of the parties’ dispute by a North Dakota court would not interfere with TUSA’s bankruptcy proceeding, and, moreover, that the bankruptcy court was required to — or should — abstain from resolving the pure state law issue that it raises. TUSA, on the other hand, contended that litigating in North Dakota would prejudice the administration of its bankruptcy case: The parties’ dispute relates to TUSA’s motion to reject certain of its agreements with Caliber, which, in turn, is central to its reorganization efforts. Thus, the dispute with Caliber, TUSA argued, is a core bankruptcy matter properly resolved by the bankruptcy court. 

At a hearing conducted on November 21, 2016, the bankruptcy court granted Caliber’s motion to lift the automatic stay. It also granted Caliber’s motion to dismiss TUSA’s adversary proceeding. In so ruling, the court stressed that the issue implicated by the parties’ competing declaratory judgment actions “really should be decided” by a North Dakota court. The court further emphasized the parties’ forum selection clause and Third Circuit precedent that favors enforcement of such provisions in non-core matters. On this point, the court stated that the parties’ declaratory judgment actions raise only the state law question of whether their agreements contain covenants that run with the land or equitable servitudes. They do not concern “federal or bankruptcy law.” The court thus rejected TUSA’s efforts to tie its adversary proceeding to its motion to reject certain of its agreements with Caliber. And, having concluded that the matter was a non-core question of state law, the court abstained from deciding it.

The bankruptcy court’s decision to lift the stay in TUSA may be a harbinger for future disputes over the rejection of gas-gathering contracts in oil and gas bankruptcies. Recent criticism aimed at bankruptcy courts asked to opine on arcane questions of state property law in foreign jurisdictions may prompt more bankruptcy judges to defer to their state court brethren on these questions, if and where possible. In addition to authorizing relief from the stay in cases like TUSA, bankruptcy courts may seek to certify thorny questions regarding covenants running with the land to state courts, where certification procedures permit. But that impulse highlights a catch-22: The certification procedures in a number of important oil- and gas-producing states (including Texas and Pennsylvania) do not allow bankruptcy courts to certify questions of law to their highest courts. Thus, bankruptcy courts may be forced to rule on state-law property issues to facilitate appeals to federal district courts, which can certify questions to most states’ supreme courts. Given the various dynamics at work, it will be interesting to see if the TUSA decision signals a new phase in gas-gathering rejection disputes or is a sui generis circumstance. Only time and oil prices will tell.  

To read the previous installment in this series, please see “R&I Update: Hot Topics in Oil and Gas Restructurings, Volume 1” and “R&I Update: Hot Topics in Oil and Gas Restructurings, Volume 2, R&I Update: Hot Topics in Oil and Gas Restructurings, Volume 3, and R&I Update: Hot Topics in Oil and Gas Restructurings, Volume 4.”

McGuireWoods’ Restructuring and Insolvency Department has 36 lawyers working from most of the firm’s 21 offices, including in New York, Texas, and London. They have significant experience in energy insolvencies.