Texas Bankruptcy Ruling Reinforces Dedication Clauses in Gas-Gathering Agreements

January 10, 2020

A Texas bankruptcy court recently ruled that dedication clauses in gas-gathering agreements run with the land and cannot be rejected by a debtor. That decision, In re Alta Mesa Resources, Inc., affirms an industrywide practice that faced an uncertain future following the ruling in In re Sabine Oil & Gas Corp. from the Southern District of New York, which was upheld by the 2nd U.S. Circuit Court of Appeals in 2018.

Contract or Covenant?

Midstream companies make significant up-front infrastructure investments to transport natural gas from producers to buyers, generating revenue from fees guaranteed by dedication clauses in gas-gathering agreements. These clauses are typically styled as covenants that run with the underlying well or acreage, which were previously viewed as generally preventing debtors in bankruptcy from rejecting the obligation under 11 U.S.C. § 365. But when a N.Y. bankruptcy court held that a dedication clause failed to create a covenant under Texas law in Sabine — the first time a court had decided the issue in an adversary proceeding — it pushed parties to evaluate the need to renegotiate contracts in advance of potential bankruptcy filings by contract counterparties.

A Return to Normalcy With Alta Mesa

Declining to follow Sabine, the Alta Mesa court held that dedication clauses in two agreements met the requirements for a covenant running with the land under Oklahoma law. The court described the debtor producers’ leasehold interests as rights “to facilitate the capture of hydrocarbons” and held that the dedication clauses “touched and concerned” these rights because they dedicated all the produced hydrocarbons for delivery to the midstream provider, were required to be recorded as well as affirmed by any transferee, established fixed gathering fees and created surface easements for the provider’s pipelines.

The Alta Mesa court further held that the easements created privity of estate because they were “a crucial component in an oil and gas lease” and that the recording and affirmation requirements, along with express language designating the clauses as covenants, demonstrated an intent for them to be binding on successors. Critically, the court observed that the requirements for a covenant under Oklahoma law mirror Texas law, thus calling into further question the long-term precedential effect of Sabine. Alta Mesa follows a September 2019 Colorado ruling, In re Badlands Production Co., which held that dedication clauses are covenants under Utah law.

Future Implications

Alta Mesa and In re Badlands Production Co. demonstrate a judicial trend not to follow the approach to the treatment of gathering agreements subject to bankruptcy proceedings established in Sabine. Given the current split of authority, however, risk remains inherent to the interests of non-debtor parties to gathering agreements in instances where counterparties become subject to bankruptcy proceedings.