Locke Lord QuickStudy: We Are Off and Running (With the Land) Again

Locke Lord LLP
December 23, 2019

On December 20, 2019, Judge Marvin Isgur of the United States Bankruptcy Court for the Southern District of Texas became the second court this year to limit the reasoning of In re Sabine Oil & Gas Corp., 550 B.R. 59 (Bankr. S.D.N.Y. 2016) in holding that two midstream gathering agreements satisfied the legal requirements to run with the land and accordingly were not subject to rejection under Section 365 of the Bankruptcy Code.  Contrary to Sabine, in Alta Mesa Holdings, LP v. Kingfisher Midstream, LLC, No. 19-03609, slip op. at 1 (Bankr. S.D. Tex. Dec. 20, 2019), Judge Isgur refused Alta Mesa Holdings, LP and Oklahoma Energy Acquisitions, LP’s (collectively, “Alta Mesa”) attempt to reject two midstream gathering agreements with Kingfisher Midstream, LLC (“Kingfisher”) because the agreements run with the land.  The two agreements—a gas gathering agreement and a crude oil gathering agreement (collectively, the “Gathering Agreements”)—have essentially identical terms, and six covenants in the Gathering Agreements were central to the dispute.  The first four covenants—including (1) Alta Mesa’s dedication of all its interests within a geographic area, (2) a provision declaring that the Gathering Agreements are “covenants running with the land” that require recordation and condition any assignment on the express assumption of the assignor’s obligations, (3) Alta Mesa’s promise to convey surface easements to Kingfisher for the purpose of installing, operating and maintaining its gathering system, and (4) a provision for fixed gathering fees—were contained in the original Gathering Agreements.  Alta Mesa, slip op. at 4, 16.  Two additional covenants were introduced by an amendment to each of the Gathering Agreements: (5) a reduction to the fixed gathering fees, and (6) a provision granting Kingfisher the exclusive right to transport oil and gas produced from Alta Mesa’s interests, which the parties intended to “be a conveyance of a portion of [Alta Mesa’s] real property interests.”  Id. at 4–5, 16–17.

Like Sabine and In re Badlands Production Co., No. 17-17465, 2019 WL 5549463 (Bankr. D. Colo. Sept. 30, 2019)—the other court to reject Sabine’s reasoning this year—this court’s determination turned on whether the Gathering Agreements were covenants running with the land.  Under Oklahoma law, a covenant runs with the land if (1) it touches and concerns the real property at issue, (2) there is privity of estate, and (3) the original parties intended to bind their successors.  Id. at 10.  The Alta Mesa court held that each element was satisfied and granted summary judgment to Kingfisher.

First, the court held that the Gathering Agreements touched and concerned Alta Mesa’s leasehold interest.  In Oklahoma, the touchstone for a covenant to touch and concern the real property at issue is a “logical connection” between the benefit derived from enforcing the covenant and the real property.  In other words, “[i]f the value of the owner’s interest in the land itself is affected by the covenant, either positively or negatively, the covenant touches and concerns the land.”  Id. at 14.  After concluding that Alta Mesa’s real property at issue included its oil and gas leases and its implied surface easement to explore and produce the mineral estate, the court held that the related benefits and burdens from Kingfisher’s gathering system were logically connected to those property rights.  The gathering system’s installation benefited the leases by facilitating the collection of produced reserves, thus increasing the value of the leases, and the conveyed easement to operate the gathering system burdened the leases by diminishing Alta Mesa’s possessory interest in the leases.  Id. at 17.  The court’s reasoning notably distinguished Sabine, which focused its inquiry on a fee mineral estate instead of an oil and gas leasehold interest, and rejected Sabine’s distinction between covenants concerning the surface or mineral estate by finding that a surface easement may directly relate to the exploration of mineral reserves.

Second, the Alta Mesa court concluded that privity of estate—specifically horizontal privity—existed between the parties.  Horizontal privity exists when the covenant at issue is formed in connection with a conveyance of real property, and, while the parties disputed whether horizontal privity remains a requirement under Oklahoma law, the court held that it was present in this case to the extent it was required.  Id. at 21.  According to the court, “[t]he conveyance of the easements to Kingfisher is enough to show horizontal privity” with respect to the Gathering Agreements because a surface easement is a crucial component of an oil and gas lease.  Id.  The court again rejected Sabine’s distinction between covenants affecting the surface estate and the mineral estate to reach this conclusion.

Finally, the court held that the original parties to the Gathering Agreements intended for the covenants at issue to bind their successors.  Oklahoma courts determine intent by examining the “entire agreement construed as a whole,” and the court identified several provisions to support the necessary intent.  Id. at 22.  The Gathering Agreements included a declaration that their provisions are “a covenant running with the land,” required their dedication provisions to be recorded for notice to subsequent purchasers, and required each party to cause any purported assignee to expressly assume its obligations under the Gathering Agreements.  According to the court, “[t]hese provisions show a clear intent to bind successors to the covenants” of the Gathering Agreements.  Id.

Alta Mesa provides additional support for midstream companies in the event their counterparty enters into bankruptcy proceedings and attempts to avoid their agreements under Section 365 of the Bankruptcy Code.  Although Alta Mesa was decided in a different jurisdiction than Sabine (and Badlands), its reasoning should assist midstream litigants with distinguishing Sabine and should provide additional guidance for practitioners to draft midstream gathering agreements going forward.

For further guidance, please see our March 11, 2016 Locke Lord QuickStudy, “Running with the Land,” by Philip Eisenberg.