The Extraction opinions stand in contrast to the opinions issued by the Bankruptcy Court for the Southern District of Texas and the Bankruptcy Court for the District of Colorado in Alta Mesa Holdings LP v. Kingfisher Midstream LLC (In re Alta Mesa Resources)2 and Monarch Midstream, LLC v. Badlands Prod. Co. (In re Badlands Energy, Inc.),3 respectively, in which those courts found that the midstream agreements created “covenants running with the land,” and therefore that they were real property interests that could not be rejected as executory contracts under section 365 of the Code.
Factual Background
On June 14, 2020, Extraction and its affiliates filed chapter 11 in Delaware. On August 10, 2020, Extraction sought the Court’s authorization to reject certain of its midstream gathering agreements (the Commercial Agreements)4 with Elevation Midstream, LLC (Elevation). On September 4, 2020, Extraction initiated an adversary proceeding against Elevation, seeking a declaratory judgment that the Commercial Agreements do not create covenants running with the land such that they may be rejected as executory contracts under section 365 of the Code.
Court’s Analysis
Judge Sontchi found that not all three elements required to form a real property covenant under Colorado law were satisfied. “To create a covenant running with the land, the parties must intend to create a covenant running with the land and the covenant must touch and concern the land with which it runs.” Extraction Oil & Gas, Inc. v. Elevation Midstream, LLC, 2020 Bankr. LEXIS 2855 *43 (Bankr. D. Del. Oct. 14, 2020). “In addition … there must also be privity of estate between the original covenanting parties at the time of the covenant’s creation.” Id.
The Court conducted a covenant-by-covenant analysis regarding whether each covenant runs with the land. “In order to run with the land, each covenant must meet the elements required of real covenants. That one covenant meets these elements and runs with the land does not mean that all covenants contained in the contract run with the land, even if they do not themselves meet each of the elements.”5 Id. at *44. Thus, “[i]f only one covenant runs with the land, that covenant is enforceable against the contracting party through privity of contract, and it is also enforceable against successors-to-title in land with which the covenant is intended to run through privity of estate; the remaining covenants that do not run with the land are enforceable only against parties bound by privity of contract.” Id. at *46 (internal citations omitted).
(1) Intent to Create a Covenant Running with the Land
As to the first element, the Court found that “the only covenants in the Commercial Agreements that the parties clearly intended to run with the land” were those pertaining to dedication and delivery. Id. “To create covenants running with the land, the contracting parties must express an intent to create covenants running with the land in clear and unambiguous terms.” Id.
Because the Commercial Agreements expressly provided that “[t]he Dedication and Delivery Obligation ... are not merely contract rights but are covenants running with (and touching and concerning) all of the Dedicated Interests and, in addition, are binding upon the successors and assigns of Dedicated Interests,” the Court found that the parties intended the covenants to run with Extraction’s mineral estates. Id. at. *47. Conversely, because the parties did not expressly identify other covenants to run with the land, the Court found that the intent element was not satisfied with respect to the other covenants in the Commercial Agreements. Id.
(2) Privity of Estate
As to the second element, the Court noted “[t]he Colorado Supreme Court requires privity of estate between the covenanting parties at the time of the covenant’s creation in order for a covenant to run with the land.” Id. at *48 (internal citations omitted). “Privity of estate requires that any covenant that allegedly runs with the land be accompanied by a contemporaneous conveyance of some interest in the land with which the covenant runs.” Id. at *54. Further, “[t]he conveyance contemplated by privity of estate cannot be satisfied by the purported covenant running with the land itself; there must be a conveyance of an independent real property interest.” Id. (internal citations omitted).
Focusing its analysis on the mineral estate, the Court found privity of estate was not satisfied because the Commercial Agreements did not convey to Elevation any interest in Extraction’s mineral estates. Although Elevation contended that Extraction’s conveyance of easements, rights -of-way and other surface rights satisfied the privity of estate requirement, the Court found that, because the “surface estate and mineral estate, once severed, are separate and distinct estates in real property … [c]onveyances of easements or rights-of-way across the surface estate are interests in the surface estate that cannot satisfy the privity of estate respecting a mineral estate”. Id. at *56.
Elevation also argued that the Commercial Agreements’ dedication and commitments satisfy the privity of estate requirement. The Court disagreed, however, and held that “[d]edications and commitments to the performance of the agreements are not conveyances of real property interests, and they do not satisfy privity of estate.” Id. at *58-59 (internal citations omitted). Similar to the Sabine6 court’s reasoning, the Court found that dedications simply “identify the particular [produced minerals or produced water] within a particular area that is subject to the parties’ contractual obligations.” Id. at *59. “The Commercial Agreements’ dedications and commitments were not intended to convey anything implicated thereunder; Extraction still owns any real property interest that was dedicated and committed to the performance of the Commercial Agreements.” Id. at *61. Thus, “the original covenanting parties to the Commercial Agreements were not in privity of estate at the time of the creation of the covenants created therein, and the Commercial Agreements contain no covenants that run with the land.” Id. at *63 (internal citations omitted).
(3) Touch and Concern
In order for the “touch and concern” element to be met, “the particular covenant intended to run with the land must closely relate to the estate in real property with which it is intended to run (here, Extraction’s mineral estate), its use, or enjoyment.” Id. (internal citations omitted). The Court noted that the touch and concern analysis was an objective one that analyzed the covenant’s effect upon the land and did not turn on party intent or word choice. Id. at *64.
Conducting a covenant-by-covenant analysis of the covenants contained in the Commercial Agreements, the Court concluded the following:
- The “Drilling Commitment” touched and concerned Extraction’s mineral estates because “it closely related to the land by altering the parties’ legal relationship thereto.” Id. at *69. According to the Court, the Drilling Commitment “directly affects the parties’ physical use and enjoyment of the land because the obligation to drill a certain number of wells on a certain schedule affects Extraction’s drilling and development of its mineral estates.” Id. at *70.
- Extraction’s dedications and commitments were made “to the performance of the Commercial Agreements,” pursuant to which, “Elevation committed to service Extraction’s produced minerals and water in exchange for a contractual fee.” Id. at *71. According to the Court, “[t]he dedications and commitments do not touch and concern Extraction’s mineral estates because the obligations and services for which they were made concern only personal property and do not closely relate to real property, specifically Extraction’s mineral estates.” Id. at *72. Elevation’s provision of services under the Commercial Agreements “did not affect the use or enjoyment of the minerals or water in place, or the use of the mineral estate, but instead minerals that have been severed from the mineral estate and water that has been reduced to possession and that now constitutes the personal property of Extraction, as a merchant in these commodities. As a result, the covenants … do not benefit Extraction in its capacity as a landowner but benefit and affect Extraction’s use of its personal property (i.e., its produced minerals and produced water).” Id. at *78.
- Extraction’s obligation to deliver its extracted minerals to Elevation “only touch[ed] and concern[ed] personal property, Extraction’s produced hydrocarbons and water.” Id. at *81. “Because the Delivery Obligation does not touch and concern Extraction’s mineral estates, it cannot be a covenant that runs with the land as a matter of Colorado law.” Id. at *84.
- Assignment provisions contained in the Commercial Agreements did not touch and concern Extraction’s mineral estate because they did not closely relate to or affect the use or enjoyment of the mineral estates; rather, they relate solely to contractual rights and obligations. Id. at *84-85.
- Elevation’s obligation to construct and operate the midstream facilities to service produced gas, oil and water also did not touch and concern Extraction’s mineral states because “the midstream facilities benefitted Extraction as owner of personal - and not real - property.” Id. at *86. Further, the midstream facilities did not limit Extraction’s rights to produce or develop its mineral estates in its sole discretion. Dismissing Elevation’s contention that the midstream facilities increased the value underlying the real property, the Court concluded that such an incidental increase in value did “not closely relate to the mineral estates and, therefore, cannot satisfy touch and concern, as its primary effect is on the use and enjoyment of personal property and not real property.” Id. at *78.
- The easements and rights-of-way conveyed to Elevation pursuant to the Commercial Agreements “are interests in the surface estate, which is a separate and distinct estate in real property from Extraction’s mineral estates. As a result … they do not closely relate to or affect the use or enjoyment of Extraction’s mineral estates because they are, by definition, right in the use of a different estate in land.” Id. at *94. Thus, the easements and rights-of-way did not touch and concern Extraction’s mineral estates and cannot be covenants that run with the land.
Because no covenant in the Commercial Agreements met all three elements necessary for a covenant to run with the land, the Commercial Agreements were subject to rejection as an executory contract under section 365 of the Code.
Practical Considerations
In view of the foregoing, midstream service providers would be wise to reconsider the ways in which they seek to “bulletproof” their commercial agreements with their producer counterparties. Insofar as they are able to renegotiate their existing midstream agreements, midstream companies might consider employing the following strategies:
- First, to satisfy the “touch and concern” element of the analysis, midstream companies might consider introducing a “drilling commitment” obligation that requires the producer to drill a certain number of wells on a certain schedule.
- Second, midstream companies might consider negotiating for the receipt of an interest in the underlying minerals or the underlying oil and gas leases of the producer, in the form of a non-participating royalty interest in the minerals or an overriding royalty interest in the oil and gas leases, either of which would create a non-expense bearing real property interest in the mineral estate, in an effort to satisfy the “privity of estate” prong of the analysis.
- Finally, the gathering agreements should include an express statement identifying the particular covenants that are intended to “run with the land” and that inure to the benefit and burden of the parties and their respective successors and assigns, in order to satisfy the intent element of the analysis.
- See, Extraction Oil & Gas, Inc. v. Elevation Midstream, LLC (In re Extraction Oil & Gas, Inc.), 2020 Bankr. LEXIS 2855, Adv. Proc. No. 20-50839 (Bankr. D. Del. Oct. 14, 2020); Extraction Oil & Gas, Inc. v. Platte River Midstream, LLC (In re Extraction Oil & Gas, Inc.), 2020 Bankr. LEXIS 2853, Adv. Pro. No. 20-50833 (Bankr. D. Del. Oct. 14, 2020); Extraction Oil & Gas, Inc. v. Grand Mesa Pipeline, LLC (In re Extraction Oil & Gas, Inc.), 2020 Bankr. LEXIS 2854, Adv. Pro. No. 20-50816 (Bankr. D. Del. Oct. 14, 2020). While Chief Judge Sontchi issued three separate Findings of Fact and Conclusions of Law, the facts and conclusions across all three rulings are substantially similar. However, because the ruling in Extraction Oil & Gas, Inc. v. Elevation Midstream, LLC contains the Court’s most in-depth discussion of the issues presented in these proceedings, the discussion contained herein is in reference to that specific ruling.
- 613 B.R. 90 (Bankr. S.D. Tex. 2019).
- 608 B.R. 854 (Bankr. D. Colo. 2019).
- The Commercial Agreements include: (1) Gas Gathering and Compression Agreement; (2) Crude Oil Gathering and Stabilization Agreement; and (3) Producer Water Commercial Agreement.
- The covenants across the Commercial Agreements analyzed by the Court include: (1) drilling commitments; (2) dedications; (3) delivery obligations; (4) facilities obligations; (5) fixed fee provisions; (6) exclusivity provisions; and (7) easements and rights-of-way.
- See, Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC (In re Sabine Oil & Gas Corp.), 550 Bankr. S.D.N.Y. 2016).
Client Alert 2020-577
