Reed Smith Client Alerts

We recently reported on Delaware Judge Christopher Sontchi’s decision in the Extraction bankruptcy to permit the rejection of midstream gathering agreements.1 Fellow Delaware Judge Karen Owens followed Extraction in the Southland Royalty decision issued November 13, 2020.2 Judge Owens determined that Southland Royalty Company, LLC (“Southland”), an E&P operator with assets primarily in Wyoming, could reject the gas gathering agreement and sell its assets free and clear of the agreement. But the Delaware court denied the debtor’s central economic request to force the midstream company to flow the debtor’s gas under another gathering agreement with the same midstream company (that the debtor did not seek to reject) and to sever the minimum volume commitment (“MVC”) from the agreement.

Authors: Omar J. Alaniz Gary C. Johnson Michael P. Cooley Keith M. Aurzada Ramy A. Morad

Golden pipes going to oil refinery

Background

Southland and Wamsutter LLC, an affiliate of The Williams Companies, Inc. (“Wamsutter”) were parties to two midstream agreements, the L60 and L63 agreements. After the parties had entered into the L60 agreement, Southland enhanced its drilling program to include horizontal wells that required an expansion and update to the Wamsutter gathering system. To accommodate this expansion and update, the parties entered into the L63 agreement. The area covered by the L63 agreement was located within the area covered by the L60 agreement, but it served different receipt points. Both agreements included MVCs, but the L63 agreement contained the more onerous of the two, with an estimated net present value between $413 and 568 million.

Southland filed chapter 11 on January 27, 2020 after Wamsutter made a $6.9 million adequate assurance request on the cash-strained operator. Citibank is the debtor’s lead administrative agent to a lending syndicate with $540 million outstanding as of the bankruptcy. The bank agreed to a sale process that the debtor kicked off shortly after the filing. But the sale process came to a grinding halt when it became clear that the parties had widely divergent views on go-forward gathering and processing terms for Wamsutter’s services, thereby dashing away the chapter 11 parties’ hope of a speedy sale.

Southland subsequently initiated an adversary proceeding against Wamsutter seeking a declaration from the bankruptcy court that it could (i) reject the L63 agreement, (ii) sell its assets free and clear of Wamsutter’s interest under section 363(f) of the Bankruptcy Code, (iii) sever out the terms of the minimum volume commitment (“MVC”) under the L63 agreement under a variety of theories, and (iv) unilaterally transfer all gathering and processing services from the L63 agreement to the L60 agreement, thereby avoiding the L63 MVC obligations.

Bankruptcy case law momentum favored Wamsutter at the time of the Southland trial. Bankruptcy courts in Badlands3 and Alta Mesa4 had concluded that the midstream agreements in those cases contained covenants that ran with the land and created real property interests, or real covenants, that could not be rejected in a bankruptcy case. These two courts had reached an outcome different from the Sabine5 case, where the New York court held that the covenant running with the land language in the agreement did not create real property interests. The pendulum swung even further with the Delaware court’s decision in Extraction, which the court issued after the Southland trial concluded but before Judge Owens’ decision. Indeed, in Judge Owens’ decision in Southland, she acknowledged the case law split.6