Oil and Gas Matters
In the first purchaser protection matchup, Oklahoma leads Texas 1-0
By Bernard F. Clark Jr. and Ellen Conley
After the decline of oil prices in the 1980s, oil and gas producing states, including Oklahoma and Texas, passed laws to protect the oil and gas interests of their royalty owners and producers by securing their rights to amounts owed for their oil and gas produced and sold.1 The effectiveness of these “first purchaser statutes” was first challenged three decades later when SemGroup L.P., a large pipeline and oil marketer, along with certain of its subsidiaries, including SemCrude, L.P. (collectively, “SemGroup”), filed for bankruptcy in 2008, reporting $2.4 billion in losses trading on Nymex and over-the-counter future contracts.2 Texas and Oklahoma producers, as creditors of SemGroup, relied on each state’s first purchaser statutes and asserted that they were secured interest holders against SemGroup’s bankruptcy estate.3 SemGroup’s secured banks, its downstream purchasers, and ultimately, the bankruptcy judge, however, took a different view.4 The court held that the Texas and Oklahoma statutes were ineffective to prime the banks’ liens and the producers collected pennies, if anything, on what they were owed.5
Oklahoma’s Legislature responded by rewriting its first purchaser statute to address the defects highlighted by the SemCrude decision.6 To date, Texas’ Legislature has not.7 A recent bankruptcy case has recognized and rewarded Oklahoma for its efforts, while affirming that Texas has yet to adequately protect its producers and royalty owners in cases where the first purchaser of their oil and gas is organized in a state other than Texas.8
In the first match since SemCrude, the score is Oklahoma 1, Texas 0.
Texas’ First Purchaser Statute
Texas added Section 9.343 (formerly Section 9.319), the Texas First Purchaser Statute, to the Texas Business and Commerce Code in 1983 as a non-standard provision to the Uniform Commercial Code (“UCC”) of Texas, which provides an interest owner, as secured party, a security interest to secure the payment obligations of a first purchaser, who has purchased such interest owner’s share of production.9 The security interest covers oil and gas production in the first purchaser’s possession and the identifiable sales proceeds owned, received, or due to the first purchaser.10 To facilitate the protection of Texas producers and other interest owners, the statute provides that the security interest is automatically perfected without the filing of a financing statement or any other action.11
Unfortunately for Texas interest owners, the court in SemCrude found that the jurisdiction where the first purchaser, as debtor, is located, rather than where the oil and gas, as collateral, is produced, governs the applicable UCC; therefore, Texas interest owners could not take advantage of Texas’ non-standard provision when the debtor is organized outside of Texas.12 Because none of the debtors were “located” in Texas, the court in SemCrude held that the Texas First Purchaser Statute was not applicable, but rather, depending upon the relevant debtor in that case, that Delaware law or Oklahoma law governed perfection.13
Neither Delaware nor Oklahoma’s UCC contained an automatic perfection statute to protect producers’ claims.14 The court held that the Texas producers were required under the applicable state’s UCC to file financing statements in the appropriate jurisdictions to perfect their security interests.15 The Texas producers had not filed financing statements, presumably relying on the protections of the Texas First Purchaser Statute, and their claims were classified as unsecured and subordinate to the claims of the secured banks against the SemGroup estate.16
Oklahoma’s First Purchaser Statute
Oklahoma passed the Oil and Gas Owners’ Lien Act of 1988 in response to pressure from Oklahoma mineral interest owners and working interest owners to guarantee a “right to payment” for such owners’ share of the production sold to a first purchaser.17 However, as highlighted in SemCrude, the 1988 Act suffered from two major flaws: (1) as discussed above with respect to the Texas interest owners, a debtor’s “location” determined the governing law and not the state where the oil and gas was produced, and (2) the act expressly provided that the liens created under the 1988 Act did not impair the priorities of other secured creditors under Oklahoma’s UCC.18 Accordingly, the court in SemCrude held, in part, that the security interests held by SemGroup’s secured banks had priority over any claims under the 1988 Act.19
Following the decision in SemCrude, Oklahoma passed the Oil and Gas Owners’ Lien Act of 2010 to address the deficiencies of the 1988 Act.20 To resolve the situs issue, under the 2010 Act, each interest owner is granted an oil and gas lien (rather than a security interest) “to the extent of the interest owner’s interest in oil and gas rights” to secure the first purchaser’s obligations to pay and the lien “is granted and shall exist as part of and incident to the ownership of oil and gas rights” in Oklahoma.21 The 2010 Act replaces the security interest as a claim against personal property, which would be governed by the UCC, with a lien tied to the interest owner’s real property interest in oil and gas rights.22 “Oil and gas rights” are defined in the 2010 Act as any right, title, or interest in and to produced oil and gas, proceeds from the sale thereof, an oil and gas lease, a pooling order, or an agreement to sell production.23 Unlike its predecessor statute, this lien is a part of and appurtenant to the ownership of “oil and gas rights” under Oklahoma real property law.24 Finally, the 2010 Act provides that the governing law is the law of the state where the oil and gas rights, and not the debtor, are located.25
To resolve the prior act’s issue regarding competing liens, the 2010 Act provides that an interest owner’s oil and gas lien takes priority over any other security interest or lien (other than a “permitted lien”26), creating an automatic super-priority without requiring the filing of a financing statement or any other further action.27
Enforceability Under First River
The effectiveness of the 2010 Act was tested last year in In re First River Energy, LLC, and Oklahoma’s efforts paid off.28 First River Energy, LLC, a Delaware limited liability company, owed Texas and Oklahoma producers for oil and gas purchased pre-bankruptcy.29 After First River filed for bankruptcy, Texas producers asserted that they had secured claims for amounts owed under the Texas First Purchaser Statute, while Oklahoma producers asserted that they held a first, prior, and automatically perfected lien pursuant to the 2010 Act.30
Unfortunately for the Texas producers, the court reaffirmed the SemCrude decision and found that the Delaware UCC would apply because First River was formed in Delaware; therefore, the Texas producers could not benefit from the Texas First Purchaser Statute.31 As for the Oklahoma producers’ claims, however, the court noted that this was a case of first impression regarding the application of the 2010 Act among competing creditors.32 The court held that the 2010 Act created a superior lien right for the benefit of the Oklahoma producers so long as the Oklahoma producers could demonstrate that they held “oil and gas rights” in accordance with the act.33 Because the issue before the court was raised under First River’s banks’ summary judgment motion, not all facts necessary to prove the Oklahoma producers’ claims had been proffered at the time of the court’s ruling denying the lenders’ summary judgment motion.34
Could Texas Try to Even the Score?
In SemCrude, the Texas and Oklahoma producers’ claims were found to be governed by Delaware’s or Oklahoma’s UCC and not protected by statutes passed in response to energy bankruptcies of the 1980s.35 Oklahoma responded by implementing the 2010 Act, successfully circumventing the court’s reasoning in SemCrude.36
If Texas had adopted a statute similar to the 2010 Act, it is likely that the Texas producers’ claims would have triumphed in First River Energy. The Texas First Purchaser Statute was designed in the 1980s to protect Texas interest owners, stiffed by first purchasers filing for bankruptcy. Because of the precedent set in SemCrude and recently affirmed in First River Energy, however, Texas interest owners’ security interests will likely continue to be unsecured and subordinate to other perfected security interests if interest owners continue to solely rely on their state-given “protection” in cases where the first purchaser is organized or incorporated outside of Texas. On the other side, the 2010 Act preserves and protects the rights of Oklahoma interest owners to receive payments owed them for their share of oil and gas production, while upholding the essential purpose of the initial 1988 Act. A similar statute in Texas could offer Texas interest owners a similar safeguard. TBJ
The authors would like to thank Grant Armentor, a second-year law student at South Texas College of Law Houston, for his assistance with this article.
BERNARD F. CLARK JR. is the co-chair of Haynes and Boone’s Energy Practice Group representing clients in the oil and gas industry, including banks, private capital providers and producers in secured and unsecured credit transactions and equity investments; producers, joint venturers and midstream companies in oil and gas exploration, production and development agreements, and producing property and midstream acquisitions, joint developments and partnerships; and energy related litigation and bankruptcies. He is the author of Oil Capital: The History of American Oil, Wildcatters, Independents and Their Bankers.
ELLEN CONLEY is an associate in the Energy, Power and Natural Resources Practice Group in the Houston office of Haynes and Boone. She handles energy finance matters, as well as the acquisition and disposition of oil and gas properties. Conley represents lenders and borrowers in secured reserved-base credit facilities and has experience with a variety of transactions, including ISDA master agreements and schedules and oil and gas purchase and sale agreements.