chapter 7 common issues in oil and gas bankruptcy - energy & mineral law … · 2018-06-29 ·...

Chapter 7

Common Issues in Oil and Gas Bankruptcy

Mitchell E. Ayer1

Thompson & Knight LLPHouston, Texas

Synopsis§ 7.01. Operating Agreements (OA) Are Executory Contracts.................242

[1] — Contractual Lien Rights ............................................................243[2] — The Twilight Zone .....................................................................243 [3] — Where the Debtor Is a Non-operator ........................................243[4] — Where the Debtor Is Operator ...................................................245[5] — Where the Debtor Later Rejects the Operating Agreement (OA) ........................................................................245 [6] — Where the Debtor Seeks to Sell the Property ...........................246[7] — Operator’s Liens ........................................................................246[8] — Practice Tip ................................................................................247[9] — The Automatic Stay Bars Effectuations of Offset Rights, But Not Recoupment ....................................248

§ 7.02. Oil and Gas Leases May or May Not Be “Executory Contracts” or “Unexpired Leases” ..................................................248 § 7.03. Reclamation Rights ............................................................................249 [1] — Practice Tip ................................................................................250 [2] — Reclamation Rights ....................................................................250 [3] — Practice Tip ................................................................................253§ 7.04. Royalty Claims Do Not Come First — or If They Do, Only to a Limited Extent ...................................................................253

1 MitchellAyerisapartnerwiththelawfirmofThompson&KnightLLPinHouston,Texas.Hispracticeincludesdisputeswithroyaltyowners,workinginterestowners,andavarietyofoilandgasbankruptcymatters.HerepresentedDavisPetroleumCorp.inapre-packagedbankruptcy thatwasconfirmedwithin96hoursoffiling thebankruptcypetition.Mr.AyerisBoardCertifiedinOil,GasandMineralLawbytheTexasBoardofLegalSpecializationandBoardCertifiedinBusinessBankruptcyLawbytheAmericanBoardofCertification.HehasservedaspastchairoftheHoustonBarAssociationOil,Gas&MineralLawSection.HeisamemberoftheAmericanBankruptcyInstituteandAmericanInnsofCourt.Additionally,Mr.AyerhasbeennamedtoTexasSuperLawyersintheBankruptcy&Creditor/DebtorRightsandEnergy&NaturalResourcesareas,andistheauthorofnumerouspublicationsandpresentations.HehasaB.A.fromWittenbergUniversity,anM.B.A.fromClevelandStateUniversity,andaJ.D.magna cum laude from theUniversityofHoustonLawCenter(firstinclass).HeservedonboardthelegendaryCoastGuardCutterBibbfrom1971through1974.

CITE AS34 Energy & Min. L. Inst. 7 (2013)

ENERGY & MINERAL LAW INSTITUTE

240

SYNOPSIS

[1]—AreUnpaidRoyaltyOwnersUnsecuredCreditors? .......... 253 [2]—TheRoyaltyOwnerTypicallyIsOwedaContractual Obligation Only .................................................................253[3] — The “Termination for Non-payment” Clause in Bankruptcy ....................................................................254[4] — A Review of Statutory Efforts to Protect Royalty Owners .................................................................255

[a] — In the Case of Private Parties, § 9.343 of the Texas UCC Creates a Lien in Favor of Royalty OwnersandWorkingInterestOwners ....................256[b]—RoyaltyLiensAreStatutoryandMayBe AvoidedUnder§545oftheCode ...........................257 [c]—ProceedsofProduction ............................................260 [d]—ConflictBetweenRoyaltyOwners’Lien andAccountsReceivableFinancing Institution..................................................................260 [e] — Royalty Liens Are Not in Competition with Mineral Contractor Liens on the Same Property ............................................... 261[f]—TheMineralContractorLiensandRoyaltyLiens Attach to Different Collateral ..................................262[g] — Texas Statute Creates a Lien in Favor of the StatetoSecuredUnpaidRoyaltyOwed to the State of Texas .................................................264[h]—LouisianaStatuteGivesUnpaidRoyalty Owners the Right to Cancel a Lease .......................264[i] — Minerals Management Service (MMS) RegulationsGivetheMMStheRight toCancelaLeaseforUnpaidRoyalty .....................265

§ 7.05. The Conflict Between Avoiding Powers (§ 544(a)(3)) and Equitable Title (§ 541(d)), or the Issue of Recorded Versus Unrecorded Title ..............................................266§ 7.06. The § 541(b)(4) Safe Harbor for Recipients of Farmouts from Debtors in Bankruptcy ......................................269

[1] — When the Debtor Is the Farmor ................................................270 [2] — The Problem with the “Fat Farmout Agreement” ....................273

§ 7.07. The § 541(b)(4)(B) Safe Harbor for Recipients of Production Payments .....................................................................273§ 7.08. In Texas, the Priority of a Mineral Contractor’s Lien Is

Determined by the Date of First Work, All Lien Claimants Share Pro Rata, and the Lien Attaches to the Greater of the

Customer’s Legal or Equitable Title ................................................275

OIL AND GAS BANKRUPTCY

241

SYNOPSIS

[1] — Date of Inception for Purposes of Priority ................................ 276[2]—WheretoFiletheLienAffidavit ............................................... 276

[a] — Where to File a Mineral Contractor’s or Subcontractor’s Lien Against an Outer Continental Shelf (OCS) Lease ........................277[b]—TheReachandExtentofaMineral Contractor’s Lien .............................................................277[c]—HowtoForecloseaMineralContractor’s andSubcontractor’sLien .................................................278[d]—PracticeTip .....................................................................278

[3]—InterplayBetweenMineralLiensandBlanketMortgages: PriorityandAllocation ..............................................................279

[a] — Texas Mineral Subcontractor’s Liens ..............................280[b] — No Constitutional Lien for Mineral Contractors in Texas ...........................................................................282[c]—WhatandWhoseInterestIsAttachedwhen theMineralLienClaimantFilesHisLien? ....................282

[4]—TheConstructionTrustFundStatuteandIts ApplicationtoOilandGas ......................................................283

§ 7.09. Whether the Mineral Lien Contractor Has an Interest in the Proceeds of Production as Cash Collateral ..........................284

[1] — The State Law Problem .............................................................285[2] — The Bankruptcy Law Issue .......................................................285[3] — The Resolution ...........................................................................286[4] — An Alternative Resolution .........................................................286

§ 7.10. The Automatic Stay of § 362 Does Not Prohibit Perfecting a Contractor’s Lien If, Under State Law, a Bona Fide Purchaser for Value Does Not Cut Off the Rights of the Lien Claimant ..........................................................................287

[1] — Whether It Is Necessary to File Suit Post-petition toAvoidtheLienBeingLost ...................................................287

§ 7.11. Whether a Mineral Contractor’s Lien Rights Will Act as a Defense to a Preference Action ..................................288§ 7.12. Plugging and Abandonment Obligations and Environmental and Site Restoration Obligations May (or May Not) Be Administrative Claims .................................................................292§ 7.13. Defenses to Avoidance Actions Found in §§ 546(e), (f) and (g) .......................................................................295

[1] — The Basic Immunization of § 546(e) .........................................296[2]—TheStatutoryDefinitionof“ForwardContract” ......................296[3]—TheBlurredDistinctionBetweenFuture andForwardContracts ..............................................................297


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[4] — The Parenthetical Exception “Other than a CommodityContract” ...............................................................298 [5]—WhatIsaForwardContractMerchant? .................................... 301[6]—WhatIsaSettlementPayment? .................................................302

Bankruptcy lawgivesadebtornumerous tools forwriggling freeofburdensomeobligationswhileretainingvaluablepropertyrights.Theissuesthatcanarisewhenadebtorownsmineralinterestsorisapartytooilandgas contracts, includingoperating agreements, are complex.While theunderlyingpropertyrightsaredefinedbystatelaw,bankruptcylawallowscertainmodificationstothoserights.Adebtor’sactionsthuscaninterferewithotherparties’expectations.Acreditororparty toacontractwithapotentialdebtorinanoilandgasbankruptcyshouldbepreparedfor—andprotect against — some of the harsher potential outcomes. The following isasummaryoftheissuesinatypicaloilandgasbankruptcycase,alongwithpracticepointersforpartiesdealingwithdebtorsorpotentialdebtors.

§ 7.01. Operating Agreements Are Executory Contracts.TheBankruptcyCodeallowsadebtortoassumeorrejectanexecutory

contract.2Anexecutorycontract isgenerallydefinedasacontractunderwhichbothsidesstillhavematerialobligationstoperform.3 If a contract isexecutoryandthedebtordecidesthatitisburdensome,bankruptcylawallowsthedebtortogetoutofitsobligations.Ifthecontractisprofitable,ontheotherhand,thedebtorhastheoptiontoassumeit.

Courtshaveuniformlyheld that anoperatingagreement (OA) is anexecutory contract.4 Because an OA is almost always an executory contract, thedebtormaygenerallychooseeithertoassumeorrejectanOA.Theother

2 11 U.S.C. § 365.3 E.g.,Wilsonv.TXOProductionCorp. (In re Wilson), 69 B.R. 960, 962 (Bankr. N.D. Tex. 1987) (citing In re SunbeltElec.Constructors,Inc.,56B.R.686,688(Bankr.N.D.Ga.1986))(“Anexecutorycontractisoneunderwhichtheparties’obligationstothecontractaresofarunperformedthatthefailureofeithertocompleteperformancewouldconstitutea material breach excusing the performance of the other.”).4 E.g., Wilson, 69 B.R. at 963 (joint operating agreement is an executory contract).

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partytoanOAmustthereforebepreparedforasubstantialinterferencewithits expectations.

[1] — Contractual Lien Rights. Operatorsandnon-operatorsoftenhavecontractuallienrightsfound

intheOA,whichoperateindependentlyofwhethertheOAisassumedorrejected.AcontractuallienunderanOAmay,however,beavoidedifitisnotperfectedbyrecording.Therefore,theOAshouldberecordedpromptlyuponexecution(andwellinadvanceofthebankruptcyfiling)inordertoperfect its contractual liens.

[2] — The Twilight Zone. Whenadebtorfilesforbankruptcy,thedebtorhaseither60days(ina

Chapter7case),untiltheconfirmationofaplan(inacaseunderChapter9,11,12,or13),oruntilthetimespecifiedbythecourttoassumeorrejectexecutory contracts.5This timeperiod iscalled the“TwilightZone.”6 A difficultissueiswhathappenstotheserights,dutiesandobligationsundertheOAduringtheTwilightZonebeforeassumptionorrejection.7

[3] — Where the Debtor Is a Non-operator. Whenthedebtorisanon-operatorunderanOAandhasnotyetdecided

to assume or reject the OA, it is unclear whether the operator can enforce the OAagainstthedebtor.Forexample,cantheoperatorenforceprovisionssuchastheconsentornon-consentelectionduringtheTwilightZone?

Afteradebtorcommencesachapter11proceeding,butbeforeexecutorycontracts are assumedor rejected such contracts remain in existence,enforceable bythedebtorbutnotagainstthedebtor.8Thisseemsonerousandunfair,butthedebtorcannotsimplytakethebenefitswithoutpayingaprice:

5 11U.S.C.§365(d)(1)&(2).6 “Twilight Zone,” Wilson, 69 B.R. at 965-66.7 Id.8 NLRBv.Bildisco&Bildisco,465U.S.513,532 (1984);see also UnitedStatesv.DeweyFreightSystem,31F.3d620,624(8thCir.1994);In re ProvidenceTelevisionLimitedPartnership,113B.R.446,451(Bankr.N.D.Ill.1990)(brokerageagreement);Wilson, 69 B.R. at 965 (joint operating agreement).

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Ifthedebtor-in-possessionelectstocontinuetoreceivebenefitsfromtheotherpartytoanexecutorycontractpendingadecisiontorejectorassumethecontract,thedebtor-in-possessionisobligatedtopayforthereasonablevalueofthoseservices,...which,dependingonthecircumstancesofaparticularcontract,maybewhatisspecifiedin the contract . . . . 9

The WilsoncourtheldthattheOAdoesnotgoverntherightsofthepartiesduringtheTwilightZone.10Thisisaharshand,weargue,improperresult.If, as Bildiscotellsus,thedebtorcanenforcetheOAduringtheTwilightZone,thelogicalcorollaryshouldbethatthedebtorhastopaythefairpriceoftakingthebenefitoftheOA.ThatpriceisallowingtheotherpartiestoalsoenforcetheOAduringthatsameperiod,notwithstandinglanguagetothe contrary in Bildisco.

WesuggestthattheOAcontinuestobeenforceableduringtheTwilightZonebecausetheconsiderationpaid(“reasonablevalueofthoseservices”asdescribedinBildisco,11)forcontinuingtoownandacceptthebenefitsofthepropertyismeasuredbytherightsgrantedbyeachownertotheotherintheformofthetermsoftheOA.Owning,developingandoperatinganoilandgaspropertyisanexpensiveproposition.Itisnotforthefaintofheart.Decisionshavetobemadeexpeditiously,ofteninhours,andtherightsofthepartiesmustbe readily ascertainablewhile important decisions arebeingmade.Theconsiderationgiven,eachownertotheother,isfoundinthe terms of the OA.

It may be, as the Wilson court held, that the non-debtorsmaynotaffirmativelyenforcetheOAduringtheTwilightZoneonapassivedebtor.Butifthedebtorisaffirmativelytakingthebenefitofoperations,thenthepriceofsuchbenefitoughttobetheenforceabilityofthoseobligationsbyallpartiesduringthatsameperiod.

9 Bildisco, 465 U.S. at 531.10 Wilson, 69 B.R. at 966 (“When there is no operating agreement between them, the law ofco-tenancygovernstheirrelationship.ThislawalsogovernstheirrelationshipduringtheTwilight Zone.”).11 Bildisco, 465 U.S. at 531.

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Animportantpointtorememberisthat,atsomepoint,theJOAwillbeassumedorrejected.Ifitisassumed(e.g.,ifthedebtorsellsthepropertyandassignsitsrightsundertheJOA),thenalltheactsofthedebtorduringtheTwilightZonemustbemeasuredbythefactthatthepartiesnowknow,lookingback, that the contractwas in effect during theTwilightZone,notwithstandingBildiscoandWilson.ThefactthatmostpropertiesaresoldwiththeJOAintactmaybethemostimportantconsiderationtothedebtorindecidingwhethertocomplywiththeJOAduringtheTwilightZoneperiod.

[4] — Where the Debtor Is Operator. Likewise,ifthedebtoristheoperatoroftheproperty,canthedebtor

enforcethetermsoftheOAbeforeassumingthecontract?Again,theanswerislikely“yes.”Duringthe“run-up”toassumptionorrejection,thedebtorcanenforcetheOAastotheothernon-operatingownersbuttheconsiderationfordoingsoisthedebtor’sbeingboundbythesametermsoftheOAduringthesameperiod.12

[5] — Where the Debtor Later Rejects the OA. Whathappenstotherightsofthepartiesifthedebtorhascontinuedto

operatethepropertyundertheOAfor30,60or90daysintothechapter11proceedingandthendeterminestorejecttheOA?Theanswerisuncertainbutpresumablytherightsof thepartiesas theyhaveaccruedduring theinterimperiodwouldbefixed,andtherightsofthenon-debtorpartiesafterthedateofrejectionwouldbetreatedasaprepetitionunsecuredclaim.But,forexample,ifapartyproposedanoperation,thedebtorelectednon-consentandthedebtor’sinteresthadgoneintonon-consentstatusonthe30thdayoftheproceeding,thefactthatthedebtorrejectedtheOAonthe60thdayoftheproceedingoughtnottaketheinterestoutofnon-consentstatus,ithavingbeenfixedasconsiderationforacceptingthebenefitsofownershipduringtheinterimperiod.

12 See Wilson,69B.R.at966,quotedabove.

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Again, however, the answer to this question is uncertain.13 In a typical OA,ifapartygoesnon-consent,theOAprovidesthatthenon-consentingparty’sinterestisrelinquisheduntilthecontractualamountsduearerecoupedfromproduction.Those relinquished interestswouldbe interests in realproperty.Ifinterestsgointonon-consentstatusduringtheTwilightZone,we suggest that the interests ought not to be exempt from that status if the debtorlaterrejectstheOA.Section365(a)doesnotgrantbankruptcycourtsthepower to repudiate, terminate, or cancel property interests.14 Thus, therejectionoftheOAshouldhavenoeffectonthecontinuingvitalityoftherelinquishedinterests.However,pre-petitionnon-consentrelinquishedinterestsarenotpartofthedebtor’sbankruptcyestate.15

[6] — Where the Debtor Seeks to Sell the Property. Section 363 of theBankruptcyCode governs sales of assets of a

bankruptcy estate.16Whenthesesalesinvolveoilandgasproperties,theacquiring party will want the applicable OA to remain in place. Since the OAisunquestionablyanexecutorycontract,asaleunder§363willrequiretheOAtobeassumedorrejected.Giventheseoptions,mostpurchaserschooseassumptionandassignmentoftheOAalongwithprocessingrightsandother contractdocuments thatgovern theoperationof theproperty.ThereareanumberofdifficultissuesthatoftenariseintheassumptionandtransferofanOAinconnectionwiththesaleofaninterestinanoilandgaslease, such as, e.g., how to cure non-monetary breaches, or how to reconcile two inconsistent area of mutual interest clauses.

[7] — Operator’s Liens. The operating agreement often grants the operator a contractual,

consensual lien on the non-operator’s interest in the minerals to secure the

13 Id.14 See In re Bachinski,393B.R.522,544(Bankr.S.D.Ohio2008);(quotingIn re Bergt, 241 B.R. 17, 35 (Bankr. D. Alaska 1999)).15 TransTexasGasCorp.v.ForcenergyOnshore,Inc., 2012 WL 1255218, at *7 (Tex. Ct. App. 2012).16 11 U.S.C. § 363.

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non-operator’sobligationsundertheOA.Suchacontractualoperator’slienisnotbindingonthirdpartiesunless(i)theOAoramemorandumofit,withasufficientdescriptionofthelienrights,isfiledofrecord,(ii)constructivenoticetotheworldisgiveninsomeothercontextsuchaspossession,or(iii)the lien claimant is in possession of the collateral.17 Clearly the better course ofactionistorecordtheOAoramemorandumoftheOAwithreferencetoitsoperator’slien.Thisoperatestoperfectthelien.Intheabsenceofrecording,theoperator’slienmaynotbeenforceableagainstadebtorinchapter11.

The Wilsoncourtheldthatanoperatorinpossessionoftheoilandgaspropertyisnotinpossessionasagentofthenon-operatorsufficienttoputtheworldonnoticeoftheliencontainedintheoperatingagreement.18However,the Wilsoncourtnoted,if theoperatorisholdingfundsbelongingtothedebtorandisowedmoneybythedebtor,thentheoperatorisfreetooffset,providedonlythattheotherrequirementsofoffsetaremet,i.e., mutuality andaliftingofthestay.19

[8] — Practice Tip. Makesureyourcompanyhasproceduresinplacetorecorditsoperator

ornon-operator’slienwhenitacquirespropertiesbyfilingamemorandumoftheOAwithreferencetothelien.ThismemorandumisanexhibittotheAAPL Form Operating Agreement.

Ifthedebtorisanon-operator,theoperatorhasmultiplerightsthatmaybeenforced,including(i)anoperator’slien,whetherperfectedornot;(ii)arightofrecoupmentoroffset,withrespecttounpaidamountsowingundertheOA;and(iii)therighttoforceacureoftheOA,ifthedebtorwishestoassumethatcontract.Themostpowerfulofthesetoolsis,withoutdoubt,therightofrecoupmentoroffset.At least twocourtshavesustained theoperator’s claim of recoupment.20

17 Wilson, 69 B.R. at 964.18 Id. 19 Id. at 964-65.20 SecurityPacificNat’lBankv.EnstarPetroleumCo. (In re Buttes Res. Co.), 89 B.R. 613,617(S.D.Tex.1988)(operator’sclaimtoproductionrunsischaracterizedasrecoupmentandthestayisliftedtoalloweffectuationofsetoff);FarmersUnionCentralExch.,Inc.v.

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[9] — The Automatic Stay Bars Effectuations of Offset Rights, But Not Recoupment.

The automatic stay applies to the effectuation of an offset,21 but an “administrativefreeze”isavailablependingrelieffromthestay.22

Becauserecoupmentdoesnotinvolveanyactionagainstpropertyoftheestate,butratheradeterminationoftheproperamountoftheestate’sclaimagainstthepartyseekingrecoupment,itisnotbarredbytheautomaticstay.23

Significantly,therecoupmentrightsoftheoperatormaybesuperiortoabankmortgageencumberingthedebtor’sinterest.IntheButtes Resources case,thebanksintervenedinthemotiontoliftthestayandunsuccessfullyarguedthattheirmortgagewaspriortotheoperator’srightofrecovery.Thecourtnotedthattheclaimofthedebtorwas“subjectab initiotoreductionfortheveryexpensesthatwererequiredtoproducetheoil.”24

The OA may grant the non-operator a reciprocal lien on the operator’s interesttosecureamountsowedbytheoperator.Thenon-operator’slienislessmeaningful,however,sincethenon-operatorseldomiscalledupontopay the operator’s obligations.

§ 7.02. Oil and Gas Leases May or May Not Be “Executory Contracts” or “Unexpired Leases.”

Section365oftheBankruptcyCode,asdiscussedabove,allowsadebtortoassumeorrejectanexecutorycontractorunexpiredlease.Whetheranoil

SecurityPacificNat’lBank (In re ButtesGasandOil), 72 B.R. 236, 239 (Bankr. S.D. Tex. 1987)(operator’srighttorecovercostsfromproductionrunsisrecognizedasrecoupment).21 11 U.S.C. § 362(a)(7).22 CitizensBankv.Strumpf,516U.S.16(1995)(administrativehold).23 See, e.g., Beaumont v. Dep’t of Veteran’s Affs. (In re Beaumont),586F.3d776,781(10thCir.2009) (“If the recoupmentdoctrineapplies, then there isno ‘debt’or ‘claim’hereasdefined in theBankruptcyCode,andDefendanthasnotviolated theautomaticstay.”);Kosadnarv.Met.LifeIns.Co. (In re Kosadnar),157F.3d1011,1016(5thCir.1998)(referencingHolfordv.Powers(In re Holford),896F.2d176,178(5thCir.1990))(“Post-petitionrecoupmentdoesnotviolatetheautomaticstayimposedbythebankruptcycourt.”).24 ButtesResources,89B.R.at617(quotingShawEstesv.Tex.Consol.Oils,299S.W.2d307(Tex.Civ.App.1952);Frestonv.GulfOilCo.U.S.,565P.2d787(Utah1977));Aldridgev.N.E.Ind.SchoolDist.,428S.W.2d447(Tex.Civ.App.1968).Contra, Sterling Nat’l Bank andTrustCo.ofNewYorkv.SouthwireCo.,713F.2d684(11thCir.1983).

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andgasleasefallswithinthedefinitionof“executorycontract”or“unexpiredlease”isdeterminedunderapplicablenon-bankruptcylaw.25 The nature of thepropertyrightcreatedbyanoilandgas“lease”variesfromstatetostate.InTexas,anoilandgasleaseisadeterminablefee,notaleaseorotherformofexecutorycontractthatadebtormayassumeorreject.26

UnderKansaslaw,ontheotherhand,aleaseisessentiallyalicensetogouponthelandinsearchofoil,anditissubjecttoassumptionorrejectionunder§365.27

InPennsylvania,as inTexas,oilandgas leaseholdsareclassifiedasreal estate.28Whetheraleaseunderfederalnon-bankruptcylaw(offshoreLouisiana)isan“executorycontract”or“unexpiredlease”iscurrentlybeinglitigatedinIn re ATP Oil & Gas Corp., Case No. 12-36187 in the Bankruptcy Court for the Southern District of Texas.

If,undertheapplicablestatelaw,anoilandgasleasequalifiesasanunexpiredleaseofnonresidentialrealpropertyunder§365,beawareofthetimeframeforassumptionunder§365(d)(4).Section365(d)(4)requiresthataleasefornonresidentialrealpropertybeassumedbytheearlierof120daysaftertheorderforrelief(typicallythedatethebankruptcywasfiled)ordateofanentryconfirmingaplan,unlessthecourtextendsthetimeperiod.Iftheleaseisnotassumedwithinthistimeperiod,itisdeemedrejected.Frequentlyadebtorwillfileaprophylacticmotionassumingoilandgasleasesoutofanabundanceofcaution.

§ 7.03. Reclamation Rights.Hydrocarbons are “goods” under theUniformCommercialCode

(UCC),andthusthesellerofoilandgashasreclamationrightsunderboththeUCCandtheBankruptcyCode.Inaddition,manystateshavegranted

25 SeeButnerv.UnitedStates,440U.S.48-49(1979).26 TerryOilfieldSupplyCo.,Inc.v.Am.Sec.Bank,N.A., 195 B.R. 66, 70 (S.D. Tex. 1996).27 In re J.H.Land&CattleCo.,8B.R.237.239(Bankr.Okla.1981).28 See Jacobsv.CNGTransmissionCorp.,332F.Supp.2d759,772(W.D.Pa.2004).See also In re Powell,482B.R.873,878(Bankr.M.D.Pa.2012)(holdingthatanoilangasleaseis“clearly”aleaseofrealpropertywithinthebankruptcydefinition).

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statutorylienstoprotectsellerssothatthesellerwillhaveasecuredclaimforhydrocarbonssoldbutnotpaidasofthefiling.29 Some states require filingswiththecountyclerktoperfectaproducers’lien;inothers,includingTexas,producers’liensare“automatically”perfected.

[1] — Practice Tip. Whenconsideringthealternativesavailabletoasellerofhydrocarbons

sold to a counterparty in bankruptcy, thefirst two action items are to(i)sendareclamationdemandand(ii)takestepsasnecessarytoperfectanyapplicableproducer’slien.Thegoalistohavebothasecuredclaimandanadministrativeclaim.

[2] — Reclamation Rights. TheTex.Bus.&Com.Code§2.702provides:(b)Wherethesellerdiscoversthatthebuyerhasreceivedgoodsoncreditwhileinsolventhemayreclaimthegoodsupondemandmadewithintendaysafterthereceipt,butifmisrepresentationofsolvencyhasbeenmadetotheparticularsellerinwritingwithinthreemonthsbeforedelivery the tenday limitationdoesnot apply.Except asprovidedinthissubsectionthesellermaynotbasearighttoreclaimgoodson thebuyer’s fraudulentor innocentmisrepresentationofsolvency or of intent to pay. (c) Theseller’srighttoreclaimunderSubsection(b)issubjecttotherightsofabuyerinordinarycourseorothergoodfaithpurchaserorliencreditorunderthischapter(Section2.403).Successfulreclamationofgoodsexcludesallotherremedieswithrespecttothem.

Outsideofbankruptcy,thesellercanreclaimgoodsfora10-dayperiodafter delivery.That time limit doesnot apply if amisrepresentationofsolvencyhasbeenmadebythesellerinwriting.Oneexampleofasolvencyrepresentationthatmaybeincludedinasalescontractorpurchaseorderisasfollows:

29 Tex.Bus.&Com.Code§9.343;Kan.U.Com.Code§84-9-339a;NewMex.Stat.§48-9-3and§70-10-1;see also La.Civ.Codeart.3227(vendor’sprivilegeonmovables).

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Buyerherebyrepresentsthatitissolventandthatoneachdeliverythisrepresentationshallbedeemedrenewedunlessnoticetothecontrary is given in writing by the buyer to the seller at or before deliveryofthegoods.30

Sincetheseller(andseller’scounsel)generallywillnotknowonthedateoffilingwhetherornotawrittenmisrepresentationhasbeenmade,betterpracticemaybetosendanoticereclaimingallunpaidgoods.TheUCCformletterstatesasfollows:

To:[NameofBuyer]

Iherebyreclaimfromyouthefollowinggoodssoldtoyouoncreditandreceivedbyyouon[dateofreceipt]:[descriptionofgoods].Ireclaimthegoodsbecauseofyourinsolvency.

_________________

[Name of Seller]31 It is simplest to attach the invoices to the reclamationdemand.The

BankruptcyAbusePreventionandConsumerProtectionAct (BAPCPA)expandedthetimeperiodduringwhichsellerscanexercisetheirreclamationrights.Section546(c)(1)provides:

(1)Exceptasprovidedinsubsection(d)ofthissectionandinsection507(c),andsubjecttothepriorrightsofaholderofasecurityinterestinsuchgoodsortheproceedsthereof,therightsandpowersofthetrusteeundersections544(a),545,547,and549aresubjecttotherightofasellerofgoodsthathassoldgoodstothedebtor,intheordinarycourseofsuchseller’sbusiness,toreclaimsuchgoodsifthedebtorhasreceivedsuchgoodswhileinsolvent,within45daysbeforethedateofthecommencementofacaseunderthistitle,butsuchasellermaynotreclaimsuchgoodsunlesssuchsellerdemandsinwritingreclamationofgoods—

30 Vernon’sTexasCodeFormsAnnotatedUniformCommercialCodeForms§2.702(4thed.2007).31 Id.

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(A)notlaterthan45daysafterthedateofreceiptofsuchgoodsbythedebtor;or

(B)notlaterthan20daysafterthedateofcommencementifthecase,ifthe45-dayperiodexpiresafterthecommencementofthecase.32 PriortotheBAPCPAamendments,reclamationrightswereonlygranted

tosellersthatdemandedreclamationofthegoodsinwritingwithin10daysofdelivery.TheBAPCPAamendmentsexpandedthistimeperiodfrom10to45days(or20daysaftercommencementofthecase,ifthe45dayperiodexpires after the commencement of the case, whichever is later.) Further, the rightsgrantedunderBAPCPAaregenerallybetterthantherightsgrantedundertheUCCbecausetheUCClimitsthedemandforreclamationto10daysinmostcircumstances.Importantly,BAPCPAexpandedtherightofasellertorecoveranadministrativeclaim.Section503(b)(9)provides:

(b)Afternoticeandahearing,thereshallbeallowedadministrativeexpenses,otherthanclaimsallowedundersection502(f)ofthistitle,including—

* * * *

(9)thevalueofanygoodsreceivedbythedebtorwithin20daysbeforethedateofcommencementofacaseunderthistitleinwhichthegoodshavebeensoldtothedebtorintheordinarycourseofsuchdebtor’sbusiness.33

Section503(b)(9)entitlesasellertoanadministrativeexpenseclaimforgoodsthatwerereceivedbythedebtorwithin20daysofthecommencementofthecaseandsoldintheordinarycourseofthedebtor’sbusiness.Thesellerneednotdemandreclamationunder§546(c)(1)tobeentitledtoanadministrative expenseunder§503(b)(9).Further, since administrativeexpenseclaimsareentitledtopriorityoverunsecuredclaimants,§503(b)(9)oftenservestoincreasethepriorityoftradecreditors.

32 11 U.S.C. § 546(c)(1).33 11 U.S.C. § 503(b)(9).

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[3] — Practice Tip. Since there is some uncertainty as to whether bankruptcy reclamation

isforgoodsdeliveredforthe20daysor45dayspriortofilingbankruptcy,andthesellermayormaynotknowwhetherawrittenmisrepresentationhasbeenmade,thebetterpracticeistomakeareclamationdemandforall unpaidgoods.Typicallyinlargercasestherewillbeaproceduresorderputinplaceonhowandwheretofilethese20-dayclaims.

§ 7.04. Royalty Claims Do Not Come First — or If They Do, Only to a Limited Extent.

[1] — Are Unpaid Royalty Owners Unsecured Creditors? It is rare for adebtorwhooperatesoil andgaswells andwhofiles

bankruptcy to be current on royalty. Royalty owners occasionally believe theirentitlementsarespecial,thattheyaresecuredcreditors,orthatoperatorsholdtheirmoneyintrust.Generallyspeaking,noneofthatistrue.

In theordinarycase,prepetition royalty is anunsecuredclaim.Theroyaltyownermayclaimthemoneyishisandisnotpropertyofdebtor’sestate(thoughtypicallyitisgonebythetimebankruptcyisfiled)butthatisnotthelaw in the state of Texas. Louisiana gives royalty owners the right to cancel aleasefornon-paymentofroyaltyafternoticeandcontinuedfailuretopay.

Theguidingprincipalisthatthenatureofthepropertyrightownedbyanownerofroyaltyisdefinedbyapplicablenon-bankruptcylaw.34

[2] — The Royalty Owner Typically Is Owed a Contractual Obligation Only. Inatraditionalprivate-partytransaction,theobligationtopayroyaltyisa

contractrightand,thoughitisrecognizedasaninterestinrealty,theunpaidroyaltyowneris,intheordinarycase,anunsecuredcreditor.35

Contrarytopopularopinionamongroyaltyowners,thedutyowedbyanoperatortotheroyaltyownerisnotafiduciarydutyandtherelationshipis

34 Butner,440U.S.at5455;Patterson, 504 U.S. at 758.35 E.g.,T.W.PhillipsGas&OilCo.v.Jedlicka,42A.3d261,267(Pa.2012).

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almost entirely contractual.36 Otherthanobligationsfoundinthecontract,royaltyownersareowednospecialdutybylessees.37

Intheusualsituation,therefore,aroyaltyownerissimplyanunsecuredcreditorwithrespecttounpaidprepetitionroyalty.38

[3] — The “Termination for Non-payment” Clause in Bankruptcy. Occasionally leases contain a clause that allows the lessor (typically the

originallandownerbutsometimestheinterveningassignor)toterminatetheleasefornon-paymentofroyalty.Atypicalclausewouldreadsomethinglikethis:

IfLesseefailstotimelypaywhenduetheroyaltyowedhereunder,aftertendaysnoticeandanopportunitytocure,theLeaseshallbecanceledattheoptionofLessor.

InTexas,suchclausesareenforceableandgivethelessortherighttodeclaretheleaseterminatedfornon-paymentofroyalty.However,wouldsendingthenoticeletterbeaviolationoftheautomaticstay?Arguablysoandwouldrequireamotionforrelieffromstay.Inthecaseofafeesimpledeterminable,thefailureoftheconditioncausestheleasetoautomatically

36 Pickensv.Hope,764S.W.2d256,270 (Tex.Ct.App.1988);AmocoProd.Co.v.Alexander, 622S.W.2d563, 567-68 (Tex. 1981) (“The standardof care in testing theperformanceofimpliedcovenantsbylesseesisthatofareasonablyprudentoperatorunderthesameorsimilarfactsandcircumstances....Everyclaimofimproperoperationbyalessoragainstalesseeshouldbetestedagainstthegeneraldutyofthelesseetoconductoperationsasareasonablyprudentoperatorinordertocarryoutthepurposesoftheoilandgaslease.”);seeHurdEnter.,Ltd.v.Bruni,828S.W.2d101,108-11(Tex.Ct.App.1992)(surveyingTexascaselawandholdingthatnospecialrelationshipexistsinthecontextofanoilandgaslease);CambridgeOilCo.v.Huggins,765S.W.2d540,540-45(Tex.Ct.App.1989)(therelationshipbetweenlessorandlesseeispurelycontractualabsentsomespecialdealingsbetweenthepartiesoutsideoftheleasecontext).37 Shelton v. Exxon Corp.,921F.2d595,599(5thCir.1991).38 Some thingsapractitionermight look for inorder toenhance the royaltyowner’spositionwouldbespeciallanguageinthelease,aspecialrelationshipoutsidethelease,orsome other consensual or statutory entitlement that might give the royalty owner more rights than a normal lease.

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terminate.39 Because leases in Texas are a fee simple determinable,bankruptcy practitioners have longbelieved that clauses such as thosequotedabovegivetheroyaltyownertherighttoterminatetheleasefornon-payment,notwithstandingtheipso facto clause of 11 U.S.C. § 365(e), which preventsterminationormodificationofaleaseonthebasisofinsolvencyorabankruptcyfiling,andtheautomaticstayof11U.S.C.§362(a).

Thelogicalremedywouldbetosimplypayamountsduepost-petitionandpreserve the asset. Of course, there is a strong bankruptcy policy opposing paymentofprepetitionunsecuredclaimsoutsideofconfirmationofaplanof reorganization.40

If such clauses are, in fact, enforceable in bankruptcy, there is no statutory mechanismbywhichsuchassetscanbepreservedotherthan11U.S.C.§

39 Triggv.UnitedStates,630F.2d1370,1374(10thCir.1980)(failuretopaydelayrentaltimelycausedterminationoftheleaseandbankruptcycourthasnoremedy);In re MSB Energy, Inc.,438B.R.571,596-97(Bankr.S.D.Tex.2010);see alsoGoodHopeRefineries,Inc.v.Benavides,602F.2d998,1003(1stCir.),cert. denied, 444 U.S. 992 (1979) (“[T]he lawissettled,...that‘unless’leasesaretrueoptioncontractsinthesensethatfailuretodrillorpaydoesnotworkaforfeiture.”).40 Chiassonv.J.LouisMatherneandAssocs. (In re OxfordMgmt.,Inc.),4F.3d1329(5thCir.1993)(“But,thepowersgrantedbythatstatutemustbeexercisedinamannerthatisconsistentwiththeBankruptcyCode....[W]efindthatthebankruptcycourtwasinerrorwhenituseditsequitypowerstocommandthepaymentoftheappellees’commissions.”Id.at1334);OfficialCommitteeofEquitySec.Holdersv.Mabey,832F.2d299,302(4thCir.1987)(“TheBankruptcyCodedoesnotpermitadistributiontounsecuredcreditorsinaChapter11proceedingexceptunderandpursuanttoaplanofreorganizationthathasbeenproperlypresentedandapproved.”Emergencytreatmentfundwasdisallowed.);In re Structurlite Plastics Corp.,86B.R.922,93233(Bankr.S.D.Ohio1988(denyingpaymentsgenerallybutallowingpaymentsunder§507(a)(4)toanemployeebenefitplan);In re FCX, Inc.,60B.R.405,41011(E.D.N.C.1986)(“Thiscourtfindsthatbyauthorizingthepaymentofprepetitionindebtednessarisingfromunpaidpayrollexpenses,unpaidpayrolltaxes,andunpaidpurchasesofgrain,theBankruptcyCourteffectivelysubordinatedtheclaimsoftheremainingunsecuredcreditors.Suchsubordinationisnotauthorizedunderthelawabsentinequitableconductonthepartoftheseremainingunsecuredcreditors....Sec.105(a),...certainlyconfersequitypowersuponthebankruptcycourtbutitdoesnotauthorizeittocreaterightsnototherwiseavailableunderapplicablelaw.”).But see In re Chateaugay Corp., 80 B.R.279(S.D.N.Y.1987)(approvingJudgeLifland’sorderauthorizingLTVtocontinuepaymentofprepetitionwages, salaries,employee reimbursementexpensesandbenefits,includingpaymentsonworkers’compensationclaimsaccruingpriortopetitiondate).

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105(a).Thecommonresolutionofthisproblemisforthedebtortopresentalistofleasesthatitbelievesare(a)valuableand(b)indangerofbeinglostduetonon-paymentofroyaltybaseduponclausesprovidingforunilateraltermination.Uponmotionandnotice,thebankruptcycourtwilloftenapprovepaymentofprepetitionroyaltiestotheroyaltyownersofsuchleasesinordertopreserveassetsthatallpartiesagreetobevaluable.However,theweightofauthoritysuggeststhatoverproperobjection,suchpaymentwouldbeanimproper payment of a prepetition claim without a plan. There may be other reasonstopayroyaltyiftheDebtorneedsroyaltyownerconsentforcertainoperations or new wells.

[4] — A Review of Statutory Efforts to Protect Royalty Owners. Over the years, the various states have taken efforts to protect the rights

ofroyaltyownersandtoensurethattheyarepaid.

[a] — In the Case of Private Parties, § 9.343 of the Texas UCC Creates a Lien in Favor of Royalty Owners and Working Interest Owners.

Section9.343,Tex.Bus.&Com.Codeprovides,inpertinentpart,asfollows:

(a)Thissectionprovidesasecurityinterestinfavorofinterestowners(assecuredparties)tosecuretheobligationsofthefirstpurchaserofoilandgasproduction(asdebtor)topaythepurchaseprice....41

Thestatute,§9.343,providesa“security interest infavorof interestowners . . . “42Itmaybequestionedwhethertheterm“interestowner”isintendedtoinclude“royaltyowner,”thoughthestatutorydefinitionseemssufficientlybroad.43

41 Tex.Bus.&Com.Code§9.343(a)(Vernon2002).42 Id.43 Id. at § 9.343(r)(2).

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[b] — Royalty Liens Are Statutory and May Be Avoided Under § 545 of the Code.

Thenextquestiontoconsideriswhetherthestatutorylienof§9.343,insofar as it relates tohydrocarbonsproduced,maybeavoidableby thetrustee (ordebtor-in-possession) inbankruptcy.Lienscreatedby§9.343arestatutoryliens.Statutoryliensareavoidableunder11U.S.C.§545(2)totheextentthatsuchliensarenotenforceableagainstabonafidepurchaser(BFP)ofproduction.Itisclearfromtheexpresslanguageof§9.343thatsuchliensarenotvalidagainstaBFPofproduction.44 The only exception is thatthelien,oncecutoffbyaBFP,continuesastoproceedsasestablishedin§9.343(c),aprovisionwhichisbroaderthanthetraditionalUCCproceedsprovision, i.e. § 9.315.

Asstated,avoidanceunder§545(2) requires twoelements: (a) theremustbeastatutorylienand(b)thecollateraltowhichthestatutorylienisaffixedmustbeincapableofbeingsoldtoaBFPforvalue.Isa§9.343lienastatutorylien?ThecourtinSemCrude consideredtheissue,albeitinanothercontext,andconcludedthat§9.343creates“consensualsecurityintereststhat arise by contract, not statutory liens or similar statutory interests, . . .”45 Thisseemswrong.TheBankruptcyCodedefinesastatutorylienasone

arising solelyby forceofa statuteon specificcircumstancesorconditions, . . .whether or not statutory, but does not includesecurityinterestorjudiciallien,whetherornotsuchinterestorlienisprovidedbyorisdependentonastatuteandwhetherornotsuchinterestorlienismadefullyeffectivebystatute.46

Thelegislativehistoryindicatesthat“[a]statutorylienisonlyonethatarisesautomatically,andisnotbasedonanagreementtogivealienoron

44 See id.at§9.343(c)(1)(A)(“saleofsuchproceedsbyafirstpurchasertoabuyerintheordinarycourseofbusiness....willcutoffthesecurityinterest....”);and§9.343(e)(“Thesecurityinterests....arecutoffbythesaletoabuyerfromthefirstpurchaserwhoisintheordinarycourseofthefirstpurchaser’sbusiness....”).45 In re SemCrude,L.P., 407 B.R. 112, 134 (Bankr. D. Del. 2009).46 11 U.S.C. § 101(53).

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judicialaction.”47Itistruethattheliencreatedby§9.343isfoundinArticle9 of the UCC, that it utilizes many of the characteristics of a consensual securityinterest,andthat§9.343(a)specificallystatesthat“[t]hissectionprovidesasecurity interest”andnotastatutorylien.48Yetaliencreatedby§9.343seemsmoreanalogoustoamechanic’sandmaterialman’slienthan a consensual lien. While entering into the transaction is consensual, there is nothing consensual about the giving of the lien, which is entirely a creation of statute.

In Tri-Union Development Corporation, theCreditors’Committeeopposedthepaymentofroyaltyowners,assertingthatsuchliensasexistedunderthen-§9.319couldbeavoidedasstatutoryliensunder11U.S.C.§545(2)oftheBankruptcyCode.49Thecourtrejectedthatargumentfortworeasons:First,thecourtnotedthat§545(2)isnotmandatorybutisoptional.50 In Tri-Union,thedebtorhadelectednottoavoidtheliensandsoughttopayits royalty owners.51

Thedebtorhasprudentlychosennottoattempttoavoidtheseroyaltyliens—itisseekingtoadequatelyprotectnotonlythecollateralinterestsoftheroyaltyowners,butalsoitsownimagebyfilingthismotion to pay.52

Second,thecourtnotedthatthe§9.343liencontinuesinproceedsthataretraceabletoaccountsorcashforanindefiniteperiodoftime,i.e., forever.53 “When,however, theproceedsareeitheraccountsorcashproceeds, thesecurityinterestexists‘foranunlimitedperiodoftime.’”54

47 S.Rep.No.95-989,95thCong.,2dSess.27(1978),reprinted in App. Pt. 4(e)(i). See Practical Inv. Corp. v. Rellen ( In re Practical Inv. Corp.), 95 B.R. 935, 939 (Bankr. E.D. Va. 1989)(“Astatutorylienisonethatarisesautomaticallyandisnotbasedonanagreementto give a lien.”).48 U.C.C.§9.343(a)(emphasisadded).49 In re Tri-Union Dev. Corp., 253 B.R. 808, 811 (S.D. Tex. 2000).50 Id. at 813.51 Id. 52 Id. 53 Id. at 813-14.54 Id. at 813.

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Thefirstbasisforthecourt’srulingiscorrectandis,standingalone,probablysufficienttosustainthecourt’sdecision.Werespectfullysubmitthatthesecondalternativebasisiswrong.Section545(b)oftheBankruptcyCodeallowsadebtor-in-possessionand/ortrusteeinbankruptcytoavoidastatutorylienif,andonlyif,aBFPunderstatelawcouldtaketitletothepropertyfreeof the lien.55Bywayofexample,amechanic’sandmaterialman’slienisentirely statutory. Because a BFP (in Texas at least) cannot take free of that lien,§545(b)doesnotallowthetrusteetoavoidit.Theissueisnothowlongtheliencontinueswhilethecollateral(andproceeds)areinthepossessionofthedebtor.Theissueiswhetherthedebtorcouldconveygoodtitletothecollateral(andtheproceeds)toaBFPfreeandclearofthelien.Inourcase,therearetwoissues:thecollateralandtheproceeds.ThestatuteexpresslystatesthatthedebtorcouldconveygoodtitletothecollateraltoaBFPfreeof the lien.56Itistruethattheliencontinuesintheproceeds(solongasitisaccountsandcash)foranunlimitedtime—butthatistrueonlywhileinthehandsofthedebtor.TherealquestioniswhetherthedebtorcantransferthecashproceedstoaBFPfreeofthelienof§9.343(a)?Clearlythedebtorcoulddoso.Thus,wesubmit,therequisitesfora§545(b)avoidanceactionaresatisfied.Ifaliteralreadingof§9.343(c)(1)(C)weretrue,i.e. that the lien continuedinthecashfor“anunlimitedtime,”thenthelienwouldfollowthecashintothehandsofemployees,thelightcompanyorthelandlord—clearlyanimproperanduntenableresult.Wesuggestthat§9.343(c)(1)(C)’smeaningisthatthe20-dayrequirementof§9.315iseliminatedby§9.319(c)(1)(C)andtheliencontinuesforan“unlimitedtime”solongastheproceedsareinthehandsofthedebtororthefirstpurchaser,butnotthereafter.Insum,the§9.343liensareakintofloatingliensagainstinventoryandaccountsreceivableanddonotfollowtheproduction(ortheproceeds)intothehandsofsubsequentpurchasersintheordinarycourseofbusiness.

Theonlyexceptionoccurswhenasaleofproductionhasoccurredwithin20daysofthedateoffiling.Thenthelienwouldbesaved(toalimitedextent)

55 11 U.S.C. § 545(b).56 Tex.Bus.&Com.Code§9.343(e).

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by§9.343(c)(1)(A).Butthebenefitisthenlostiftheamountsreceivedarecommingled.57Thestatute,§9.315(d)(3),limitsalienclaimtoamountspaidwithin20dayspriortobankruptcy(ifcommingled).

[c] — Proceeds of Production. Theoutcomeisdifferentwithrespecttoproceedsofproductionthatcan

betraced.Itistypicallythecasethattheoperatorwilldissipate(somemonthsbeforethedateoffiling)theproceedsofproductionthatwereinthebankaccountusedbytheoperatortopayroyaltyandworkinginterestowners.Itoftenhappensthat,afterdissipatingtheproceeds,theoperatorwillthenreplacesomeorallofthefundswithotherfundsduringthemonthsleadinguptobankruptcy.Thosefundsarethencommingledwithotherfundsadmittedlybelongingtotheoperator.Thisdissipationandcomminglingeliminatesanytracing that might otherwise enable the royalty lien claims to be effective.

Thecommonexceptionistheproceedsofproductiondueforthesaleofhydrocarbonsproducedintheperiod(eitheramonthoraportionofamonth)justpriortofilingofbankruptcy.Forthatperiod,thepurchaserofproductiontypicallywillhavenotyetpaidtheoperator.Itisconceivableandperhapslikelythattheroyaltyowners’lienunder§9.343willattachtotheproceedsofproductioninthehandsofthefirstpurchaserpriortopaymenttotheoperator.CouldtheDebtorassigntheaccountreceivablefromthefirstpurchasertoaBFPfreeoftheroyaltyowners’lien?Ifso,itisavoidableunder§545.Ifnot,thennot.

[d] — Conflict Between Royalty Owners’ Lien and Accounts Receivable Financing Institution.

In the scenario just discussed, there is often a conflictbetween theroyaltyownersandthecollateralassigneeofthedebtor’saccountsreceivable.Because the sale of hydrocarbons generates an account receivable, a

57 SeeTex.Bus.&Com.Code§§9.343(c)(1),(2),and9.315.(Thestatuteprovidesthat§9.315governsastocommingling);In re PrudentialEnergy,58B.R.857,862(Bankr.S.D.N.Y.1986).

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collateral assignee of accounts receivable will assert its entitlement to a lien ontheproceedsofproductionaheadofanylienoftheroyaltyownersandworkinginterestowners.Theanalysisandresolutionofthisconflictturnsontheinceptiondateofthelienforpurposesofpriorityandtheoutcomeis uncertain. First, note that the collateral assignee of accounts receivable hasa lienonlyagainst thedebtor’s interest in theproceeds, i.e., no lien againsttheportionattributabletotheinterestsofnon-operatorsandroyaltyownerswhoaretakinginkind.Second,notethatthecollateralassignmentofreceivablesisaconsensualliengovernedbyArticle9oftheUniformCommercialCode,whereastherightsofroyaltyownerswhoarenottakinginkindisastatutorylien(albeitarisingunderArticle9also)thatattachestothefunds(reallyaportionofthefunds,beingtheamountnecessarytopayroyalty)inthehandsofathirdparty.Third,notethatthedocumentsgivingrisetotheroyaltyowners’lienunder§9.343almostalwaysexistprior to theattachmentofthelienofthefinancinginstitution,butthestatutoryliencannotexistuntilthehydrocarbonsareproduced.Priortothatdate,thereisnodebt.Sincetheretypicallyisnoperfectionofthe§9.343lien,theroyaltyowners’liendoesnotexistandthereisnonoticeorattachmentofthelienuntil the obligation arises, almost always after the attachment of the lien ofthefinancinginstitution.Theoutcomeofthepriorityfightbetweenthefinancing institutionand the royalty lienclaimantswas recentlydecidedby the Delaware bankruptcy court in SemCrude Arrow Oil & Gas Inc. v. SemCrude L.P.58 Thecourtheldthebankstrumpedtheproducerlienclaimants.59TheBankruptcyCourtcertifiedthecaseforimmediateappealtotheThirdCircuit,butthecasesettled.

[e] — Royalty Liens Are Not in Competition with Mineral Contractor Liens on the Same Property.

Occasionally royalty claimants assert that their § 9.343 lien (if any) attachestothedebtor’sinterestintheleaseholdestateandispriortomineral

58 In re Semcrude,L.P., 407 B.R. 112 (Bankr. D. Del. 2009).59 Id. at 139.

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contractor liens.The significanceof such argument is that themineralcontractorliens(withexceptionsnotedabove)areoftenpaid(albeitusuallyatadiscount)outoftheproceedsofthesaleofleasesoutofthebankruptcyestate.Royaltyclaimantshaveoccasionallyarguedthattheroyaltyliens(ifany)mightbeaheadofthemineralcontractorlienssothatsuchpaymentmightprejudicetherightsoftheroyaltyclaimants.Webelievethisargumenthasnomerit.Mineralcontractorliensandroyaltyliensunder§9.343attachtofundamentallydifferentthings,i.e.,theformertothepropertyandthelatter totheproductiononcesevered.Asaresult,paymentofoneoutofcollateralcannotprejudicetheother.Inanyevent,theruleofpriorityisfirstintimeisfirstinright(i.e.,§9.322(a)(1)providesthatthefirstlienintimetobothattachandbeperfectedispriortoanotherlienthatislaterintime).

Inourview,theroyaltylienunder§9.343cannotbothattachandbeperfected(asrequiredunder§9.309)untilafterthedateofproduction,sothatmineral contractor liens will often be prior in time to the royalty claims. If it isfoundthattheroyaltylienunder§9.343arises,attachesandisperfectedwhentheleaseissigned,thewelldrilled,andproductionbegins,thenitmaybe a close question as to which lien is prior in time.

[f] — The Mineral Contractor Liens and Royalty Liens Attach to Different Collateral.

Itisafundamentalprinciplethatliensarisingunder§9.343attachonlytoproduction(andproceedsofproduction).60 Mineral contractor liens, on theotherhand,attachonlytothelandsandleasesastowhichservicesandmaterialswereprovided,butdonot attachtoproduction.61Thecourtstatedin Hess v. Bank of Oklahoma (In re Hess):62

60 Tex.Bus.&Com.Code§9.343(c)(“securityinterestexistsinoilandgasproduction”),and§9.343(r)(1)(definitionof“Oilandgasproduction”);see also§9.343(p)and§9.343(r)(3). 61 UnitedStatesv.TexasEasternTransmissionCorp., 254 F. Supp. 114 (W.D. La. 1965) (courtshaveconsistentlyheldthatsincetheproceedsofanoilandgaswellwerenotexplicitlylistedinArt.5473(predecessorof§56.003),theywerenotsubjecttothemechanic’sandmaterialman’slien);Wilkinsv.Fecht,356S.W.2d855(Tex.Civ.App.1962); see Abella v. KnightOilTools,945S.W.2d847,850-51(Tex.Ct.App.1997).62 Hessv.BankofOklahoma (In re Hess), 61 B.R. 977, 978-79 (Bankr. N.D. Tex. 1986).

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InTexas,MineralsareconsideredrealestateandgovernedbyrealestatelawwhileProductionisconsideredpersonaltyandisgovernedbythelawofpersonalproperty....ItissettledunderTexaslawthattheholderofalienontherealestate(includingtheMinerals)doesnothavealienontheProductionbecauseitispersonalproperty....This is true even where the lien on the real property is a mechanic’s lienforworkperformedonanoilandgaswell....[W]henoilandgasareproduced,theybecomepersonalpropertyandthelienofthe Bank [as mortgagee] on real estate is subject to being lost unless theBank’ssecuritydocumentscoverproductionandareproperlyperfectedastopersonalproperty.... 63

BecauseinTexasthetwoliensattachtoquitedifferentaspectsoftheoilandgasestate,theyaremutuallyexclusiveandthepaymentofone(mineralcontractorliens)fromtheproceedsofthesaleoftheleasescannotaffecttherightsof§9.343claimants,whoserightsextendonlytoproduction.

Ifthelienswereconflicting,thenbystatutethefirstintimeprevails.Thereisnothinginthestatute,§9.343,whichstatesthatliensunderthatprovision are prior to statutory liens of mineral contractors. Sections 9.343(f), (g)establishanddefinetheprioritiesof§9.343withregardtoconflictingliens.Theydonotexplicitlyaddresstheissueofamineralcontractorlienarisingby statute.Thus the latter lien’sprioritywouldbeestablished inaccordancewiththeordinaryrulefoundin§9.322(a)(1),thatis,thefirstlienintimetobothattachandbeperfectedispriortoanotherlienthatislaterintime.Inatypicalcase,theroyaltyclaimants’lienunder§9.343cannotarisepriortoproductionofhydrocarbons,whereasthelienofmineralcontractorsarisesandisperfectedonthedateoffirstservice,adateoftensubstantiallyinadvanceoffirstproduction.

63 Id.at978;see also Crowleyv.AdamsBros.&Prince,262S.W.883,885(Tex.Civ.App. 1924).

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[g] — Texas Statute Creates a Lien in Favor of the State to Secured Unpaid Royalty Owed to the State of Texas.

WithrespecttolandsleasedfromtheStateofTexas,thestatehasalientosecurepaymentofroyaltyandotheramountsdue.Sec.52.136oftheTexasNaturalResourcesCodeprovidesthat“Thestatehasastatutoryfirstlienonalloilandgasproducedonanyleaseareatosecurepaymentofunpaidroyaltyandotheramountsdue.”Therehavebeennoreporteddecisionsinterpretingthis provision. It is not clear from the statute or from case law whether such aliencouldbedefeatedbyaBFP.InsupportoftheargumentthataBFPwouldbebound,thelegislaturein1997addedthefollowinglanguage:

(c) The statutory and contractual liens and security interestsdescribedinthissectionmaybeforeclosedwithorwithoutcourtproceedingsinthemannerprovidedunderChapter9,Business&CommerceCode.64

Thissentencemakesonethinkthatthestatemaybefreetoseizeandforecloseuponthecollateralwithoutregardtowhereitisfound.Ontheotherhand,thelegislaturealsoaddedthefollowinglanguage,indicatingthataBFPwouldnotbebound:

Thestatemayrequirethelesseetoexecuteandrecordinstrumentsreasonablynecessarytoacknowledge,attach,orperfecttheliens.65

Ifthelastsentenceservesanypurpose,itcouldonlybetoprovidenoticeeffectiveagainst thirdpartieswhoareotherwisenotbound. If aBFP isnotbound(thereisnoreasonwhyitwouldnotbe)suchstatutoryliensareavoidableunder§545(2)oftheBankruptcyCode.

[h] — Louisiana Statute Gives Unpaid Royalty Owners the Right to Cancel a Lease.

Louisianalawprovidesthatifalesseefailstopayroyalty,thecourtmayawardasdamagesdoubletheamountofroyaltydue,interest,andattorney’s

64 Tex.Nat.Res.Code,§52.136(c)(VernonSupp.1998).65 Id.

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fees.Thecourtmayalsodissolve the lease in itsdiscretion.66However,dissolutionisnotafavoredremedyanddissolutionshouldbegrantedonlyiftheconductofthelessee“issuchthattheremedyofdamagesisinadequatetodojustice.”67Thisusuallyrequiresevidenceoffraudulentconduct.68 As aresult,leasesareseldomcanceled.Theprovisionistypicallypleadedforits in terrorem effect.

[i] — Minerals Management Service (MMS) Regulations Give the MMS the Right to Cancel a Lease for Unpaid Royalty.

TheOuterContinentalShelfLandActprovides:

(d)Cancellationofproducinglease

Whenevertheownerofanyproducingleasefails tocomplywithany of the provisions of this subchapter [Subchapter 3 - Outer ContinentalShelfLands]oroftheleaseor theregulationsissuedunderthissubchapter,suchleasemaybeforfeitedandcanceledbyanappropriateproceedinginanyUnitedStatesdistrictcourthavingjurisdictionundertheprovisionsofthissubchapter.69

Further,

AleaseissuedunderthisAct,...doesnotconveytitleintheland,nordoesitconveyanunencumberedestateintheoilandgas.70

TheMMSregulationsprovide:

Producing leases issuedunder theActmaybe canceledby theSecretary whenever the lessee fails to comply with any provision

66 La.Rev.Stat.Ann.§31:140(West1998).67 La.Rev.Stat.Ann.§31:141(West1998);see Little Bell, LLC v. Centerpoint Energy, Inc.,838F.Supp.2d522,529-30(W.D.La.2012).68 Wegmanv.CentralTransmission,499So.2d436,453(La.Ct.App.1986);see Slattery Co., Inc. v. Chesapeake La. Co.,2013WL1152718,at*3(W.D.La.2013)(leasedissolutionavailableonlyiflesseefailstoprovideareasonableexplanationfornonpaymentwithin30days).69 43U.S.C.§1334(d)(1986).70 UnionOilCo.ofCal.v.Morton,512F.2d743,747(9thCir.1975).

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of theAct, applicable regulationsor the leaseonly after judicialproceedingsasprescribedbysection5(d)oftheAct.71

Thisprovisionwould require thedebtor tobringpast-due royaltiescurrent,ifthedebtorwishestoassumetheleaseandavoidcancellationofthelease.Presumablythedebtorandcreditorswouldonlypermitsuchanassumptionifthevalueoftheproducingleaseexceededtheamountofthepast-dueroyalties.

§ 7.05. The Conflict Between Avoiding Powers (§ 544(a) (3)) and Equitable Title (§ 541(d)), or the Issue of Recorded Versus Unrecorded Title.

Inmostjurisdictions(includingTexasandLouisiana),itoftendoesnotmatterwhetherthedebtorhasmadeassignmentsthatare“recorded”ornot.Whatmattersiswhetherthepurportedassigneecansatisfythestatuteoffraudsandhaspaidthecontractualpurchaseprice.Thebankruptcyestateiscomprisedofthedebtor’s“truetitle,”whichistheequivalentof“equitabletitle.”72Whetheranassignmenthasbeenrecordedornotisamechanismforgivingnoticetotheworldofthetransferoftitle.Inmostjurisdictions,recordingiseffectivetocutofftherightsofabonafidepurchaserforvalue(“BFP”)whoisunrecorded.AlthoughtheBFPtestiscriticallyimportantinthecontextofafraudulenttransferunderbankruptcylawandmoststatelaws, e.g.,11U.S.C.§544(a)(3),thedebtor’sandtrustee’s(andhencethecreditors’)abilitytobenefitfromafailuretorecordisundercutbytheCode’ssafeharborfor“equitabletitle,”foundin11U.S.C.§541(d).Inshort,§541(d)oftentrumps§544(a)(3).TheFifth,TenthandEleventhcircuitsholdthat§541(d)prevailsoveracompeting§544(a)(3)avoidanceclaim.73

71 30 C.F.R. § 256.77(b) (1997).72 11 U.S.C. § 541(a).73 HaberOilCo.v.Swinehart (In re HaberOilCo.),12F.3d426,436(5thCir.1994); City Nat’lBankofMiamiv.GeneralCoffeeCorp. (In re GeneralCoffeeCorp.),828F.2d699,704-07 (11th Cir. 1987), cert. denied,485U.S.1007(1988);Turleyv.Mahan&Rowsey,Inc. (In re Mahan&Rowsey,Inc.),817F.2d682,684(10thCir.1987);Sandozv.Bennett (In re EmeraldOilCo.),807F.2d1234,1238(5thCir.1987);Vineyardv.McKenzie (In re QualityHolsteinLeasing),752F.2d1009(5thCir.1985)(dictum);see also In re Cutter, 398 B.R. 6, 22 n.20 (B.A.P. 9th Cir. 2008).

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Eveninthosejurisdictionswhichresolvetheconflictinfavorof§541(d),however,aprerequisitefor§541(d)toprevailisthattheunrecordedinterestownerestablishhisownershipunderapplicablenon-bankruptcylaw.Inmostreportedopinions,thishastakentheformoflitigatingwhetheraconstructivetrustisfoundtoexist,entitlingtheunrecordedassigneetoberecognizedas an owner.74

But establishing a constructive trust can be difficult. InTexas, aconstructive trust requires (1) breach of informal relationship of special trust orconfidencearisingpriortoandapartfromthetransactioninquestionoractualfraud;(2)unjustenrichmentofthewrongdoer;and(3)tracingtoanidentifiableres.75Inthetypicaloilandgascase,theunrecordedinterestownerhasfounditextremelydifficulttoestablishanentitlementtoconstructivetrust.76Asaresult,ithasbeenrarefortheunrecordedassigneestoprevailin Texas on a constructive trust theory.77

ItisoccasionallyarguedthatWilson v. Parson (In re Jones)78 supports theargument that§544(a)(3)prevailsover§541(d).ThisargumentandthepreciseholdingintheJonescasearedirectlycontrarytoFifthCircuitprecedent.ThecourtinJonesincorrectlyassumedthedebtorisaBFPandisentitledtotreattheunrecordedassignmentasvoid,pertheTexasrecordingstatute.“Section544givestheTrusteetherightsofabonafidepurchaserandanattachingliencreditor(thestrong-armpowers).Theserightscutoffmostunrecordedinterestsandunperfectedsecurityinterests.”79 The court in Jones acknowledgedthat§541(d)prevailsover§544,80andevenacknowledgedthat§541(d)’sapplicationwasmuchbroaderthanthemortgageservicing

74 E.g.,Boydv.MartinExplorationCo., 56 B.R. 776, 781 (E.D. La. 1986).75 AmericanCancerSocietyv.Cook,675F.3d524,529(5thCir.2012);Monnig’sDep’tStores,Inc.v.AzadOrientalRugs,Inc. (In re Monnig’s Dep’t Stores, Inc.),929F.2d197,201(5thCir.1991);Meadowsv.Bierschwale,516S.W.2d125,128(Tex.1974);Thigpenv.Locke,363S.W.2d247,250-53(Tex.1962).76 Haber Oil Co.,12F.3dat43537.77 E.g., Wilson v. Parson (In reJones),77B.R.541(Bankr.N.D.Tex.1987); but seeToddv. Pettit (In re Elliott),108F.2d139(5thCir.1939).78 In re Jones, 77 B.R. 541 (Bankr. N.D. Tex. 1987).79 Id. at 548.80 Id.

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industry.81 The Jonescourtthenconcludedthattheunrecordedassigneeshadnotpleaded“constructivetrust,”82anddeniedthemreliefbasedonthetrustee’s BFP status.83 The reasoning in Jones ignores the obvious fact that thedebtorinJoneswasnot a BFP except insofar as the statute grants such statustoatrusteeforthelimitedpurposeofpursuinga§544(a)(3)action.Andofcourse,§541(d)prevailsover§544,astheJonescourtacknowledged.84

In Jones,theflawinthereasoningwastoassumethattheassignmentsarevoidunderstatelaw(theyarenot—exceptastoBFPs),thatthetrusteeisaBFP(heisnot,exceptfor§544purposes),andtofailtorealizethatthetrustee’sBFPstatusunder§544isofnoimportbecause§541(d)prevailsover§544.Tostatetheobvious,atrusteecannotobtainthebenefitsofBFPstatuswithoutfirstbringinganadversaryproceedingtopleadandadjudicatealloftheelementsofanavoidanceaction,whichmustresultinafinaljudgmentsettingforththerightsandremedies,ifany,towhichthetrusteeisentitled.And,ofcourse,§541(d)prevailsover§544,sothetrusteewouldfailinsuchanaction.WethereforesuggestthattheholdinginJonesisincorrectandisdirectlycontrarytoboththestatuteandcontrollingFifthCircuitprecedent.

Further, the Jones court incorrectly analogizedapersonwhoholdsanunrecordedassignmentinanoilandgaspropertytoapersonwhoisa“secured”partyinpropertybutwhodidnotperfecthissecurityinterest.85 Indrawingthecomparison,thecourtfailedtorecognizeacriticaldifferencebetweenacreditorandanowner.UnderTexaslaw,thepartywhohaspaidthe consideration andholds theunrecorded assignmentowns legal andequitable title to the property.86Becausethedebtordoesnothaveequitabletitle, the interest is not property of the bankruptcy estate.87Ontheotherhand,

81 Id.82 Id. at 549.83 Id. at 550.84 In re Jones, 77 B.R. at 548.85 Id.86 Johnsonv.Wood,138Tex.106,157S.W.2d146,148(1941);Wrightv.Riley,118S.W.1134,1135(Tex.Civ.App.1909);Picklev.Whitaker,224S.W.2d741,745(Tex.Civ.App.1949).87 11U.S.C.§541(d).

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theunperfected“secured”partyisacreditorwithanunperfectedsecurityinterestinpropertyofthebankruptcyestate.Accordingly,thecircumstancesfacingtherespectivepartiesareverydifferent—oneisanownerandoneisacreditor—and,asaresult,theinterrelationandapplicationof§§541(a),541(d),and544(a)leadtodifferentresults.“[T]hisCourtreadssection541(d)inconjunctionwithsection541(a)(1)ratherthanastwodistinct,inconsistentprovisions.”88

ThereissubstantialauthoritythatLouisianadoesnotrecognizeequitabletitleandthusrejectsnotionsofconstructivetrust.89

Regardlessofwhethertheassigneehaspaidthepurchasepriceornot,thestatuteoffraudsstillapplies.Thus,thetestforequitabletitleiswhether(i)thereisawritingthatadequatelydescribestheinterestand(ii)theassigneehaspaid thepurchaseprice inconnectionwitha transactionevidencingan intent to presently pass title. An alternative to a constructive trust is the resultingtrust,inwhichthepurportedassigneehaspaidtheconsiderationandownsequitablebutnotlegaltitle.90

Itmustberecognized,however,thattheFifthCircuithasnotsquarelyfacedthe§544(a)(3)versus§541(d)issuesincethe1984amendmentsaddingthelimitinglanguagein§541(d)(“undersubsection(a)(1)or(2)”)which,byimplication,take§544(a)(3)outfromthe§541(d)safeharbor.Thus,theseissues remain, to some extent, a work in progress.

§ 7.06. The § 541(b)(4) Safe Harbor for Recipients of Farmouts from Debtors in Bankruptcy.

In theoil&gas industry, a “farmout” is a contractual arrangementby which one party (the farmee) earns all or a portion of the interest in a propertyownedbyanother(thefarmor)inexchangefortheperformance

88 In re Ramba,437F.3dat461n.4(citingIn reMapleMortg.,81F.3d592,595(5thCirc.1996)).89 Sandozv.Bennett(In reEmeraldOilCo.),807F.2d1234,1238(5thCir.1987);Wilsonv.Bigger (In reLathamExplorationCo.,Inc.),83B.R.423,426(W.D.La.1988);see generally, Zeddav.Babin,103F.3d1195(5thCir.1997);but seeBoydv.MartinExplorationCo.,56B.R. 776, 781 (E.D. La. 1986).90 TricentrolOilTrading,Inc.v.Annesley,809S.W.2d218,220(Tex.1991).

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of certain tasks,suchasdrillingorcompletingcertainwells.Inatypicalfarmout,thefarmeedrillsawelland,uponsatisfactorycompletion,earnsapercentageoftheacreageandadditionalrightsgoingforward.Significantlyforourpurposes,titleremainsinthenameofthefarmorpendingthefarmee’scompletionofthecontractualobligations.Alsosignificantly,anincompletefarmout agreement is almost certainly an executory contract. Section 541(b)(4) of theBankruptcyCodeprovides thatmineral leases coveredbycertaintypesof“farmout”agreements(asdefinedintheCode)arenotpropertyofthedebtor’sestate.Alsonotethatthedebtorcanbeeitherthefarmororthefarmeeandthattheresultinglegalissuesarequitedifferent.

[1] — When the Debtor Is the Farmor. Ifthedebtoristhefarmorandthefarmeehasdrilledasuccessfulwell,

it may be the case that rejection of the farmout agreement will create more value for the estate than a recognition of the farmee’s interest. From the non-debtor farmee’spointofview, this isparticularlydifficultwhen thefarmeehassoldinterestsinthe“tobeacquired”propertytothirdparties.ThishashappenedoftenenoughandachievedasufficientlyinfamousresultthatCongressenacted§541(b)(4)oftheBankruptcyCodetoprohibitwhatisperceivedas awindfall to thedebtor-farmor.However, aswithmuchlegislationthathasgenerallanguageaimedataspecificproblem,itmaybethattheamendmentshaveovershotthemark.Thus,theBankruptcyCodenowcontainsadefinitionoffarmoutthatismuchmorebroadthanthattypicallythoughtofintheoilandgasindustry.Section101(21A)oftheCodeprovides:

Farmout agreement means a written agreement in which —

(A)theownerofarighttodrill,produce,oroperateliquidorgaseoushydrocarbonsonpropertyagreesorhasagreedtotransferorassignallorapartofsuchrighttoanotherentity;and

(B) suchother entity (eitherdirectlyor through its agentsor itsassigns), as consideration, agrees toperformdrilling, reworking,recompleting, testing,orsimilarorrelatedoperations, todeveloporproduceliquidorgaseoushydrocarbonsontheproperty;....91

91 11 U.S.C. § 101(21A) (1993).

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Thesignificanceisthatanyagreementfortheassignmentofaninterestinanoilandgasleasethatincludes,asconsideration,thedefinedoperationsuponthepropertywillbeafarmoutunder§101(21A).Thisencompassesmanymoreagreementsandtransactionsthanpartiesintheindustrywouldnormallythinkofasbeingafarmout.Ifyourclientisanunrecordedinterestownerthroughadebtor,ifthepropertyinterestcanbedefinedasa“farmout”under§101(21A),andifyourclientprovidedpartofthecapitalthatenabledthedebtortoperformoperations,then§541(b)(4)(A)(i)maygiverelief.Ifso,therearetwosubstantialbenefitstotheunrecordedinterestowner:(i)theunrecordedinterestowner’sshareisnotpropertyoftheestateand(ii)theownercansuccessfullydefendagainstanavoidanceaction.

Asstated,whatiscreatedby§541(a)(definingpropertyoftheestate)isthenlimitedby§541(b)(4),whichprovides:

(b)Propertyoftheestatedoesnotinclude—. . . .

(4)anyinterestofthedebtorinliquidorgaseoushydrocarbonstothe extent that –

(A)(i)thedebtorhastransferredorhasagreedtotransfersuchinterestpursuanttoafarmoutagreement;and

(ii)butfortheoperationofthisparagraph,theestatecouldincludetheinterestsreferredtoinclause(i)onlybyvirtueofsection365or544(a)(3)ofthistitle;or

(B)(i)thedebtorhastransferredsuchinterestpursuanttoawrittenconveyanceof aproductionpayment to an entity that doesnotparticipate in the operation of the property from which such productionpaymentistransferred;and

(ii)butfortheoperationofthisparagraph,theestatecouldincludetheinterestreferredtoinclause(i)onlybyvirtueofsection542ofthistitle;....92

92 11 U.S.C. § 541(b)(4) (Supp. 1998).

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Clearly,§541(b)(4)(A)isintendedtoapplytofarmouts,primarilythoseinwhichthedebtoristhefarmor.Bytheoperationof§541(b)(4)(A),thedebtor-farmorisnotabletowithholdfromitsfarmeeanassignmentofaninterestifitisotherwiseearned.Thereferenceto§365isintendedtonegatethedebtor’sabilitytorejectanotherwiseearnedfarmoutasanexecutorycontract.Afarmoutthatisincompleteonthedatethedebtorfilesbankruptcyis probably an executory contract capable of rejection,93 though § 541(b)(4)(A) prevents that rejection from having the effect of terminating the farmee’s right to receive an assignment of its interest. The reference to § 544(a)(3) declaresthatthefarmee’srighttoanassignment(ifitisotherwiseproperlyearned)maynotbedefeatedbythefactthatthefarmee’sinterestisnotofrecord.Section544(a)(3)probablywouldotherwisehavethiseffectbecausethatsectionenablesadebtortoavoidanassignmentofpropertytoanotherifabonafidepurchaserforvaluecouldtaketitlesuperiortotheassignee.

Amoredifficultquestionarisesfromthefactsituationwherethedebtoristhefarmeeandpromisedtosell,oractuallysold,intereststothedebtor’sassigneesbutsuchassignmentsarenotofrecord.Inthatcase,does§541(b)(4)(A)(i)provideanysolacetotheunrecordedinterestowner?Afirstreadingofthestatutewilldemonstratethatitdoesnotreallyaddresstheissuebecauseitiscouchedintermsofthedebtorbeingthefarmor.Asaresult,theanalysismay fall back on the issue of whether the farmout is an executory contract capableofbeingassumedunder11U.S.C.§365.

Ifthefarmoutisassumed,thenwhatabouttheundividedintereststhatthefarmee(inthisexample,thedebtor)contractedtoassigntoothers?Somebenefitmaybegleanedfromthewords“pursuanttoafarmoutagreement”in§541(b)(4)(A)(i).Ifthedebtoracquiredaleaseholdinterestthroughbeingafarmeeofafarmout,promisedtoassignaninterestintheearnedfarmoutacreagetoathirdparty,andifsuchfarmoutcanbeassumedunder§365,doessuch a “transfer” of an interest fall within the phrase “pursuant to a farmout agreementoranywrittenagreementdirectlyrelatedtoafarmoutagreement...”?Onepossibleresolutionisthatifthedebtor’sfarmoutagreementhasno

93 In re Texaco, Inc.,79B.R.560,563(Bankr.S.D.N.Y.1987).

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referencetothirdparties,thentheobligationtotransfertosuchthirdpartiesisprobablynot“pursuantto”thefarmoutagreement.Ontheotherhand,ifthedebtor’sabilitytoperformunderthefarmout(throughcashorothercapitalinfusion)arisesinpartfromtheassignmenttothirdparties(whichis commonly the case), then suchassignmentmay (andperhaps should)be“directlyrelatedto”thefarmoutagreement.Otherconstructionsofthestatutory language are, of course, possible.

Ifthedebtorisafarmorunderafarmout,thepropertyinterestthatis(orwillbe)earnedbythefarmeeisnotpropertyoftheestateexcepttotheextentofthecontractrightsofthefarmorunderthefarmoutagreement.94 Thatis,thedebtor/farmorcannot“reject”thefarmoutandtakeawaythefarmee’s right to earn title.

[2] — The Problem with the “Fat Farmout Agreement.” Whatabouta situationwhere theDebtorhasbeenpaid twomillion

dollarstofarmoutanareainwhich10wellscanbedrilledand10separateassignmentswillbemadefortheacreagesurroundingthewells.Atthetimeoffilingofthepetition,threewellshavebeendrilled.Clearlythefarmeehasearnedthatacreage.Butwhatabouttherightstoearntheacreagefortheothersevenwells?Theanswerisnotclearbutwesubmitthefarmeeshouldbeentitledtodrillandearntheremainingacreage.

§ 7.07. The § 541(b)(4)(B) Safe Harbor for Recipients of Production Payments. Section541(b)(4)(B)oftheBankruptcyCodeprotectstheassigneesof

productionpaymentsandmakesclearwhathasgenerallybeenconsideredtobethelawbypractitioners,thatis,thattheassigneeofaproductionpaymenttakestitletopropertyand,asaresult,suchproductionpaymentceasestobeproperty of the estate.95Section541(b)(4)oftheBankruptcyCodeprovides:

94 11 U.S.C. § 541(b)(4)(A).95 E.g.,TerryOilfieldSupply,195B.R.at74(productionpaymentisownershipofrealpropertyinterestandnotpropertyofestate).

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(b)Propertyoftheestatedoesnotinclude—. . . .

(4)anyinterestofthedebtorinliquidorgaseoushydrocarbonstothe extent that —

(A)(i)thedebtorhastransferredorhasagreedtotransfersuchinterestpursuanttoafarmoutagreement;and

(ii)butfortheoperationofthisparagraph,theestatecouldincludetheinterestsreferredtoinclause(i)onlybyvirtueofsection365or544(a)(3)ofthistitle;or

(B)(i)thedebtorhastransferredsuchinterestpursuanttoawrittenconveyanceofaproductionpaymentto an entity that does not participate in the operation of the property from which such productionpaymentistransferred;and

(ii)butfortheoperationofthisparagraph,theestatecouldincludetheinterestreferredtoinclause(i)onlybyvirtueofsection542ofthistitle;....96

The limiting language ‘to an entity that doesnotparticipate in theoperationoftheproperty’isapparentlyintendedtoapplytoentitieswhoprovidefinancingonlyandwhodonotparticipate inoperations.97 This is unfortunate language because it is not uncommon for one party to take aproductionpayment as compensationwhileproviding serviceson theproperty,sometimesevenconductingoperations.98 By negative implication, § 541(b)(4)(B)(i) may cause someone to believe that “property of the estate” under§541(a)picksupanassignmentofaproductionpaymenttoanentitythat participates inoperations. If so, thiswouldbe anunfortunate andprobablyunintendedresult—certainlycontrarytopreexistinglaw.

Whenthedebtoristhefarmee,thefarmoutagreementisanexecutorycontractandthedebtormustcureprepetitiondefaultsandprovideadequateassurance of future performance.

96 11U.S.C.§541(b)(4)(Supp.1998)(emphasisadded).97 11 U.S.C. § 541(b)(4)(B)(i).98 E.g.,TerryOilfieldSupply, 195 B.R. at 70.

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Certaintypesofproductionpaymentsarenotpropertyoftheestate.99 Mostpractitionersneverbelievedthatproductionpaymentswerepropertyof the estate.100 Because of the § 541(b)(4)(B) safe harbor, we know that one specifictypeofproductionpaymentisnot.Whatabouttheothers?

Furthermore,so-called“productionpayments”mayberecharacterizedasloansandthusnotsubjecttothesafeharborunder§541(b)(4)(B).101

§ 7.08. In Texas, the Priority of a Mineral Contractor’s Lien Is Determined by the Date of First Work, All Lien Claimants Share Pro Rata, and the Lien Attaches to the Greater of the Customer’s Legal or Equitable Title.

Oil&gascontractors’lienclaimscomeintoexistenceonthedateoffirstworkbutdonothavetobeevidencedbyarecordedlienaffidavituntilastatutoryperiodafterthedateoflastwork(solongasthereiscontinuousintervening work). For priority purposes, the contractors’ lien claims incept backtothedateoffirstwork.InTexassuchlienclaimantsnormallyhavetherighttoshareandsharealikeuponforeclosurebyanysinglelienclaimant(other states suchasMississippigobyfirst-filed lien).Contractors’ liens(with certain exceptions) attach only to the leases upon which services or materialswereprovided.

Texashas statutorilyprovided lien rights tomineral contractorsandsubcontractors.102 Texas mineral contractors, § 56.001(2), receive a lien to securepaymentforlabororservicesrelatedtomineralactivities.103 The propertysubjecttothelienistheleasehold(butnotthefee,§56.003(b))andrelatedpropertyandequipment.Tex.Prop.Code§56.002.Theamountsecuredisnomorethantheamountcontractedfor.Tex.Prop.Code§56.006.

99 11 U.S.C. § 541(b)(4)(B).100 TerryOilfieldSupply, 195 B.R. at 70.101 See PSI,Inc.ofMo.v.Aguillard (In re Senior-G&AOperatingCo.),957F.2d1290,1296(5thCir.1992)(lookingtothesubstanceof“ProductionPaymentLoanAgreement”anddeterminingthatthetransactionwasaloanratherthanthetransferofamineralinterest).102 Tex.Prop.Code§56.001et seq. (Vernon 1995).103 Id. § 56.002.

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For purposes of enforcement, mineral liens incorporate the provisions of mechanic’s, contractor’s or materialman’s liens from Chapter 53 of the Tex. Prop.Code§56.041(a).

[1] — Date of Inception for Purposes of Priority. UnderTexaslaw,amineralcontractorhassixmonthsfromthedateof

accrualofindebtednessinwhichtofilethelienaffidavit.104 The contractor mustprovideanoticeofintenttofilealienatleast10daysbeforefilingthelienaffidavit.105

Forpurposesofpriority,themineralcontractor’slien(andsubcontractor’slienifotherwisevalid)inceptsbacktothedateoffirstwork,providedthatthelienisotherwisetimelyfiled.106Thedateof“priority”seemstobethedateoffirstworkregardlessofwhetherthatworkwaspaidforornot.107 All mineral lien claimants share pro rata in recoveries from the collateral.108 Because they share pro rata, it is unclear whether the priority of the earliest mineralcontractorwillbesufficienttoprimeaninterveningmortgageforthebenefitofalllienclaimants.

[2] — Where to File the Lien Affidavit. UnderTexaslaw,amineralcontractororsubcontractormustfilethe

lienaffidavitwiththecountyclerkofthecountyinwhichthepropertyislocated.109Thestatutedoesnotaddresstheperfectionofalienonleasesoutsideanycounty,asinthecaseofOuterContinentalShelf(OCS)leases.

104 Id. § 56.021(a).105 Id. § 56.021.106 Id. §53.124(a)(commencementofconstructionofimprovementsordeliveryofmaterials)asincorporatedby§56.041(a).107 GrassoProd.v.BMOFin.Inc. (In re Century Offshore Mgmt. Corp.),83F.3d140,141(6th Cir. 1996) (Louisiana lien law).108 Tex.Prop.Code§53.122(a),asincorporatedby§56.041(a).LaneWellsCo.v.ContinentalEMSCO Co.,397S.W.2d217,219-20(1965);In re MEGPetroleumCorp., 61 B.R. 14, 21 (Bankr.N.D.Tex.1986)(“Butsinceholdersofcompetingmechanic’sandmaterialmen’slienshaveequalpriority,AWSandHalliburtonmustshareNetProductionIncomepaymentsattributable to the Lopez Creek lease on a pro rata basis.”).109 Tex.Prop.Code§56.021(a).

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[a] — Where to File a Mineral Contractor’s or Subcontractor’s Lien Against an OCS Lease.

ThefederalsystemdoesnotestablishamechanismforfilingorperfectingoilandgascontractorandsubcontractorliensagainstOCSleases.Asaresult,earlycasesrecognizedsomeuncertaintyastowheretofileliensagainstOCSleases.110 O’KaneandBolackappeartorecognizetheexistenceofa“voidorgap”infederallawapplicabletotheperfectionofoilandgascontractor’sliensagainstonshorefederaloilandgasleases.111Morerecentcasesconfirmedwhat appears intuitive, i.e.,thatintheabsenceofanyexpressfederalorstatelaw,thelienaffidavitshouldandmustbefiledwiththecountyclerkoftheadjacentparishorcounty.112

[b] — The Reach and Extent of a Mineral Contractor’s Lien.

Amineralcontractor’slieninTexasreachesonlytotheleaseholdinterestof the party contracting with the contractor, as well as improvements.113 It is

110 E.g.,O’Kanev.Walker,561F.2d207(10thCir.1977);Bolackv.Underwood,340F.2d816 (10th Cir. 1965).111 Id.112 Union Texas Petroleum Corp. v. PLT Eng’g, Inc.,895F.2d1043(5thCir.1990)(holdingthatcontractorswereentitledtoLouisianalienseventhoughtheleaseswerenotlocatedwithinaparish;alsoholdingthatfilingofliennoticewithintheparishrecordsoftheparishadjacenttotheOCSleasewasproper);WorldHospitality,Ltd.v.ShellOffshore,Inc., 699 F.Supp.111,113-14(S.D.Tex.1988)(offshorecateringservicewasheldtohavealienunderTexasstatuteagainstanOCSlease;liensfiledwithMMSfoundineffectivebutliensfiledintwoTexascoastalcountiesadjacenttoleasesheldtoperfectliens).But see St. Mary Iron Works, Inc. v. McMoRan Exploration Co.,802F.2d809(5thCir.1986),op.withdrawn,809F.2d1130(5thCir.1987)(Louisianalawrequiredfilingsintheparishwherethepropertywaslocatedtoperfectavalidlien;thereisnostatutorymeansoffilingwhenpropertyisontheOCSandthus,courtheld,plaintiffhasnolien.Opinionwaswithdrawnbecauseofalatercaseholdingthatnolienfilingisrequiredtoperfectalien.)113 Tex.Prop.Code§56.003(a).BethlehemSupplyCorp.v.WotolaRoyaltyCorp., 165 S.W.2d443,445(Tex.1942);YoungstownSheet&TubeCo.v.Penn,355S.W.2d239,245-46 (Tex. Civ. App. 1962), aff’d in part and rev’d in part on other grounds,363S.W.2d230(Tex. 1962).

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wellestablishedinTexasthatamineralliendoesnotextendtotheproductionfromtheleasebutonlytotheleaseholdinterestitself.114

ItissettledunderTexaslawthattheholderofalienontherealestate(including theMinerals)doesnothave a lienon theProductionbecause it is personal property. . . . This is true even where the lien ontherealpropertyisamechanic’slienforworkperformedonanoilandgaswell.115

The astute practitionerwill immediatelynote that themineral lienclaimant,becausehehasnolienonproduction,issubjecttobeingdepletedduringthependencyofthebankruptcyunlessheeitherproceedstoforecloseor is granted a substitute lien toprotect against depletion.The latter isnormally the proper result.

[c] — How to Foreclose a Mineral Contractor’s and Subcontractor’s Lien.

Amineral lien is foreclosed in the samemanner as amechanic’sandmaterialman’s lien, pursuant toChapter 53.116Amechanic’s andmaterialman’slienmaybeforeclosedonlybyajudicialforeclosure.117

[d] — Practice Tip. Ajudicialforeclosuremaytakesometimeand,inthemeantime,the

wellisbeingdepleted.Thesolutionistohaveareceiverappointedtocollect

114 UnitedStatesv.TexasEasternTransmissionCorp., 254 F. Supp. 114 (W.D. La. 1965) (courtshaveconsistentlyheldthatsincetheproceedsofanoilandgaswellwerenotexplicitlylistedinArt.5473(predecessorofTex.Prop.Code§56.003),theywerenotsubjecttothemechanic’sandmaterialman’slien);Hessv.BankofOklahoma (In re Hess), 61 B.R. 977, 979 (Bankr. N.D. Tex. 1986).115 Id. In re Hess,61B.R.at978(citingWilkinsv.Fecht,356S.W.2d855(Tex.Civ.App.1962);Crowleyv.AdamsBros.&Prince,262S.W.883,884(Tex.Civ.App.1924));UnitedStates v. Texas Eastern Transmissions Corp., 254 F. Supp. 114, 119 n.13 (W.D. La. 1965) (construingTexaslaw,holdingthatlienonlyattachestotheleaseholdandnottotheoilandgasproduced).116 Tex.Prop.Code§56.041(a).117 Id. § 53.154.

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andhold theproceedsofproductionuntil the court adjudicates the lienforeclosure.118

[3] — Interplay Between Mineral Liens and Blanket Mortgages: Priority and Allocation.

Itiscommonforaservicecompanytoprovideservicesonlytoawell,lease,orseriesofwellsandleases,butnotuniformlyonallofthedebtor’sproperties. Indeed, itwouldbeunusual for theservicecompany tohaveprovided the identical services to all properties ownedby a particularcustomer.Abank,on theotherhand,commonlysecures itsdebtwithablanketmortgageonall propertiesof thedebtor,wherever located.Themineralliensandthebank’smortgagecommonlycompeteinbankruptcyfortheequityinthedebtor’sproperties.Thethresholdissueisthatofpriority.Thebank’spriorityastothedebtor’spropertiesinagivencountyorparishwillbedeterminedbythedateoffilingthemortgageinthatjurisdiction.Thesameistrueformineralliensexceptthatthosestatutorilygetthebenefitofasix-monthreachbackbeforethedateoffilingthelien,andtheninceptbackthroughallworktothedateoffirstwork.119

Oncethethresholdissueofpriorityisdetermined,usuallyonacountyby county or parish by parish basis, the next question is one of allocation. Considerthefollowingillustration:Assumethebankisowed$10millionandhasafirstlienagainstallassetsofdebtor,whichconsistoffourpropertiesworth$5million,$3million,$2million,and$1million,respectively,foranaggregatevalueof$11million.Theoreticallythereis$1millionofequityformineralcontractors’liens—butfromwhichpropertydoesthe$1millioninequitycome?Themineralcontractors’liensonlyattachtospecificproperties.Ifthereare$6millioninmineralcontractors’liensagainstthe$5millionproperty, then how can we say there is equity in that property if it is worth only$5millionandhas$10millionofbankdebtagainstit?Thisraisestheissueofmarshaling,anequitableconceptthatisnotwelldefinedinTexas,Louisiana, or in bankruptcy.

118 SeeTex.Prop.Code,§§53.154,56.041,andTex.Civ.Prac.&Rem.Code§64.092.119 Id. at § 53.154.

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Marshalingisbeyondthescopeofthispaperbut,briefly,isthedoctrinebywhichajuniorcreditormayrequireaseniorcreditortolooktoaspecificitemofcollateralfirstifitmakesnodifferencetotheseniorcreditorbutmakesagreatdealofdifferencetothejunior.120

Inourexample(andinmostoilandgasbankruptcies),nomatterwhichwaythebankallocatesitsdebt,someminerallienclaimantwillsufferinjury.Inthevastmajorityofcases,theresolutionhasbeenanegotiatedoneinwhichthebankdebtisspreadoverallthepropertiesproratainaccordancewith some known measure of value. The absolute values of the properties constitutingthebank’scollateralneednotbeknownbuttherelativevaluesare critical. For example, if one property is worth twice as much as another, itoughttobeartwiceasmuchofthebank’sdebt.Note,however,thatthereis no clear authority for accomplishing this other than inherent fairness. Also note that these issues are not unique to bank mortgages — the same principleswouldapply toanycase inwhich thesenior liencoversmorecollateral than the junior lien.

[a] — Texas Mineral Subcontractor’s Liens. The Texas mineral subcontractor’s lien statute appears to create a lien

ontheleaseholdandtheimprovements,§56.003(a),butitisuncleartowhatextentthisreallyoccurs.Section56.006providesthattheownerisneverliableformorethantheamountcontractedfor,and§56.043statesthattheownermaywithholdpayment to thecontractoronce the subcontractor’snoticeisserved.Theownerisnotliabletothesubcontractorformorethan

120 E.g., In re JackGreen’sFashionsforMen–BigandTall,Inc.,597F.2d130132-33(8thCir.1979)(juniorlienholderwantedthefirstlienholdertopursueguarantor’scollateralpriortopursuitofdebtor’scollateral;courtgrantedtherequestandorderedmarshalling).But see In re Mesa Intercontinental, Inc.,79B.R.669,672n.1(Bankr.S.D.Tex.1987)(describingJack Green’sasunclearlyreasoneddeparturefrommajorityrule).In re SanJacintoGlassIndustries,Inc., 93 B.R. 934, 938 (Bankr. S.D. Tex. 1988) (“The hallmark of the marshaling doctrineiscontainedintherequirementthatonecreditoralonehaveaccesstomorethanoneofthedebtor’sassetsbywhichtorealizeitsclaim.Inequity,theparamountcreditor’spowertomakediscretionarychoicesregardingsourcesofrepaymentshouldbetemperedbutonlytotheextentnecessarytoinsurethatotherdeservingcreditorsbesparedneedlessadverseeffects.”).

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the amount that the owner owes the original contractor when the notice is receivedbyhim.121

The result is that the Texas mineral subcontractor’s lien is, in essence, nothingmorethanatrappingstatutesimilartoTex.Prop.Code§53.082,partof the Mechanic’s, Contractor’s, or Materialman’s Lien Statute.122 The basic principleisthattheservicecompanywhocontractsthroughtheoperatorandperfectsasubcontractor’slienisentitledtoalienonallamountsduefromnon-operators to the operator.123

Thecharacteristicsofcontractorandsubcontractorcanbecomeblurred.Inthetypicaltransaction,theoperatorcontractsdirectlywithvendorsbutthenon-operatorsdonot.Aservicecompanycontractingwiththeoperatorisa contractor as to the operator (if the operator owns an interest in the lease) but a subcontractor as to non-operators.124 In that example, the service companywouldneedtoperfectitslienbothways,firstasasubcontractorandsecondasacontractor.

Thesubcontractor,asaconditionofperfectingthesubcontractor’slien,mustserveontheowneranoticeofclaimofliennotlaterthan10dayspriortofilingtheaffidavit.125 Do not fall into the trap of serving the notice on the operator only, because the operator is not the agent of the non-operators (owners) for purpose of the statutory notice.126

121 Tex.Prop.Code§56.043.ContinentalCasingCorp.v.SamedanOilCorp.,751S.W.2d499(Tex.1988);Energy–AgriProductsInc.v.EisenmanChem.Co.,717S.W.2d651,653(Tex.Ct.App.1986);DuniganTool&SupplyCo.v.Burris,427S.W.2d341(Tex.Civ.App.1968).122 FirstNat’lBankinGrahamv.Sledge,653S.W.2d283,286(Tex.1983)(“Article5463isa‘trapping’statute.Itprovidesthesubcontractorscantrap,intheowner’shands,fundspayable to the general contractor if the owner receives notice from the subcontractors that theyarenotbeingpaid.”).123 YoungstownSheet&TubeCo.v.LuceyProductsCo.,403F.2d135,141-43(5thCir.1968);Wilsonv.SherwinWilliamsPaintCo.,217S.W.372-73(Tex.1919).124 EnergyFundofAmerica,Inc.v.G.E.T.ServiceCo.,610S.W.2d833,836(Tex.Civ.App.—Eastland1980),aff’d in part and rev’d in part on other grounds sub. nom. Ayco Dev. Corp.v.G.E.T.ServiceCo.,616S.W.2d184(Tex.1981).125 Tex.Prop.Code§56.021(b).126 Burk Burnett-Mann Oil Co. v. Robertson, 240 S.W. 1046-47 (Tex. Civ. App. 1922).

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[b] — No Constitutional Lien for Mineral Contractors in Texas.

InTexas, themineralcontractororsubcontractor isnotentitled toaconstitutionallien.OrdinarymechanicsandmaterialmencanobtainalienonaconstructionprojectpursuanttotheTexasConstitution:

Sec.37.Mechanic’s,artisansandmaterialmen,ofeveryclass,shallhavea lienupon thebuildingsandarticlesmadeor repairedbythemforthevalueoftheirlabordonethereon,ormaterialfurnishedtherefor;andtheLegislatureshallprovidebylawforthespeedyandefficientenforcementofsaidliens.127 However, this does not apply to oil and gas contractors and

subcontractors.128

[c] — What and Whose Interest Is Attached when the Mineral Lien Claimant Files His Lien?

Itiscommonforapromoter/operatortocontractwithservicecompaniesforworkonleasesatatimewhenrecordtitleisinastateofflux.Atatimewhenfarmoutsandletteragreementsareubiquitousandrecordtitletendstoplaycatch-upatalaterdate,thereisasubstantialquestionastowhataminerallienattaches,dependinguponthestateoftitle.Asabasicruleofthumb,theminerallienclaimantwhoproperlyfilesandperfectsitslienisentitledtoalienagainstthegreateroftherecordedinterestortheequitableinterestofits customer.129 The possible permutations on the state of title are extensive.

127 Tex. Const art. XVI, § 37.128 MidAmericaPetroleumInc.v.AdkinsSupply, Inc. (In re MidAmericaPetroleum,Inc.),83B.R.937,943(Bankr.N.D.Tex.1988)(oilandgaslienclaimantsaregenerallynotentitledtoassertthebenefitsoftheconstitutionalliencontainedinArt.XVI,§37oftheTexasConstitution);OilFieldSalvageCo.v.Simon,168S.W.2d848,851(Tex.1943)(confirmedtheholdingofBallastounavailabilityofaconstitutionallienforlaborersandmaterialmenintheoilandgasindustry);Ballv.Davis,18S.W.2d1063,1066-67(Tex.1929).129 E.g.,McCartyv.HalliburtonCo.,725S.W.2d817,821(Tex.Ct.App.1987).

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[4] — The Construction Trust Fund Statute and Its Application to Oil and Gas. For the sake of completeness, it is worth noting that a contractor in

theconstructionindustrywhoreceivesfundsintendedforthepaymentofsubcontractorsisthetrusteeofastatutorytrustcreatedforthebenefitofthe subcontractors.130 The statutory requirements for the creation of such atrustarethat:

(a)Constructionpaymentsaretrustfunds...ifthepaymentsaremade . . .underaconstructioncontract for the improvementofspecificrealpropertyinthisstate.

(b)Loanreceiptsaretrustfunds...ifthefundsareborrowed...forthepurposeofimprovingspecificrealpropertyinthisstate,andtheloanissecuredinwholeorinpartbyalienontheproperty.131

Thebeneficiariesofthetrustare,broadlyspeaking,theworkersandsubcontractorswhoprovidelabor,materialsandservicesforthe“constructionorrepairofanimprovementonspecificrealpropertyinthisstate....”132

The trusteewhomisapplies such trust funds by failing to pay thebeneficiaries commits aClassAmisdemeanoror a thirddegree felony,dependingontheamountofmoneyinvolved.133Misapplicationoccurswhen:

(a) A trustee who, intentionally or knowingly or with intent to defraud,directlyorindirectlyretains,uses,disburses,orotherwisedivertstrustfundswithoutfirstfullypayingallcurrentorpastdueobligationsincurredbythetrusteetothebeneficiariesofthetrustfunds,hasmisappliedthetrustfunds.134

Therearecertainaffirmativedefensestoanactionformisapplicationoffiduciaryfunds.

130 Id. at § 162.002.131 Id. at § 162.001(a)-(b).132 Id. at § 162.003.133 Id. at § 162.032.134 Id. at § 162.031(a).

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Thestatutewaswrittenwith the realestateconstruction industry inmind;however,itwouldseemthataproducingoilandgaswellisorcouldbeanimprovementtorealproperty.Anoldercaseheldtheidenticalstatute,beforecodification,tobeapplicabletotheoilandgasindustry.135 A more recentcasehasheldthatthestatutedoes notapplytofundspaidtooperatorsforthepurposeofdrillingoilandgaswells.

Thedrillingofanoilwelldoesnotinvolveconstruction,inthesenseofassemblingmaterialstomakeapermanentwhole.Thedrillingrig,itself,isnotapermanentfixture,butratherisremovedfromthewellsiteafterdrilling iscompleted.Drillingahole in thegrounddoesnotinvolvetheassemblyofvariousmaterialsintoapermanentstructure.Theonlypermanentconstructioninvolvedindrillinganoilwellisthecasingpipewhichisputintotheholeinordertopreservetheholeandpreventtheearthfromcollapsingintoit.Insum,thisCourtconcludesasamatteroflawthatdrillinganoilandgaswellisnot the construction of an improvement on real property within the meaningofChapter162ofthePropertyCode.136

Weobservethatwhetheraparticularwellisan“improvement”wouldappear to be a question of fact for the jury.

§ 7.09. Whether the Mineral Lien Contractor Has an Interest in the Proceeds of Production as Cash Collateral.

Whetheracreditorhasaninterestincashcollateralisoftencriticallyimportantinthefirstdaysofanybankruptcycase.Amineralliencontractorin Texas probably can have an interest in cash collateral if his lien claim is properlyperfected,thoughthisisnotcertain.

135 TritonOil&GasCorp.v.E.W.MoranDrillingCo.,509S.W.2d678,687(Tex.Civ.App. 1974).136 Holleyv.NLIndus./NLAcmeToolCo.,718S.W.2d813,815(Tex.Ct.App.1986).

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[1] — The State Law Problem. The problem for the mineral lien contractor is that Texas law clearly gives

the lien claimant a lien against the minerals but notagainsttheproceeds.137 Thus,iftheanalysisendedhere,theminerallienclaimantinTexaswouldhave no interest in cash collateral.

From a practical perspective, this is a serious problem for the lien claimant becausethecollateral(theproducingwells)aredepletingthereserves,andthusdepletingthevalueofthecollateral.Inmostbankruptcies,theproceedsofproductiongotopaythecostsofadministrationofthebankruptcyestateand,absentspecialrelief,theminerallienclaimantgetsnosubstitutelienor enhancement of collateral elsewhere to compensate for the loss of value throughproduction.Thus,theminerallienclaimant,fromaneconomicpointofview,needseitheradequateprotection,aninterestincashcollateral,orasubstitutelientoreplacedepletion.

[2] —The Bankruptcy Law Issue. Notwithstandingstatelaw,theBankruptcyCodegivesalienclaimant

aninterestincashcollateralifitisthe“proceeds”ofpropertyinwhichtheclaimanthasasecurityinterest.Section363(a)states:

(a) . . .[“C]ash collateral” means cash, . . . or other cash equivalents whenever acquired . . . and includes the proceeds, products,offspring,rents,orprofitsofproperty...subjecttoasecurityinterestasprovidedinsection552(b)ofthistitle,...138

Atfirstblush,thisappearstogivetominerallienclaimantsaninterestincashcollateralas“proceeds,products, . . .”ofpropertysubject to themineralclaimants’lien.However,oncloserreview,§552(b)islimitedtoconsensual security interests whereas the mineral lien claimants’ rights arisebystatute.ItishardtoimaginethattheBankruptcyCoderecognizes

137 UnitedStatesv.TexasEasternTransmissionCorp., 254 F. Supp. 114 (W.D. La. 1965) (courtshaveconsistentlyheldthatsincetheproceedsofanoilandgaswellwerenotexplicitlylistedinArt.5473(predecessorofSec.56.003),theywerenotsubjecttothemechanic’sandmaterialman’slien);Wilkins,356S.W.2d855(citing Crowley, 262 S.W. 883).138 11 U.S.C. § 363(a).

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asecuredcreditor’sinterestincashcollateralcreatedbyaconsensuallienbutdeniesittoaclaimantwhoselienarisesbystatuteonly.Butthatmaybetheoutcomeif§363(a)isreadliterallyandinconjunctionwith§552(b).

[3] — The Resolution. Fortunately for the lien claimant, Texas law gives that party the

opportunitytoseizetheproceedsofawellpendingajudicialforeclosureofthe lien,139andtheappointmentofareceiverforsuchpurposeisexpresslyrecognizedin§64.092,Tex.Civ.Prac.&Rem.Code.TheBankruptcyCodegives a lien claimant the right to effectuate the equivalent of such a seizure under§546(b)(1)and§362(b)(3)bygivingnoticetothedebtorandthecourtof the claimant’s assertion of such a right.140

Weconclude,therefore,thataminerallienclaimantwhotakestheproperstepsandgivessuchnoticehasaninterestincashcollateral.

[4] — An Alternative Resolution. Because the mineral lien claimant unquestionably has an interest in the

underlyingmineralestateownedbyhiscustomer,thelienclaimantisentitledtoadequateprotection.Sinceproductiondepletesthecollateralduringthependencyofthecase,theminerallienclaimantcouldfileamotionunder§362tocompelthegivingofadequateprotection.Dependingupontherelativevalues, such a motion may achieve the same outcome as an interest in cash collateral,dependinguponwhetherthereisanadequateequitycushionorother alternative protection for the lien claimant’s economic interest.

Undereithertheory,whetheraninterestincashcollateralorviamotionforadequateprotection,wesuggestthatminerallienclaimantsareentitledto a substitute lien in other assets of the estate to secure the amount of

139 Tex.Prop.Code§§53.154,56.041.140 See Casbeerv.StateFed.Savings&LoanAssoc.ofLubbock (In re Casbeer),793F.2d1436,1443(5thCir.1986)(motiontoliftstayandcomplaintforinjunctivereliefsufficienttoperfectsecurityinterestinrents);MarylandNat’lBankv.MayorandCityCouncilofBaltimore(InreMarylandGlassCorp.),723F.2d1138(4thCir.1983);Taylorv.Brennan,621S.W.2d592,594(Tex.1981).Ananalogousrightisfoundintheareaofrealpropertyrents, see In re VillageProps.,Ltd.,723F.2d441(5thCir.1984),cert. denied sub nom. WoltersVillage,Ltd.v.VillageProps.,Ltd., 466 U.S. 974 (1984).

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diminutioninvalueoftheireconomicinterestinthecollateral,ifany,duringthependencyofthecase.

§ 7.10. The Automatic Stay of § 362 Does Not Prohibit Perfecting a Contractor’s Lien If, Under State Law, a Bona Fide Purchaser for Value Does Not Cut Off the Rights of the Lien Claimant.

Theautomaticstayof11U.S.C.§362(a)doesnotpreventthefilingofnoticesoraffidavitsthatareaprerequisitetoperfectingastatutoryoilandgas contractor’s lien.141Thestatutorybasisforthisruleisfoundin11U.S.C.§362(b)(3)and§546(b)(1).However,inorderfortheclaimanttobeabletofilenoticeofperfectionofthelienpost-petition,itisnecessarythatstatelawprovidethatabonafidepurchaserforvaluebesubjecttosuchliens.TheMississippilienstatute,forexample,providesthataBFPcutsofftherightsoflienclaimantsuntilthelienaffidavitisfiled.142ForalienfiledagainstaMississippimineralproperty,therefore,§362(a)oftheBankruptcyCodewouldlikelyprohibittheperfectionofsuchalienpost-petition.

[1] — Whether It Is Necessary to File Suit Post-petition to Avoid the Lien Being Lost.

Thetimewithinwhichtofileanactiontoforecloseamineralcontractor’slienistolledby11U.S.C.§108(c).143

141 In re Houts,23B.R.705(Bankr.W.D.Mo.1982)(courtholdsthatfilingofmechanic’slien statement was allowable in spite of the stay, though further enforcement of the lien was stayed.)See also In re YobeElec.,Inc.,30B.R.114,11618(Bankr.W.D.Pa.1983).142 MississippiCodeAnn.§85-7-131,85-7-133(1972).143 MinerCorp.v.HuntersRunLtd.P’ship (In re HuntersRunLtd. Part’ship),875F.2d1425(9thCir.1989)(statelawrequiredclaimanttofileanactioninstatecourttoforeclosealienorelseloseit;thecourtholdsthat§362(a)stayedanyactiontoenforceamechanic’sandmaterialman’slien,andthat11U.S.C.§108(c)tolledthestatelawstatuterequiringsuittoenforcesame,sothatthelienclaimisstillgood);In reMorton,866F.2d561,566(2dCir.1989)(holdingthat§108(c)tollsNewYork’s10-yearperiodgoverningjudgmentliensonrealproperty);In re Phillips Constr. Co.,579F.2d431,43233(7thCir.1978)(notingthat In re Warren[citedbelow]isarguablydistinguishable);NashPhillips/Copus,Inc.v.El Paso Floor, Inc. (In re NashPhillips/Copus,Inc.), 78 B.R. 798, 802 (Bankr. W.D. Tex. 1987) (defendantfiled suit inColorado toenforceamechanic’s andmaterialman’s lienagainstpropertyofdebtor;foundnotpermittedby§546(b),andaviolationofautomatic

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Thetimewithinwhichtofileanactiontoforeclosealienisnottolledbythepredecessorto§108(c),ifthestatutebeingproceededunderisoneofdurationratherthanlimitation.144 Warrenholdsthatafailuretofilesuitduringbankruptcycausesthelientobelost.

In the case of a unit in a jurisdiction that treats a unit as a crossconveyance,thelienwouldattachtothecustomer’sproportionateshareoftheunitthatbenefitedfromtheservicesormaterials.Insomecases,aliencan attach to a “project” rather than a lease or a unit.145“Wheredifferentlotsortractsoflandarecontiguous,andaretreatedasasingletract,thelienstatutesdonotrequiretheaffidavitandaccounttostipulateonwhichtractthematerialwasdeliveredorused.”146Thisexceptionhasseldombeenapplied.

§ 7.11. Whether a Mineral Contractor’s Lien Rights Will Act as a Defense to a Preference Action.

Itiscommonforaservicecompanytoreceivepaymentforservicesandmaterialsrenderedduringtheperiodinwhichalienaffidavitcouldbefiledand,asaresultofpayment,toforegothefilingofthelienaffidavit.Infact,itwouldbeimpermissiblefortheservicecompanytostateinanaffidavit

stay;defendantwasprotectedby§108(c)ofCodeandneednothavefiledsuittoperfectitslien);In re Cantrup,38B.R.148(Bankr.D.Colo.1984)(filingnoticeofperfectionofmechanic’slienisallthatisnecessary.Filingsuitisnotnecessarytoperfectthelien);In re VictoriaGrainCo.ofMinneapolis,45B.R.2,6(Bankr.D.Minn.1984)(“...filingofmechanicslienstatementisperfectionofalienasthattermisusedin11U.S.C.§546(b).However,clearlythecommencementofforeclosureproceedingsissomethingotherthanperfectionofalien....”);In re NewEnglandCarpetsCo.,26B.R.934,939(Bankr.D.Vt.1983).(§546(b)appliestoperfectionoflienonly;enforcementisstayedby§362);In re Houts,23B.R.705,707(Bankr.W.D.Mo.1982)(§108(c)appliesand§546(b)doesnotbecause“[t]hecourtsdistinguish,andproperlyso,betweentheactofperfectingthelienandtheactofattemptingtoenforceit.”);In re DesignBuilders,Inc., 18 B.R. 392, 39495 (Bankr.D.Idaho1981);GarbeIronWorks,Inc.v.Priester,99Ill.2d84,75Ill.Dec.428,431,457N.E.2d422,425(1983)(§108(c)tollsIllinoismechanic’slienenforcementperiodeventhoughstatuteinvolved‘notanordinarystatuteoflimitationssinceitconditionstherighttoenforceamechanic’slienandnotjusttheremedy.’)144 In re Warren, 192 F. Supp. 801 (W.D. Wash. 1961) (applying § 11(f) of Act, which appliedonlytostatutesoflimitation);seeMinerCorp.v.HuntersRunLtd.Partnership(InreHuntersRunLtd.Partnership),875F.2d1425,1426andespeciallyn.3(9thCir.1989).145 OilFieldSalvageCo.v.Simon,168S.W.2d848,853(Tex.1943).146 Id. at 853.

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thattheamountstatedisdueandunpaid(whichisaprerequisiteforsuchalien)atatimewhensuchstatementwouldbefalse.Sadly,italsohappensthattheowner/operatormayfilebankruptcywithin90daysandcreatetheissueofwhethersuchpaymentisrecoverableunder11U.S.C.§547(b)(4)(A)asapreference.Mostpractitionerswillimmediatelynotethatiftheservicecompanywasfullysecuredatthetimeofpayment,thennopreferencecanhavebeenreceivedbecauseoneoftheelementsof§547requires,inessence,thatthepaymentbeonanunsecuredclaim.(Thisisanotherwayofviewingthe requirement that thepaymentmust have allowed thepayee tohavereceivedmorethanhewouldhavereceivedinachapter7liquidation.Thisissobecauseasecuredcreditorwhoreceivesapaymentwillalwaysfailtosatisfythe“morethanhewouldhavereceived”requirement.)

Theproblemarisesbecauseaservicecompany,inordertobesecured,hastofilethelienaffidavit.Bynotfilingit,theservicecompanyarguablywasneversecured.Doesthefactthattheservicecompanyreceivedpaymentwithin theperiodduringwhich ithad the statutory right tofile the lienaffidavit (and thusbecomesecured)operate toshield thecompanyfromliabilityforreceivingapreferenceunder§547?Onereporteddecisionheldthatpaymentinlieuofalienrightwherethelienwouldhavebeenagainstthedebtor’spropertyisnotapreference.147

In Cimmaron, certain consultants providedfield servicegeologicalservicestoCameronontwoofCameron’swells.Thecourtheldthat§547(c)(6)prohibitsthetrusteefromavoidingtheperfectionofatruestatutorylien.The“fixing”thatmaynotbeavoidedincludes“transfersinsatisfactionofliens.” “This interpretation of 547(c)(6), while faithful to congressional intent, obviatesthecommerciallyunreasonableconsequencesthatcouldresultifthetrusteewerepermittedtopayforalienor’sservices,therebyprecludingtheperfectingofthelien,andlateravoidthepaymentsaspreferences.ItisalsoconsonantwiththeCode’sintentingrantingavoidancepowertothetrustee.”148

147 Cimmaron Oil Co. v. Cameron Consultants, Inc., 71 B.R. 1005, 1011 (N.D. Tex. 1987).148 Id.

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Section547(c)(6),asinterpretedbythecourttoday,doesnotpermittheliencreditortoobtainfromthedebtoranygreaterinterestthanthecreditorwouldotherwisehaverealized.149 In BakerHughesOilfieldOperations,Inc.v.Cage(InreRamba,Inc.),

however,theFifthCircuitrejectedCimmaron’s analysis as being contraryto the statute.150However,thecourt’sstatementinBakerHughesOilfield maywellbedicta.Otherreporteddecisionshaveheldsuchpaymentstoberecoverable as preferences.151

Obviously,wherethelienwouldbeagainstpropertyofathirdparty(thatis,notpropertyofthedebtor),thenthepaymentisnotapreference.152

149 Id.;see also RandEnergyCo.v.StrataDirectionalTech.,Inc. (In re RandEnergyCo.), 259B.R.274(Bankr.N.D.Tex.2001)(preferentialtransfercouldnotbeavoidedbydebtorwhere,ifdebtorhadnotpaidcreditor’sinvoices,creditorcouldhaveperfectedastatutorylienunderstatelaw);Weillv.EvansLumberCo. (In re Johnson), 25 B.R. 889, 89294 (Bankr. E.D. Tenn.1982)(paymentofcreditorwhohadagoodlienclaimwasheldnottobeapreference);Ricottav.BurnsCoal&BuildingSupplyCo.,264F.2d749,75051(2dCir.1959)(“Surelyreceiptofpaymentitselfshouldnotbelesssecurethanthelienwhichcouldhavesecuredit.”);interpretingSec.67(b)oftheBankruptcyAct;itisnotclearfromthedecisionwhoownedthepropertyastowhichtheinchoatelienwouldhaveattached.However,thecourtdoessay:“Hadtheliensbeenfiled,paymentmerelydischargingthem,withoutimprovingthecreditor’spositionasagainstthegeneralcreditorsofthebankrupt,wouldlikewisehavebeenimmunefromattack.”);Greenblattv.Utley,240F.2d243,247n.10(9thCir.1956)(creditwhichdischargedunperfectedmechanic’s lienondebtor’spropertycouldnotbeavoidedasapreference).150 BakerHughesOilfieldOperations,Inc.v.Cage (In re Ramba, Inc.), 416F.3d394,401(5thCir.2005);see also St. Paul Travellers Ins. Co. v. Century Asphalt Materials, LLC. (In reContractorTechnology,Ltd.),529F.3d313(5thCir.2008)(Inchoatelienrightsarenotadefenseandfailuretocomplywiththelienstatutetimelyisnotexcusedbybeingpaid.Iflienclaimantissuedforapreferenceandpaysthepreferenceback,thetimetogivenoticeandfilealienisnotreinstated.Thereisnoequitabletolling.).151 In re Control Electric, Inc.,66B.R.624,62627(Bankr.N.D.Ga.1986);In re GeorgiaSteel,56B.R.509,522(Bankr.M.D.Ga.1985),rev’dBethlehemSteelCorp.v.Tidwell,66B.R.932(M.D.Ga.1986);In re GeorgeRodman,39B.R.855,858(Bankr.W.D.Okla.1984), rev’d792F.2d125(20thCir.1986);In re KenGardnerFordSales,Inc., 23 B.R. 743, 747(Bankr.E.D.Tenn.1982))(holdingapparentlylimitedtofactsofcase).152 4CollieronBankruptcy,para.67.22n.17ap.266267(14thed.1978);Langv.HeieckSupply (In re AndersonPlumbingCo.), 71 B.R. 19, 20 (Bankr. E.D. Cal. 1986) (“the payment bythecontractortothesupplierholdingalienonthirdparty’spropertyisnotpreferentialandthe release of the lien by accepting such payment constitutes a contemporaneous exchange ofnewvalue,givingrisetoanaffirmativedefenseasprovidedforinSection547(c)(1).”);

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Atroublingcase,findingananalogouspaymenttobeapreference,isGulf Oil Corp. v. Banque de Paris et des PaysBas (In re Fuel Oil Supply and Terminaling, Inc.).153 Fuel Oil Supplyisnotspecificallyamechanic’sandmaterialman’sliencasebutletterofcredit;howeverthereasoningisanalogousbecausetheletterofcreditissimilartohavingalienonpropertyofathirdparty.Fuel Oil Supply specificallyrejectsHenleyandAdvanced Contractors.

TheseminalcaseholdingsuchpaymentstobeapreferenceseemstobeSan Mateo Feed & Fuel Co. v. Hayward,154 although that case is not truly a mechanics’andmaterialmen’sliencase.InSan Mateo Feed, the bankrupt was aplastercontractorwhohadreceivedcheckspayablejointlytohimselfandmaterialmenwhohadfurnishedthebankruptplasteringmaterialsforuseinabuilding.155Withinfourmonthsofbankruptcythechecksweredeliveredtothematerialmen,therebyreducingthebankrupt’sindebtednessforthematerialsbutalsoreducingbyalikeamountthematerialmen’sacknowledgedliens on the building of thewriter of the checks.156 Nevertheless, the courtheldthedeliveryofthecheckstobepreferentialandrecoverywas

Cooleyv.GeneralElevatorCorp. (In re AdvancedContractors), 44 B.R. 239, 241 (Bankr. M.D. Fla. 1984), rejected, In reChase&SandbornCorp.,904F.2d588(11thCir.199)(“[T]heabandonmentoftherightofdirectactionasagainstathirdpartyconstitutespresentconsiderationwhichrepresentsnewvaluetothedebtor...“Id.at241.Becausethedebtorwouldhaveowedindemnitytothesuretyifthelienhadbeencollected,thereleaseofthelienrightwasvaluetotheDebtor);In re Flooring Concepts, Inc., 37 B.R. 957, 961 (B.A.P. 9thCir.1984);LaRosev.Crosby&SonTowing,Inc. (In re DickHenley,Inc.), 38 B.R. 210, 213 (Bankr. M.D. La. 1984), declinedtofollow,MatterofFuelOilSupply&Terminaling,Inc.,837F2d.224(5thCir.1988)(heldnottobeapreference,eventhoughthelienwasagainstthepropertyofathirdparty.“Anyotherresultwouldbeinequitable.”Id. at 215. “The release of the owner’s claim against the general contractor constitutes new value to thedebtorfromthesubcontractor....”Id. at 214. “The release of the owner’s claim against thegeneralcontractorconstitutesnewvaluetothedebtorfromthesubcontractor....”Id. at213);In re Coulter,6F.Cas.639(D.Or.1871)(arrivingatthesameconclusionundertheAct of 1867).153 GulfOilCorp.v.BanquedeParisetdesPaysBas (In re FuelOilSupplyandTerminaling,Inc.),72B.R.752,757(S.D.Tex.1987),onappeal,837F.2d224(5thCir.1988).154 SanMateoFeed&FuelCo.v.Hayward,149F.2d875(9thCir.1945).155 Id. at 875.156 Id. at 876.

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allowed.157 Greenblattinvolvedpropertyofthebankrupt.ThedecisioniswrittenbyJudgeAfee,theauthoroftheSan Mateo Feed & Fueldecisionanddistinguishesthatcaseonthegroundsthatpaymentheredidnotcomefrom property of the bankrupt.158

§ 7.12. Plugging and Abandonment Obligations and Environmental and Site Restoration Obligations May (or May Not) Be Administrative Claims.

So-called“endoflife”liabilitiesassociatedwithoil&gaspropertieshavebecomeamajorissueinconnectionwithenergycases.Offshoreabandonmentliabilitycasesrunintothetensofmillionsofdollars.Theissueofwhoistheproperclaimantandwhetherthe“P&A”claimisentitledtoadministrativepriority have become increasingly important.

InTexas,pluggingandabandonmentoperationsmustbecommencedonawellwithinoneyearfromthedatethatdrillingoroperationscease.159 Althoughinitiallycontingent,theobligationtoplugandabandonawellcomesintoplaywhendrillingoperationsarecommenced.ThepartiesobligatedtopaytheP&Aandrestorationcostsare,atthefirstlevel,theoperator,thentheco-owners,andultimatelyanypredecessorowner.IfonepartypaystheP&Acost,thatpartymayormaynotbeentitledtoindemnityorcontributionfromotherpartieswhoeitherareorwereownersofundividedinterests.TheTexasSupremeCourtdecisioninSeagull Energy E&P, Inc. v. Eland Energy, Inc.160raisedanumberofdifficultissuesbyholding,inessence,thatapartytoanOAwhohadsolditsinteresttoathirdpartymayyetbeliableforplugging&abandonmentcostsastooperationsperformedmanyyearsafteritsownershipterminated.

TheFifthCircuit,interpretingTexaslaw,hasheldthatP&Aliabilitiesareentitledtoadministrativeclaimpriorityiftheliabilityaccruedunder

157 Id. But seeGreenblattv.Utley,240F.2d243,247n.10(9thCir.1956)(creditwhichdischargedunperfectedmechanic’s lienondebtor’spropertycouldnotbeavoidedasapreference).158 Greenblatt,240F.2dat247.159 16Tex.Admin.Code§3.14(b)(1)(2007).160 SeagullEnergyE&P,Inc.v.ElandEnergy,Inc.,207S.W.3d342,346-47(Tex.2006).

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statelaw(thatis,ifoperationsceasedeitherafterthedateoffilingorlessthanoneyearpriortothedateoffiling).161 Applying the test of Reading Co. v. Brown,162thecourtheldthatthepluggingandabandonmentwasactual,necessary,andalso“benefited”theestate.163Thecourtreasonedthatadebtor(andtrustee)mustcomplywithstatelaw164andmaynotabandonpropertyincontraventionofastatelawreasonablydesignedtoprotectpublichealthandsafety.165Significantly, forourpurposes, the trusteeargued that theobligationtoP&Aawellarisesassoonasitbecomesunproductive,butthisargumentwasrejectedbythecourtbasedonareadingoftheTexasstatute.Rather,thecourtheldasamatteroflawthattheobligationdoesnotaccrueuntil the passage of one year.166Thetrusteealsoarguedthatthechapter11trusteenever“operated”thewells,sothatcostsassociatedwiththewellswereofnobenefitandwerenotnecessarytohismanagementoftheestate.167 Thecourtrejectedthisargumentaswell,saying“Again,Texaslawdirectlydictatesotherwise....Itmattersnotwhetherthebankruptestateproducedanyoilor receivedany revenues from thewells.As theoperator, itwasrequiredtoplugthem.”168

One commentator has gone behind the opinion inH.L.S. Energy and found, from thebriefs in theFifthCircuit, that theTexasRailroadCommissionhad apparently entered afinding that theunpluggedwellsconstitutedanimminentdangertothegroundwaterandthus,thestateuseditsownfundstoplugthewellsratherthanwaitforthedebtor.169 The claim at issuewas for reimbursement for costs the statehadalready incurred.

161 State v. Lowe (In re H.L.S.EnergyCo.,Inc.),151F.3d434,439(5thCir.1998).162 ReadingCo.v.Brown,391U.S.471,483(1968)(“actualandnecessarycost”).163 In re TransamericanNaturalGasCorp.,978F.2d1409,1416(5thCir.1992)(mustbenefittheestate).164 28 U.S.C. § 959(b),165 MidlanticNat’lBankv.NewJerseyDep’tofEnvtl.Protection,474U.S.494,505(1986).166 In re H.L.S.Energy,151D.3dat438n.3.167 Id. at 439.168 Id. at 439.169 FabenéJ.Welch,Residual Liabilities at the End of the Oil & Gas Lease: Who’s to Pay? (You Can Run but You Can’t Hide),May15,2007,http://www.worldservicesgroup.com/publicationspf.asp?id=1976(lastaccessedOct.14,2007).

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UsingtheRooker-Feldmandoctrine,D.C. Court of Appeals v. Feldman170 andRooker v. Fidelity Trust Co.,171 that author believes the Fifth Circuit wasboundby theRailroadCommission’s analysis and that theH.L.S. EnergydecisionthusfollowstheMidlanticlineofcases“whichfindsthatburdensomepropertymaybeabandonedbythedebtorunlesssuchpropertyisinviolationoflawsorregulationsdesignedtoprotectthepublichealthandsafetyfromimminentandidentifiablehardand,infact,imminentandidentifiableharmispresent.”172WhilethebackgroundandfindingsoftheTexasRailroadCommissionmayhelpexplainthecourt’sdecision,itmustbenotedthattheFifthCircuitdecisiondidnotmentionthosefactsasbeingsignificanttoitsholding.

Thatsaid,itissignificantthattheH.L.S. EnergydecisiondoesnotdealwiththeissueofwhetheraP&Aclaimarisingprepetitionwouldbeaccordedanadministrativeexpense.

In the case of In re American Coastal Energy Inc.,173thecourtfacedaclaimforadministrativeexpensefiledbytheTexasRailroadCommissionforremediationof“environmentalrisksforwhichAmericanCoastalhadongoingresponsibility.”174AmericanCoastal’sobligationtoplugandabandonthewellsaroseprepetitionandtheRailroadCommissionexpenditureoccurredpostpetition.Inallowinganadministrativeexpense,thebankruptcycourtheld:

Becausethedebtor-in-possessionisrequiredtooperatetheestateinaccordancewithstatelaw,post-petitionexpendituresnecessarytobring the estate into compliance with the law are necessary for the debtor’srehabilitation.Theneedtobringtheestateintocompliancewithstateenvironmentalandsafetylawsisnotlesssignificantthantheneedtomaintaincommercialrelationswithtradecreditorsthat

170 D.C.CourtofAppealsv.Feldman,460U.S.462(1983).171 Rookerv.FidelityTrustCo., 263 U.S. 413 (1923).172 Residual Liabilities at the End of the Oil & Gas Lease: Who’s to Pay? (You Can Run, but You Can’t Hide(lastviewedOctober14,2007).173 In re American Coastal Energy Inc., 399 B.R. 805 (Bankr. S.D. Tex. 2009).174 Id. at 807.

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providetherawmaterialsofthedebtor’sbusiness.Adebtorcannotoperateanestateinviolationofenvironmentalandsafetylaws.175 Generally speaking, each owner in the chain of title is statutorily

obligatedtofulfilltheplugging,abandonment,andsiterestorationobligations,regardlessof current ownership andwithout regard to indemnities andreleasesgrantedat the timeofapriorassignment.BondssupportingtheobligationtoP&Athepropertieshavevalueinthatliabilitiesarereducedbut they are not available for the payment of other types of claims.

ArelatedissueiswhetheradebtormayabandonwellsthataresubjecttoP&Aobligations.JudgeIsguroftheBankruptcyCourtfortheSouthernDistrictofTexasrecentlyheldinIn re ATP Oil & Gas Corp.,176 that where thedebtorhadnofundstopayfortheexpensiveabandonmentofoffshorewells but a predecessor in interest did, and the government supportedabandonment,thedebtorcouldabandon.ThecourtnotedthatMidlantic is intendedtoprotectthepublic’shealthandsafety,and“itwouldpotentiallyviolate MidlanticbyrequiringATPtoretainthe[properties]whentheUnitedStates has chosen an alternate course of action to protect the public health andsafety.”177Thatdecisionisonappeal.

§ 7.13. Defenses to Avoidance Actions Found in §§ 546(e), (f) and (g).

Sections546(e), (f) and (g) of theCode immunize fromavoidanceactionsallpaymentsreceivedfromcertainpartiesinconnectionwithcertaintypesof“protected”contracts.178 Many contracts for sale of oil or gas, for example,fallintothestatutorydefinitionofa“forwardcontract,”sothatall“settlementpayments”(anotherdefinedterm)cannotberecovered,eitherasapreferenceorasafraudulenttransfer.

175 Id. at 816. 176 In re ATPOil&GasCorp. (Bankr. S.D. Tex. 2013).177 Id. at *3.178 11 U.S.C. § 546(e)(g).

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[1] — The Basic Immunization of § 546(e). Section546(e)providesthat,subjecttocertainexceptions,thetrustee

maynotavoidatransferthatisamarginpaymentorsettlementpaymentmadebyorto,e.g.,aforwardcontractmerchantpriortothecommencementofabankruptcycase.Section546(e)doesnotrequirethatthesubjectmarginpaymentorsettlementpaymentbemade“inconnectionwith”aforwardcontractinordertoobtainthebenefitofitsavoidanceexemption.179 Rather, thekeyiswhethertherecipientisoneoftheprotectedcategoriesincluding,inter alia,a“forwardcontractmerchant,”andwhetherthepaymentorothertransfer at issue is a margin payment or settlement payment.180Additionally,thebreadthofthe§546(e)exemptionhasbeenenhancedbythebroadscopeaccordedtheterm“settlementpayment”bythecourts.Thelanguageof§546(e)allowsthemarginpaymentorsettlementpaymenttobemadebytheprotectedparty(forwardcontractmerchant,stockbroker,financialparticipant,financialinstitution,orsecuritiesclearingagency)toathirdparty,orbyathirdpartytotheprotectedparty.Theprotectedpartiesareexemptedfromtheautomaticstayandmayoffsetthedebtor’smarginpaymentsagainstthelossesofderivativescontracts.181

[2] — The Statutory Definition of “Forward Contract.” TheCodedefines“forwardcontract”as:

(A)acontract(otherthanacommoditycontract)forthepurchase,sale,ortransferofacommodity,asdefinedinsection761(8)ofthistitle,oranysimilargood,article,service,right,or interestwhichispresentlyorinthefuturebecomesthesubjectofdealingintheforward contract trade, or product or byproduct thereof,with amaturitydatemorethantwodaysafterthedatethecontractisenteredinto,including,butnotlimitedto,arepurchasetransaction,reverserepurchasetransaction,consignment,lease,swap,hedgetransaction,

179 Id.180 Id.181 11 U.S.C. § 362(b)(6) (2006).

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deposit,loan,option,allocatedtransaction,unallocatedtransaction,oranyothersimilaragreement;

(B)anycombinationofagreementsor transactions referred to insubparagraphs(A)and(C);

(C) anyoptiontoenterintoanagreementortransactionreferredtoinsubparagraph(A)or(B);

(D)amasteragreementthatprovidesforanagreementortransactionreferred to in subparagraph (A), (B), or (C), togetherwith allsupplementstoanysuchmasteragreement,withoutregardtowhethersuchmasteragreementprovidesforanagreementortransactionthatisnotaforwardcontractunderthisparagraph,...;or

(E) any security agreement or arrangement, or other creditenhancement related to anyagreementor transaction referred toinsubparagraph (A), (B), (C),or (D), includinganyguaranteeorreimbursementobligationbyortoaforwardcontractmerchantorfinancialparticipantinconnectionwithanyagreementortransactionreferredtoinanysuchsubparagraph,.... 182

[3] — The Blurred Distinction Between Future and Forward Contracts. A“forward contract is a legal agreement tomakeor takedelivery

in the future,”usually involving fungiblegoods such as currencies andcommodities.183Partiesusephysicalcontracts,whetherfutureorforward,toensuredeliveryofacommoditytheyneedatacertainprice;actualdeliveryisthekey.Earlyintheprocess,partiesusedfutureandforwardcontractstoprotectagainstpricefluctuationwithoutintendingtotakeactualdeliveryofthecommodity.Financialcontracts,whetherfutureorforward,areusedtoprotectagainstpricefluctuation—asortofinsurancepolicy.

182 11 U.S.C. § 101(25) (2006).183 StevenErreraandStewartL.Brown,Fundamentals of Trading Energy Futures & Options7(1999)(hereinafter“ErreraandBrown”).

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Thereisno“bright-line”distinctionbetweenforwardandcommoditiescontracts.184Courtshave,however,developedguidelinesforcharacterizingacontract as a futures contract. A futures contract (i.e.,acommoditycontractforfuturedeliverytradedonanationalorregionalexchange)hasfourdistincttraits:(i)itisstandardizedastoalltermsotherthanprice,(ii)itisfreelytransferable, usuallyon the sameexchange, (iii) themarkethas afixedlocation,and(iv)theconclusionofthecontractseldominvolvesphysicaldelivery.185Aforwardcontractisnon-standard,mayormaynotbefreelytransferable,istradedoverthecounter(notonafixedexchange)andmayormaynotrequirephysicaldelivery.

Thereisalsoadifferenceinregulationoftheforwardcontractsmarketandthefuturesmarket.Theforwardcontractsmarketislargelyunregulated.Itsrulesofconstructionandenforcementaredrawnfromthecommonlawof contracts. In theUnitedStates,most regulatoryprovisions regardingcommoditiesfuturescontractsarefoundintheCommodityExchangeAct,whichisadministeredandenforcedbytheCommoditiesFuturesTradingCommission.186 The futures market is also subject to self-regulation by theNationalFuturesAssociation, an industrywide selfregulating entityauthorizedbyCongress.187

[4] — The Parenthetical Exception “Other than a Commodity Contract.” Oneproblemininterpretingthelegaldefinitionof“forwardcontract”

liesintheexceptioncontainedintheparenthetical“(otherthanacommoditycontract).”Theproblemarises,inpart,becausetheCodelacksageneraldefinitionof“commoditycontract”andbecause,withintheindustry, theterm“commoditycontract”canmeanalotofthings,including“on-exchange

184 CommodityFuturesTradingComm’nv.CoPetroMktg.Group,Inc.,680F.2d573,581 (9th Cir. 1982).185 See generally Abramsv.OppenheimerGov’tSec.,Inc.,737F.2d582,590-92(7thCir.1984);and Shmuel Vasser, “Derivatives in Bankruptcy,” 60 Bus. Law. 1507, 1523-24 (2005).186 7 U.S.C. § 1 et seq.187 Klineat10;see Nat’l Futures Ass’n, http://www.nfa.futures.org(lastvisitedOctober5, 2013).

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futurescontract,”“off-exchange futurescontract,”“forwardcontract,”or“contractforthepurchaseofacommodity(withoutregardtotime).”188 The generaldefinitionssection,§101oftheCode,hasnodefinitionof“commoditycontract,” though there isadefinitionof“commoditycontract” found inChapter7,SubchapterIVoftheCodeat§761(4).189

ThedefinitionalproblemwasaddressedbytheFifthCircuit inIn re Olympic Natural Gas Co.,wheretheissuewaswhetherthedefinitionofforwardcontractsundertheBankruptcyCodeencompassedoff-exchangecontractsforthecommercialsupplyofcommoditieswithafuturedeliverydate(theFifthCircuitheldthat itdid)andwhetherMorganStanleywasaforwardcontractmerchantentitledtothesafeharborbenefits(thecourtconcludeditwas).190MorganStanleyCapitalGroup,Inc.(MorganStanley)wasapartytoaNaturalGasSalesandPurchaseAgreement(the“Contract”)withOlympicNaturalGasCo.andOlympicGasMarketing,Inc.(collectively,Olympic).191UndertheContract,eachmonththepartieswouldenterintoa seriesof individual transactions after agreeingon theprice, quantity,timing,anddeliverypointforthenaturalgas.192 Because of the numerous transactions conducted eachmonth and becauseMorganStanley andOlympiceachwouldatdifferenttimesactasbuyerorasseller,thecontractprovidedforasinglenetpaymenttobemadeinsettlementofeachmonth’strading.193AfterbankruptcyproceedingsinvolvingbothOlympicentitieswereconsolidated intoa singleChapter7proceedinganda trusteewasappointed,thetrusteefiledacomplaintagainstMorganStanleyseekingtorecover$1.8millioninpaymentsmadewithin90daysofthedateoffilingbyOlympictoMorganStanley,arguingthatthepaymentswereavoidableaspreferentialtransfersunder§547(b)oftheCode.194Asadefense,Morgan

188 11 U.S.C. § 101.189 11 U.S.C. § 761(4).190 In re OlympicNaturalGasCo.,294F.3d737,740(5thCir.2002).191 Id. at 739.192 Id.193 Id.194 Id.

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Stanley argued that thepaymentswere settlementpaymentsmadebyaforwardcontractmerchantwithinthemeaningof§546(e)oftheCode.195

Thetrusteearguedthatforwardcontractsunder§546(e)arelimitedtooffexchange financial transactions, relying in large part on the legislative history.196Thus, the trustee argued, because theContract provided forphysicaldelivery,itwasnota§546forward(financial)contractbutwasratheranordinarycommodity(physical)contractthatwouldbeexemptedfromthedefinitionofforwardcontractbytheparentheticalinthefirstline“other thanacommoditycontract.”197The trusteeargued that therearethree typesofcontracts in the“worldofcommerce incommodities,” towit: (1) future contracts (onexchangefinancial instruments), (2) forwardcontracts(offexchangefinancialinstruments),and(3)ordinarycommoditycontractssuchastheContractbetweenMorganStanleyandOlympic.198 MorganStanley argued that theparenthetical “other than a commoditycontract”reinforcestheestablishedpracticeofdistinguishingoffexchangeforwardcontractsfromonexchangefuturecommoditiescontracts.199 Morgan Stanleyalsoarguedthatthethirdcategoryenunciatedbythetrustee,forwardoffexchangefinancialcontracts,doesnotexistasadistinctlegalcategory,andthatthesecondcategory,forwardcontracts,includesbothfinancialandphysical transactions.200

TheFifthCircuit agreedwithMorganStanley and held that “thecommoditiesmarket isdivided intoonly twocategories: (1)onexchangefuturestransactions;and(2)offexchangeforwardcontracts.”201 The Fifth Circuitfurtherwrotethatitsinterpretationis“inaccordwiththetraditional

195 Id. at 739-40.196 In re OlympicNaturalGasCo.,294F.3d at 742.197 Id. at 740.198 Id.199 Id. at 741.200 Id.201 Id.(citing5Collier§556.02,556-5(providing“[t]hattheterms‘commoditycontract’and‘forwardcontract’,takentogether,seamlesslycovertheentiretyoftransactionsinthecommodityandforwardcontractmarkets,whetherexchangetraded,regulated,over-the-counter,orprivate.”))(internalcitationsomitted).

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definitionof‘forwardcontract’”andrejectedtheassertionbythetrusteethatbecausethecontractcontemplatedactualdelivery,itwasnota§546(e)forwardcontract.202TheFifthCircuitcitedcasesinothercircuitsforthepropositionthatoneofthedistinguishingcharacteristicsofaforwardcontractisthatthepartiesexpecttomakeactualdelivery.203

[5] — What Is a Forward Contract Merchant? A“forwardcontractmerchant”isdefinedbythestatuteas:

aFederalreservebank,oranentitythebusinessofwhichconsistsinwholeorinpartofenteringintoforwardcontractsasorwithmerchantsinacommodity(asdefinedinsection761)oranysimilargood,article,service, right, or interest which is presently or in the future becomes thesubjectofdealingintheforwardcontracttrade.204

Is a party to a forward contract, by definition, a forward contractmerchant?205Infact,theFifthCircuitengagedinthispreciseanalysisinIn re Olympic Natural Gas Co.,wherethecourtseemstohavedecidedthatMorganStanleywasaforwardcontractmerchantwithnomoreanalysisthanitshavingenteredintoaforwardcontract.206

In In re Mirant Corp.,thecourtconsideredthequestionmorecloselyandfoundtworelevantsubpartstothedefinition,“business”and“merchant.”207 Thecourtdeclinedtofocusonthenatureofthecontractbutratherthenatureofthebusinessortradebeingprotected.

202 Olympic,294F.3dat741.203 See, e.g., Nagel v. ADM Investor Servs., Inc., 217F.3d436,441 (7thCir. 2000);CommodityFuturesTradingComm’nv.CoPetroMktgGroup,Inc.,680F.2d573,579(9thCir.1982);GrainLandCoopv.KarKimFarms,Inc.,199F.3d983,990(8thCir.1999).204 11 U.S.C. § 101(26) (2006). 205 MirantAmericasEnergyMktg.,L.P.v.KernOil&RefiningCo. (In re Mirant Corp.), 310B.R.548,567(Bankr.N.D.Tex.2004)(Withoutmore,thedefinitioncouldsimplymean“anypersonthatentersintoforwardcontractsisaforwardcontractmerchant.”).206 Olympic,294F.3dat740-42.207 In re Mirant Corp.,310B.R.548,568(“aforwardcontractmerchantisapersonthat,inordertoprofit,engagesintheforwardcontracttradeasamerchantorwithmerchants.”).

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[T]heCongressionalpurposebehindprovisionsdealingwithforwardcontracts, . . . was not to affect a class of transactions (i.e.,forwardcontracts), but rather was to protect certain persons (i.e., those engagedintheforwardcontracttrade)andthemarketinwhichtheywere participants.208 Focusingfirston“merchant,”thecourtfoundthat“amerchantisonethat

isnotactingaseitheranend-useroraproducer.Rather,amerchantisonethatbuys,sellsortradesinamarket.”209 “Business,” of course, “is something oneengagesintogenerateaprofit.”Asaresult,inordertobea“forwardcontractmerchant”thecourtconcludedthatone“musthaveenteredintotheAgreementsasaparticipantseekingprofitintheforwardcontacttrade.”210

[6] — What Is a Settlement Payment? TheCodedefinesa“settlementpayment,”forthepurposesoftheforward

contract provisions, as

a preliminary settlement payment, a partial settlement payment, an interimsettlementpayment,asettlementpaymentonaccount,afinalsettlement payment, a net settlement payment, or any other similar paymentcommonlyusedintheforwardcontracttrade.211

Thiscircularandcrypticdefinitiondefiesplainmeaning.212 Thefirstsix examples tell us that a “settlement payment” is a “settlement payment.” Thelastphraseadoptstheusageofthecommoditiesindustryintheforwardcontract trade.Recognizing this,many courts construing “settlement

208 Id. at 567.209 Id. (ThecourtanalogizedthatCongressprobablydidnotintendforafarmertobeclassifiedasa forwardcontractmerchant,notwithstanding thata farmermayoftensellcommoditiesintotheforwardcontractmarket.Id. at 568 n.31.)210 Id. at 570.211 11 U.S.C. § 101(51A) (2006).212 Jacksonv.Mishkin (In re Adler,ColemanClearingHouseCorp.), 263 B.R. 406, 475 (S.D.N.Y.2001);Zahnv.YucaipaCapitalFund,218B.R.656,675(Bankr.D.R.I.1998);Brandtv.Hicks,Muse&Co. (In re HealthcoInt’l), 195 B.R. 971, 983 (Bankr. D. Mass. 1996).

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payment”haverecognizedthatthestatutorydefinition,thoughcircular,isextremelybroad.213

Many courts interpreting the meaning of “settlement payment” have analyzedthelegislativehistoryandthetraditionalworkingofthesecuritiesindustry.214Inasimpleexample,atransferofpurchasedsecuritiestothepurchaserconstitutesasettlementpayment,andapurchaser’spaymenttothebrokerforsecuritiespurchasedalsowouldseemtoeasilyfitthedefinitionof settlement payment.215

Mostofthereporteddecisionsinterpreting“settlementpayment”ariseinthecontextofanavoidanceactionbecause§§546(e)and(f)provideadefenseifthetransfersoughttobeavoidedisasettlementpaymentmadebyor to a “commoditybroker, forward contractmerchant, stockbroker,financialinstitution,financialparticipant,orsecuritiesclearingagency,”orifmadebyortoarepoparticipant.216Thisdefensetoanavoidanceactioniscommonlyknownasthe“stockbrokerdefense”andtherearenumerousreporteddecisionsregardingtheextentofitsapplication.217

213 E.g.,BevillBresler&ShulmanAssetMgmt.Corp.v.SpencerSav.&LoanAss’n,878F.2d742,752(3dCir.1989)(settlementpaymentincludesanytransfersthatoccurduringthesettlementprocess);but see EnronCorp.v.BearStearnsInt’lLtd. (In re Enron Corp.), 323 B.R.857,864,866,870(Bankr.S.D.N.Y.2005)(focusingon“oranyothersimilarpaymentcommonlyusedinthesecuritiestrade”asabasisfordiscerningthemeaningof“settlementpayment”).214 BevillBresler&ShulmanAssetMgmt.Corp.,878F.2dat747.(extensivediscussionofindustryat745-47andlegislativehistoryat746-49);KaiserSteelCorp.v. Charles Schwab &Co.,913F.2d846.849(10thCir.1990)(discussionofindustry);In re Adler,ColemanClearingCorp.,263B.R.at406,475-76(examinationofpurposeofstatuteandusagesoftheindustry);Zahn,218B.R.at675(discussionofindustry);Raleighv.Schottenstein (In re WieboldtStores,Inc.), 131 B.R. 655, 664-65 (N.D. III. 1991) (examination of legislative history,anddiscussionof“clearanceandsettlement”system;see especially nn. 9-10).215 Bevill, Bresler & Schulman,878F.2dat751(“Deliveryofthesecuritieswaspartofthesettlementprocess,andthusconstitutesa‘settlementpayment’forpurposesofsection546(f).”). See Cohenv.Sav.Building&LoanCo. (In re Bevill, Bresler & Schulman Asset Mgmt Corp.),896F.2d54,61(3dCir.1990)(transferringsecuritiestoasafekeepingaccountforapurchaserisasettlementpayment);but see Edelsbergv.Thompsonv.McKinnonSec.,Inc. (In re Edelsberg),101B.R.386,389(Bankr.S.D.Fla.1989)(executiononjudgmentarisingfromadebtforsettlementamountsowedisnotasettlementpayment).216 11 U.S.C. § 546(e) (2006).217 In re Adler, Coleman Clearing Corp.,263B.R.at473;JewelRecovery,L.P.v.Gordon,196 B.R. 348, 352 (N.D. Tex. 1996).

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In Kaiser Steel Corp.,theTenthCircuitheldthatapaymentmadetoashareholderinconnectionwithaleveragedbuy-out(LBO)wasasettlementpaymentandthusreceivedtheexemptionofthesafeharbor.218 In reaching thisdecision,thecourtsaid“[t]hedefinitionin§741(8),whilesomewhatcircular,is‘extremelybroad,’...inthatitclearlyincludesanythingwhichmaybeconsideredasettlementpayment.”219Thecourtalsonotedthat

[I]nterpreting “settlement payment” to include the transfer ofconsiderationinanLBOisconsistentwiththeway“settlement”isdefinedinthesecuritiesindustry.Settlementis“thecompletionofa securities transaction.220

In the case of In re Resorts Int’l, Inc.,theThirdCircuitjoinedtheTenthinholdingthatpaymentstotenderingshareholdersinanLBOaresettlementpayments.221

Notwithstandingthebroadstatutorydefinitionof“settlementpayment,”somecourts,includingtheEleventhCircuit,haveconcludedthatexemptingpaymentsandtransferstoshareholdersmadeinconnectionwithapurelyprivatetransaction,suchasanLBO,doesnotimplicatethenationalsecuritiesmarketsortheclearanceandsettlementsystemandthereforeisnotthekindof“settlementpayment”intendedtobeprotectedby§546(e).222

218 Kaiser Steel Corp.,913F.2dat850;see alsoKaiserSteelCorp.v.PearlBrewingCo.(In reKaiserSteelCorp.),952F.2d1230,1237(10thCir.1991),cert. denied sub nom.KaiserSteelRes.Inc.v.PearlBrewingCo.,505U.S.1213(1992)(inholdingLBOpaymentstobesettlementpayments,thecourtsaid:“Theclearaimofthedefinitionistoencompassall‘settlementpayments’commonlyusedinthesecuritiestrade.”); see also Lowenschuss v. Resources Int’l, Inc. (In reResortsInt’l,Inc.),181F.3d505,515(3dCir.1999);andOfficialCommitteeofUnsecuredCreditorsv.Clark(In re National Forge Co.), 344 B.R. 340, 351 (W.D. Pa. 2006).219 Kaiser Steel Corp.,913F.2dat848.220 Id.at849,citingA.Pessin&J.Ross,Words of Wall Street: 2000 Investment Terms Defined 227 (1983).221 In re ResortsInt’l,Inc.,181F.3d505,516(3dCir.1999)(“ApaymentforsharesduringanLBOisobviouslyacommonsecuritiestransaction,andwethereforeholdthatitisalsoasettlementpaymentforthepurposesofsection546(e).”);see also In re National Forge Co., 344 B.R. at 351.222 E.g., In reWieboldtStores,Inc.,131B.R.655.SeeMunfordv.ValuationResearchCorp.(In reMunford,Inc.),98F.3d604,610(11thCir.1996),cert. denied sub nom. DFA Inv.

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Illustrative of the reasoning in these cases is that of the court in Wieboldt Stores:

In the instant case,however, requiring theTrumpdefendants (orotherWieboldtshareholders)[LBOsellers]toreturntotheTrusteepaymentstheyreceivedfromWSI[LBOpurchaser]throughHarrisBank[theclearingagent]posesnosignificantthreattothoseintheclearanceandsettlementchain.NeitherHarrisnoranyotherfinancialintermediarypurportedlyinvolvedintheclearanceandsettlementprocesswouldbemeaningfullyaffectedbysuchajudicialorder.223

AsindicatedinthelanguageoftheWieboldt court, these cases focus on theinvolvementofthesecuritiesmarketsorthefinancialclearingsysteminordertoqualifyasasettlementpayment.Similarly,severalreporteddecisionshavefocusedontheimportanceofprotectingthenationalcapitalmarketsandfinancialclearingsystemswhileresolvingthetensionbetweenChapter5avoidanceactionsandthesafeharborsof§546(e),(f).224

In § 546(e),Congress recognized that the unwindingof settledsecuritiestransactionscouldcreateanenvironmenthostiletocapitalformation,engenderingdiminishedinvestorconfidence,aswellasincreasedcostsandvolatilityoftransactionsincapitalmarkets.Tothatend,strongpolicyreasonsfavorastatutoryreadingofsettlementpayments thatprotectsparticipants in the securitiesmarkets and

DimensionsGroupv.Munford,Inc.,522U.S.1068(1998)(“Here,thetransfers/paymentsweremadebyMunfordtoshareholders.Noneoftheentitieslistedinsection546(e)...madeorreceivedatransfer/payment.Thus,section546(e)isnotapplicable.”)(emphasisinoriginal);Buckleyv.Goldman,Sachs&Co.,No.Civ.A.02-CV-11497RGC,2005WL1206865(D.Mass. 2006) (following Zahn,thecourtdoesnotapply546(e)toLBOs;findsnoimplicationofpublicclearingsystem);Zahn, 218 B.R. at 677 (D.R.I. 1998) (“It thus appears highly unlikely thatCongresswouldintendthesetransferstobecoveredas‘settlementpayments.’”);In re HealthcoInt’l,195B.R.at983(“Thepaymentto[Defendant]wasaone-timedistributionincompleteliquidationofitsstockinterest.Thesecircumstances,particularlywherethereisnoshowingofaguarantybyasecuritiesclearingagency,arenotwhatCongresshadinmindinenactingsection546(e).”).223 In reWieboldtStores,Inc.,131B.R.at664-65.224 Bevill, Bresler,878F.2dat751;Adler, Coleman,263B.R.at479;Jewel Recovery, L.P., 196 B.R. at 353 (“[A]pplying the plain language of § 546(e) to this private transaction conflictsandisinconsistentwithCongress’statutoryschemeinChapter5oftheCode.”).

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promotesfinalityof securities transactions, as a counterbalancetosafeguardingtheinterestsofcreditors...Atthesametime,thespiritthatinfusesthewholeofSIPAandtheBankruptcyCodeisCongress’sdetermination,reflectedinatrustee’savoidancepowersunder§548aswellasSIPCRule300.503,that“afewindividualsshouldnotbeallowedtobenefitfromtransfersbyaninsolvententityattheexpenseofthemany.Rather,Congressintendedequalsharesofthebankruptcyestateforcreditorsofequalrank.”225

Onecourtheldthatinorderforapaymenttoqualify“asasettlementpaymentprotectedby§546(e)”suchpaymentmustbe“commonwithinthesecuritiestrade.”226

Inanyevent,thetensionbetweenthetrustee’savoidingpowerscontainedinChapter5oftheCodeandCongressionalpolicymanifestedin§546(e),(f)(includingtheextentofthereachofthedefinitionof“settlementpayment”)isexemplifiedbypaymentstoshareholdersinaprivateLBO.

The plain language of § 546(e)would appear to apply to thistransaction. . . . [but] [t]he . . . transaction was a private transaction whichdidnotimplicatetheclearanceandsettlementprocess.227

In In re Olympic Natural Gas Co., theFifthCircuit concluded thatmonthly contract payments constituted “settlement payments” under§ 101(51A).228Inreachingitsdecision,thecourtreasonedthat“’settlementpayment’ shouldbe interpretedverybroadly” and rejected the trustee’sargumentthatinordertobeexemptfromavoidance,asettlementpaymentmustbemadeonafinancialderivativecontractandbeclearedthroughacentralizedsystem.229

225 Adler, Coleman, 263 B.R. at 479.226 EnronCorp.v.J.P.MorganSec.,Inc. (In re Enron Corp.), 325 B.R. 671, 677 (Bankr. S.D.N.Y.2005)(withrespecttoearlypaymentofcommercialpaper,courtfoundafactissueastowhether“commonwithinthesecuritiestrade,”justifyingdenialofsummaryjudgment).227 JewelRecovery,L.P.,196B.R.at352.228 In re OlympicNaturalGasCo.,294F.3dat742.229 Id. (citing Kaiser Steel Corp.,952F.2dat1240).See also In re Resorts Int’l, Inc., 181 F.3dat51516(holdingthatpaymentforsecuritiesmadeinconjunctionwithaleveragedbuyoutisasettlementpayment,regardlessofwhetheraclearingagencywasinvolved).

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Insummary,theThird,Fourth,Fifth,andTenthCircuits,aswellastheBankruptcyCourtfortheSouthernDistrictofNewYork,interpret“settlementpayments”broadlyanddonotrequiretheimplicationofnationalsecuritiesmarkets or clearing systems, whereas the Eleventh Circuit utilizes a more restrictivedefinition and requires the involvementof securitiesmarketsandfinancialclearingsystems.230 The Ninth Circuit interprets “settlement payment”broadly,buthasnot addressed the issueofwhether securitiesmarkets or clearing systems are essential.231

230 Hutsonv.E.I.duPontdeNemoursandCo.(In reNat’lGasDistrib.,LLC),556F.3d247,257(4thCir.2009);In re Resorts Int’l, Inc.,181F.3d505(3dCir.1999);Olympic Natural Gas,294F.3d737,citedinLightfootv.MXEnergyElec.(In re MBS Mgmt. Servs., Inc.), 690F.3d352,356(5thCir.2012).;In re Kaiser Steel Corp.,952F.2d1230(10thCir.1991);KaiserSteelCorp.v.CharlesSchwab&Co.,913F.2d846(10thCir.1990);In reMunford,Inc.,98F.3d604(11thCir.1996);Buchwaldv.WilliamsEnergyMktg.&TradingCo.(In reMagnesiumCorp.ofAm.),460B.R.360,374(Bankr.S.D.N.Y.2011).231 In reComark,971F.2d322(9thCir.1992).

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