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Energy Alert: Bankruptcy Court Rejects Midstream Contracts

In a highly anticipated ruling being carefully watched by both distressed upstream producers of natural gas and the pipelines that gather the gas, Judge Shelly Chapman of the United States Bankruptcy Court for the Southern District of New York ruled in In re Sabine Oil & Gas Corp. that the Debtor who is a gas producer may reject two gas gathering agreements notwithstanding “dedication” language in the contracts that purported to create covenants running with the land.  See the full bench decision here.

Judge Chapman concluded that the gas gathering agreements contain neither covenants running with the land under Texas law nor any equitable servitudes as was argued by the midstream gathering companies. As a result, the contracts may be rejected as executory contracts.

Judge Chapman reasoned that the contracts were instead service contracts for the purpose of transporting Debtor’s gas after the gas was severed from the land which she determined was personal property of the Debtor and not related to any real property interest.  As a result, she concluded that the “dedication” of such gas to the gathering contracts did not constitute a burden on or a covenant running with the land itself.

Outlook 

While Judge Chapman’s ruling may be encouraging to distressed upstream gas producers with above market gathering agreements and other pipeline alternatives to get their gas to market, this issue is far from over as other courts will be taking up the issue. Due to some procedural requirements under applicable Second Circuit law, the ruling regarding rejection of the contracts is binding, but her findings regarding covenants running with the land under Texas law are not yet final at this time.  A decision on this issue in the Quicksilver bankruptcy case currently pending in Delaware is expected before the end of the month.

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