In re First River Energy, LLC: First Purchaser Statutes

In re First River Energy, LLC: First Purchaser Statutes

By: Grant Armentor Student South Texas College of Law Houston

Introduction

Oil and gas development is an intricate and precarious venture requiring extensive expertise and capital. In light of the complexity and risk of production, most mineral interest owners will “lease” their interest, transferring their mineral rights to oil and gas producers in exchange for a bonus payment and a royalty interest in the production. Subsequent to development, producers will then sell the oil to “first purchasers,” generally midstream services providers. Should the first purchaser fall into financial distress and file for bankruptcy protection, however, the producer and mineral interest owners may find themselves at risk of never receiving the payments due to them. To protect royalty interest owners and producers during difficult times, some oil-producing states have enacted statutes to assist producers in securing payments from first purchasers for production sold. In light of a recent bankruptcy and Fifth Circuit decision, however, Texas producers may not enjoy the full protections that its legislature has provided for them.

First Purchaser Protection

In response to pressures from mineral interest owners to secure their interest in delivered production, Oklahoma legislature passed the Oil and Gas Owner’s Lien Act of 1988 (“1988 Act”).1 Additionally, Texas passed Section 9.343 of the Texas Business and Commerce Code (“Texas First Purchaser Statute”), a non-standard UCC provision.2 Each of these statutes, however, had significant deficiencies regarding the applicable choice-of-law and the governing law of perfection, which were both underscored in the SemCrude decision.3

SemCrude

In SemCrude, producers from Oklahoma and Texas sold and delivered oil and gas production to SemCrude L.P., a limited partnership incorporated in Delaware.4 Trouble arose when SemCrude fell into bankruptcy with hundreds of millions of dollars still owed to producers—and through the producers’ leases—with mineral owners owed royalties through leases. 5 Consequently, the Oklahoma and Texas producers asserted lien priority under the 1988 Act and the Texas First Purchaser Statute, respectively.6

Oklahoma’s 1988 Act was enacted to provide Oklahoma oil and gas producers an automatically perfected and prioritized statutory lien in the resultant proceeds of oil and gas sold and delivered to first purchasers.7 As the SemCrude decision highlighted, however, two flaws of the 1988 Act included: (1) that the governing law was determined by the debtor’s “location”—here, Delaware as the debtor’s state of incorporation— as opposed to Oklahoma law where the producing wellheads were located; and (2) expressly subdued Oklahoma producer’s rights to the rights of those under the UCC.8 Thus, because Delaware law requires the filing of a financing statement to duly perfect, any opposing security interests that were properly perfected had primed the interests asserted by the Oklahoma producers under the 1988 Act.

Similarly, the Texas First Purchaser Statute granted Texas producers a prioritized purchase money security interest in production sold and delivered to first purchasers, as well as in proceeds thereof.9 The purpose of the statute was to assist Texas producers in securing outstanding payment obligations of first purchasers by

granting the producers an automatically perfected security interest without the filing of a financing statement. In similar fashion to the Oklahoma 1988 Act, the court held that the laws in which a first purchaser is “located,” rather than where the oil and gas was produced and sold, was the appropriate governing law – here, Delaware. 10 Thus, the Texas producer’s security interests under the Texas First Purchaser Statute were also deemed unsecured and subordinate to the capital lending bank’s Article 9 UCC security interests that were filed and perfected in Delaware.

Oklahoma’s Oil and Gas Owner’s Lien Act of 2010

In response to the SemCrude decision, Oklahoma legislature passed the Oil and Gas Owner’s Lien Act of 2010 (“2010 Act”).11 The 2010 Act was fashioned to circumvent the deficiencies identified by the bankruptcy court and to ensure intended protection to Oklahoma mineral interest owners and producers. Specifically, the 2010 Act: (1) granted an oil and gas lien to producers, as opposed to a security interest, in attempt to avert an application of an opposing state’s UCC as in the SemCrude decision; and (2) stipulated that the 2010 Act granted an automatic super-priority lien, subordinating any conflicting liens or security interests created under the UCC.12

First River

Ten years later, the 2019 bankruptcy court decision of First River was rendered by Bankruptcy Judge Craig Gargotta, examining the integrity of the Texas First Purchaser Statute and Oklahoma’s newly enacted 2010 Act.13 Similar to the SemCrude decision, this case involved a Delaware limited liability company, First River, LLC, acting as first purchaser for the acquisition of oil and gas produced from wells located in Oklahoma and Texas. 14 Following the first purchaser’s acceptance of oil purchased from Oklahoma and Texas producers, the first purchaser filed for bankruptcy with outstanding payments still due. 15 The Texas producers claimed they held an automatically-perfected security interest under the Texas First Purchaser Statute, while the Oklahoma producers asserted that they held a prioritized lien under Oklahoma’s newly enacted 2010 Act.16

Unsurprisingly, the bankruptcy court applied the same reasoning as the SemCrude court in determining that the Texas debtor’s “location” determined the governing law to be applied. 17 Thus, Delaware law governed, and the Texas First Purchaser Statute was not applicable. Accordingly, Texas producers were left unsecured on their right to outstanding payments.

The Oklahoma producer’s claims, however, encountered a pleasant deviation. In a first impression decision determining the efficacy of the 2010 Act, the bankruptcy court concluded that the 2010 Act had corrected the deficiencies of the 1988 Act in successfully creating a super-priority oil and gas lien, securing the payment obligation of first purchasers.18 The bankruptcy court noted that to the extent the Oklahoma producers could demonstrate their interest in “oil and gas rights,” Oklahoma law would apply to the perfection and priority of the Oklahoma producer’s lien over conflicting duly perfected security interests. 19 Thus, the 2010 Act successfully provided Oklahoma producers liens in production that primed the capital lending banks’ Article 9 UCC security interests.

The Texas producers appealed the bankruptcy court’s decision to the Fifth Circuit Court of Appeals. On February 2, 2021, Judge Edith Jones of the Fifth Circuit entered judgment affirming the bankruptcy court’s decision. 20 Judge Jones emphasized Delaware’s denial of “certain nonstandard UCC security interests.”21 This was significant because Delaware has no provision

comparable to the Texas First Purchaser statute. Thus, application of Delaware law thwarted the Texas producer’s ability to acquire an automatically perfected security interest without the filing of a financing statement in Delaware.

The Fifth Circuit ultimately concluded that the Delaware UCC governed the issues of perfection and priority with respect to the Texas producer’s asserted security interests in production delivered to first purchaser and proceeds thereof.22 Further, the court confirmed that the Texas producer’s security interests created by the Texas First Purchaser Statute were subordinate to the perfected security interests of the capital lending banks.23

Looming Effect

The Fifth Circuit decision highlights the deficiencies in Texas legislature’s attempt to protect Texas oil and gas producers—and through them, parties owed royalty—with the Texas First Purchaser Statute. The court notes that producers must “beware the amazing disappearing security interest and continue to file financing statements.”24 This language by the court should be sincerely received by Texas producers as the current protection provided under the Texas First Purchaser Statute will undoubtedly fall short in situations similar to those in the SemCrude and First River decisions where Texas producers solely rely on the Texas First Purchaser Statute without the filing of a financing statement. In order to ensure that a security interest in production sold and delivered to first purchasers is duly perfected, Texas producers should file a financing statement in the debtor’s state of incorporation or organization after every delivery of production.

The Fifth Circuit additionally recognized Oklahoma’s success in curing the defects of the 1988 Act determined in the SemCrude decision. Oklahoma was able to strengthen the rights of Oklahoma producers with the enactment of the 2010 Act, while Texas producers must continue to rely on the vulnerable protections afforded under the Texas First Purchaser Statute. In order to ensure the intended protection that the Texas First Purchaser Statute was enacted to provide for the state’s producers, the Fifth Circuit notes that “Texas legislature should take note” of the Texas First Purchaser Statute’s shortcomings.

1 Okla. Stat. Ann. tit. 52, §§ 548–548.6, repealed by Okla. Stat. Ann. tit. 52, §§ 549.1–549.12 (West 2021). 2 Tex. Bus. & Com. Code § 9.343 (West 2021). 3 Samson Res. Co. v. SemCrude, L.P. 407 B.R. 140 (Bankr. D. Del. 2009). 4 Id. at 150. 5 Id. at 144. 6 Id. at 147. 7 Okla. Stat. Ann. tit. 52, §§ 549.4, repealed by Okla. Stat. Ann. tit. 52, §§ 549.1–549.12 (West 2021). 8 Sahar Jooshani, There’s a New Act in Town: How the Oklahoma Oil and Gas Owners’ Lien Act of 2010 Strengthens the Position of Oklahoma Interest Owners, 65 OKLA. L. REV. 133, 136 (2012). 9 Tex. Bus. & Com. Code § 9.343(b) (West 2021). 10 Arrow Oil & Gas, Inc. v. SemCrude, L.P., 407 B.R. 112, 137 (Bankr. D. Del. 2009). 11 Okla. Stat. Ann. tit. 52, §§ 549.1–549.12 (West 2021). 12 Okla. Stat. Ann. tit. 52, § 549.3 (West 2021). 13 In re First River Energy, LLC, No. 18-50085-CAG, 2019 WL 1103294 (Bankr. W.D. Tex. Mar. 7, 2019). 14 In re First River Energy, LLC, 2019 WL 1103294, at *3. 15 In re First River Energy, LLC, 2019 WL 1103294, at *4. 16 In re First River Energy, LLC, 2019 WL 1103294, at *11. 17 In re First River Energy, LLC, 2019 WL 1103294, at *20. 18 In re First River Energy, LLC, 2019 WL 1103294, at *16. 19 In re First River Energy, LLC, 2019 WL 1103294, at *16. 20 In re First River Energy, L.L.C., 986 F.3d 914 (5th Cir. 2021). 21 Id. at 921. 22 Id. at 931. 23 Id. at 928. 24 Id. at 917.

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