Gas Agreements Rejected For Not “Running With Land,” Part I in a two part series

The last quarter of 2020 has brought with it two important rulings from the Delaware bankruptcy court. Applying real covenant law in the states of Wyoming and Colorado, the two decisions concluded that the terms of the specific gas gathering agreements at issue did not contain real covenants (covenants that run with the land) and, thus, could be rejected and extinguished in bankruptcy under 11 U.S.C. § 365. In re Extraction Oil & Gas, Inc., No. 20-11548 (CSS), 2020 WL 6694354 (Bankr. D. Del. Oct. 14, 2020); In re Southland Royalty Co. LLC, No. 20-10158 (KBO), 2020 WL 6685502 (Bankr. D. Del. Nov. 13, 2020). These holdings may suggest that producers and midstream companies rethink the dedications in their gas gathering agreements.

In the Colorado law case, Extraction sought to reject transportation service agreements it had with Elevation Midstream pursuant to 11 U.S.C. § 365(a). The bankruptcy court determined that under Colorado law a covenant only runs with the land if (a) the parties intend to create a covenant running with the land; (b) the covenant touches and concerns the land with which it runs; and (c) privity of estate between the original covenanting parties existed at the time of the covenant’s creation.

Starting with the first element, the Extraction court determined that the dedications were the only provisions the parties clearly intended to run with the land. No other provision in the agreements expressed an intent for the covenants to run with the land. However, despite the parties’ expressed intent for the dedications to run with the land, the court determined that the dedication provisions did not meet the privity of estate requirement. “Privity of estate requires that any covenant that allegedly runs with the land be accompanied by a contemporaneous conveyance of some interest in the land with which the covenant runs.” Because the agreements did not convey any interest in Extraction’s mineral estate, only easements in gross, not real property interests, attached to the leases and therefore the covenants did not run with the land. Although the court could have stopped there, it went on to determine that the dedication provisions also failed to “touch and concern the land” because they “simply identify the produced minerals and produced water subject to the parties’ contractual obligations.” Since the produced minerals and water are personalty (personal property) and not real property, the dedications did not touch and concern the land.  Lastly, the court noted that the drilling commitments in the agreements did touch and concern land but lacked the other requirements to be a real covenant. Accordingly, the court granted summary judgment to Extraction and allowed rejection of the agreements.

In the Wyoming law case, Southland sought to eliminate the minimum volume requirement in its gas gathering agreements with Wamsutter, sell its assets free of any interest Wamsutter had because of the agreements, and reject the agreements under bankruptcy laws. As in the Extraction case, this determination hinged on analysis of real covenant law. Similar to the parties in Extraction, the parties in Southland clearly manifested their intent that the dedication provision in their agreements be a covenant running with the land. An intent to create a covenant running with the land did not appear in any other section of the agreement, thus the bankruptcy court focused its attention on the dedication provision. The court concluded that the dedication was not a real covenant that ran with the land because it did not touch and concern the land. The court reasoned that, in order to touch and concern the land, some of Southland’s rights in the land would have to be substantially altered. Much like the court in Extraction, the court in Southland determined that the agreements did not require Southland to do or refrain from doing anything with its real property. Only once the minerals were severed from the estate was there a covenant between Southland and Wamsutter. Since severed minerals are personalty, there was no agreement that touched and concerned the land. The court also briefly considered privity and concluded there was no privity of estate in the agreements, citing reasoning similar to that employed by the Extraction court.

As COVID-19-related bankruptcies increase in the oil and gas industry, prudent producers and midstream service providers can learn from the bankruptcy courts’ analysis in Extraction and Southland. For guidance on how to approach future agreements or amend existing ones check out part II in this series, next week.

Tags:  Bankruptcy, In re Extraction Oil & Gas, Inc., In re Southland Royalty Co. LLC, gas gathering agreements, real property covenants, covenants running with land