Forgotten Stakeholders

24 May 2017 Bankruptcy Talk Publication

The Bankruptcy Code provides protection to unsecured creditors by directing the United States Trustee (“UST”) to appoint a statutory committee to represent such creditors in Chapter 11 cases.  The Bankruptcy Code also says that the UST may appoint additional committees of creditors or equity security holders as the UST thinks is appropriate.  Official committees, i.e., those appointed by the UST, are entitled to hire counsel and advisors at the expense of the bankruptcy estate.  In this way, the Bankruptcy Code provides a voice to groups impacted by a bankruptcy case that might not otherwise have meaningful representation because individual creditors’ claims are too small to justify hiring lawyers and advisors to represent their interests.

But, there are other groups with an economic stake in the case that may not qualify as “creditors” as the Bankruptcy Code defines that term.  Examples are utility customers, non-unionized employees, and royalty interest owners, to name a few. The focus in this posting will be royalty interest owners, and how the Bankruptcy Code may or may not provide them with a statutory committee.

Nearly all oil and gas debtors file some garden variety Motion Authorizing Payment of All Funds Relating to Royalty Interests (“Royalty Motion”) as one of the first pleadings in the case.  Typically, a Royalty Motion will seek recognition that royalty interests[1] are not property of the estate, and will further seek permission to pay pre-petition royalty or working-interest proceeds to those holders.  This occurs when the debtor, acting as operator under a joint operating agreement, has sold all of the production from the wells together, and thus received one payment from the purchaser.  The payment represents proceeds from the debtor’s property, as well as proceeds from property owned by third party working interest holders and royalty interest holders.  Normally, these third party owners will have accounting adjustments due to them, which may not be reconciled until months after the commencement of the Chapter 11 case.

Too often, the very same debtors that first acknowledged the separate ownership of third party mineral interests, and the proceeds thereof, in the Royalty Motion, take a contrary position later in the Chapter 11 case.  The subsequent contrary position is that any such amounts subsequently reconciled represent a “claim” within the meaning of section 101(5) of the Bankruptcy Code against the debtor.  In short, such a debtor will first argue “this money is your property, not mine,” and will later change its tune regarding prior period adjustments or corrections to argue “this is my money, but you may have a claim against me.”

This change in position is problematic for both debtors and royalty interest owners.  For debtors, they may be barred from changing their position based on principles of judicial estoppel, which precludes parties in a proceeding from taking a contrary position to what they took earlier in the case.[2] For royalty interest owners, they may have to fight the debtor regarding its change in position, or commence a lawsuit, known as an adversary proceeding, against the debtor so that a bankruptcy court can determine the royalty owner’s interest in the proceeds.

Many times, thousands of royalty owners simply give up because their monthly royalty payments are only $30 to $40 dollars (and often times less).  Hiring a lawyer isn’t economical for these small royalty interest owners. Moreover, most individuals, like the one quoted below, may find the bankruptcy process difficult to navigate.

Does the Bankruptcy Code provide relief for these small mineral owners who are unable to keep track of a large bankruptcy case?  If royalty interests are considered “claims,” as some of the debtors categorize them, then the answer is yes.  As mentioned above, the Bankruptcy Code allows the appointment of additional statutory committees to represent bodies of creditors.  The so-called “claims” of royalty and working interest owners are materially different than those of unsecured bondholders or trade creditors.  So, if a debtor takes the position that reconciled amounts due to working interest or royalty owners are “claims”, then it seems appropriate for the UST to consider appointing a separate statutory committee to represent that class of creditors, at the expense of the estate.  Conversely, if proceeds of the production owned by royalty and working interest owners are not property of the estate, then these mineral owners do not have a “claim.”  But, the debtor may be compelled to turnover 100% of the disputed cash to them upon resolution of final accounting.

Royalty interest owners may have options available other than forming a statutory committee. One is forming a royalty ad hoc committee.  Ad hoc committees are formed through voluntary collaborations between similarly situated individuals with a basic objective of pursuing a common goal.  By banding together in an ad hoc committee, royalty interest owners create a unified and potent position to advocate their specific goal.  However, because their fees and expenses may have to be paid by individual owners, ad hoc committees of royalty interest holders are very uncommon.

The plight of these parties is reflected in many letters they write to the courts in oil and gas cases.  Because judges are not permitted to correspond with parties to a case, these letters are posted to the dockets by the clerks’ offices.  Here is an excerpt from a typical letter:

We are royalty and WI owners. I have no idea of the amounts of money we are owed. I do not know how to file papers to get any money due [to] us. Thank you for your help.[3]

The problem is genuine and impacts real people.  The Bankruptcy Code provides a potential solution by permitting the appointment of an official mineral owners committee.  This puts the burden elsewhere, e.g. the DIP lender, first lien lender, or debtor, who are left with the Hobson’s choice of either agreeing that proceeds of third party mineral interests owners are not property of the estate, or of shouldering an additional committee’s expenses.

[1] A royalty interest is an ownership interest in either the oil and gas produced from operations or the proceeds from the oil and gas once sold. Royalty interests are free from the operational costs needed to extract the oil and gas from the ground. When an oil and gas company extracts oil or gas from the ground, a portion of these resources or their proceeds belong to the royalty interest owner, no one else.

[2] As mentioned in one earlier blog post, the bankruptcy court in Breitburn noted the debtor’s inconsistent positions on this issue, but judicial estoppel was not raised.

[3] Excerpt from letter of royalty / working interest owner to the Bankruptcy Court in In re Samson Resources Corporation, et al., Case No. 15-11934 (CSS) (Bankr. Del. Sept. 28, 2017) (ECF No. 1419).

Related Services