Upstream Oil and Gas Company: Ways to Protect Your Oil and Gas Interests

• Record all recordable interests
  • Recordable interests are leases, deeds, assignments of working interests, royalty interests, and memorandum of contracts² that affect real property.
  • Though the more recent model form AAPL joint operating agreements (1989 & 2015) contain language specifically developed to protect operators from non-operator bankruptcies and vice versa, a memorandum of such JOA needs to be recorded in the real property records.In addition, a financing statement can be recorded as well.
  • Risk: Whose lien is first?If possible, it’s desirable to confirm that the memorandum of JOA / Exploration and Development Agreement is in first position vis a vis the operator’s lender’s lien or obtain a written and recordable agreement that the lender’s lien is subordinated.
  • Risk: Unrecorded interests may be set aside in bankruptcy under the broad powers granted to debtors and trustees under the Bankruptcy Code.
    
    
• Confirm that the operator is paying its vendors and service providers
  • The operator is required to pay field expenses as such become due.
  • Non-operators are particularly vulnerable in this area, thus they must use all reasonable efforts to ensure that cash calls, etc. are actually paid to the contractors³ providing the services and not utilized by the operator for other purposes.
  • Escrowing funds would be ideal but might not be practical in all circumstances.In any case, a non-operator should demand proof of payment from the operator in situations where the operator appears to be financially distressed.
  • Risk: Failure of operator to fully or timely pay contractors allows such contractors to file mechanics and materialman liens⁴ and/or mineral liens⁵ against the entire lease, not just the operator’s property.
  • Risk: Enforcement and foreclosure of the lien against a non-operating working interest’s property will depend on whether JIBs were paid as well as when such JIBs were paid.
    
    
• Don’t Sit Back and Rely on the Operator – Actively Monitor Activities
  • Payments due to non-operating working interests – this property belongs to the working interest owner.
  • Make sure the operator is paying any and all funds due under the JOA to you as a working interest owner and a royalty owner, as applicable.
  • Confirm where the operator maintains these funds (watch out for sweeps of operator’s bank account by a secured lender).
  • Risk: If the operator has insufficient cash to pay working interest owners or royalty owners, the operator may have converted your funds to its use.
  • Risk: An operator who has fallen behind in making these payments could leave you with nothing more than a general unsecured claim in a future bankruptcy case.

¹ Based on an article written by John Melko, an energy industry focused bankruptcy partner in Foley’s Houston office, entitled “An ounce of protection is worth a bbl of cure” which was printed in the April 2008 edition of OIL & GAS FINANCIAL JOURNAL.

² Often, parties do not want to file the actual operating agreement or exploration and development agreement. Instead, a memorandum of such contract is filed in the real property records of the applicable counties.

³ Contractors includes other services providers and vendors.

⁴ Statutory mechanics and materialman have broad rights to file mechanics and materialman liens (“M&M Liens”) in most states, giving such contractors extensive lien rights against the property where the work was performed.

⁵ In oil and gas producing states, in addition to M&M Liens, contractors who provide services/sell goods at the well site also are entitled to file separate statutory liens called “mineral liens” against the property where the work was performed.