Operator Bankruptcy: Considerations for a Royalty or Mineral Owner

Since the start of 2020, SARS-CoV-2 has caused the oil and gas industry to fall on hard times. There was a rapid and drastic drop in demand for oil as countries implement social isolation and quarantine measures. These unprecedented measures resulted in oil trading at a negative value for the first time in history – when the cost for storage of the oil was more than the value of the oil itself. 

As a result, bankruptcies are expected, and indeed, many royalty and mineral owners already find themselves the recipient of notices of bankruptcy from their operators or first purchasers. This article broadly discusses bankruptcies, and how royalty and mineral owners can protect their interests in bankruptcy. 

There are generally two types of bankruptcies that operators and first purchasers are likely to initiate:

1. Voluntary, Chapter 11 bankruptcy, occurs when the debtor actively and voluntarily files for bankruptcy because of excess debts. The debtor seeks the protection of the court so that it may reorganize, negotiate down, and/or cancel certain debts.
2. Involuntary or Voluntary, Chapter 7 bankruptcy, requires the debtor to liquidate or sell assets to the highest bidder to generate cash that will satisfy debts in order of their priority. Quite often, a Chapter 11 filing is converted or forced to become a Chapter 7 if the court determines there is little likelihood that the reorganized company can expect to survive.   

When the royalty owner receives a bankruptcy notice, here are some points to consider:

1. The court staff will not be able to help.
2. The attorney for the debtor is charged with zealously defending the rights of the debtor, and as the royalty owner, there is little point to contacting the debtor’s attorney.
3. Keep track of important deadlines, as missing these may carry significant penalties. 
4. To protect your interest, consider collecting detailed records that prove ownership of the interest, and track any funds that may be owed. At a minimum, consider procuring the following: 

a.      Copy of your original oil and gas lease.

b.      Copy of all division orders received from debtor.

c.      Copies of recent checks, with all attendant information provided by debtor.

d.      Summary of historic production and income.

e.      Estimate the royalty and overriding royalty income that has been missed since

bankruptcy. 

The collected information should be reviewed and compiled by a qualified attorney and filed with the bankruptcy court to preserve the royalty owner’s rights. 

Note that in Texas, under the First Purchaser Statute (Section 9.343 of the Texas Business and Commerce Code), producers and royalty owners have a security interest in oil and gas produced from their properties to secure the purchaser’s obligation to pay for that oil and gas. Under the same statute, producers and royalty owners do not need to file financing statements in order to perfect their security interest. Furthermore, the Legislature provided that the security interest granted to producers and royalty owners is a “purchase-money security interest.” This generally means that the producer or royalty owners’ rights are automatically preserved. However, in some complex cases, which may include situations when operators and producers were organized or bank in another state, the producers and royalty owners may not be automatically protected. In these cases, it is important to consult a qualified attorney to determine how best to protect oneself. 

Author

James H. Niu

Informational Purposes Only  

The information is provided for informational purposes only and is not legal advice, nor does reading anything that we author or post constitute legal advice. Likewise, communicating with us through LinkedIn does not form an attorney/client relationship. You should contact an attorney for advice on specific legal problems.  

McCarn & Weir, P.C. is comprised of attorneys and professional staff highly experienced in transactions and litigation involving the Energy, Real Estate, Banking and Finance industries. Our firm has multiple attorneys Board Certified in Oil, Gas and Mineral Law by the Texas Board of Legal Specialization, along with attorneys licensed in Texas, Oklahoma, New Mexico and California. Our goal is to provide high quality and cost-effective legal services, while maintaining the flexibility to adapt to the ever-changing needs of the industries we represent.