By David H. Sweeney, Jason P. Rubin, and Laura P. Warrick (Akin Gump Strauss Hauer & Feld, LLP), with Practical Law Oil & Gas
Producers of hydrocarbons generally require some level of gathering, processing, and other midstream services to monetize hydrocarbons. Midstream services are typically secured through contracts between the producers and the midstream providers. The fixed facilities that are required to perform those midstream services require significant investment by the midstream providers and have capacity constraints. To ensure producers’ performance and protect their investment, midstream providers often include in their contracts a dedication clause styled as a “covenant running with the land”. This clause purports to dedicate the land or reserves to the midstream infrastructure and is intended to bind third parties, including estates in bankruptcy, as an interest in real property.
Decisions in recent Chapter 11 cases have challenged the notion that midstream services contracts containing purported covenants running with the land are not rejectable under section 365 of the Bankruptcy Code. The result is that a debtor may be able to reject a midstream contract containing a covenant running with the land, repudiate future performance of its duties, and a midstream service provider may find its claims reduced to a pre-petition unsecured claim for monetary damages.
This article explores some recent case law regarding covenants running with the land in bankruptcy and offers practical suggestions for how producers and midstream providers might navigate the newly developing reality, including:
- Conducting diligence on midstream contracts to identify red flags and address potential issues before they become problems.
- Addressing the shortcomings of covenants running with the land noted by bankruptcy courts.
- Replacing covenants running with the land with a substitute, such as a presently possessory interest or a lien.
The full article is available here.