The volatility of the current oil and gas market has many mineral owners wondering the extent to which their leases will be impacted. Below we look into two issues: the impact of bankruptcy on the royalty owner and the applicability of the force majeure clause to save a lease.
Bankruptcy of Oil & Gas Operators
- Will my lease automatically terminate if the operator files bankruptcy?
- What will happen to the royalty payments that I am owed?
- What should I do if I receive bankruptcy paperwork?
Probably not. The two most likely bankruptcy paths for an operator would be Chapter 7 (liquidation) and Chapter 11 (reorganization). Regardless of the path taken, maintaining the leases is typically a priority. However, in a Chapter 7, the lease would most likely be sold to another company.
Oil and gas operators often hold funds on behalf of royalty owners, either because they have not yet hit the requisite threshold amount for payment (for example, at least $100.00) or pending the resolution of title issues. Any funds held in suspense due to title issues that are not resolved are usually secure for a number of years, at which point they are released to the State of Oklahoma’s Unclaimed Property program. However, upon filing a bankruptcy, many are concerned that these funds will no longer be securely held and will instead be available for distribution by the bankruptcy trustee. Whether this is the case is largely dependent upon whether the royalty owner is considered a “creditor” of the bankrupt company. As a creditor, the royalty owner would need to get in line, in order of priority, amongst the company’s other creditors and may not receive 100% of the funds owed. Some would argue, however, that because the funds held by the operator are fully attributable to the royalty owner and not property of the bankrupt, the funds are entitled to full distribution to the royalty owner and cannot be apportioned amongst the creditors.
Regardless of whether a royalty owner is considered a creditor of the oil and gas company, most will likely receive notices of the proceedings out of an abundance of caution on the part of the operator and its legal team. These should be reviewed by the royalty owner with oversight from an attorney to ensure the mineral owner is best protected and all necessary measures are taken within the strict timelines.
Failure to Produce in Paying Quantities
All oil and gas leases require that there be production in “paying quantities” in order for the lease to continue beyond the primary term. Low demand for oil and gas (and correspondingly low prices) have resulted – or likely will result – in most wells producing scant amounts. In a normal world, this would result in a fight to cancel the lease for its failure to produce in paying quantities. However, many are wondering whether a lease’s force majeure clause – a clause that allows the operator to suspend operations without risking the cancellation of the lease upon the occurrence of an act of god – will circumvent this.
Force majeure clauses are strictly construed in the state of Oklahoma and their breadth is largely dependent upon the exact language used. Oklahoma Governor Kevin Stitt has requested that President Trump declare the COVID-19 pandemic an act of god in order to protect these leases (although the low demand for oil and gas, which is only tangentially related to COVID-19, has played a role). Further, the Oklahoma Corporation Commission has tested the limits of its authority by authorizing a 90-day decrease in well output. Further, producers are looking to the Oklahoma Corporation Commission to make a determination that all production in this economically poor market would be “waste” and are seeking a possible halting of all production, a position that has increasingly strong opinions on both sides. In addition, Oklahoma case law allows a lease to continue despite the temporary cessation of production so long as the length of cessation was not “unreasonable” under the circumstances (and unless otherwise specified in the lease). However, the above doesn’t necessarily rule out the termination of a lease for the failure to produce; instead, it raises a host of questions.
About the Authors
Carissa King, J.D. is an highly skilled in estate planning, trust and probate administration, real property, and business transactions. You can read more about her and her legal experience here.
Anthony S. Moore, J.D. is an expert in representing clients in oil and gas, civil litigation, real estate transactions, title opinion, estate planning, and real property matters.