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Producers still using Chapter 11 to pressure midstream contracts

Oil andgas exploration and production companies continue to use the bankruptcy protectionprocess to try to terminate or restructure contracts with midstream providers —a move that has predictably caused more than hard feelings, industry lawyers say.

Duringa midyear update on the industry in Houston, Akin Gump attorneys Chuck Gibbs andDoug Glass said the overall situation for producers is clearly difficult, with increasinglylarge numbers seeking Chapter 11 bankruptcy protection.

"Ithink through June 30 there have been almost as many Chapter 11s filed as therewere in all of 2015, and the vast majority are in some way related to the oil andgas business," Gibbs said.

Withproducers looking to cut costs in any way they can, Gibbs said one issue "thatwas on nobody's radar" has become a big one: E&P companies looking to terminatetheir contracts with their midstream counterparts. Section 365(a) of the U.S. BankruptcyCode says "the trustee, subject to the court's approval, may assume or rejectany executory contract or unexpired lease of the debtor." Gibbs said that manyproducers want their oil and gas transportation contracts placed in the categoryof "burdensome executory contracts or leases," which can then be rejectedand eliminated.

Gibbsnoted the case of Texas-based SabineOil & Gas LLC, which filed for bankruptcy in the Southern Districtof New York. Shortly after filing for bankruptcy, it attempted to reject two contractswith midstream providers. In both cases, the midstream companies to claim the contractswere running with the land.

"Thedebtor's business judgment will likely be upheld by the court," said Gibbs,a partner in Akin Gump's financial restructuring practice.

In theevent a producer does attempt to get out of a contract, Gibbs said it is an all-or-nothingproposition; there is no way to keep portions of the contract the debtor thinksare favorable. "It's a binary choice; you assumeit in all its glory or reject it," he said.

Giventhe all-or-nothing nature, many companies have used this leverage to restructure contracts. Glass, who is a partnerin Akin Gump's oil and gas/natural resources practice, said midstream companiesare fighting back with a concept known as "covenant running with the land,"which claims a contract is tied to the land and not to the owner. Under this concept,a contract would pass to the trustee and cannot be considered executory, he said.

"Thebasic reason for these types of provisions … is to make sure that the successorto the producer or the gatherer is subject to the contract," he explained."The question is whether that provides a secondary purpose, to take it outof the region of executory contracts."

Othermidstream companies may try their luck on their home turf. Gibbs said Texas judgesmay be more sympathetic.

"Inthe [SandRidge Energy Inc.]case, when the debtor came to the court and said, 'We've reached an agreement withour midstream partners,' the [Houston-based] judge has basically said 'Darn, I wantedto rule on that like they did in New York.'"