In a decision dated April 17, 2018 in the “Matter of ATP Oil & Gas Corporation” (888 F.3d 122), the Fifth Circuit Court of Appeals rendered a decision dealing with the relative rights or priorities between the holder of overriding royalty interests (“ORRI”) and parties asserting lien claims or privileges under the Louisiana Oil Well Lien Act (“LOWLA”) (La. Rev. Stat § 9:4861).
Before filing for bankruptcy, and in order to raise money, APT Oil & Gas Corporation (“APT”) sold what were described as ORRI to a third party, OHA Investment Corporation (“OHA”). The total amount was for $65 million with the sale completed in July 2012. The ORRI entitled OHA to receive a cost-free percentage of the hydrocarbons “produced, saved and sold from or attributable” to a mineral lease until it received a certain sum. In August 2012, ATP filed a voluntary chapter 11 bankruptcy case.
Then, OHA filed a declaratory judgment action within the bankruptcy. OHA sought a determination (i) that it, not the bankruptcy estate, owned the ORRI, and (ii) that the ORRI was not an executory contract that could be rejected. The holders of liens under the LOWLA intervened in the declaratory judgment action and sought recovery against OHA.
Initially, the bankruptcy court bifurcated the matter into two phases: First, whether OHA owned the ORRI, and if the ORRI were capable of being rejected as executory contracts under Bankruptcy Code section 365. Second, the priority or LOWLA issues. The parties resolved the first phase by an agreed judgment.
For the second phase, OHA sought dismissal under FRCP 12(b)(6) arguing that: (i) LOWLA liens could not attach to ORRI, and, alternatively (ii) if the liens did attach, they were extinguished by LOWLA’s “safe harbor” provisions; i.e. these protect a “bona fide onerous transaction by the lessee or other person who severed or owned them at severance.”
The bankruptcy court determined that LOWLA liens could attach to an ORRI, but they also held the LOWLA safe harbor provisions protected OHA. As such, OHA would prevail unless the LOWLA lien claimants had provided notice to OHA before it purchased its ORRI. The bankruptcy court went on to conclude that the safe harbor provisions required actual notice by the claimants. The LOWLA lien claimants did not make any such allegation of notice and thus the bankruptcy court recommended that OHA’s motion to dismiss be granted.
The bankruptcy court ultimately made a report and recommendation to the District Court. The District Court largely agreed with the bankruptcy court’s report and recommendation and further held that since the lien claimants failed to allege they provided notice, it was not necessary to decide whether actual notice was required.
After the District Court decision, the LOWLA lien claimants appealed to the Fifth Circuit on this second phase.
While the Fifth Circuit identified three potential issues, it decided only a single issue: Does the LOWLA safe harbor provisions cover OHA’s purchase of the ORRI?
While it generally used normal principles of statutory interpretation, the Fifth Circuit did have to rely on substantive Louisiana oil and gas law. This was due to the fact the LOWLA did not define all the terms necessary to answer the single issue addressed. Initially, the 5th Circuit Court rejected the lien claimants argument ATP could not sell to OHA the hydrocarbons in the ground, noting a lease not only provides ownership of the minerals after production, but also gives the lessee the right to produce hydrocarbons. Therefore, the 5th Circuit held ORRI sold to OHA the to then to-be-produced hydrocarbons.
Further, the Appellate Court rejected the argument that the ORRI could only attach to proceeds. They noted that an ORRI, like the one at issue, could be paid in cash or in-kind and by definition, was a percentage free of drilling and production costs.
Then, turning to the safe harbor language, the Court reviewed but rejected the LOWLA lien claimant’s main argument that the safe harbor language covered not an interest in shares of production, but only the already-severed hydrocarbons. Instead, the Court held the term “hydrocarbons” encompassed both those in the ground as well as that produced. As a result, hydrocarbons (including in the ground) can be sold to and owned by an overriding royalty owner. Because the text of the safe harbor language extinguished liens in a conveyance to a purchaser, the ORRI purchased by OHA “fit squarely within that [safe harbor] category.” The failure of the LOWLA claimants to provide pre-purchase notice of their liens extinguished those liens under the safe harbor provisions.
The importance of this case is, absent notice by LOWLA lien creditor, a party purchasing an overriding royalty interest, or a production payment, appears to be protected from those lien claims.
An unanswered question is this:
How would LOWLA lien claimants provide notice to anyone considering entering into a transaction with a lessee and therefore put those persons on notice? The corollary of this is what type of diligence should a party negotiating the purchase of an ORRI undertake to be covered by the safe harbor provisions?
These important questions await further clarification by our courts.
The full decision can be found here.