Texas Mineral Lease

Oil and natural gas prices are by their very nature volatile and subject to the whims of the market. This has been particularly true since 2014 and more recently with the pandemic essentially shutting down the economy for months. For one plaintiff who owned mineral leases in West Texas, this meant not only fluctuating royalties but also being caught up in bankruptcy proceedings when the owners of the land on which they had interests sought Chapter 11 bankruptcy reorganization. As detailed below, the plaintiff faced an uphill battle to ensure that their royalties were not caught up in the bankruptcy proceeding.

Texas Mineral Lease Case Details

The mineral interests at issue in West Texas can be traced back to 1925, but the relevant transaction to the case occurred in 1989 when Company A acquired a 47/96th interest in two sections of land (“Sections 1 and 2”) and a 15/32 interest in another section (“Section 3”) from the same seller. Company A sold the 47/96th interest in 2007 to the plaintiff. It held on to the 15/32 interest in the nearby parcel at Section 3 until 2016 when it sold that interest to Company B. The defendant was in charge of, among other things, calculating and dispensing royalties to the plaintiff and Company B on these parcels.

In early 2020, Company B filed suit against the defendant in Texas state court regarding royalty payments on Section 3 which had been originally sold to Company A with Sections 1 and 2. In response, the defendant issued a Notice of Suspension effective February 28, 2020 in which it suspended not only Company B’s royalties but those of the plaintiff since its Sections 1 and 2 were originally part of the same transaction in 1989 which was the subject of the state court litigation filed by Company B. The suspension was made retroactive to January 1, 2020.

The defendant filed for bankruptcy in June 2020. In September 2020, the plaintiff demanded payment from the defendant of its royalties from January and February 2020. The defendant failed to comply with the demand during the 30 day period set forth by law and so the plaintiff petitioned the bankruptcy court to compel the defendant to issue the payments which the court rebuffed. Then, the plaintiff filed an adversary complaint against the defendant in the bankruptcy proceeding.

With the adversary complaint, the plaintiff asked the bankruptcy court to make certain declarations about the ownership and status of the royalties. In particular, the plaintiff wanted the court to find that the defendant was not allowed to hold on to the royalties to fund its bankruptcy because the royalties were not the defendant’s property subject to the bankruptcy proceedings. The plaintiff pointed out that the defendant had never argued that the royalties were part of its property subject to the bankruptcy nor had it asserted ownership of the royalties.

Further, the plaintiff argued that the defendant also did not seek to prove that it had any interest in the royalties, which was a requirement for claiming the royalties as part of its estate. The plaintiff alleged that the defendant singled it out for a zero damages “cram down” which it was not allowed to do under bankruptcy law. The plaintiff also alleged that the provisions of the bankruptcy code that the defendant was attempting to use to complete this plan violated the Due Process clause of the U.S. Constitution as applied to mineral lease owners.

Also, the plaintiff asked the bankruptcy court to declare that the defendant did not own an interest in the plaintiff’s royalties that was sufficient to include these royalties in the bankruptcy estate and that those royalties should not have been included in the property of the defendant’s bankruptcy estate.

If the court did not want to make these particular findings, the plaintiff argued in the alternative that it held a perfected security interest in the royalties under the Texas Business and Commerce Code. Since the royalties were subject to the dispute playing out in the pending state court proceeding, they should be included in the Carve Out Reserve under the bankruptcy plan until the state court ruled on the correct percentage. By including the royalties in the Carve Out Reserve, the court would prevent them from being included in the bankruptcy estate and they would be essentially removed from the bankruptcy proceeding.

The plaintiff also asked the court to declare that the defendant was required to hold its royalties dating from January 1, 2020 going forward in suspense until the state court or other court of appropriate jurisdiction had made a determination of the correct percentage of mineral ownership.

Royalties Successfully Excluded from Bankruptcy Proceedings

With this adversary complaint, the plaintiff wanted to ensure that the defendant could not use the plaintiff’s legitimate royalties to fund its attempt to get other creditors off of its back, especially since the defendant had never claimed ownership of the royalties or argued that the plaintiff did not own them. This was an action to claw back what should never have been included in the bankruptcy proceeding in the first place and to question the fundamental constitutionality of the provision being used in the first place.

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