Rejection of Mid-Stream Agreements Upheld … Again

Originally published by Charles Sartain.

Co-author Lydia Webb

Q: How many New York federal judges does it take to make a mess of Texas property law?

A: In In Re: Sabine Oil and Gas Corp., five. One to get it wrong, another to affirm the wrongness, and three more for reinforcement.

For the third time, a federal court in New York has allowed an E&P debtor to reject its gas gathering agreements because its midstream counter-parties could not establish that the agreements were covenants running with the land under Texas law. This time it was the Second Circuit, which upheld a district court ruling, which upheld a  bankruptcy court ruling.

E&P debtor Sabine sought to reject a series of above-market gas gathering agreements. The bankruptcy court allowed the debtor to do exactly that, over the objection of the midstream counter-party. The question on appeal: Under Texas law, are midstream agreements covenants running with the land (and thus, cannot be rejected in bankruptcy)?

This result could have wide-reaching negative effects on the oil and gas industry.  We won’t delve deep into the weeds of the legal analysis.  But we will raise a serious question about the process.

Horizontal privity?

The key question was whether Texas law requires a showing of horizontal privity as part of the covenant analysis.  The New York courts concluded that Texas requires horizontal privity, which was not satisfied under the present circumstances. This allowed Sabine to escape from its midstream agreements.

Horizontal privity requires that the parties make their covenant in connection with, and at the same time as, a conveyance of real property.  The Second Circuit acknowledged that the trend across the country is to do away with the horizontal privity requirement. However, the Court went on to rationalize that “[i]t would be improper for us to read a traditional requirement of real covenants out of Texas state law when there is no Texas law instructing courts to do so.”

The maddening reality

The test, according to the Texas Supreme Court, does not include horizontal privity as a requirement for a covenant to run with the land!

Rather than opining on the nuances of Texas property law, the Second Circuit could have (and should have) certified the question to the Texas Supreme Court so that the law could be uniformly applied by all federal courts in similar cases arising from contracts for the transportation or sale of Texas oil and gas production.  This option would have made the most sense and was proposed by several trade groups.

The Texas high court, the ultimate authority on Texas common law, should decide what it takes to constitute a covenant running with the land in this state – not a federal court sitting thousands of miles away and not at all versed in Texas property law. Leave it to the experts and let Texas tell the world how its laws should be interpreted and enforced.

Railroaded?

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