Sabine Oil & Gas Corporation

FOR PUBLICATION
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
)
In re: 	) 	Chapter 11
)
SABINE OIL & GAS CORPORATION, et al.,1 ) 	Case No. 15-11835 (SCC)
)
Debtors. 	) 	(Jointly Administered)
)
)
BENCH DECISION ON DEBTORS’ OMNIBUS MOTION
TO AUTHORIZE REJECTION OF CERTAIN EXECUTORY CONTRACTS 2
APPEARANCES:
KIRKLAND & ELLIS LLP
KIRKLAND & ELLIS INTERNATIONAL LLP
601 Lexington Avenue
New York, NY 10022
By: 	Paul M. Basta, P.C.
Jonathan S. Henes, P.C.
Christopher Marcus, P.C.
300 North LaSalle
Chicago, IL 60654
By: 	James H.M. Sprayregen, P.C.
Ryan Blaine Bennett, Esq. (argued)
Brad Weiland, Esq.
Counsel to the Debtors
BRACEWELL & GIULIANI LLP
1251 Avenue of the Americas, 49th Floor
New York, NY 10020
1 The Debtors in these chapter 11 cases, along with the last four digits of each Debtor’s federal tax
identification number, include: Sabine Oil & Gas Corporation (4900); Giant Gas Gathering LLC
(3438); Sabine Bear Paw Basin LLC (2656); Sabine East Texas Basin LLC (8931); Sabine Mid-
Continent Gathering LLC (6085); Sabine Mid-Continent LLC (6939); Sabine Oil & Gas Finance
Corp. (2567); Sabine South Texas Gathering LLC (1749); Sabine South Texas LLC (5616); and
Sabine Williston Basin LLC (4440). The location of Debtor Sabine Oil & Gas Corporation’s
corporate headquarters and the Debtors’ service address is: 1415 Louisiana St., Suite 1600,
Houston, Texas 77002.
2 This decision was dictated on the record of the hearing held on March 8, 2016. 	It has been
modified to include full citations and defined terms, and reflects minor additional non-substantive
modifications.
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By: 	Robert G. Burns, Esq. (argued)
711 Louisiana St., Suite 2300
Houston, TX 77002
By: 	William A. (Trey) Wood III, Esq.
Jason G. Cohen, Esq.
Counsel to Nordheim Eagle Ford Gathering, LLC
LATHAM & WATKINS LLP
885 Third Avenue
New York, New York 10022
By: 	Keith Simon, Esq. (argued)
Annemarie V. Reilly, Esq.
Counsel to HPIP Gonzales Holdings, LLC
ROPES & GRAY LLP
1211 Avenue of the Americas
New York, New York 10036
By: 	Mark R. Somerstein, Esq. (argued)
Keith H. Wofford, Esq.
D. Ross Martin, Esq.
C. Thomas Brown, Esq.
Counsel to the Official Committee of Unsecured Creditors
LINKLATERS LLP
1345 Avenue of the Americas
New York, New York 10105
By: 	Margot B. Schonholtz, Esq. (argued)
Robert H. Trust, Esq.
Counsel to Wells Fargo, National Associate,
as Administrative Agent under First Lien Credit Agreement
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HONORABLE SHELLEY C. CHAPMAN
UNITED STATES BANKRUPTCY JUDGE:
Before the Court is the Debtors’ Motion (the “Motion”) for an Order Authorizing
Rejection of Certain Executory Contracts [ECF No. 371]. By the Motion, the Debtors seek to
reject certain contracts between Sabine Oil & Gas Corporation (“Sabine”) and Nordheim Eagle
Ford Gathering, LLC (“Nordheim”), and between Sabine and HPIP Gonzales Holdings, LLC
(“HPIP”) pursuant to section 365(a) of the Bankruptcy Code.
On October 8, 2015, Nordheim and HPIP3 each filed an objection to the Motion [ECF
Nos. 386 and 387]. On October 14, 2015, the Debtors filed their omnibus reply to the objections
[ECF No. 410]. On January 8, 2016, Nordheim filed a surreply to the Motion [ECF No. 676],
and on January 22, 2016, the Debtors filed a response to that surreply [ECF No. 742]. The Court
heard oral argument on the Motion on February 2, 2016.
Background
The Debtors — an independent energy company engaged in the acquisition, production,
exploration, and development of onshore oil and natural gas properties in the United States —
filed petitions for relief under chapter 11 of the Bankruptcy Code with this Court on July 15,
2015. The Debtors are operating their businesses and managing their properties as debtors in
possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code. The Court entered an
order authorizing the joint administration and procedural consolidation of the Debtors’ chapter
11 cases pursuant to Bankruptcy Rule 1015(b) on July 16, 2015. There has not been a request
3 Nordheim and HPIP are so-called “midstream gatherers.” Situated operationally between
upstream companies such as Sabine and downstream refining companies, midstream gatherers
gather, treat, transport, and/or process mineral products produced from a well before such
products enter the commercial market. See, generally, Kurt L. Krieger, Gathering and
Transporting Marcellus and Utica Shale Natural Gas to the Market and the Regulation of
Midstream Pipeline Companies, 19 Tex. Wesleyan L. Rev. 49 (2012).
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for the appointment of a trustee or examiner in these chapter 11 cases. On July 28, 2015, the
Office of the U.S. Trustee for the Southern District of New York formed the official committee
of unsecured creditors pursuant to section 1102 of the Bankruptcy Code. Familiarity with the
background of the Debtors’ businesses and chapter 11 cases, and with the December 16, 2014
combination of Sabine Oil & Gas LLC and Forest Oil Corporation (the “Combination”), is
assumed. 4
A. The Nordheim Agreements
As a result of the Combination, Sabine became party to two contracts with Nordheim,
each dated January 23, 2014: the first, a Gas Gathering Agreement, and the second, a Condensate
Gathering Agreement (together, the “Nordheim Agreements”). By the Gas Gathering
Agreement, Sabine agreed to “dedicate” to the “performance” of that agreement all of the gas
produced by Sabine from a designated area and deliver such gas to Nordheim, and Nordheim
agreed to gather, treat, dehydrate, and re-deliver that gas to Sabine. Nordheim further agreed to
construct, at its sole cost and expense, a gathering system of pipelines and treatment facilities to
provide certain agreed-upon services. The Gas Gathering Agreement contemplates a separate
and subsequent conveyance from Sabine to Nordheim of a mutually agreed tract of land in
connection with Nordheim’s construction and operation of the gathering system. Sabine also
agreed to deliver a certain minimum amount of gas to Nordheim on an annual basis. To the
extent it does not deliver such minimum amounts, Sabine is required to make a deficiency
payment to Nordheim; Sabine also is obligated to pay monthly gathering fees to Nordheim. The
Gas Gathering Agreement has a 10-year term, with automatic yearly renewal subject to
termination, and is governed by Texas law.
4 See, generally, Declaration of Michael Magilton (A) in Support of First Day Motions and (B)
Pursuant to Local Bankruptcy Rule 1007-2 [ECF No. 3].
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The Condensate Gathering Agreement between Sabine and Nordheim contains
substantially the same terms as the Gas Gathering Agreement, but it relates to liquid
hydrocarbons and other liquids rather than gas. The Court will refer to the liquid hydrocarbons,
gas, and other products that are the subject of the dedications in the Nordheim Agreements as the
“Nordheim Products.”
Each Nordheim Agreement specifically provides that the agreement itself is a “covenant
running with the [land]” within the designated area, and is enforceable by Nordheim against
Sabine, its affiliates, and their successors and assigns.5
B. The HPIP Agreements
Sabine also became party to two contracts with HPIP as a result of the Combination: one,
a Production Gathering, Treating and Processing Agreement, dated May 3, 2013, and the other a
Water and Acid Gas Handling Agreement, dated May 2014, with no specific date (together, the
“HPIP Agreements”). The former, the HPIP Gathering Agreement, obligates Sabine to
“dedicate” to the “performance” of the agreement certain leases owned by Sabine and the oil,
gas, and water produced from the wells located on the land subject to those leases, and to deliver
that oil, gas, and water to HPIP. Pursuant to the agreement, HPIP agreed to construct, operate,
and maintain gathering facilities to provide certain services with respect to the products delivered
by Sabine. The HPIP Gathering Agreement is also governed by Texas law.
The latter, the HPIP Handling Agreement, contains substantially similar terms to those
set forth in the HPIP Gathering Agreement, but provides for HPIP to construct, operate, and
maintain disposal facilities for and perform disposal services with respect to all of the water and
acid gas produced by Sabine from the same land subject to the leases. The Court will refer to the
5 Nordheim Gas Gathering Agreement ¶ 1.6; Nordheim Condensate Gathering Agreement
¶ 1.6.
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oil, gas, acid, and water that are the subject of the dedications in the HPIP Agreements as the
“HPIP Products.”
Each HPIP Agreement provides that Sabine’s undertaking to deliver the HPIP Products to
HPIP is a covenant “running with the lands and leasehold interests” identified in the agreement,6
and further provides that the agreement “shall be binding upon and inure to the benefit of the
Parties hereto, their successors, assigns, heirs, administrators and/or executors.” 7
Discussion
A. The Debtors Have Satisfied the Standard for Rejection of the Agreements
The Debtors seek to reject the Nordheim Agreements and the HPIP Agreements (referred
to collectively as the “Agreements”) pursuant to section 365(a) of the Bankruptcy Code. Under
that provision, a debtor in possession, “subject to the court’s approval, may assume or reject any
executory contract…of the debtor.”8 Subject to the requirement of notice and a hearing, and the
bankruptcy court’s approval, section 365(a) allows the debtor in possession to evaluate its
executory contracts (and unexpired leases) and “decide which ones would be beneficial to adhere
to and which ones it would be beneficial to reject.”9 “The purpose behind allowing the
assumption or rejection of executory contracts is to permit the trustee or debtor-in-possession to
use valuable property of the estate and to renounce title to and abandon burdensome property.” 10
As the Second Circuit held in Orion Pictures Corp. v. Showtime Networks, the “process
of deciding a motion to assume [or reject] is one of the bankruptcy court placing itself in the
position of…the debtor in possession and determining whether assuming [or rejecting] the
6 HPIP Gathering Agreement ¶ 1.2; HPIP Handling Agreement ¶ 1.2.
7 HPIP Gathering Agreement ¶ 9.2.1; HPIP Handling Agreement ¶ 8.2.1.
8 11 U.S.C. § 365(a).
9 Orion Pictures Corp. v. Showtime Networks (In re Orion Pictures Corp.), 4 F. 3d 1095, 1098 (2d
Cir. 1993).
10 Id.
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contract would be a good business decision or a bad one.”11 This analysis is generally referred to
as a “business judgment” test, although it varies somewhat from the traditional business
judgment rule employed in state corporate law,12 and requires the court to look at whether the
debtor’s decision to assume or reject is beneficial to the estate.13 The bankruptcy court generally
defers to a debtor’s determination as to whether rejection of an executory contract is
advantageous,14 unless the decision to reject is the product of bad faith, whim, or caprice.15
Unless a separate provision of the Bankruptcy Code provides a non-debtor party with specific
protection, the interests of the debtor and its estate are paramount; adverse effects on the non-
debtor contract party arising from the decision to assume or reject are irrelevant.16 At root, the
question for the court on a motion to reject is “whether a reasonable business person would make
a similar decision under similar circumstances.”17
The Debtors argue that rejection of the Nordheim Agreements and the HPIP Agreements
is a reasonable exercise of their business judgment and is in the best interests of their estates
because those Agreements are unnecessarily burdensome. Specifically, the Debtors submit that
it is not financially viable for them to deliver the minimum amounts of gas and condensate set
forth in the Agreements, and, absent rejection, they would therefore be required to make the
contractual deficiency payments, which would impose a considerable and unnecessary drain on
11 Id. at 1099; see also In re Penn Traffic Co., 524 F.3d 373, 383 (2d Cir. 2008); In re The Great
Atlantic & Pacific Tea Co., 544 B.R. 43 (Bankr. S.D.N.Y. 2016) (RDD).
12 In re The Great Atlantic & Pacific Tea Co., 544 B.R. at 48.
13 In re Enron Corp., No. 01-16034 (AJG), 2006 WL 898033, at *4 (Bankr. S.D.N.Y. Mar. 24,
2006).
14 In re Balco Equities Ltd., Inc., 323 B.R. 85, 98 (Bankr. S.D.N.Y. 2005).
15 Westbury Real Estate Ventures v. Bradlees, Inc. (In re Bradlees Stores, Inc.), 194 B.R. 555, 558
n.1 (Bankr. S.D.N.Y. 1996).
16 In re Penn Traffic Co., 524 F.3d at 383; In re The Great Atlantic & Pacific Tea Co., 472 B.R. at
672-73; In re Old Carco LLC, 406 B.R. 180, 192-93 (Bankr. S.D.N.Y. 2009).
17 In re Helm, 335 B.R. 528, 538-39 (Bankr. S.D.N.Y. 2006).
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the estates’ resources. If rejection is authorized, the Debtors state that they plan to enter into new
gathering agreements with other gatherers on terms more favorable to the Debtors.
Both Nordheim and HPIP object to the Debtors’ proposed rejection, but for slightly
different reasons. In its papers, Nordheim argues that the Debtors’ decision to reject the
Nordheim Agreements does not satisfy the business judgment standard because Sabine’s
covenants to dedicate the Nordheim Products and to pay a “transportation fee” are covenants that
run with the land and therefore would survive rejection.18 As argued by Nordheim, if the
Debtors reject the Nordheim Agreements, Sabine would remain bound by those covenants, and
rejection of the remainder of the agreements would provide little or no benefit to the Debtors’
estates.
At oral argument, however, Nordheim put forward an additional and distinct argument
for the first time: that while the Court can authorize the Debtors’ rejection of the Nordheim
Agreements, it cannot in doing so make a determination as to the legal status under Texas
property law of those covenants in the Nordheim Agreements that Nordheim argues “run with
the land.” In support of its argument, Nordheim relies on the Second Circuit’s decision in Orion
as a legal limitation on the Court’s authority in the context of the Motion. In that case, the
Second Circuit found that a bankruptcy court had committed reversible error by deciding a
disputed factual issue in the context of a motion to assume an executory contract.
Like Nordheim, HPIP argues that Sabine’s dedication of certain of its leases and the
HPIP Products are covenants that run with the land and are not subject to rejection.19 Unlike
18 Nordheim Objection, ¶ 16 (citing In re Banning Lewis Ranch Co., LLC, 532 B.R. 335, 346
(Bankr. D. Colo. 2015) for proposition that debtor’s rejection of an agreement does not affect
covenants to non-debtor parties that run with the land).
19 HPIP Objection, ¶ 9 (citing Gouveia v. Tazbir, 37 F.3d 295, 298 (7th Cir. 1994) holding that
covenants running with the land are property interests and cannot be extinguished through
bankruptcy).
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Nordheim, however, HPIP does not object to the rejection of the HPIP Agreements, but opposes
only the Debtors’ attempt to reject those certain covenants contained in the HPIP Agreements
that HPIP argues “run with the land.”20 Contrary to Nordheim’s Orion argument, HPIP submits
that the Court should make an affirmative determination in the context of this Motion that the
covenants do in fact run with the land and therefore cannot be rejected.
Significantly, neither Nordheim nor HPIP has put forward any arguments or evidence
that the Debtors’ decision to reject their Agreements is the product of “bad faith, whim or
caprice.”
As discussed more fully below, after review of Nordheim’s Orion argument and Judge
Drain’s recent decision in In re The Great Atlantic & Pacific Tea Company, Inc. interpreting
Orion, the Court concludes that it cannot decide substantive legal issues, including whether the
covenants at issue run with the land, in the context of a motion to reject, unless such motion is
scheduled simultaneously with an adversary proceeding or contested matter to determine the
merits of the substantive legal disputes related to the motion.21 Although Federal Rules of
Bankruptcy Procedure 6006 and 9014 provide that a proceeding to reject an executory contract is
a contested matter, the Second Circuit’s decision in Orion makes clear that such a proceeding
“should be considered a summary proceeding, intended to efficiently review the trustee's or
debtor's decision to adhere to or reject a particular contract in the course of the swift
administration of the bankruptcy estate. It is not the time or place for prolonged discovery or a
lengthy trial with disputed issues.”22 In the instant case, because there is not procedural clarity or
consensus as to whether issue was properly joined on the substantive legal issues presented by
the Motion – i.e., whether certain of the contractual terms are covenants that “run with the land”
20 HPIP Objection, p. 2.
21 Orion, 4 F.3d. at 1099.
22 Id. at 1098-99.
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under Texas law – the Court must proceed in accordance with Orion and rule on the Motion
without deciding in a binding way the underlying legal dispute with respect to whether the
covenants at issue run with the land. The Court does so reluctantly inasmuch as there is no doubt
that bifurcating the motion to reject and further proceedings to finally resolve the underlying
property law dispute is an inefficient use of judicial and private resources; it would have been far
preferable for the Court to hear the two together.
At oral argument, counsel for HPIP acknowledged that HPIP does not object to the
Debtors’ rejection of the HPIP Agreements, stating that “there’s no question they should reject”23
and that “assumption wouldn’t make any sense.”24 Accordingly, there is no dispute with respect
to the reasonableness of the Debtors’ decision to reject the HPIP Agreements. Nordheim,
however, challenges the reasonableness of the Debtors’ decision to reject the Nordheim
Agreements, but has put forward no evidence or argument that the Debtors’ decision was the
product of bad faith, whim, or caprice, or was otherwise an unreasonable exercise of the Debtors’
business judgment.
If it is ultimately determined that the covenants at issue in the Agreements do not run
with the land, as the Debtors argue and the Court believes to be the case, the Debtors will be free
to negotiate new gas gathering agreements with any party, likely obtaining better terms than the
existing agreements provide. If, however, the covenants are ultimately determined to run with
the land, the Debtors will likely need to pursue alternative arrangements with Nordheim and
HPIP consistent with the covenants by which the Debtors would remain bound. In either
scenario, the Debtors’ conclusion that they are better off rejecting the Nordheim and HPIP
Agreements is a reasonable exercise of their business judgment. Therefore, even though, as
23 Tr. of 2/2/16 Hearing 94:16-17 [ECF No. 816].
24 Tr. of 2/2/16 Hearing 97:20-23.
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explained below, the Court’s conclusion that the covenants at issue do not run with the land is
non-binding, the Court finds the Debtors’ decision to reject each of the Nordheim Agreements
and the HPIP Agreements to be a reasonable exercise of business judgment.
In the absence of any allegation challenging the Debtors’ decision-making process, the
Court finds that the Debtors have properly and adequately considered the business and legal risks
associated with rejection of the Nordheim Agreements and the HPIP Agreements. Taking into
account HPIP’s consent to the rejection of the HPIP Agreements, and having identified no basis
to find otherwise with respect to either the Nordheim Agreements or the HPIP Agreements, the
Court defers to the business judgment of the Debtors to reject the Agreements. Rejection of the
Agreements relieves the Debtors of those terms that are subject to rejection (whether that be all
or some of the terms of the Agreements as will be decided in a subsequent proceeding or agreed
to by the parties), and will likely allow for the more efficient use of the Debtors’ assets.
The Court’s non-binding analysis as to whether the covenants at issue “run with the land”
under Texas law follows. 25
B. The Covenants At Issue Do Not “Run with the Land” under Texas Law
The covenants at issue are (i) the Debtors’ dedication to HPIP of the HPIP Products and
certain leases to the performance of the HPIP Agreements; (ii) the Debtors’ dedication to
Nordheim of the Nordheim Products to the performance of the Nordheim Agreements; and (iii)
the Debtors’ covenant to pay Nordheim a gathering fee. Generally, a covenant may run with the
land as a real covenant or as an equitable servitude. Here, the Court preliminarily finds that none
of the covenants runs with the land either as a real covenant or as an equitable servitude.
25 It is clear that under Orion the Court may consider disputed legal issues in a non-binding way in
the context of a motion to reject. In re The Great Atl. & Pac. Tea Co., Inc., 544 B.R. at 52.
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1. 	Historical Development of Covenants “Running with the Land”26
As many practitioners have noted, “[i]n U.S. property law, no rules are more arcane and
anachronistic than those governing real covenants,” 27 a statement with which every first-year law
student undoubtedly agrees. Nevertheless, the use of property covenants is pervasive in the
United States, and the law relating to covenants, while archaic, must still be faithfully applied.
To inform its analysis of Texas law and its application to the facts here, the Court provides some
background on the origins and development of covenants “running with the land” in the United
States.
The original concept of covenants “running with the land” was introduced in early
English law at a time when neither the rights nor the duties created by contract could be
assigned. Beginning in the landlord and tenant context, the idea that the benefit and burden of a
covenant could run with the ownership interest was applied in other situations, including
covenants included in a conveyance of land. These covenants respecting the use of land that ran
with the estate came to be known as “real covenants” and were enforceable in the English courts
of law.
In the early cases, the courts tended to restrict the expansion of the use of real covenants
by adding requirements to be met in order for a successor to recover for breach of a covenant in
the original contract. For example, in one of the earliest cases dealing with the running of a
burden, Spencer’s Case,28 the English court in the year 1583 created two requirements: (1) for a
covenant relating to something not in existence to run, it must expressly bind assigns and (2) a
covenant must “touch and concern” the land in order for it to run.
26 See generally 9 Richard R. Powell, Powell on Real Property, § 60.01 (2015).
27 53 Rocky Mt. Min. L. Inst. § 19.01 (2007).
28 77 E.R. 72 (1583).
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By 1834, the English courts of law had greatly narrowed the scope of legal relief
available for breaches of covenants by holding that the running of the burdens on owners in fee
violated public policy against encumbering land and restricting alienation. Thereafter, English
courts of equity began developing rules for the enforcement of covenants against successive
interestholders. Although over time English courts stopped finding that affirmative covenants
run with the land, American jurisdictions have generally rejected that approach, instead adopting
a policy that the requirements for running with the land should be more strictly applied to
affirmative covenants than to negative ones. The covenants that meet the test established by the
courts of equity have come to be known as “equitable servitudes.”
Over time, the use of covenants, both real and equitable, has become common. Yet,
many characterize the law of covenants as an “unspeakable quagmire,”29 in part because of the
continued distinction between real covenants and equitable servitudes even after the union of law
and equity, as well as the development in judicial decisions of additional requirements and
wrinkles across different jurisdictions. Although the American Law Institute has pursued
clarification by adopting the Restatement (Third) of Property: Servitudes in 1998, acceptance of
some of the newer propositions has not been universal.
It is in this historical context that the Court has considered the arguments as to the status
under Texas property law of the covenants at issue in this case, and has preliminarily concluded
that the covenants do not run with the land either as real covenants or as equitable servitudes.
2. 	Real Covenants
29 See 9 Richard R. Powell, Powell on Real Property, § 60.01 (2015) (citing Edward Rabin, Roberta
Kwall, Jeffrey Kwall, and Craig Arnold, Fundamentals of Modern Real Property Law 489 (6th
ed. 2011).
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The parties agree that whether the covenants run with the land is a question of Texas law,
which is the law governing the Agreements. Unfortunately, there appears to be no applicable
binding decision of the Texas Supreme Court on all aspects of the question. What follows is the
Court’s analysis of the issue based on existing caselaw.
Under Texas law, language in a contract containing a covenant is the primary evidence of
the parties’ intent, but terminology is not dispositive. 30 Rather, a covenant runs with the land
when (1) it touches and concerns the land; (2) it relates to a thing in existence or specifically
binds the parties and their assigns; (3) it is intended by the original parties to run with the land;
and (4) the successor to the burden has notice.31 Many courts have also required that the parties
have horizontal privity of estate. Neither Nordheim nor HPIP has identified any governing
authority that has rejected the horizontal privity requirement, and so the Court has considered the
issue of horizontal privity of estate in its analysis. 32
In their omnibus reply to the objections, the Debtors dispute the existence of three of
these elements: (1) that there is horizontal privity of estate between, respectively, Sabine and
Nordheim, and Sabine and HPIP; (2) that the relevant covenants “touch and concern” the land;
and (3) that the parties intended those covenants to run with the land.
Horizontal privity of estate generally means that there was “simultaneous existing
interests or mutual privity” between the original covenanting parties as either landlord and tenant
or grantor and grantee.33 According to the traditional concept, the original covenanting parties
seeking to create a covenant “running with the land” would need to have some additional
transactional element to their relationship, and not merely be two parties seeking to covenant
30 Musgrave v. Brookhaven Lake Property Owners Ass’n, 990 S.W.2d 386, 395 (Tex. App. 1999).
31 Inwood North Homeowners’ Ass’n, Inc. v. Harris, 736 S.W.2d 632, 635 (Tex. 1987).
32 Westland Oil Dev. Corp. v. Gulf Oil Corp., 637 S.W.2d 903, 910-11 (Tex. 1982).
33 Newco Energy v. Energytec, Inc. (In re Energytec, Inc.), 739 F.3d 215, 222 (5th Cir. 2013).
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with one another.34 The traditional paradigm involves a property owner reserving by covenant,
either for itself or another beneficiary, a certain interest out of the conveyance of the property
burdened by the covenant. That was the factual context before the Fifth Circuit in its decision in
Newco Energy v. Energytec, Inc.35 on which both Nordheim and HPIP rely almost exclusively in
support of their argument that the covenants at issue run with the land. In Energytec, the owner
of a pipeline system assigned its property rights to one party, while reserving by covenant for
another party the right to receive a fee for product transported on that property (i.e., through the
pipeline) and a right to consent to any assignment of that property – a clear instance of the
promisor seeking to ensure that the conveyance of its property interests did not eradicate an
interest in the property of a third party.
The facts here do not fit within that traditional model. In this case, the Debtors did not in
the context of a relevant conveyance reserve any interest for Nordheim or HPIP; rather, they
simply engaged Nordheim and HPIP to perform certain services related to the hydrocarbon
products produced by Sabine from its property. The covenants at issue are properly viewed as
identifying and delineating the contractual rights and obligations with respect to the services to
be provided, and not as reserving an interest in the subject real property.
Moreover, the Agreements do not grant Nordheim or HPIP a real property interest in the
Debtors’ mineral estate, which is comprised of five real property rights, or “sticks,” under Texas
law: “(1) the right to develop (the right of ingress and egress), (2) the right to lease (the
executive right), (3) the right to receive bonus payments, (4) the right to receive delay rentals,
[and] (5) the right to receive royalty payments.” 36 A right to transport or gather produced gas is
34 53 Rocky Mt. Min. L. Inst. § 19.03 (2007).
35 739 F.3d at 221.
36 Lesley v. Veterans Land Bd., 352 S.W.3d 479, 481 n.1 (Tex. 2011) (quoting Altman v. Blake, 712
S.W.2d 117, 118 (Tex. 1986)).
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clearly not one of these “sticks.”37 Therefore, under Texas law, the Debtors have not transferred
any portion of their real property interests to Nordheim or HPIP through the Agreements.
The covenants at issue also do not appear to satisfy the “touch and concern” prong.
Courts utilize two tests for determining whether that prong is satisfied under Texas law, although
these tests are not “absolute.”38 The first test considers whether the covenant “affected the
nature, quality or value of the thing demised, independently of collateral circumstances, or if it
affected the mode of enjoying it.”39 The second test evaluates whether “the promisor’s legal
relations in respect of the land in question are lessened—his legal interest as owner rendered less
valuable by the promise…[and] if the promisee’s legal relations in respect to the land are
increased—his legal interest as owner rendered more valuable by the promise.”40 The Fifth
Circuit, in interpreting Texas law, has stated that “[a]lthough the caselaw is somewhat unclear, it
is at least arguable that the benefit requirement has been abandoned by the Texas courts”—
meaning that a covenant need only burden the promisor’s legal interest in the land to “touch and
concern” that land.41 But, the Fifth Circuit has also explained that it is not enough that a
covenant affect the value of the land; “it must still affect the owner's interest in the property or its
use in order to be a real covenant.”42 The covenants at issue here do not satisfy either test: they
do not impact the value of the land “independent of collateral circumstances” and do not affect
any interest in the real property of, or its use by, the owner. Rather, those covenants constitute
37 Id. at 481.
38 Westland Oil, 637 S.W.2d at 911.
39 El Paso Refinery, LP v. TRMI Holdings, Inc. (In re El Paso Refinery, LP), 302 F.3d 343, 356 (5th
Cir. 2002).
40 Westland Oil, 637 S.W.2d at 911.
41 El Paso, 302 F.3d at 356. Not only is the caselaw “somewhat unclear,” but each of the two tests
identified in the caselaw is somewhat analytically circular.
42 Id. at 357.
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an undertaking personal to the producer (Sabine) and the midstream service providers (Nordheim
and HPIP).
Under Texas law, once minerals are extracted from the ground, such minerals cease to be
real property and instead become personal property.43 The covenants at issue concern only
Sabine’s interests in the produced “Products.” The dedication covenants provide Nordheim and
HPIP, as Sabine’s service-providers, with the products needed to perform the contracted-for
services. This is true even for the Debtors’ dedication of certain leases in the HPIP Agreements
inasmuch as that dedication is in furtherance of the overarching purpose of the contract, which is
to provide product services to the Debtors. Similarly, the gathering fee compensates Nordheim
for gathering those Products as part of its provision of those services. Contrary to HPIP’s
argument, the “dedication” does not constitute a burdening of the Debtors’ property interests, but
rather an identification of what property and products are the subject of the Agreement and will
be made available to the gatherer in furtherance of the purposes of the Agreements. Under Texas
law, such covenants do not have a direct impact upon the real property from which those
products were produced and thus do not “touch and concern” the land. They concern only the
Products produced from real property and affect only Sabine’s personal property rights.44
43 See, e.g., Sabine Prod. Co. v. Frost Nat. Bank of San Antonio, 596 S.W.2d 271, 276 (Tex. Civ.
App. 1980); Colorado Interstate Gas Co. v. Hunt Energy Corp., 47 S.W.3d 1, 10 (Tex. App.
2000), pet. denied; Riley v. Riley, 972 S.W.2d 149, 155 (Tex. App. 1998); Phillips Petroleum Co.
v. Adams, 513 F.3d 355, 363 (5th Cir. 1975).
44 An argument might be made that the fact that only “produced” Products are dedicated to the
performance of the Agreements does not limit such a dedication to Products extracted from the
ground (i.e., personal property) but also includes Products that are still in the ground (i.e., real
property) because, under Texas law, a conveyance of oil and gas “produced and saved” is
classified as a royalty interest, which is characterized by Texas courts as a real property interest.
Such an argument, however, depends on the separate and different conclusion that a conveyance
of oil and gas “produced and saved” is a conveyance of oil and gas not extracted from the ground,
i.e., the reserves. That conclusion does not logically follow, and therefore any such argument
would fail. Moreover, as discussed infra, the Debtors’ reserves are subject to the liens of their
reserve-based lenders.
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Another consideration that the Fifth Circuit has examined in determining whether a
covenant burdens the land is whether the action triggering the covenant is one that affects the
land.45 In Westland Oil, for example, the Texas Supreme Court held that a covenant obligating a
third-party to assign part of its interest in certain oil and gas leases “touched and concerned the
land” in part because the covenant was triggered by the drilling of a test well on the land.46
Here, the triggers for the covenants at issue relate to the Products, not to the land itself.
The dedication covenants are triggered contractually by Sabine’s production and saving
of the Nordheim and HPIP Products, while the Nordheim gathering fee covenant is triggered by
Nordheim’s receipt of the Nordheim Products. None of those triggers affects the land from
which those products have been produced. Rather, only the products themselves, and,
importantly, Sabine’s rights with respect to those products, are affected by those covenants.47
The land itself remains unburdened.48
On this basis, once again, Energytec is distinguishable.49 First, the right to consent to an
assignment in Energytec was a clear burden on the land because it restricted the landowner’s
rights of alienation of its property. Such a burden does not exist here. Second, unlike the
Nordheim gathering fee, the transportation fee in Energytec was secured by a lien on the entire
45 El Paso, 302 F.3d at 356 (distinguishing Westland Oil).
46 Westland Oil, 302 F.3d at 357.
47 A question as to the extent of the Debtors’ rights under the Agreements or otherwise to transport
Products by means other than the gathering systems of Nordheim and HPIP arose at oral
argument – to wit, the Debtors acknowledged that they are in fact using trucks instead of the
HPIP gathering system to transport certain HPIP Products, a fact of which HPIP’s counsel stated
he was unaware. See Tr. of 2/2/16 Hearing 105:18-23. The transportation of the HPIP Products
other than through HPIP’s gathering system, if permissible under the HPIP Agreements, supports
the conclusion that the dedication covenants in the HPIP Agreements do not “touch and concern”
the land. As of the date hereof, HPIP has not, to the Court’s knowledge, sought injunctive relief
against the Debtors relating to such activities.
48 See El Paso, 302 F.3d at 356 (citing Mobil Oil Corp. v. Brennan, 385 F.2d 951, 953 (5th Cir.
1967) (describing covenant preventing mineral estate owner from interfering with surface grazing
and from placing pipelines above certain depth)).
49 739 F.3d at 221.
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gas pipeline system, which was owned by the promisor. As the Debtors point out, not only is the
Nordheim gathering fee not secured, but the property subject to the Nordheim Agreements is
subject to preexisting liens held by the Debtors’ secured lenders. Those lienholders did not
approve a conveyance of any interest in the land subject to the liens, and they were not informed
of any interest being created in those properties.50 Moreover, while Nordheim and HPIP point to
local recordings filed in connection with their respective Agreements, there was no security
provided to them with respect to their alleged interests in the property. Contrary to Nordheim’s
argument that any lien priority dispute is an issue between the Debtors and their lienholders, 51
those facts strongly militate against a finding that the covenants at issue burden the property and
thus touch and concern the land.
Energytec is also distinguishable by the fact that the obligation to pay the transport fee in
that case was triggered simply by the flow of gas through the pipeline. Here, in contrast, the
Nordheim gathering fee is triggered by Nordheim’s receipt of gas from Sabine into Nordheim’s
own facilities. Nordheim’s gathering fee is thus not as directly tied to the promisor’s land as was
the case in Energytec. The Nordheim gathering fee covenant therefore has no direct connection
to or impact on the land or on Sabine’s property rights.52 Neither the property owner’s interest in
the land (as distinct from the products produced from those lands) nor its use of those lands is
affected by such covenants, which, as the Fifth Circuit stated in El Paso, do not “compel []or
preclude [the owner]…from doing anything on the land itself.”53
Having found preliminarily that the covenants at issue do not (i) readily fit into the
traditional paradigm for horizontal privity of estate or (ii) “touch and concern” the Debtors’ land,
50 Tr. of 2/2/16 Hearing 114:6-9.
51 Tr. of 2/2/16 Hearing 119:18-25.
52 El Paso, 302 F.3d at 346.
53 Id. at 346, 356-57.
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the Court need not further extend its real covenant analysis at this time; accordingly, the Court
has not considered the issue of the parties’ intent.
3. 	Equitable Servitudes
Nordheim, in its surreply, alternatively argues that even if the covenants at issue are
personal covenants, they constitute equitable servitudes which cannot be rejected pursuant to the
Bankruptcy Code. This argument lacks merit. An equitable servitude is enforceable when the
contracting parties are in privity of estate at the time of the conveyance and a subsequent party
purchases the land with notice of the restriction.54 However, in the case of an equitable
servitude, the restriction sought to be enforced must still “concern the land or its use or
enjoyment.” 55 Because the Court has concluded that the covenants at issue do not “concern the
land or its use,” the Court also must conclude that the covenants at issue are likewise not
enforceable as equitable servitudes.
Conclusion
For all of the foregoing reasons, the Court finds that the decision to reject the Nordheim
Agreements and HPIP Agreements is a reasonable exercise of the Debtors’ business judgment.
Accordingly, the Court authorizes the rejection of those agreements as of the dates requested in
the Motion.
As required by Orion, in granting the Motion, the Court does not make any final
determination as to whether the covenants at issue run with the land or as to any substantive legal
issue other than granting authority to reject the contracts under section 365(a). The Court does
not at this time grant the Debtors’ request to limit the nature of the claims that Nordheim or HPIP
may file against the Debtors’ estates, nor does it grant Nordheim’s request for what is effectively
54 Id. at 358.
55 Id.
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relief from the automatic stay to pursue remedies against Sabine and its property. Nordheim and
HPIP may file claims (and, in HPIP’s case, amend its previously filed claim) against the
Debtors’ estates consistent with what each of them believes its legal rights to be, and those
claims may be resolved promptly through the Debtors’ claims administration process. The
parties are directed to submit an order consistent with this decision.
Dated: March 8, 2016
New York, New York 	/S/ Shelley C. Chapman
HONORABLE SHELLEY C. CHAPMAN
UNITED STATES BANKRUPTCY JUDGE
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