Given the current state of oil and gas markets and the number of U.S. “upstream” operators that may need to restructure this year, investors in this sector should be aware of a number of recent cases addressing the ability of upstream operators to shed covenants made to midstream operators as part of a Chapter 11 restructuring. Recently, two bankruptcy courts (the U.S. Bankruptcy Court for the Southern District of Texas in Alta Mesa and the U.S. Bankruptcy Court for the District of Colorado in Badlands) issued opinions in favor of midstream operators that either distinguish or expressly disagree with the findings of the U.S. Court of Appeals for the Second Circuit’s opinion in the Sabine. These decisions are discussed in detail below, along with a checklist of key questions investors should consider in determining the likelihood that an upstream operator will be able to shed covenants made to a midstream operator if the upstream operator commences a Chapter 11 case.
Gathering Agreements
In the oil and gas world, midstream operators provide a critical bridge between “upstream” exploration and production companies and “downstream” operators who handle marketing and delivery of the oil and gas extracted by the upstream operator. Under the typical “gathering agreement” documenting the relationship between upstream and midstream operators, the upstream operator will “dedicate,” for the benefit of the “midstream operator,” all oil and gas produced from certain designated sites. In return, the midstream operator will agree to gather and process the oil and gas received from the upstream operator and deliver the processed hydrocarbons to a downstream company or other specified location in exchange for minimum monthly or annual payments. In order to perform these services, the midstream operator generally incurs significant upfront expenses, including the cost of constructing pipeline systems, treatment facilities and other infrastructure.
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