On May 3, 2016, Hon. Shelley C. Chapman of the U.S. Bankruptcy Court for the Southern District of New York ruled that covenants contained in certain executory contracts do not run with the land and may be rejected pursuant to § 365 of the Bankruptcy Code. In re Sabine Oil & Gas Corp., et al. involved agreements between the Sabine Oil & Gas Corp. (“Sabine”), an independent energy company engaged in the exploration and production of oil and natural gas, Nordheim Eagle Ford Gathering, LLC (“Nordheim”) and HPIP Gonzales Holdings, LLC (“HPIP”)[1].
In applying Texas law, the court stated that “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.”
Focusing on the “touch and concern” prong of the test, the court addressed the Nordheim and HPIP assertion that oil and gas “produced and saved” is a dedication of minerals and therefore “touches and concerns” real property. The court stated that burdening the oil and gas “produced and saved,” — i.e., as a royalty interest — does not burden the oil and gas that remains in the ground. Under Texas law, minerals extracted from the ground constitute personal property, not real property, and therefore do not “touch and concern” the land.
Furthermore, the agreements include provisions “such as (i) Sabine’s reservation of rights to operate its oil and gas properties independent of and without interference from its gatherer; (ii) the obligations of Nordheim and HPIP to connect to certain ‘Receipt Points’ (as defined in the Nordheim Agreements) or ‘Central Delivery Points’ (as defined in the HPIP Agreements) and not directly to Sabine’s wells; and (iii) that the gathering fee payable to the gatherer is triggered by the gatherer’s receipt of the gas, not by the extraction from the ground.” Therefore, the “touch and concern” prong of the test was not met.
It was unclear to the court whether horizontal proximity was required under Texas law in determining whether a covenant runs with the land. Nonetheless, the court determined “that neither Nordheim nor HPIP has demonstrated that horizontal privity of estate exists between the original covenanting parties with respect to the covenants at issue.”
In connection with the agreements, Sabine conveyed unto Nordheim a parcel of land on which to build a gathering facility. Sabine and Nordheim also entered into a pipeline easement agreement. On that basis, Nordheim averred that horizontal privity was satisfied. The court disagreed, however: “[T]he model for the creation of horizontal privity of estate is the conveyance of an interest in property that itself is being burdened with the relevant covenant, not the conveyance of an interest in property that is distinct from (even if somewhat related to) the property burdened by the covenant.” The court also reiterated the premise that Nordheim and HPIP were obligated to construct a gathering system without connecting pipelines directly to Sabine’s wells.
Lastly, the court dismissed the contention that the covenants at issue constitute an equitable servitude that runs with the land: “[T]he covenants at issue do not limit the use of or burden Sabine’s mineral estate such that they could run with that real property as equitable servitudes.” The court likened the agreements to service contracts relating to the personal property (i.e., the oil and gas as extracted from the property).
In granting Sabine’s motion for summary judgment on declaratory judgment against Nordheim and HPIP, the court succinctly repeated its ruling that the covenants contained in the agreements do not run with the land as either real covenants or equitable servitudes.
[1] Specifically, Sabine entered into a Gas Gathering Agreement and a Condensate Gathering Agreement with Nordheim for the gathering and delivery of natural gas and liquid hydrocarbons, respectively, to a delivery point (the “Nordheim Agreements”). Similarly, Sabine entered into a Production Gathering, Treating and Processing Agreement and a Water and Acid Gas Handling Agreement with HPIP (the “HPIP Agreements” and, together with the Nordheim Agreements, the “Agreements”).