Fifth Circuit Rules that Louisiana Statutory Mineral Liens Are Extinguished as to Production Payments Sold in Arm’s-Length Transactions, Without Notice

Most oil and gas-producing states have oil and gas mineral lien statutes (similar to what many lawyers know as mechanic’s and materialman’s lien statutes) that grant automatically arising liens in favor of vendors that provide services in connection with oil and gas well operations. Louisiana’s version of the statute is known as the Louisiana Oil Well Lien Act (LOWLA).[1] On June 14, 2018, in a case of first impression, the U.S. Court of Appeals for the Fifth Circuit entered a final judgment affirming for purposes of LOWLA’s “safe harbor” provision that the sale of a production payment qualifies as the sale or transfer of “hydrocarbons” under the terms of LOWLA. Accordingly, the court held that LOWLA’s safe harbor operates to extinguish statutory liens as to production payments that are conveyed in “bona fide onerous transactions.” The Fifth Circuit panel’s opinion was issued on April 17, 2018[2] and was subject to a motion for rehearing en banc until June 14, 2018.

In OHA Investment Corp. v. Schlumberger Tech. Corp. (In re ATP Oil & Gas Corp.), OHA had purchased a production payment, aka a term overriding royalty interest (the “Term ORRI”), in outer continental shelf oil and gas properties owned and operated by ATP, an oil and gas exploration and production company. When ATP filed bankruptcy and failed to pay its vendors, many of those vendors sued OHA in bankruptcy court, claiming that their automatically arising liens against ATP’s oil and gas lease incepted prior to OHA’s purchase of its Term ORRI. Therefore, the lien claimants asserted that their liens attached to ATP’s property and followed the conveyance of the Term ORRI from ATP to OHA. The lien claimants were asserting their rights to disgorge over $35 million in royalties paid to OHA. OHA moved to dismiss the claims, arguing, among other things, that LOWLA’s safe harbor provision applied to its purchase of the Term ORRI and that LOWLA extinguished any liens that would have attached. LOWLA’s safe-harbor provision provides:

The privilege^[[3]] is extinguished as to hydrocarbons that are sold or otherwise transferred in a bona fide onerous transaction by the lessee or other person who severed or owned them at severance if the transferee pays for them before he is notified of the privilege by the claimant.[4]

The U.S. Bankruptcy Court for the Southern District of Texas granted OHA’s motion to dismiss, which was affirmed (on recommendation) by the district court and unanimously affirmed by the Fifth Circuit panel.

Among other things, the Fifth Circuit discussed the nature of overriding royalty interests. Specifically, while LOWLA does not define what an overriding royalty interest is, the court looked to its “commonly understood legal meaning” and concluded that “an overriding royalty[] is, first and foremost, a royalty interest. In other words, it is an interest in oil and gas produced at the surface, free and clear of the expense of production.”[5] Notably, the court recognized that an overriding royalty interest is a “‘real right,’ albeit a nonpossessory one.”[6] Therefore, it is irrelevant in what form a royalty interest-holder receives payment, because “an overriding royalty is, again, an interest in oil and gas produced at the surface.”[7] Accordingly, the Fifth Circuit determined that a “purchase of an interest in hydrocarbon production is itself the purchase of ‘hydrocarbons’ in LOWLA’s eyes.”[8] In other words, under LOWLA, when a purchaser acquires an interest in the oil and gas produced at the surface (i.e., a royalty interest), the purchaser is purchasing hydrocarbons. This is so because, while one cannot own hydrocarbons until they are severed, “this principle by no means forbids a landowner or lessee from conveying pre-extraction mineral interests.”[9]

Turning next to LOWLA’s safe-harbor provision, the court interpreted the safe harbor provision as extinguishing an oil and gas vendor’s statutory lien as to hydrocarbons that are sold or otherwise transferred in a bona fide onerous transaction by (1) “the lessee” prior to severance, or (2) an “other person who severed or owned them at severance....”[10] In other words, a party that acquires its royalty interest directly from the lessee prior to severance, like OHA, “fits plainly” within LOWLA’s safe-harbor provision.[11] Thus, where a lessee grants an overriding royalty interest prior to severance, the safe harbor applies to extinguish the vendor’s statutory lien in favor of the overriding royalty interest-holder if the interest holder “pays for [its interest] before [it] is notified of the [vendor’s lien]” by the claimant.[12]

Notably, the Fifth Circuit’s decision is the only case in American jurisprudence that has considered whether a vendor’s statutory lien can attach to (and follow) a subsequently conveyed non-cost-bearing interest in an oil and gas lease. The case is significant and may provide guidance to other courts to the extent similar claims are asserted under mineral lien statutes of other oil and gas-producing states.[13]