The Texas legislature blew it.
In 2009, the Delaware bankruptcy court decided that Oklahoma law did not give oil and gas producers a lien in proceeds that would prime the lien of a bank lender. Oklahoma dutifully amended its law in 2010 to close the loophole and protect the state’s oil and gas producers.
Texas had a lien statute with the same defect as Oklahoma’s, but Texas did not amend its law. You can guess the result: The Fifth Circuit upheld Bankruptcy Judge Craig A. Gargotta of San Antonio by ruling on direct appeal that oil and gas producers in Texas had an unperfected security interest in proceeds that came behind the out-of-state bank’s lien on the debtor’s deposit accounts.
In her opinion on February 3, Circuit Judge Edith H. Jones said that producers in Texas “must beware ‘the amazing disappearing security interest’ and continue to file financing statements.” She added, “The Texas legislature should take note.”
Simple Facts
The facts were simple. Producers in Texas and Oklahoma sold and delivered oil and natural gas to the debtor, a Delaware corporation. The debtor should have paid the producers on the 20th of the month after delivery, but the debtor’s chapter 11 filing intervened.
The debtor had sold the producer’s petroleum products before filing to so-called downstream purchasers. On the petition date, the debtor had $27.6 million in accounts receivable from the downstream purchasers that were later collected.
The debtor’s New York bank had a perfected security interest in deposit accounts, accounts receivable and proceeds. The security agreements with the bank were governed by Delaware law.
The Texas Lien Statute
Judge Jones explained how Texas and Oklahoma exacted “special laws . . . whose purpose was to facilitate and ensure payment to the states’ oil and gas producers for sales of their production.” The Texas lien law was made a nonstandard provision in the Texas Uniform Commercial Code § 9.343. It gives producers a first priority purchase money security interest in oil and gas produced in Texas. The security interest in the oil and gas and accounts receivable extends for an unlimited time to proceeds and is perfected automatically, without filing a financing statement.
In other words, the Texas nonuniform provision “deviates” from “Texas’s (and Delaware’s) uniform Article 9 requirements for perfection, the effect of perfection, the length of perfection, and priority among security interests,” Judge Jones said.
The Oklahoma Lien Statute
As amended in 2010, the Oklahoma Lien Act § 549 gives producers a lien in proceeds until the producer is paid, without filing a financing statement.
“Critically, ‘the interest owner’s oil and gas lien created by the Lien Act is not a UCC Article 9 security interest but rather arises as part of a real estate interest of the interest owner in the materials,’” Judge Jones said, quoting Section 549.3.
Texas Producers Lose in Bankruptcy Court
Bankruptcy Judge Gargotta wrote a 49-page opinion in March 2019, ruling that the bank had lien priority over the Texas producers. However, the Oklahoma producers came out ahead of the bank.
The Texas producers appealed. The Fifth Circuit accepted a direct appeal recommended by Judge Gargotta.
The Choice of Law
The producers faced “a formidable choice of law hurdle in that Delaware, the state of Debtor’s formal organization, does not recognize certain nonstandard UCC security interests,” Judge Jones said. Finding that Delaware’s law governed perfection would be a death sentence for the Texas producers because the standard provisions in the Delaware UCC require a financing statement.
Therefore, the pivotal issue was choice of law.
There being no choice of law in the Bankruptcy Code, Judge Jones said that the federal independent judgment test and Texas law both follow the Restatement (Second) of Conflicts. Invoking the Restatement, the Fifth Circuit had previously applied the law of the state with the “most significant relationship.”
Also under circuit precedent, the Fifth Circuit had applied the Texas choice of law rules in Texas UCC § 9.301. For priority and perfection, that section looks to the law where the debtor is “located.” In turn, Section 9.307(e) defines “location” as the state of “organization” for a limited liability corporation like the debtor.
Thus, “Delaware law governs the competing priorities under either Texas choice of law or the federal independent judgment test,” Judge Jones said. She therefore agreed with Judge Gargotta “that substantive Delaware UCC law governs these priority disputes.”
Texans Lose, Sooners Win
The Delaware UCC, of course, requires filing financing statements to perfect security interests in goods, inventory, and proceeds. Consequently, the “Texas Producers are out of luck under Delaware UCC law, which does not recognize the priority of their unfiled, unperfected security interests in proceeds under Texas UCC Section 9.343,” Judge Jones said.
Judge Jones affirmed “the bankruptcy court’s conclusion that the Bank’s interests in the disputed collateral prime any interests held by the Texas Producers.”
The Oklahoma producers came out on top because “the Delaware UCC does not preempt statutory liens created by other states,” Judge Jones said. She added that “the Oklahoma Lien Act [adopted in 2010] was meant to cure the defects found in the state’s Lien Act of 1988 by the Delaware bankruptcy court in In re SemCrude. 407 B.R. 112 (Bankr. D. Del. 2009). . . . In that case, the court held that Oklahoma producers were subject, as Texas Producers still are, to UCC rules governing choice-of-law and priority and perfection of security interests.”
With regard to the Oklahoma producers, Judge Jones ruled that the producers’ liens were prior to the bank’s. She remanded for the producers “to prove up the extent and amount of their secured claims.”
Observations
Will the Texas producers file motion for rehearing and ask the circuit court to certify the question to the Texas Supreme Court? Or, should it be a certification to the Delaware Supreme Court?
All is not lost for producers in Texas whose purchasers are not (yet) in bankruptcy. They can solve their perfection problems by filing financing statements. But will filings now give them priority over previously perfected bank liens? Texas producers may come out on top because the nonuniform Texas UCC purports to give them purchase money security interests.
The opinion is Deutsche Bank Trust Co Americas v. U.S. Energy Development Corp. (In re First River Energy LLC), 19-5646 (5th Cir. Feb. 3, 2021).
The Texas legislature blew it.
In 2009, the Delaware bankruptcy court decided that Oklahoma law did not give oil and gas producers a lien in proceeds that would prime the lien of a bank lender. Oklahoma dutifully amended its law in 2010 to close the loophole and protect the state’s oil and gas producers.
Texas had a lien statute with the same defect as Oklahoma’s, but Texas did not amend its law. You can guess the result: The Fifth Circuit upheld Bankruptcy Judge Craig A. Gargotta of San Antonio by ruling on direct appeal that oil and gas producers in Texas had an unperfected security interest in proceeds that came behind the out-of-state bank’s lien on the debtor’s deposit accounts.
In her opinion on February 3, Circuit Judge Edith H. Jones said that producers in Texas “must beware ‘the amazing disappearing security interest’ and continue to file financing statements.” She added, “The Texas legislature should take note.”