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Sabine: The Next Episode

April 13, 2017

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Sabine: The Next Episode

April 13, 2017

Authored by: Craig Schuenemann

Editor’s Note: On June 16, 2016, The Bankruptcy Cave gave you our previous summary of the controversial Sabine decision.  When Bankruptcy Judge Chapman determined there was no reason to expedite review of her decisions in the case, we brought you Sabine Lives On (and On) detailing the struggles of Sabine’s midstream adversaries.  Like Hollywood, Bankruptcy Cave knows that sequels sell (with some notable awful exceptions, such as here and here).  We now bring you the third installment of Sabine.  If it sounds like a horror film or slasher flick, it was for the midstream sector.

The bankruptcy court was right!  Judge Rakoff of the United States District Court for the Southern District of New York stated starkly: “[T]he bankruptcy court did not err in authorizing the rejection of the Agreements pursuant to 11 U.S.C. § 365(a).  Nordheim challenges the decision only on the ground that the Agreements are real covenants that run with the land, and, since the Court reaches the contrary conclusion; Nordheim’s argument in this regard has no merit.”[i]

Backing up almost a year, on March 9, 2016, Bankruptcy Judge Chapman of the Southern District of New York issued her decision on the Debtor’s motion to reject certain contracts in Sabine Oil & Gas Corporation’s Chapter 11 case.  The decision allowed Sabine to reject “gathering agreements” between it and two “midstream operators” [for more info on these technical terms see my prior blog post here] Nordheim Eagle Ford Gathering, LLC and HPIP Gonzales Holdings, LLC, under Section 365(a) of the Bankruptcy Code.  In June, 2016, Judge Chapman refused to allow the midstream operators to appeal her decision to the Second Circuit Court of Appeals and rejected requests to stay her decision.[ii]  These decisions sent shockwaves through the midstream energy sector and leveled the playing field for bankrupt production companies.

Judge Rakoff’s opinion (full copy Here) turns immediately to the question of “whether the Agreements run with the land and therefore cannot be rejected pursuant to § 365(a).”[iii]  Relying on Texas law and citing Inwood N. Homeowner’s Ass’n v. Harris, the Court notes that

In Texas, a covenant runs with the land when it touches and concerns the land; relates to a thing in existence or specifically binds the parties and their assigns; is intended by the original parties run with the land; and when the successor to the burden has notice.[iv]

It is the first requirement, that a covenant touch and concern the land, which drew the Court’s attention.

Judge Rakoff rejected Nordheim’s argument that the dedication of gas and condensate “produced and saved” under the Sabine contract was an interest that touched and concerned the land.[v]  Instead, Judge Rakoff reasoned that the Sabine contract had not granted Nordheim a royalty interest or any other mineral rights or interests recognized by Texas law.  The Court also noted that the Agreements “did not decrease Sabine’s legal relation to its real property interests.”[vi]  In other words, Sabine did not convey real property interests to the appellants, only personal property interests in the oil and condensate after it was produced.

Judge Rakoff’s reasoning followed Judge Chapman’s previous decision very closely and directly rejected any contrary interpretation of Texas law.  Specifically, both rejected Nordheim’s argument that In re Energytec, Inc. applied to the circumstances of the case.[vii]

The latest Sabine ruling has three immediate impacts. First, the ruling expands the precedential value of the bankruptcy court’s decision.  While technically the District Court’s ruling is only binding in the Southern District of New York, its practical implications are far broader.  Sabine is no longer a rogue decision; it has been upheld on a de novo review by a very well-regarded Judge Rakoff.  Second, the District Court’s ruling places additional pressure on midstream operators to settle and renegotiate their gathering agreements with bankrupt producers, as has been the case in multiple cases with gathering agreements similar to those at issue in Sabine.[viii]  [Of course, this is exactly what Congress had in mind with Section 365 – forcing parties with above-market contracts to come to the table and negotiate with a debtor-in-possession.]  Finally, attorneys for midstream operators will need to devise new contract language if they want to protect their clients’ interests by attaching them to the land.  It is no longer enough for a gathering contract to simply say that it is a covenant running with the land; the language and reach of the contract must be broad enough to actually provide the midstream operator with a property right.

[i] HPIP v. Sabine, No. 16-04127(JSR) Docket No. 28 (S.D.N.Y. Mar. 10, 2017).

[ii] In re Sabine Oil & Gas Corp., No. 15-11835 (SCC), Docket. No. 1276 (Bankr. S.D.N.Y. June 15, 2016).

[iii] HPIP Supra. Note 1 at *7-*8.

[iv] 736 S.W. 2d 632, 635 (Tex. 1987).

[v] HPIP Supra. Note 1 at *9-*10.

[vi] Id, at *11.

[vii] 739 F.3d 215, 221 (5th Cir. 2013).

[viii] See, e.g., In re Quicksilver Resources Inc., Case No. 15-10585 (Bankr. D. Del.) (settlement reached); In re Penn Virginia Corp., Case No. 16-32395 (Bankr. E.D. Va.) (settlement reached); In re Emerald Oil, Inc., Case No. 16-10704 (Bankr. D. Del.) (settlement reached); In re Magnum Hunter Resources, Case No. 15-12533 (Bankr. D. Del.) (agreements assumed); In re SandRidge Energy, Inc., Case No. 16-32488 (Bankr. S.D. Tex.) (settlement reached).

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Executive Compensation Under Section 503(c) – The Sports Authority Story

October 18, 2016

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A recent, and highly publicized, decision from the case formerly known as Sports Authority, In re TSA WD Holdings, Inc. et al., Case No. 16-10527 (MFW), Bankr. D. Del. (Docket #2863, Aug. 31, 2016), allowed the defunct company to pay three unnamed senior executives $1.425 million in “incentive pay” to remain with the company and oversee its liquidation.[i]  Judge Mary Walrath granted Sports Authority’s[ii] Motion for Order (A) Approving Modified Executive Incentive Program and Authorizing Payments Thereunder and (B) Authorizing the Debtors to File the Unredacted Modified Key Employee Incentive Program Under Seal (Docket #2746) (the “EIP Motion,” a copy of which is here) over the strenuous objection of the U.S. Trustee (Docket #2809) (the “UST Objection,” a copy of which is here), and only after she had denied a similar from the Debtors request a month earlier.  More importantly, Judge Walrath authorized the incentive payments in a case where Sports Authority’s primary assets had already been liquidated, Debtors would almost certainly pay nothing to unsecured creditors, and the estate may or may not be administratively insolvent.  The Sports Authority example is informative for three reasons: 1) it demonstrates how a company that needs to keeps its top executives in place, post Chapter 11 filing, can structure an incentive package; 2) it reinforces the requirement to evaluate any incentive package that pays insiders under Section 503(c); and (3) it demonstrates that a debtor’s ability to push through an incentive package is not dependent on the solvency of the estate.

Background of the Case

On March 2, 2016, Sports Authority and its subsidiaries filed voluntary Chapter 11 cases in Delaware.[iii]  At the time of filing, Debtors filed a Sales Motion pursuant to Sections 105, 363, and 365 of the Bankruptcy Code.[iv]  Debtors then solicited interest in substantially all of their assets, including their leasehold interests, inventory, and FF&E.[v]  Debtors did not receive any going concern bids for their assets on an enterprise level.  Instead, Debtors were forced to accept a bid from a joint venture for their retail inventory.[vi]  On May 24, 2016, the Court issued a Sale Order approving the sale of substantially all of Debtors’ retail inventory.  Debtors had liquidated substantially all their assets by August 10, 2016.[vii]

On July 12, 2016, Debtors filed a Motion for Order Approving Executive Incentive Program (Docket #2478) (the “First EIP Motion,” a copy of which is here).  The Executive Incentive Program (“EIP”) would have paid four of Debtors’ top executives up to $2,825,000 “to continue to provide services required of their existing positions with the Debtors, fully support the liquidation process and Chapter 11 Cases, and execute a release of claims . . . .”[viii]  Payments under the EIP were to be funded by Debtors’ Term Loan Agreement.[ix]  As such, Debtors stated in the First EIP Motion that they were seeking the Court’s approval out of an abundance of caution, that there was sufficient business justification for the incentive payments, and that Section 503(c) was not applicable to the incentive payments because they were not “Administrative Expenses of the Estate.”[x]  The U.S. Trustee objected to Debtors’ First EIP Motion (Docket #2602, a copy of which is here).  The U.S. Trustee argued that the EIP was subject to Court approval, that Section 503(c) applied to the EIP, and that the EIP did not pass muster under Section 503(c).[xi]  On August 2, 2016, the Court held a hearing on the First Motion.  At the hearing, the Court sided with the U.S. Trustee, entering an order (Docket #2720, a copy of which is here) denying Debtors’ First EIP Motion.[xii]

Undeterred by the Court’s denial, the Debtors brought the next EIP Motion. Debtors drastically altered the EIP for the second go-around and, perhaps most crucially, analyzed the EIP under Section 503(c).[xiii]  “The metrics included in the Original Incentive Plan [were] replaced and . . . Participants will [now] only be entitled to incentive bonus payments if the Debtors are able to (a) trigger the sharing provisions provided for in the Agency Agreement, and (b) achieve a considerable cost-savings relative to the Controllable Costs included in the Wind-Down Budget.”[xiv]  Despite Debtors’ changes to the EIP, the U.S. Trustee filed an objection to the EIP Motion stating that the incentive payments were still “impermissible insider retention bonuses, and the motion should be denied.”[xv]  Debtors prevailed, in an order that is here.

Takeaways

The Court authorized Sports Authority’s modified EIP after denying its initial EIP program, and over the U.S. Trustee’s Objection, for two reasons. First, Debtors sought relief under the appropriate provisions of the Code.  Instead of offering the Court a cursory review of the Debtors’ justification as was done in the First EIP Motion, the EIP Motion carefully justified the modified EIP explaining why it could be approved under Section 503(c)(3).  The EIP Motion set forth the reasons why “the payments incentivize and reward achievement of performance based on specific goals and targets and to do not provide payment for retention or severance . . . .”[xvi]

Second, Debtors showed how the program conformed to the statute, setting hard metrics that delineated executive performance. While the original EIP offered incentive payments for rather amorphous accomplishments like “inventory shrinkage levels” and “controllable wind-down costs,” the modified EIP provided tangible metrics referencing inventory reduction levels to those set forth in the Agency Agreement and setting cost controls relative to the numbers in the Wind-Down Budget.[xvii]  Sports Authority convinced the Court that the modified EIP satisfied Section 503 because it fit neatly into Section 503(c)(3) and was not subject to the restriction of  Sections 503(c)(1&2).  Because the modified EIP fit into Section 503(c)(3), the Court could apply the business judgment standard of Section 363(b) to the modified EIP.  That standard allowed the Court to approve the modified EIP regardless of the financial condition of Debtors’ estate.  The modified EIP also did away with fixed payments for the “Participants remaining employed with the Debtors through certain agreed upon dates.”

Debtors’ attempts to circumvent Section 503(c)’s requirements and failure to conform the First EIP Motion to the statute cost them more time and two rounds of briefing. Ultimately, the Court granted the EIP Motion because Debtors provided the Court with a payment structure it could approve under Section 503.  The Sports Authority case provides a road map for how a debtor can keep its executives in place even though incentive payments to those executives may not be embraced by the debtor’s creditors or its former employees.

A Sidenote

Debtors also prevailed in their attempts to withhold the names of the executives benefitted by the EIP. Over the U.S. Trustee’s Objection, the Court allowed the Debtors to file the actual EIP under seal.  Neither the public nor Sports Authority’s former employees will know which of Debtors’ executives received incentive payments for their work winding down the company.

 

[i]           All docket references that follow refer to the docket in In re TSA WD Holdings, Inc. et al., Case No. 16-10527 (MFW), Bankr. D. Del.  Debtors in the consolidated Case No. 16-10527 (MFW) may hereafter be referred to as “Debtors” or “Sports Authority.”

[ii]           Sports Authority is controlled by TSA WD Holdings, Inc., which is currently the Debtor in Possession in Case No. 16-10527, the jointly administered case for all of Sports Authority’s entities currently in Chapter 11.

[iii]          EIP Motion (Docket #2746) at ¶ 8.

[iv]          Id. at ¶ 10.

[v]           Id. at ¶ 11.

[vi]          Id.

[vii]         Id. at ¶ 2.

[viii]         First EIP Motion (Docket #2478) at ¶ 14.

[ix]          Id. at ¶ 10.

[x]           Id.

[xi]          First UST Objection (Docket # 2602).

[xii]         Order on First EIP Motion (Docket # 2720).

[xiii]         EIP Motion (Docket #2746) at ¶¶ 20-29.

[xiv]         EIP Motion (Docket #2746) at ¶ 4.

[xv]          UST Objection (Docket #2809) at ¶ 1.

[xvi]         EIP Motion (Docket #2746) at ¶ 21.

[xvii]        The Agency Agreement and Wind-Down Budget were previously approved by the Court as part of the Sale Order (Docket #2081).

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Sabine Lives On (and On): Bankruptcy Court Rejects Immediate Appeal to Second Circuit and Motion for Stay

July 4, 2016

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Editor’s Note:  On June 16, 2016, The Bankruptcy Cave gave you our summary of the controversial Sabine decision.  At that time, post-hearing motions were pending.  As luck would have it (we at The Bankruptcy Cave should start wagering on college football, or who will win JoJo’s heart, with this luck!), just a few days later the drama continued with some important rulings on the timing of any final resolution of these important issues.  Here’s the skinny:

On June 15, 2016, Bankruptcy Judge Shelley Chapman of the Southern District of New York issued a follow on decision concerning rejection of certain midstream contracts in Sabine Oil & Gas Corporation’s (“Sabine”) Chapter 11 case.[i]  In its decision, the Court rejected Nordheim Eagle Ford Gathering, LLC’s (“Nordheim”) request for an immediate appeal to the Second Circuit Court of Appeals.  The Court also refused to stay enforcement of either its decision to allow Sabine to reject Nordheim’s gathering agreements with the Debtor or its final adversary decision where it found that Nordheim did not have an “interest running with the land.”

The Court rejected Nordheim’s argument that an immediate appeal was warranted under 28 U.S.C. § 158(d)(2)(A) because “the Rejection Decision addressed legal issues of first impression under Texas law which neither the Second Circuit nor the United States Supreme Court has previously addressed.”[ii]  The Court also determined that its previous orders did not “involve a matter of public importance” under 28 U.S.C. § 158(d)(2)(A)(i).[iii]  In both instances, Judge Chapman took the position that her rulings on Nordheim’s gathering agreements were limited.  The Court viewed its previous decisions as based on the facts of the case and established bankruptcy law, not the novel issues of Texas property law.[iv]  Finally, Judge Chapman premised her decision not to stay the case pending appeal on the basis that Nordheim would not suffer “irreparable harm” were the case to proceed, but Sabine would be harmed by a stay.[v]

Judge Chapman’s June 15th decision means that her previous rulings will not be on appellate review any time soon. While the June 15th decision attempts to downplay the influential value of those decisions, they will no doubt be cited by other producers in their attempts to shed onerous midstream arrangements. Sabine lives on.

[i] In re Sabine Oil & Gas Corp., No. 15-11835 (SCC), Docket. No. 1276 (Bankr. S.D.N.Y. June 15, 2016).

[ii] Id. at *7-*9.

[iii] Id. at *11.

[iv] Id. at *7-*9.

[v] Id. at *13-*14.

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Sabine – A New York Bankruptcy Judge’s Interpretation of Texas Property Law Encourages Compromise and Leaves an Industry in Limbo

June 17, 2016

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On March 9, 2016, Bankruptcy Judge Shelley Chapman of the Southern District of New York issued her decision on the Debtor’s motion to reject certain contracts in Sabine Oil & Gas Corporation’s Chapter 11 case.[i]  The decision, which allowed Sabine to reject “gathering agreements”[ii] between it and two “midstream operators,”[iii] Nordheim Eagle Ford Gathering, LLC and HPIP Gonzales Holdings, LLC, under Section 365(a) of the Bankruptcy Code, sent shockwaves through the midstream energy sector and leveled the playing field for bankrupt production companies.  Yet, the case leaves undecided the ultimate question – what midstream contracts are protected as real covenants running with the land?  That question may be months, or even years, away from any resolution.[iv]  In the interim, energy companies are left with Sabine, which implies producers can renegotiate midstream contracts in a slumping energy market, using the threat of bankruptcy and rejection as a powerful bargaining chip to bring midstream operators to the table.

The Decision

By its Motion, Sabine sought to reject four contracts under Section 365, two with Nordheim and two with HPIP. Under all four agreements, Sabine agreed to “dedicate” to the “performance” of the agreement certain leases owned by Sabine and the hydrocarbons from the wells located on the land subject to those leases.  For their part, Nordheim and HPIP agreed to construct, operate, and maintain gathering facilities for the respective leases.

When it addressed the Motion, the Court undertook a two part analysis to determine whether Sabine could reject the contracts. First, the Court deferred to Sabine’s business judgment and found “that the Debtors have properly and adequately considered the business and legal risks associated with rejection of the Nordheim Agreements and the HPIP Agreements.”[v]  There was little question that rejection would benefit the estate as Sabine indicated that rejection could save it up to $200,000 a month.

The second part of the Court’s analysis was more involved. There the Court was forced to determine whether any of the contracts were real covenants or equitable servitudes that ran with the land.  Both Nordheim and HPIP argued that Sabine could not reject the contracts because they were real property interests that cannot be rejected under Section 365.  While Judge Chapman acknowledged her inability to decide substantive legal issues under Orion Pictures Corp. v. Showtime Networks (In re Orion Pictures Corp.), and In re The Great Atlantic & Pacific Tea Co.[vi] without an accompanying adversary proceeding, she dove into an analysis of what constituted a covenant running with the land under Texas law.

After applying Texas’ four-part test for determining whether a covenant runs with the land, the Court rejected HPIP and Nordheim’s contention that their contracts were real property interests. The Court found that the covenants in Nordheim’s and HPIP’s contracts did not satisfy the “touch and concern” prong of Texas’ test for a covenant running with the land.  Instead, the interest in the extracted minerals was a personal property interest.  The Court also determined that the covenants “do not readily fit into the traditional paradigm for horizontal privity of estate.”[vii]  Consequently, the Court made a “preliminary” determination that the contracts between Sabine and the two gathering companies could be rejected.

The Fallout

Despite Judge Chapman’s later statement that “this was not a broad sweeping pronouncement,”[viii] the ruling may significantly impact the energy industry. Moreover, the case and its progeny could shape jurisprudence on the rejection of similar contracts in several energy sector bankruptcy cases while an appeal works its way up the chain.  Until Sabine, agreements between producers and midstream companies were generally treated as constants, not subject to renegotiation upon insolvency.  That paradigm may now be realigned.

Upstream producers, many of whom are suffering under today’s low energy prices, can now seek concessions from their midstream partners. This places the parties on more equal footing and could actually be a catalyst for negotiated resolution.  In fact, courts dealing with the issue may actually prefer the parties resolve the issue through compromise. Sabine has already had an impact in this respect.  In In re Magnum Hunter Resources Corp., Bankruptcy Judge Kevin Gross encouraged the parties to resolve a similar dispute before the Court had to weigh in on the motion to reject.[ix]  Likewise, in In re Quicksilver Resources Inc., the purchaser of the debtor’s assets was able to reach a compromise with its midstream operator before the Court had to rule on a Section 365 motion.[x]  Both cases are examples of how producers have greater power to negotiate terms with midstream companies in the wake of Sabine.

Finally, Sabine is not over.  Nordheim’s and HPIP’s adversary case was decided on May 3, 2016.[xi]  Once again, in a decision located here, Judge Chapman found “that the covenants at issue in the Nordheim Agreements and the HPIP Agreements do not run with the land either as real covenants or as equitable servitudes.”[xii]  On June 1, 2016, Nordheim and HPIP sought Judge Chapman’s consent to appeal that decision.  The midstream operators argued that an appeal to the Second Circuit and a subsequent reference to the Texas Supreme Court to decide the state property law issues were appropriate.  The Court has not yet ruled on the request, but no one believes that this will be the end of the debate.  Upstream producers will continue to pursue rejection of midstream contracts that are overly burdensome and midstream operators will continue to argue that rejection is improper until more concrete guidance is issued by District and Circuit Courts.

[i]            In re Sabine Oil & Gas Corp., 547 B.R. 66, 69 (Bankr. S.D.N.Y. 2016).

[ii]           Gathering Agreement means an agreement by which one party agrees to collect oil, gas or other hydrocarbons at the wellhead and transport such oil, gas or other hydrocarbons through a network of pipelines to a central point, often a processing system or an inlet to a larger transportation pipeline.

[iii]           Midstream Operator means a company that gathers, transports and processes oil, gas or other hydrocarbons by pipeline, rail, trucks or otherwise.

[iv]          On June 1, 2016, Judge Chapman declined to rule on Nordheim’s request for an immediate appeal her decision to the Second Circuit Court of Appeals.  While the Court determined that the contracts at issue in the case do not run with the land, in both its preliminary decision and in a later adversary opinion, it left open the question of what type of midstream contract would run with the land such that it constituted a real property interest.

[v]           Sabine Oil, 547 B.R. at 74.

[vi]          4 F.3d 1095, 1098 (2d Cir. 1993) and 544 B.R. 43 (Bankr. S.D.N.Y. 2016).

[vii]          Sabine Oil, 547 B.R. at 79.

[viii]         See Judge Skeptical of Quick Appeal in Sabine Midstream Dispute located at http://www.law360.com/articles/802504/judge-skeptical-of-quick-appeal-in-sabine-midstream-dispute.

[ix]          In re: Magnum Hunter Resources Corp. et al., No. 15-12533, in the U.S. Bankruptcy Court for the District of Delaware.

[x]           See Jones Day’s advisory, Quicksilver Drops Motion to Reject Midstream Agreements in Connection with Closing of Sale to Bluestone Natural Resourcesfor a more in depth discussion.

[xi]          Following the Court’s decision to grant Sabine’s Motion to Reject, Nordheim and HPIP filed an adversary proceeding in which they sought a declaration that the their respective leases were “covenants running with the land.”  The Court, once again, rejected the midstream operators’ argument and issued a final ruling that the leases did not convey a real property interest to the midstream operators.

[xii]          In re Sabine Oil & Gas Corp., No. 15-11835 (SCC), 2016 WL 2603203, at *8 (Bankr. S.D.N.Y. May 3, 2016).

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