Protection against operator bankruptcy filing

File your Memorandum of Operating agreement

Michael S. Haynes, Gardere Wynne Sewell LLP

While energy prices remain depressed, non-operating working interest owners are looking for ways to protect themselves in the event the operator files bankruptcy (and if they are not, they should be!). One relatively simple and inexpensive form of protection is available via a memorandum of joint operating agreement, which evidences and can be used to perfect lien rights granted by an operator to non-operating working interests owners in the operating agreement. The older, 1982 model form operating agreement, granted very modest lien rights to secure payment of proportionate shares of expenses, and did not contemplate a memorandum of operating agreement. The more recent, 1989 form operating agreement, greatly expanded the lien rights of both the operator and non-operator. In that respect, the 1989 form is more favorable for a non-operating working interest owner.

The 1989 form specifically contemplates that the parties will execute and file a memorandum of operating agreement. In fact, the 1989 form states that the parties “shall” execute the memorandum, and either party may file it of record. Unfortunately, non-operating working interest owners may not have been as diligent in recording the memorandum as they were in recording their working interest assignments. Because energy prices have been and remain depressed, now is the time to double-check not only that working interest assignments have been properly recorded, but also that memoranda of operating agreements have been properly recorded.

To enforce a lien—any lien—in a bankruptcy context, evidence of the lien must be recorded in the applicable county records (for real property such as mineral interests, in most states) and with the secretary of state (for personal property such as equipment and proceeds of production). The same holds true for the liens granted in a joint operating agreement. Most parties are hesitant (for good reason) to file an entire joint operating agreement in the public record. Fortunately, the 1989 model form memorandum of operating agreement contains explicit descriptions of the liens granted in the joint operating agreement, but omits the market-sensitive terms contained in the operating agreement.

As most sophisticated energy players know, an assignment of a mineral interest, such as a working interest, is enforceable against a bona fide purchaser only if the purchaser has knowledge of the assignment—such as through recording the assignment in the applicable county records. A lien granted under an operating agreement is likewise dependent on recordation. Even though the operator may have granted non-operating working interest owners a lien under the operating agreement, executed the operating agreement, and has personal knowledge of the lien, such liens likely will not be enforceable in the operator’s subsequent bankruptcy unless the liens have been filed of record. Unrecorded liens likely will be unenforceable in an operator’s bankruptcy proceedings because an operator in bankruptcy is treated like a bona fide purchaser. Thus, absent proper recordation, the non-operating working interest owner’s liens likely will not be enforceable in a bankruptcy. As a result, lender liens or M&M liens, which might otherwise have been subordinate to the non-operating working interest owner’s liens, might instead be senior in priority.

In short, filing a memorandum of operating agreement in the applicable county records and with the appropriate secretary of state is a simple and inexpensive way to obtain some protection against a future bankruptcy filing by an operator. Non-operating working interest owners using a form of operating agreement that does not contain a form memorandum should consider interlineating into future operating agreements a form similar to that contained in the 1989 form operating agreement. Then, importantly, they should ensure such memorandum is filed of record.

About the author
Michael Haynes Dallas attorney Michael Haynes is a partner in the Financial Restructuring and Reorganization Practice Group at Gardere Wynne Sewell LLP. Haynes focuses his practice on workouts and restructurings, with an expertise in the energy sector.

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