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Can I Get Out of a Bad Oil and Gas Lease If I File Bankruptcy?

By Peter Orville, Attorney at Law

Many landowners, particularly struggling farmers in Upstate New York, are trying to get out of gas leases they signed several years ago and replace them with new gas leases. It could make a difference of over $1,000,000 to the landowner. Filing bankruptcy could be the tool they need.

For several years gas companies have known about the Marcellus Shale. This is a deposit of up to 500 trillion cubic feet of natural gas lies at a depth of 7000 to 10,000 feet under significant parts of New York, Pennsylvania, Ohio and West Virginia.
Until recently the technology to retrieve this massive gas deposit in an economically feasible way was not possible. In the last few years, however, two technologies, hydrofracking (fracking) and horizontal drilling have been developed. You may have heard of fracking because it is the subject of an Oscar nominated documentary film at tonight?s Oscar presentation. (This article is not getting into the substantial issues of the environmental risks of fracking; rather it is looking at the financial issues facing landowners.)

In anticipation of this new technology, several gas companies began aggressively signing leases with landowners to allow them to explore, drill and produce oil &/or gas for a specified amount of time or as long as there is oil/gas to produce. In exchange the company provided a certain amount of dollars per acre up front and royalty payments to the landowner when and if they extract the oil/gas. They usually paid as little as $5 to $25 per acre up front and 12% royalties.

Now that the fracking technology is being used, gas companies have had to substantially increase their offers. Current leases being offered to landowners are offering over $5,000 per acre and over 20% royalties. Many landowners, particularly area dairy farmers are stuck with the $5 / 12% contracts and want out. For a struggling dairy farmer (many of whom are facing foreclosure of their farms) with 200 acres, they got as little as $1000 for their gas leases, but would stand to get over $1,000,000 if they could get a new lease.

So how would bankruptcy help these landowners? Under the Bankruptcy Code, any executory contract or unexpired lease may be assumed or rejected by the Debtor. The bankruptcy code, however, does not define ?unexpired lease? or ?executory contract?. These terms, and the question of whether a gas or oil lease can be rejected in a bankruptcy are questions that can only be answered by state law.

An examination of state laws reveal a wide difference of opinion. In some states such as Texas and Louisiana, an oil or gas lease is not considered to be an unexpired lease and cannot generally be rejected in a bankruptcy. In many other states, an oil or gas lease can be rejected in a bankruptcy, or it is unclear. In New York State, it appears that an oil or gas lease is considered to be an executory contract and can be rejected in a bankruptcy.

Many of the cases that have determined this issue involved the bankruptcy of the oil or gas company. Would bankruptcy courts consider the situation differently if the party going bankrupt was the landowner? If a landowner could reject a bad lease through a bankruptcy and replace it with a much more lucrative lease, it would result in a windfall for the bankruptcy estate and could greatly increase the benefit to the Debtor?s creditors.

In a Chapter 13 (or Chapter 12 for farmers) a landowner could reject the current gas lease, sign a new one and not only save their property and pay off all their creditors, but have substantial additional money to truly get a ?fresh start?.

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Full post as published by Credit Law Network on February 27, 2011 (boomark / email).