Coauthors Sahrish K. Soleja and Lydia Webb

If you are a royalty owner and have questions about how your claim is likely to be treated when your lessee/operator goes into bankruptcy in Delaware, In re MTE Holdings LLC is a significant case.

Historically, royalty claims have been treated as funds placed in trust because they are not the property of the debtor’s bankruptcy estate – meaning royalty claims are not subject to the bankruptcy claims process altogether. However, in this recent decision a Delaware bankruptcy court, applying Texas law, held that royalty claims were in fact subject to the bankruptcy claims process and moreover, should be classified as unsecured, not secured, claims.

The dispute

In MTE, the debtors, operators of oil and gas wells, were lessees in several hundred oil and gas leases in Texas.  Under the leases the lessee would sell the production and distribute to each royalty owner its share of the proceeds.  Here, the debtors refused to pay proceeds to royalty owners in the ordinary course during the bankruptcy, the typical treatment for trust funds, because they lacked the funds to do so. This left the royalty owners with no choice but to assert the right to payment from the bankruptcy estate, secured by their interest in the oil and gas in place.  The question before the court was whether the royalty owner claims should be classified as secured or unsecured.  The answer means the difference between receiving payment in full (for secured claims) vs. pennies on the dollar (for unsecured claims).

The First Purchaser Statute

Looking at the statutory language of Section 9.343(a) of the Texas Business and Commerce Code, commonly referred to as the Texas First Purchaser Statute, the court held that the statutory lien created by Section 9.343(a) secures only an obligation to pay the first purchaser of produced oil and gas.  Meaning, a statutory lien was created for royalty claimants who took their production in-kind and turned around and sold it.  On the contrary, royalty owners who receive payment in cash do not receive the benefit of Section 9.343(a).  In MTE, none of the royalty claimants had exercised their option to receive payment in kind and thus could not claim secured status. This is, of course, the case with virtually all Texas royalty owners.  Because there was little to no money to pay unsecured claims, the royalty claims were effectively rendered worthless by the Delaware bankruptcy court.

Help has arrived

Some help for Texas royalty owners (but too late for the  MTE claimants) is on the way. Section 9.343(a) was repealed by the 2021 Texas legislature and replaced by a new statute, Section 67.002(a)-(c), effective Sept. 1, 2021, the Texas First Purchaser Lien Act. The new statute creates a real prooperty lien on hydrocarbons before they are extracted from the land. Whether royalty owners elect to take payment in kind or in cash, they will have a valid and enforceable lien against the debtor/operator.  But the larger concern is the Delaware bankruptcy court’s willingness to look past whether royalty claims should be subject to the bankruptcy process at all.

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