New Rights of Oil and Gas Lessors when the Lessee is Bankrupt

In a recent decision from the Federal Bankruptcy Court of Western Michigan, a decision opposed by members of the oil and gas industry, a Debtor oil and gas producer which filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code and which owed lessors for unpaid royalties, has the duty to make an election under section 365 of the Code to either ratify existing leases and pay the lessors of those ratified leases all of the outstanding unpaid royalties OR reject the leases and have the unpaid royalties included among other unsecured debts. The industry position appeared to be that the debtor did not have no make such an election, that it could treat the unpaid royalties as merely unsecured debts to be paid only a fraction of their face amounts and that the debtor could, in the future, continue to operate under terms of the lease and could sell or assign that lease to another operator.  If, on the other hand, consistent with the court’s reasoning, a debtor is forced to reject an existing lease that is the basis for current operations and production of oil or gas, facially, the lessor should thereafter be free to negotiate a new lease with another operator without the same constraints as existed when the initial lease was negotiated.

In view of the complexity of the oil and gas industry and the potential impact on the multiple other parties with whom the Debtor may have had agreements including investors and working interest owners, an appeal would be expected.

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