Bankruptcy Court Allows Rejection of Gas Gathering Agreement While Preserving Real Property Covenants
The Western District of Texas Bankruptcy Court held that a Chapter 11 debtor could reject an executory gas gathering agreement despite covenants running with the land, marking a matter of first impression in bankruptcy law. The court applied the business judgment standard and found continuing mutual obligations rendered the agreement executory, even though the operator had already constructed the compression system.
Background
Hilltop SPV, LLC, a Chapter 11 debtor owning oil, gas, and mineral leases, sought to reject a gas gathering agreement ("GGA") it had inherited from its predecessor-in-interest. Under the agreement, Hilltop faced significant financial burdens, including penalties for failing to meet minimum compression volume requirements. The day after filing for bankruptcy, Hilltop initiated both an adversary proceeding seeking declaratory judgment that the GGA was an executory contract subject to rejection and a motion to reject the agreement on a nunc pro tunc basis.
The Executory Contract Dispute
The central legal question was whether the GGA constituted an "executory" contract under Section 365(a) of the Bankruptcy Code, which would permit rejection. The counterparty argued that the agreement was not executory because it had already fulfilled its primary obligation by constructing the compression system. The court rejected this argument, holding that the
"gas gathering agreement between Chapter 11 debtor that owned oil, gas, and mineral leases and operator of compression system was 'executory,' even though operator already fulfilled its contractual obligation by constructing compression system, because debtor had continuing payment obligations and operator had a continuing obligation to own and operate the compression system."
Business Judgment Standard and Approval
Applying the deferential business judgment standard, the court approved Hilltop's rejection request. The court noted that although the Bankruptcy Code does not lay out a legal standard for determining whether to approve a Chapter 11 debtor's rejection or assumption of an executory contract or unexpired lease, the court should use the deferential business judgment standard to help determine what is in the best interest of the estate. The court emphasized that
"rejection of executory contracts is vital to the basic purpose of a Chapter 11 reorganization, because rejection can release the debtor's estate from burdensome obligations that can impede a successful reorganization."Given the penalty burden and the relative savings rejection would provide to the estate, the court found the business decision sound.
Covenants Running with the Land
In a matter of first impression, the court held that Hilltop could reject the GGA even though it contained covenants running with the land, which the counterparty would retain post-rejection. The court bifurcated the contractual obligations from the property rights, allowing rejection of the burdensome contract terms while preserving any real property interests that run with the land.
Remedies Under the Gas Gathering Agreement
The court also addressed the parties' intent regarding remedies under the GGA. The agreement stated that direct actual damages would be the sole and exclusive remedy and all other remedies or damages at law or in equity were waived, despite an arbitration clause allowing injunctive relief in that forum. The court held that under Texas law, the parties
"intended to limit damages generally but allow for only an arbitral tribunal to award injunctive relief; in that way, each part of the contract was given full effect to avoid rendering another provision meaningless, and since a damages calculation was built into the agreement, it was presumed to be sufficient."
Bar Date Determination Postponed
The Bankruptcy Court postponed determination of the bar date for filing claims related to rejection of the gas gathering agreement, leaving that issue for future resolution.