In re Chesapeake Energy Corp.

622 B.R. 274

IN RE: CHESAPEAKE ENERGY CORPORATION, et al., Debtors.

CASE NO: 20-33233 (Jointly Administered)

United States Bankruptcy Court, S.D. Texas, Houston Division.

Signed October 28, 2020

Vienna Flores Anaya, Jackson Walker LLP, Fareed I. Kaisani, Baker Botts L.L.P., Dallas, TX, Victoria Nicole Argeroplos, Matthew D. Cavenaugh, Genevieve Marie Graham, Kristhy M. Peguero, Veronica Ann Polnick, Cameron A. Secord, Jackson Walker LLP, Houston, TX, Anthony Frank Arguijo, Scott Douglass & McConnico LLP, Jennifer F. Wertz, Jackson Walker LLP, Austin, TX, Alexandra Schwarzman, Kirkland & Ellis LLP, Chicago, IL, Joshua Bacon Selig, Bymes Keller et al, Seattle, WA, Dustin Lyle Womack, Anna Rotman and Kenneth A. Young, Kirkland & Ellis LLP, Houston, TX, for Debtors.

Stephen Douglas Statham, Office of US Trustee, Houston, TX, for U.S. Trustee.

MEMORANDUM OPINION

(Docket No. 27)

DAVID R. JONES, UNITED STATES BANKRUPTCY JUDGE

In this contested matter, the Debtors seek to reject a gas purchase agreement with ETC Texas Pipeline, Ltd. ("ETC") as an executory contract under 11 U.S.C. § 365. ETC objects to the requested relief asserting that the agreement contains a covenant running with the land and is therefore not executory. The Debtors counter that (i) the agreement fails to comply with Texas law to establish a covenant running with the land; and (ii) if the agreement does contain a covenant running with the land, it is not per se prohibited from rejecting the agreement.

Procedural History

The Debtors filed these jointly administered bankruptcy cases on June 28, 2020. [Docket No. 1]. The cases were designated as complex chapter 11 cases under the Procedures for Complex Cases in the Southern District of Texas. [Docket No. 82]. Chesapeake Exploration L.L.C. and Chesapeake Energy Marking, LLC (collectively "Chesapeake") are each a debtor.

On June 28, 2020, the Debtors filed their Motion for Entry of an Order (i) Authorizing Rejection of Certain Executory Contracts Effective as of July 1, 2020 and (ii) Granting Related Relief (the "Rejection Motion") [Docket No. 27]. In the Rejection Motion, the Debtors sought, in part, to reject a gas purchase agreement with ETC.¹ [Docket No. 27]. ETC filed its objection to the Rejection Motion on July 24, 2020. [Docket No. 487]. The parties filed supporting briefs on August 17, 2020. [Docket Nos. 810 and 813]. Each party filed a response brief on August 24, 2020. [Docket Nos. 999 and 1001].

The Debtors filed their reply to ETC's objection on August 27, 2020. [Docket No. 1032]. In the reply, the Debtors asserted that (i) rejection of the ETC agreement would not impair any covenant running with the land that might exist and that ETC would receive a claim under the liquidated damages provision of the agreement; (ii) no privity exists with respect to Chesapeake's mineral estate; and (iii) the ETC agreement does not touch and concern the land as severed gas is personalty under Texas law. [Docket No. 1032 at 1–2].

On August 27, 2020, ETC filed its response to the Debtors' reply [Docket No. 1033]. In its argument, ETC relies upon the proposition that an agreement cannot be an executory contract if it contains a covenant running with the land to support its objection to the Rejection Motion. [Docket No. 1033 at 3].

The Court conducted a hearing on the Rejection Motion on August 31, 2020. [Docket No. 1056]. At the conclusion of the hearing, the Court took the matter under advisement. [Docket No. 1056].

Jurisdiction and Authority

The Court has exclusive jurisdiction over this contested matter pursuant to 28 U.S.C. § 1334(b), (e). The matter is a core proceeding under 28 U.S.C. § 157(b) as a request to reject an executory contract under § 365 can only arise in a bankruptcy case. See In re Southmark Corp. , 163 F.3d 925, 930 (5th Cir. 1999) ("[A] proceeding is core under § 157 if it invokes a substantive right provided by title 11 or if it is a proceeding that, by its nature, could arise only in the context of a bankruptcy case." (quoting In re Wood , 825 F.2d 90, 97 (5th Cir.1987) )). The Court has constitutional authority to enter a final order in this contested matter. Stern v. Marshall , 564 U.S. 462, 486–87, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011). To the extent necessary, the parties have impliedly consented to the entry of a final order by the Court. See Wellness Int'l Network, Ltd. v. Sharif , 575 U.S. 665, 135 S. Ct. 1932, 1947–48, 191 L.Ed.2d 911 (2015) (holding that a party impliedly consents to adjudication when the party "voluntarily appear[s] to try the case" with knowledge of the need for consent and without affirmatively refusing to it).

Relevant Factual Background

Effective February 23, 2016, ETC and Chesapeake entered into a "Base Contract for Sale and Purchase of Natural Gas" (the "Base Contract"). [Docket No. 1035-2]. Under the Base Contract, Chesapeake agreed to sell and ETC agreed to buy certain quantities of Gas for a particular transaction. [Docket No. 1035-2]. Under Appendix 1, Special Provisions A to the Base Contract (the "Appendix"), the term "Gas" was modified from its original definition to mean "methane and other gaseous hydrocarbons, including gaseous combustible, noncombustible, and inert elements, compounds, components or mixtures thereof and liquefiable hydrocarbons in the vapor stream produced and recovered at the wellhead." (sic )" [Docket No. 1035-2, Appendix 1, at 13].

The parties executed a Transaction Confirmation effective February 23, 2016 (the "Confirmation Transaction") subject to the Base Contract that modified certain terms of the Base Contract and further defined the relationship between the parties. [Docket No. 1035-2, Transaction Confirmation]. Under the Confirmation Transaction, the parties agreed as follows:

Seller shall tender all of Seller's Gas to Buyer at the Delivery Point(s) during the term of this Transaction Confirmation, up to the SRC set forth on Exhibit "E" attached hereto. On a Firm basis, Buyer shall accept and purchase at the Delivery Point(s) all Gas that Seller delivers to such Delivery Point(s), up to the MDQ for each Delivery Point as set forth on Exhibit "A" attached hereto and the SRC in total ....

[Docket No. 1035-2, Transaction Confirmation, at 19]. The parties further agreed that:

[s]ubject to Seller's Reservations, Seller dedicates for sale and delivery hereunder all of the Gas owned or controlled by Seller or an Affiliate of Seller that is produced from the oil and gas leases described in Exhibit "C"² to this Transaction Confirmation (such Gas, "Seller's Gas", and such leases, the "Dedicated Leases"), up to the SRC; provided, however, such dedication does not include the Gas attributable to any non-operating working interest in a lease equal to less than thirty percent (30%). Seller shall not assign, transfer or convey any interest now owned or hereafter acquired (directly or indirectly) in the Dedicated Leases without expressly making same subject to this Transaction Confirmation and the Base Contract. Seller's dedication hereunder is a covenant running with the land, and Buyer and Seller shall sign, and Buyer shall file in the property records of the applicable county or counties, a Memorandum of this Transaction Confirmation in the form attached hereto as Exhibit "D".

[Docket No. 1035-2, Transaction Confirmation, at 19] (emphasis added). The Seller's Reservations include:

(a) The right to use the Gas produced from the Dedicated Leases prior to delivery to Buyer for the following purposes:

(1) For fuel in development and operation of the Dedicated Leases from which the Gas is produced or any leases and lands with which the leases covering the Dedicated Leases are pooled or unitized, including (but not limited to) the use of Gas for fuel, drilling (including Gas drilling), deepening, reworking, compressing, completing, Gas lifting, treating, cycling, re-pressuring or other supplemental recovery operations, provided, however, that any Gas so used but not consumed by such uses shall remain committed under this Transaction Confirmation; and

(2) For delivery to the lessors and other owners of interests in the Dedicated Leases if such lessors and other owners of interests are entitled to use or take such Gas in kind under the terms of the leases or other instruments creating their interests; and

(3) For fuel in the operation of the facilities which Seller may install in order to deliver Gas under this Transaction Confirmation.

(b) The right to pool or unitize the Dedicated Leases (or any portion thereof) with other lands and leases. In the event of pooling or unitization, this Transaction Confirmation will cover Seller's interest in the pool or unit and the Gas attributable thereto.

(c) The right to separate the Gas using only mechanical, ambient temperature equipment.

(d) Seller shall conduct operations on the Dedicated Leases free of any control by Buyer, including without limitation the right to make farmouts of any lease subject to this Transaction Confirmation, and to abandon any well and surrender any lease when Seller, in its sole discretion, deems the same no longer capable of producing Gas in commercial quantities. Seller shall not be required to produce and/or operate any well or wells in any manner which in its sole judgment and discretion would not constitute good operating practice and/or is uneconomic, nor shall Seller be obligated to drill additional wells or to deepen, repair or rework any existing wells.

[Docket No. 1035-2, Transaction Confirmation, at 20].

In the event of a breach of the agreement, the parties agreed to the following exclusive remedy:

3.2. The sole and exclusive remedy of the parties in the event of a breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the positive difference, if any, between the purchase price paid by Buyer utilizing the Cover Standard and the Contract

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