In re Oil

622 B.R. 608

IN RE: EXTRACTION OIL & GAS, et al. Debtors.

Case No. 20-11548 (CSS)

United States Bankruptcy Court, D. Delaware.

Signed November 2, 2020

Marc Abrams, Stephen Brett Gerald, Richard W. Riley, Whiteford, Taylor & Preston LLC, Wilmington, DE, William E. Arnault, Stephanie Cohen, Kirkland & Ellis LLP, Chicago, IL, Christian Menefee, Houston, TX, Jamie Aycock, Orla P. O'Callaghan, Anna Rotman, Rebekah Sills, Evan Swager, Kenneth A Young, Kirkland & Ellis LLP, Houston, TX, Ross Fiedler, Ciara Foster, Kevin Liang, Allyson Smith Weinhouse, Christopher Marcus PC, Kirkland & Ellis LLP, New York, NY, Kevin G. Hroblak, Whiteford, Taylor & Preston, LLP, Baltimore, MD, for Debtor

BENCH RULING

Christopher S. Sontchi, Chief Judge United States Bankruptcy Court Before the Court is a series of motions and notices to reject unexpired leases of nonresidential real property and executory contracts (see D.I. 14 and 412, collectively, the "Motions") as well as objections from Grand Mesa Pipeline, LLC (D.I. 363 and 803, referred to as "Grand Mesa"); and Platte River Midstream, LLC, DJ South Gathering, LLC, and Platte River Holdings, LLC (D.I. 482, 655 and 801, collectively referred to as "Platte River" and with Grand Mesa, the "Rejection Counterparties") and the contracts the Debtors seek to reject, collectively, the "Transportation Services Agreements" or "TSAs").¹ The Court held evidentiary hearings on the rejection motions on October 7, 20, 26, and 27, and, on October 28, the Court heard closing arguments.²

JURISDICTION

The United States Bankruptcy Court for the District of Delaware (the "Court") has jurisdiction over this matter, pursuant to 28 U.S.C. §§ 157 and 1334. Venue is proper, pursuant to 28 U.S.C. §§ 1408 and 1409. The bases for the relief requested are sections 105(a), 363(b), and 365(a) of the Bankruptcy Code, Bankruptcy Rules 6004, 6006, and 6007, and Bankruptcy Local Rule 9013-1.

BACKGROUND

Extraction Oil & Gas and certain of its affiliates (the "Debtors") filed their petitions under Chapter 11 of the Bankruptcy Code on June 14, 2020. The Debtors cases are jointly administered for procedural purposes.³ The Debtors operate primarily in the "upstream" oil and gas sector, including the exploration and production of oil and gas. The oil and gas industry can be broken up into three segments: (i) upstream, (ii) midstream, and (iii) downstream. Upstream activities are mainly "Exploration and Production" or E&P activities that focus on locating and extracting hydrocarbons from beneath the surface. Common upstream assets include mineral leases, producing wells, and associated production equipment. The midstream sector includes the activities involved in gathering, transporting, processing, and storing hydrocarbons. Common midstream assets include gathering pipelines, separation facilities, and tankage. The downstream sector is focused on the marketing and distribution of the products derived from the extracted hydrocarbons to the ultimate end users. Common downstream assets include refineries and retail sites.

The majority of the Debtors' assets are in the upstream sector, but the Debtors also have limited ownership in midstream assets. Prior to bankruptcy, the Debtors contracted with midstream counterparties, including the Rejection Counterparties, to transport their oil and gas from the production points to downstream providers. These TSAs are not only agreed to between and among the parties, but the rates are approved by the Federal Energy Regulatory Commission ("FERC"). The Debtors filed the Motions seeking authorization to reject these TSAs, which are contested by the Rejection Counterparties. This is the Court's ruling on the rejection of the TSAs.

ANALYSIS

A. Rejection of Leases and Executory Contracts

Section 365(a) of the Bankruptcy Code provides that a debtor in possession "may assume or reject any executory contract or unexpired lease of the debtor" subject to the court's approval. Courts generally authorize debtors to assume or to reject executory contracts and unexpired leases where the debtors appropriately exercise their "business judgment."⁴ "An executory contract is a contract under which the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other."⁵

Importantly, "although Congress knew how to craft exceptions to rejection, Congress declined to except FERC approved contracts."⁶ There is no prohibition on or limitation against rejecting a FERC approved contract. Therefore, the Court was tasked with determining whether (i) the Debtors' decision to reject was a proper exercise of business judgment, (ii) public policy prohibits the rejection of such contracts; and (iii) the matter should be referred to FERC.

B. Business Judgment

The "business judgment" test requires a showing that rejection of the executory contract or unexpired lease will benefit the debtor's estate.⁷ Courts generally will not second-guess a debtor's business judgment concerning the rejection of an executory contract or unexpired lease.⁸ The "business judgment" test merely requires a showing that rejection will benefit the debtor's estate. "A debtor's decision to reject an executory contract must be summarily affirmed unless it is the product of ‘bad faith, or whim or caprice .’ "⁹ Importantly, the Court cannot substitute its judgment for the Debtors' judgment¹⁰ and absent a heightened standard such as bad faith or abuse of discretion the Debtors' business judgment will be not altered.¹¹

The Debtors assert that the TSAs are neither compatible with the Debtors' ongoing business needs nor a source of potential value for the Debtors' future operations, creditors, or other parties in interest. Absent rejection, the TSAs impose ongoing obligations on the Debtors and their estates that constitute an unnecessary drain on the Debtors' resources. Here, the Debtors presented evidence of the following: (i) Debtors' estate will benefit from rejection of the TSAs because the Grand Mesa, Bayswater, and Platte River Contracts charge rates significantly above market rates, the estate will save millions of dollars annually if allowed to reject these contracts; and (ii) Rejecting the DJ South Contract is in the Debtors' interest because the Debtors would be able to use an alternative service provider that, unlike DJ South, will take their crude oil to Platteville, a location where the Debtors can sell their crude oil for a significantly higher price.

The Rejecting Counterparties presented evidence but did not rebut the Debtors' business judgment. In fact, testimony reflected that the Debtors may also use a "walk-up" rate with some of the midstream pipeline providers.¹² Additionally, the Debtors presented evidence of ability to use trucks as alternatives to using the pipelines. Furthermore, the Debtors can shut-in wells (or partially shut-in wells) until alternative shipment methods become available.

The Debtors presented evidence that the alternative transportation would cost less and that a new midstream pipeline may transport the oil to a more favorable location in some instances. With the current contract rates at higher-than-market value for transporting the Debtors' oil, it is within the Debtors' business judgment to reject these contracts and to seek alternative providers, whether by walk-up rates, trucking, or new pipeline contracts.

More specifically, the Debtors presented the testimony of its Chief Executive Officer Matthew Owens. Mr. Owens, despite his youth, is one of the most competent, well informed, measured, and persuasive executives that has ever testified before me. He made a solid case in favor of the Debtors' business judgment. Mr. Owens testified that rejection enables the Debtors to access the pipeline providers at a more competitive Platteville terminal¹³ and that such access will save the company tens of millions of dollars per year.¹⁴ Mr. Owens continued that without the onerous rates and deficiency claims, rejection of the DJ South Contract would save the Debtors between $4.5 and $5.5 million in 2021.¹⁵ Furthermore, Mr. Owens testified that, as to Platte River, reasonable alternatives could be up-and-running within 90 days¹⁶ because the alternative infrastructure was already within a mile of the well (versus constructing a whole new pipeline that was 90-miles from the well).¹⁷ Rogan McGillis, ARB Midstream's Chief Financial Officer, who was a competent and well-prepared witness but whose testimony was self-serving and, ultimately, unpersuasive, could not rebut the timing or feasibility of the Debtors' alternatives to the Platte River gathering system.

Mr. Owens also testified about the DJ South pipeline. He stated that alternative pipeline providers will be able to install the short connections between their existing infrastructure and the collection points in the DJ South dedication area in a matter of months – again, the testimony reflects that the alternative pipeline providers are relatively close to the Debtors' wells.¹⁸

Again, Mr. McGillis could not rebut the timing or feasibility of the Debtors' alternatives to the DJ South gathering systems.

As to Platte River and DJ South, Mr. Owens also testified about the economic benefit of rejection¹⁹ of the TSAs and the realistic alternatives.²⁰ Mr. Owens provided details about the cost of alternatives²¹ and the timeframe to alternative transition.²² Mr. Owens continued regarding the Debtors' analysis of the regulatory requirements to transition to another pipeline provider,²³ including interim options, such as shutting-in, trucking, and/or walk-up shipping.²⁴ Mr. Owens described the best and worst-case scenarios for making the transition to new pipeline suppliers.²⁵

Mr. Owens testified about the Grand Mesa TSAs. Mr. Owens testified that these contracts are projected to cost the Debtors approximately $100 million in annual...