1. Presented by Dana E. Dupre and Rick M. Shelby
A Trending Risk and Liability on the OCS:  What Happens When a Party Can No Longer Pay to Play?
Presented by Dana E. Dupre and
Rick M. Shelby

2. April 24 Houston Seminar
TOPIC: Trending Risk on the Outer Continental Shelf (OCS)
Business of Managing Risks – understanding offshore oil and gas activity and lessons learned
Overview of Risks
Operational issues – cost of doing business (P&A – expensed to co-owners)
Sunset Properties/Idle Iron – P&A cost outweighs value of reserves/environmental hazards
Regulatory Compliance – BOEM (financial obligations) and BSEE (‘fit for purpose’ requirements)
Offshore decommissioning liabilities are expensive – in the range of $ million per lease
Contractual disputes regarding decommissioning liabilities
Bankruptcy – culmination of all risks
ATP Oil & Gas Corporation – case study of E&P company failure and sophisticated approach to shedding residual liabilities

3. A Trending Risk and Liability on the OCS
OUTLINE 1. Decommissioning Liabilities 2. Decommissioning liabilities in bankruptcy 3. To be or not to be an overriding royalty interest – Comments on ATP case 4. OCSLA choice of law issues

5. Regulatory decommissioning liabilities
§     Who must meet the decommissioning obligations in this subpart?
(a) Lessees and owners of operating rights are jointly and severally responsible for meeting decommissioning obligations for facilities on leases, including the obligations related to lease-term pipelines, as the obligations accrue and until each obligation is met.
(b) All holders of a right-of-way are jointly and severally liable for meeting decommissioning obligations for facilities on their right-of-way, including right-of-way pipelines, as the obligations accrue and until each obligation is met.
(c) In this subpart, the terms “you” or “I” refer to lessees and owners of operating rights, as to facilities installed under the authority of a lease, and to right-of-way holders as to facilities installed under the authority of a right-of-way.
§     When do I accrue decommissioning obligations?
You accrue decommissioning obligations when you do any of the following:
(a) Drill a well;
(b) Install a platform, pipeline, or other facility;
(c) Create an obstruction to other users of the OCS;
(d) Are or become a lessee or the owner of operating rights of a lease on which there is a well that has not been permanently plugged according to this subpart, a platform, a lease term pipeline, or other facility, or an obstruction;
(e) Are or become the holder of a pipeline right-of-way on which there is a pipeline, platform, or other facility, or an obstruction; or
(f) Re-enter a well that was previously plugged according to this subpart.

6. Residual liability post-transfer
The BOEM must approve all assignments of record title (lessee’s interest) or operating rights (working interest) in an OCS lease
§ (d) You, as assignor, are liable for all obligations that accrue under your lease before the date that the Regional Director approves your request for assignment of the record title in the lease. The Regional Director's approval of the assignment does not relieve you of accrued lease obligations that your assignee, or a subsequent assignee, fails to perform.
(e) Your assignee and each subsequent assignee are liable for all obligations that accrue under the lease after the date that the Regional Director approves the governing assignment. They must:
(2) Remedy all existing environmental problems on the tract, properly abandon all wells, and reclaim the lease site in accordance with 30 CFR part 250, subpart Q [decommissioning regs].
(f) If your assignee, or a subsequent assignee, fails to perform any obligation under the lease or the regulations in this chapter, the Regional Director may require you to bring the lease into compliance to the extent that the obligation accrued before the Regional Director approved the assignment of your interest in the lease.

7. Residual liability continued § 556.64:
You do not gain a release from any accrued obligation under your lease or the regulations by assigning your record title interest or transferring your operating rights in the lease.
You are jointly and severally liable for the performance of each nonmonetary obligation under the lease and under the with each prior lessee and with each operating rights owner holding an interest at the time the obligation accrued, unless this chapter provides otherwise.
Sublessees and operating rights owners are jointly and severally liable for the performance of each nonmonetary obligation under the lease and under the regulations in this chapter to the extent that:
The obligation relates to the area embraced by the sublease; and
Those owners held their respective interest at the time the obligation accrued

8. Recent Decisions Re: Decommissioning
Noble Energy, Inc. v. Salazar, 671 F.3d 1241 (D.C. 2012) – decommissioning obligation discharged by DOI breach of lease?
Cutting Underwater Technologies USA, Inc. v. ENI US Operating Co., 671 F.3d 512 (5th Cir. 2012) – defining decommissioning for OCS properties.
Nippon Oil Exploration U.S.A. Limited v. Murphy Exploration & Prod. Co. – USA, 2011 WL (E.D. La. 3/25/2011); 2011 WL (E.D. La. 6/15/2011) – predecessor responsible for decommissioning costs accruing before effective date of assignment.
Mariner Energy, Inc. v. Devon Energy Production Co., 690 F.Supp.2d 558 (S.D. Tex. 2010)- decommissioning costs measured at time Agreement executed.
Apache Corp. v. W&T Offshore, Inc., 626 F.3d 789 (5th Cir. 2010) – no decommissioning owed under farmout agreement.
Chieftain Int’l (U.S.), Inc. v. Southeast Offshore, Inc., 553 F.3d 817 (5th Cir. 2008) – assignee remains solidarily liable for decommissioning costs.

9. Contracting around residual liability
Today, residual liabilities are always considered in the PSA and other contracts, but less likely in older contracts
Use of performance bonds or decommissioning escrow accounts to guarantee performance is sometime advisable
Beware of how you define decommissioning obligations; courts will look to the regulations for guidance if ambiguous
Careful of who may be the last owner in the chain of title

10. Bankruptcy: A Culmination of Risks
TOPICS:
Property of the Estate
Priority of Claims
Shedding Liabilities
Abandonment
Rejection
Safe Harbors
Equitable Title
Farmouts
Production Payments

11. Property of the Estate
11 U.S.C. § 541 – an estate is created by commencement of the bankruptcy case
All legal or equitable interests of the debtor in property as of the commencement of the case
NOTE: Section 541 does not define the interests. The question of whether or not the debtor has an interest in property and the determination of the nature and extent of interest is resolved under nonbankruptcy law.

12. Bankruptcy Principles to Shed Liabilities
Abandonment of Burdensome Assets
11 U.S.C. § 554
Administrative burden – no value/no benefit
Midlantic Nat’l Bank v. New Jersey Dept. of Environmental Protection, 474 U.S. 494 (1986) = a debtor cannot abandon property that would violate decommissioning regulations “reasonably designed to protect the public health or safety from identified hazards.”

13. ATP Bankruptcy Case Background
Case No (Isgur) – S.D. Texas
ATP sought Chapter 11 bankruptcy protection in August 2012, citing dramatically reduced cash flows from the deepwater drilling moratorium.
ATP listed assets of $3.6 billion and liabilities of $3.5 billion in its Chapter 11 petition.
Much of ATP’s development and production was funded by debt.
ATP was exempt from supplemental bonding until July 31, 2012 when DOI revoked ATP’s exempt status.
ATP filed for bankruptcy in August 2012, leaving its assessed decommissioning liabilities un-bonded

14. ATP Sheds Residual Decommissioning Liabilities
After filing for bankruptcy protection and a series of failed negotiations to continue operations, ATP shut-in certain OCS properties and moved to concurrently reject any unexpired leases related to the certain properties and abandon any property, right or interest in those properties.
ATP, as operator, was responsible for decommissioning all of the wells and facilities located on the Gomez Properties.
The Gomez Properties consisted of several OCS leases including the MC 711 Lease, a floating offshore platform along with a network of pipelines and wells.
The cost to decommission was estimated to exceed $100 million.

15. ATP Seeks to Shed Residual Decommissioning Liabilities - Continued
The ATP court permitted abandonment in light of Midlantic
In re ATP Oil & Gas Corp., 2013 WL , (Bankr. S.D. Tex. June 19, 2013) = Midlantic did not hold that a debtor may abandon property where abandonment would be consistent with – and perhaps in furtherance of – an environmental regulatory scheme.

16. Objections to ATP Abandonment
The DOI and Anadarko objected to abandonment
DOI – ATP cannot abandon environmental liabilities under Midlantic
Anadarko – same; as only P-I-T, Anadarko would be saddled with decommissioning liability
DOI withdrew objection, preserving admin claim
Judge Isgur permitted abandonment under Midlantic
Under the applicable decommissioning regulations, DOI could look to Anadarko to satisfy decommissioning obligations (at least for wells and facilities in place when Anadarko transferred its interest to ATP and for which ATP had no security posted).

17. IN RE: ATP OIL & GAS CORPORATION, Debtor(s)
IN RE: ATP OIL & GAS CORPORATION, Debtor(s). Motion to Abandon Gomez Properties  
The Court is not unsympathetic to Anadarko. It may be forced to bear a substantial cost as a result of ATP’s financial woes. Nevertheless, like many things in a bankruptcy case, the cost that Anadarko may bear is a reflection of the credit risk it took. Anadarko sold a portion of the Gomez Properties to ATP, and required ATP to bear the financial burden of plugging and abandonment in accordance with applicable federal law. This unfortunate position is no different from that of any other creditor that relies on the promise of performance from an eventually failed entity. In re ATP Oil & Gas Corp., 2013 WL , (Bankr. S.D. Tex. June 19, 2013)

18. Anadarko’s Relief?
After ruling, DOI ordered Anadarko to decommission properties
DOI, ATP and Anadarko ultimately settled with Anadarko receiving proceeds of ATP’s $3 million area wide bond but responsible for decommissioning properties (at cost projected to exceed $115 million)
The Anadarko decommissioning settlement agreement also preserved any administrative expense claim arising out of the maintenance and decommissioning of the platform and MC 711 Lease.
Anadarko filed a proof of claim on 1/6/2014 for $115,217,808 of projected maintenance and decommissioning costs.
Estimated $1.6 million available for to pay priority claims

19. Priority of Claims – Administrative Priority
Priorities are important in bankruptcy because some creditors’ claims are more important than others.
Holders of administrative expenses are the highest priority next to secured claims.
In Midlantic, the court ruled when a debtor cannot abandon the property, the resulting post-petition clean-up cost is an administrative expense.
In re H.L.S. Energy Co., 151 F.3d 434 (5th Cir. 1998) = P&A is an “actual and necessary” cost of administering the estate
In re American Coastal Energy, Inc., 399 B.R. 805 (Bankr. S.D. Tex. 2009) = environmental claims arising from a pre-petition liability do not fit within the same framework as trade-creditor claims arising from pre-petition liabilities

20. Priority of Claims Rejection Damage Claims
11 U.S.C. § 365(g) – “rejection of an executory contract or unexpired lease of the debtor constitutes a breach”
Estate will be liable for damages caused by the breach, but such claim is treated as a prepetition unsecured claim. See 11 U.S.C. § 365(g)(1).
The non-debtor party to the contract may file a proof of claim for the pre-petition rejection damages. See 11 U.S.C. § 502(g).
The effect of rejection is significant because the rejection claim will rank below administrative claims, priority claims and secured claims.
Contract Assumption – Cure Claims are administrative claims
Subrogation issues - In re Tri–Union Development Corp., 314 B.R. 611 (Bankr. S.D. Tex. 2004) = subrogated only to the claim and priority of BOEM (not police power)

21. Are OCS leases and carved out interests property of the estate?
Rejection of Executory Contracts
“Bringing interests back into the estate”
Remember the non-cost bearing interests that ATP created
What is the nature of the interest conveyed by these assignment?
What is the nature of the debtor’s interest in the OCS lease and derivative interests?
ATP put this creative approach into practice

22. To Be or Not to Be an ORRI…
versus

23. To Be or Not to Be an ORRI…
Pre-bankruptcy = ATP assigns/conveys Term ORRI / NPI to raise capital (lenders, drilling contractors, charterers)
Post-bankruptcy = ATP labels conveyances of non-cost bearing interests as financing transactions and not sales of a property interest
WHY? Property of the Estate or not?

24. To Be or Not to Be an ORRI…
ISSUE: “disguised financing” or transfers of ownership
Summary Judgment Phase = court not deciding on nature of the interest; only legal issue of consistency/inconsistency with the interest conveyed and possibility of “Recharacterization”
Consistent with Term ORRI?
Subordinated Interest/Payment Terms
Reversionary/Retention of Control
Inconsistent with a Debt Instrument?
Lack of Foreclosure Remedy
Economic Substance

25. Nature of Federal, Offshore Mineral Interest?
Underlying legal issue in adversary proceedings was about the nature of an OCS lease and its “derivative interests” – i.e. the nature of an OCS estate
This issue begs fundamental questions re: what
law should apply to determine the nature of
an OCS lease/mineral interest – federal or state
law?
It’s well-established that non-bankruptcy law
(generally, state law) creates and defines property
interests in bankruptcy proceedings. So for jurisdictions that characterize a private mineral lease as a fee simple determinable (Texas), the lease is not considered a true lease or executory contract under § 365. But jurisdictions that characterize a mineral lease as conveying only a true lease, then the mineral lease is an executory contract under § 365.
Thus, the question what is an OCS interest and what law should define it.

26. OCSLA CHOICE OF LAW PROVISION – 43 U.S.C. § 1333(a)(2)(A)
Federal law under OCSLA applies on the OCS.
However under the OCSLA choice of law provisions, state law serves as surrogate federal law, if there is a “gap” in applicable federal law.
So, should we be asking: why doesn’t Louisiana law apply to determine the nature of an OCS lease in a bankruptcy proceeding?

27. ATP and DOI Position on Applicable Law
ATP argued that under the OCSLA, the title it acquired from the DOI in the OCS leases was that of a lessee, and did not constitute absolute title.
Making the OCS leases executory contracts and/or unexpired leases.
Accordingly, any ORRI or NPI conveyance that is derivative of ATP’s OCS leases, did not constitute real property interests.
Therefore, the ORRIs are not property of the burden holder and may be rejected in bankruptcy.
The DOI supports ATP’s position because it agrees that OCS leases are merely contractual leasehold rights.

28. Interesting DOI arguments in ATP
In recent ATP filings, the DOI has urged that OCS leases and interests carved out of OCS leases are limited contractual rights under applicable federal law:
since OCS leases are governed by the OCSLA, federal law applies;
because the OCSLA uses the word “lease” to characterize the property interest granted by the US, OCS leases are by their plain language, leases – viz., contractual rights between lessor and lessee;
the OCSLA enabling statute grants lessees only the right to “explore, develop, and produce the oil and gas contained within the lease area,”;
the OCSLA language comports with the Bankruptcy Code’s definition of a lease in § 365 as being “any rental agreement to use real property.”; and
DOI supports its argument with jurisprudence holding that an OCS lease “does not convey title in the land, nor does it convey an unencumbered estate in oil and gas.” Boesche v. Udall

29. State Law as Surrogate Federal Law
As we all know, under Louisiana law, all mineral rights are real rights, incorporeal immovables and alienable.
The DOI argues then that Louisiana law cannot apply as surrogate federal law under the OCSLA because Louisiana law is inconsistent with this federal law – that OCS leasehold interest and other mineral rights on the OCS are merely contractual/personal rights.
But if applicable federal law exists, is there even a need for state law as gap filler?
And is this what was intended? What property law should define OCS mineral interests? What was the OCSLA choice of law provision meant to do?

30. Bonding Requirements BOEM/BSEE Regulations 30 CFR 256 – Bonding
Required prior to issuance of lease, RUE, ROW or any proposed activity, or assignment of same
General Operating Bond – area wide
Level of Activity
None = $300,000
Exploration Plan = $1,000,000
Development Plan = $3,000,000
Lease Specific
None = $50,000
Exploration Plan = $200,000
Development Plan = $5,00,000

31. Role of supplemental bonds
When is a supp bond required?
BOEM with BSEE technical assessment will determine decommissioning liability
How is decommissioning liability determined?
Review of potential liabilities, financial strength and reliability – see NTL No N07
Some companies are exempt from providing supp security
When is decommissioning liability adjusted?
After partial abandonment
Revised activity plan
Any change in responsible parties
Company request
BSEE/BOEM determination

32. More bonding Issues BOEM/BSEE Bond Reassessment Study
To apply to all shelf properties
Increase bonds for non-exempt and some cos. may lose exempt status
Bonds for ROWs?
Bonds for operating rights interest?
Bonds needed where one record title holder exempt?

33. ANY QUESTIONS?