In re Wilson

Decision Date13 February 1987
Docket NumberBankruptcy No. 584-50146,Adv. No. 584-5117.
Citation69 BR 960
PartiesIn re William B. WILSON a/k/a Willie B. Wilson Individually and d/b/a Wilson Ranches, Debtor. William B. WILSON, Plaintiff, v. TXO PRODUCTION CORP., Defendant.
CourtU.S. Bankruptcy Court — Northern District of Texas

Thomas J. Griffith, Lubbock, Tex., for Wilson.

Tim Gideon, Lynch, Chappell, Allday & Alsup, Austin, Tex., for TXO.

John E. Leslie, Shannon, Gracey, Ratliff & Miller, Fort Worth, Tex., for Unsecured Creditors Committee.

MEMORANDUM OF OPINION

JOHN C. AKARD, Bankruptcy Judge.

Procedural History

On June 21, 1984, William B. Wilson, a/k/a Willie B. Wilson, Individually and d/b/a Wilson Ranches, filed for protection under Chapter 11 of the Bankruptcy Code. On November 14, 1985, Mr. Wilson, as Debtor-in-Possession (Wilson), brought this adversary proceeding against TXO Production Corp. (TXO), seeking an accounting and turnover of income withheld by TXO as operator of oil and gas leases in which Wilson owns interests. Wilson asserted such withholding is a preferential transfer pursuant to 11 U.S.C. § 549 or, in the alternative, a fraudulent transfer pursuant to 11 U.S.C. § 548. He sought to recover not only transfers made to TXO within 90 days of the filing of the bankruptcy petition but, characterizing TXO as an insider, also transfers which occurred within one year of the filing of the petition as well as postpetition funds withheld.

TXO responded that the funds it held were cash collateral of its operator's lien on the Debtor's interests in the wells operated by TXO. TXO asserted that it had the right to withhold the funds and that such withholding did not constitute transfers, either preferential or fraudulent, from the Debtor.

Subsequently, TXO filed a Motion for Relief from Automatic Stay to allow it to foreclose its operator's lien against the various interests of Wilson in certain oil and gas wells, on the grounds that Wilson had neither paid his expenses on the wells nor paid adequate protection. Hearing was held to the Court on June 4, 1986, at which time TXO argued that the various operating agreements between TXO and Wilson constituted executory contracts which Wilson had neither assumed nor rejected.

Facts

Interests in oil and gas wells fall into two broad general categories: royalty interests and working interests. The royalty interest (often simply referred to as royalty) is the right to receive a share of the production of the well, free of any obligation to pay expenses in connection with that production. A working interest is the right to receive a share of the production of the well, but carries with it the obligation to pay a pro rata portion of the expenses of the well. In effect, the royalty owners receive their payments without having to bear any of the costs (and, in theory at least, as compensation for owning the property initially), while the working interest owners must pay the entire costs of operating the well in exchange for their share of the production. Typically there are a number of working interest owners and it is quite common for them to enter into an operating agreement which provides for one of them (the operator) to operate the properties for the benefit of both the working interest and royalty owners. Typically the royalty owners have no say in naming the operator. There is no requirement that the operator be one of the working interest owners, but it is the customary practice. The working interest owners who are not the operator of the well are referred to as non-operating working interest owners or non-operators.

TXO is both the operator and a working interest owner in the Noelke 8-1, the Arco 75-4, the Thompson P-1, the Thompson P-2, the Bankhead # 1, and the Bankhead # A-1 wells located in various counties in Texas. Wilson is one of a number of nonoperating working interest owners in the wells. He also owns a royalty interest in them.

Under the operating agreements in effect between the parties, TXO controlled operations on the leases on which the wells were situated and billed the non-operators for their proportionate share of expenses for the preceding month. Every month TXO sent the non-operators checks for their proportionate share of the proceeds of oil and gas sold from the wells. In short, the arrangement was a typical oil and gas operation. When Wilson failed to pay his share of prepetition operating expenses, TXO applied funds attributable to Wilson's interests in the wells to cover those expenses. After Wilson filed his Chapter 11 petition on June 21, 1984, TXO continued to set aside the proceeds which represented Wilson's interests in the wells. TXO insists that it has liens on the funds in question pursuant to the operating agreements and, in addition, asserts that the operating agreements must be characterized as executory contracts which Wilson must assume or reject.

Wilson alleges that, whether or not the operating agreements are executory contracts, the seizure of the proceeds of Wilson's interests in the wells constituted illegal transfers before the petition was filed and violations of the automatic stay after the petition was filed. Wilson further claims that the funds (now held by TXO) attributable to Wilson's interests in the wells do not represent cash collateral since TXO is not a secured creditor.

Executory Contract

The first question to be determined by the Court is whether an operating agreement is an executory contract. An executory contract is one under which the parties' obligations to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other. In re Sun Belt Electrical Constructors, Inc., 56 B.R. 686, 688 (Bankr.N.D.Ga.1986); Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn.L.Rev. 439, 458-62 (1973). While no attempt has been made to define the term "executory contract" in the Bankruptcy Code, the legislative history adopts the principle of mutuality in saying that the term "generally includes contracts on which performance remains due to some extent on both sides." 2 Collier on Bankruptcy ¶ 365.02, 15th ed. 1985; see also Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers, Inc.), 756 F.2d 1043, 1045 (4th Cir.1985) cert. denied, ___ U.S. ___, 106 S.Ct. 1285, 89 L.Ed.2d 592 (1986). The Court holds that both Wilson and TXO have continuing obligations under the operating agreements so long as oil or gas are produced from the wells in question and, thus, the operating agreements are executory contracts.

As executory contracts, the operating agreements between TXO and Wilson are subject to the provisions of 11 U.S.C. § 365 which govern the time for curing defaults. Section 365(a) states that, subject to the Court's approval, the Trustee (in this case, the Debtor-in-Possession, Wilson) may assume or reject any executory contract. Section (b)(1) provides that the Trustee may not assume unless, at the time of assumption, he (A) cures or provides adequate assurance that he will promptly cure such default, (B) compensates or provides adequate assurance that he will promptly compensate the other party to the contract for any actual pecuniary loss he has suffered from the default and (C) provides adequate assurance of future performance under the contract.

Section 365(d)(2) provides that "the trustee may assume or reject an executory contract ... at any time before the confirmation of a plan." In the instant case no plan has been confirmed. While the Court may order the contract assumed or rejected within a specified period of time where requested to do so by a party to the contract, TXO has made no such request. Therefore, if Wilson assumes these executory contracts, he must cure his default, but he need not cure it until he assumes. NLRB v. Bildisco & Bildisco, 465 U.S. 513, 529, 104 S.Ct. 1188, 1197, 79 L.Ed.2d 482 (1984).

Operator's Lien

Several operating agreements, each relating to different leases, were introduced into evidence at the hearing. Each agreement contained an operator's lien similar to the one in Article VII of the operating agreement dated March 6, 1978:

Each Non-Operator grants to Operator a lien upon its oil and gas rights in the Contract Area and a security interest in its share of oil and or gas when extracted and its interest in all equipment to secure payment of its share of expense, together with interest thereon ... To the extent that Operator has a security agreement under the Uniform Commercial Code of the State, Operator shall be entitled to exercise the rights and remedies of a secured party under the Code. In addition, upon default by any Non-Operator in the payment of its share of expense, Operator shall have the right, without prejudice to other rights or remedies, to collect from the purchaser the proceeds from the sale of such Non-Operator\'s share of oil and gas until the amount owed by such Non-Operator has been paid.

One of the agreements was recorded in the Oil and Gas Records of Reagan County, Texas on June 13, 1984, within 90 days of the filing of the Bankruptcy Petition (June 21, 1984). Thus, to the extent that the recording adds enforceability to the operator's lien contained in the operating agreement, it is a preference and is clearly voidable under 11 U.S.C. § 547(b). Another agreement was recorded in the Oil and Gas Records of Reagan County, Texas on July 11, 1984, subsequent to the filing of the Bankruptcy Petition. The recording of this latter agreement, to the extent that it asserts an operator's lien, is in violation of the automatic stay provisions of 11 U.S.C. § 362(a)(4).

Once oil and gas are produced, they become personal property. United States v. Texas Eastern Transmission Corp., 254 F.Supp. 114, 118 (W.D.La.1965); Onyx Refining Co. v. Evans Production Corp., 182 F.Supp. 253, 256 (N.D.Tex.1959); Phillips Petroleum...

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