by Wade D. Gungoll

On July 22, 2008, SemGroup LP, the parent entity of the various SemGroup subsidiaries, filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the District of Delaware, even as the price of crude oil was in excess of $140 per barrel.^1,2 As a major purchaser of production from Oklahoma oil and gas producers, SemGroup’s bankruptcy thrust a host of unresolved legal issues into the limelight. Of those issues, perhaps none were more relevant and pressing than 1) the level of priority given to the hundreds of producers who sold to SemGroup prior to its bankruptcy; and 2) whether Oklahoma’s Oil and Gas Owners’ Lien Act permits an operator to file a lien on behalf of all interest owners. As such matters would be implicated in any future bankruptcy filing by a purchaser of production affecting Oklahoma producers, this article will address each of these important topics in detail.

THE OKLAHOMA OIL AND GAS OWNERS’ LIEN ACT

In the wake of a recently released A.G. opinion, 2008 OK AG 31, oil and gas producers selling production in Oklahoma can persuasively argue that the proceeds of their production are subject to a statutory trust, and, accordingly, their interests should not be subject to the bankruptcy estate, as would otherwise be the case for liens filed under the Oklahoma Oil and Gas Owners’ Lien Act.

Oklahoma has two statutory regimes that provide protection to producers of oil and gas who sell their production but are not paid for that production by the purchaser. Producers have rights to a statutory lien under the Oklahoma Oil and Gas Owners’ Lien Act, 52 O.S. §§ 548 et seq. (Lien Act) and producers have rights to a statutory or resulting trust under the Oklahoma Production Revenue Standards Act. 52 O.S. § 570.1 et seq. (PRSA). In a case such as the SemGroup bankruptcy case, these acts can provide priority to producers that could serve to elevate their rights to payment over the rights of general unsecured creditors.³ However, where the purchaser of production has loans from banks or other entities that are secured by mortgages and other security interests that are perfected by the filing of financing statements under the Uniform Commercial Code (UCC) in inventory of the purchaser, and where the perfection of those liens predates the sale of the production to the purchaser, questions of priority arise. Such a dispute is now playing out in the SemGroup bankruptcy.

Where there are existing perfected security interests, predating any producer lien filing or sale of production, certain provisions of the Lien Act create problems for a producer attempting to assert priority over the perfected lender. Under the Lien Act, when producers of oil and gas are not paid by the first purchaser of the production, the producers have lien rights (producer’s lien) in the production sold and the proceeds of such production.⁴ The producer’s lien can be perfected by the filing of verified lien statement no later than 90 days from the time when payment is otherwise due under the Lien Act and when timely perfected, the producer’s lien relates back to the date when severance of the production occurred.⁵ The Lien Act provides that the producer’s lien takes priority over the rights of all persons whose rights or claims arise or attach to the production or the proceeds, including those which arise or attach between the time the producer’s lien attaches (the date of severance) and the time of filing of the producer’s lien, with certain exceptions.⁶

The most difficult issue for producers who sell production to a purchaser who fails to pay arises from § 548.6(C) of the Lien Act which provides that nothing in the Lien Act “shall be construed to impair or affect the rights, priorities, or remedies of any person under the provisions of the UCC, and the provisions of this act shall be deemed cumulative to and not a limitation on or a substitution for any rights or remedies otherwise provided by law to a creditor against his debtor.” It is this provision that the debtors and their lenders in the SemGroup case will likely rely upon to argue that the liens of the lenders in the inventory of the debtors, which were perfected under the UCC before the date of severance of the production sold and not paid for, have priority over the subsequently perfected producer’s liens.

The Oklahoma appellate courts have not yet had occasion to opine on these provisions of the Lien Act and there is only a federal case that is instructive on this point. In Arkla v. Norwest Bank of Minneapolis, N.A., 948 F.2d 656 (10th Cir. 1991), the 10th Circuit significantly restricted the priority of oil and gas producers who sell to purchasers of production that fail to pay and then file for bankruptcy when there is a preexisting perfected security interest in inventory, including production, in the possession of the purchaser. The Arkla decision addressed the specific question of whether a claimant with a lien in inventory perfected under the UCC has superior rights in bankruptcy to a lien claimant under the Lien Act, where the UCC claimant’s lien predates a lien filed under the Lien Act. Following the language of 52 O.S. § 548.6(C), the Arkla court held that an earlier-filed UCC lien in inventory including production has superior priority, and that later-filed liens under the Lien Act must be subordinated to earlier-filed liens whose origins are in the UCC.⁷ Accordingly, under the interpretation of the statute in the Arkla decision, the Lien Act is of no benefit in a lien contest between royalty owners and producers against a first purchaser’s bank lender with an earlier perfected lien in the production.⁸

Against this background, it would appear inevitable that a lien claimant under the Lien Act would have its interests subordinated to all earlier-filed UCC liens in a bankruptcy proceeding. As of the date of its filing, SemGroup had tens of millions of dollars in outstanding payments due to the oil and gas producers from whom it had purchased production. The prospect of being subordinated to SemGroup’s lenders with earlier-filed UCC financing statements is clearly disfavored among the producers because, given the magnitude of the debt owed to lenders, there likely will be insufficient proceeds from the production to pay both the lenders and the producers.⁹

Counsel for the producers who sold to SemGroup made the argument that the PRSA, 52 O.S. § 570.1 et seq., should be construed to impose an implied trust upon a bankrupt purchaser for the benefit of producers. Under such a statutory trust theory, the adverse limitations of the Arkla decision would be avoided: any unpaid production and the proceeds from such production would not be the property of the bankruptcy estate.¹⁰ Under the statutory trust theory, the purchaser would not acquire an equitable property interest in the production unless and until the producer gets paid. Thus, the only interest of the debtor that could be property of the bankruptcy estate under 11 U.S.C. § 541 would be bare legal title. The equitable rights to the production and the proceeds of any production would be held by the debtors as trustee for the benefit of the Oklahoma producers who sold that production to the debtors. Consequently, creditors with a preexisting UCC financing statement could not claim an interest to any unpaid production or proceeds from such production because it would not belong to the debtor. The lien of the creditor with the preexisting UCC financing statement would not have attached to the equitable interest under the UCC since the lien attaches only when the debtor obtained rights in the property that the lender argues is subject to its lien.¹¹ Moreover, any purchaser of production with outstanding payment obligations would be rigorously subjected to the duties required of a trustee.

In consultations with the bankruptcy court, and with the statutory trust theory in mind, counsel for the producers urged the court to enter a procedures order for the resolution of lien claims and statutory trust claims under Oklahoma law. On Sept. 17, 2008, the court entered an Order Establishing Procedures for the Resolution of Liens Asserted Pursuant to Producers’ Statutory Lien or Similar Statutes (procedures order) that specifically addressed the producers’ concerns.¹² The procedures order provides for declaratory judgment actions for each state implicated in the bankruptcy proceedings, including Oklahoma. The Oklahoma action seeks a determination of the priority of both statutory trust and statutory lien claims of Oklahoma producers.

The procedural method outlined in the procedures order will allow the affected producers to adjudicate the statutory trust argument in their attempt to obtain greater bankruptcy protection:

The Declaratory Judgment Actions shall seek declaratory judgments as to the rights, status, priority, and other legal relations of the Producers related to the Debtors and their Pre-Petition Secured Parties. The Declaratory Judgment Actions, as may be amended pursuant to the Federal Rules of Civil Procedure, will seek a declaration on the threshold questions of law germane to the Statutory Lien Claims and/or the Statutory Trust Claims [emphasis added] for any Goods delivered or received prepetition or resulting proceeds under the laws of each state in which Debtors purchased Goods from Producers, including, but not limited to, the legal issues related to validity and priority of such claims.¹³ 

Of great importance, not only as it relates to the SemGroup case but also for any future bankruptcy involving a purchaser of Oklahoma production, is that the Oklahoma attorney general has endorsed the producers’ statutory trust argument. In 2008 OK AG 31, issued Nov. 5, 2008, Attorney General Drew Edmondson thoroughly examined both the language and legislative history of the PRSA and concluded that it must be interpreted to create a statutory trust for the benefit of producers.

Central to the attorney general’s analysis was 52 O.S. § 570.10(A), which states:

All proceeds from the sale of production shall be regarded as separate and distinct from all other funds of any person receiving or holding the same until such time as such proceeds are paid to the owners legally entitled thereto. Any person holding revenue or proceeds from the sale of production shall hold such revenue or proceeds for the benefit of the owners legally entitled thereto. Nothing in this subsection shall create an express trust.¹⁴

According to the attorney general, 52 O.S. § 570.10(A)’s mandatory language creates a trust relationship between a producer and its purchaser of production:

First, by using the word “shall” the Legislature made the provisions of Section 570.10(A) mandatory… Thus, it is mandatory that the proceeds be regarded as separate and distinct from all other funds of the person receiving or holding those proceeds. Also, it is mandatory that the person receiving those revenues or proceeds hold them for the benefit of the owners legally entitled to them.

Second, since the proceeds are regarded as separate and distinct from all other funds of the person receiving or holding them, and since it is mandatory that the person receiving or holding the revenue or proceeds holds them for the benefit of the owners legally entitled to them, it follows that the person receiving or holding such revenue or proceeds acquires no rights in the revenue or proceeds. The “holding for the benefit of another” principle is at the heart of Section 570.10(A). That principle is analogous to the fundamental structure of a trust relationship; i.e., “a person in whom some estate, interest, or power in or affecting property of any description is vested for the benefit of another.” Riedell v. Stuart, 2 P.2d 929, 933 (Okla. 1931).¹⁵

While 52 O.S. § 570.10(A)’s pronouncement that “Nothing in this subsection shall create an express trust” could be construed against the creation of a trust relationship, the attorney general dismissed such a notion due to the distinction between “express” and “implied” trusts. In his strongest statement in support of the statutory trust concept, the attorney general declared that the PRSA would be rendered meaningless without the incorporation of an implied trust for the benefit of producers:

A statute plain on its face may not be added to or expanded under the guise of statutory interpretation… Consequently, since there has been a long-standing and universal distinction in Oklahoma jurisprudence between express trusts and implied trusts, there is nothing ambiguous about the phrase “express trust” when used in Section 570.10(A). If the legislature had intended to negate all manner of trusts (including implied trusts), it could easily have done so by not using the word “express” or by employing language such as, “Nothing in this subsection shall create a trust of any nature.” The principles of statutory construction in Oklahoma preclude any attempt to expand or rewrite the term “express trust” to mean or include implied trusts. In fact, without the imposition of an implied trust, Section 570.10(A) is nothing more than a hollow statement of intent without an enforcement mechanism. Therefore, the conclusion is compelling that the Legislature intended an implied trust under Section 570.10(A).¹⁶

As to the nature of the implied trust, the attorney general opined that the PRSA creates both a resulting trust and a constructive trust which function in conjunction with one another for the benefit of producers:

Section 570.10(A) declares that proceeds from the sale of production shall be the property of the owners legally entitled to them. Section 570.10(A) directs that the holder of the revenue or proceeds hold them for the benefit of those legally entitled them. If a holder of the revenue or proceeds tried to exercise ownership of or rights in the revenue or proceeds for the holder’s benefit, or the benefit of others who were owners not legally entitled to the revenue or proceeds, such conduct would be in direct disregard of statutory language and the duties imposed by the section and hence would be “unconscionable” and against “equity and good conscience.” It would be against equity and good conscience for the holder to hold the revenue or proceeds of production and not pay them to the owners legally entitled thereto in violation of the statute.

Additionally, not enforcing Section 570.10(A) through the imposition of a constructive trust would promote unjust enrichment. It would give the holder of the revenue or proceeds both legal and beneficial title to and use of property of others not only in violation of law, but also for which the holder had not paid. Thus, the holder of those proceeds would obtain legal and beneficial title to the property of others in violation of State law and at the actual expense of those who sold presumptively in reliance on the State law. Consequently, if Section 570.10(A) were found not to create a resulting trust, Section 570.10(A) would impose a constructive trust on the holder of such funds.¹⁷

With 2008 OK AG 31 on the books as a source of persuasive legal authority concerning the obligations established in the PRSA, practitioners who represent producers will certainly want to utilize it to their advantage. Attorneys can use the opinion both for purposes of avoiding subordination of the liens of their producer clients to preexisting liens under the UCC, and as an independent basis to bring suits for the recovery of production proceeds.

FILING A LIEN ON BEHALF OF NON-OPERATING INTEREST OWNERS

The Oklahoma Oil and Gas Owners’ Lien Act is ambiguous as to whether an oil and gas operator may file a lien on behalf of non-operating interest owners.

Another interesting aspect related to the SemGroup bankruptcy involves an interpretation of whether the Lien Act authorizes oil and gas operators to file liens on behalf of the appropriate non-operating interest owners. In the wake of the SemGroup filing, hundreds of SemGroup’s creditors and purchasers of production took the necessary steps to protect their interests in the bankruptcy proceedings. Numerous operators secured their interests in the production and proceeds of sold production by filing oil and gas liens under the Lien Act. Many of such liens were filed by operators not only on their own behalf but also on behalf of the various royalty owners, overriding royalty owners, and non-operating working interests owners in wells operated by those operators whose interests were affected by SemGroup’s bankruptcy filing. Remarkably, the language of the Lien Act does not explicitly specify whether an oil and gas operator is entitled to file a lien on behalf of all other affected interest owners.¹⁸

The statutory language defines an “interest owner” as “a person owning an entire or fractional interest of any kind or nature in the oil or gas at the time it is severed, or a person who has a right, either express or implied, to receive a monetary payment determined by the value of the oil or gas severed.”¹⁹ Additionally, an “operator” is defined as “any person engaged in the severance of oil or gas for himself, for himself and other persons or for other persons.”²⁰ As to perfecting a lien, 52 O.S. § 548.2 provides that an “interest owner… shall have a continuing security interest in and a lien upon the oil and gas severed, or the proceeds of sale if such oil or gas has been sold, to the extent of his interest until the purchase price has been paid to the interest owner.”²¹

Noticeably absent from the statutory text is whether the operator is permitted to file a lien on behalf of the non-operating interest owners. Although the issue has never been judicially determined, the strongest argument in favor of interpreting the Lien Act to allow operators to files liens on behalf of other interest owners is found in 52 O.S. § 548.4, the form for “Perfection of Security Interest and Lien by Filing of Verified Notice of Lien.” Below the signature line of the form notice are the words “(Signature of interest owner or operator),” which would seemingly indicate that operators are permitted to file liens and notice of liens on behalf of other interest owners.

Note, however, that whether the conjunctive “or” in the signature line actually suggests that operators may file liens and notices of liens on behalf of interest owners is certainly open to interpretation. From a practical standpoint, it would be difficult to imagine that the Legislature intended for the potential chaos of requiring hundreds of individual interest owners, irrespective of the sizes of their interests, to file liens or risk losing their security interests in a bankruptcy proceeding. On the other hand, history suggests that the “intent” of a state Legislature can be difficult to decipher.

On a tangentially related note, counsel for producers in the SemGroup bankruptcy made the argument that the court should explicitly recognize that operators are permitted to file proofs of claim on behalf of non-operating interest owners. The court accommodated the producers’ request through subsection (h) of the Procedures Order, which states in part:

Producers who are the operators of oil or gas wells and/or properties (“Operating Producers”) may (but are not required to) file proofs of claims for Statutory Lien Claims and/or Statutory Trust claims on their own behalf and on behalf of all non-operating interest owners in any such oil or gas wells and/or properties, including, but not limited to, working interest owners, royalty owners, and/or overriding royalty interest owners (the “Non-Operating Interest Owners”). When asserting a claim on behalf of Non-Operating Interest Owners, the Operating Producer need only file a single proof of claim form which clearly references the wells or properties for which Statutory Lien Claims and/or Statutory Trust Claims are asserted, and include a list of the Non-Operating Interest Owners for whom the proof of claim is filed, or, alternatively, identify the specific division order(s) or other contract(s) with the Debtor(s) that lists the Non-Operating Interest Owners for each such well or property.²²

While the procedures order does not remedy the Lien Act’s ambiguity because it does not address lien filing, it nevertheless serves as an example, in a similar circumstance, of a court’s determination that the proper course is to allow operators the opportunity to file claims on behalf of non-operating interest owners.

The bottom line is that unless and until the Lien Act’s operator/non-operating interest owner issue is definitively addressed by an Oklahoma court decision or executive opinion, counsel for oil and gas entities conducting business in Oklahoma need to be aware that the Lien Act contains an ambiguity with potentially drastic implications.

CONCLUSION

If an oil and gas entity such as SemGroup can go bankrupt amidst record high crude prices, then it stands to reason that the same is possible for other companies, particularly in less favorable market conditions. Numerous of Oklahoma’s energy companies, engrained with the difficult lessons learned from the bust of the 1980s, have likely approached the ever-so volatile energy markets with an abundance of caution this time around. However, future energy-related bankruptcy filings by Oklahoma companies are not out of the purview of possibilities, and counsel for oil and gas producers will want to incorporate these important aspects related to the SemGroup bankruptcy into their practice.

1. In re: SemCrude, L.P., et al., Case No. 08-11525 (Bankr.D.Del. 2008).

2. Walton, Rod. “SemGroup companies file for bankruptcy.” Tulsa World, as published July 22-23, 2008, available online at www.tulsa world.com/news/article.aspx?articleID=20080722_11_SemC687402.

3. It should be noted that in addition to the rights under the Lien Act and the PRSA, the Bankruptcy Code and provisions of the UCC also provide some additional protections applicable to producers. The Bankruptcy Code coupled with the UCC protects the reclamation rights of a producer for any production sold to the debtor in the 45 days before the filing of bankruptcy. See, 12, O.S. §2-702 and 11 U.S.C. § 546(c). In addition, the Bankruptcy Code grants an administrative claim for production sold in the 20 days preceding the filing of bankruptcy. See 11 U.S.C. §503(b)(9). A detailed discussion of these provisions is beyond the scope of this article.

4. 52 Okla. Stat. § 548.4(A).

5. Id.

6. See, 52 Okla. Stat. § 548.4(C) which provides: “Upon perfection by filing, the security interest and lien of the interest owner shall relate back to and be effective as of the date on which the severance occurred and shall take priority over the rights of all persons whose rights or claims arise or attach to the oil or gas unpaid for, or the proceeds of oil or gas if such oil or gas has been sold, including those which arise or attach between the time the security interest and lien attaches and the time of filing. The security interest and lien created pursuant to this act shall not have priority over the security interest and/or lien rights previously created and perfected pursuant to Section 144 of Title 42 of the Oklahoma Statutes, subsection (e) of Section 87.1 of Title 52 of the Oklahoma Statutes, or an operating agreement or other voluntary agreement for the development and operation of the property.”

7. 948 F.2d 656 at 659. The court stated: “[U]nder the unambiguous language of section 548.6.C, a lien authorized under the Lien Act shall not “impair or affect the rights and remedies of any person under the provisions of” the Oklahoma UCC. Thus, as the bankruptcy and district courts held, while the Lien Act, by its clear language, authorizes a lien to secure payment from oil or gas to an interest owner, it also ensures that security interests under the Oklahoma UCC are not subordinated to that lien. Any other reading of the Lien Act is simply contrary to the plain language used by the Oklahoma Legislature.

8. Terry I. Cross, Oil and Gas Product Liens — Statutory Security Interests for Producers and Royalty Owners under the Statutes of Kansas, New Mexico, Oklahoma, Texas, and Wyoming, 50 Consumer Fin. L.Q. Rep. 418 (1996).

9. Schedules of Assets and Liabilities of SemGroup Holdings, L.P., entered on December 2, 2008, and available online at www.kccllc.net/documents/0811532/0811532081203000000000001.pdf; See also SemGroup Claims Register Report, available online at www.kccllc.net/Creditor/CR130.asp.

10. It should be noted that there will still be issues of tracing of trust fund proceeds that will be raised by the debtors and their lenders in an attempt to defeat the rights of producers even if the court determines that the Oklahoma producers do have rights to statutory trusts.

11. See, 12 O.S. § 9-203 which provides in pertinent part that “a security interest is not enforceable against... third parties with respect to the collateral and does not attach unless ... the debtor has rights in the collateral.”

12. Order Establishing Procedures for the Resolution of Liens Asserted Pursuant to Producers’ Statutory Lien or Similar Statutes, Dkt. #2397, entered September 17, 2008 in Case No. 08-11525 (Bankr.D.Del. 2008).

13. Id., at 3.

14. 52 O.S. § 570.10(A).

15. 2008 OK AG 31 at 5-6.

16. Id., at 8-9.

17. Id., at 10-11.

18. 52 Okla. Stat. §§ 548 et seq.

19. 52 Okla. Stat. §548.1.

20. Id.

21. 52 O.S. §548.2.

22. Supra Note 7 at 5.

Article originally published in OBJ Vol. 80, No. 13 — May 9, 2009.