Since 1983, LL&E has owned a net overriding royalty interest in the “Jay Field,” pursuant to a recorded “Conveyance of Overriding Royalty Interests”. From 1983 until 2006, the working interest owners of the Jay Field were ConocoPhillips Company and ExxonMobil. During this 23-year period, LL&E regularly received royalty payments from the ongoing operation of the Jay Field on a monthly basis.
Between late 2006 and 2014, through various mergers and acquisitions, The Breitburn Debtor Parties acquired or took control of ConocoPhillips’ and ExxonMobil’s working interests in the Jay Field, began to operate the Jay Field, and became collectively responsible for ensuring royalty payments were regularly made to LL&E pursuant to the Conveyance in the same manner such payments had previously been made.
Despite their obligations, however, the Debtor Parties failed and refused to pay royalty payments to LL&E since they acquired their working interests in the Jay Field. The only payment occurred in September 2008 when they were forced to make a payment of approximately $437,000 as a result of an audit. Instead of paying the royalties to LL&E as required, the Debtor Parties have caused the funds to be deposited into what they call a “Special Cost Escrow" in the name of QR Energy. As of the petition date, QR Energy held more than $18.3 million in the Escrow Account. On 8/12/15, QRE filed the Texas Litigation against LL&E in Harris County Texas (Case No. 2015-47031), seeking a declaratory judgment regarding its rights and fiduciary obligations to LL&E under the Conveyance. On 2/19/16, LL&E filed a counterclaim against QRE, third-party claims against the other Debtor Parties, and third-party claims against non-debtors Quantum Resources Management, LLC, Bank of New York Mellon, Bank of New York Mellon Trust Company, N.A., Stifel, Nicolaus & Company, Inc. and ConocoPhillips Company. LL&E asserts counts for breach of fiduciary duty, breach of contract, tortious interference, and conspiracy. LL&E’s claims primarily arise from the past failures and ongoing failures by the Debtor Parties and Non-Debtor Parties to comply with the terms of the Conveyance, and their efforts to interfere with and dilute LL&E’s royalty interests in the Jay Field. LL&E also demanded a jury trial. In the Texas Litigation, the Debtor Parties assert that they have the right to withhold the Escrowed Funds from LL&E under the terms of the Conveyance in order to cover certain alleged anticipated future costs called “excess production costs.” LL&E disputes that assertion and claims that the Escrowed Funds are immediately payable as part of LL&E’s royalty interests under the Conveyance.
On 5/16/16, the Debtors filed a Motion for Entry of Interim and Final Orders (I) Authorizing Payment of All Funds Relating to Royalty Interests and (II) Directing Financial Institutions to Honor and Process Checks and Transfers Related to Such Royalty Interests. In the Royalty Motion, the Debtors explained that royalty interests and their proceeds, including the type of royalty interests at issue in the Texas Litigation, do not constitute property of the estate pursuant to 11 U.S.C. §541(b)(4)(B)(i) and applicable case law, but rather that the Debtors administer such payments for various royalty interest holders (such as LL&E) in a bailee, agent or fiduciary capacity, and therefore that the Debtors should be permitted to continue to make such payments to royalty interest holders in the ordinary course. The Bankruptcy Court granted the Royalty Motion in a final order on 6/15/16.
On 5/02/17, the Bankruptcy Court entered the Order Granting in Part and Denying in Part LL&E Royalty Trust’s Motion for Relief from the Automatic Stay (the “Lift Stay Order”, ECF No. 1217). Pursuant to the Lift Stay Order, the automatic stay was modified solely “to permit the ‘Texas Petition’ and ‘Count One’ in the ‘Texas Answer’. The Lift Stay Order further provided that the automatic stay shall remain in effect as to all other counts or causes of action asserted by LL&E in the Texas Litigation and as to any relief that may be entered by the Texas Court. The Lift Stay Order further provided that following the disposition of the litigation as to which the stay was lifted, the parties shall return to the Bankruptcy Court to determine the appropriate remedy, if any, under bankruptcy law. In either case, a final determination of the issues raised in the Texas Litigation by the state court is unlikely to have any material impact on these bankruptcy cases.
Conveyance, which by its terms is governed by Texas law, does not constitute an executory contract or unexpired lease for purposes of Section 365 of the Bankruptcy Code. Rather, the Conveyance is a conveyance of real property under Texas law, and is therefore not subject to assumption, rejection, or cure.
For the reasons set forth by the Debtors in the Royalty Motion, if LL&E prevails in the Texas Litigation on its assertion that the Escrowed Funds are immediately payable to LL&E as part of LL&E’s royalty interest, none of the Escrowed Funds will constitute property of the estate. If the Debtor Parties prevail in the Texas Litigation, however, the percentage of the Escrowed Funds determined to be necessary to pay alleged anticipated “excess production costs” may arguably constitute estate property (but may also be determined to constitute specially earmarked or trust funds for paying such costs and therefore not available for distribution to general creditors of the estate), and LL&E will be entitled to receive any net funds remaining in the Escrow Account after withholding of the funds necessary to pay those costs.
The Texas Litigation, which involves only state-law claims, will very likely result in complete resolution of all present disputes related to the Conveyance and the Escrowed Funds. This includes complete resolution of the state-law claims between LL&E and the other Non-Debtor Parties to the Texas Litigation, over which this Court’s subject matter jurisdiction and/or ability to enter final orders is questionable at best. This Court has previously recognized that where a state court “is the only forum that can award complete relief to all parties,” factors 1 and 10 go hand-in-hand and weigh in favor of granting stay relief. By contrast, if stay relief is not granted, LL&E may be required to bring an adversary proceeding against the Debtor Parties in this Court while pursuing its related third party claims against the Non-Debtor Parties in the Texas Litigation, which would be contrary to the interests of judicial economy and may even result in incompatible rulings from this Court and the state court.