IN RE FOOTHILLS TEXAS, INC. Bankruptcy No. 09-10452. Adversary No. 10-51308 (CSS).
476 B.R. 143 (2012)
In re FOOTHILLS TEXAS, INC., et al., Debtors. Foothills Texas, Inc., et al., Plaintiffs, v. MTGLQ Investors, L.P., Defendant.
United States Bankruptcy Court, D. Delaware.
July 20, 2012.
Fox Rothschild LLP, Jeffrey M. Schlerf, L. John Bird, Wilmington, DE, Fox Rothschild LLP, Samuel H. Israel (Argued), Philadelphia, PA, Winston & Strawn LLP, James Donnell, Sarah L. Trum, New York, NY, Allen D. Cummings (Argued), Law Offices of Allen D. Cummings, San Antonio, TX, for Reorganized Debtors.
Neil B. Glassman, Colin R. Robinson, Wilmington, DE, Thompson & Knight LLP, David M. Bennett (Argued), Katharine E. Battaia, Dallas, TX, for MTGLQ Investors, L.P.
CHRISTOPHER S. SONTCHI, Judge.
In 2006, the Debtors executed an Instrument in favor of MTGLQ. Under applicable law, the Instrument conveyed to MTGLQ an "overriding royalty interest" of 5% of the working interest in oil and gas produced from the subject land. MTGLQ timely and properly recorded the Instrument soon after it was executed.
In 2009, the Debtors filed for bankruptcy. After filing the petition, the Debtors made post-petition transfers to MTGLQ under the Instrument. In addition, prior to confirmation, the Debtors scheduled the Instrument as an executory contract that was subject to rejection. In 2010, the Court confirmed the Debtors' Plan, which deemed any "executory contracts" listed in the Debtor's schedules (such as the Instrument) to be rejected. The Court retained jurisdiction to hear disputes concerning executory contracts.
The crux of this dispute is whether the Instrument was, in fact, at the time of confirmation of the plan, an executory contract subject to rejection. The Debtors argue that the Instrument was an executory contract. As such, they filed this action seeking a declaration that the Instrument was rejected and that any remaining obligations under it have been terminated. Assuming the Instrument was rejected, the Debtors also demand the return of the unidentified post-petition transfers. MTGLQ argues that the Court should dismiss the suit for lack of subject-matter jurisdiction or for failure to state a claim.
The Court will grant MTGLQ's motion to dismiss for failure to state a claim.
The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157 and 1334. Venue is proper in this district pursuant to 28 U.S.C. sections 1408 and 1409. The Court has the judicial power to enter a final order in this matter.
A. Factual Background
Foothills Texas, Inc. ("Foothills") and certain affiliates (collectively, the "Debtors") filed for bankruptcy in February 2009. However, the facts precipitating the instant proceedings begin three years earlier.
In September 2006, Foothills and MTGLQ executed an instrument (the "Instrument") conveying an overriding royalty interest (the "overriding royalty" or "override") to MTGLQ of 5% of the working interest in oil and gas produced from the subject land.
In the oil and gas industry, an overriding royalty interest (sometimes called an override) conveys a fraction of oil and gas production, whether in proceeds or in-kind.
In January 2010 (approximately one year after the Debtors filed bankruptcy), this Court entered an order confirming the Debtors' Plan of Reorganization (the "Plan"). Appended to the Plan was a Plan Supplement. And, in the Plan Supplement, the Debtors listed the "Conveyance of Overriding Royalty Interest as an executory contract to be rejected."
Through the Confirmation Order, this Court authorized the Debtor to reject any "executory contracts" that were "listed in the Debtors' Plan Supplement as agreements
The Debtors have interpreted the Confirmation Order as rejecting the Instrument and terminating all of their duties owed under the overriding royalty interest. For its part, MTGLQ agrees that the Court rejected any "executory contracts."
B. Procedural Posture
Initially, in May 2010, the Debtors initiated a contested matter (not an adversary proceeding) against MTGLQ seeking to release any encumbrances related to the override, including the Debtors' continued royalty obligations under the Instrument.
The Debtors filed the Amended Complaint shortly thereafter. In the Amended Complaint, the Debtors seek a declaration that the Instrument was rejected pursuant to the Confirmation Order and the Debtors' Plan. They also assert five related, derivative claims. More specifically the Debtors seek:
MTGLQ filed a motion to dismiss arguing that, notwithstanding the provisions of the plan, at the time of its confirmation, the Instrument was not an executory contract capable of being rejected. MTGLQ further argues that each of the Debtors' claims is premised upon the Debtors' improper conclusion that the Instrument constituted an "executory contract" and, thus, the Complaint should be dismissed in its entirety.
C. The Instrument
The Instrument in question is the "Conveyance of Overriding Royalty Interest." In standard oil and gas parlance, the term "overriding royalty" means a given percentage of gross production carved from the working interest in the land but, by agreement, not chargeable with any of the expenses of operation.
Nonetheless, whether the interest is an overriding royalty (or something else) depends on the true nature of the particular conveyance which gives rise to the interest.
The Instrument conveying the overriding royalty in this case provides as follows:
An important feature of overriding royalty interests is the fact that the interest is free and clear of costs and expenses. More specifically, the characteristics of a royalty interest necessarily include that "it is an expense-free obligation ..., payable as a specified share of the gross production, and is to continue throughout the life of the lease."
The Instrument specifies that the override is free and clear of a number of obligations:
In addition, it specifies the entity charged with those obligations.
Thus, the Instrument is an overriding royalty interest. But is it an executory contract?
The applicable legal standard is well known. A Rule 12(b)(6) motion serves to test the sufficiency of the factual allegations in the plaintiff's complaint.
Where might these facts be found? Generally, a court may consider the facts alleged in the pleadings, documents attached as exhibits or incorporated by reference in the pleadings and some matters judicially noticed.
Here, the question is whether the Debtors' allegations — apart from a mere legal conclusion that the Instrument was an executory contract — support the view that the Instrument was subject to rejection. In resolving the dispute, the Court will base its discussion on the pleadings and the Instrument referenced and incorporated within the pleadings.
The crux of the dispute is whether the Instrument was an executory contract at the time of confirmation of the plan and, thus, subject to rejection. The Debtors asserts it was and not surprisingly, MTGLQ disagrees. MTGLQ protests that the overriding royalty interest was a fully vested conveyance of an interest in real property, so that the Instrument could not be rejected.
We begin with the Code. With certain exceptions not relevant here, section 365(a) of the Code provides that "the trustee [or debtor in possession], subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor."
A. Executory Contracts in § 365(a)
What is an executory contract? The Code does not define the term. At minimum, Congress intended the term to refer to contracts "in which performance is due to some extent on both sides."
Under this definition, the Third Circuit has not only reiterated that both parties must owe obligations, but also clarified the extent to which performance must be due. In Columbia Gas, for instance, the Court explained that "unless both parties have unperformed obligations that would constitute a material breach if not performed, [a] contract is not [an] executory [contract] under § 365."
Consider the following. Corporation A licenses the right to use its trademark to Corporation B in a single integrated agreement. B pays for the right to use, thereby substantially performing, but has some insignificant obligations outstanding. Can A terminate B's right by rejecting it? The answer will typically be no. The parties must owe reciprocal material obligations or the agreement is not executory for purposes of § 365.
Here, the Debtors do not argue that MTGLQ owes outstanding obligations. Instead, the Debtors argue that the contract is executory because they, the Debtors, owe continuing obligations to MTGLQ, including obligations related to royalty payments, expenses, indemnification, marketing, record keeping, operating, and sale of the working interest as a consequence of the Instrument. But this misses the mark. In this two party arrangement "[the basic] inquiry is to determine whether [the relevant instrument] contained at least one obligation for both [the promisee] and [promisor] that would constitute a material breach under [applicable state] law if not performed. If not, then the [Instrument] is not an executory contract."
B. Do Both Owe Continuing, Material Obligations?
MTGLQ argues that the Instrument was not subject to rejection because it was not an executory contract at the time of confirmation of the Debtors' plan. In response, the Debtors argue that the Instrument contains severable, continuing obligations owed by the Debtors to MTGLQ. To address these points, the Court (1) notes that the Instrument was clear, definite, and unambiguous; (2) finds that the Instrument was a single, integrated agreement; and (3) concludes that the Instrument was not subject to rejection as an executory contract.
1. The contract is clear, definite and unambiguous.
To determine the parties' obligations, as well as whether the parties have performed under the contract, the Court must examine the Instrument. Here, general rules of construction will be utilized; "[w]hen construing instruments purporting to grant or reserve oil and gas interests, general rules of construction apply."
When construing a contract the court will divine the parties' intent at the time that the parties entered into the contract.
Here, the Instrument is not ambiguous, but instead definite and certain. Therefore, the Court must interpret the Instrument as a matter of law.
2. The Instrument is not severable; it is a single integrated agreement.
As a general rule, the decision to reject a contract "is an all-or-nothing proposition."
As with all things, there are limits. One important limit is the court will only sever a contract if it can be severed under applicable law.
Under Texas law, determining whether a contract is severable is ordinarily a question of law. A "divisible contract" is said to exist when performance by one party consists of several distinct and separate items and the price paid by either party is apportioned to each item.
The intent of the parties is the principal determinant of divisibility.
In the current case, the manifest intent of the parties was to convey an overriding royalty interest. Among other things, the Instrument was named the "Conveyance of Overriding Royalty Interest"; the Debtors do not assert any facts to support the intention of the parties to treat the "Conveyance" as divisible; the Debtors have not provided any facts to indicate that separate consideration was paid for the various items; and the Debtors have not asserted any facts to demonstrate that the parties treated the agreement as divisible. Rather, as in Johnson, the parties appear to have contemplated agreement to the entire bundle of rights and duties.
Additionally, the Debtors' Amended Complaint treats the Instrument as a single, indivisible whole. Absent evidence to the contrary, Texas courts will not treat a contract as severable where the parties have not done so themselves.
In the instant case, the Debtors' pleadings continually refer to the Instrument as a single Instrument (i.e., as "the Contract"); the Debtors' schedules listed the Instrument as a single instrument (i.e., as the "Conveyance of Overriding Royalty"); and MTGLQ's pleadings refer to the Instrument as a single instrument (i.e., as "the Conveyance"). There is no reason to treat the instrument as severable.
3. The Instrument was not subject to rejection.
Having explained that the Instrument was clear and unambiguous and finding that the Instrument was a single integrated agreement, the remaining question is did parties owe continuing, material obligations sufficient to render the Instrument executory? If not, the Instrument was not an executory contract subject to rejection.
a) Full performance.
MTGLQ does not owe any remaining performance obligations under the Instrument.
The instrument "CONVEY[ED] ... and DELIVER[ED] ... an overriding royalty interest ... to Royalty Owner," MTGLQ, "[f]or a good and valuable consideration, the receipt and sufficiency of which [were] acknowledged."
The Instrument also indicates that the covenants and warranties were not only part-and-parcel of the conveyance but also given in exchange for a single consideration. For instance, each covenant specifically relates back to the conveyance of an overriding royalty interest. And the Instrument's language incorporates the covenants, warranties and obligations. Specifically, the Instrument states:
According to the plain language in the Instrument, MTGLQ delivered valid consideration in exchange for the overriding royalty, including the Debtors' continuing obligations, covenants and warranties.
b) Substantial performance.
At minimum, MTGLQ substantially performed under the Instrument, precluding
In Exide, the Third Circuit explained that, in jurisdictions recognizing the substantial performance doctrine, substantial performance will preclude rejection, as the contract cannot be materially breached and, therefore, cannot constitute an executory contract.
Texas courts recognize the substantial performance doctrine.
Here, MTGLQ substantially performed under the contract, which the Court is bound to treat as "the legal equivalent of full compliance."
The Court will grant MTGLQ's motion to dismiss. The Instrument was a single indivisible contract which was not an "executory contract." As such, the debtor-in-possession could not "reject" the Instrument as an "executory contract."
The remaining claims will be dismissed along with the rejection claim. The first claim is the foundation. It asks the court to declare the contract rejected. Every other claim that follows is founded upon the conclusion that the Instrument was subject to rejection. Because they are based upon, and derivative of, the first claim for declaratory relief, these claims fail. An order will be issued.
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