Bankruptcy allows the sale of real property free and clear of certain liens and interests. A covenant running with the land, however, is likely not affected by a sale in bankruptcy. Whether a right is a covenant running with the land is thus a crucial issue, especially when a debtor in bankruptcy seeks to strip the right without the owner’s consent. The Fifth Circuit recently held in Newco Energy v. Energytec, Inc. (In re Energytec, Inc.), that a right to a transportation fee in connection with a pipeline and a right to consent to the assignment of the pipeline were covenants running with the land.
Energytec, Inc. (“Energytec”) filed for Chapter 11 bankruptcy in 2009. Under Section 363 of the Bankruptcy Code, which allows a debtor to sell property free and clear of liens and interests, Energytec proposed to sell a pipeline system to Red Water Resources, Inc. (“Red Water”). The pipeline system included a gas pipeline, its rights-of-way, and a processing plant.
The sale was subject to approval by the bankruptcy court. The bankruptcy court authorized the sale, but reserved the issue of whether the sale would be free and clear of the rights of Newco Energy (“Newco”).
Under a 1999 letter agreement, Newco had a right to receive a “transportation fee” based on the amount of gas flowing through the pipeline, and this right was secured by a security interest and lien in the pipeline system. The letter agreement was executed in connection with the assignment of the pipeline system from Mescalaro Oil & Gas, Inc. (“Mescalaro”) to Energytec’s immediate predecessor, Producers Pipeline Corporation (“Producers”), and it was executed by Mescalaro, Producers, and Newco. Under the letter agreement, Newco also had a right to consent before any assignment of the pipeline. The letter agreement and the bill of sale conveying the pipeline system to Energytec’s predecessor were properly recorded in the relevant county’s land records.
After the sale had closed, the bankruptcy court ruled that the transportation fee was not a covenant running with the land, but it did not address the issue of the right to consent. The district court affirmed, and Newco appealed.
The Fifth Circuit reversed. The court concluded that the transportation fee and the right to consent were covenants running with the land.
Under Texas law, “a covenant runs with the land when it  touches and concerns the land;  relates to a thing in existence or specifically binds the parties and their assigns;  is intended by the original parties to run with the land; and  when the successor to the burden has notice.” Because the 1999 letter agreement stated that Newco’s interests ran with the land and that the agreement was intended to bind the parties’ successors, it was uncontested that the latter three factors were satisfied. The court therefore considered whether Newco’s rights touched and concerned the land and whether there was privity between Newco and Red Water, such that Newco’s rights were enforceable against Red Water.
The court found that there was privity. Noting that if Mescalaro had conveyed the rights to Newco first and then conveyed the pipeline system to Producers subject to Newco’s rights, there would be no question about privity. Even if the two conveyances occurred simultaneously, the court stated, there was “no meaningful effect on the privity concerns.”
The court also concluded that the transportation fee and the right to consent touched and concerned real property. Under Texas law, there is no absolute test for determining whether a right touches and concerns the land, but courts consider whether the covenant “affected the nature, quality, or value of the thing demised, independently of collateral circumstances, or if it affected the mode of enjoying it” or if the covenant either lessens the promisor’s legal relations in respect to the land or increases the promisee’s legal relations in respect to the land.
Because the transportation fee was directly related to the use of the real property for transporting natural gas along the pipeline, the court concluded that the covenant to pay the fee touched and concerned the land. Specifically, the requirement to pay the transportation fee affected the use of the land: Whenever the owner of the pipeline system wanted to transport gas, the owner had to pay Newco. Newco’s right to consent to the assignment of the pipeline directly impacted the owner’s interest, so it also touched and concerned the land. Both rights affected the value of the pipeline. Concluding that the transportation fee and right to consent were covenants running with the land, the Fifth Circuit vacated the district court’s judgment and remanded to the district court for future proceedings.
Practice Tip: This same rationale could apply to oil and gas agreements such as participation agreements, joint venture agreements and joint operating agreements. To improve the chances that a purchaser’s obligations will survive bankruptcy (i) characterize the obligations as covenants running with the land and (ii) file the agreement of record by referencing the agreement in the assignment (assuming you are in a state like Texas that allows record notice by reference).
- By Mitchell Ayer and Evelyn Breithaupt