The Oil and Gas Addendum

In mid-2019, Fram Operating, LLC and its parent, Fram Americas, LLC filed for Chapter 7 bankruptcy protection in Colorado. Fram was an oil and gas producer with wells in the prairies north of Minot, North Dakota and on the Western Slope of the Rocky Mountains in Colorado. So, how does this bankruptcy impact or effect landowners here in Pennsylvania? More than you may think.

In each of the In re Fram Americas, LLC and the In re Fram Operating, LLC bankruptcy proceedings, the Trustee of the bankruptcy estate filed a motion to “abandon any interest the Bankruptcy Estate may have in the machinery, fixtures, equipment, leases, oil, and oil barrels in Delta and Mesa Counties in Colorado and Renville County, North Dakota”. In support of the motions, the bankruptcy trustee asserted that “the machinery, fixtures, equipment, leases, oil, and oil barrels . . . are burdensome to the Estate and are of inconsequential value and benefit to the estate and it would therefore be in the best interest of the Estate to abandon said burdensome property, pursuant to 11 USC §554(a).” In other words, the Trustee was asking the Bankruptcy Court to exclude the underlying oil and gas wells and related infrastructure from the debtor’s estate. This could be an alarming trend for landowners.

Section 554 of the Bankruptcy Code is entitled “Abandonment of Property of the Estate”. Section 554(a) states that “[a]fter notice and a hearing, the trustee may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate.” All of a debtor’s interests in property form the bankruptcy estate when the bankruptcy is commenced. See, 11 USC 541(a). So, through these abandonment motions in the Fram cases, the bankruptcy Trustee was attempting to jettison “burdensome” oil and gas wells from the bankruptcy estate. Many courts have determined that, when property is abandoned by the bankruptcy estate, it reverts to the debtor outside of the bankruptcy context. So, with respect to abandoned property under §554 (i.e. the oil/gas wells), it is like no bankruptcy petition was ever filed. See, In re Dewsnup, 908 F.2d 588, 590 (10th Cir. 1990) aff’d 502 U.S. 410 (1992).

The Colorado Oil and Gas Conservation Commission (the “COGCC”) opposed efforts by the bankruptcy trustee to abandon the Fram wells in Colorado. The COGCC is the agency charged with regulating oil and gas in Colorado. The COGCC noted that while there were plugging and reclamation bonds in place, it believed that “the bonds cover less than half of the actual plugging and reclamation costs associated with the well sites in question.” The COGCC argued that there were questions about whether the wells were really of inconsequential value and that the bankruptcy schedules suggested that there were assets that could be liquidated to pay plugging and reclamation costs. The COGCC also suggested that wells could be sold in the bankruptcy proceeding and that the buyers would take responsibility for operating and possibly plugging the wells.

A short time after the COGCC lodged its objection to the proposed abandonment, the bankruptcy Trustee in both of the Fram cases filed a “No Asset Report” which averred that the Trustee determined that there was no property available for distribution from either bankruptcy estate. Based on that filing, the COGCC withdrew its objection to the proposed abandonment, based on its view that under a 1985 bankruptcy decision from Wyoming, In re A&T Trailer Park, Inc., 53 B.R. 144 (Bankr. D. Wy. 1985), a bankruptcy trustee would not be required to spend its personal resources on the bankruptcy estate, including compliance with environmental laws. The court then entered orders in both Fram cases that authorized abandonment of the wells under 11 USC §554(a).

Before the Fram entities filed for bankruptcy protection, they did not have money to satisfy their obligations to plug and decommission the wells. The COGCC appeared to recognize that whether the wells were “abandoned” from the bankruptcy estate or not, there simply was no money to plug these wells. Essentially, the COGCC saw the proverbial “writing on the wall” that plugging and reclaiming these wells would become its responsibility.

Federal law requires a bankruptcy debtor to comply with state and federal laws in the conduct of its business. Norris Square Civic Association v. St. Mary Hospital, 86 B.R. 393, 398 (Bankr. E.D. Pa. 1988). But, as demonstrated in the Fram Americas, LLC and Fram Operating, LLC bankruptcies, the court approved the bankruptcy trustee’s request to abandon wells carrying environmental plugging and reclamation obligations and liabilities. The reason for this appears to be the fact that while wells may carry plugging and reclamation obligations under state regulations, there was not a demonstrated risk of harm from the wells to prevent statutory abandonment under §554.

In Midlantic Nat’l Bank v. NJDEP, 474 U.S. 494 (1986), the United States Supreme Court confronted the question about whether a bankruptcy trustee could abandon contaminated property under §554. The Supreme Court reasoned that “a trustee may not abandon property in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards.” But, courts have read this restriction very narrowly to situations where there is imminent danger to the public; speculation that danger may arise in the future has been seen as insufficient to avoid abandonment. See, In re Smith-Douglass, Inc., 856 F.2d 12 (4th Cir. 1988); see also In re MCI, Inc., 151 B.R. 103, 108 (E.D.Mich.1992); State of N.J. Dept. of Environmental Protection v. North American Products Acquisition Corp., 137 B.R. 8 (D. NJ 1992).

When gas companies receive a permit to drill wells in Pennsylvania, they become obliged to plug the well when the well itself eventually reaches the end of its useful life. “Upon abandoning a well, the owner or operator shall plug it in the manner prescribed by regulation of the [Department of Environmental Protection]”. See, 58 P.S. § 3220(a). Drillers must post a bond with the DEP that is designed to assure that wells are drilled, operated and plugged according to Pennsylvania law. But the problem is that the bond is likely woefully deficient. Under 58 P.S. § 3225, there are tiered bonding requirements for drillers who have wells with a bore length in excess of 6,000 feet:

(ii) For wells with a total well bore length of at least 6,000 feet:

(A) For operating up to 25 wells, $10,000 per well, but no bond may be required under this clause in excess of $140,000.

(B) For operating 26 to 50 wells, $140,000 plus $10,000 per well for each well in excess of 25 wells, but no bond may be required under this clause in excess of $290,000.

(C) For operating 51 to 150 wells, $290,000 plus $10,000 per well for each well in excess of 50 wells, but no bond may be required under this clause in excess of $430,000.

(D) For operating more than 150 wells, $430,000 plus $10,000 per well for each well in excess of 150 wells, but no bond may be required under this clause in excess of $600,000.

58 P.S. 3225(a)(1)(ii). We believe these bonding requirements are inadequate. While there is not much public information associated with the costs to plug unconventional Marcellus wells, it has been reported that in 2010, Cabot Oil & Gas spent approximately $700,000 per well to plug three vertical Marcellus wells in Susquehanna County. If this is accurate, then it is clear that the bonds required by §3225(a) may not cover the cost to plug a single horizontal well.

In a world where drillers face historically low oil and gas prices along with significant debt obligations, there is a strong likelihood that some drillers will seek bankruptcy protection. One could imagine that, in an effort to shed liabilities, drillers (or the trustees of their bankruptcy estates) could invoke §554 to shed the plugging and reclamation liabilities associated with old, underperforming or played-out wells. So, if wells are worthless, carry liability and costs and a driller wants to move on without them (or is liquidating), what could happen?

In a best case scenario, if wells do not pose an imminent harm and could be abandoned through a bankruptcy, the plugging responsibility for those wells would fall to the Commonwealth. But, there are at least 200,000 wells in Pennsylvania that the state is already responsible for plugging. Therefore, there is little guarantee that a horizontal well abandoned by a bankrupt driller would be quickly plugged to ensure no environmental issues arise. A property owner would have to live with the issue until the DEP could address the plugging. Not only could this situation pose a risk for the property, it could cause issues with insurance and selling or marketing the property. But, a more alarming situation is the prospect that landowners may be saddled with the legacy environmental liability.

In Sgro v. Getty Petroleum Corp., 854 F.Supp. 1164, 1181 (D. N.J. 1994) aff’d 96 F.3d 1434 the district court held that underground storage tanks that were not removed from a leased service station became part of the real estate, whether by abandonment by the owner of the storage tanks or conversion by the landowner. Likewise, in In re Sheffield Oil Co., Inc., 162 B.R. 339, 342 (Bankr. M.D. Ala. 1993) a Chapter 7 bankruptcy trustee was permitted to abandon 110 underground petroleum storage tanks in Alabama over the objections of the owners of property where those storage tanks were located – and without undertaking a review to determine if there were any environmental issues.

Closer to home, in In re Purco, 76 B.R. 523, 531-32 (Bankr. W.D.Pa. 1987), the bankruptcy court for the Western District of Pennsylvania wrestled with the request of a bankruptcy trustee to abandon alleged hazardous waste in Erie County, consisting of as many as 200 drums of fluids, some of which may have been leaking. The bankruptcy court opined that “[i]f the inventory is abandoned by the trustee, then the problem of its disposal will be that of (1) the empty corporate shell of Purco, Inc., and (2) the owner of the real estate, i.e., Coon Refrigeration. Defendants Coon and Coon Refrigeration therefore oppose such abandonment.” In re Purco, 76 B.R. 523, 525 (Bankr. W.D. Pa. 1987).

The In re Purco court allowed abandonment reasoning that “the court infers from the [Department of Environmental Resources] lack of interest in this proceeding that there is no threat to the public health or safety which warrants DER’s participation. Also, there is no showing that the landlord/landowner (Coon Refrigeration), which will be in possession of such inventory upon abandonment, is not capable of any remedy which may be necessary to adequately protect the public.” In re Purco at 533 (emphasis added). The rationale of the In re Purco court should concern all landowners.

If you have wells on or under your property (regardless of whether they are conventional or unconventional wells) and the driller files for bankruptcy, it is important that you take notice of the proceeding and seek legal counsel to explore and protect your rights. The fact that Pennsylvania law requires wells to be plugged and abandoned – and that there are bonds in place – is not a substitute for landowner diligence. We are in unchartered waters and we urge all landowners to be mindful of this potential liability.