Keanotes

An Oil & Gas Bankruptcy Related Ruling – Why Does This Matter?

By Heather Gabell, Director of Compliance and Gary Joseph, Senior Manager, Consulting & Advisory Services Team

March 24, 2020

While a number of recent paradigm shifting cases have commanded the attention of unclaimed property holders (Temple Inland, Marathon Petroleum, and Card Compliant to name a few), a 2019 bankruptcy-related decision appears to have flown under the radar.

The number of bankruptcy filings in the oil and gas sector skyrocketed in 2015, before peaking in 2016 and subsequently slowing down over the last few years. However, as we see signs of another economic downturn, a decision by the Fifth Circuit Court of Appeals in Matter of Linn Energy L.L.C. could be viewed as precedential.[1]

In May 2016, Linn Energy, LLC (“Linn”), an oil and gas company operating in Texas and Oklahoma, along with fourteen of its affiliates, filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. As creditors, both the Oklahoma State Treasurer (“OK Treasurer”) and the Texas Comptroller of Public Accounts (“TX CPA”) filed proofs of claims with the bankruptcy court.

Linn filed an unclaimed property report in November 2016 with the OK Treasurer for $956,212.72, but failed to remit the property to the OK Treasurer. The OK Treasurer contended that Linn was required under the state’s unclaimed property law to remit the funds with the report, but failed to file an adversary complaint demanding the funds. The TX CPA filed an adversary complaint upon Linn’s disclosure that it owed $1.5 million in unclaimed property.

As part of the bankruptcy proceedings, Linn sent the OK Treasurer and the TX CPA a ballot to vote on the proposed Reorganization Plan (“Plan”). The OK Treasurer failed to vote or contest the Plan, but the TX CPA objected to the Plan, as it proposed to disburse unclaimed property funds owed to Texas residents to parties other than the TX CPA. The bankruptcy court confirmed the Plan in January 2017 and authorized the TX CPA to pursue its claims for unclaimed property. As the order confirming the Plan was uncontested, confirmation became final in March 2017.

Linn objected to the OK Treasurer’s proofs of claim a few months later, alleging that the organization was not liable and that the Bankruptcy Code preempted the state’s unclaimed property law. The OK Treasurer then filed an adversary complaint against Linn, emphasizing that although Linn was in possession of the funds, it was not the owner of the funds and as such, was required by state law to remit the funds to the OK Treasurer.

Linn moved to dismiss the adversary compliant under Bankruptcy Rule 7012(b)(6), arguing that the OK Treasurer’s claim violated certain provisions of the Plan, including the injunction, vesting and discharge provisions, was barred by res judicata and was preempted by federal law. The OK Treasurer asserted that because Linn was not the owner of the unclaimed property, the property was not part of the bankruptcy Estate and could not therefore be governed by the Plan. The bankruptcy court agreed with Linn and dismissed the compliant, finding that the OK Treasurer’s complaint was a “collateral attack” on the Plan.[2]

The OK Treasurer appealed to the United States District Court for the Southern District of Texas, which reversed the bankruptcy court’s decision. In Oklahoma State Treasurer v. Linn Operating, Inc., the District Court found that Linn held legal, but not equitable, title to the unclaimed property at the time of the bankruptcy filing as the custodian of the unclaimed property.[3] As such, the unclaimed property should have been excluded from the bankruptcy Estate and the bankruptcy court should not have adjudicated the case.

On appeal, the United States Fifth Circuit Court of Appeals reversed the District Court’s decision and held that the bankruptcy court’s dismissal of the OK Treasurer’s adversary complaint based on res judicata was correct. The Court of Appeals agreed with Linn’s prevailing argument, that the bankruptcy court’s approval of the Plan and confirmation order constituted a final judgement that could not be collaterally attacked.[4] Both parties were given an opportunity to challenge the bankruptcy court’s decision and thus they were collaterally barred from subsequently challenging it.[5]

Under the Plan, unclaimed mineral royalties were treated as an unsecured debt; and upon approval of the Plan, any remaining property vested in Linn and no future claims could be brought against the organization. The OK Treasurer had the opportunity to vote on the Plan but failed to do so, and did not object or contest the Plan’s treatment of the unclaimed property. The TX CPA, on the other hand, had objected to the Plan’s treatment of such property, and as a result, the unclaimed property was excluded from the Plan, and they were free to pursue their claims.

While the TX CPA was allowed to pursue its claims for the unclaimed property because it asserted its rights to property due and owing to Texas residents, the OK Treasurer was barred from pursuing its claims to the unclaimed property because it sat on its rights.

While the Court of Appeals relied on the principles of res judicata and barred the OK Treasurer’s claims, it is noteworthy that the District Court looked to Sec. 546(a) of the Bankruptcy Code to find that the Bankruptcy Code does not expand a debtor’s rights against creditors and others beyond those existing rights present at the time of the proceedings. Under this concept of derivative rights, the District Court determined that the debtor could have no greater claim to the unclaimed property than the rightful owners of the property could. The debtors held legal, but not equitable, title to the unclaimed property and thus could only assert claims to legal title. Under the unclaimed property law, the OK Treasurer acted as a trustee for the benefit of the rightful equitable owners, and thus the unclaimed property belonging to third parties at the time of the bankruptcy proceeding remained the property of the individuals to whom it was due and should have been excluded from the bankruptcy Estate.[6]

If a court determines that a debtor has no greater right to the unclaimed property than the rightful owner, the state may then pursue its claim to unclaimed property, but under the derivate rights doctrine, the state has no greater right to the unclaimed property than the rightful owner. The state merely steps into the shoes of the owner as a custodian of the property until the rightful owner comes forward to claim it.

Takeaways

If your company is considering a bankruptcy proceeding, it is important to identify and document property that should be considered reportable to the states as unclaimed property in the event that they make a claim for the funds.

As a holder, if you are under audit, be weary of a state’s estimation methodology, which often uses estimation and extrapolation to calculate a liability that is a windfall for the state (contrary to the derivative rights doctrine). Maintain and retain adequate records in accordance with state unclaimed property laws record retention periods.

Further, if your organization acquires a company that previously declared bankruptcy, it is essential that you gather information pertaining to prior unclaimed property compliance efforts and the actions taken by the states to claim funds on behalf of the rightful owners. In both situations, be aware of hidden pockets of unclaimed property liability that your organization could be assuming prior to finalizing any agreements.



[1] Matter of Linn Energy, L.L.C., 927 F. 3d 862 (Fifth Cir. 2019).
[2] Id. at 866.
[3] Oklahoma State Treasurer v. Linn Operating, Inc., No. 6:17-CV-0066, 2018 WL 1535354 (S.D. Tex. March 29, 2018).
[4] Linn at 866.
[5]Id.
[6]Oklahoma at 3.

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