Commentary: There Are No Unencumbered Assets in Texas

Six years ago, in an otherwise unremarkable opinion, a court in Texas undermined one of the fundamental concepts embedded in the statute of frauds and deprived unsecured creditors of millions of dollars in value that would otherwise have been available to them. Nobody noticed—until now.

Why does a six-year-old Texas bankruptcy case matter now? Oil and gas companies are failing at an unprecedented rate. The creditor who can get at the oil and gas company’s real property interests holds the keys to the debtor’s estate. If the real property interests are subject to a properly recorded mortgage, unsecured creditors are, in most instances, out of luck.

Any contract for the transfer of an interest in real property, such as oil and gas interests, is subject to the statute of frauds. The statute of frauds requires a contract for the sale or transfer of real property to contain “sufficient” information to identify the property being conveyed with “reasonable certainty.”  In most states, that means a granular description—think metes and bounds. In Texas, in the wake of a 2010 ruling in the bankruptcy of Cornerstone E&P Co., a blanket lien on “all real property interests now owned or hereafter acquired” is deemed sufficiently descriptive to satisfy the statute of frauds.

What happened in Texas stayed in Texas right up until the Delaware bankruptcy court used that 2010 Texas decision to defeat a claim by unsecured creditors that certain secured lenders didn’t have perfected security interests in generically described assets, as happened in the Quicksilver Resources Inc. chapter 11 case. There, the official committee of unsecured creditors commenced an adversary proceeding against a group of secured lenders asserting that the lenders, represented by the Bank of New York Mellon Trust as indenture trustee, didn’t have liens against hundreds of oil and gas leases held by the debtors because the real property interests were not specifically identified in the mortgages. The lenders responded that their mortgages contained language that granted a blanket lien on any and all real property interests held by the debtors within the state of Texas.

The court agreed with the lenders. It held that a mortgage containing blanket lien language relating to a defined territory is sufficient to establish a lien on all of the debtor’s real property holdings in that county regardless of whether or not the real property, here the oil and gas leases, was specifically identified in the mortgage. Moreover, the court held that because the blanket lien on all of the debtor’s real property assets in a defined territory was sufficient to establish a lien, a mortgage properly recorded with the county clerk was sufficient to prefect the liens and secure the lenders. Thus, the unsecured creditors were out of the money.

This holding in Quicksilver Resources is currently limited to oil and gas leases located in Texas, but it will still have a wide-ranging effect. If a lender properly records the mortgage, and the mortgage has blanket lien language for that county in Texas, it is likely that all of the debtor’s real property interests in that county will be encumbered by perfected liens. Creditors looking for unencumbered assets in oil and gas cases will need to look elsewhere—the oil fields in Texas appear to have run dry.

Dan Geoghan is a member of Cole Schotz’s bankruptcy and corporate restructuring department.