March 16, 2021

Opinion of Interest – Matter of First River Energy: Some State-Specific Liens May be no More than “Amazing Disappearing Security Interests”

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In its recent decision in Matter of First River Energy, LLC,1 the Fifth Circuit resolved a priority dispute between lienholders regarding their competing claims to cash held by the debtor, First River Energy, LLC. The cash at issue was the proceeds of a pre-bankruptcy sale of crude oil that the debtor purchased from certain producers (located in Texas and in Oklahoma) and then sold on to certain downstream purchasers. Following the debtor’s filing, each of the producers asserted a first-priority lien on the cash proceeds, as did the administrative agent for certain of First River Energy’s secured lenders. The administrative agent subsequently filed an adversary proceeding seeking to confirm its first priority status (senior to the producers), based on its perfection by the filing of a first-in-time UCC-1 financing statement with the Delaware Secretary of State in 2015. The two issues before the Bankruptcy Court were what law applied to the priority dispute (as between Delaware, First River’s state of organization, or Texas or Oklahoma, the locations of the producers and the oil sold) and, based on such choice of law, the priority of the parties’ liens. The Bankruptcy Court ruled that Delaware law applied and found that, under Delaware law, the administrative agent’s lien had priority over the lien of the Texas producers, but that the administrative agent’s lien did not have priority over the Oklahoma producers’ lien. The Fifth Circuit took an interlocutory appeal of the decision.

Concerning what law to apply to the priority dispute, the Fifth Circuit affirmed the Bankruptcy Court’s application of Delaware law, noting that applicable choice of law principles required that the law of the jurisdiction where the debtor is “located” be applied to disputes over the perfection and priority of liens. The Fifth Circuit concluded that because First River Energy was a limited liability company, it was considered to be “located” in Delaware, its state of organization.

Concerning the priority of the parties’ respective liens, the Texas producers argued that they had a first priority lien under section 9.343 of Texas’ UCC—a non-standard UCC provision—“which grants a first priority purchase money security interest in oil and gas produced in Texas as well as proceeds in the hands of any ‘first purchaser.’” The Oklahoma producers argued that their lien arose under the Oklahoma Lien Act, which creates a statutory lien outside of the UCC in favor of oil and gas producers that attaches to the proceeds of a sale of oil and gas until the producer is paid by the buyer.2 Applying Delaware law to the Texas producers’ argument, the Fifth Circuit affirmed the Bankruptcy Court and held “[t]he Texas Producers are out of luck under Delaware UCC law, which does not recognize the priority of their unfiled, unperfected security interests in proceeds under Texas UCC Section 9.343.” Applying Delaware law to the Oklahoma producers’ argument, the Fifth Circuit also upheld the Bankruptcy Court in ruling to the contrary that the Oklahoma producers had a first priority lien ahead of the administrative agent’s claim, noting that “[a]lthough Delaware law contains no statutory lien provision similar to the Oklahoma Lien Act, the Delaware UCC does not preempt statutory liens created by other states.”

This decision illustrates the contrasting viability of Texas’ and Oklahoma’s statutory schemes intended to protect producers of crude oil against non-payment and, as the Fifth Circuit noted, should serve as a warning to Texas crude oil producers that they “must beware ‘the amazing disappearing security interest’” – indeed, the Fifth Circuit suggested that the “Texas legislature should take note” of its decision and perhaps revisit section 9.343 of the Texas UCC. Until that happens though, crude oil producers in Texas will likely be best served by continuing to file financing statements against midstream purchasers in their state of incorporation or organization to protect their interests in the crude oil they produce notwithstanding section 9.343 of the Texas UCC.

1986 F.3d 914 (5th Cir. 2021).

2 The current version of the Oklahoma Lien Act was specifically enacted in response to the Delaware Bankruptcy Court’s decision in In re Semcrude, 407 B.R. 112 (Bankr. D. Del. 2009), which identified similar defects in a previous version of the Oklahoma Lien Act as those identified by the Fifth Circuit with respect to the Texas statute at issue in this case.

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