IN RE: CENTURY OFFSHORE MANAGEMENT CORPORATION CASE NO. 93-51340

UNITED STATES BANKRUPTCY COURT 

FOR THE EASTERN DISTRICT OF KENTUCKY

LEXINGTON DIVISION

IN RE:

CENTURY OFFSHORE MANAGEMENT CORPORATION CASE NO. 93-51340

DEBTOR IN POSSESSION

BMO FINANCIAL, INC. AND BANK OF

MONTREAL PLAINTIFFS

and

K.E. RESOURCES, LTD., APACHE

CORPORATION, AND NUEVO ENERGY

COMPANY PLAINTIFFS IN INTERVENTION

v. ADV. NO. 93-5140

CENTURY OFFSHORE MANAGEMENT

CORPORATION, et al. DEFENDANTS

MEMORANDUM OPINION

Intervening plaintiffs K. E. Resources, Ltd., Apache Corporation, and Nuevo Energy Company (hereinafter referred to collectively as the "Non-operators") seek a declaration by way of summary judgment that their claim against the debtor's interest in the West Cameron block 368 oil and gas lease is superior to the mortgage and security interest of plaintiffs BMO Financial, Inc. and Bank of Montreal therein.

FINDINGS OF FACT:

Century Offshore Management Corporation, the debtor in possession, is an independent oil and gas exploration and production company engaged in the drilling and development of offshore oil and gas wells in the Gulf of Mexico.

On April 30, 1987, Century and Apache Corporation executed an "Offshore Operating Agreement" whereby they agreed to mutually explore, develop, produce and operate oil and gas lease OCS-G 5315 covering all of Block 368, West Cameron Area, West Addition, OCS Leasing Map, Louisiana Map No. 1A (hereinafter the "West Cameron block 368 lease"). According to Exhibit A attached to and incorporated in the operating agreement, Century acquired a 91.66667% working interest and Apache retained an 8.33333% working interest in the lease. Thereafter Century apparently assigned a 26.950000% working interest in the lease to K.E. Resources, Ltd. and a 1.833334% working interest in the lease to Nuevo Energy Company. Century retained a 62.883333% working interest in the lease; Apache retained its 8.33333% interest.

Century was designated operator by the operating agreement and continues to serve in that capacity. The operating agreement provides that the operator shall pay all costs incurred in connection with drilling and production of oil and gas wells on the West Cameron block 368 lease and further provides that each non-operator working interest owner shall reimburse the operator for costs in proportion to such non-operator's ownership interest in the lease. Exhibit "C" to the operating agreement sets forth the accounting procedure to be followed. In accordance with the operating agreement and the accounting procedure, Century as operator sells oil and gas produced from the lease and collects proceeds from production on behalf of all joint interest owners. Century pays to Apache and Nuevo their respective share of proceeds and invoices them for their proportionate share of operating costs, which they then remit to Century. Century deducts K.E. Resources' proportionate share of operating costs before paying K.E. Resources its share of the proceeds. At all relevant times each Non-operator satisfied its obligation to reimburse Century for operating costs.

The operating agreement further provides as follows:

8.5 Security Rights. In addition to any other security rights and remedies provided by law with respect to services rendered or materials and equipment furnished under this Agreement, OPERATOR shall have a first lien on each PARTY'S PARTICIPATING and/or WORKING INTEREST, including the production and equipment credited thereto, in order to secure payment of charges against such PARTY, together with interest thereon at the rate set forth in Exhibit "C" or the maximum rate allowed by law, whichever is less, plus attorneys' fees, court costs, and other related collection costs. If any PARTY does not pay such charges when due, OPERATOR shall have the additional right to collect from the purchaser the proceeds from the sale of such PARTY'S share of production until the amount owed has been paid. Each purchaser shall be entitled to rely on OPERATOR'S statement concerning the amount owed. Each NON-OPERATOR shall have comparable security rights on OPERATOR'S PARTICIPATING and/or WORKING INTEREST.

8.6 Unpaid Charges. If any PARTY fails to pay the charges due hereunder . . . within sixty (60) days after payment is due, the PARTICIPATING PARTIES shall, upon OPERATOR'S request, pay the unpaid amount in proportion to their interest. Each PARTY so paying its share of the unpaid amount shall be subrogated to OPERATOR'S security rights to the extent of such payment.

. . . .

8.8 Carved-out Interests. Any overriding royalty, production payment, net proceeds interest, carried interest, or any other interest carved-out of the working interest in the Lease, after the effective date of this agreement, shall be subject to the rights of the PARTIES to this Agreement, and any PARTY whose working interest is so encumbered shall be responsible therefor. If a PARTY does not pay its share of expenses and the proceeds from the sale of production under Section 8.5 are insufficient for that purpose, the security rights provided for therein may be applied against the carved-out interests with which such working interest is burdened. In such event, the rights of the owner of such carved-out interest shall be subordinated to the security rights granted by Section 8.5.

. . . .

19.1 Individual Obligations. The obligations, duties and liabilities of the PARTIES shall be several and not joint or collective; and nothing contained herein shall ever be construed as creating a partnership of any kind, joint venture, association or other character of business entity recognizable in law for any purpose. Each PARTY shall hold all the other PARTIES harmless from liens and encumbrances on the LEASE arising as a result of its acts.

. . . .

26.1 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the PARTIES and their respective heirs, successors, representatives and assigns and shall constitute a convenant [sic] running with the LEASE. Each PARTY shall incorporate in any assignment of an interest in the LEASE a provision that such assignment is subject to this agreement.

Offshore Operating Agreement Between Century Offshore Management Corpooration (Operator) and Apache Corporation (Non-Operator) Dated April 30, 1987.

This agreement was never recorded as it might have been under Louisiana law.

On June 28, 1990, BMO Financial, Inc. and the Bank of Montreal (hereinafter referred to collectively as "the Bank") extended financial accommodations to the debtor pursuant to an Original Credit Agreement. The indebtedness owed by the debtor to the Bank is evidenced by a $45,000,000 revolving note dated June 29, 1990, as subsequently amended. To secure repayment of the indebtedness, the debtor granted to the Bank security interests in the debtor's interest in certain oil and gas properties and improvements thereon and production therefrom. The debtor executed and delivered to the Bank an Act of Collateral Mortgage, Pledge, Assignment and Security Agreement dated June 28, 1990 (hereinafter "Collateral Mortgage"), a Collateral Mortgage Note dated June 28, 1990 in the amount of $150,000,000, a Collateral Pledge, Assignment and Security Agreement dated June 28, 1990, and Uniform Commercial Code Financing Statements. The Bank timely filed the mortgage and financing statements to perfect its liens.

The debtor granted to the Bank, inter alia, a security interest in the debtor's interest in all oil and gas leases described on Exhibit A to the Collateral Mortgage and in all operating agreements which relate to any of the oil and gas leases described on Exhibit A. The West Cameron block 368 lease is identified on Exhibit A as an oil and gas lease to which the Bank's security interest attaches. The debtor warranted that the mortgaged property is free of any and all "liens, encumbrances, security interests, contracts, agreements, preferential purchase rights, unitization agreements or unitization orders or other restrictions or limitations of any nature or kind (collectively called the "Encumbrances") except those Encumbrances which may be specified herein or on attached Exhibit A." Collateral Mortgage at 4, 1. The Collateral Mortgage also provides: "This Mortgage is, and always will be kept, a direct first lien, privilege and security interest upon the Mortgaged Property subject only to the Encumbrances described on Exhibit A. . . ." Collateral Mortgage at 5, 3.

Exhibit A to the Collateral Mortgage provides: "Mortgagor's rights, titles, interests and estates in and to [the West Cameron 368 lease] are subject to the following Encumbrances: . . . Operating Agreement dated April 30, 1987, by and between Apache Corporation and Mortgagor." Exhibit A to Collateral Mortgage, at 2-3.

In August of 1992, Hurricane Andrew caused extensive damage to the debtor's production platforms in the Gulf of Mexico. The storm was followed by a series of events which impaired the value of the debtor's oil and gas reserves and reduced the debtor's cash flow. In early 1993, the debtor found it increasingly difficult to maintain regular monthly payments to the Bank and pay suppliers of goods and services used in connection with its operations. As a result of Century's failure to pay its suppliers, mechanics' and materialmen's liens were filed against various leases, including the West Cameron block 368 lease, proceeds therefrom and improvements thereon (creditors who filed mechanics' and materialmen's liens are referred to hereinafter as the "M & M lien creditors").

On August 24, 1993, Century filed a petition for relief under chapter 11, title 11 United States Code. Century's bankruptcy was precipitated by the recordation and attempted enforcement of M & M liens on the debtor's interest in its oil and gas leases for labor, equipment, materials and services provided to the debtor during March, June and July, 1983.

On December 1, 1993, the Bank initiated this adversary proceeding against numerous M & M lien creditors. The Bank's complaint requested that the court determine the extent, validity and priority of the M & M lien claims vis-a-vis the Bank's security interest in the debtor's interest in oil and gas leases, including the West Cameron block 368 lease. By entry of summary judgments, default judgments, and agreed orders this court has adjudged the Bank's security interest to be superior to M & M liens on the debtor's interest in the West Cameron block 368 lease, improvements thereon, and revenues therefrom.

On or about December 2, 1993, Lasalle Marine Services, Inc., L & L Oil Company, Inc., Reeled Tubing, Inc. and Power Offshore Services, Inc., four of the creditors holding M & M lien claims against the West Cameron block 368 lease, filed a complaint in the United States District Court for the Eastern District of Louisiana, civil action no. 93-3971, sect. N, Mag. 4, against the Non-operators. The complaint alleges that during the period of March 1993 through July 1993, the plaintiff M & M lien creditors furnished to Century, operator of the West Cameron block 368 lease, labor, equipment, materials and services in connection with the drilling, operation, and production of oil and gas on the lease, that the M & M lien creditors were not paid, that the M & M lien creditors timely and properly filed lien affidavits pursuant to the Louisiana Oil Well Lien Act, La. Rev. Stat. 9.4861 et seq., and that the liens attach to the interests of the Non-operators. Judgment was rendered against the Non-operators in favor of the lien claimants.

On or about May 26, 1994, Coastwide Marine Services, Inc., f/k/a Grasso Marine Service Centers, Inc., Grasso Production Management, Inc., and Air Logistics, Inc., also creditors holding M & M lien claims against the West Cameron block 368 lease, filed a similar complaint in the United States District Court for the Eastern District of Louisiana, civil action no. 94-1756, sect. F, Mag. 3, against the Non-operators.

In reaction to the ongoing actions against them in the United States District Court for the Eastern District of Louisiana, the Non-operators, with leave of court, filed intervening complaints in this adversary proceeding and in adversary proceeding no. 94-5045, Century Offshore Management Corporation and Settle Oil and Gas Company v. A.M.C. Marine Services, Inc., et al.. In adversary no. 94-5045 the Non-operators requested this court to enjoin the M & M lien creditors from enforcing the judgment rendered in their favor in civil action no. 93-3971 in the United States District Court for the Eastern District of Louisiana. At the conclusion of the presentation of evidence on the motion for a preliminary injunction, the Non-operators agreed to pay to the M & M lien claimants who are plaintiffs in civil action no. 93-3971 the sum of $30,000 per month, which payments have been made since July 1994. At the time they filed the motion for summary judgment now before the court, the Non-operators were attempting to reach a similar agreement with the lien creditors who are plaintiffs in civil action no. 94-1756 in the United States District Court for the Eastern District of Louisiana.

On November 11, 1994, the court approved a disclosure statement propounded by Settle Oil and Gas Company, an affiliate of Century, for the reorganization of the debtor. A plan of reorganization proposed by Settle Oil and Gas Company (hereinafter "Plan") was accepted by all classes of creditors except class III, the Bank. On February 21, 1995, the court commenced a four-day evidentiary hearing on confirmation of the Plan by cramdown against the Bank under 11 U.S.C. 1129(b). On March 15, 1995, the court entered an order declining to confirm the Plan at that time but continuing the confirmation hearing until June 15, 1995.

The Plan defines West Cameron block 368 creditors as (a) holders of allowed M & M lien claims that attached to the debtor's interest in the West Cameron block 368 lease and (b) the Non-operators. West Cameron 368 creditors are classified as creditors holding Class VI claims.

The Plan provides that the Non-operators will pay the "reorganized debtor" the sum of $30,000 per month in addition to their share of current operating costs. The reorganized debtor is to distribute the $30,000 monthly payments on a pro-rata basis to the West Cameron block 368 M & M lien creditors. The Plan further provides that creditors holding class VI claims will receive a promissory note providing for payment of such claims in full, with interest, in consecutive monthly payments. In consideration of payment of such claims in full by the debtor and the Non-operators, the lien creditors must release all claims they have against the Non-operators. When the West Cameron block 368 lien creditors have been paid in full, the Non-operators will be subrogated to the rights of the lien creditors and will be entitled to receive subsequent payments due to the lien creditors under the promissory notes until the Non-operators are repaid. Settle Oil and Gas Company's Second Amended and Restated Plan of Reorganization Dated November 7, 1994, 3.6.

The Plan was subsequently modified to provide that if in this adversary proceeding the Non-operators are determined to have a claim superior to the Bank's security interest in Century's share of production proceeds from the West Cameron block 368 lease, the Non-operators shall receive 100% of the net revenue generated from the West Cameron block 368 lease until they have been repaid in full. Monthly payments to West Cameron block 368 M & M lien creditors required by the debtor's promissory note will be reduced by the amount required to pay the Non-operators until the Non-operators are paid in full. Thereafter Century will make full payment under the promissory notes and will assume the obligation of the Non-operators to pay $30,000 per month to lien creditors. Third Modification to Settle Oil and Gas Company's Second Amended and Restated Plan of Reorganization.

CONCLUSIONS OF LAW:

The parties agree and the Plan, if confirmed, provides that to the extent they satisfy such claims the Non-operators are subrogated to the rights of creditors holding M & M lien claims on the West Cameron block 368 lease. Thus, although actually or potentially secured by proceeds from production from oil and gas wells on the West Cameron block 368 lease, the claim by way of subrogation of the Non-operators is junior to the secured claim of the Bank.

Nevertheless, relying on a "right of prior claim" rationale applied by the Fifth Circuit Court of Appeals in Grace-Cajun Oil Company No. 3 v. Federal Deposit Insurance Corporation, 882 F.2d 1008 (5th Cir. 1989) (hereinafter "Grace-Cajun"), the Non-operators argue that their claim to the debtor's interest in proceeds from production of oil and gas from the West Cameron block 368 lease primes the Bank's security interest therein. The Non-operators urge this court to adopt the holding of the Fifth Circuit in Grace-Cajun as indicative of Louisiana jurisprudence. A detailed recitation of the facts of the Grace-Cajun case is in order.

In February 1980 Delta Energy Resources, Inc. acquired a mineral lease from Louisiana Farm and Livestock Co. (the LF&L lease). In October 1980 Delta and Grace-Cajun entered into an operating agreement designating Delta as the operator. That operating agreement like the one in this case was not recorded. In March 1981 Delta assigned to Grace-Cajun a 31.36% working interest in the lease. The assignment was recorded. 882 F.2d at 1009.

On May 28, 1981, Delta executed a promissory note in favor of MBank, predecessor in interest to appellee Federal Deposit Insurance Corporation, and thereby refinanced an existing debt then owing to MBank and obtained an extension of a line of credit in the approximate amount of $1.8 million. MBank's Reply Brief at 5, Grace-Cajun Oil Company No. 3 v. MBank (5th Cir.) (No. 88-4481). To secure repayment of the indebtedness, Delta executed a Collateral Mortgage and Assignment of Production, assigning to MBank, inter alia, Delta's interest in oil and gas reserves in the LF&L lease and its share of proceeds from the sale of hydrocarbons produced from the lease. 882 F.2d at 1009. The Collateral Mortgage and Assignment of Production was recorded in the mortgage records of Calcasieu Parish, Louisiana, on June 5, 1981. Id. Delta commenced drilling wells on the LF&L lease in April 1983. Grace-Cajun (and the other non-operator co-lessees) paid their respective shares of drilling and completion costs, but Delta's inability to pay its share of costs resulted in the filing of mechanics' and materialmen's liens totalling more than $1.6 million against the interests of Grace-Cajun (and the other co-lessees) in the LF&L lease. Grace-Cajun's Brief at 9.

On December 23, 1983, Delta filed a petition for relief under chapter 11 of the Bankruptcy Code. In order to avoid foreclosure of the mechanics' and materialmen's liens against their interests in the lease, Grace-Cajun and other non-operators entered into a settlement agreement with the lien creditors, agreeing to pay Delta's share of drilling costs from proceeds of production allocable to their working interests. MBank obtained relief from the automatic stay to foreclose on Delta's interest in the lease and thereafter received Delta's proportionate share of proceeds from the sale of oil and gas produced from the lease. 882 F.2d at 1010.

On July 9, 1986, Grace-Cajun commenced a civil action against MBank, recipient of Delta's share of production proceeds, to recover drilling costs which Grace-Cajun had paid on behalf of Delta.

The United States District Court for the Western District of Louisiana adopted the magistrate's report and recommendation and granted summary judgment in favor of MBank. The court noted the legal distinction between assuming an obligation of another and taking a security interest "subject to" a prior obligation. The fact that MBank's mortgage was "subject to" the operating agreement did not make MBank a party to the operating agreement nor did it cause MBank to assume any of Delta's obligations to Grace-Cajun. MBank merely acknowledged Delta's personal obligations to Grace-Cajun and other non-operators. Grace-Cajun Oil Company No. 3 v. MBank, No. 86-1872-LC, Magistrate's Report and Recommendation at 3-4 (W.D. La. Jan. 27, 1987), and Magistrate's Report and Recommendation (W.D. La. May 26, 1988). The district court further held that MBank's right to receive proceeds from production arose from a validly executed security agreement, whereas Grace-Cajun's claim against production proceeds was based on the operating agreement, which does not create either a security interest or a "real right" under Louisiana law. The district court stated that security devices must be expressly provided for by statute, and that under Louisiana law an operating agreement is not recognized as a security device. The operating agreement only afforded Grace-Cajun an in personam remedy against Delta. Grace-Cajun Oil Company No. 3 v. MBank, No. 86-1872-LC, Magistrate's Report and Recommendation at 4-5 (W.D. La. Jan. 27, 1987), and Magistrate's Report and Recommendation (W.D. La. May 26, 1988).

On appeal, the Fifth Circuit Court of Appeals reversed the judgment of the district court. The Fifth Circuit first held that under Louisiana law a co-lessee is not entitled to share in the proceeds of production from an oil and gas well until the co-lessee pays its share of costs of drilling and completing a well. 882 F.2d at 1010, citing Huckabay v. Texas Co., 78 So.2d 829 (La. 1955); Willis v. International Oil & Gas Corp., 541 So.2d 332 (La. Ct. App. 1989). "Delta had the right to share in the proceeds of production from the LF&L lease, conditioned on its obligation to pay its proportionate part of well costs." 882 F.2d at 1011. The Fifth Circuit then stated: "Delta could transfer no greater right to MBank than it had. . . . MBank took as its security interest only what Delta had - production proceeds encumbered by the obligation to pay well costs." 882 F.2d at 1011-12. The court held: "By paying Delta's share of the well costs, Grace-Cajun acquired a 'right of prior claim' to the proceeds allocable to Delta's interest until those costs were recouped." 882 F.2d at 1012, citing Scurlock v. Getty Oil Company, 344 So.2d 1134 (La. Ct. App. 1977).

The case of Scurlock v. Getty Oil Company, 344 So.2d 1134 (La. Ct. App. 1977), is the genesis of the term "right of prior claim" employed by the Fifth Circuit. Louisiana statutes and jurisprudence provide that whenever a "drilling unit" includes mineral rights for which the operator has no lease, the owner of the mineral rights is entitled to share in the proceeds of production and is obligated to reimburse the operator for the owner's share of drilling costs if the operator complies with the procedure for seeking reimbursement set forth by statute. Waterbury, the owner of a 40% "unleased forced working interest" in a well located within a drilling unit for which Bauman was designated operator, sought to compel Scurlock, the purchaser of oil and gas produced from the well, to pay to Waterbury his share of proceeds from production. The amount Scurlock had theretofore remitted to Bauman was less than Waterbury's share of drilling costs. The trial court held, without explanation, that Scurlock had properly paid to Bauman proceeds allocable to Waterbury's interest in the well. The Louisiana Court of Appeals found three alternative grounds for affirming the trial court, one of which the court identified as the "right of prior claim." 344 So.2d at 1137. The court succinctly stated: "[T]he party drilling the well, here Bauman, had the right . . . to retain or receive the well proceeds until his well costs were paid and Waterbury therefore had no prior right to the proceeds." 344 So.2d at 1137. The case did not involve a controversy between the lessor and a creditor holding a security interest in Bauman's interest in the lease.

The decisions in Huckabay v. Texas Co., 78 So.2d 829 (La. 1955), and Willis v. International Oil & Gas Corp., 541 So.2d 332 (La. Ct. App. 1989), were based on the equitable principle of unjust enrichment, that "no one ought to be enriched at the expense of another." Huckabay, 78 So.2d at 831. The courts in Huckabay and Willis considered the respective rights of co-owners or co-lessees of mineral interests and concluded that where one co-owner or co-lessee drills and develops an oil and gas well without the concurrence or assistance of the other co-owner or co-lessee, equity demands both co-owners or co-lessees share expenses of drilling and operating the well before profiting from production. Huckabay, 78 So.2d at 831; Willis, 541 So.2d at 336. In 1979, after decisions were rendered in Huckabay and Scurlock, the right to reimbursement enunciated in those cases was codified in article 488 of the Louisiana Civil Code, which provides:

Art. 488. Products; reimbursement of expenses.

Products derived from a thing as a result of diminution of its substance belong to the owner of that thing. When they are reclaimed by the owner, a possessor in good faith has the right to reimbursement of his expenses. A possessor in bad faith does not have this right.

La. Civ. Code art. 488 (effective January 1, 1980). The Revision Comments accompanying the amendment, revision, and reenactment of Title II of Book II of the Louisiana Civil Code, articles 477 to 532, provide in pertinent part:

(a) This provision is new. It is based on Louisiana jurisprudence. It changes the law as indicated in Comment (d) [relative to determining good faith].

(b) According to Louisiana jurisprudence, persons engaging in timber or mineral operations in good faith are bound to account to the owner of the land but they are entitled to reimbursement of their production costs. . . . As to mineral operations, see Huckabay v. Texas Co., 227 La. 191, 78 So.2d 829 (1955); Allies Oil Co. v. Ayers, 152 La. 19, 92 So. 720 (1922); Cooke v. Gulf Refining Co., 135 La. 609, 65 So. 758 (1914). Recovery of expenses in these circumstances is said to rest on the principle of unjust enrichment. See Scott v. Hunt Oil Co., 152 So.2d 599 (La.App. 2d Cir. 1963).

Revision Comments, La. Civ.Code art. 488 (effective January 1, 1980) (emphasis added).

The "right of prior claim" recognized by the Fifth Circuit in Grace-Cajun is akin to an equitable lien, based on the principle of unjust enrichment, in favor of Grace-Cajun on proceeds allocable to Delta's interest in the lease. Concerned that MBank was unjustly enriched to the detriment of Grace-Cajun, the Fifth Circuit elevated Grace-Cajun's equitable lien above MBank's perfected security interest in proceeds of production from the lease and required MBank to reimburse Grace-Cajun for drilling costs allocable to Delta's interest in the lease.

The fallacy of the opinion in Grace-Cajun lies in the failure of the Fifth Circuit to distinguish between cases in which the relationship of the parties is governed necessarily by equitable principles of unjust enrichment and cases in which the relationship of the parties is governed instead by contract and appurtenant principles of commercial law. This distinction was cogently explained by the Fifth Circuit in SMP Sales Management, Inc. v. Fleet Credit Corp., 960 F.2d 557 (5th Cir. 1992):

"Not every unjust enrichment warrants usage of equity. Courts may resort to equity only in cases of unjust enrichment for which there is no justification in law or contract. In other words, an enrichment is justified if it is the result of, or finds its explanation in, the term of a valid juridical act between the impoverishee and the enrichee or between a third party and the enrichee."

 

Carter v. Flanagan, 455 So.2d 689, 692 (La.App. 2d Cir. 1984)(citing Edmonston v. A-Second Mortgage Co., 289 So.2d 116 (La. 1974). In the instant case, there is a justification in law. There was a contractual relationship between Fleet [the secured creditor] and Wonderline [the debtor] and, as a secured creditor of Wonderline, Fleet would be entitled to be paid first. Allowing unsecured creditors to recover on a theory of unjust enrichment would render the secured creditor status useless. The secured creditor is entitled to be paid first.

960 F.2d at 560 (emphasis added). The existence of a contract, i.e., the operating agreement, between Delta and Grace-Cajun in the Grace-Cajun case and between Century and the Non-operators in the case at hand, triggers other applicable statutory and codal provisions of Louisiana law which should have guided the Fifth Circuit in Grace-Cajun to a contrary conclusion and which compel this court to reject the Grace-Cajun case as precedent in resolving the factually similar situation here presented.

Application of Louisiana law is required in this case. The Supreme Court of Louisiana has not had occasion to determine the priority of claims to production proceeds as between a creditor of the debtor who holds a perfected security interest in production proceeds and co-lessees of or joint working interest owners with the debtor who assert a superior equitable or contractual right to be reimbursed from those proceeds for drilling and operation costs expended on behalf of the debtor. It is incumbent upon this court to construe Louisiana codal and statutory law as the Supreme Court of Louisiana would.

Section 18 of title 31 of the Louisiana Revised Statutes, the Mineral Code, provides: "A mineral right is an incorporeal immovable. . . . All sales, contracts, and judgments affecting mineral rights are subject to the laws of registry." La. Rev. Stat. 31:18 (emphasis added).

Section 9:2756 of the Louisiana Revised Statutes, which was redesignated from Louisiana Civil Code article 2266 effective January 1, 1985, provides:

All sales, contracts and judgments affecting immovable property, which shall not be so recorded, shall be utterly null and void, except between the parties thereto. The recording may be made at any time, but shall only affect third persons from the time of the recording. . . .

La. Rev. Stat. 9:2756 (emphasis added).

Section 9:2721 of Louisiana Revised Statutes provides as follows:

A. No sale, contract, counter letter, lien, mortgage, judgment, surface lease, oil, gas or mineral lease, or other instrument of writing relating to or affecting immovable property shall be binding on or affect third persons or third parties unless and until filed for registry in the office of the parish recorder of the parish where the land or immovable is situated. Neither secret claims or equities nor other matters outside the public records shall be binding on or affect such third parties.

La. Rev. Stat. 9:2721 (emphasis added).

The operating agreement between Century and Apache is a contract relating to or affecting immovable property. The Non-operators assert that the operating agreement confers on them a lien on Century's working interest in oil and gas production from the West Cameron block 368 lease. In order for the lien to be effective against third parties in accordance with Louisiana law it must be filed for registry. Thus the lien of the Non-operators is not effective against the Bank because it was not recorded.

The Bank's knowledge of the operating agreement at the time its security interest became effective does not alter this result. An unrecorded act will have no effect on a third person, even if the third person has actual knowledge of the unrecorded act. Judice-Henry-May Agency, Inc. v. Franklin, 376 So.2d 991 (La. Ct. App. 1979) (unrecorded lease of office space is not binding on purchasers of building).

The Non-operators argue the Bank is bound by the unrecorded security interest provided to them by the operating agreement because the Bank specifically took its mortgage and security interest "subject to" the operating agreement. They rely on dicta contained in a footnote to the opinion in Grace-Cajun in which the Fifth Circuit Court of Appeals stated:

Ordinarily, third parties are not bound by an unrecorded agreement, but that rule is not absolute; it admits of an exception. The unrecorded instrument may bind if the third party knows of it and knows that his transferor intends that he be bound by it. Chevron U.S.A. v. Martin Exploration Co., 447 So.2d 469 (La. 1984); Stanley v. Orkin, 360 So.2d 225 (La. App. 1978). The evidence shows that MBank was aware of the operating agreement; in fact, it expressly took its security interest subject to its terms.

882 F.2d at 1012 n.3.

The cases cited by the Fifth Circuit suggest that the Louisiana Supreme Court would not apply such an exception to the case at hand, despite dicta of the Fifth Circuit to the contrary. In both Stanley v. Orkin, 360 So.2d 225 (La. App. 1978), and Chevron U.S.A. v. Martin Exploration Co., 447 So.2d 469 (La. 1984), the "third party" was a universal successor in interest who clearly was expected to assume the obligations of or be bound by the contract. The same cannot be said of a lender who extends credit to a borrower and takes a mortgage and security interest "subject to" specific agreements previously executed by the borrower. What the Non-operators are suggesting is that by taking its security interest "subject to" the operating agreement, the Bank essentially agreed to subordinate its security interest to the claim of the Non-operators, a claim that did not even arise until approximately three years after the Bank perfected its security interest.

The result reached herein is harmonious with the priority scheme among creditors envisioned by the Louisiana Legislature. Relevant articles of the Louisiana Civil Code provide as follows. "The property of the debtor is the common pledge of his creditors, and the proceeds of its sale must be distributed among them ratably, unless there exist among the creditors some lawful causes of preference." La. Civ. Code art. 3183. "Lawful causes of preference are privilege and mortgages." La. Civ. Code art. 3184. "Privilege is a right, which the nature of a debt gives to a creditor, and which entitles him to be preferred before other creditors, even those who have mortgages." La. Civ. Code art. 3186. "Mortgage is a nonpossessory right created over property to secure performance of an obligation." La. Civ. Code art. 3278. "A mortgage has the following effects: . . . (3) The mortgagee is preferred to the unsecured creditors of the mortgagor and to others whose rights become effective after the mortgage becomes effective as to them." La. Civ. Code art. 3307.

The putative lien of the Non-operators is a nonpossessory right to oil and gas production and proceeds therefrom to secure Century's performance of its obligations under the operating agreement. As described supra, mortgages and liens relating to mineral rights must be recorded to be effective against third parties. Thus the Non-operators' "mortgage" as that term is defined by Louisiana law fails to be effective against the Bank.

Although certain privileges may take priority over mortgages, there is no privilege provided by Louisiana law which inures to the benefit of the Non-operators.

Louisiana law provides to suppliers of goods and services used in connection with the drilling and operation of oil and gas wells a privilege, also commonly referred to as a mechanic's or materialman's lien, on all oil and gas produced from the well and proceeds thereof. La. Rev. Stat. 9:4861. The party claiming a privilege must file a notice of the privilege.

When so recorded, the privileges are superior to all other privileges, mortgages, or other security interests against the property, except taxes or a bona fide vendor's privilege, or privileges or mortgages filed or recorded, or security interests under Chapter 9 of the Louisiana Commercial Laws as to which financing statements were filed prior to the date on which the first labor . . . or supplies covered by the privilege herein granted is furnished.

La. Rev. Stat. 9:4862. Louisiana law does not provide a privilege in favor of joint working interest owners such as the Non-operators who pay drilling costs allocable to the interests of other joint working interest owners. There is nothing in the Louisiana Civil Code, statutes, or jurisprudence to suggest the Louisiana Legislature or the Louisiana Supreme Court intended to place the claim of a party who satisfies an M & M lien claim in a better position than the M & M lien claim itself vis-a-vis a mortgagee.

The Non-operators also assert they are entitled to recoupment of production costs and expenses from Century's share of production proceeds. The doctrine of recoupment might authorize Century as operator to recoup unpaid production costs from production proceeds it would otherwise distribute to the Non-operators if the Non-operators were in default of their obligations to Century under the operating agreement, but the doctrine has no application here.

The motion of the Non-operators for summary judgment shall be overruled.

Dated:

 

By the court -

 

 

 

Chief Judge

 

Copies to:

Counsel of Record