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Bankruptcy Court Holds that Overriding Oil and Gas Royalty Interest is not an Executory Contract Subject to Rejection Pursuant to 11 U.S.C. § 365

On July 20, 2012, Judge Christopher S. Sontchi of the United States Bankruptcy Court for the District Court of Delaware granted a motion to dismiss the Debtors’ complaint (the “Complaint”). The Complaint had sought a declaration that an oil and gas royalty interest (the “Instrument”) granted to the defendant, MTGLQ Investors, L.P., (“MTGLQ”), was an executory contract that was properly rejected pursuant to Debtors’ confirmed plan of reorganization. The Court held that the Complaint failed to state a claim because the Instrument was an unambiguous, single integrated agreement that the defendant had substantially performed, not an executory contract subject to rejection. The Court also dismissed the Debtors’ five related claims that were premised on the executory nature of the Instrument, including recovery of post-petition transfers made pursuant to the Instrument. The Court denied MTGLQ’s motion to dismiss for lack of subject matter jurisdiction.

The Instrument, executed prior to the Debtors’ bankruptcy, conveyed to MTGLQ an overriding royalty interest in oil and gas produced from certain real property. The Court noted because the Instrument was an interest in real property under Texas law, MTGLQ properly and timely recorded its interest in real property with the appropriate state authorities. The Debtors listed the Instrument on a plan supplement as an executory contract that was subject to rejection and which was then later deemed rejected pursuant to the confirmation order. MTGLQ disagreed and argued that the Instrument was a fully vested conveyance of an interest in real property that could not be rejected.

The Court analyzed whether the Instrument was (i) clear, definite and unambiguous, (ii) a severable or single integrated agreement, and (iii) subject to rejection as executory because the parties owed each other continuing, material obligations. After determining that the Instrument was unambiguous and a single integrated agreement (under applicable Texas law), the Court held that MTGLQ had substantially performed under the Instrument, thereby conveying sufficient consideration to the Debtors in exchange for the right to receive royalty payments and other related benefits under the Instrument. Under Third Circuit law, where a party has substantially performed under applicable law, the contract is not executory and cannot be rejected.

A copy of the Court’s opinion can be found here.

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