A bankruptcy proceeding involving an upstream company may result in a ruling that challenges acreage dedications for midstream operators.

Judge Shelley Chapman of the Southern District of New York said that she was “inclined” to permit the rejection of gathering and processing agreements between Houston-based Sabine Oil & Gas Corp. and two counterparties. The decision could save the independent E&P, which filed for bankruptcy protection last July, a significant amount in ongoing payments.

“Many midstream companies have long taken comfort in acreage dedications in midstream contracts being characterized as ‘covenants running with the land,’” Akin Gump Strauss Hauer & Feld LLP stated in a recent report. “This has historically served as a protection against asset sales being made without the new owners being subject to the contracts.”

With ongoing weakness in commodity prices squeezing the finances of many in the upstream, the meaning of the dedications is now being tested in bankruptcy court, Akin Gump wrote. In the firm’s opinion, such a rejection would be supportable under Texas law.

Immediate cost savings aside, asking for a ruling like this would not necessarily benefit an E&P in terms of dealings with midstream partners.

“Given the unique nature of many of these gathering and processing systems, it is likely the counterparties will still want to work together due to the critical need for cash flow on both sides,” Akin Gump wrote. “Contract renegotiations will turn on the leverage of the parties involved, particularly whether the E&P company can survive a shut-in (harming cash flow and potentially putting its oil and gas leases at risk) or has another way to move or process its hydrocarbons.”

To protect themselves, midstream companies and financing partners may need to pursue security requirements or contract structuring to limit future risk, Akin Gump said.

With oil prices likely to remain low, the law firm said it expects ongoing questions to emerge in oil and gas bankruptcy proceedings, with each case turning on specific background facts, contract language, applicable state law and how a particular court interprets applicable precedent.

Joseph Markman can be reached at jmarkman@hartenergy.com.