06 May Interest Owner and Producer’s Rights Under Texas’ First Purchaser Statute

by Robert Mongole with contributing editor Joshua Cochran

We are in the midst of historically low oil prices in Texas. In late April, the West Texas Intermediate collapsed and ultimately dipped into negative territory for the first time ever. These historically low prices increase the risks of bankruptcy of producers and purchasers. In response to low oil prices in the past, Texas passed what is commonly referred to as the First Purchaser Statute. The First Purchaser Statute was codified in Section 9.343 of the Texas Business and Commerce Code (the Texas version of the Uniform Commercial Code or UCC) and is a non-uniform provision. In other words, the First Purchaser Statute is not included in the standard UCC and is unique to Texas. Generally speaking, the UCC governs the rights of parties involved in commercial transactions. Article 9 of the UCC governs security interest granted in “goods” and proceeds from the sale of goods, including oil and gas, once produced.

Who is the First Purchaser?

Depending on how a transaction is structured, the producer could be the first purchaser and as such is obliged to pay the purchase price to the interest owner. A party who signs an agreement to purchase oil or gas production, issues a division order, or makes any other voluntary communication to the interest owner or any governmental agency recognizing the interest owner’s right can be considered a first purchaser under the First Purchaser Statute.

First Purchaser Statute and Royalty Owners

The First Purchaser Statute creates a security interest in favor of a royalty owner in oil and gas produced from a property to secure the purchaser’s obligation to pay for that oil and gas. Royalties are typically paid by the producer; however, the purchaser sometimes pays royalties.

First Purchaser Statute and Producers

The First Purchaser Statute also creates a security interest in favor of a producer in the event a purchaser fails in their obligation to pay for produced oil and gas.

First Purchaser Statute and Non-Operated Working Interests and Overriding Royalties

The First Purchaser Statute can also protect non-operated working interests against a producer for non-payment of the proceeds of production. Under these circumstances, the Joint Operating Agreement (JOA) evidences an agreement between a producer and non-operator. Standard form JOAs also contain their own lien provisions. The JOA should be recorded in the county where the property is located in order to enforce provisions of the First Purchaser Statute or the lien provisions of the JOA against a producer.

Perfecting Security Interests Created Under the First Purchaser Statute

Article 9 of the UCC requires that the holder of a security interest must perfect their security interest by filing a financing statement in the deed records of the county where the security interest is located. By perfecting their interest, a producer or interest owner has priority over other creditors who claim security interests in the same oil and gas. However, in Texas, Section 9.343 relaxes these standards. The First Purchaser Statute does not require a producer or interest owner to file a financing statement in order to perfect their security interest. Under Section 9.343, a producer or interest owner is granted a purchase-money security interest (PMSI). A purchase-money security interest creates a priority over other claimants to any oil and gas produced and ultimately sold by the purchaser. In other words, the First Purchaser Statute grants an automatically perfected security interest in severed oil and gas “identifiable proceeds” owned by, received by, or due to the first purchaser.

Bankruptcy Considerations and Out of State Purchasers

In bankruptcy, the First Purchaser Statute typically means the producers and interest owners are first in line for getting paid their claims if their purchaser goes bankrupt. While the First Purchaser Statute does not require the filing of a financing statement in order to perfect a security interest, the First Purchaser Statute is unique to Texas. When a purchaser is organized under the laws of a different state or their principal bank accounts are located in a different state, the potential exists for that state’s law to apply. Under the commercial codes of Delaware, Texas, and Oklahoma, in order determine whether a security interest in collateral is properly perfected, the court must apply the law of the state where the debtor was organized. For example, if the state laws of Delaware were applied, the Texas producer or interest owner would have to perfect their security interest by filing a financing statement in Delaware. In the event a Texas producer or interest owner does not perfect their security interest under the laws of another state, the potential exists that their liens are held subordinate to a bank’s security interest.

In the event Texas law applied throughout, a Texas producer or interest owner would have the priority over banks as long as the instrument (such as an oil and gas lease, deed, or joint operating agreement.) which created the interest in the land from which oil and gas was produced was filed before the bank’s financing statements covering the same

Similar Provisions in Other States

New Mexico: Oil and Gas Products Lien Act [NM Stat §§ 48-9-1 – 48-9-8 (2019)] provides an interest owner with a purchase money security interest and a lien upon his interest in or share of the unpaid for product severed from a production unit in which he owns an interest or the proceeds of product if such unpaid for product has been sold by the first purchaser. This security interest and lien covers the purchase price, state royalty and taxes. An interest owner may perfect the purchase money security interest and lien by filing for record in the office of the county clerk of the county in which the production unit is located a Notice of Lien. NM Stat § 48-9-5 (2019) provides the recommended form for the Notice of Lien. The Notice of Lien must be filed after 15 days and within 45 days from the time payment is due by terms of agreement. If the Notice of Lien is not filed for record within the time limit, the purchase money security interest and lien shall terminate at the expiration of that time limit. Upon perfection by filing, the purchase money security interest and lien of the interest owner will take priority over any subsequent claims.

The Oil and Gas Products Lien Act is not part of the version of the Uniform Commercial Code adopted by New Mexico [NMSA 1978, Chapter 55], and does not affect the rights available under the provisions of the UCC. The Oil and Gas Products Lien Act is cumulative to any rights provided by law to a creditor against a debtor. Also, of note, the Oil and Gas Products Lien Act does not alter or restrict remedies available to the State of New Mexico, including the cancellation of state oil and gas leases for nonpayment of state royalty.

North Dakota: Oil and Gas Owner’s Sales Liens (N.D.C.C. §§ 35-37-01 – 35-37-06) provides an interest owner with a continuing security interest and lien on oil or gas severed, or the proceeds from sale to the extent of the interest owner’s interest until the purchase price has been paid to the interest owner. A security interest or lien under this statute is not effective against an interest owner, operator, first purchaser or purchaser until a copy of the notice of lien has been delivered by registered mail. An interest owner may perfect the security interest and lien by filing electronically a UCC-1A in the central indexing system and recording the lien in the county records of the county in which the well is located. If the lien is not filed within 90 days from the date of production, the security interest is not perfected, and will not provide priority over a perfected security interest in the same proceeds. Upon perfection by filing, the security interest and lien take priority over any subsequent claims, including claims which arise between the time the security interest attaches and the time of filing. The security interest created pursuant to this statute does not have priority over rights previously created and perfected or an operating agreement or other voluntary agreement for the development and operation of the property. The security interest expires one year after the date of filing of the notice unless action to enforce is commenced in the district court of the county in which the well is located, or wherever the oil or gas unpaid for or the proceeds of oil or gas sold may be found.

N.D.C.C. Chapter 35-37 is separate from the version of the Uniform Commercial Code adopted by North Dakota (N.D.C.C. Chapter 41) and does not impair the remedies available under the Uniform Commercial Code. N.D.C.C. Chapter 35-37 is cumulative to any rights provided by law to a creditor against a debtor.

Oklahoma: Oil and Gas Owners’ Lien Act of 2010 (Okla. Stat. Ann. tit. 52, §§ 549.1–549.12) is nearly identical to Texas’s First Purchaser Statute, however it is not found in Oklahoma’s UCC provisions and therefore will additionally apply to out of state purchasers and bank accounts located in other states. Oklahoma amended their prior Lien Act in 2010 in response to previous bankruptcy court decisions which forced the application of the laws of another state when the first purchaser is organized, or their principal bank account is located in another state. Like Texas, Oklahoma’s Oil and Gas Owners’ Lien Act of 2010 is automatically perfected and applies to oil and gas and their proceeds. The lien remains attached until the last day of the calendar month one year after indebtedness.

Key Takeaways for Producers and Interest Owners

1. Record your oil and gas lease or other instrument which evidences your interest in produced oil and gas.
2. Investigate the laws of the state in which a purchaser is organized as well as the location of a purchaser’s principal bank accounts. The First Purchaser Statute may not protect a producer or interest owner if the purchaser is organized in another state, or if the purchaser’s principal bank account is located in another state.
3. Check your lease. An argument can potentially be made that a royalty owner’s share of proceeds are not part of the bankruptcy estate, but rather held in trust for the benefit of the royalty owner.
4. Protect yourself by filing a lien and security interest in the oil and gas produced and sold. In Texas, your lien is perfected once the lease, or memorandum of lease is recorded in the deed records of the county where the interest is located. However, if a producer or purchaser is organized in another state or their principal bank account is located in another state, a financing statement should also be filed in that state(s).