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IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE
--------------------------------------------------------------- In re MILAGRO HOLDINGS, LLC, et al., Debtors.1 ---------------------------------------------------------------
x : : : : : : : x
Chapter 11 Case No. 15-11520 (____) Joint Administration Requested
DEBTORS’ MOTION FOR ENTRY OF INTERIM AND FINAL ORDERS
(I) AUTHORIZING DEBTORS TO PAY OR HONOR PREPETITION AND POST-PETITION (A) OBLIGATIONS TO HOLDERS OF ROYALTY INTERESTS AND
WORKING INTERESTS AND (B) LEASE OPERATING EXPENSES; AND (II) GRANTING RELATED RELIEF
The debtors and debtors-in-possession in the above-captioned cases (collectively, the
“Debtors”) hereby move (the “Motion”) for entry of interim and final orders, pursuant to sections
105(a) and 363(b) title 11 of the United States Code, 11 U.S.C. §§ 101-1532 (the “Bankruptcy
Code”) and Rules 6003(b) and 6004(h) of the Federal Rules of Bankruptcy Procedure (the
“Bankruptcy Rules”), authorizing, but not directing, the Debtors to pay or honor, in the Debtors’
sole discretion, (i) pre-petition and post-petition obligations to the holders of royalty interests and
working interests and (ii) obligations incurred in connection with the operation of the oil and gas
leases and wells in which the Debtors have an ownership interest. In support of this Motion, the
Debtors submit the Declaration of Scott W. Winn in Support of Chapter 11 Petitions and First
Day Relief (the “First Day Declaration”), filed contemporaneously herewith, and respectfully state
as follows:
1 The Debtors in these cases, along with the last four digits of each Debtor’s federal tax identification number,
are: Milagro Holdings, LLC (7232); Milagro Oil & Gas, Inc. (7173); Milagro Exploration, LLC (9260); Milagro Producing, LLC (9330); Milagro Mid-Continent, LLC (8804); and Milagro Resources, LLC (6134). The Debtors’ mailing address is 1301 McKinney Street, Suite 500, Houston, Texas 77010.
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Jurisdiction
1. The Court has jurisdiction over the Motion pursuant to 28 U.S.C. §§ 157 and
1334(b) and the Amended Standing Order of Reference from the United States District Court for
the District of Delaware dated as of February 29, 2012. This is a core proceeding within the
meaning of 28 U.S.C. § 157(b)(2). Venue of these proceedings and the Motion in this Court is
proper under 28 U.S.C. § 1408 and § 1409.
2. The statutory and legal predicates for the relief requested herein are sections
105(a) and 363(b) of the Bankruptcy Code and Bankruptcy Rules 6003(b) and 6004(h).
Background
3. On July 15, 2015 (the “Petition Date”), the Debtors commenced their bankruptcy
cases by filing voluntary petitions for relief under chapter 11 of the Bankruptcy Code (the
“Chapter 11 Cases”). No trustee, examiner or creditors’ committee has been appointed in the
Chapter 11 Cases. The Debtors are operating their respective businesses as debtors-in-
possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code.
4. The events leading up to the Petition Date and the facts and circumstances
supporting the relief requested herein are set forth in the First Day Declaration.
5. Prior to the Petition Date, the Debtors entered into a Restructuring Support
Agreement with their first-lien secured lenders, certain holders of their second-lien secured
notes, certain of their equity holders, and White Oak Resources VI, LLC (“White Oak”),
pursuant to which the Debtors would seek to consummate a restructuring transaction under a
chapter 11 plan. The proposed transaction would consist of the contribution of certain of the
Debtors’ assets and the transfer of certain of the Debtors’ liabilities to White Oak in exchange
for cash consideration and equity interests in White Oak pursuant to the terms of that certain
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Contribution Agreement by and among the Debtors and White Oak dated as of July 15, 2015
(the “Contribution Agreement Transaction”).
Royalties, Overriding Royalties, Lease Operating Expenses and Joint Interest Billings
6. The Debtors are independent energy companies based in Houston, Texas engaged
in the acquisition, development, exploration, and production of oil and natural gas. The Debtors’
historic geographic focus has been along the onshore Gulf Coast area, primarily in Texas,
Louisiana, and Mississippi. The Debtors operate a significant portfolio of oil and natural gas
producing properties and mineral interests in this region and have expanded their footprint
through the acquisition and development of additional producing or prospective properties in
North Texas and Western Oklahoma. In addition, the Debtors own certain non-operated
working interests in leases located on the Outer Continental Shelf in the Gulf of Mexico. The
Debtors own an interest in approximately 4,690 oil and gas leases, substantially all of which are
subject to or burdened by royalty interests, overriding royalty interests, third party working and
non-working interests, or a sub-set or combination thereof.
7. Joint operating agreements (“JOAs”) are commonly used in the oil and gas
industry and are comprised of an operating party (called the operator) and one or more non-
operating parties, who pool their interest in oil and gas leases and wells in a particular
geographic area for the purpose of sharing the costs and proceeds of development, operation and
production in the covered area. As a general matter the operator is responsible for assuring that
the wells covered by the JOA operate and produce, and the operator often markets and sells the
hydrocarbons produced for certain non-operating working interest owners and lessees (or
distributes such hydrocarbons to the non-operating owners and lessees or their designees). The
operator is responsible for paying or causing to be paid the applicable taxes and other amounts
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owing with respect to operation of the leases and wells. The costs of operating the wells and
leases are shared among the participants in the JOA according to its terms and may either be paid
on a cash basis or through deductions from the proceeds distributable to the non-operating
lessees and owners. The Debtors are parties to numerous JOAs governing operations on their oil
and gas or wellbore leases, and one of the Debtors, Milagro Exploration, LLC, serves as the
operator for the majority of the oil and gas leases and wells in which the Debtors hold an
interest.
A. Royalties and Overriding Royalties
8. The Debtors are obligated, pursuant to their oil and gas leases, to remit to the
lessors who own the mineral rights leased by the Debtors (the “Royalty Interest Owners”) their
share of production from the producing wells located on their respective leases or leases and
lands pooled or unitized therewith, free of expenses of production (the “Royalties”). Further,
certain assignments of the oil and gas leases created an interest in a share of the production from
the producing wells located on the respective leases or leases and lands pooled or unitized
therewith, free of expenses of production, that burden the Debtors’ working interest in the leases
(the “ORRI”). The Debtors are also obligated to remit to the owners of the ORRI (the “ORRI
Owners”) the share of the proceeds attributable to the ORRI. In addition to the Royalties and
ORRIs, certain third parties own working interests in the leases and wells operated by the
Debtors under the JOAs (the “Working Interest Owners” and collectively with the ORRIs and
Royalty Interest Owners, the “Interest Owners”). As a result, the Debtors are responsible for the
timely, proper and efficient operation of the leases and wells for the benefit of the Debtors and
the other Interest Owners.
9. As part of discharging their obligations to act as a reasonable, prudent operator,
the Debtors market and sell the hydrocarbons produced from the operated leases and wells and
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pay the Interest Owners their share of the production revenue.2 Such payments are generally
paid two months in arrears on or about the twenty-fifth day of the month. Amounts owed are
calculated as provided for in the underlying lease or ORRI instrument, but typically based on the
production revenue received by the Debtors from first purchasers, calculated at the wellhead less
applicable severance taxes and, in some instances, certain post-production charges. As of the
Petition Date, the Debtors estimate that they owe approximately $2.5 million to Interest Owners
in pay status, which amount does not take into account any funds disbursed directly by
purchasers. The Debtors have approximately 6,000 Interest Owners. As of the Petition Date, the
Debtors are unable to determine the precise amounts owed on account of Interest Owners for the
months of May, June, and the pre-petition portion of July. Such amounts remain accrued but
unpaid liabilities of the Debtors.3
10. Non-payment of the amounts owed to the Interest Owners could jeopardize the oil
and gas leases. Royalty Interest Owners are paid in arrears and must be paid promptly. Said
Interest Owners may be able to make claims that their share of production revenue are not
property of the estate or may be able to argue that lease maintenance may be called into
question, leading to a lease termination claim. To the extent that the Debtors and any Interest
Owners dispute the amounts owed, the Debtors will segregate the funds they believe are owed
pending an agreement or, if necessary, further orders of the Court resolving the dispute.
Accordingly, the Debtors believe that the payment of the amounts owed to Interest Owners is in
the best interests of the Debtors and their estates.
2 Some Working Interest Owners, however, take their production in kind and market their allocable production
directly. 3 As of the Petition Date, the Debtors have accrued approximately $4.7 million in “suspense funds” on account of
Interest Owners, which have not yet been remitted to Interest Owners. By this Motion, the Debtors are not requesting authority to make payments on account of any suspense funds.
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B. Expenditures Related to Operated Properties
11. In its capacity as operator under various JOAs, Milagro Exploration, LLC, incurs
numerous current lease operating expenses and other exploration and production costs from
various third parties, including vendors, contractors, subcontractors and suppliers, who provide
services, supplies and materials necessary to ensure that operations continue in a timely manner,
as well as certain capital expenditures (collectively, the “LOEs”). The Debtors are reimbursed
for LOEs incurred in operating these leases and wells from the Working Interest Owners through
the payment of joint interest billings or by netting the Working Interest Owners’ share of
production revenue against their share of the LOEs. As discussed below, many of the vendors
whose goods and services give rise to the LOEs are entitled to assert statutory liens if they are
not paid the LOEs, and the JOAs typically require that, among other things, the operator will
keep the oil and gas interests that are subject to the JOA free and clear of liens and
encumbrances.
12. The Debtors generally pay the LOEs on a timely basis in accordance with
contractual or customary trade terms with their vendors, which range from 15 to 45 days, and the
Debtors have remained current on payment of these obligations. On a monthly basis, the
Debtors incur LOEs of approximately $3,200,000 million for oil and gas leases and wells
operated by the Debtors. Many of the invoices for the LOEs will cover both pre-petition and
post-petition expenses. Therefore, the Debtors request authority to continue to satisfy these LOE
obligations as they arise in the ordinary course of business.
C. Expenditures Related to Non-Operated Properties
13. The Debtors also own working interests in certain leases and wells operated by
third-parties under various JOAs. The Debtors receive their share of revenue from the operators
of these wells, taking an insignificant amount of such payments in-kind and then reimbursing the
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applicable operators for their share of the production costs through the payment of joint-interest
billings (“JIBs,” and together with the Royalties, the ORRI, the LOEs, and the obligations under
the JOAs, the “Obligations”). In an average month, the Debtors pay or are otherwise responsible
for approximately $1,220,000 in JIBs; however, approximately nine percent (9%) of JIBs are
deducted from the Debtors’ share of production revenue before payment of the revenue from the
operators, pursuant to contractual terms or industry standard practices.
14. In the instances where the Debtors own a non-operating working interest in
certain oil and gas leases or wells, the JOAs often grant the operator a contractual lien upon the
Debtors’ interest in a well and the underlying lease for unpaid JIBs that may include (a) all
equipment installed on the lease; (b) all hydrocarbons or other minerals severed and extracted
from or attributable to the lease; (c) all accounts and proceeds of sale, contract rights, and
general intangibles arising in connection with the sale; (d) fixtures; and (e) any and all
accessions, additions and attachments thereto and the proceeds and products therefrom. Such
lien is perfected by filing a memorandum of operating agreement or other instrument in the
county, parish or recording district(s) in which the leases or wells are located. The lien
sometimes purports to secure the payment of all charges, fees, court costs, and other directly
related collection costs. If the Debtors do not pay charges when due, the operator may also
attempt to assert additional rights to collect from the purchaser of the Debtors’ hydrocarbon
production until the amount owed has been paid. The failure to timely pay JIBs may provide
grounds for the operator to assert contractual or statutory lien rights against the Debtors’ interest
in a well and the underlying oil and gas lease and, under the provisions of certain JOAs possibly
lead to defaults. Such operating rights are a significant value driver for the Debtors’ assets.
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Therefore, the Debtors request authority to continue to satisfy these JIBs as they arise in the
ordinary course of business.
15. If the Debtors fail to satisfy the Obligations as they come due, the Debtors’
operations will be severely impacted and production may completely cease for certain wells.
Such occurrences would directly, immediately and negatively impact the Debtors’ creditors and
other parties in interest. Accordingly, the Debtors believe that satisfaction of the Obligations as
they become due is in the best interests of the Debtors and their estates.
16. Maintaining the Debtors’ rights under the oil and gas leases is of paramount
importance. The revenues derived from the lands leased by the Debtors represent the majority of
the Debtors’ operating income and are at the core of the Debtors’ businesses.
Relief Requested
17. The Debtors request, pursuant to Bankruptcy Code sections 105(a) and 363(b)
and Bankruptcy Rules 6003 and 6004, authority, but not direction, (i) to deliver, in the ordinary
course of business, the funds owed to the Interest Owners as required by the leases and related
agreements; and (ii) to continue to satisfy their LOE, JIB, and other JOA obligations, in the
ordinary course of business and without regard to whether such obligations related to pre-
petition or post-petition periods. Pending a final hearing on this Motion, the Debtors are only
seeking authority to satisfy up to $6.0 million in pre-petition obligations owed to the Interest
Owners and the LOE, JIB, and other JOA obligations. The Debtors also request that the Court
schedule a final hearing on this Motion within thirty (30) days of the Petition Date.
18. Because the Debtors satisfy the Obligations from disbursement accounts at the
Debtors’ banks and other financial institutions (the “Banks”), the Debtors further request that the
Court authorize the Banks to receive, honor, process, and pay any and all checks drawn, or
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electronic fund transfers requested or to be requested, on the Debtors’ accounts to the extent that
such checks or electronic fund transfers relate to the Obligations.
19. With respect to some Interest Owners and their shares of production revenues,
payments are made not by the Debtors but rather by the first purchaser of the oil and gas
produced by the Debtors, who sends such portion directly to Royalty and Working Interest
Owners rather than having the funds flow through the Debtors. Even though the Debtors believe
that such payments on account of post-petition Obligations are permitted in the ordinary course
of business, out of an abundance of caution, the Debtors request that the Court authorize the
payment of such post-petition amounts to give comfort to such first purchasers that those
payments are permissible.
Basis for Relief
A. A Number of Payments Ultimately will be Credited to the Debtors in the Purchase Price Adjustment
20. Under the Contribution Agreement Transaction, White Oak bears the ultimate
financial responsibility for “Property Costs” and royalty interests and similar amounts incurred
in the operation of the Debtors’ business following May 1, 2015 (referred to as the “Effective
Time” in the Contribution Agreement). As a result of the Contribution Agreement Transaction,
a number of the Debtors’ ordinary course vendors and Interest Owners will have the obligations
owed to them assumed and become the responsibility of White Oak. The Contribution
Agreement Transaction contains mechanisms to account for payments made by Milagro that are
for the benefit of White Oak (resulting in an increase in the Purchase Price) and vice versa
(which, correspondingly, results in a decrease of the Purchase Price). A substantial amount of
the obligations that are the subject of this Motion, would be assumed and paid (or credited in the
Debtors favor) by White Oak. Therefore, the relief requested in this Motion serves mainly to
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alter the timing of payment to covered vendors and Interest Owners, not the substantive recovery
to which they are entitled under the contemplated plan, which will implement the Contribution
Agreement Transaction.
B. Payment of the Obligations is Necessary to Preserve the Value of the Debtors’ Business
21. Section 363(b)(1) of the Bankruptcy Code provides that, after notice and a
hearing, the trustee “may use, sell, or lease, other than in the ordinary course of business,
property of the estate[.]” 11 U.S.C. § 363(b)(1). Section 105(a) of the Bankruptcy Code
empowers a bankruptcy court to “issue any order, process, or judgment that is necessary or
appropriate to carry out the provisions of this title.” 11 U.S.C. § 105(a). Bankruptcy courts have
invoked the equitable power of section 105 to authorize the post-petition payment of pre-petition
claims where such payment is necessary to preserve the value of a debtor’s estate. See, e.g.,
Tropical Sportswear Int’l Corp., 320 B.R. 15, 20 (Bankr. M. D. Fla. 2005) (“Bankruptcy courts
recognize that section 363 is a source for authority to make critical vendor payments, and section
105 is used to fill in the blanks.”). Courts have likewise acknowledged that “[u]nder [section]
105, the court can permit pre-plan payment of a pre-petition obligation when essential to the
continued operation of the debtor.” In re NVR L.P., 147 B.R. 126, 127 (Bankr. E.D. Va. 1992)
(citing In re Ionosphere Clubs, Inc., 98 B.R. 174, 177 (Bankr. S.D.N.Y. 1989)); see In re Just for
Feet, Inc., 242 B.R. 821, 825 (D. Del. 1999) (citing In re Penn Central Transp. Co., 467 F.2d
100, 102 n.1 (3d Cir. 1972)) (holding that court is authorized under section 105(a) to allow
immediate payment of pre-petition claims of vendors found to be critical to the debtor’s
continued operation)).
22. In a long line of well-established cases, federal courts consistently have permitted
post-petition payment of pre-petition obligations where necessary to preserve or enhance the
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value of a debtor’s estate for the benefit of all creditors. See, e.g., Miltenberger v. Logansport,
C. & S. W. Ry. Co., 106 U.S. 286, 312 (1882) (payment of pre-receivership claim permitted to
prevent “stoppage of [crucial] business relations”); In re Lehigh & New Eng. Ry. Co., 657 F.2d
570, 581 (3d Cir. 1981) (holding that “if payment of a claim which arose prior to [the
commencement of the bankruptcy case] is essential to the continued operation of the . . .
[business] during [the bankruptcy case], payment may be authorized even if it is made out of
[the] corpus”); Dudley v. Mealey, 147 F.2d 268, 271 (2d Cir. 1945) (extending doctrine for
payment of pre-petition claims beyond railroad reorganization cases).
23. This legal principle—known as the “doctrine of necessity”—functions in chapter
11 cases as a mechanism by which a bankruptcy court can exercise its equitable power to allow
payment of critical pre-petition claims not explicitly authorized by the Bankruptcy Code. See
Just for Feet, 242 B.R. at 826 (finding that “to invoke the necessity of payment doctrine, a
debtor must show that payment of the pre-petition claims is critical to the debtor’s [continued
operation].”); In re Columbia Gas Sys., Inc., 136 B.R. 930, 939 (Bankr. D. Del. 1992)
(recognizing that “[i]f payment of a pre-petition claim is essential to the continued operation of
[the debtor], payment may be authorized”); In re Boston & Me. Corp., 634 F.2d 1359, 1382 (1st
Cir. 1980) (recognizing the existence of a judicial power to authorize trustees to pay claims for
goods and services that are indispensably necessary to the debtors’ continued operation). The
doctrine is frequently invoked early in a bankruptcy case, particularly in connection with those
Bankruptcy Code sections that relate to payment of pre-petition claims. In one case, the court
indicated its accord with “the principle that a bankruptcy court may exercise its equity powers
under section 105(a) to authorize payment of pre-petition claims where such payment is
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necessary ‘to permit the greatest likelihood of . . . payment of creditors in full or at least
proportionately.’” In re Structurelite Plastics Corp., 86 B.R. 922, 931 (Bankr. S. D. Ohio 1988).
24. A debtor’s possessory interest in an account that holds oil and gas sales proceeds
that are subject to a royalty interest is likely property of the estate; however courts recognize a
royalty holder’s equitable interest in the funds. MCZ, Inc. v. Andrus Res., Inc. (In re MCZ, Inc.),
82 B.R. 40, 42 (Bankr. S.D. Tex. 1987) (“[A debtor’s] possessory interest in the [account
holding oil and gas sales proceeds] is property of the estate subject to the Court’s power to
recognize the equitable interest of the third-party royalty owners for whose benefit the funds
were escrowed.”) (citations omitted); cf Johnson v. Barnhill (In re Antweil), 154 B.R. 982,986-
87 (Bankr. D. N. M. 1993) (granting summary judgment to trustee on preferential transfer
complaint where oil and gas sales proceeds had been held in commingled account).
25. Satisfaction of the Obligations at this early stage in the Chapter 11 Cases is
warranted because the harm to the estates that may result from nonpayment of such claims will
most likely exceed the amount of such claims by a significant margin. The Debtors’ ongoing
operations depend, to a significant degree, on their relationships with the parties to whom
Obligations are owed. If these relationships are harmed, either through the nonpayment of
Obligations as they become due, or through the perceived difficulties of dealing with chapter 11
debtors, the Debtors will likely encounter particularized controversies with each entity,
unnecessary costs and distractions and corresponding harm to their businesses with the possible
loss of value. As such, the Debtors’ failure to timely pay Obligations is likely to lead to
instances of attempted setoff or recoupment.
26. Further, the competition to obtain desirable undeveloped oil and gas leases can be
intense between the Debtors and various competitors in the oil and gas industries.
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Counterparties to the Debtors’ oil and gas leases may attempt to exercise remedies in the event
that the Obligations are not satisfied. The loss of any of the Debtors’ remaining leases could
deal an irreparable blow to the Debtors’ efforts to maximize the value of their assets for
stakeholders since there is no guarantee that the Debtors would be able to renew or reinstate a
defaulted or terminated lease. Moreover, any uncertainty or questions regarding the Debtors’
ability to honor the terms of their oil and gas leases as a result of the Chapter 11 Cases may
impair the Debtors’ ability to negotiate with prospective counterparties and obtain new oil and
gas leases. Impairment of the Debtors’ oil and gas leases could also have an adverse impact on
the Contribution Agreement Transaction and the value the Debtors, their estates and their
stakeholders will derive from it. Lastly, the revenues realized from oil and gas production
related to the leases is the primary source of revenue for the Debtors, and those revenues must
not be place in jeopardy due to failure to pay prepetition Obligations.
C. Payment of the Obligations Will Avoid Disputes with the Interest Owners
27. In the instances in which the Debtors act as operator of their wells, non-operating
Working Interest Owners will likely assert that the Debtors, as operator, merely hold bare legal
title to the accrued prepetition amounts due to them as bailees. In re MCZ, Inc., 82 B.R. 40, 42
(Bankr. S.D. Tex. 1987) (ordering the debtor-operator to turnover amounts due to the working
interest owners because the debtor-operator had no interest in such amounts beyond a “bare
possessory interest as a bailee or agent”). The Debtors’ bare legal title to amounts due to actual
Interest Owners “is of no value to the estate” and, thus the Debtors should “convey the property
to its rightful owner[s].” See id. (citations omitted). By continuing to pay the claims of
undisputed Interest Owners in the ordinary course of business, the Debtors likewise avoid
unnecessary controversies with such parties and save value and resources for the estates.
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28. A failure to timely pay the Obligations also may allow various Interest Owners to
assert damage claims against the Debtors’ estates and thereby force the Debtors into unnecessary
and time-consuming litigation. Under applicable non-bankruptcy law, the unpaid Interest
Owners may assert statutory liens upon certain of the Debtors’ assets, as well as entitlement to
enhanced damages and interest. All of the states in which the Debtors operate statutorily impose
a security interest in oil and gas production and the proceeds therefrom, under certain
circumstances. See e.g., TEX. BUS. & COM. CODE § 9.343; 52 OKLA. STAT. §§ 549.1-
549.12; La. R.S. § 31:146; Miss. Code §53-3-41; see also In re Tri-Union Development Corp.,
253 B.R. 808, 815 (S.D. Tex. 2000) (“To conclude, since Texas provides for a security interest
in favor of interest owners . . ., the Debtor is authorized to pay the prepetition royalties with
respect to the Texas oil and gas leases.”). By way of example, Texas law grants an
automatically perfected statutory lien to “interest owners” to secure the obligations of the “first
purchaser of oil and gas production, as debtor, to pay the purchase price.” TEX. BUS. & COM.
CODE § 9.343(a) & (r). The operator may qualify as the “first purchaser” under the statute
where the “operator . . . receives production proceeds from a third-party purchaser who acts in
good faith under a division order or other agreement authenticated by the operator under which
the operator collects proceeds of production on behalf of other interest owners.” TEX. BUS. &
COM. CODE § 9.343(r)(3); see also In re Tri-Union Dev. Corp., 253 B.R. at 815 (finding an
automatically perfected security interest in the oil and gas production and its proceeds in the
debtor’s possession).
29. Further, it is believed that with respect to some of the royalty and working interest
owners to which payments are made, the Debtors would not be authorized to cause the non-
payment of their interests because the Debtors do not actually make those payments. Under
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division orders executed by, among others, the first purchaser, the Debtors, and royalty and
working interest owners, the first purchaser agrees to make the payments owing to the various
interest owners on account of the purchase and sale of oil and gas. As a result, the Debtors may
receive only their portion of the proceeds from the sale of the oil and gas to the first purchaser,
and the funds utilized to pay the royalty and working interest owners may not flow through the
Debtors.
30. Moreover, certain Interest Owners are likely to allege that, under non-bankruptcy
law, the failure to timely make royalty payments can result in the automatic termination of the
underlying mineral lease(s). Such Interest Owners may allege that the making of the payments
due on account of their ownership interests is a condition to the continued effectiveness of such
lease(s). Some courts have held that the failure to make payments required under a lease could
allow an Interest Owner to terminate the lease, and that such termination would not violate the
automatic stay. See, e.g., Trigg v. United States (In re Trigg), 630 F.2d 1370, 1372-75 (10th Cir.
1980) (holding under the former Bankruptcy Act and former Bankruptcy Rule 11-44, that
automatic contractual termination as a consequence of nonpayment was not stayed post-
petition); see also Good Hope Refineries, Inc. v. Benavides, 602 F.2d 998, 1002 (1st Cir. 1979)
(automatic termination of an oil and gas lease for nonpayment of delay rental does not constitute
a “proceeding” within the meaning of the Bankruptcy Act’s automatic stay provisions).4 In the
present case, the Debtors’ nonpayment of the Obligations could amount to a breach of the
relevant leasing agreements, but those agreements do not explicitly provide for automatic
termination of the leases in such circumstances. Nonetheless, like the counterparties did in
4 The relevant holding in Trigg has been upheld in the context of the Bankruptcy Code by numerous courts,
including those in the Third Circuit. See, e.g., In re Tudor Motor Lodge Assocs., Ltd. P’ship, 102 B.R. 936, 949 (Bankr. D. N. J. 1989) (agreeing with a collection of cases applying Trigg in a Code setting); In re W. Pine Const. Co., 80 B.R. 315, 320 (Bankr. E. D. Pa. 1987) (same).
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Trigg, some or all of the Interest Owners may argue that the Debtors’ timely payment of the
Interest Owners’ share of production is a condition to the continued effectiveness of the relevant
leases and that such leases may automatically terminate in the event of nonpayment. By paying
the Interest Owners the amounts owed on pre-petition and post-petition production, the Debtors
will avoid such a dispute and help ensure the continued existence of the underlying leases,
thereby preserving the value of the Debtors’ assets.
31. For these reasons, the Debtors believe that they should be authorized, but not
directed, to continue to make prepetition and postpetition payments to the Interest Owners.
D. Payment of the LOEs will Allow the Debtors to Continue to Meet their Obligations under the JOAs and Avoid Litigation with the Service Providers and Working Interest Owners
32. In the ordinary course of operations, and the discharge of their obligations to act
as reasonable, prudent operators, the Debtors regularly incur LOEs provided by third-party
service providers who, under applicable law, may be entitled to assert claims against the
Debtors’ leases to secure payment for pre-petition goods and services provided to the Debtors.
33. Specifically, many of the LOE service providers are likely to assert rights under
applicable state laws that provide for statutory or other liens that attach to the Debtors’ interest in
the oil and gas leases. Pursuant to section 362(b)(3) of the Bankruptcy Code, the act of
perfecting statutory liens, to the extent consistent with section 546(b) of the Bankruptcy Code, is
expressly excluded from the automatic stay. Under section 546(b) of the Bankruptcy Code, a
debtor’s lien avoidance powers are “subject to any generally applicable law that . . . permits
perfection of an interest in property to be effective against any entity that acquires rights in such
property before the date of perfection[.]” 11 U.S.C. § 546(b)(1)(A). Therefore, notwithstanding
the automatic stay imposed by section 362 of the Bankruptcy Code, the LOE service providers
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may be entitled to assert and perfect statutory liens against the Debtors’ property during these
Chapter 11 Cases and with respect to any prepetition claims against the Debtors.
34. Each of Texas, Louisiana, Mississippi and Oklahoma law protect the rights of
LOE providers by granting them statutory liens to secure payment for their services. Chapter 56
of the Texas Property Code grants a “mineral contractor” or “mineral subcontractor” a lien to
secure payment for labor or services related to “mineral activities.” TEX. PROP. CODE ANN. §
56.002. “Mineral contractor” and “mineral subcontractor” are broadly defined to include, inter
alia, persons performing labor or furnishing or hauling material, machinery, or supplies used in
mineral activities. Id. § 56.001(2) & (4). The statutory lien may be secured by filing the lien
affidavit with the county clerk of the county in which the property is located, and the contractor
may have six months from the date of accrual of indebtedness to file the lien affidavit. Id. §
56.021. However, for purposes of priority, the statutory lien may incept back to the date of first
work, provided that the lien is otherwise timely filed. Id. §53.124(a); MEG Petroleum Corp. v.
Halliburton Servs. (In re MEG Petroleum Corp.), 61 B.R. 14, 18 (Bankr. N.D. Tex. 1986).
Further, § 56.004 of the Texas Property Code provides that “[t]he lien on material, machinery,
supplies, or a specific improvement takes priority over an earlier encumbrance on the land or
leasehold on which the material, machinery, supplies, or improvement is placed or located.”
TEX PROP. CODE ANN. § 56.004.
35. Similarly, the Louisiana Oil, Gas, Water Wells Lien Act (“Oil Well Lien Act”)
creates a statutory lien and privilege in favor of those who supply labor, services, and/or
materials to the oil and gas industry. L. REV. STAT. ANN. § 9:4861 et seq. (1995); see also Lor,
Inc. v. Martin Exploration Co., 489 So.2d 1326 (La. App. 1st Cir. 1986); see generally Patrick
H. Martin & J. Lanier Yeates, Louisiana And Texas Oil & Gas Law: An Overview Of The
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Differences, 52 LA. L. REV. 769, 847-49 (1992). This lien attaches to a broad class of property
enumerated in the statute and includes, inter alia, (a) the oil and gas wells for or in connection
with which services or materials are supplied; (b) leases where the same are located; (c) certain
related equipment; and (d) all oil and gas produced from the wells and the proceeds thereto
inuring to the working interests. LA. REV. STAT. ANN. § 9:4863 (197). Further, under the Oil
Well Lien Act, the statutory lien attaches to all property listed in the statute. Guichard Drilling
v. Alpine Energy Servs., Inc., 657 So.2d 1307, 1312 (La. 1995) (citations omitted). Similar to
Texas law, under the Oil Well Lien Act, the statutory lien relates back in time to the
commencement of work, as the effective date of the lien. In re Jack/Wade Drilling, Inc., 213
B.R. 493, 498 (Bankr. W.D. La. 1997) (“The lien attaches when the person performs labor or
services”).
36. With respect to oil and gas activities in Oklahoma, Oklahoma’s Mechanic’s and
Materialmen’s Lien Statute grants a person or company that provides labor or furnishes material
to an owner of a leasehold for oil and gas purposes to claim a lien upon the leasehold, pipeline,
lease, equipment and proceeds from the sale of oil and gas benefiting the working interest. 42
Okla. Stat. § 144. The purpose of such liens is to protect the provider of goods or services from
a situation in which the owner of the property or leasehold fails to pay for the goods or services
provided. See Davidson Oil Country Supply Co., Inc. v. Pioneer Oil & Gas Eqpt., 1984 OK 65,
¶ 6, 678 P.2d 1268. Such liens give laborers and materialmen a level of protection enjoyed by
no other lien holder because such liens have priority from the date the first labor or materials are
furnished. Fourth Nat’l Bank of Tulsa v. Appleby, 1993 OK 53, ¶ 9, 864 P.2d 827.
37. A properly perfected lien will attach only to the property specifically described in
the lien statement whether it be the entire leasehold interest, the pipeline, oil or gas well, the oil
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and gas lease, the buildings and appurtenances and/or the proceeds from the sale of the oil and
gas. Stanolind Crude Oil Purchasing Co. v. Busby, 1939 OK 234, ¶ 23, 90 P.2d 876. Exempt
from the lien are “any valid, bona fide reservations of oil or gas payments or overriding royalty
interests executed in good faith and payable out of such working interest” so long as the
reservation is properly recorded and notice given prior to the commencement of work on the
well. Zone Oil & Gas Co. v. Dudley & Heath Drilling Co., 1970 OK 155, ¶ 14, 474 P.2d 385;
42 Okla. Stat. § 144. Additionally, the lien will not attach to or encumber the surface rights from
which the mineral interest(s) was severed. 1983 OK AG 38, ¶ 5. However, the lien will be
preferred over any other liens which may attach to the oil and gas leasehold, pipeline, wells or
material and equipment used in the oil and gas product. 42 Okla. Stat. § 144.
38. Finally, Mississippi grants LOE service providers a lien for labor done or
materials furnished, extending to the extent of the operations and nonoperation interests in the
mineral estate, as well as the fixtures and equipment in the producing unit assigned by the
Mississippi State Oil and Gas Board. Miss. Code § 85-7-131.
39. Accordingly, in order to preserve the status quo, avoid the incurrence of
unnecessary statutory liens, and to eliminate the risk of pervasive litigation over the existence of
statutory liens, lien priorities, and the amounts of claims of the various Interest Owners and the
LOE service providers, the Debtors hereby request the authority to pay the LOEs that accrued
pre-petition and to continue to make payments in the ordinary course of business.
40. In the past, this Court and other bankruptcy courts have granted relief similar to
that requested herein. See, e.g., In re Quicksilver Resources, Inc., Case No. 15-10585 (LSS)
(Bankr. D. Del. April 15, 2015); In re TriDimension Energy, L.P., Case No. 10-33565 (Bankr.
N. D. Tex. June 29, 2010); In re Edge Petroleum Corp., Case No. 09-20644 (Bankr. S. D. Tex.
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Oct. 5, 2009); In re Pac. Energy Res., Ltd., Case No. 09-10785 (KJC) (Bankr. D. Del. June 10,
2009); In re Crusader Energy Group Inc., Case No. 09-31797 (Bankr. N. D. Tex. Apr. 2, 2009).
The Debtors’ Reservation of Rights
41. Nothing contained herein is intended or should be construed as an admission of
the validity of any lien or claim against the Debtors, a waiver of the Debtors’ rights to dispute
any lien or claim, or an approval or assumption of any agreement, contract or lease under section
365 of the Bankruptcy Code. The Debtors expressly reserve their rights to contest any assertion
to the contrary and any objection to the relief sought in this Motion under any grounds available
to the Debtors in accordance with applicable non-bankruptcy law.
The Motion Satisfies Bankruptcy Rule 6003
42. Pursuant to Bankruptcy Rule 6003, the Court may grant relief regarding a motion
to pay all or part of a prepetition claim within twenty-one (21) days after the Petition Date “to
the extent the relief is necessary to avoid immediate and irreparable harm.” Fed. R. Bankr. P.
6003.
43. Paying the Interest Owners immediately, and in accordance with their ordinary
course terms, is necessary to allow the Debtors to continue their business operations
uninterrupted, maintain the Interest Owners’ good will, and will eliminate the risk that the
Interest Owners will argue that there has been an automatic termination as a result of non-
payment to which the automatic stay does not apply. Termination of the leases by Interest
Owners would prevent the Debtors from realizing current cash flow from their assets and would
place an enormous strain on the Debtors’ liquidity needs. Finally, with respect to the amount
owed under the JOAs, either as LOEs or JIBs, payment of such amounts is necessary to ensure
the timely, safe and proper function of the wells in which the Debtors’ have an interest. Failure
to pay the amounts requested herein will place the operation of the wells in which the Debtors
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own an interest at risk. This will, in turn, jeopardize the Debtors’ ability to recognize revenue
from such wells, and may also lead to harm to the Debtors’ JOA-counterparties, as well as the
public and environment at large. Accordingly, the Debtors submit that they have satisfied the
requirements of Bankruptcy Rule 6003 to support immediate payment of the Obligations as and
when they come due.
Waiver of Bankruptcy Rule 6004(h)
44. The Debtors further seek a waiver of any stay of the effectiveness of the order
approving this Motion. Pursuant to Rule 6004(h) of the Bankruptcy Rules, “[a]n order
authorizing the use, sale, or lease of property other than cash collateral is stayed until the
expiration of 14 days after entry of the order, unless the court orders otherwise.” Fed. R. Bankr.
P. 6004(h). As set forth above, satisfying the Obligations in the ordinary course of business is
necessary to prevent irreparable damage to the Debtors’ operations and the value of the Debtors’
businesses. Accordingly, the Debtors submit that ample cause exists to justify a waiver of the
fourteen (14) day stay imposed by Bankruptcy Rule 6004(h), to the extent it applies.
Notice
45. Notice of this Motion shall be provided to: (i) the Office of the United States
Trustee for the District of Delaware; (ii) counsel to TPG Specialty Lending, Inc., the
administrative agent under the Debtors’ pre-petition secured credit facility and proposed DIP
Agent; (iii) counsel to the Initial Consenting Noteholders; (iv) those parties listed on the list of
creditors holding the thirty (30) largest unsecured claims against the Debtors (on a consolidated
basis), as identified in their chapter 11 petitions; (v) the Internal Revenue Service; (vi) the
United States Attorney for the District of Delaware; (vii) the Securities and Exchange
Commission; and (viii) the Banks. As this Motion is seeking “first day” relief, within two
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business days of the hearing on this Motion, the Debtors will serve copies of this Motion and any
order entered in respect to this Motion as required by Local Rule 9013-1(m). The Debtors
submit that, in light of the nature of the relief requested, no other or further notice need be given.
Conclusion
WHEREFORE, the Debtors respectfully request that the Court enter an order,
substantially in the form attached hereto as Exhibit A, granting the Debtors authority, in their
discretion, (i) to deliver to the Interest Owners the pre-petition amounts due to them on account
of their respective Royalties, ORRI and working interests and to honor post-petition obligations
to Interest Owners as such amounts become payable, and (ii) to pay the Obligations as such
amounts become payable, and for such other and further relief as is just and proper.
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Dated: July 15, 2015 Wilmington, Delaware
YOUNG CONAWAY STARGATT & TAYLOR, LLP
/s/ M. Blake Cleary M. Blake Cleary (No. 3614)
Joel A. Waite (No. 2925) Ryan M. Bartley (No. 4985) Ian J. Bambrick (No. 5455) 1000 N. King Street Rodney Square Wilmington, Delaware 19801 Telephone: (302) 571-6600 Facsimile: (302) 571-1253 -and-
John F. Higgins Eric M. English PORTER HEDGES LLP 1000 Main Street, 36th Floor Houston, TX 77002 Telephone: (713) 226-6687 Facsimile: (713) 226-6287 Proposed Counsel for the Debtors and Debtors in Possession
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3697948v2
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Exhibit A
Proposed Order
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IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE
--------------------------------------------------------------- In re MILAGRO HOLDINGS, LLC, et al., Debtors.1 ---------------------------------------------------------------
x : : : : : : : : X
Chapter 11 Case No. 15-11520 (____) Jointly Administered Ref. Docket No. ___
ORDER (I) AUTHORIZING DEBTORS
TO PAY OR HONOR PREPETITION AND POST-PETITION (A) OBLIGATIONS TO HOLDERS OF ROYALTY INTERESTS AND WORKING INTERESTS AND (B) LEASE OPERATING EXPENSES; AND (II) GRANTING RELATED RELIEF
Upon consideration of the motion (the “Motion”)2 of the Debtors for the entry of an order
(this “Order”), pursuant to sections 105(a) and 363(b) of the Bankruptcy Code and Bankruptcy
Rules 6003(b) and 6004(h), authorizing, but not directing, the Debtors to pay or honor, in the
Debtors’ sole discretion, pre-petition and post-petition obligations to the holders of royalty
interests, working interests and obligations incurred in connection with the operation of the oil
and gas leases and wells in which the Debtors have an ownership interest; and the Court having
jurisdiction to consider the Motion pursuant to 28 U.S.C. §§ 157 and 1334, and the Amended
Standing Order of Reference from the United States District Court for the District of Delaware
dated as of February 29, 2012; and venue of the Chapter 11 Cases and the Motion in this district
being proper pursuant to 28 U.S.C. §§ 1408 and 1409; and this matter being a core proceeding
pursuant to 28 U.S.C. § 157(b); and proper and adequate notice of the Motion, the hearing
1 The Debtors in these cases, along with the last four digits of each Debtor’s federal tax identification number,
are: Milagro Holdings, LLC (7232); Milagro Oil & Gas, Inc. (7173); Milagro Exploration, LLC (9260); Milagro Producing, LLC (9330); Milagro Mid-Continent, LLC (8804); and Milagro Resources, LLC (6134). The Debtors’ mailing address is 1301 McKinney Street, Suite 500, Houston, Texas 77010.
2 All terms not defined in this Order are given the meaning assigned to them in the Motion.
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thereon, and opportunity for objection having been given; and the relief requested in the Motion
being in the best interests of the Debtors and their estates and creditors; and the Court having
heard evidence and statements of counsel regarding the Motion and having determined that the
legal and factual bases set forth in the Motion and attested to in the First Day Declaration
establish just cause for the relief granted herein; and the Court having determined that immediate
relief is necessary to avoid irreparable harm; and after due deliberation and sufficient cause
appearing therefor,
IT IS HEREBY ORDERED, ADJUDGED, AND DECREED THAT:
1. The Motion is GRANTED on an INTERIM basis, to the extent set forth herein.
2. The Debtors are authorized but not directed, in the Debtors’ sole discretion, (i) to
deliver to the Interest Owners, the pre-petition amounts due to them for their respective
Royalties, ORRI and working interests and to honor or have third-parties honor on behalf of the
Debtors any post-petition obligations to the Interest Owners as such amounts come due, and
(ii) to pay the LOE, JIB, and other JOA obligations as such amounts come due, without regard to
whether such amounts were incurred or accrued prior to or following the Petition Date; provided
that the pre-petition amounts authorized to be paid pursuant to this paragraph shall not exceed
$6.0 million pending entry of a final order on the Motion.
3. In accordance with this Order and any other order of this Court, the financial
institutions at which the Debtors maintain their accounts (the “Banks”) shall be, and hereby are,
authorized, when requested by the Debtors (in the Debtors’ sole discretion), to honor and pay all
checks or electronic fund transfers drawn on the Debtors’ accounts for the payments authorized
pursuant to this Order, whether such payments were presented prior to or following the Petition
Date, provided that sufficient funds are on deposit in such accounts to honor and make such
payments.
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4. The Banks may rely on the representations of the Debtors with respect to whether
any check or electronic fund transfers drawn or issued by the Debtors prior to the Petition Date
should be honored pursuant to this Order, and any such Bank shall not have any liability to any
party for relying on such representations by the Debtors as provided for in this Order.
5. The Debtors are authorized to issue post-petition checks, or to effect post-petition
electronic fund transfers, in replacement of any checks or electronic fund transfers in respect of
payments authorized by this Order that are dishonored or rejected after the Petition Date.
6. Nothing in the Motion or this Order, nor as a result of any payment made pursuant
to this Order, shall be deemed or construed as (a) an admission as to the validity, amount,
classification, or priority of any claim or lien against the Debtors, (b) a waiver of the right of the
Debtors, or shall impair the ability of the Debtors, to contest the validity, amount, classification,
or priority of any claim, lien, or payment made pursuant to this Order or (b) a request or an
approval to assume any agreement, contract or lease pursuant to section 365 of the Bankruptcy
Code.
7. The Debtors are authorized and empowered to take such actions as may be
reasonably necessary to implement and effectuate this Order.
8. The requirements set forth in Bankruptcy Rule 6003(b) are satisfied.
9. Notwithstanding any applicability of Bankruptcy Rule 6004(h), the terms and
conditions of this Order shall be immediately effective and enforceable upon entry of this Order.
10. Notwithstanding anything to the contrary contained herein, any payment to be
made, or authorization contained, hereunder shall be subject to the requirements imposed on the
Debtors under any approved debtor-in-possession financing facility or any order regarding the
use of cash collateral approved by this Court in the Chapter 11 Cases.
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11. A final hearing to consider the relief requested in the Motion shall be held on
August ____, 2015 at __:__ _.m. Objections to approval of the Motion on a final basis shall be
filed with the Court not later than August ____, 2015 at 4:00 p.m., and at the same time such
objection shall be served on counsel to the Debtors.
12. This Court shall retain jurisdiction over the Debtors and any party receiving
payment from the Debtors pursuant to this Order with respect to any matters, claims, rights, or
disputes arising from or related to the Motion, the implementation of this Order, or the validity of
any of claims against the Debtors or payment made pursuant to this Order.
Dated: July ___, 2015 Wilmington, Delaware
_________________________________________ UNITED STATES BANKRUPTCY JUDGE
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