By Kim Mai, Buddy Clark and Kraig Grahmann, Haynes and Boone LLP

Editor’s Note: The following is an excerpt of an article published on It has been shorten for this space. The entire article, including further explanation of each type of lien and conclusions, is available here.

With the steep collapse of oil and gas prices in the last 18 months, dozens of exploration and production companies have declared bankruptcy and many more companies are expected to file for bankruptcy protection unless prices rebound dramatically. As the prospect of further bankruptcies looms, it is important for parties to understand how to adequately protect their security interests and the nature of competing liens that could prevent them from fully realizing on the value of the collateral securing their counterparty’s obligations.

This article sets forth types of liens that can encumber the assets of an exploration and production company and the priority of such liens.

Secured Lender’s Liens

A secured lender’s loan documentation generally consists of a mortgage that creates a lien on a company’s real property oil and gas interests, a security agreement that creates a lien on a company’s personal property and financing statements that perfect the security interests on hydrocarbons produced from the oil and gas properties (“as-extracted” collateral) and other personal property.

To properly perfect a security interest on “as-extracted” collateral, the financing statement should be filed in the recorder’s office of the county or parish in which the “as-extracted” collateral is located. To perfect a security interest on all other personal property, the financing statement should be filed with the office of the secretary of state in the state in which the debtor is located, which for business organizations is the entity’s state of incorporation or organization. In the majority of states, a mortgage is also effective as an “as-extracted” collateral filing, but as with standard financing statements, the effectiveness of a mortgage as an “as-extracted” collateral filing will lapse in five years unless a continuation statement is filed during the six-month period prior to the end of the five-year period.

Joint Operating Agreement Liens

There are four versions of the model American Association of Professional Landmen Form Joint Operating Agreement, but parties most frequently use the 1982 and 1989 forms. Under the 1989 Joint Operating Agreement, each of the operator and non-operator grants to each other consensual liens on both current and future acquired real property and the personal property associated with such real property. In contrast, the 1982 form only grants the operator a lien on the non-operator’s properties and must be amended to create a lien in favor of a non-operator.

Liens granted pursuant to a Joint Operating Agreement secure obligations by the parties thereunder, including, but not limited to the non-operator’s payment of expenses, interests and fees and the operator’s obligation to properly disburse money paid under the Joint Operating Agreement.

First Purchaser Liens

Several producing states have enacted statutes to grant royalty owners and producers a statutory lien securing the first purchaser’s payment for production. Texas’ statutory protection is under Section 9.343 of the Texas Business and Commercial Code and provides a security interest in favor of “interest owners” in order to secure the obligation of the “first purchaser” of oil and gas production to pay the purchase price of such production.

A person who has an interest of “any kind or nature in oil and gas production at the time of severance” is an “interest owner.” A “first purchaser” is the first person who purchases the oil or gas from an operator or interest owner after the oil or gas has been produced. An operator will generally be considered a first purchaser if it collects proceeds of production on behalf of other interest owners pursuant to a division order or other agreement, but will not be considered a first purchaser if it has not yet received proceeds from the third-party purchaser.

Environmental Liens

Under Superfund and Texas’ comparable statute, the Texas Solid Waste Disposal Act (“SWDA”), remediation costs incurred by the government give rise to a lien on the property remediated. Under Superfund and SWDA, environmental liens do not have priority over prior recorded liens, but in other states, such as Arkansas, Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, and Tennessee, a lien securing remediation costs is a “Superlien” that takes priority over prior recorded liens, including mortgages.

Moreover, in select states a lien may be imposed on both the property that is subject to remediation and on other real and personal property owned by the owner of the remediated property; however, such liens do not constitute “Superliens” and must be recorded. Because there is no way for a lender to gain priority over “Superliens,” lenders should conduct thorough due diligence to ensure that properties securing their loans are not contaminated, as well as include environmental covenants and indemnities in their credit agreements and security instruments.

Recoupment and Setoff

The right of recoupment provides an operator with the right to recoup outstanding amounts owed by nonoperators, including amounts outstanding under Joint Interest Billings, from the revenues owing to the non-operators. The automatic stay in bankruptcy applies to the right of recoupment, but an “administrative freeze” is available pending relief from the stay.

Recoupment rights apply to amounts owing both pre- and post-petition. To exercise the recoupment remedy, an operator has to prove that the amounts owed under a contract offset debts under the same contract.

The entire article, including further explanation of each type of lien and conclusions, is available here.