IN THE UNITED STATES BANKRUPTCY COURT FOR THE …new.reorg-research.com/data/firstday/4071_0.pdf ·...

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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.

Case 15-11520-KG Doc 10 Filed 07/15/15 of 28

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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


3697948v2

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Exhibit A

Proposed Order


7 01:15

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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