In a June 28 opinion in In re SemCrude, L.P., et al., the Delaware federal bankruptcy court recommends that summary judgment be granted in favor of downstream purchasers of oil and gas from the insolvent first purchaser, SemCrude. In Chapter 11 proceedings before the bankruptcy court, the producers that sold to the debtor-in-bankruptcy, SemCrude, filed claims to recover oil and gas proceeds from the downstream purchasers, asserting that those proceeds are subject to liens created by the original sale. The downstream purchasers contested these claims on the basis that they are buyers for value (BVP) under Uniform Commercial Code §9-317, and therefore take free and clear of prior liens of which the purchasers had no actual knowledge and which had not been perfected prior to delivery of the collateral oil and gas. After extensive legal and factual analysis, the bankruptcy court concluded that the downstream purchasers are indeed buyers for value and are entitled to judgment as a matter of law.
While acknowledging that it did not have to reach the issue, the court also ruled on the downstream purchasers’ defense that they are buyers in the ordinary course of business (BIOC) under UCC §9.320. A BIOC takes free of a security interest created by the seller, even if the security interest is perfected and the buyer knows of its existence. Consequently, it is a complete defense to claims based on prior liens, whereas the BVP defense is conditional. In order to prove up a BIOC defense on summary judgment, the downstream purchasers had to show that there was no genuine dispute of material fact that they bought oil and gas from the debtors in good faith, without knowledge that the sale violated the Producers’ rights, and in the ordinary course.
After evaluating each element of the defense, the court determined that the downstream purchasers had met their burden of proof. The producers argued that the practice of “netting,” whereby the transactions between the first (or “midstream”) purchaser and the downstream purchasers are settled by netting physical purchases against derivatives trading liability, was not “ordinary course of business.” The court strongly rejected this argument, stating:
“The record reflects that the Debtors (SemCrude) were in the business of buying and selling oil and gas as a midstream purchaser. The Debtors bought oil and gas from the Producers and promptly sold it to the Downstream Purchasers. It is undisputed that the Downstream Purchasers–among the largest energy companies in the world–were also in the business of buying and selling oil and trading oil derivatives. It is clear to the Court that buying and selling millions of barrels of oil, and trading oil and gas derivatives was ordinary course of business for these parties.” In re SemCrude, p. 33.
During this spring’s regular session, Sen. Juan Hinojosa (D-McAllen) and Rep. Myra Crownover (R-Denton) carried legislation (SB 1094/HB 1859) responding to the SemCrude litigation and to clarify that typical industry netting practices are ordinary course of business under the UCC. SB 1094 unanimously passed the Senate but stalled in House committee. “The court’s ruling accurately interprets Texas oil and gas lien law,” said Sen. Hinojosa. “Subsequent good faith purchasers of oil and gas should not have to pay twice for the same product, and I am pleased that the court sees this the same way the Texas Senate does.” Rep. Crownover concurred. “We had hoped to pass legislation in the spring to clarify that netting is ordinary course of business under the UCC in order to avoid costly and repetitive litigation of the same issue,” Rep. Crownover said. “Although we didn’t succeed this session, the court’s ruling is a big step in the right direction and will help us pass the bill in 2015.”
TCJL will continue to follow this litigation, which the bankruptcy court characterized as “a tidal wave of disparate adversary proceedings.” In re SemCrude, p. 7. Given the size of the interests involved and the participation in the litigation of major plaintiff’s firms from Texas and elsewhere, we expect a lengthy appellate process.