April 17, 2020
Because defaults, bankruptcies, or other distress may occur in the current oil and gas price environment, we wanted to highlight some key concepts related to perfection.
Perfection of Liens and Security Interests in Oil and Gas Collateral:
Oil and gas collateral is a hybrid of real property and personal property, and bank’s liens and security interests in oil and gas collateral are typically perfected with two types of filings: (i) a deed of trust or a mortgage (both including a security agreement) (collectively “Mortgage”) filed in the county records where the property is located, and (ii) a central UCC filing. In general terms, the Mortgage filing acts as a both a mortgage on the oil and gas interests and production in the ground and a local financing statement and perfects bank’s lien on the oil and gas interests, minerals in place, fixtures, and as-extracted collateral, which includes the oil and gas production and accounts receivable and cash proceeds from the sale of the production. The central UCC filing perfects bank’s security interest on other personal property.
If bank must enforce its rights to the oil and gas collateral, it is vital that bank’s liens and security interests have been properly perfected and have not lapsed.
To properly perfect, bank should ensure that Mortgage filings are filed in the correct county, against the correct debtor entity, and sufficiently describe the most-valuable oil and gas interests from the bank’s reserve report. It is not uncommon for Borrower affiliates to own oil and gas interests included in bank’s valuation, so bank should take care that any such entity is a party to the Mortgage and is covered by a UCC financing statement filing. Bank should also be mindful of any changes to debtor’s name or state of formation and make sure that the Mortgages and UCC filings are updated to address.
The timing of perfection is discussed in greater detail below, but we remind you that Mortgages and other security documents executed or filed within 90 days prior to a bankruptcy filing may be voided as a preference, so the earlier they are executed, the better for Bank. There are also circumstances under state and federal bankruptcy and insolvency law where Mortgages and other security documents granted while insolvent within the prior one or two years could be voided as fraudulent transfers.
Mortgage filings typically specify the maturity date of the credit facility, and bank must bring suit or foreclosure action before the relevant statute of limitations has lapsed. States have distinct statutes of limitations that apply, for example, four years in Texas or six years in New Mexico.
In addition to the timing, it is also critical that the Mortgage filing sufficiently describe the oil and gas collateral, which is typically accomplished with legal descriptions of the land, schedules of assignments, and schedules of the leases covering the subject properties. Confirming the most-valuable wells from the bank’s reserve report are covered is typically a part of a title due diligence review.
A UCC Financing Statement is valid for five years from the filing date. The financing statement automatically lapses unless a continuation statement is filed within six months of its expiration. Typically banks use tickler services to manage continuations.
With the possibility of defaults, it is a good idea for bank to obtain updated UCC searches to ensure that bank’s UCC filings are in good standing and are first priority.
It is our current practice to file an all-asset UCC on deals that have a general security agreement or a negative pledge on all other assets. If the original UCC filing was limited to specific properties, bank should be sure that any collateral added to the mortgage was also added to the UCC Financing Statement by a UCC-3 amendment. Bank may also consider amending to an all-assets filing if it is permissible under the loan documents.