I. Security Interests in Minerals General
A security interest, under Texas’ version of the Uniform Commercial Code (the “Texas UCC”), is an interest in personal property or fixtures which secures payment or performance of an obligation. Real property is not subject to the Texas UCC.
Oil, gas, and other minerals that have not been extracted from the ground are treated as real property, to which the Texas UCC does not apply. Instead, the property laws of Texas govern perfection. However, as the minerals come out of the ground, they cease to be part of the mineral estate and instead become both a “good” and “as-extracted collateral,” to which the Texas UCC does apply.
“Perfection” is the process of publicly establishing a security interest in personal property collateral for the purpose of gaining priority. Perfecting collateral is often a law intensive process. With the assistance of outside counsel, proper perfection can enable a party who is owed money to in essence call “dibs” against underlying collateral to secure “first-in-line” rights for what is owed to them. In other words, a perfected security interest is subordinate or “second in line” to the security interest rights of anyone whose interest becomes perfected before your security interest is perfected. This is known appropriately as the “first in time, first in right” rule.
The method by which a secured party perfects its secured interest varies and is largely determined by the type of personal property serving as collateral. The Texas UCC provides a number of ways in which a creditor may perfect a security interest, and the majority of those ways are uniform from state to state. Foremost among these perfection methods is the filing of a “UCC-1” financing statement with the secretary of state. A secured party may also perfect a security interest in certain categories of collateral, including goods and money, by taking possession of the collateral. Outside counsel can assist greatly in selecting the proper method of perfection for a particular situation.
II. The First Purchaser Statute
Section 9.343 of the Texas UCC, commonly known as the First Purchaser Statute, is unique to Texas and automatically creates a security interest in favor of working interest owners to secure the obligations of the first purchaser of oil and gas production. This “springing” security interest “exists in” or attaches to the oil and gas production itself, and also to the identifiable proceeds of that production “owned by, received by, or due to” the first purchaser. Therefore, under Texas law, working interest owners such as producers and royalty owners automatically possess a security interest in the oil and gas extracted from their properties against said first purchaser, thereby providing protection, clarity, and efficiency in the legal framework governing these transactions.
But what about perfection? The security interest provided by the First Purchaser Statute is also perfected automatically, without the filing of a financing statement, and in effect grants the interest owner superior priority over all other claimants. This is particularly important in the event of the first purchaser's bankruptcy.
Who is considered the “first purchaser” for purposes of applying the First Purchaser Statue is generally dependent on how the relevant transaction for the sale of production was structured. This is often the subject of litigation, and one of the reasons outside counsel should be retained when structuring the sale of oil and gas assets. A party can be considered a first purchaser under the First Purchaser Statute by signing an agreement to purchase oil or gas production, issuing a division order, or in making any other voluntary communication to the interest owner or any governmental agency recognizing the interest owner's right.
III. Unique to Texas
While the First Purchaser Statute does not require the filing of a financing statement in order to perfect a security interest, it is unique to Texas and is not necessarily recognized under the laws of other states. Under the Texas UCC, as well as the commercial codes of most other states, in order to determine whether a security interest in collateral is properly perfected, the court must apply the law of the state where the debtor was organized, not the claimant. By way of illustration, the law of the state where a first purchaser was organized is determinative as to interest owners pursuing claims against said purchaser. It follows that when a first purchaser is organized under the laws of a different state, the potential exists for that state’s law to apply instead.
To safeguard a perfected security interest from a scenario where their priority under the First Purchaser Statue, a working interest owner can work with outside counsel to enact a “belt and suspenders” approach to perfection, using alternative methods to perfect their security interest that cover a wide range of scenarios.
