In re Johnson

513 B.R. 333, 183 Oil & Gas Rep. 291, 2014 WL 2986600, 2014 Bankr. LEXIS 2858
United States Bankruptcy Court, S.D. Illinois·Decided July 2, 2014·No. No. 13-40605·Published·Cited by 2 cases

Opinion

OPINION

KENNETH J. MEYERS, Bankruptcy Judge.

A dispute has arisen between the chapter 7 trustee and the debtors over whether certain property belonging to the debtors is property of the bankruptcy estate that must be turned over to the trustee. The initial inquiry raised by the trustee’s motion for turnover involves whether Jerry Johnson’s “working interest” in an oil well, and the revenue received upon sale of extracted oil, is property of the bankruptcy estate or income to the debtors. A second inquiry focuses on whether property held in a trust belongs to the bankruptcy estate. A last inquiry addresses whether equitable considerations may govern the Court’s determination as to the other two issues before it.

Oil and Gas Working Interest

The trustee seeks turnover of all indicia of debtor Jerry Johnson’s u/i2nds “working interest” in an oil well, and of all the revenue received by Jerry Johnson from that oil well since the commencement of the chapter 7 case on May 30, 2013. According to the trustee, the “working interest” is an interest in real estate and the extracted oil and the funds produced from the extracted oil are proceeds of that real estate interest. The debtors dispute the trustee’s analysis that Jerry Johnson’s “working interest” is realty. They concede that the “working interest” is personal property,1 yet contend that it is a contractual right to payment that must be treated as income and, therefore, is protected from the trustee’s reach.

The following facts are not in dispute. On March 5, 1980, Raymond W. Clayton entered into an Agreement pursuant to which he became the lessee and operator under an oil and gas lease of indefinite duration (Clayton Lease). On September 3, 1982, Raymond Clayton d/b/a Clayton Enterprises entered into an Agreement and Receipt calling, among other things, for Raymond Clayton, as Operator, to drill a well for oil and gas exploration and for Jerry Johnson, as an Interest Holder, to pay Raymond Clayton a sum of money to complete the well if it appeared productive. Under this Agreement and Receipt, at ¶ 6, Raymond Clayton, as operator, expressly “reserve[d] the right to operate and manage the said premises herein in behalf of all INTEREST HOLDERS.” On November 27, 1982, Raymond W. Clayton d/b/a Clayton Enterprises assigned a % “work[336] ing interest” in the Clayton Lease to Jerry Johnson. On August 14, 1985, Cecil D. Karnes and Bobbie A. Karnes assigned a % “working interest” in the same oil and gas lease to Jerry Johnson. There is no indication from the documents of record that Jerry Johnson is a lessee or operator under an oil and gas lease. Rather, the documents reflect that he became an “As-signee” under each “Assignment Oil and Gas Lease.”

On June 7, 2012, the debtors filed a chapter 13 case in this District which was dismissed on February 4, 2013, without a confirmed plan. The debtors contend that during the course of the chapter 13 case, they were allowed to keep the income derived from Jerry Johnson’s working interest in the oil and gas lease.

On May 30, 2013, the debtors filed the instant chapter 7 case. On their schedule of personal property, Schedule B, the debtors listed Jerry Johnson’s oil interest as follows:

Approximately 34% C^arids) of working oil well
Operated by Bi-Petro2
Receives $924.45/month income3

The debtors have provided no evidence to show that the income at issue is earnings from services performed by either of them after the commencement of the bankruptcy case.

While the Bankruptcy Code, 11 U.S.C. § 541(a), sets the parameters of what property is included in the bankruptcy estate, the nature of an interest in property is defined by state law. E.g., In re Chenoweth, 132 B.R. 161, 164 (Bankr. S.D.Ill.1991) aff'd, 143 B.R. 527 (S.D.Ill.1992) aff'd, 3 F.3d 1111 (7th Cir.1993). This Court has previously held that, in Illinois, oil and gas interests have a hybrid character involving both real and personal property components. In re Fullop, 125 B.R. 536, 539 (Bankr.S.D.Ill.1990) aff'd, 133 B.R. 627 (S.D.Ill.1991) aff'd as modified, Matter of Fullop, 6 F.3d 422 (7th Cir.1993). In Fullop, this Bankruptcy Court found:

As a general rule in Illinois, oil and gas in place constitutes land or real estate and belongs to the owner of the land so long as it remains under the land. Miller v. Ridgley, 2 Ill.2d 223, 117 N.E.2d 759 (1954); see 26 I.L.P. Mining, Oil, and Gas, § 12 (1956). An Illinois oil and gas lease, while not granting title to the oil itself, grants to the lessee the right to enter upon the surface of the land and to reduce the oil and gas to the lessee’s possession. Ohio Oil Co. v. Daughetee, 240 Ill. 361, 88 N.E. 818 (1909). Because such a lease concerns the right to oil prior to extraction, Illinois courts classify an oil and gas leasehold as a freehold or real estate interest subject to real estate law. In re Hanson Oil Co., Inc., 97 B.R. 468 (Bankr.S.D.Ill.1989).
Once oil reaches the surface and is reduced to possession, it is considered personalty and its sale and disposition is governed by personal property law. Palumbo v. Harry M. Quinn, Inc., 323 Ill.App. 404, 55 N.E.2d 825 (1944); see Nation Oil Co. v. R.C. Davoust Co., 51 Ill.App.2d 225, 201 N.E.2d 260 (1964): oil pumped out of the ground and stored in tanks is personal property. Thus, while an oil and gas lease itself conveys a real property interest, transactions concerning oil after extraction involve [337] personal property interests subject to rules of personal property law.

Id.

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In re Johnson, 513 B.R. 333, 183 Oil & Gas Rep. 291, 2014 WL 2986600, 2014 Bankr. LEXIS 2858 (Ill. 2014).

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