April 4, 2017
from the United States District Court for the District of
Delaware (D. Del. Nos. 1-14-cv-00038, 1-14-cv-00039,
1-14-cv-00040, 1-14-cv-00041, 1-14-cv-00357 &
1-14-cv-00358) District Judge: Honorable Sue L. Robinson.
H. Bailey Paul D. Moak Basil A. Umari McKool Smith, Peter S.
Goodman Sarah O. Jorgensen Michael R. Carney Hugh M. Ray
McKool Smith, Lewis T. LeClair, McKool Smith, Adam G. Landis
Matthew B. McGuire Landis Rath & Cobb, Counsel for
Anstine & Musgrove Inc., et. al. (The Associated
Beskrone Stacy L. Newman Ashby & Geddes, Boaz S. Morag
Rishi Zutshi Thomas J. Moloney, Cleary Gottlieb Steen &
Hamilton One Liberty Plaza, Counsel for J. Aron & Co.
S. Carr Melissa E. Byroade David Zalman, Monica Hanna Kelley
Drye & Warren, Kevin M Capuzzi Jennifer R. Hoover Benesch
Friedlander Coplan & Arnoff, Counsel for BP Oil Supply
Bifferato Thomas F. Discoll, III Bifferato, Kevin G. Collins
Barnes & Thornburg, Mark D. Collins John H. Knight
Michael Romanczuk Zachary I. Shapiro Richards Layton &
Finger, L. Katherine Good Whiteford Taylor & Preston,
Maris J. Kandestin DLA Piper, Garvan F. McDaniel Hogan
McDaniel, R. Stephen McNeill Potter Anderson & Corroon,
Travis A. McRoberts Akin Gup Strauss Hauer & Feld,
Benjamin L. Stewart Bailey Brauer, Mark Stromberg Stromberg
Stock, W. Robert Wilson, Counsel for Semcrude LP.
Charles J. Brown, III Shannon Dougherty Humiston Gellert
Scali Busenkell & Brown, Counsel for Star Production
Inc., LCS Production Co.
Hartley B. Martyn, Martyn & Associates, Duane D. Werb
Werb & Sullivan, Counsel for IC Co. Inc.
Before: AMBRO, JORDAN, and FISHER, Circuit Judges.
who are oil producers, sold their product to SemGroup L.P.
and affiliates (including SemCrude L.P.), midstream oil and
gas service providers and the Debtors in the underlying
Chapter 11 cases. SemGroup sold oil to and traded oil futures
with Appellees, downstream oil purchasers. The producers took
no actions to protect themselves in case of SemGroup's
insolvency. The downstream purchasers did; in the case of
default, they could set off the amount they owed SemGroup for
oil by the amount SemGroup would owe them for the value of
the outstanding futures trades. Accordingly, when SemGroup
filed for bankruptcy, the downstream purchasers were paid in
full while the oil producers were paid only in part.
the oil producers did not take precautionary measures to
ensure payment in case of SemGroup's insolvency, all they
have to rely on are local laws they contend give them
automatically perfected security interests or trust rights in
the oil that ended up in the hands of the downstream
purchasers. But the parties who took precautions against
insolvency do not act as insurers to those who took none.
Accordingly, we affirm the grant of summary judgment in the
downstream purchasers' favor.
L.P. and its subsidiaries (jointly and severally referred to
as "SemGroup") provided "midstream" oil
services. It purchased oil from producers and resold it to
downstream purchasers. It also traded financial options
contracts for the right to buy or sell oil at a fixed price
on a future date. At the end of the fiscal year preceding
bankruptcy, SemGroup's revenues were $13.2 billion.
SemGroup's operating companies, SemCrude, L.P. and
Eaglwing, L.P., purchased oil from thousands of wells in
several states and from thousands of oil producers, including
from Appellants, producers located in Texas, Kansas, and
Oklahoma. The producers act on behalf of many parties who
have interests in the oil at the wellhead. These interest
owners include the person or entity who owns the land in fee
simple, and thus owns the rights to the minerals. That person
or entity transfers the mineral rights to an oil company
through a lease. The company holds the "working
interest"-the right to drill and sell the oil from the
leased land. The working-interest owners appoint an operator
to work the well. Most of the producers in this appeal are
owners of working interests or operators.
purchase, SemGroup moved the oil via trucks and pipelines and
stored it in major aggregation centers in Oklahoma, Kansas,
and elsewhere. Per industry custom, SemGroup purchased the
oil on credit, paying for it on the 20th day of the month
following the sale. For example, oil purchased in January
would be paid for on February 20.
always paid the producers for the oil in full until the
bankruptcy filing. It then resold the product to downstream
purchasers, including to Appellees, J. Aron & Company and
BP Oil Supply Co., both large oil distributors. SemGroup
expressly warranted to the downstream purchasers that it sold
them oil "free from all royalties, liens, and
encumbrances." See, e.g., Conoco General
Provisions § B, J.A. 2505. Again, per industry custom
the downstream purchasers bought the oil on credit, with
payment due the 20th of the following month. J. Aron and BP
had no communication with the thousands of oil producers from
whom SemGroup purchased the oil and only knew of the
existence of some of the larger producers. J. Aron and BP
dispute whether they even purchased any of Appellants'
oil and contend that Appellants cannot trace the oil they
sold, as it was mixed with millions of barrels of oil from
innumerable other producers.
the bankruptcy filing, J. Aron and BP paid in full for the
oil they bought. BP also sold oil to SemGroup, so when
payment was due they would net out their obligations-
i.e., if BP bought $10 million from SemGroup and
SemGroup bought $8 million from BP, then BP would just pay $2
million to SemGroup.
addition to midstream oil services, SemGroup also traded oil
futures with J. Aron and BP. This trading strategy lead to
SemGroup's insolvency. Essentially SemGroup bet that the
price of oil would drop, while J. Aron and BP wanted to
secure a low price of oil in the event that prices would
rise. SemGroup would win the bet if the oil price dropped
while J. Aron and BP would win if the price rose. The
(simplified) mechanics are as follows.
sold what are known as call options. In exchange for an
upfront premium, the purchaser of the call option received
the right to purchase oil at a specified price and date. To
illustrate, if in December J. Aron purchased the right to buy
10, 000 barrels of oil at $50 a barrel on March 1, but the
market price that date was $45 a barrel, that option was
worthless because J. Aron could buy oil at a cheaper price on
the market; the $50 buying right did not save J. Aron money.
SemGroup therefore would make money: it received the upfront
premium J. Aron paid for the option, but did not end up
losing the bet because it would not have to sell oil at less
than market price. Conversely, if the market price on March 1
was $55 a barrel, J. Aron would be "in the
money"-SemGroup would have to sell J. Aron 10, 000
barrels of oil at $50 a barrel, $5 below the market rate.
SemGroup thus would lose $50, 000 dollars on the option
because, if J. Aron did not have the buying right, SemGroup
could have sold that oil on the market for the going price of
$55. These options did not "physically settle."
That is, SemGroup would not actually sell these oil barrels;
it would just owe J. Aron $50, 000.
gambling strategy was in stark contrast with hedging oil
prices. To hedge a drop in the price of oil, SemGroup could
have acquired put options-the right to sell oil at a
specified price. This would protect them against price drops
while still allowing them to take advantage of selling at
high oil prices.
turns out, SemGroup was a bad gambler. Oil prices rose
throughout 2007 and 2008. Its CEO believed that eventually
oil prices would drop. So each time SemGroup lost money on
these options, rather than realize the financial loss, it
would sell more options to cover the loss. This is referred
to as "rolling" in the industry, and is essentially
doubling down on a lost bet. For example, if SemGroup lost $1
million on the March 1 trade, it would resell new options and
collect $1 million in new premiums, thus betting that the
price of oil would drop on a date in the future. SemGroup
thought that, if it kept "rolling" these options,
eventually the price of oil would drop and all the options
would be worthless. If that happened, SemGroup would have
acquired all of these upfront premium payments at no cost.
This doubling-down strategy had a downside, however. Rolling
options greatly increased SemGroup's exposure to future
losses. By July 2008 it was exposed to a potential $2.8
billion loss if the option bets did not pay off.
Problems, Setoff Rights, and the Bankruptcy Filing
had to pledge cash collateral to margin accounts to cover its
exposure on the options. The cash in these margin accounts
assured the trading counterparties that SemGroup could pay
for any loss on the options. The margin exposure was
calculated by the "mark to market" method- the
amount SemGroup would owe the counterparty if the option
liquidated that day. As SemGroup's exposure on these
options increased, so did its margin requirements. Eventually
it ran out of funds to meet those margin obligations, causing
the bankruptcy, J. Aron and BP started buying oil from, and
trading options with, SemGroup. In November 2007, J. Aron
entered into a master agreement governing its relationship
with SemGroup, and in April 2008 BP entered into a similar
arrangement. Under the agreements, in the event of
SemGroup's default J. Aron and BP could set off any
outstanding amount due for oil purchases with the amount owed
on options trades. Until SemGroup's default, J. Aron and
BP always paid in full for their oil purchases and never
exercised a setoff right.
the late spring and early summer 2008, oil prices kept rising
and SemGroup continued losing on its trades. It failed to
receive additional financing to meet its ever-increasing
margin obligations. On July 17, 2008, as set out in their
agreement, J. Aron asked SemGroup for adequate assurance of
performance and that SemGroup meet certain credit-support
thresholds. When SemGroup did not respond, J. Aron called a
default. The parties thus set off the outstanding amounts
due. J. Aron owed to SemGroup $435 million in oil purchases,
and SemGroup owed to J. Aron $345 million in outstanding
options trades. Accordingly, J. Aron owed $90 million, the
net amount after the oil and options were set off.
22, 2008, soon after J. Aron called the default, SemGroup
filed for bankruptcy. This triggered a default as to BP, so
it also set off the prepetition amount it owed SemGroup for
oil less the amount SemGroup owed it for the options trades.
Consequently, BP owed $10 million.
its Chapter 11 filing, more than a thousand oil producers
were unpaid. Oil producers, purchasers, and SemGroup's
lending banks inundated the Bankruptcy Court with adversary
proceedings and motions to distribute SemGroup's assets.
The Court established omnibus procedures to determine the
producers' rights and priorities versus the banks, with a
single adversary proceeding for each state where the
producers sold product. The relative priority of the
producers and downstream purchasers was preserved for later
those rulings, the Bankruptcy Court first held that the
lending banks' security interests in SemGroup's
assets took priority over any purported lien or trust rights
granted under state law. It certified appeals directly to our
Court as matters of first impression, 28 U.S.C. §
158(d)(2), but the producers and lending banks settled while
the appeals were pending. By stipulation, the producers
reserved their right to pursue their claims against the
downstream purchasers and to appeal these rulings in the
J. Aron and BP filed separate adversary proceedings where
they sought to tender the amount they owed to the bankruptcy
estate in exchange for a release from all liability. The
producers also filed nearly 30 separate lawsuits against J.
Aron and BP in state and federal courts. These suits were
transferred to the Bankruptcy Court for resolution. In
September 2009, it confirmed the reorganization plan by which
J. Aron and BP's tendered funds were turned over to the
producers for full payment of oil delivered between July 2
and July 21, 2008. The tendered funds also paid off 12.9% of
the amount owed for oil sold from June 1 to July 1, 2008.
discovery process involving more than 100 parties, over 150
depositions, and millions of pages of documents, J. Aron and
BP moved for summary judgment against the Appellant-Producers
(hereafter, the "Producers"). The Bankruptcy Court
filed proposed findings of facts and conclusions of law
recommending summary judgment in favor of J. Aron and BP. It
concluded in exceptional depth and easily understood language
that there was no evidence of fraud and that J. Aron and BP
purchased the oil from SemGroup free of any purported
security interest either as (1) buyers for value, or (2) as
buyers in the ordinary course. In re SemCrude, L.P.,
504 B.R. 39, 44 (Bankr. D. Del. 2013). The District Court
overruled the Producers' objections to the Bankruptcy
Court's recommendation and adopted it. In re
Semcrude, L.P., No. 14-CV-41 (SLR), 2015 WL 4594516 (D.
Del. July 30, 2015).