UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

In re: PACIFIC ENERGY RESOURCES LTD., et al. Debtors.

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Chapter 11 Case No. 09-10785 (KJC) (Jointly Administered)

Related Docket No. 309

Hearing Date: June 3, 2009 at 1:00 p.m. (ET) Committee Objection Deadline: May 27, 2009 at 4:00 p.m. (ET)

LIMITED OBJECTION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS TO THE MOTION BY MEDEMA PROPERTIES AND MEDEMA FAMILY TRUST TO COMPEL The Official Committee of Unsecured Creditors (the Committee) of the abovecaptioned debtors and debtors-in-possession (the Debtors),1 through its undersigned counsel, hereby submits this limited objection (the Objection) to the Motion by Medema Properties and Medema Family Trust to Compel Pacific Energy Alaska Holdings to Segregate and Pay Medemas 1.25% ORRI in the West MacArthur Leases and Provide a Full Accounting of Production from the Relevant Properties Including Disposition of Cash Proceeds from Sale of Production, [Dkt. No. 309] (the Medema Motion). The Medema Motion asks the Court to require one of the debtors, PEAO, to pay Medemas 1.25% overriding royalty interest in oil and gas leases in West MacArthur, Alaska (ORRI or override), to segregate all funds pertaining to that ORRI, and to account for all production and cash proceeds of Medemas ORRI . . . . Memorandum in Support of Medema
The Debtors in these Chapter 11 cases are: Pacific Energy Resources Ltd. (PERL); Petrocal Acquisition Group; Pacific Energy Alaska Holdings, LLC; Carneros Acquisition Corp.; Pacific Energy Alaska Operating LLC (PEAO); San Pedro Bay Pipeline Company; Carneros Energy, Inc.; and Gotland Oil, Inc.
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Motion (Medema Memorandum) at 1. As set forth below, the Committee opposes the Medema Motion with respect to pre-petition ORRI claims and proposes an orderly process for addressing the post-petition ORRI claims of Medema and certain other ORRI holders. DISCUSSION As a preliminary matter, the type of relief sought by the Medema Motion must be brought by commencing an adversary proceeding, not by motion.2 See 10 Collier on Bankruptcy, 7001.02 (15th Ed. Rev.) (explaining that actions or proceedings for the recovery of money or property, whether brought by a trustee or debtor or by a third person claiming property held by the trustee or debtor, will come within Rule 7001 [of the Federal Rules of Bankruptcy Procedure]) (emphasis added).3 In any event, the Medema ORRI claims were previously addressed in Medemas response to the Debtors Emergency Motion for Authority to Pay or Honor Pre-Petition and Post-Petition Obligations to Royalty Interests, [Dkt. No. 15] (the Royalty Motion), in which Medema argued that PEAO had no discretion in whether to pay the ORRI claims because the
Medema essentially recognized this requirement in its response to the Debtors Emergency Motion for Authority to Pay or Honor Pre-Petition and Post-Petition Obligations to Royalty Interests, [Dkt. No. 15]: In the event that the Debtors assert any interest in the ORRIs, Medema insists on having the matter fully and appropriately adjudicated in an appropriate adversary proceeding. Any assertion by the Debtors that they hold an interest in the ORRIs cannot be addressed as an incidental part of an emergency first day motion. Response by Medema Family Trust to Debtors Emergency Motion for Authority to Pay or Honor Prepetition and Postpetition Obligations to Royalty Interests at P 9, [Dkt. No. 151] (emphasis added).
3 2

Rule 7001 of the Federal Rules of Bankruptcy Procedure provides: An adversary proceeding is governed by the rules of this Part VII. following are adversary proceedings: (1) a proceeding to recover money or property . . . ; (2) a proceeding to determine the validity, priority, or extent of a lien or other interest in property . . . ; . . . (7) a proceeding to obtain an injunction or other equitable relief . . . ; The

F. R. Bankr. P. 7001 (emphasis added).

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ORRIs constituted a property interest of Medema and the other ORRI holders. The Committee addressed that argument in its subsequent response to the Royalty Motion (the Committee Response). There, the Committee demonstrated that the pre-petition claims of royalty holders (including ORRI holders) with respect to oil already produced and sold constituted unsecured claims against the bankruptcy estate, rather than separate property of the holders. Response at 9, 11. In addition to addressing the ORRI interests of certain lender parties, id. at 31-39, the Committee indicated that it could not determine the status of the numerous remaining ORRI interest holders from the information available and therefore objected to paying those parties post-petition claims on an emergency basis. Id. at 9, 40. The Medema Motion addresses the Committees arguments with respect to the nonlender party ORRIs. Medema first contends, as it did in its previous pleading, that an ORRI is an interest in land that is generally superior to later-created liens and other interests. Medema Memorandum at 3. The point at issue, however, is not whether an ORRI is a property interest in general, but rather the status of the claims of ORRI holders to the cash proceeds of sales of oil that occurred prior to the filing of the petition. Applicable case law and general principles of oil and gas law support the view that the non-payment of pre-petition ORRI claims by the debtor gives rise to a contract claim by the ORRI holder against the debtor, because the ORRI holder has no separate property interest in undifferentiated cash proceeds deposited into the debtors general accounts. Committee Response at 11, 15-16.4 Thus, as to pre-petition ORRI claims, Medemas argument that it holds a separate property interest is unavailing.

See also Tarrant v. Capstone Oil & Gas Co., 178 P.3d 866, 872 (Okla. Civ. App. 2008) (failure to pay royalties . . . created a debt but did not result in deprivation of tangible personal property where royalties were cash payments and not in-kind).

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Second, Medema argues that its ORRI interest, although not a production payment as defined in the Code, is obviously a much greater interest than a mere oil payment or production payment and therefore should receive the same treatment Congress provided to production payments in section 541(b)(4)(B) of the Code. Medema Memorandum at 3-5. The short answer to Medemas contention is that Congress has spoken explicitly to the treatment of production payments and has not done so as to ORRIs. Since Medema implicitly concedes that its ORRI interest is not a production payment (i.e., it is not limited by a specific volume or value cap), section 541(b)(4)(B) does not apply here. Finally, Medema argues that Alaska statutory law creates lien rights in favor of the ORRI holder, Medema Memorandum at 5, implying that Medema has a statutory lien protecting its right to collect unpaid ORRIs from the debtor. Id. at 5-7. However, Medema has misconstrued the statute on which it purports to rely. That statute exists primarily to provide a statutory lien in cases where the owner of a tract within a unit fails to pay its share of unit operating expenses.5 The first sentence of the applicable statutory provision states: Subject to such reasonable limitations as may be set out in the plan of unitization, the unit has a first and prior lien upon the leasehold estate and all other oil and gas rights (exclusive of a landowners royalty interest) in and to each separately owned tract, the interest of the owners in and to the unit production and all equipment in the possession of the unit, to secure the payment of the amount of the unit expense charged to and assessed against such separately owned tract. AS 31.05.110(h) (emphasis added). The next sentence provides that the unit must look first to the interest of the lessee responsible for the operating costs and may resort to overriding

A unit is typically a set of properties that share production from a single pool of oil and are jointly operated under a unit agreement with each of the respective owners sharing proportionately in the expenses and production generated by the unit. See White v. State Dept. of Natural Resources, 984 P.2d 1122, 1125 (Alaska 1999).

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royalties, oil and gas payments, or other interests . . . only in the event the owner . . . primarily responsible fails to pay . . . . Id. The section principally relied on by Medema then goes on to provide that, if an overriding royalty (or other interest) holder elects to pay the unit expenses for the purpose of protecting such interest, or the amount of the assessment in whole or in part is deducted from the unit production to the credit of such interest, the holder of that interest is subrogated to all the rights of the unit with respect to the interest or interests primarily responsible for the assessment of unit expenses. Id. Thus, under a proper reading of the statute, the ORRI holder has a statutory lien against the lessee (i.e., the debtor in this situation) only if the ORRI holder has paid operating expenses of the unit that the lessee failed to pay and then only to the extent of such payments (not for payment in full of its ORRI interest in the lease at issue). Since Medema has not alleged that PEAO has failed to pay its assessed share of expenses in the West MacArthur unit, or that Medema has stepped in to make such payments on PEAOs behalf, AS 31.05.110(h) is simply irrelevant here. Medema nonetheless contends that the lien rights established in AS 31.05.110(h) make it impossible for the holder of the net revenue interest (in this case the Debtor) to draw any production or cash proceeds out of the leasehold for its own benefit at the expense of the ORRI holders. Medema Memorandum at 6. Medema reaches this strained conclusion by asserting that [i]f unit costs have been paid, but the amount due the ORRI holder has not been paid, then the ORRI holder is deemed to have paid the production costs and has the lien rights of the unit. Id. Medema cites no authority for this proposition, however, and nothing in the statute supports such deeming. Rather, if the debtor has paid the unit expenses, AS 31.05.110(h)

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simply does not apply by its own terms. Since Medema has not alleged any unpaid unit expenses applicable to it, the asserted statutory lien does not exist. In any event, as Medema appears to acknowledge (Medema Memorandum at 5), the issue of a statutory lien arises only if Medemas pre-petition ORRI claim relating to oil produced and converted to cash does not constitute a separate property interest of Medemas. As a result, even if the statutory lien were applicable (which it is not), Medema would not have a right to be paid ahead of all other creditors, but would at most have a secured rather than unsecured claim. With respect to Medemas claim for post-petition ORRI payments, the Committee notes that there are a large number of individuals and other entities that appear to hold or assert ORRI claims similar in nature to those of Medema.6 The Committee believes it would be in the best interest of all concerned for the Court to establish an orderly process for determining what claimants exist and the validity of their respective claims for ongoing post-petition ORRIs on production by the Debtors, so that similarly situated parties are treated alike to the extent possible. The Committee therefore requests a brief period of 30 days from the date of the decision on Medemas Motion in which the Committee and other interested parties, with the cooperation of the Debtors, can inquire into the particulars of the various post-petition ORRI claims and determine whether any of them is subject to a bona fide dispute. Any post-petition claims not disputed at the end of that period could then be paid in the ordinary course of business.

For example, on May 27, 2009, two joinders were filed in regard to the Medema Motion. See Joinder by John M. Robinson and Debra Robinson in Medema Properties and Medema Family Trusts Motion to Compel Pacific Energy Holdings to Pay Overrides in the West MacArthur Leases, to Segregate, and to Account for Production from Other Relevant Properties; Joinder by Lab Properties in Medema Properties and Medema Family Trusts Motion to Compel Pacific Energy Holdings to Pay Overrides in the West MacArthur Leases, to Segregate, and to Account for Production from Other Relevant Properties.

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CONCLUSION
For the reasons stated, the Committee respectfully requests that this Court enter a modified order consistent with the Committees proposed modifications set forth above.

Dated: May 27, 2009

Respectfully submitted,

By: /s/ John H. Schanne II_______________________ David B. Stratton, Esq. (DE No. 960) James C. Carignan, Esq. (DE No. 4230) John H. Schanne II, Esq. (DE No. 5260) PEPPER HAMILTON LLP Hercules Plaza, Suite 5100 1313 N. Market Street P.O. Box 1709 Wilmington, Delaware 19899-1709 Tel: (302) 777-6500 Fax: (302) 421-8390 and Francis J. Lawall, Esq. PEPPER HAMILTON LLP 3000 Two Logan Square Eighteenth & Arch Streets Philadelphia, PA 19103-2799 Tel: (215) 981-4000 Fax: (215) 981-4750 and Filiberto Agusti, Esq. (DC Bar No. 270058) (admitted pro hac vice) Steven Reed, Esq. (DC Bar No. 337501) (admitted pro hac vice) Joshua R. Taylor, Esq. (VA Bar No. 45919) (admitted pro hac vice) STEPTOE & JOHNSON LLP 1330 Connecticut Avenue NW Washington, DC 20036 Tel: (202) 429-3000 Fax: (202) 506-3902

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and Robbin L. Itkin, Esq. (CA Bar No. 117105) (admitted pro hac vice) Katherine C. Piper, Esq. (CA Bar No. 222828) (admitted pro hac vice) STEPTOE & JOHNSON LLP 2121 Avenue of the Stars Suite 2800 Los Angeles CA 90067 Tel: (310) 734-3200 Fax: (310) 734-3300 Counsel for the Official Committee of Unsecured Creditors of Pacific Energy Resources Ltd., et al.

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CERTIFICATE OF SERVICE I, John H. Schanne, II, hereby certify that on May 27, 2009, I caused to be served the Limited Objection of the Official Committee of Unsecured Creditors to the Motion By Medema Properties and Medema Family Trust to Compel upon the following entities in the manner indicated: Laura Davis Jones, Esq. Scotta E. McFarland, Esq. Robert M. Saunders, Esq. James E. ONeill, Esq. Kathleen P. Makowski, Esq. Pachulski Stang Ziehl & Jones LLP 919 N. Market Street, 17th Floor P.O. Box 8705 Wilmington, Delaware 19899-8705 Facsimile: (302) 652-4400 VIA FACSIMILE AND HAND DELIVERY Ira D. Kharasch, Esq. Pachulski Stang Ziehl & Jones LLP 10100 Santa Monica Boulevard Los Angeles, California 90067-4100 Facsimile: (310) 201-0760 VIA FACSIMILE AND FEDEX Joseph R. McMahon, Esq. Office of the United States Trustee J. Caleb Boggs Federal Building 844 King Street, Suite 2207 Lockbox No. 35 Wilmington, Delaware 19801 Facsimile: (302) 573-6497 VIA FACSIMILE AND HAND DELIVERY William Chipman, Jr., Esq. Landis Rath & Cobb LLP 919 Market Street Wilmington, Delaware 19801 Facsimile: (302) 467-4450 VIA FACSIMILE AND HAND DELIVERY John C. Siemers, Esq. Burr, Pease & Kurtz 810 N Street, Suite 300 Anchorage, AK 99501-3293 Facsimile: (907) 258-2530 VIA FACSIMILE AND FEDEX Lorenzo Marinuzzi, Esq. Morrison & Foerster LLP 1290 Avenue of the Americas New York, New York 10104 Facsimile: (212) 468-7900 VIA FACSIMILE AND FEDEX Jeffrey D. Landry, Esq. Senior Assistant Attorney General State of Alaska 1031 West 4th Avenue, Suite 200 Anchorage, Alaska 99501-1944 Facsimile: (907) 279-8644 VIA FACSIMILE AND FEDEX

Dated: May 27, 2009 Wilmington, DE

/s/ John H. Schanne, II John H. Schanne, II (DE No. 5260)

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