In a recently decided, but long-running dispute, the U.S. Court of Appeals for the Third Circuit has found that oil ­producers do not hold automatically ­perfected security interests in product they sell to midstream intermediaries, nor are the proceeds generated through the subsequent sale of such product held in an implied trust for the benefit of the upstream producers, as held in Arrow Oil & Gas v. J. Aron (In re SemCrude), 2017 U.S. App. LEXIS 12975 (3d Cir. July 19). In its ­decision, the Third Circuit determined that an automatically perfected security interest or implied trust would result in “chaos” in an industry where oil is comingled and sold multiple times in the stream of commerce.

SemGroup L.P. was a midstream oil service provider that, along with its ­subsidiaries, bought oil from thousands of producers, including those located in Kansas, Oklahoma and Texas (collectively, the appellants). SemGroup then resold the oil to downstream purchasers, including J. Aron & Co. and BP Oil Supply Co. ­(collectively, the appellees). Per industry custom, SemGroup expressly warranted oil sales as being “free from all royalties, liens, and encumbrances.”

SemGroup also engaged in trading oil futures with the appellees. SemGroup sold “call options,” whereby the purchaser of the option would pay SemGroup an upfront premium in exchange for the right to ­purchase an amount of oil at a set price on a certain date. If on the futures option date, the market price for oil was less than the option price, the option became worthless leaving SemGroup with the profit from the upfront premium. If, however, on the option maturity date, the market price for oil exceeded the strike price, SemGroup would lose money as it could have sold the oil for more on the open market but was constrained by the options price.