United States: Risks And Opportunities In Distressed Oil And Gas

In this eight-week alert series, we are providing a broad look at current and emerging issues facing the energy sector. Attorneys from across the firm will discuss issues ranging from environmental disclosures and risk management in business transactions to insolvency, compliance programs and intellectual property. Please click here to read all of our recent publications.


Recent volatility in the energy markets has put increasing stress on the capital structures of companies operating in those markets. When commodity prices were higher between 2010 and 2014, many of those companies took on significant amounts of debt to pursue new opportunities.1 Starting in 2014, oil prices dropped precipitously, and since then have remained at record lows.
 
This unique economic environment presents companies operating in this space (and their directors and officers) with numerous challenges involving complicated business and legal issues. This article focuses on three scenarios that an energy company may face depending on its particular financial situation—over-leverage, risk isolation, and strategic opportunities—and discusses some of the legal considerations with respect to each. Indeed, many of these scenarios have played out in one form or another across a variety of companies over the past 18 months.
 
The range of issues a company may confront depends to some extent on its overall financial position. At one end of the spectrum, highly-levered companies with significant debt loads may have difficulty complying with their current obligations (or may expect those difficulties on the horizon), but they may also be able to mitigate their financial situation by seeking to refinance or restructure a portion of their existing debt. Companies that are financially healthy, at least on an overall basis, often face different issues. Those companies may want to isolate or divest potential sources of financial stress to stem losses or to minimize the risk that they could adversely affect the enterprise as a whole. Finally, at the other end of the spectrum are companies that, given their relatively strong current financial condition, may in a position to take advantage of current market opportunities presented by the abundance of businesses that are not as healthy. Companies in these situations should focus on the risks attendant to taking such opportunities. 
 
Highly-Levered Companies May Face Obstacles and Opportunities
 
As noted above, many energy companies took on substantial amounts of debt during a period of higher commodity prices and more generous credit availability. By way of background, it is helpful to consider an example of a typical capital structure of an energy company, for example an oil or gas exploration and production (E&P) company. The top level of the capital structure of many energy companies consists of first lien secured debt, often in the form of a revolving asset-based loan facility. Lower levels of the capital structure may consist of secured or unsecured notes issued pursuant to an indenture.
 
The typical E&P company's debt capacity is linked to the value of its oil and gas reserves, a critical element of its revolving credit facility borrowing base and its high-yield indenture covenant measure of adjusted consolidated net tangible assets.2 Lower commodity prices and declining investments in new reserves have combined to reduce the value of reserves precipitously, thus restricting borrowing ability. With limited borrowing capacity and no viable refinancing options, E&P companies have been seeking other ways to increase liquidity, including the reduction or elimination of dividends, asset sales, and cost-cutting measures. With their remaining projected liquidity, E&P companies must weigh the risks and benefits of reinvestment, deleveraging through market debt purchases of their own debt now trading well below par, and a host of other in- and out-of-court restructuring options. 
 
Out-of-court options may include, among other things, consent solicitations, private exchanges, tender offers, and negotiating waivers or modified terms with credit facility lenders. Each of these options raises numerous complex business and legal issues that are beyond the scope of this article. In the context of private exchanges, one critical issue is that it is often difficult or impossible to get all noteholders to agree to any proposed restructuring. Recent litigation involving noteholder invocation of the Trust Indenture Act (TIA), which requires unanimous consent before an issuer can alter the basic payment terms of notes outside of bankruptcy,3 has brought into focus some potential limits of out-of-court note restructurings. Even when an overwhelming majority of (but not all) noteholders are in favor of an exchange, it may be difficult to consummate certain types of restructurings without the compulsive features of chapter 11.4
 
When out-of-court options are not viable or sufficient, chapter 11 bankruptcy restructuring, of course, is also one such option, and it carries with it both advantages and disadvantages that should be thoroughly considered. In the energy company context, certain bankruptcy rules may apply differently, and in ways that a borrower thinking about chapter 11 should fully consider in advance. For example, the general rules regarding the treatment of contracts apply in unique ways to contractual arrangements like joint operating agreements and oil and gas leases, which can be essential to an energy company's ability to continue operations. The presence of significant regulatory obligations, which are often treated differently in bankruptcy than run-of-the-mill creditor claims, should also be considered. And of course, even when chapter 11 might be a suitable solution from a legal perspective, its financial and other costs may weigh against pursuing bankruptcy. 
 
Financially Sound Companies May Nevertheless Seek to Isolate Risks
 
A company that is financially sound may nevertheless have subsidiaries or divisions under financial stress, or that are likely to come under financial stress, and it may want to make sure that stress is isolated.
 
In many situations, a company may make a strategic commitment to maintain its existing business, including underperforming divisions, during a period of depressed commodity prices, so that it can take advantage of any future rebound. This approach may carry with it an increased business cost, but may also present fewer legal risks than its alternatives.
 
As an alternative to maintaining distressed divisions through a downcycle, there may be instances where a company needs to wind-down or divest assets that it has determined are not worth its continuing investment. Implementing such divestitures can involve unexpected complications and risks.

Three primary considerations come to mind. First, certain intercompany arrangements like guaranties or co-liability on contracts can result in the continuing enterprise remaining liable as a contractual matter for the divested entity's debts. A company considering such a transaction should fully analyze which liabilities can be minimized or eliminated, and which may remain. Second, a buyer of a distressed business segment may insist on obtaining contractual indemnities from the seller as a condition to consummating the sale. From a seller's perspective, such provisions should be thoughtfully tailored to mitigate and contain the risk of continuing liability. Third, even putting aside intercompany and contractual liabilities, there may be extra-contractual liabilities that will remain with the seller following a divestiture. In particular, environmental regulations, which often impose strict liability, pose a risk of trailing a sale or wind-down. 
 
Thriving Companies May Seek to Take Advantage of Market Opportunities
 
A company that is in a strong financial position may seek to capitalize on opportunities presented by companies that are not as financially healthy by acquiring those companies or their assets. But the acquirer needs to approach such transactions with its eyes wide open.
 
The general rule is that a buyer does not take on liability for claims against a seller. However, the doctrine of successor liability can operate as an "exception" to that rule. Under the doctrine of successor liability, a creditor may be permitted to assert against a purchaser a claim based on the seller's pre-sale actions. It is important to diligence these potential liabilities, but in a distressed scenario, it is often difficult to obtain a full picture of the potential liabilities. In some circumstances, bankruptcy can help. The Bankruptcy Code allows, under certain circumstances, a sale "free and clear" of certain liabilities. But there are exceptions. As one example (and there are more), environmental liability cannot always be cleansed entirely in bankruptcy, and buyers can often be held strictly liable for clean-up obligations.
 
Even in situations where successor liability and debt concerns are contained, there are additional risks to consider. Where a transaction leaves creditors of the acquired entity with insufficient recoveries, they may seek to challenge the transaction. For example, in 2014, Sabine Oil & Gas LLC combined with and then merged into a publicly traded oil and exploration and production company, Forest Oil Corporation. Ultimately, the combined enterprise filed for chapter 11 bankruptcy.5 The Official Committee of Unsecured Creditors is seeking to assert a myriad of claims stemming from the business combination. The claims include fraudulent transfer claims against the company's lenders, as well as breach of duty claims against the directors and officers, and claims against the private equity owner of Sabine. This highlights the risk that a transaction will be put under a microscope in a distressed context, and emphasizes the care that must go into diligence and structure for these types of transactions.
 
Conclusion
 
Each of the scenarios discussed above (which are only some of the scenarios that companies in the current market may be facing) raises varied and complex issues (only some of which are previewed above). In addressing these scenarios, directors and officers often must consider the interests of various stakeholders, including shareholders, creditors, and other constituencies. Accordingly, it is important to involve legal counsel early in the process to strategize about ways to approach these and other scenarios to mitigate risk and maximize benefits while balancing the interests of various stakeholders. 

1 http://www.oilgasmonitor.com/the-domestic-oil-gas-industrys-current-debt-problem-a-new-chapter-of-an-old-book/9009/
2 The SEC requires public companies to use a discounted cash-flow analysis, called the "PV-10," to value their oil and gas assets. The PV-10 includes only "economically producible" reserves, which, under SEC rules, are measured by the average price during the 12-month period prior to the reporting date. 17 CFR 210.4-10(a)(22)(v). The backward-looking nature of the PV-10 calculation means that (a) in some scenarios, companies still have not felt the full effect of a downward adjustment of their reserve values on their borrowing ability, though they can see that effect on the horizon, and (b) even if oil and gas prices rebound, it will take some time for the increased value of a company's reserves to be reflected in its borrowing ability and ability to meet financial covenants.
3 Section 316(b) of the Trust Indenture Act provides that "the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security . . . shall not be impaired or affected without the consent of such holder . . ." Trust Indenture Act of 1939, 15 U.S.C. § 77ppp(b).
4 Marblegate Asset Mgt. et al. v. Education Management Corp., et al., 111 F. Supp. 3d 542 (S.D.N.Y. 2015); Marblegate Asset Mgt. et al. v. Education Management Corp., et al., 75 F. Supp. 3d 592 (S.D.N.Y. 2014); Meehancombs Global Opportunities Funds, L.P., et al. v. Caesars Entm't Corp., et al., 80 F. Supp. 3d 507 (S.D.N.Y. 2015); BOKF, N.A. v. Caesars Entm't Corp., Nos. 15–cv–1561 (SAS), 15–cv–4634 (SAS), 2015 WL 5076785 (S.D.N.Y. Aug. 27, 2015).
5 In re Sabine Oil & Gas Corporation, et. al., Case No. 15-11835 (SCC) (Bankr. D. Del.).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions