DEALING WITH COUNTERPARTY/BANKRUPTCY RISK IN THE UPSTREAM OIL & GAS INDUSTRY Speakers: Mitchell E. Ayer and Tye C. Hancock

Transcription

1 DEALING WITH COUNTERPARTY/BANKRUPTCY RISK IN THE UPSTREAM OIL & GAS INDUSTRY Speakers: Mitchell E. Ayer and Tye C. Hancock

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3 HOW CAN WE PROTECT AGAINST COUNTERPARTY RISK IN THIS ENVIRONMENT? 3

4 TWO THEMES I. Things to do on the Front End At Nominal Cost that can save your Company Millions of Dollars a. Perfect Producer Liens b. Perfect Operators/Non Operators Liens c. Perfect Forced Pooling Operators Liens d. Record Assignments, or memoranda of farmout agreements anything you care about II. Vigilance in Bankruptcy Horror of Res Judicata Order Final in two Weeks Even if Relief Not Allowed by Law a. Cash Collateral/DIP Orders b. Don t Violate Automatic Stay c. File Reclamation Claim / 20 day claims d. File Expansive Proofs of Claim for every conceivable claim e. Beware Sale Orders/Cure Schedules f. Beware of Order Confirming Plan and Plan 4

5 What s the Point? Achieve the Benefit of Your Bargain Bankruptcy and Insolvency can interfere Reduce the probability of loss / downside risk by being proactive pre-bankruptcy Chapter 11 Orderly liquidation / Liquidating Plan Reorganization / Plan of Reorganization Asset Values are Allocated Based on Priorities Set forth in the Bankruptcy Code 5

6 Priority of Claims in Chapter 11 Owners are at the Top. Best to Own Mineral Interest or Real Property Interests such as Production Payment, Relinquished Interest, Working Interest. Generally, Secured Creditors (Lien Creditors) are Entitled to the Value of their Collateral 1. Administrative Claims (super-priority or general administrative) (20 day claims) 2. Unsecured Claims (priority or general unsecured) 3. Equity Interests (preferred or common) 6

7 Secured Creditors, Priority Liens Consensual Non-Consensual Must be Properly Perfected Notice Why? Bankruptcy Trustee Strong Arm Powers 7

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9 Secured Creditors, Priority Unperfected Liens are Almost Worthless in Bankruptcy Paid as Unsecured Claim Typically Pennies on the Dollar Perfect as Soon as You Have the Right to do so Because Timing Matters First in Time, First in Right / Prevalence of Asset Based Lending Preference Exposure 9

10 Practice Tip #1 Perfect Your Producers Liens Following bankruptcies of Basin, Inc., Brio Petroleum, Inc., Compton Petroleum Corp., and Gratex Corp. in The states of Texas, Oklahoma, Kansas and Wyoming enacted statutory producers liens. These liens protect sellers so that the seller will have a secured claim for hydrocarbons sold but not paid as of the filing. (New Mexico had previously enacted one in 1973). 10

11 Perfect Your Producers Liens Purchaser is often highly leveraged. The idea of the statute is to transfer to producers and royalty owners a purchase money security interest in proceeds of production. That way the producers get the proceeds rather than the Bank with its liens on all the assets. But, in the SemCrude case, Delaware bankruptcy court held the Bank primed Oklahoma, Texas and Kansas producers as no UCC filed against purchaser of production. Resulting loss of over 100 million dollars to producers. Practice Tip: File UCC to perfect statutory producers lien in the producer s state of incorporation. Should be on marketing checklist. 11

12 Joint Operating Agreements Operator and Non-Operating Working Interest Owners Bear Counterparty Risks Operator Operates, Markets Hydrocarbons Produced Non-operators bear risk of performance by the operator including that it will distribute production proceeds Operator bears the risk that non-operators will pay their proportionate shares of production costs Operator and Non-Operators Bear the Risk the Purchaser of Production will Pay for Production Sold Structural Solutions some companies drill Heads-Up 100% Ownership Eliminates Working Interest Owner Credit Risks 12

13 Operating and Non-Operating Liens Reciprocal Consensual Liens Granted Under Most JOAs to Secure Performance of the Counterparty Contractual Lien and Security Interest on Current and Future Acquired Real and Personal Property in the Contract Area Secures Operator as to Amounts owed by Non-Operating Working Interest Owners Secures Non-Operating Working Interest Owners as to Amounts Owed by Operator, Other Performance Obligations 13

14 Practice Tip #2 Perfect your Consensual Operator, Non-Operator s Liens Perfection Should be Undertaken in Accordance with Applicable State Law Realty: Record an Executed, Acknowledged Memorandum of the Operating Agreement in the Appropriate Land / Mortgage Records. Exhibit to AAPL Form JOA Record in All Counties Where the Property is Located Personalty: File a UCC-1 Financing Statement with the Secretary of State in the Counterparty s State of Incorporation 14

15 But Wait, There s More The Perfection of JOA Rights Also Perfects Your Relinquished (Non Consent) Interests Other Rights Under the JOA (if Recorded) May Qualify as Burdens on Title, Not Subject to Rejection 15 Important to do to Recover Non-Consent Penalties and to Prime Bank Liens on such Relinquished Interest (May also Work if JOA Referenced in Assignment to Counterparty). Determined according to applicable non-bankruptcy law, character of O&G lease TransTexas Gas Corp. v. Forcenergy Onshore, 2012 WL (Tex. App. Corpus Christi); April 12, 2012 (No CV), review denied (Nov. 16, 2012) (non consent interest not part of debtor s estate). Merely Personal Contractual Rights or Burdens on the Debtor s Title to Real Property i.e. covenants running with the land TX Real Covenants Touch and Concern the Land and Are in the Chain of Title 365, 363

16 Practice Tip #3 Perfect Forced Pool Unit Liens Certain States Grant Operators Statutory Liens on Participating Interests in Forced Pooled Units e.g. Oklahoma Must Perfect Statutory Liens in Accordance with Applicable Law For Statutory Liens on Force - Pooled Units, Usually Requires the Filing of Record the Order Approving the Unit 16

17 Related Issues Relating to the Perfection of JOA Rights Almost Always an Executory Contract Under 365. Material Unperformed Obligations Subject to Assumption or Rejection Assumption vs. Rejection Twilight Period Effect of Lien Cannot be Avoided by Rejection. (BUT lien must be properly perfected and must not be otherwise avoidable) 17

18 Practice Tip #4 Obtain and Record Any Assignments to Which You are Entitled If a Party has Purchased an Oil & Gas Interest, But Has Not Received and Recorded an Assignment/Conveyance If the seller files bankruptcy, are the purchaser s rights cut-off under the Bankruptcy Code? The issue has not been clearly determined Favorable Fifth Circuit precedent, but it s a difficult question based on the language of the Bankruptcy Code Best Practice: If this comes up, get something on the record. Hypothetical BFP. 18

19 Practice Tip #5 Follow Good Credit Risk Management Practices Review and Analyze your Rights under the JOA for Best Practices Cash call rights as Operator? Drilling and completion? Escrow rights as to pre-payments as non-operator? Identify any applicable non-consent penalties and deadlines relating thereto As Non-Operator, consider the character of pre-payments for operations in the event of a bankruptcy filings If appropriate, consider requesting amendments to the JOA in order to clarify ambiguities or address risk exposure Consider Third Party Guaranties Consider Bad Boy (and Bad Girl ) Guaranties aka Springing Guaranties. 19

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21 But that s illegal Republic Supply v. Shoaf, 815 F2d 1046 (5th Cir. 1987) Bankruptcy court confirmed a plan that released a third party guaranty in favor of Republic Bank. Republic Bank sued guarantor and guarantor argued res judicata barred the claim. Fifth Circuit admitted release of guaranty exceeded statute s authority but Republic Bank did not object or appeal confirmation order. Res judicata. 21 If fail to object to motion, waive your rights. Short appellate period After 14 days, order is final. If fail to timely appeal, waive your rights. If fail to obtain a stay and plan is consummated or sale closed, appeal may be moot.

22 #1 Don t trust Debtors. #2 See Practice Tip #1. Practice Tips: #3 Task someone and an alternate with reviewing every pleading filed. 22

23 23 How to View Bankruptcy Pleadings

24 Vigilance Cash Collateral and DIP Financing Debtor needs permission or a court order to use cash collateral. This is often done in connection with Debtorin-Possession (DIP) Financing. Need to be sure cash collateral order does not let DIP Lender prime you and if does that you get adequate protection in form of replacement liens, etc. Need to be sure Debtor does not seek to commingle royalty or working interest owner. Proceeds protected by local bankruptcy rule in Southern District of Texas not so in other jurisdictions. [Learning of New Bankruptcies. Our Firm has an Insolvency Blog in which we report on new oil and gas bankruptcies. Let us know if you would like to receive, and we ll sign you up.] 24

25 What is the Nature of an Oil & Gas Lease? Is the Lease Subject to Assumption or Rejection? Character determined by non-bankruptcy law. Examples: Texas a determinable fee; not a lease or other form of executory contract that a debtor may assume or reject. Kansas license to go upon the land in search of oil: subject to assumption or rejection under 365. But if rejected as a real property lease, lessee has protections under 11 USC 365(h)(i)(a)(ii) (lessee may retain its rights under such lease for the balance of term of lease and any renewal or extension). Federal OCS Leases Not Clear Prophylactic motion to assume leases. 25

26 Issues: Lease deadlines Lease Termination Provision for non-payment Liability of original lessee for royalties Legacy Liability developments ATP Gomez Abandonment Opinion, In Re ATP Oil & Gas Corp., Case No , Document No. 2078, Bankr. Ct. S.D. Tex. (June 20, 2013) Virgin Oil Supplemental Bond Issue 26

27 Don t Violate Automatic Stay Generally cannot take action against Debtor or Debtor s property after filing bankruptcy. If ask question I wonder if this action violates the automatic stay, file motion to lift stay. An exception is to file M&M lien or operator s statutory lien in states where lien relates back to first work. 27

28 Send Reclamation Demands Hydrocarbons are goods under the UCC. The seller of oil and gas has reclamation rights under both the UCC and the Bankruptcy Code. Outside of bankruptcy, the seller can reclaim goods for a ten-day period after delivery. That time limit does not apply if a misrepresentation of solvency has been made by the seller in writing. To: [Name of Buyer] I hereby reclaim from you the following goods sold to you on credit and received by you on [date of receipt]: [description of goods]. I reclaim the goods because of your insolvency. [Name of Seller] 28

29 Better practice is to demand everything since often don t know extent of misrepresentation of solvency and whether demand should be limited to ten days of production. The Code expands the time period during which sellers can exercise their reclamation rights. not later than 45 days after the date of receipt of such goods by the debtor; or not later than 20 days after the date of commencement of the case, if the 45-day period expires after the commencement of the case. 29

30 File 20 Day Claims Section 503(b)(9) entitles a seller to an administrative expense claim for the value of goods that were received by the debtor within 20 days of the commencement of the case and sold in the ordinary course of the debtor s business The seller need not demand reclamation under 546(c)(1) to be entitled to an administrative expense under 503(b)(9). Administrative expense claims come ahead of unsecured claims. Typically Debtor will establish procedure to file. 30

31 File Proofs of Claim Practice Tips: File Proof of Claim promptly the deadline is not the due date. List two people to receive notices of claim objection. Objections are sent regular mail and an objection filed eight years later may not reach intelligent life if only one person listed. General guideline is to file a claim for every conceivable claim and if possible as secured or priority. Remember by amount of claim, add asterisk, Plus attorneys fees, interest and other matters allowed by law. If a party to the purchase and sale agreement, file contingent proof of claim for indemnity. If debtor is successor in title, file contingent proof of claim, especially for offshore. 31

32 Bankruptcy Sales Beware Cure Schedules Key executory contracts can be assumed and assigned by the Debtor company JOAs, management agreements, development agreements these contracts are assumed or rejected as part of the sale process buyer will elect contracts to be assumed and assigned and debtor may be required to assume certain contracts as a condition of the sale debtor is required to cure any defaults and provide adequate assurance of future performance cost to cure may be accounted for in the sale price anti-assignment clauses not enforceable ipso facto clauses which provide that rights terminate upon bankruptcy filing are unenforceable be sure cost to cure is accurate. If Debtor lists zero and then cost to cure is $200,000 need to object or lose $200,

33 Bankruptcy Sales Sale is free and clear of all liens liens and encumbrances eliminated covenants running with land will continue successor liability is minimized Secured creditor can credit bid Court approves highest and best bid parties receive notice and opportunity to object Court enters order authorizing the sale Beware Res Judicata Effect can lose AMI or preferential right to purchase 33

34 34 Questions?