Strategies for Buying Energy Assets in Bankruptcy

THE UNIVERSITY OF TEXAS SCHOOL OF LAW The University of Texas School of Law Gas and Power Institute August 15-16, 2013 Four Seasons Hotel Houston, Texas Strategies for Buying Energy Assets in Bankruptcy David M. Bennett David M. Bennett Thompson & Knight LLP Dallas, Texas David.Bennett@tklaw.com 214-969-1486

Opportunities in Chapter 11 Reorganizations 1 Most modern bankruptcy sales of operating businesses occur in chapter 11: In a chapter 7, significant assets can be sold but the business is not a going concern. Planned chapter 11: Structure of a deal is in place prior to the bankruptcy filing; and An effective way to acquire assets from an insolvent entity. Nonconsensual chapter 11: All negotiations and entire sale process occurs after the bankruptcy filing; and Opportunities for buyers to become involved and acquire valuable assets.

Two Main Paths for Disposition of Debtor s Assets and/or Business Through Bankruptcy (1) Section 363 sale advanced by motion filed in bankruptcy case; or (1) Plan of reorganization 11 U.S.C. Section 1129. 2

Common Characteristics of Independent 363 Sale and Plan Are a means of selling assets of a debtor s bankruptcy estate; 541 defines property of the estate as all legal or equitable interests of the debtor in property as of the commencement of the case. Subject to Bankruptcy Court approval; Consent of all parties not required; 3

Common Characteristics of Independent 363 Sale and Plan (cont d.) Often better than a foreclosure because: Bankruptcy timeline is often more expeditious than nonbankruptcy alternatives; and For example, a 363 sale is often quicker than a state court judicial process. See, e.g., Cano Petroleum Inc. Sale Timeline (attached). Company s own management, rather than third party facilitates sale process (greater knowledge of the assets). 4

Common Characteristics of Independent 363 Sale and Plan (cont d.) Possibility of successor liability is minimized; and Obtain assignment of contracts despite contractual non-assignability clauses; See e.g., In Re Crow Winthrop Operating P ship, 241 F.3d 1121 (9th Cir. 2001). 5

What is a 363 Sale? Bankruptcy Section 363 permits debtors to sell some or all assets of bankruptcy estate; Based initially on business judgment of Debtor, but subject to bankruptcy court approval; Conducted under 363 of Bankruptcy Code, allowing the trustee (or Debtor in Possession) to use, sell, or lease, other than in the ordinary course of business, property of the estate if certain requirements are met; and The trustee must provide notice and a hearing. See 363(b)(1). 6

What is a 363 Sale? (cont d.) Sale is free and clear of all liens, including restrictions on use See 363(f). Contractual covenants no longer attach; See In re TWA, 322 F.3d 283 (3d Cir. 2003). Covenants running with land continue; and See Silverman v. Ankari (In re Oyster Bay Cove, Ltd.), 196 B.R. 251, 255 (E.D. N.Y. 1996). Obligations of ownership continue. Obligations to pay royalty; Plugging and abandonment and site restoration; and Regulatory obligations continue. 7

Contract Treatment in 363 Sale In bankruptcy, a debtor may assume or reject contracts that, as of the petition date, were executory. 11 U.S.C. 365. Sale of assets is frequently linked to assumption and assignment of executory contracts and unexpired leases pursuant to Bankruptcy Code 365. E.g., In re Cano Petroleum, Inc., No. 12-31549, 2012 Bankr. LEXIS 3281 (Bankr. N.D. Tex. July 18, 2012). Assumption and assignment of contracts as part of a 363 sale of assets requires notice to the agreement counterparties and an opportunity for the counterparties to demonstrate (1) the amount of the cure claims that must be paid as a condition to the assignment of the executory contracts; and (2) adequate assurance of future performance. See River Production Co. v. Webb (In the Matter of Topco, Inc.), 894 F.2d 727, 730 (5th Cir. 1990). 8

Procedural Principles of a 363 Sale that Cannot be Avoided Notice to all interested parties and opportunity for hearing (want a valid sale order a form of title insurance). See In re Cano Petroleum, Inc., 12-31549-BJH-11, 2012 WL 2931107 at *3 (Bankr. N.D. Tex. July 18, 2012). Interested parties include: creditors, equity holders, contract counterparties, regulatory authorities and parties who have otherwise appeared in the bankruptcy case. Opportunity for higher or better bids. Secret agreements among bidders to control bidding are prohibited (disclosed joint bidding is permitted). See In re Edwards, 228 B.R. 552 (Bankr. E.D. Pa. 1998); In re New York Trap Rock Corp., 42 F.3d 747, 752 (2d Cir. 1994). 9

Procedural Principles of a 363 Sale that Cannot be Avoided (cont d.) Court finding that assets are sold for highest & best possible price. See In re Moore, 608 F.3d 253, 263 (5th Cir. 2010). After exposure to market; Exposure can occur, at least in part, before filing bankruptcy; and Miscellaneous sale issues: Holdbacks? Finance contingencies? Non-cash consideration? 10

Elements of a Modern 363 Bankruptcy Sale Court order approves a structure for a transaction based on a stalking horse contract negotiated prepetition or a procedure for soliciting a stalking horse post-petition. The stalking horse is the initial bid (against which other bids are measured); and The stalking horse contract establishes structure for the transaction. 11

The Stalking Horse Contract Typically includes a breakup fee which is payable in the event the lead purchaser is not successful. Breakup fees must be reasonable; Usually 1-4% of the purchase price; Approved by court order in advance; and Designed to cover legal fees, expenses, and to encourage the lead buyer to move forward with the transaction. 12

Bankruptcy Marketing Procedures Debtor opens data room. Potential purchasers conduct due diligence. All bidders must best the stalking horse bid. Structure of bidding/auction: Minimum overbid (at least the breakup fee); Sets a date for bids or an auction date; Minimum incremental bid after first overbid; Forms of auction: private, sealed, court auction, or public outcry; Importance of back-up bidders; and 13

Bankruptcy Marketing Procedures (cont d.) Currency is typically cash (but not in every instance). Public companies may bid equity, but subject to the court assigning a value to such equity. See In re Crusader Energy Group Inc., 09-31797-BJH-11, 2011 WL 479565 (Bankr. N.D. Tex. Feb. 3, 2011). 14

Whether 363 Allows Sale Without a Plan? Law is unclear. See In re Braniff Airways, Inc., 700 F.2d 935 (5th Cir. 1983); In re Jasik, 727 F.2d 1379 (5th Cir. 1984). But see Matter of Cajun Elec. Power Co-op., Inc., 119 F.3d 349, 352 (5th Cir. 1997). Some judges will NOT allow 363 sale of all assets apart from a plan. See In re Braniff Airways, Inc., 700 F.2d 935 (5th Cir. 1983). If a freestanding 363 sale is the goal, care is taken in selecting the court where case is filed. 15 Venue selection may be relevant. See 28 U.S.C. 1408 (options for venue selection include the debtor s domicile, residence and principal place of business in the United States).

Benefits of a 363 Sale free and clear (vs. sale through a Plan of Reorganization) Can be accomplished quickly. See In re Lehman Bros. Holdings Inc., 445 B.R. 143, 155 (Bankr. S.D.N.Y. 2011) (conducting initial 363 sale within 5 days of petition date). A sale through a plan is subject to more uncertainty because plan confirmation requires additional requirements and procedural steps. See 11 U.S.C. 1129. Approval of Disclosure Statement. See 11 U.S.C. 1129(a)(5). Solicitation of creditor votes. See 11 U.S.C. 1129(8). Higher burden of proof. See In re Genesis Health Ventures, Inc., 266 B.R. 591 (Bankr. D. Del. 2001)(To confirm a proposed Chapter 11 plan of reorganization, the proponent bears the burden of establishing the plan's compliance with each of the thirteen elements of 11 U.S.C. 1129(a)). 16

Benefits of a Sale through a Plan (vs. 363 sale) Plan is dispositive of most issues in the bankruptcy case. Plan allows for more flexibility. For example, the sale of equity in a reorganized debtor can only be accomplished through a plan. Sale accomplished through a plan avoids the argument that such sale cannot be accomplished outside of a plan (i.e., avoid the sub rosa argument). 17

Burdens Associated with a Bankruptcy Sale Generally, bankruptcy courts require some benefit to the estate and parties-in-interest other than senior secured lender. What if the ONLY creditor benefiting from sale is a secured creditor? Chapter 11 is NOT a device for transferring title to secured creditors. See In Re Theroux, 169 B.R. 498, 499 (Bankr. D.R.I. 1994) (declining to approve a sale because the sale only benefitted the secured creditor). See Matter of Winshall Settlor s Estate, 758 F.2d 1136, 1137 (6th Cir. 1985)( The purpose of chapter 11 reorganization is to assist financially distressed business enterprises by providing them with a breathing space in which to return to a viable state ). 18

Burdens Associated with a Bankruptcy Sale (cont d.) There must be something in it for the estate and the unsecured creditors. See In re Fremont Battery Co., 73 B.R. 277 (Bankr. N.D. Ohio 1987) (finding no business reason to justify sale, the proceeds of which would, at best, benefit only one creditor). Can be overcome if some (modest) cash or other value moves to estate. At a minimum, an amount sufficient to pay administrative claims. Confirmation of plan requires payment of administrative claims (which can be significant). See 11 U.S.C. 1129(a)(9). 19

Influencing the Sale Process Assets in bankruptcy are not automatically for sale. At the beginning of a bankruptcy case, the debtor has control over the process, but, the debtor s control has limits. 20 See 1121(b)(providing that the debtor has the exclusive right to file a chapter 11 plan during the first 120 days of its bankruptcy case). A debtor can request extension of exclusivity period, but the extension is limited to 18 months after the petition date. See 1121(d)(2)(A). Unsecured Creditors Committee or any creditor may attempt to gain control by (1) seeking examiner (mismanagement); or (2) proposing a plan.

Influencing the Sale Process (cont d.) A cramdown plan (after expiration of exclusivity) can include an involuntary sale. Interested buyer that is not a creditor has limited standing. May purchase a claim to establish standing. Interested parties have standing to complain about the process. Join forces with Unsecured Creditors Committee; Seek to be a DIP Lender; Terminate plan exclusivity; and File a competing plan. 21

Creditors Committee as Part of Strategy to Influence the Sale Process Whether an interested purchaser should serve on the creditors committee? 11 U.S.C. 1102 Members of committee may have access to inside information. Service on committee creates conflicts that could serve as grounds for litigation; and Membership will subject any claim purchase to greater scrutiny. 22

Lock-up Agreements as Part of Strategy to Influence Sale Process Lock-up agreements (a/k/a Plan Support Agreements ) provide that parties will agree to a plan if it contains certain, pre-negotiated terms. See In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013). Lock-up agreements with debtors, shareholders, creditors committees. Generally entered into prior to bankruptcy filing; Not per se improper; See In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013). 23

Lock-up Agreements as Part of Strategy to Influence Sale Process (cont d.) Disclosure is required; Assets must be exposed to the market during bankruptcy case, however briefly; and Remedies for breach? Not many. An effective way to control the process. And speed it along. Often the basis for a pre-packaged or pre-negotiated Plan of Reorganization. 24

Buying a Secured Claim as Part of Strategy to Influence the Sale Process Secured creditors are allowed to credit bid for its collateral using the debt it is owed to offset the purchase price. See 11 U.S.C. 363(k). See also RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012). Secured creditor can credit bid up to the amount of its indebtedness. Can only credit bid as to collateral. See Quality Props. Asset Mgmt. Co. v. Trump Va. Acquisitions, LLC, No. 3:11 CV 00053, 2012 WL 3542527, at *7 n.13 (W.D. Va. Aug. 16, 2012). Must pay cash for senior indebtedness (superior to the credit bidder). 25

Buying a Secured Claim as Part of Strategy to Influence the Sale Process (cont d.) US Supreme Court recently ruled that a secured creditor cannot be denied the right to credit bid. See RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012). Credit bidding can sometimes chill the process. If a dispute exists as to the validity or amount of secured claim, it may create issues as to credit bidding. See In re Daufuskie Island Props., LLC, 441 B.R. 60 (Bankr. D.S.C. 2010). 26

Becoming DIP Lender as Part of Strategy to Influence the Sale Process Third parties may become Debtor-in-Possession ( DIP ) lender. See 11 U.S.C. 1107(a); see also In re Downey Reg'l Med. Ctr. - Hosp., Inc., No. 09-bk-34714, 2009 Bankr. LEXIS 4859 at *11 (Bankr. C.D. Cal. Sept. 18, 2009). Obtain information; Debtor pays for due diligence; and Term of credit agreement can establish deadlines for filing and/or obtaining plan confirmation. 27

Applicable Energy Regulatory Risks and Considerations When a debtor s property includes interests in unproductive assets, the debtor may seek to abandon such interest to relieve the estate of burdensome liabilities pursuant to 11 U.S.C. 554 or 11 U.S.C 365. 11 U.S.C. 554 allows a debtor to abandon any property of the estate that is burdensome to the estate or that is of inconsequential value to the estate. 11 U.S.C. 365 allows debtor to reject burdensome or nonbeneficial executory contracts. See Contract Treatment in 365 Sale slide. Issue: May a debtor exercise its abandonment or rejection power to avoid regulatory obligations? 28

Oil and Gas Regulatory Obligations State and federal obligations that may burden buyers of oil and gas assets: E.g., TEX. NAT. RES. CODE ANN. 89.011 (providing that operator of a well shall properly plug the well). Plugging of the well and removal of facilities from the site are defined as plugging and abandonment ( P&A ) or decommissioning activities. 30 CFR 250.1700, et. seq. E.g., 30 CFR 256.52 (providing that lessee or designated operator is required to obtain surety bond guaranteeing performance of all contractual and regulatory obligations under lease before DOI will issue new lease or approve assignment of existing lease). 29

Power Generation Regulatory Obligations State and federal obligations that may burden buyers of power generation assets: E.g., 16 U.S.C. 824 (authorizing Congress (through Federal Energy Regulatory Commission) to regulate the interstate sale of electricity through the wholesale rates that utility companies are permitted to charge). E.g., Tex. Utilities Code 36.001 (authorizing PUC to establish and regulate utility rates as long as not in conflict with a ruling of a federal regulatory body). 30

Energy Regulatory Obligations Continue Post-Bankruptcy Courts generally have held that a debtor s abandonment and/or rejection power does not release or modify regulatory obligations. E.g., Texas v. Lowe (In re H.L.S. Energy Co.), 151 F.3d 434, 437 (5 th Cir. 1998)(holding that P&A liabilities entitled to administrative claim priority if plugging obligations accrued post-petition under state law because debtor cannot avoid such liability and, thus, the expenses are necessary and beneficial to the estate under an administrative claim analysis). E.g., Midlantic Nat l Bank v. New Jersey Dep t of Envtl. Protection, 474 U.S. 494, 507 (1986)(holding that trustee may not abandon property in contravention of a state law reasonably designed to protect public health or safety). 31

Energy Regulatory Obligations Continue Post-Bankruptcy(cont d) A bankruptcy court generally does not substitute its judgment for the judgment of a regulatory authority. E.g., Louisiana PSC v. Mabey (In re Cajun Elec. Power Coop., Inc.), 185 F.3d 446, 451 (5 th Cir. 1999)(citing to 11 U.S.C. 1129(a)(6) (requiring regulatory authority approval of rate changes provided in plans) and holding that bankruptcy court abused its discretion by enjoining PUC from decreasing rates of debtor, regulated electricity utility). E.g., Mirant Corp. v. Potomac Electric Power Co. (In re Mirant Corp.), 378 F.3d 511 (5th Cir. 2004)(allowing debtor, public electricity utility, to reject regulated contract for energy rates notwithstanding FERC s exclusive jurisdiction over such contract rates because rate is given full effect when determining damages resulting from rejection). E.g., Gulf States Utilities Co. v. Alabama Power Co., 824 F.2d 1465 (5 th Cir. 1987)(holding that federal courts have jurisdiction over FERCregulated contract disputes so long as the outcome does not override FERC-approved rates). 32

Cano- Case Timeline Event Petition Date T&K, Blackhill, Canaccord retained Plan & Disclosure Statement filed Amended Disclosure Statement filed Amended Plan filed Disclosure Statement Hearing (continued) Second Amended DS filed Second Amended Plan filed Second Amended DS approved Bid Deadline Notification of Qualifying Bids (NBI declared Successful Bidder) Ballot/Global Objection Deadline Combined Hearing (Sale and Confirmation) Plan Confirmed Effective Date Date March 7 th March 7 th March 8 th May 21 st May 21 st May 24 th May 30 th May 30 th May 31 st June 6 th June 8 th July 6 th July 16 th July 16 th August 2 nd 33

David M. Bennett Partner, Dallas Office 214,969.1486 David.Bennett@tklaw.com Assists clients in the formulation, implementation, and confirmation of plans of reorganization, including loan restructurings and out-of-court Represents debtors, creditors, capital providers, and other counter-parties in reorganization and liquidation bankruptcy proceedings Assists clients in maximizing unsecured claims and counsels clients regarding postbankruptcy recovery of security Extensive experience representing unsecured creditors committees and other creditor or equity groups in bankruptcy cases Recognized in The Best Lawyers in America, Chambers USA, Texas Super Lawyers, and Texas Lawyer s Go-To Guide for Bankruptcy Law 34