Download the slides to the last installment of our webinar series where we address the issues faced in a hypothetical chapter 11 case from the perspective of the Debtor, Senior Secured Creditor, Junior Secured Creditor, Unsecured Creditors' Committee, and Investment Banker.
For questions, contact Partner Trent Rosenthal at trosenthal@burlesonllp.com.
Drilling Down on Strategic Alternatives in the Current Energy Crisis: Chapter 11 in Practice - A Case Study (June 3, 2015)
1. Drilling Down on
Strategic Alternatives
in the Current Energy Crisis
Part IV: Chapter II in Practice – A Case Study
Wednesday, June 3, 2015
12:00-1:00 pm Central
WEBINAR SERIES
2. Housekeeping Items
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webinar. We will also have the recording on our website
(www.burlesonllp.com)
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̶ Enter questions into the Questions Pane and we will
respond in the Q&A session at the end
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or other relationship with, any of Burleson LLP, Gibson, Dunn & Crutcher LLP, M1 Energy Capital, or OFSCap. Parties are urged to consult their own advisors for such advice.
3. Speakers
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Trent Rosenthal (moderator) | Restructuring & Reorganization Partner – Burleson LLP
● Board Certified in Business Bankruptcy Law by the Texas Board of Legal Specialization
● Over 3 decades of experience in restructuring and bankruptcy law
● Handled numerous oil & gas restructurings and workouts
James (“Jim”) C. Row, CFA | Managing Director & Founder – OFSCap, LLC
● Background in energy investment banking (international/domestic)
● Securities and valuation expert
● Former E&P operator and former CFO
Michael Rosenthal | Co-Head, Restructuring & Reorganization Practice – Gibson Dunn
● Represents debtors/creditors in complex, high profile national & cross-border restructurings and Chapter 11 cases
● Provides insolvency-related board advice to large public and privately held companies
● Experience with corporate separateness and successor strategies and defenses
Rich Bernardy | Managing Director – M1 Energy Capital
● Over 25 years of banking and finance, management and entrepreneurial experience
● Experience includes project and structured finance, private equity, debt securities, sponsorship of equity
investments, financial risk management, accounting, forecasting and capital budgeting
4. Agenda
• Key Issues in E&P Cases
• Overview of Past Webinars – Background for
Discussion
• Case Study Discussion
• Q&A Session
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6. Oil & Gas Financing: Reserve-Based Loans (RBLs)
• Unlike asset based credit facilities in other industries, a typical
RBL has no specified advance rates – the lenders set that based
upon facts at the time
o advance rates depend on whether proved producing or non-
producing, developed or undeveloped
o discount rate is key – 8-10%
o assumption about rate of production – will depend on projected
forward rates for the price of oil/gas - so if the price of oil is low,
production may not seem economical, reducing the PV of the
reserves
o Each lender has their own price deck
• The run up to bankruptcy may be different in an RBL financing
because the lenders tend to lower advance rates if the E&P
borrower has financial difficulty.
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7. Oil & Gas Interests, Generally
• An owner of mineral interests, i.e. the rights to gas, oil and other
minerals at or below the surface of a parcel of land (often the
landowner) will typically seek an oil and gas exploration and production
company to extract the oil and gas from the land. The mineral interest
owner grants the exclusive right to explore, drill, and produce oil and
gas conveying a “working interest”
• The working interest owner bears the risks, costs, and expenses
associated with exploring for, developing, and producing oil and gas
• Net Profits Interests (“NPIs”), Overriding Royalty Interests (“ORRIs”),
and Production Payments (“PPs”) (each as described below) are
generally created out of the working interest of an existing oil/gas lease
o Investors may purchase these interests in oil and gas production, but it is important
to understand the treatment of such interests in bankruptcy
o In re Delta Petroleum Corporation – In both California, Colorado, and perhaps other
states, an ORRI is an interest in real property. The assignment must be recorded to
be effective and trump a bankruptcy estate. If recorded, not property of the estate
and rides through the bankruptcy case. If not, available for creditors. Best practice
is to record because another court may apply the law in its jurisdiction to eliminate
your ownership
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8. Oil & Gas Interests, Generally
• Property of the estate generally does not include
o Volumetric production payments sold to an entity that does not
participate in the operation of the property (Sec. 546 (b)(4)(B)
o Any interest in liquid of gaseous hydrocarbons to the extent the
Debtor has transferred or agreed to transfer pursuant to farmout
agreement, but does include the consideration the Debtor retains,
receives, or is entitled to receive for transferring to a farmout
agreement. Sec. 546 (b)(4)(A) and last sentence of Sec. 546 (b)
• Transfer or sale of an interest might be re-
characterized as a financing transaction, making
the asset property of the estate and payment of
the debt would need to be addressed. In re ATP Oil
& Gas, Debtor
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9. Summary of Various Oil & Gas Interests
• Mineral Interest is the ownership of all rights to gas, oil and other
minerals at or below the surface of a tract of land. The mineral
interest includes the exclusive right to explore, drill and produce the
oil, gas and any other mineral at or below the surface of a tract of land.
Mineral Interest
• Working Interest is an interest in an oil and gas lease that gives the
owner of the interest the right to drill for and produce oil and gas on
the leased tracts of land and requires the owner of the interest to pay
a share of the costs of drilling and production operations.
• The working interest will always pay a greater percentage of the
production costs than it will receive in percentage of the production.
For example, the working interest would bear 100% of the
production costs, but receive only 87% of the production, if it agreed
to give a 13% landowner royalty.
• NPIs, ORRIs, and PPs (each as described below) are generally created
out of the working interest of an existing oil/gas lease.
Working Interest
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10. Summary of Various Oil & Gas Interests
•Net profit interests (“NPI”) is a share of production of the oil and gas from a property. The
owner of an NPI receives a share of the profits earned from production after expenses.
•Typically a percentage of a working interest is calculated as a percentage of profits from
operation of the property.
•While the NPI is net of expenses, the NPI owner is not directly responsible for any
expenses. Additionally, the NPI owner typically does not have rights with respect to
operations.
Net Profits
Interest
•An overriding royalty interest (“ORRI”) is an interest in oil and gas free of the expense of
production. An ORRI owner is entitled to its interest of oil/gas produced, and will
generally not bear any risk of the costs of operations. The owner of an ORRI is entitled
to share in a portion of the production but has no rights with respect to operations.
•Perpetual ORRIs last for the life of the lease.
•Term ORRIs last until a specified volume or stated value of production is achieved.
Overriding Royalty
Interests
•A production payment (“PP”) is a share of the oil and gas free of expense of production,
terminating when a given volume of production has been paid over, or when a specified
sum from the sale of such oil has been realized. Production payments are a type of ORRI,
but they are limited in term.
Production
Payments
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11. Statutory Liens
• Jurisdiction itself my be a disputed issues and may effect the outcome
• Some states, like Texas, have statutes granting producers automatic
perfection of liens in oil, but those liens may not be perfected under
other applicable state law
o See In re SemCrude, L.P., 407 B.R. 112 (Bankr. D. Del. 2009) (because
Delaware law governed under choice of law analysis, Texas statute did
not create automatic perfection for producers, and liens would be
subordinate to bank liens perfected by earlier-filed financing
statement)
• The automatic stay does not prevent the filing of notices or affidavits
that are a prerequisite to perfecting a statutory oil and gas
contractor’s lien
o See 11 U.S.C. §§ 326(b)(3), 546(b)(1); In re Houts, 23 B.R. 705 (Bankr.
W.D. Mo. 1982) (holding that filing of mechanic’s lien statement was
allowable in spite of the stay, though further enforcement of the lien
was stayed)
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13. Initial Legal Considerations for Board of Directors
• Hire competent restructuring team
• Review organizational and financial documents, including
loan agreements
• Review historical operations and expense reduction options
• Consider current and near term liquidity requirements
• Consider points of leverage with lenders, including leverage
Chapter 11 provides
• Obtain debtor in possession financing (if Chapter 11 filing is
a possibility)
• Conduct and keep records of board meetings, discussions
and decisions
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14. Fiduciary Duty - Duty of Care & Duty of Loyalty
• Duty of Care
o Directors and Officers must be diligent and informed, and exercise
prudent & unbiased business judgment
o Directors are entitled to rely in good faith and with ordinary care
on reports prepared by Officers of the company or outside experts
within the area of their expertise
• Duty of Loyalty
o Obligates Directors and Officers to act in good faith and in the best
interests of the company, and to deal fairly with the company
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15. How Do Duties Change When Company is Insolvent?
• Directors owe fiduciary duty to the entire corporate
enterprise
• Directors should act in manner to preserve and
maximize the value of the corporation
• When company is insolvent (or, in some states, in
zone of insolvency), creditors as well as
shareholders can derivatively (not directly) enforce
breaches
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16. Credit Bidding Limitations
• In re Fisker Automotive Holdings, Inc.
o Court in Delaware capped credit bid amount to amount holder paid
for the debt, and not face value, to encourage competitive bids.
o See also In re Free Lance-Star Publishing
• In re Momentive (upheld on appeal on 5/4/2015)
o The Court held that the lenders were not entitled to a “make
whole” and other prepayment penalties upon acceleration of the
debt caused by a bankruptcy filling, unless the agreement expressly
provides for same upon acceleration. Moreover, the lenders were
crammed down to an interest rate using a formula approach (e.g.
T-Bill rate plus small risk premium) and not a market rate interest
• In re R.L. Adkins Corporation
o The Fifth Circuit held that a creditor/prospective purchaser failed to
timely exercise its credit bid rights and therefore would lose the
right
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17. Benefits of Purchasing Assets Under a Plan
• Despite stringent confirmation process, purchasing assets
through a Plan allows purchaser more flexibility than a purchase
of assets through 363 sale
o Can purchase assets or acquire equity in reorganized entity
o 363 sale purchaser can only offer dollars (or a credit bid) and
cannot dictate which creditors obtain what portion of purchase
price nor can it reorganize capital structure
o Greater ability to obtain protection from successor liability
o Greater ability to avoid competitive bidding
o Ability to obtain protection from future asbestos and other tort
liability
» Appointment of future claimants’ representative
» Section 524(g) statutory trusts
• Competitive bidding not generally required in plan context
if creditors vote to confirm the plan
o Different rule for new value contributions from equity owners
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19. Case Study Fact Pattern
1. OILCO is a well run family owned E&P Company. Its cash flow has been crushed by
the recent plunge in oil prices, reducing revenue from $100M to $50M per year, and
EBITDA to $20 million per year.
2. Its reserve based first lien lender is owed $100M, which bears interest at 6%, and was
only willing to waive covenant defaults if OILCO made principal and interest payments
that OILCO could not afford. This forced OILCO to file for chapter 11.
3. OILCO obtained authority to use cash collateral and did not need DIP financing.
4. OILCO has also issued $250M of second lien notes, bearing interest at 9% per
annum. There is an intercreditor agreement between the first and second lien
holders that says that proceeds of the collateral must go first to pay the first lien in
full.
5. Royalty owners are owed $5M, and unsecured creditors are owed $30M.
6. The equity consists of 1M common shares trading at .05 cents per share.
7. A hedge fund recently purchased all of the second lien notes for $.30 on the dollar, or
a total net outlay of $75M.
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20. Case Study Fact Pattern
7. OILCO is in the 120 day exclusive period in which only it can file a plan of
reorganization.
8. The unsecured creditors committee is aggressively represented.
9. OILCO believes that the enterprise value of OILCO is between $225M to $250M,
leaving value for the second lien notes, but nothing for the unsecureds. OILCO has
teamed up with the second lien holder and proposed a plan to issue a new note to the
first lien holder at an interest rate of T-Bill plus .5%. The $250M in second lien notes
will convert to 80% equity in OILCO. The remaining balance of the equity, 20%, will be
distributed 10% as a management incentive plan, 5% to unsecureds and 5% to current
equity.
10. OILCO intends to pay all royalty and working interest owners in full.
11. The Bank (first lienholder) does not like its treatment and has teamed up with an
investment banking firm to sell OILCO for $175M in cash, paying them off in full and
leaving $75M for the second lien holders.
12. The Committee disputes all of the liens and argues the plan is unconfirmable because
of the distribution to old equity.
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21. Case Study Fact Pattern
• Players:
o Debtor/Management, CRO: OILCO (Michael Rosenthal)
o Bank: First Lien Note Holder (Trent Rosenthal)
o Second Lien Note Holders held by Hedge Fund (Rich Bernardy)
o Unsecured Creditor (Jim Row)
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22. Debtor/Management Perspective
• As the Well Turns – Continuing Operations
o Goal – uninterrupted operations and preservation of going concern
value
o Protecting key vendors, mineral interest owners, employees
o Funding for operations
• Exiting the Merry-Go-Round
o Basic confirmation requirements – voting requirements, absolute
priority rule and feasibility
o Developing the outline of a plan
o Garnering support for the plan – must have one accepting class
o Forcing dissenting classes or creditors to accept – cramdown and class
consent issues
• Protecting Waldo – The Non-Creditor Players
o Management and the Board
• Role of management ongoing
• Releases and exculpation
o The tip to equity
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23. First Lien Lender’s Perspective
• Pay me now – Pay me in full
• Sell assets
• Make whole provisions
• Cram-down concerns
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24. Second Lien Lenders Concerns
• Expectations of equity owners – unexpected issues
to address
• Market Value of assets once out of bankruptcy
• Do the unsecured creditors have any merits to their
filings
• Are there issues that must be addressed before we
can take control of the company
• Do we need to make changes to management for
the exit of the bankcruptcy.
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25. Unsecured Creditor Committee
• Recovery based on unencumbered assets
• Priority last after Administration, Secured, and
Unsecured Special Priority
• First Day – CRITICAL
o Impact all future rights
o Are you a priority for the company?
o Are you a critical supplier or service provider?
o Court may grant special priority if going concern
• DIP financing and timing
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26. Unsecured Creditor Committee
• Monitor – unsecured’s benefit the most from
monitoring
o Filing objections
o PROTECT YOUR RIGHTS
• If not, the game is ½ over just after it starts
• File under Rule 2002 – added to Service List
o Interface with US Trustee (UST) – good source of info
o 341 Meeting
• Committee Fees are paid for by the Estate
• Reclamation – days
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27. Possible Outcomes
1. First Lien Solution – Plan unconfirmable; assets
should be sold, first lien paid with balance to second
lien and others.
2. Second Lien Solution – Plan confirmable; first lien
crammed down with new note given at low interest
rate. Second converts to equity, with small equity
distribution to unsecureds and old equity.
3. Unsecured Solution – Plan unconfirmable because of
old equity distribution and lien avoidance issues;
unsecured creditors should be bought out at face
with lien creditors taking debt and equity in
reorganized entity.
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28. Negotiated Resolution
• First lien holder, under threat of cramdown, agrees to
deferred payment note at 90% of face with reasonable
terms and market interest rate; 5% new equity kicker.
• Second lien holder full conversion of debt to 80% of
new equity
• Unsecureds $10 million cash payment and interest in
litigation trust funded with avoidance actions
• Management gets 5% Management Incentive Plan
• Old equity invests $15 million to retain 10% of new
equity
The CFO's Dilemma - Proactive Next Steps 28
29. Q&A Session
• Please Submit Questions via Questions Pane on
Your Screen
• Please Be Patient As We Try to Answer All
Questions
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30. Thank You For Joining Us!
A recording of today’s webinar will be emailed
For more information and to sign up for our energy-
related newsletters and alerts, visit www.burlesonllp.com
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31. Contact Information
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Trent Rosenthal [Online Bio]
Restructuring & Bankruptcy Partner – Burleson LLP
Phone: 713.358.1724
Email: trosenthal@burlesonllp.com
James (“Jim”) C. Row, CFA [Online Bio]
Managing Director & Founder – OFSCap, LLC
Phone: 713.823.2900
Email: jrow@ofscap.com
Michael Rosenthal [Online Bio]
Restructuring & Reorganization Partner – Gibson, Dunn & Crutcher
Phone: 212.351.3969
Email: mrosenthal@gibsondunn.com
Rich Bernardy [Online Bio]
Managing Partner – M1 Energy Capital
Phone: 713.300.1420
Email: rbernardy@mecapital.com