oil and gas industry: dealing in distress assets, midstream issues, offshore regulatory changes

OIL AND GAS INDUSTRY:DEALING IN DISTRESS ASSETS, MIDSTREAM ISSUES, OFFSHORE REGULATORY CHANGES.

OCTOBER 2016

NADÈGE A. ASSALÉ, MEMBER, SLATTERY, MARINO & ROBERTS

CHUCK GIBBS, PARTNER, AKIN GUMP

BENJAMIN KADDEN, SHAREHOLDER, LUGENBUHL, WHEATON, PECK, RANKIN & HUBBARD

BILL WALLANDER, PARTNER, VINSON & ELKINS

22nd Annual Bankruptcy Law SeminarOctober 6-7, 2016

The content of this presentation does not constitute legal advice.

DISCUSSION TOPICS

363/Plan Sales

Issues Related to Midstream and Upstream Contracts

Offshore Regulatory Issues

Q&A

Industry Headwinds a/k/a Restructuring Tailwinds

Out-of-Court Acquisitions from Distressed Sellers

This communication is provided for educational and informational purposes only and is not intended, nor should it be construed, as legal or tax advice. Firm names are not necessarily the formal legal name.


Industry Headwinds

a/k/a

Restructuring Tailwinds


INDUSTRY HEADWINDS A/K/A RESTRUCTURING TAILWINDS

“The number of energy loans labeled as “classified,” or in danger of default, is on course to extend above 50% this year at several major banks, including Wells Fargo & Co. and Comerica Inc., according to bankers and others in the industry.”

Source: The Wall Street Journal, “Coming to the Oil Patch: Bad Loans to Outnumber the Good”

Source: The Wall Street Journal

Select Oil and Gas Bankruptcy Filings of 2016

Filing Date Debtor

7/27/2016 Halcon Resources Corporation7/27/2016 Atlas Resource Partners, L.P.6/30/2016 Triangle Petroleum Corporation6/2/2016 Warren Resources, Inc.

5/16/2016 Breitburn Energy Partners L.P.5/16/2016 SandRidge Energy, Inc. 5/12/2016 Penn Virginia Corporation5/11/2016 LINN Energy, LLC5/9/2016 Chaparral Energy, Inc.

4/30/2016 Midstates Petroleum Company, Inc.4/29/2016 Ultra Petroleum Corp.4/15/2016 Goodrich Petroleum Corporation4/14/2016 Energy XXI Limited3/27/2016 Southcross Holdings LP2/14/2016 Paragon Offshore Plc


Out-of-Court Acquisitions from Distressed Sellers


• Benefits– Faster than bankruptcy sales– Customary allocation of liabilities and pre- and post-effective time expenses– General diligence period and adjustment for title and environmental defects, casualty losses,

etc.– No court approval required

• Risks/Downside– Fraudulent Transfer Risks / Avoidable Preferences– Acquisition is not “free and clear” of existing liens, claims and encumbrances – PSA Considerations

o If seller files for bankruptcy after signing but before closing, Buyer may be stuck with a “hanging” PSA that Seller can reject as an executory contract

o If seller files for bankruptcy after closing, Buyer may be left with unenforceable indemnities and no post-closing recourse; prepetition unsecured claims against debtor seller

– Must comply with anti-assignment provisions, consent rights and rights of first refusal

OUT-OF-COURT ACQUISITIONS FROM DISTRESSED SELLERS (PRE-BANKRUPTCY)


• Pre-bankruptcy transactions may be avoided as a “fraudulent transfer” or “fraudulent conveyance”

• Federal and State Look-Back Period – Federal look-back period: 2 years – State look-back period: usually longer (TX: 4 years)

• If transaction is determined to be a fraudulent transfer:– Trustee has the power to (1) recover assets from the Buyer or (2) recover the full value of the

assets from the Buyer (e.g., the value of the assets at the time of transfer less than what was actually paid)

– Remedies of Buyero “Good faith” Buyers are entitled to a lien on the assets to secure the value of any improvements made by the

Buyer after the initial closingo If Debtor in possession or Trustee recovers the assets, Buyer has a claim for damages/recovery of purchase

price – typically a general unsecured claimo If PSA has not closed, Buyer can seek return of deposit

‒ Note: Even though assets may be returned to the Debtor in possession or Trustee, Buyer may remain liable for unavoidable obligations (such as plugging and abandonment, credit support, environmental obligations, etc.) by virtue of closing the avoided transaction and/or entering the chain of title

AVOIDANCE OF TRANSACTIONS -- FRAUDULENT TRANSFER


• Actual Fraud: Transfers “with actual intent to hinder, delay, or defraud” a creditor• Constructive Fraud: Debtor received less than a “reasonably equivalent value” and

debtor: – was insolvent at the time, or as a result of, the transfer; – made the transfer, or incurred such obligation, to or for the benefit of an insider, under an

employment contract and not in the ordinary course of business; – was engaged, or was about to engage, in business or a transaction for which any property

remaining with debtor was “unreasonably small capital” (this prong is applicable in TX but not other states); or

– intended to, or believed that debtor would, incur debts that would be beyond debtor’s ability to pay such debts as they mature (this prong is applicable in TX but not other states).

• Defense to Constructive Fraud: Transferee acted in “good faith” and the transfer was “for reasonably equivalent value”

AVOIDANCE OF TRANSACTIONS -- FRAUDULENT TRANSFER (CONT’D)


• Possible mechanisms to mitigate risk that seller files for bankruptcy between sign/close:– Risk that seller rejects PSA

o Consider requiring the payment of an upfront work fee

– Risk of “hung” PSAo Draft outside date so that the PSA automatically terminates at a certain date unless buyer elects to extendo No deposit or deposit in escrow

– Risk of auction processo Consider whether Seller can grant Buyer exclusivityo If seller (or bankruptcy court) require an auction, require seller to name buyer as the stalking horse

• Possible mechanisms to mitigate risks with seller filing for bankruptcy after closing:– Risk of fraudulent transfer risks/avoidable preferences

o Include seller reps on solvency; marketing efforts; use of proceeds; and PSA is in good faith and arms-lengtho Solvency / fairness opinionso Include covenants requiring seller to maintain / provide records on marketing efforts

– Risk that seller rejects PSA (i.e., terminates indemnity provisions)o Require a post-closing escrow or a holdback for indemnity claims

PSA PROTECTIONS


363/Plan Sales


363 SALES TRANSACTIONS

• Stalking horse bidder – bidder that subjects proposal to topping bids and subject to court approval– Debtor conducts initial marketing process to find a stalking horse bidder– Stalking horse PSA is typically executed and attached to initial motion– Bid protections (1-3% of transaction amount) and expense reimbursement– Minimum bid increments– Lenders may be the stalking horse bidder through a credit bid

• 363 Sale PSA– Highly negotiated– Effective Date purchase price adjustments– Treatment of title and environmental matters– Minimal reps and warranties/burn off– Closing Conditions– Limited post-closing recourse– Key stakeholders and other parties in contest may object to sale– Subject to court approval


363 SALES TRANSACTIONS (CONT’D)

• Treatment of executory contracts– Debtors may assume and assign certain contracts to purchaser– Cure costs– Assignment limited by applicable law– Dealing with pref rights

• Auction process– Additional marketing process to find bidders at the auction– Determination of qualified offers and court approved bidding procedures to govern process– Auction conducted– Winner signs up PSA with debtor, bankruptcy court approves transaction– Closing / backup bidder

• “Free and clear”– Interaction with applicable state law, federal law, tribal law– Oil and gas leases and royalty obligations under state law

• Dealing with debtor's main creditor groups (secured creditors/committees of unsecured creditors)


PLAN SALES

• Process steps for bidding/auction similar to 363 sale• Plan can be a sale plan or a sale proceeds distribution plan

• Sale under the plan itself (direct asset sale, synthetic sale)• Sale prior to plan, plan to distribute proceeds

• Direct distributions• Plan trust distributions/waterfall

• Synthetic sale• Cancel equity• Issue new equity to purchaser via 1145 or securities exemption• Purchased assets vest in reorganized debtor• Excluded assets vest in liquidating trust

• Can be useful to avoid need to file numerous assignments, consent rights, pref rights, etc.


Issues Related to Midstream and Upstream Contracts


• Midstream• Gathering and Processing Agreements (GPAs)

o Impact of bankruptcy filing / Automatic Stayo Rejection / Assumption of GPAso Dedications and volume commitmentso Covenants running with the lando Recent cases

• Sabine, where the arcane journey began

• Quicksilver, rejection vs sales

• Magnum Hunter, rejection of a schedule…process

• Emerald Oil, 100% co-dependency

• Upstream• Joint Operating Agreements

o Removal of operatoro Impact on continuing operationso Advanced funds, JIBs and production revenue o Non-consent penaltieso Covenants running with the lando JOA lien, lien priority and default provisionso Consent and pref rights

KEY CONTRACTS/ISSUES


REGULATORY UPDATE ON FINANCIAL ASSURANCE FOR DECOMMISSIONNG LEASE OBLIGATIONS ON THE OUTER

CONTINENTAL SHELF


• Outer Continental Shelf Land Act 43 U.S.C. § 1301 – Defines BOEM’s jurisdiction and regulatory responsibility over the submerged lands of the OCS

• 30 CFR § 556, Subpart I– General Financial Assurance Requirements

o No operation: $50,000 per lease or $300,000 areawideo Exploration: $200,000 per lease or $1,000,000 areawideo Development: $500,000 per lease or $3,000,000 areawideo Pipeline Rights-of-Way: $300,000 areawide [30 CFR § 550.1011]

– Supplemental Financial Assurance Requirementso Discretionary o 30 CFR § 556.901(d-f) provides that the Regional Director has the authority to determine the amount of

supplemental financial assurance required to guarantee compliance, taking into consideration potential underpayment of rents and royalty, and cumulative obligations to abandon wells, remove platforms and facilities, and clear the seafloor of obstructions in case-specific analysis

• Notice to Lessees and Operators NTL No. 2016-N01– Issued July 14, 2016, effective September 12, 2016– Provides clarification and description of the scope and meaning of the regulation based on the

DOI’s interpretation of same; provides guidelines on BOEM’s implementation of the updated financial assurance police

PRINCIPAL REGULATORY SOURCES REGARDING BOEM’S FINANCIAL ASSURANCE REQUIREMENTS


SUMMARY OF KEY POLICY CHANGES

2008 Policy 2016 PolicyCo-Lessee Reliance Yes No

Redundant Securities Yes No

Premature Demands Yes No

Decommissioning Cost Estimate Models

- Updated August 2016

Forms of Financial Assurance

- Expanded

Assets Impacted - Expanded (ROWs + ORI owners and operators)

Joint and Several Liability Yes Yes

Waiver/Self-Insurance Yes – all or nothing and for select few only

Yes – capped to 10% of TNW and available to all*

Tailored Plans Maybe Yes


CRITERIASame as before, per regulation at 30 CFR § 556.901(d)(1); different application, however

• Financial Capacity• Projected Financial Strength• Business Stability • Reliability • Record of Compliance

TANGIBLE NET WORTH• Total Assets – Total Liabilities – Intangible Assets

SELF-INSURANCE ASSESSMENT CRITERIA

Total Assets

Cash and cash equivalents Investments Real property

Total Liabilities

Secured liabilities - Debt backed or secured by collateral to reduce the risk associated with lending Unsecured liabilities – debt or general obligation that is not collateralized

Intangible Assets

Goodwill Patents Trademarks Intellectual property Other IP


CONT’D

• Financial Capacity– Substantially in excess of existing and anticipated lease and other obligations; Assessed through

most recent (not more than 12 months old) audited financial statements; – (Not interested in the absolute size of the ratio but in its relative size, compared to the same ratio

of the industry – Benchmark ratios updated yearly (no later than September 1) to reflect market conditions. They

are built using a 5-year moving average – Need to pass 5 of the above 9 ratios to be eligible for initial self-insurance

E.g. of Applicable Financial Ratios 2011-2015 Industry AveragesCash Flow from Operations / Total Debt at or above 0.20

Current Ratio at or above 1.07

Earnings Before Interest & Taxes / Interest Expense at or above 4.78

Quick Ratio at or above 0.97

Return on Assets at or above -2.56%

Return on Equity at or above 0.18%

Total Debt / Capital at or below 0.57

Total Debt / Earnings Before Interest, Taxes, Depreciation and Amortization at or below 4.35

Total Debt / Equity at or below 1.25


CONT’D

• Projected Financial Strength– The estimated value of existing OCS lease production and proven reserves of future production.

o Proved Developing Producing (PDP) reserves valued using the SEC’s PV10 or Fair Market Value method o BOEM may add up to 25 percent of the PV10 value of PDP Reserves to the amount of Tangible Net Worth,

hence increasing the base to which the percent of self-insurance is applied.

• Business Stability– 5 years of continuous operation and production on the OCS or onshore.

• Reliability – Credit rating from Moody’s or Standard and Poor’s, or trade references

o Investment Grade “Bond Rating” to obtain self-insurance. Investment Grade is Moody’s Baa3 or S&P BBB-. The minimum credit rating to be allowed to apply self-insurance to sole liability properties is A3 (Moody’s) or A- (Standard and Poor’s)

o Self-Insurance Increase of up to 5% of tangible net worth if > A2/A; up to 2% if =or>Baa3/BBB-; no increase for Ba1/BB+; any rating <Ba1/BB+ may result in negative adjustment [-1% for Ba2/BB- to -5% for B3/B-]

• Record of Compliance– Civil penalties; Incidences of Non-compliance (“INCs”); Citations by any other agency(ies) with

jurisdiction on the OCS; Citations for non-payment or under-payment of rentals, royalties, interest bills, civil penalties, or inspection fees, referred to the U.S. Treasury for collection within the past 5 years.


TAILORED PLANS

• Formal agreement to be filed and approved by BOEM for any type of financial assurance other than surety bond(s) or Treasury security(ies) used to meet supplemental security requirement, or for requests to phase-in such provision

– Encourages creativity– Should be as detailed as the arrangement and forms of security proposed allow, and identify any

properties to be covered by others’ self-insurance (e.g. co-lessees’, operating rights owners, and/or co-owners of ROWs or RUEs)

– BOEM will not hold annual meetings but will conduct annual reviews for financial ability evaluation. Upon receipt of BOEM’s evaluation result, a company can request a meeting with BOEM to discuss. A demand letter can be sent within 60 days after BOEM conducts the annual review. Audited financials to be submitted to BOEM by July 1 as before (extensions can be granted for companies with fiscal years ending on a date other than December 31). Note that other events can prompt a review (e.g. assignments, news reports)


PHASED-IN TIMETABLE FOR NTL 2016-N01 COMPLIANCE


KEY ISSUES

1) Potential issues between creditors; debtors/trustees; JV partners; and Government as to access of the funds in the DTA/escrow to perform the actual decommissioning work

From a federal regulatory perspective, decommissioning obligations accrue when a well is drilled, a platform, pipeline or other facility is installed, or when an entity “becomes a lessee or owner of operating rights of a lease on which there is a well that has not been permanently plugged according to this subpart, a platform, a lease term pipeline, or other facility.” 30 C.F.R. § 250.1702. Clearly, performance and accrual of the obligation are two separate concepts. As a result, claims for accrued obligations that have not been performed are merely “contingent administrative claims” at the time of the bankruptcy filing.

2) Contractual JOA issues as already discussed

3) ??


OIL AND GAS INDUSTRY ISSUES

Q&A
