JurisdictionUnited States
Financial Distress in the Oil & Gas Industry
(Feb 2010)


Rhett G. Campbell
Thompson & Knight LLP
Houston, Texas

Rhett G. Campbell is with the firm of Thompson & Knight LLP in Houston and represents clients in corporate reorganization and business and commercial litigation, with a special emphasis on creditors' rights and bankruptcy matters. He is experienced in all aspects of business bankruptcy and particularly in energy bankruptcies, in which he represents public and private companies, creditors' committees, bondholders, large and small service companies, individual working interest owners and operators, exploration, and production companies. He also serves as an expert witness in oil and gas bankruptcy matters. Mr. Campbell's complex business litigation expertise includes business ownership disputes and fraud, negligence, and multiparty cases. Mr. Campbell is Board Certified in Business Bankruptcy Law and Civil Trial Law by the Texas Board of Legal Specialization and is a Fellow of the American College of Bankruptcy. He was named among the The Best Lawyers in America (Bankruptcy and Creditor-Debtor Rights Law, Commercial Litigation, Derivatives Law, Oil and Gas Law) for 2003-2010.

Rocky Mountain Mineral Law Foundation

"Dealing with Financial Distress in the Energy Industry"

February 4-5, 2010

Buying & Selling Oil & Gas Assets in Bankruptcy

I. Introduction

"Oil and gas exploration and production is a particularly complex business." In re Gulf Coast Oil Corp., 404 B.R. 407, 411 n.3 (Bankr. S.D. Tex. 2009). Companies engaged in oil & gas exploration and production ("E&P") have always been prime candidates for financial reorganization for several reasons: the high cost of exploring and producing hydrocarbons; low barriers to entry into the market; the lure of high returns; and cyclical commodity prices. The "high risk, high reward" nature of the upstream E&P industry means that many try and many fail. This explains, in part, why chapter 11 seems to attract E&P companies with regularity. Once a company with hydrocarbon assets files chapter 11, a common outcome is a sale of the assets (or the equity of the company) either through a formal sale process or through an opportunity for competing parties to file a plan of reorganization. As high quality E&P assets in the continental United States become harder to find, it has become more common for prospective purchasers of hydrocarbons to view chapter 11 as a potential source of acquisition targets. An understanding of the rules of chapter 11 and of purchases through bankruptcy are important to those entities who wish to consider buying oil & gas assets through the bankruptcy process.

Bankruptcy trustees and debtors in chapter 7 and chapter 11 cases conduct private sales and true auctions with regularity. All such sales since 1978 (the year of adoption of the Bankruptcy Code) are governed by 11 U.S.C. § 363, either with or without an accompanying plan of reorganization. In the early years of bankruptcy, sales of assets were permitted when they appeared to be perishable or deteriorating in value. See Committee of Equity Sec. Holders v. The Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1066-1071 (2d Cir. 1983) (reviewing the history of bankruptcy asset sales and the origin of concepts such as "perishable," "deteriorating," and "emergency.") Although the 1978 Bankruptcy Code was silent on the subject, the notion of an "emergency sale" was carried forward in practice, as in the classic example of the tomatoes rotting in the sun. E.g., In re Ancor Exploration Co., 30 B.R. 802, 806-08 (D. Okla. 1983) (with no emergency apparent in the record, a sale of all assets was reversed and remanded). When the assets of the estate are perishable, an expeditious sale is regarded by all as the proper and necessary course. In recent years, however, a § 363(b) sale of assets of the debtor out of the ordinary course and without a confirmed plan of reorganization has become more common. In fact, it is often the goal of the parties to the chapter 11.

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II. The two paths for sales in chapter 11

There are two paths for a sale in chapter 11: the § 363 sale and the confirmed plan of reorganization (which can incorporate a § 363 sale).

There are two sections of the Bankruptcy Code applicable in chapter 11 that explicitly authorize the sale of property. Section 363(b) authorizes a trustee to sell property of the estate outside the ordinary course of business. Section 1123 provides that a chapter 11 plan may include provisions (i) for transfer of all or any party of the property of the estate, and (ii) for sale of all or any part of the property of the estate. A § 363(b) sale is generally viewed as quicker. Only a motion and a hearing are required, and most courts apply a "business judgment test" to determine whether to approve the sale. By contrast, confirmation of a chapter 11 plan usually involves (i) preparation, court approval, and distribution of a disclosure statement, (ii) voting by creditors to accept or to reject the plan, and (iii) determination by the Court of whether the plan meets statutory confirmation standards.

In re Gulf Coast Oil Corp., 404 B.R. 407, 414-15 (Bankr. S.D. Tex. 2009) (footnotes omitted).

A § 363 sale implies an auction or some form of exposure of the assets to the market. In the case of E&P companies, a confirmed plan generally takes three possible forms: (i) a refinance or restructure of debt, (ii) a sale of some or all assets, or (iii) a sale of some or all equity of the company (which can include an exchange of debt for equity). It is also possible that all assets may be sold first and a liquidating plan filed later. See Florida Dept. of Revenue v. Piccadilly Cafeterias, Inc., ___ U.S. ___, 128 S.Ct. 2326, 2330 n.2, 171 L.Ed.2d 203 (2008). There are many permutations of these outcomes but it is quickly seen that the majority of possible outcomes involve a sale of some or all assets or equity of the debtor.

The major unresolved issue in current bankruptcy practice is the tension between the desire of management, creditors and equity owners to achieve a quick resolution, often a sale under § 363, versus the relatively more complex, more costly, and more time-consuming confirmation of a plan of reorganization (which can and often does include a sale of equity or assets). This tension was explained by Judge Steen in the recent decision of In re Gulf Coast Oil Corp.:

Unprecedented liquidity in the capital markets, investment strategies that include significant claims trading in large cases, alleged "loan to own" strategies, active participation in bankruptcy cases by hedge funds and other non-bank lending entities, and venue selection based on a court's perceived propensity to approve § 363(b) sales without requiring satisfaction of chapter 11 confirmation requirements have altered the landscape of chapter 11 in large cases. While these factors have initially appeared in the very large cases, the practice in smaller cases has followed the lead of the larger cases. As indicated in the following paragraphs, the result has been a huge increase in motions to sell substantial parts (or all) of the estate under § 363(b) prior to plan confirmation.

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404 B.R. 407, 418-19 (Bankr. S.D. Tex. 2009). Sales of assets in chapter 11 are big business, including some of the largest corporations on the planet, including Lehman Brothers, Bay Harbour Mgmt., L.C. v. Lehman Brothers Holdings Inc. (In re Lehman Brothers Holdings, Inc.), 415 B.R. 77, 83 (S.D.N.Y. 2009) (§ 363 sale of over $100 billion of assets - including assets belonging to entities not in bankruptcy - approved 5 days after filing), Chrysler, In re Chrysler LLC, 405 B.R. 84 (Bankr. S.D.N.Y. 2009) ("Chrysler"), aff'd sub nom. Pascale v. Chrysler LLC (In re Chrysler LLC), 576 F.3d 108 (2d Cir. 2009), vacated and appeal dism'd as moot sub nom. Police Pension Trust v. Chrysler LLC, No. 09-285, 2009 BL 267592 (U.S. Dec. 14, 2009). (§ 363 sale for $2 billion cash purchase price approved 31 days after filing), and most recently General Motors. In re General Motors Corp., 407 B.R. 463, 482 (Bankr. S.D.N.Y. 2009) (§ 363 sale valued at $45+ billion approved 34 days after filing).

III. Section 363(b)(1) authorizes a sale outside the ordinary course of business

A. The concept of ordinary course of business

Most sales of E&P assets involve § 363(b)(1), sales of assets outside the ordinary course of business. The debtor can, of course, sell assets in the ordinary course of business without notice, a hearing, or court approval. 11 U.S.C. § 363(c)(1). Section 363(c) is "designed to strike [a] balance, allowing a business to continue its daily operations without excessive court or creditor oversight and protecting secured creditors and others from dissipation of the estate's assets." Med. Malpractice Ins. Ass'n v. Hirsch (In re Lavigne), 114 F.3d 379, 384 (2d Cir. 1997). In re Roth Am., Inc., 975 F.2d 949, 952 (3d Cir. 1992). These sales tend to be of smaller, isolated (termed "non-core") assets and not a sale of all or substantially all of the debtor's assets. Clearly if the debtor's business is selling shoes retail, it need not get court approval each time it seeks to sell a pair of shoes; that is the essence of "ordinary course of business." But selling all the company's inventory of shoes would be out of the ordinary course. As stated, the debtor can sell property of the estate other than in ordinary course after notice and a hearing. 11 U.S.C. § 363(b)(1).

B. The test for determining whether a sale is in the ordinary course of business

There is no statutory definition of ordinary course of business and it is, therefore, left to the courts to interpret on a case by case basis. The courts have established two tests for analyzing ordinary course, horizontal (or industry-wide) and vertical (a creditor's...

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