CHAPTER 12 STEPS TO MAXIMIZING RECOVERY: WHAT CAN AN OIL AND GAS FINANCIER DO AND WHEN SHOULD IT DO IT?
| Jurisdiction | United States |
STEPS TO MAXIMIZING RECOVERY: WHAT CAN AN OIL AND GAS FINANCIER DO AND WHEN SHOULD IT DO IT?
Haynes and Boone, LLP 1
Houston, TX
[Page 12-1]
ELLEN CONLEY is an associate in the Energy, Power and Natural Resources Practice Group in the Houston office of Haynes and Boone. She handles energy finance matters, as well as the acquisition and disposition of oil and gas properties. She represents lenders and borrowers in secured reserved-base credit facilities, and has experience with a variety of transactions, including ISDA master agreements and schedules and oil and gas purchase and sale agreements.
The successful exploration, development and production of oil, gas and other minerals requires large amounts of capital. As a result, exploration and production (E&P) companies often utilize a variety of credit arrangements with financial institutions and other capital providers, under which the companies, as borrowers, convey liens on and security interests in their assets to such institutions, as secured parties, to serve as collateral on loans. From time to time, whether because of economic factors, such as the March 2020 oil price war between Russia and Saudi Arabia, or otherwise, a borrower may find itself unable to satisfy its obligations during the life of the loan. Although loan documents will provide a secured party with a variety of remedies to exercise in the event of a borrower's default—including a secured party's ultimate ability to foreclose on its collateral—a well-informed secured party will know when and which of those remedies to exercise in order to maximize its recovery.
The first step in an oil and gas financier's recovery process actually occurs before the dust has settled on the lending transaction by ensuring that its borrower's assets are encumbered by a first priority lien and security interest in its favor as a secured party. After a default has occurred, but prior to the enforcement of remedies, a secured party should confirm that such assets remain encumbered and continue to hold their priority in order to determine what course of action will minimize the secured party's exposure and maximize recovery. Should a secured party proceed with exercising remedies, it may be required to satisfy various procedural requirements to avoid any recovery measures from being rendered invalid. If a borrower files for bankruptcy, however, a secured party will likely be suspended from exercising remedies outside of bankruptcy.
I. Step One: Secure the Collateral
When entering into a credit arrangement with an E&P company, a secured party should make certain that most, if not all, assets of the borrower are encumbered by a first priority lien and security interest in favor of the secured party. Regardless of how such companies are financed, loans are typically secured by liens on a borrower's real property and security interests in such borrower's personal property.2 The characterization of a borrower's property as a real property
[Page 12-2]
interest or a personal property interest must be determined in order to enforce and perfect, and subsequently exercise remedies upon, such collateral.3 The real property law of the state in which a real property interest is located governs the creation and priority of a lien on such real property interest.4 Apart from limited exceptions, Article 9 of the Uniform Commercial Code (UCC) of the state in which a borrower is "located" governs the creation, perfection and priority of a security interest in a personal property interest.5
Any oil, gas or other mineral interest of a borrower that will serve as collateral will be considered either a real property interest or a personal property interest depending on (i) the characterization of the interest and (ii) the stage in the extraction and production process.6 A borrower may own, or have its interests subject to, various types of interests in oil, gas and other minerals, often referred to as the various "sticks" in the "bundle of sticks" of rights in real property.7 The most common types of interests include mineral interests, leasehold interests, lessors' royalty interests, overriding royalty interests, nonparticipating royalty interests, production payment interests, net profits interests and carried interests.8 Whether any such interest is or has been characterized as a real property interest or a personal property interest varies by state.9 Property designated as a real property interest may be considered a personal property interest, however, depending on the stage in the extraction and production process.10 Oil, gas and other mineral interests may be treated as real property interests while still in the ground, but once extracted, such interests are treated as personal property interests.11
A. Deed of Trust or Mortgage
Oil, gas and other minerals that constitute real property interests are typically the primary assets of an E&P company, serving as the principal portion of a secured party's collateral. A lien on such interests is secured using a deed of trust or mortgage, wherein a borrower grants its interests in real property for the benefit of the secured party as collateral under the financing arrangement.12 The real property law of the state in which a real property interest is located determines whether a deed of trust, mortgage or either may be used to secure the real property collateral.13 Typically, under a deed of trust, a borrower directly grants both a lien and a "power
[Page 12-3]
of sale" to a trustee, who holds the lien for the benefit of a secured party.14 Utilizing a deed of trust rather than a mortgage is preferred, if available, because the power of sale provides a secured party with the option to exercise a non-judicial foreclosure as discussed in Part III.A.2 below.15 Though some mortgages contain a power of sale, a deed of trust also permits a trustee, rather than a secured party, to conduct foreclosure proceedings, providing a secured party with the opportunity to submit its own bid at a foreclosure sale.16
Frequently in a deed of trust or mortgage, a borrower not only grants a lien on its oil, gas and mineral real property interests, but also grants a security interest in those same interests at the moment such interests are extracted at the wellhead or minehead and characterized as personal property; at that moment, such interests constitute "as-extracted collateral".17 As a result, a secured party's collateral is secured at all stages of the development and production process, even attaching to the proceeds received from the sale of oil, gas or other minerals, provided the secured party had an interest in such assets before extraction.18 Similarly, in a deed of trust or mortgage, a borrower will grant a security interest in fixtures, including certain physical structures or facilities used in oil and gas exploration, development and production, to the secured party.19 Fixtures are personal property interests, permanently affixed to the land or improvements thereon, "that have become so related to particular real property that an interest in them arises under real property law."20 Although as-extracted collateral and fixtures are personal property interests governed by Article 9 of the UCC (Article 9), most producing states allow for a deed of trust or mortgage to serve as a financing statement to perfect the secured party's interest in the as-extracted collateral and fixtures so long as the deed of trust or mortgage satisfies certain statutory requirements.21 The local law of the jurisdiction in which the wellhead or minehead is located, rather than where the borrower is located, governs perfection and the priority of a security interest in as-extracted collateral.22 Similarly, the local law of the jurisdiction in which fixtures are located governs perfection of a security interest in fixtures.23 The lien on the real property collateral and the security interest in the as-extracted collateral and fixtures are effective and binding against third parties when the deed
[Page 12-4]
of trust or mortgage is recorded in the county real estate records where the real property is located.24 A secured party typically retains its first priority status from the date the deed of trust or mortgage is recorded until such instrument is released from the records by the secured party.25
As additional security, a deed of trust or mortgage should contain "assignment of production" language, under which a borrower assigns to a secured party its interest in the oil, gas and other minerals, as well as the borrower's right to receive proceeds attributable to the sale thereof once produced.26 A secured party typically then grants to the borrower a license to "use and enjoy" the oil, gas and other minerals to earn revenues and receive proceeds until a default occurs and continues, at which point the secured party has the option to terminate such license and begin receiving such proceeds of production.27 Simultaneously with the execution of the deed of trust or mortgage, the secured party should require the borrower to execute and deliver original transfer order letters in blank to be addressed to purchasers of production in the event the secured party elects to exercise its rights under the assignment of production.28 If a default occurs and continues, the secured party could send such executed letters to the purchasers of production, directing them to begin making payments directly to the secured party.29
A well-drafted deed of trust or mortgage will not only include provisions centered around the creation and priority of a lien on and security interest in a borrower's oil, gas or other minerals, but will also provide a secured party with additional rights and remedies that may be exercised to maximize recovery. As discussed in Part III.B below, a deed of trust or mortgage...
To continue reading
Request your trial