CHAPTER 13 GOING ONCE, GOING TWICE: HOW TO SURVIVE (AND THRIVE) IN A BANKRUPTCY SALE OF OIL AND GAS ASSETS
| Jurisdiction | United States |
GOING ONCE, GOING TWICE: HOW TO SURVIVE (AND THRIVE) IN A BANKRUPTCY SALE OF OIL AND GAS ASSETS
Kyler K. Burgi
Davis Graham & Stubbs LLP
Denver, CO 1
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CHRIS RICHARDSON is a partner at Davis Graham & Stubbs in Denver, Colorado. He has worked with secured and unsecured creditors, debtors, and creditors' committees in numerous Chapter 11 proceedings. He has also assisted clients and debtors in buying and selling companies out of Chapter 11, as well as reorganizing or liquidating debtor companies, and has represented purchasers of oil and gas assets in Chapter 11 Section 363 auctions in bankruptcy proceeding in Wyoming, Colorado, and Delaware. Mr. Richardson has lectured on acquisition agreements, deal structures, and debtor-creditor issues, including the impact of bankruptcy on environmental laws, lessor-lessee relationships in bankruptcy, bankruptcy current developments, and asset sales in a bankruptcy.
KYLER K. BURGI is an associate in the Trial Department of Davis Graham & Stubbs LLP. His practice focuses on bankruptcy & creditors' rights, complex commercial litigation, and toxic tort litigation. He has a diverse bankruptcy & creditors' rights practice that spans multiple industries, with a focus on oil & gas and mining. Mr. Burgi assists clients with purchases of distressed assets through the Section 363 sale process, from preparing bids, to obtaining court approval, to post-closing matters. He helps lenders, borrowers, trade creditors, and equity holders develop and implement strategies to navigate in-court and out-of-court restructurings, bankruptcy proceedings, judicial and non-judicial foreclosures, and receivership actions. He also represents debtors and trustees in Chapter 7 and Chapter 11 bankruptcies. Mr. Burgi is the co-chair of the Colorado Bar Association Bankruptcy Subsection and serves on the Associate Board of Directors for Big Brothers Big Sisters of Colorado. He is a graduate of the University of Denver Sturm College of Law.
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Introduction
More than 35 oil and gas companies have filed for relief under chapter 11 of the United States Bankruptcy Code since the start of 2020.1 Over the past eight months alone, companies holding a combined $85 billion in debt have sought bankruptcy protection.2 Given the continued impact of COVID 19 and the flat forward pricing curve for oil and gas from now through 2024, it is likely that the upward trend in significant bankruptcy filings will continue.3 Unless oil prices rebound, some consultants predict nearly 190 oil and gas bankruptcies by the end of 2022.4
Many larger exploration and production ("E&P") companies have pursued "balance sheet restructurings" or "equitizations" that convert funded debt to equity in a reorganized company. Equally, if not more common, are chapter 11 filings that result in the sale of substantially all assets of the debtor under section 363 of the Bankruptcy Code or through a plan of reorganization. These sales present both challenges and opportunities. They impact every segment of the oil and gas industry, from operators to mineral interest owners to service providers to taxing authorities. Failure to properly conduct the sale can harm debtors and their creditors. Buyers that do not apprehend the nuances of a section 363 sale may find themselves caught in a difficult situation. Vendors and service providers can have their claims and liens wiped out, joint operating agreements ("JOAs") and midstream agreements can disappear, and state and local governments can lose significant tax revenue. On the other hand, a properly conducted sale can provide value to creditors, a new solvent business partner for service providers and working interest owners, and the chance for buyers to acquire assets that have been cleansed of liens, claims, encumbrances, and burdensome contracts. With the expected increase in oil and gas bankruptcies, overcoming the challenges and capitalizing on the opportunities of section 363 sales has never been more important.
Section I of this paper explores an E&P company's options for accomplishing the sale of its assets through a bankruptcy proceeding. Section II lays out the procedural steps of a section 363 sale. Section III discusses operation of section 363(f) and how it can protect the buyer from pre-bankruptcy liabilities. Section IV details the key provisions of a section 363 purchase and sale agreement or "PSA" and how those agreements may differ in the bankruptcy context.
I. Locate the Exit Nearest You.
a. Prepetition Considerations
Most of us are familiar with the standard airline safety presentation. A crew member or heavily-produced video instructs passengers on how to buckle the seatbelt, operate the oxygen masks
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(removing COVID mask first), and what to do in the event of a water landing. Passengers are also told to "locate the exit nearest you; keep in mind that the nearest exist may be behind you." Debtors strapping in for a bankruptcy journey would do well to heed this advice. Unless there is no alternative, a debtor should not start a chapter 11 unless it has a plan for getting out of chapter 11.
Although some cases test this maxim, a company cannot stay in bankruptcy forever. Bankruptcies are expensive. Few distressed companies can indefinitely shoulder the costs of continued operation and the added cost of bankruptcy, which costs include retention of estate and committee professionals, investment bankers, loan fees, and other incidental expenses. The Bankruptcy Code is designed to give debtors considerable breathing room from creditors. However, a long-term stay in bankruptcy without active pursuit of an articulated exit strategy will test the patience of the court and creditors as well as diminish the debtor's remaining value.
That is not to say that identifying an exit strategy is easy. Quite the contrary. Although the advent and growth of hydraulic fracturing has dramatically increased oil and gas output in the United States, the cost of operations for fracking-based companies is high and investors are wary.5 In 2018, prior to the current crisis, the 60 largest E&P companies were not generating sufficient cash to cover operating and capital cash needs.6 One reason is that fracked wells typically show steep decline curves, producing significantly less oil in their second year of production.7 Given the decline in commodity prices, the regular borrowing base redeterminations for reserve-backed or "RBL" loans are restricting access to existing capital. Thus, with the increased capital costs for fracking operations, accelerated decline curves, and reduced access to existing credit, the modern-day E&P company is in a constant search of new capital. Often, the only options are expensive debt, leading to increased sensitivity to the price fluctuations.
This economic reality creates challenging circumstances for an E&P debtor, all of which must be addressed in any exit strategy. First, many companies are overleveraged and unable to service their debt, either from falling production or commodity price reductions followed by borrowing-base redeterminations. Second, substantially all of the debtor's assets may be secured by liens and security interests in favor of the debtor's RBL lender. Third, there are no new sources of capital—equity or debt—available to the company. Fourth, the debtor may have fallen behind with their major oilfield service providers, leading to statutory liens on the debtor's properties.8 Fifth, the debtor's transportation and gathering agreements may be expensive and above-market, often with unsustainable take-or-pay obligations.
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A debtor must engage with key stakeholders on these issues well in advance of the bankruptcy. It is less expensive and easier to determine and begin implementing a sale process or plan of reorganization prepetition before the administrative and statutory burdens imposed by a bankruptcy and the active participation of statutory committees. Early efforts will pay dividends in court and may lead to an out-of-court restructuring or a prepackaged or pre-negotiated plan, all of which can be quicker and cheaper than filing first and figuring out the exit later.9
b. Choosing the Proper Exit
A chapter 11 bankruptcy offers an oil and gas debtor and its creditors various options for restructuring the debtor's business. Historically, there are two ways that assets sales occur in chapter 11: through a section 363 sale or through a confirmed plan of reorganization.10 Until the last decade or so, the sale of substantially all the debtor's outside a plan of reorganization was the exception. Now, if the major debtholders have determined that they have no interest in taking over the company through foreclosure or in a debt-for-equity swap or balance sheet restructuring, then a section 363 sale becomes the remaining viable option. Although the focus here is on the section 363 sale process, the debtor's other potential options for selling its assets merit brief discussion.
i. Section 363 Sale
A section 363(b) sale is generally viewed as the quickest and most efficient method of selling a debtor's assets. Although historically less common and more difficult to consummate,11 section 363 sales of substantially all the assets of a distressed oil and gas company have become increasingly common. Section 363 sales are, comparatively speaking, inexpensive, with the primary cost the fees of a banker or other professional tasked with marketing the assets. Section 363 sales allow the debtor to continue operation of its oil and gas wells during the sale process, which preserves value and creates cash flow for the estate. The alternative is often a chapter 7 liquidation, which may result in the shutting in of debtor-operated wells, loss of personnel, and significant harm to the...
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