Addressing Oil and Gas Loan Defaults: Options and Consequences

01/27/2015

The prior article in our series of alerts relating to distressed commodity prices discussed options that producers and bankers can use to stretch a borrowing base. If an E&P company cannot stretch its borrowing base and ends up with a borrowing base deficiency that is not timely cured, it will default under its credit agreement. Even if a borrower is not overdrawn on its credit facility, the sudden and steep drop in oil prices may cause it to default under another provision of its credit agreement, such as a financial covenant. For the last several years E&P companies thrived on high commodity prices and borrowed money from financial institutions eager to take part in the U.S. oil and gas renaissance. In this new price environment many producers will face a different situation—default—which they will need to resolve with their lenders. Producers and their bankers should understand the various ways in which they can address a default under a credit agreement. This alert lays out a range of options that are available to temporarily or permanently move past a default under an E&P company’s reserved-based credit facility.

Overview

A bank may respond to a default by accelerating, after any applicable grace period, the debt and exercising remedies, especially in the case of a material default where deterioration of collateral or the borrower’s financial condition requires quick action for the bank to maximize its recovery. However, if there is a reasonably clear path forward, such as optimism that commodity prices will recover, or a likelihood that the borrower will obtain additional or replacement capital, the lenders will most likely provide the borrower relief from the default. There are different ways an E&P borrower can be relieved from a default—some of the measures provide permanent forgiveness, while others only allow for temporary reprieve.

Both parties to a loan agreement—borrower and lender—are incentivized to address a default. A default deprives the producer of its ability to borrow under its credit facility, is concerning to its investors and generates cross-defaults under other contracts. It may also result in a new party unfamiliar to the borrower holding all or a portion of its debt. The E&P company normally has a consent right when an existing lender, such as a commercial bank, desires to assign its loans and commitments to a financial institution that is not currently party to the credit agreement, such as a distressed debt fund. This consent right disappears any time a default exists.

Inaction after default can be harmful to the lender as well. Banks do not want defaulted loans sitting on their balance sheets. Failure to act can make it easier for the E&P company to raise certain challenges and defenses in a bankruptcy proceeding. Below are ways in which lenders and producers may address a credit agreement default.

Read the full alert on oil and gas loan defaults.

If you have any questions about this alert, please contact one of the lawyers listed below.

The next article in our series of news alerts relating to distressed commodity prices will discuss mechanics and materialmens’ liens in the oilfield and issues relating to filing, handling and enforcing those liens that service providers and producers should understand.

View prior articles in our series.

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