Distressed Oil and Gas Sales to Avoid Bankruptcy

12/09/2015

Even in a difficult commodity price environment, acquisition transactions can produce lucrative opportunities for buyers of oil and gas interests and creditor relief for sellers. One type of transaction in particular provides an opportunity for distressed sellers not only to avoid bankruptcy, but also eliminate the greatest amount of debt possible that is secured by its oil and gas properties. Rather than face an impending bankruptcy, a seller can enter into a structured distressed sale, conveying its property to a buyer with the agreement of the seller’s creditors that satisfies the debt secured by that property.

When a distressed seller agrees to convey its property and an interested buyer agrees to satisfy the seller’s debt related to that property, the parties draft a Purchase and Sale Agreement (“PSA”), in which the seller agrees to execute an assignment of its property and place it in escrow pending resolution of creditor claims against the property. Prior to finalizing the PSA, the buyer must perform thorough due diligence, identifying and classifying the seller’s creditors who have claims against the property, which helps the buyer determine which debts must be satisfied before acquiring the seller’s property.

By conducting an up-to-the-minute lien search of the property, the buyer can identify the pool of creditors whose agreement is necessary to effect the proposed acquisition. Further analysis determines the perfection and validity of the asserted liens and claims so that the buyer can evaluate the enforceability and amount of claims that encumber the property. A review of the seller’s accounting and land files, including documentation of asserted claims and served notices of liens or suits filed against the seller or specifically against the property, aids in quantifying the total indebtedness and encumbrances. A title search of the real property records indicates the seller’s ownership of the property and confirms the filing of liens, including both those already known and unidentified encumbrances. In most states oilfield mechanics and materialmen may file statutory liens up to 180 days following the date services or materials were last provided to the property. Accordingly, a lien search of the county records will not pick up the mechanics and materialman’s (“M&M”) liens that may be filed against seller’s interest in the property over the next six months. Therefore, a review of recent operations conducted on the property is also important.

Although the PSA is an agreement between the distressed seller and the buyer, it may contain provisions intended to persuade creditors with interests in the property to support the sale. If the PSA contains provisions allowing the buyer to walk away from the transaction at any time before closing, and another stating that the seller is not prohibited from voluntarily filing bankruptcy, the PSA may convince the creditors to cooperate with the sale; a creditor may lose a repayment opportunity if the buyer chooses to walk, and the creditor may recover on its debt more quickly if the seller stays out of bankruptcy.

After the seller and buyer sign the PSA, the buyer drafts a Creditors Agreement (“CA”) between the buyer and the seller’s creditors. The CA sets forth the buyer’s plan to pay off the seller’s debt and provides sufficient security and performance assurance to persuade the creditors to accept the sale. Closing under the PSA is only effective once a certain percentage of secured creditors and a certain percentage of unsecured creditors accept the workout plan under the CA. When an entity files bankruptcy, all creditors of a particular class are bound by the reorganization plan if enough of the creditors in the class accept the plan. Creating creditor approval percentages in the PSA allows the buyer to attempt to control unruly creditors from preventing the payment plan.

The motivation for creditors to sign up for the payment plan outside of bankruptcy is that the creditors could receive less favorable treatment in a bankruptcy. For example, in a bankruptcy, the seller can consummate a sale of the property free and clear of all liens and claims, with those liens and claims attaching to the sale proceeds. In that case, all senior secured creditors are entitled to have their claims paid in full before any further proceeds drop down to junior creditors. The payment plan in the CA could provide better terms for junior creditors so long as they agree to go along with the sale and avoid a bankruptcy filing.

Once the buyer decides to acquire the seller’s property, it should promptly approach the seller’s creditors to identify itself, share its intention to pay off the seller’s debt, and forestall any adverse activity. The buyer’s payment plan involves three factors: (1) the sum of the seller’s debt, (2) the value of the property, and (3) the amount the buyer proposes to pay the seller’s creditors. In a distressed transaction where the seller’s debt is higher than the value of the property, a buyer generally purchases such debt at a discount. Subsequently, the buyer offers the seller’s creditors, differentiating between secured and unsecured creditors, a percentage of the creditors’ original lien amounts. Since a payment plan in bankruptcy must treat the creditors within each class of creditors similarly to be confirmable, the buyer’s offer under the CA cannot contain separate settlements or compromises with individual creditors. Secured creditors typically do not receive much less than the estimated amount than they would receive at the end of a bankruptcy proceeding; unsecured creditors, however, will usually receive just enough compensation to make the payment plan more desirable than bankruptcy. Payment to creditors under the CA does not have to occur at closing. CAs can provide for the buyer to make payments over a period of months by committing an amount of production revenue and the CA can give creditors the right to receive directly from the purchasers of production in the event the buyer defaults on these payments.

A major concern for buyers and creditors is to structure a transaction that will survive bankruptcy. It is possible that the seller (or other creditors of the seller not involved in the transaction with the buyer) could attempt to void the transaction after closing by filing bankruptcy and attempting to set aside the purchase as a fraudulent conveyance. The Bankruptcy Code generally provides that the transaction will not be set aside if the buyer can show that the seller and its creditors received reasonably equivalent value in exchange for the property.

Each creditor receives a copy of the CA, which includes the names of the secured and unsecured creditors, an acceptance form, and lien and mortgage releases. When a creditor signs an acceptance form, it agrees to be bound by the terms of the CA and will be required to submit lien and mortgage releases to the buyer upon final payment of the reduced claim amount. Creditors have a short period of time to dispute the characterization or the amount of their claims. This time period helps establish whether the buyer’s information is correct and provides an opportunity for additional, unknown creditors to step forward and assert their claim. Once the time period for disputes has closed, the buyer holds an informational meeting to further explain the CA and why it is an attractive alternative to bankruptcy, indicating its method of valuation and the possibility for future projects in which the buyer can procure the creditors’ services. Before closing, each creditor will deliver executed forms of various releases, stipulations for the dismissal of pending lawsuits, and the satisfaction of judgments previously entered against the seller.

When the buyer receives the appropriate percentage of acceptances and accompanying documentation, it presents them to the escrow agent, who releases the property assignment to the buyer. Once the buyer is assigned the property, it promptly records the assignment and all relevant settlement documents in the real property records and appropriate courts.

After closing, the buyer sends a Notice of Closing (“NOC”) to the accepting creditors. The NOC lists the creditors and their principal claims that are subject to the CA, indicates that the buyer has carried out the transactions contemplated by the PSA and CA, and identifies each creditor’s pro rata share of the monthly plan payments, if applicable. Once all payments have been made, the buyer receives a receipt and release from each creditor. The buyer owns the conveyed property free of encumbrances, the seller’s debt related to the property is eliminated, and the creditors’ loans are reasonably satisfied without enduring a burdensome and lengthy bankruptcy.

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

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