March 13, 2020
The oil price plunge starting on March 6 seems like a sucker-punch to the oil and gas industry after the price decreases and market unrest as a result of COVID-19. However, for those with capital to spend, including international players, it will lead to opportunities to acquire assets and distressed companies (including acquisitions of asset packages, acquisitions of companies, and take-private transactions). U.S. Bankruptcy law can be daunting for many foreign investors; however, the bankruptcy process can provide real advantages. In other cases, out of court transactions may be the preferred approach. Acquiring distressed assets requires careful planning and a measured approach that minimizes the risk of any subsequent challenge by creditors of the seller. Below, we highlight certain issues for international buyers to consider in connection with acquisitions of assets from distressed companies. Our energy team is experienced in these issues and invites the opportunity to discuss them with you and answer specific questions you may have.
Buying assets from a distressed seller outside of bankruptcy often presents opportunities and risks. On the one hand, out of court transactions are generally subject to less competition and public disclosure. However, where a seller is potentially insolvent and yet willing to transact, a buyer must consider the risk of subsequent challenges by creditors (or a bankruptcy trustee) to unwind the sale transaction and otherwise claw back value from the buyer. In the current climate of volatility and distress, this risk should not be overlooked. In some instances, pursuing the transaction through a structured Chapter 11 case is the best way to mitigate claw-back risks, execute with greater certainty, and maximize the extent to which the sale is free and clear of the seller’s liabilities. In other instances, particularly where there are few creditors and they are tactfully engaged in the sale process, an out of court approach can be an effective strategy to minimize competition and transaction costs. In any out of court transaction with a potentially insolvent seller there are steps that buyers can and should take (through due diligence and the negotiation of specific representations, warranties and covenants in the purchase agreement) to mitigate risks to themselves and the transaction. We have particular experience negotiating on behalf of buy-side clients with the lender and bondholder groups of a seller in a manner that minimizes public competition.
In certain circumstances, distressed M&A transactions are best implemented through a structured chapter 11 proceeding to provide the buyer with certainty that the sale is free and clear of any liabilities of the seller. One common way to do this is through a sale process pursuant to Section 363 of the Bankruptcy Code. This sale process typically includes two stages of auctions. The initial selected bidder on the assets of a bankrupt company, known as a stalking-horse bidder, agrees to set a floor price, ensuring a minimal recovery to creditors. Thereafter, interested parties bid against the stalking horse. In exchange, the stalking horse typically obtains court-approved bid protections, including a break-up fee and expense reimbursement that compensate the stalking horse for its opportunity cost and the value provided to the bankruptcy estate should the stalking horse bid induce any higher or better bids. . Therefore, a stalking-horse bidder should consider the risk of being outbid at an auction when negotiating the terms and conditions of the purchase agreement, maximize the scope of its bid protections, and ensure that any court-approved bidding procedures are as favorable to its bid as possible.
The bankruptcy court must approve the purchase agreement in connection with any purchase of assets from the debtor. In connection therewith, the bankruptcy court has broad discretion to consider the objections of the seller’s creditors, including those with liens on the assets at issue, those holding blocking debt positions on the terms of any Chapter 11 plan and any post-petition DIP lenders that otherwise have material consent rights. As a result, a buyer must consider how the seller’s creditors may react when negotiating the terms and conditions of the purchase agreement. In some instances, negotiating directly with such creditors on the terms of a Chapter 11 plan can minimize public competition and otherwise improve the position of a potential buyer. In any case, a buyer should structure its bid to maximize the extent to which it may acquire assets free and clear of liens, claims and other liabilities of the seller under Section 363(f) of the Bankruptcy Code.
An “executory contract” is a contract under which unperformed obligations remain on both sides, such that either party would be excused from performance if the other party were to breach its remaining obligations. Section 365 of the Bankruptcy Code provides the debtor the option to reject, assume or assume and assign its executory contracts in bankruptcy. Many contracts commonly entered into in the oil and gas industry, including joint operating agreements, vendor contracts, farmout agreements and midstream agreements, may qualify as executory contracts under the Bankruptcy Code. Therefore, it is important for a buyer to identify material contracts that may qualify as executory contracts and timely direct the debtor as to those executory contracts that will be assumed by the debtor and assigned to the buyer pursuant to the bankruptcy process. This process is typically addressed in any purchase agreement as well as in the sale motion and related orders proposed to the bankruptcy court.
In order for a seller to assume and assign any executory contract, it must cure any defaults with respect to such executory contract. The amount and allocation of responsibility for payment of such “cure costs” is a key consideration when buying assets pursuant to thebankruptcy process. Although cure costs are technically the seller’s responsibility, a buyer can increase the value of its bid by assuming all or some portion of them.
While consent to assignment provisions in oil and gas contracts are typically enforceable outside of bankruptcy, it is possible for them to be rendered unenforceable under Section 365(f)(1) of the Bankruptcy Code. Section 365(f)(1) provides that a trustee may assign an executory contract or unexpired lease “notwithstanding a provision in an executory contract or unexpired lease of the debtor…that prohibits, restricts or conditions the assignment of such contract or lease.” Note that this safe harbor provision is only applicable tocontracts and unexpired leases that qualify as executory contracts and not available with respect to consent to assignment provisions in oil and gas leases in Texas and other jurisdictions where oil and gas leases are not considered executory contracts.
Following a sale of assets pursuant to the bankruptcy process, a seller is likely to distribute the sale proceeds soon thereafter and remain insolvent or, if possible, wind down. As a result, the seller’s representations and warranties in the purchase agreement typically do not survive closing and the seller’s post-closing indemnification obligations are often very limited.
The Bankruptcy Code requires that all administrative claims must be paid in full. Accordingly, the question as to whether plugging and abandonment claims are entitled to administrative priority and the party responsible for plugging and abandonment obligations is a key consideration when buying assets pursuant to the bankruptcy process. The answer largely requires a state-by-state analysis and, therefore, it is important that the parties address the allocation of plugging and abandonment and other environmental obligations in the purchase agreement. Understanding a debtor’s ability or inability to abandon assets with P&A liabilities in excess of market value may also provide a buyer with additional leverage.
On February 13, 2020, new regulations issued by the U.S. Department of the Treasury came into effect that significantly expanded the authorities of the Committee on Foreign Investment in the United States (CFIUS) to review foreign acquisitions of, and investments in, U.S. businesses. The new regulations specifically broadened the jurisdictional authority of CFIUS to review foreign investments in certain sensitive business sectors (including aspects of the oil and gas industries). While the new regulations also imposed a mandatory filing requirement for certain foreign investments, the CFIUS process will remain voluntary for most deals. Transaction parties thus will continue to have the discretion to seek CFIUS review and clearance of a particular transaction or investment. Furthermore, the new regulations allow for a short-form filing process in certain situations that should facilitate CFIUS review of a transaction as it requires CFIUS to act within 30 days. The new CFIUS regulations should not be seen necessarily a “poison pill” for international buyers looking to invest in energy assets either through a bankruptcy sale process or as part of an out-of-court transaction. Our team has extensive experience in these issues and can help you to evaluate any potential transaction to help you manage the CFIUS process in a way that accomplishes your objectives and, in many instances, helps to ensure your offer to purchase assets is competitive and attractive to potential distressed sellers and their creditors.
The above includes certain key issues that may arise in connection with the acquisition of assets by international buyers from distressed companies, but the list is by no means exhaustive. The key is for a buyer to be proactive and make the most of distressed opportunities. Our energy team is experienced in these issues and invite the opportunity to discuss them with you and answer specific questions you may have.