Can Filing a Chapter 11 Save My Oil and Gas Business?

 

By Steven H. Felderstein and Jennifer E. Niemann*

 

What will happen to your oil and gas business if low commodity prices eliminate your ability to borrow additional funds, or worse, force you to pay down some or all of your company’s credit line?  Can you reduce your cost of production to make a small profit or break even at current crude prices?

 

Dozens of oil and gas companies filed bankruptcy cases in 2015 to take advantage of Chapter 11’s tremendous flexibility to restructure balance sheets and reorganize operations.  Companies in Chapter 11 can restructure payment terms, adjust equity, sell non-core business assets or even sell an entire business as a going concern.  A successful Chapter 11 reorganization depends on many factors, including not waiting too long to file, developing an exit strategy before filing, minimizing the expense of a Chapter 11 case by moving through the process quickly, and being represented by experienced Chapter 11 counsel.

 

How Chapter 11 Can Benefit a Business

 

The primary benefits of Chapter 11 are: (1) protection from collection actions by creditors; (2) management remains in control and can continue to operate in the ordinary course of its business; (3) management can decide which leases and contracts to keep or reject; (4) management has the exclusive right to propose a plan of reorganization for the first six months of the case; (5) all creditors are before the same bankruptcy court represented by a committee with whom management can negotiate a plan; and, (6) the bankruptcy court can confirm a plan over the objection of creditors.

 

An “automatic stay” goes into effect immediately upon filing a Chapter 11 case permitting a business to reorganize its operations with relative freedom from creditor actions.  The automatic stay stops creditors from taking any action to collect their pre-bankruptcy debts.   This gives management and its general counsel a breathing space to focus on righting the ship and coming up with a reorganization plan.

 

Management remains in control of the company which becomes known as the “debtor in possession” (“Debtor”).  Continuity of management helps reassure employees, customers and creditors during the difficult initial phase of the case.

 

The Debtor can review its contracts to decide if it wants to continue to perform.  Undesirable or unprofitable contracts may be rejected after approval by the bankruptcy court. Desirable contracts can be “assumed,” at which time the Debtor must cure any defaults under those contracts. 

 

The ultimate goal of Chapter 11 is to confirm a reorganization plan so the Debtor can stay in business and retire all or a portion of its debt, with the unpaid portion, if any, being discharged.  Only management can file a plan of reorganization for the first 120 days of a Chapter 11 case.  If filed within the 120 days, management gets another 60 days to obtain votes in favor of the plan.  Such a plan can include selling non-core business assets, or selling the entire business as a going concern. 

 

Filing a Chapter 11 brings all creditors and litigation before the bankruptcy court, thus eliminating the need to defend collection actions in different courts all over the country.  To give the Debtor a representative group of creditors with which to negotiate a plan, the Bankruptcy Code provides for the appointment of a committee of the seven largest unsecured creditors.

 

Finally, the plan process favors a consensual plan, but gives the Debtor negotiating leverage because a plan can be “crammed down” or confirmed over the objection of recalcitrant creditors.

 

Possible Downsides to Filing Chapter 11

 

Filing a Chapter 11 bankruptcy case has several potential downsides.  First, the reputation of the business could suffer.  Customers may decline, current vendors may stop doing business with the Debtor or may supply on a COD basis only, and employees may leave.  At a minimum, filing a Chapter 11 disrupts the Debtor’s business operations and takes time away from managing the business.

 

Second, the automatic stay only protects the filing entity (the Debtor) and its assets.  It does not protect guarantors, co-debtors, affiliates, general partners or others liable for the indebtedness. 

 

Third, state law could impede the Debtor’s ability to deal with its leases and other contracts.  In California, the Debtor likely will be able to assume or reject oil and gas leases because the landowner cannot convey a fee interest in oil and gas under the surface of his land.  Rather, the landowner can only lease or transfer an exclusive right to explore for, develop and produce that oil and gas.  Laws in other states may differ.

 

Fourth, Chapter 11 is expensive for smaller businesses because it is designed for large, publicly-traded companies. 

 

Fifth, the Debtor may not be able to successfully exit Chapter 11 if: (1) the business does not perform sufficiently during the Chapter 11; (2) the Debtor does not have the funding to pay post-bankruptcy claims; (3) the Debtor is unable to secure the votes needed to confirm a plan; or, (4) the Debtor is unable to meet the Bankruptcy Code cramdown requirements.

 

Finally, the Debtor’s management must meet its fiduciary obligations to creditors as well as operate within the constraints of the Bankruptcy Code to avoid the appointment of a Chapter 11 trustee, which would displace the Debtor’s management.

 

A Debtor Needs Experienced Counsel

 

Experienced bankruptcy counsel helps a company and its general counsel determine if the benefits of Chapter 11 justify the cost and disruption to business resulting from filing a bankruptcy case.  If Chapter 11 is a viable alternative, the company and counsel need to determine an exit strategy before entering bankruptcy to reduce the time and cost of the legal process.

 

Because the debtor remains in possession when filing a Chapter 11 case, the Debtor's management is a fiduciary of the bankruptcy estate and must operate the business in compliance with all state and federal laws and regulations.  Bankruptcy counsel helps the Debtor comply with the Bankruptcy Code and Rules, as well as with filing schedules and statements detailing the Debtor’s assets and liabilities and its historical business activities. 

 

Management must attend and be represented by counsel at two very important meetings. The first is with the administrative arm of the bankruptcy court to check on compliance.  And the second, called the first meeting of creditors, provides creditors with the opportunity to ask management questions under oath about the company’s past and future performance.  Chapter 11 rules also require management to prepare monthly operating reports and a statement of compliance with federal and state tax laws on forms provided by the bankruptcy court.

 

While the Debtor can operate in the ordinary course of its business without bankruptcy court approval, questions of what actions are not in the ordinary course require the assistance of experienced counsel. 

 

In the first days of the case, counsel for the Debtor typically brings several motions to approve certain post-bankruptcy actions.  Most are administrative, like maintaining bank accounts and making payroll.  In many cases, however, where one or more creditors has a security interest in the company’s cash or assets that can turn into cash, like inventory and accounts receivable, called “cash collateral,” it is very important to the Debtor’s continued operation that counsel obtain immediate bankruptcy court approval to use cash collateral.  Usually, the secured creditors stipulate to the continued use of cash collateral subject to various restrictions and a budget, and the bankruptcy court approves the stipulation and budget.  If the secured lenders and the Debtor are at odds, experienced bankruptcy counsel can help the Debtor obtain authority to use cash collateral from the bankruptcy court by showing that the secured lenders will be no worse off as the result of the proposed use of cash collateral.  

 

While the Bankruptcy Code gives the Debtor great flexibility in developing a plan, counsel provides essential legal advice and structure for plan confirmation.

 

Conclusion

 

The oil and gas industry is in a downturn because of low commodity prices.  Barring a prompt turnaround in oil and gas prices, many in the industry will need a legal process for reorganization.  Chapter 11 is a powerful tool designed to help a business in distress restructure its debts and reorganize and, when applied properly, to help it succeed in the future.  Experienced bankruptcy counsel working with general counsel enables management to develop a viable exit strategy prior to entering Chapter 11, operate in Chapter 11, and negotiate and confirm a successful plan of reorganization. 

 

This article is issued for informational purposes only and is not intended to be construed or used as general legal advice.

______________________________________________________________________________

Steven H. Felderstein
Felderstein Fitzgerald Willoughby & Pascuzzi LLP
400 Capitol Mall, Suite 1750
Sacramento, CA 95814
sfelderstein@ffwplaw.com
(916) 329-7400, Ext.220

 

Jennifer Niemann
Felderstein Fitzgerald Willoughby & Pascuzzi LLP
400 Capitol Mall, Suite 1750
Sacramento, CA 95814
jniemann@ffwplaw.com
(916) 329-7400, Ext. 232

 

Felderstein Fitzgerald Willoughby & Pascuzzi LLP (FFWP) specializes in bankruptcy and insolvency matters.  Martindale-Hubbell, Chambers USA and Reuters, The Best Law Firms all recognize FFWP as a top law firm.  Steven Felderstein is a member of the American College of Bankruptcy, an adjunct professor of law at McGeorge School of Law, and recognized for his expertise in bankruptcy related matters by Best Lawyers in America, Super Lawyers® of Northern California, and Chambers USA.  Jennifer Niemann writes and speaks frequently on bankruptcy topics, is senior counsel and a very experienced lawyer.