Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.
By Nushin Huq
Feb. 22 — In the current low oil price environment, it’s important for oil and gas companies to know what type of preparatory steps companies can take if a counter party has weakening credit or files for bankruptcy, including learning the warning signs of bankruptcy risk, automatic stays and exceptions to the stay for certain contracts in the energy sector, Reed Smith LLP attorneys told conference attendees in Houston, Feb. 18.
Low commodity prices can lead to higher credit costs, which can have indirect and flow-through implications from a bankruptcy standpoint, Paul Turner, partner at Reed Smith’s Energy and Natural Resources group, said during a panel discussion at the Center for American and International Law’s 67th Annual Oil and Gas Conference.
While the price of oil fell from more than a $100 per barrel in mid-2014, to below $30 a barrel currently, oil is not the only energy commodity losing value, Turner said. Prices of natural gas, electricity and coal have all been falling, so the economic impact is across all the segments of the energy industry.
“It’s hard these days not to see the constant barrage of bad news, an effect of oil prices,” Turner said. “”It’s also important to note from [Energy Information Administration] projections, it doesn’t look like it’s going to get all that good, all that soon.”
There are a lot of different signs that there is trouble on the horizon including certain financial stresses related to the debt companies are harboring and third party actions that bring that stress into the public sphere, Andrea Pincus, partner at Reed Smith’s Financial Industry Group, said.
Since the fourth quarter of 2015, there’s an expectation that loans and bond payments may be coming due, creating a troubling situation for companies that are strapped, Pincus said. Companies may try to negotiate forbearance of a loan, a sign that trouble is looming.
Restated financials can also be a sign that a company is in trouble so it’s always important to look at the fine print and footnotes to understand what the restatement means, Pincus said. Signs from third-party sources that a company could be at risk for bankruptcy include downgrades from rating agencies for companies or their bonds, loss of credit insurance or markets for puts, or notice of delisting from a stock exchange.
Warning signs of imminent bankruptcy include sudden change of leadership, such as the chief executive officer or chief financial officer, retention of a chief restructuring officer or crises manager, or the formation of an ad hoc bondholder committee. A WARN Act notice, a required notice under federal labor law, gives employees a 60 day notice of plant closings and mass layoffs and can be another warning sign.
“These are things you see days or weeks before a bankruptcy gets filed,” Pincus said. “These are really the red flashing lights.”
When a bankruptcy is filed an automatic stay kicks in, which prohibits counter parties and others to collect debt, to sue, to modify or terminate contracts. It’s generally very broad.
There are some automatic stay safe harbor contracts, which are prevalent in the energy industry, Pincus said. These include forward contracts, swap contracts and master netting agreements. The Bankruptcy Code allows these contracts to be terminated or liquidated. It allows for collateral that was posted to be foreclosed upon without seeking authority from the court.
The safe harbors exist to protect markets from systemic risk and prevent a domino effects in the futures market, Pincus said. At the same time, the counter party that’s not in bankruptcy, cannot pick when to terminate a contract in order to improve its own position. The termination must only be done because of the bankruptcy. A court can determine a termination is invalid if it finds that it was done for other reasons such as limited exposure.
“In the course of discovery, if there’s an e-mail that says, ‘Wait, don’t terminate now, let’s wait a couple of weeks and see what the markets like,' that’s bad,” Pincus said. “You don’t want those types of e-mails.”
Commodity traders, who are often in the front line of these types of transactions, contract administrators and legal departments need to understand what can and cannot be done, Pincus said.
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