The media have been paying considerable attention to the current financial distress of the energy industry in Alberta, focusing primarily on the impact a company’s financial condition can have on its stakeholders, including its employees, shareholders and creditors. But there is another group that is also being affected: counterparties to commercial arrangements with insolvent companies. Increasingly, financially strong companies are having to deal with insolvent joint venture partners, financially distressed operators, and bankrupt lessees. When they attempt to exercise contractual rights to terminate commercial arrangements with such companies, or to replace an insolvent operator, or cancel a lease, they are finding themselves stayed from exercising such remedies against the counterparty who is in receivership or undergoing restructuring proceedings. As a result, these companies are left wondering how best to respond and what options are available to them.
Fortunately, a few early and proactive measures can help minimize the financial and operational risks companies might encounter when dealing with counterparties who are either insolvent or highly likely to become insolvent.
First, companies should implement a regular practice of monitoring at-risk counterparties for signs of financial distress. Common indicators include going concern qualifications in financial statements, failed capital raises, cash flow shortages, ballooning payables and increasing demands by creditors. By reviewing publicly available financial information and negotiating financial reporting obligations for privately-held counterparties into commercial arrangements, companies can gain valuable insight into potential future distress, prior to the commencement of receivership or restructuring proceedings.
Second, companies might consider registering land charges and personal property security interests at the Alberta Personal Property Registry to perfect security interests granted to them under contractual liens for operator’s and/or processor’s fees or royalties if outstanding amounts for such items are owed.. Registration of a secured claim against a counterparty’s real property rights, including mineral interests, will rank ahead of unsecured creditors or subsequently registered secured creditors.
Third, companies should ensure that governing agreements with its counterparties contain clear set-off provisions permitting the netting of debts. Where affiliates of a company and its counterparty have commercial dealings, the company should consider including set-off provisions permitting the netting of debts across inter-company lines (often referred to as “square set-off”). Inclusion of clear contractual language permitting one or both forms of set-off can result in significantly enhanced recovery under a counterparty’s bankruptcy, receivership or restructuring proceedings as all applicable legislation recognizes the law of set-off within such proceedings.
Similarly, if agreements with joint venture partners lacking strong balance sheets are necessary, consider buy out and termination rights or cross-default provisions, secured by a security interest at the time of execution. Such rights may improve a party’s position in dealing with a subsequently insolvent counterparty.
Finally, companies should be aware that a counterparty in receivership or restructuring proceedings has the right to terminate out-of-the-money executory contracts. While this right is subject both to court supervision and to a number of exceptions, companies should prepare for this contingency to minimize any potential losses.
The risks associated with dealing with financially distressed counterparties can be concerning and given current commodity prices, these concerns are unlikely to be assuaged soon. However, adopting a few simple and proactive measures into contractual dealings can help companies both identify counterparty financial issues early on and put important remedies into effect, thereby minimizing the risks they face while maximizing their chances for recovery.