Buying natural gas assets from financially distressed companies is an inherently risky proposition. Even when an attractive prospect is identified, the purchaser has to overcome a number of issues such as clearing up title, including mechanic and materialman liens and getting assignments of contracts and lessor consents. Assuming these hurdles can be managed, the purchaser is also faced with legacy liability problems ranging from plugging and abandonment and decommissioning costs, unknown claims from interest owners under joint operating agreements, general claims from oil field suppliers, service companies and surface owners. Even years after the transaction has closed, the transaction potentially is subject to being unwound as fraudulent transfer, as we discussed in a previous alert.
Advantages of Bankruptcy Acquisitions
A means to deal with these issues and protect the acquisition from challenge is to acquire the natural gas assets through a structured bankruptcy transaction. Acquiring assets through bankruptcy offers several advantages:
- Free and Clear. A key benefit of a bankruptcy acquisition is that the purchaser obtains the purchased assets washed from liabilities, free and clear of any liens, claims and encumbrances, including other general liabilities. Moreover, because an acquisition in bankruptcy is approved by a court order, the purchaser can often obtain findings in the order that the purchase is not a fraudulent transfer and that there is no successor liability.
- Potential Limitation of Future Liability. Outside of bankruptcy, there are greater risks under various legal theories that a purchaser may inherit the liabilities of seller related to the properties sold. The free and clear nature of a bankruptcy acquisition generally cuts off these future liabilities.
Bind Non-Consenting Constituencies.
- Many company bylaws and organizational documents require the approval of a majority of shareholders to sell substantially all of the company’s assets. In a bankruptcy acquisition, generally these requirements do not apply.
- Assets (including contract rights) can be purchased free from rights of first refusal, termination rights, consent rights or change of control provisions. However, certain successor liability issues should be reviewed and addressed on a case-by-case basis - for example, whether a purchaser will be liable for the seller’s pre-existing environmental liabilities.
- “Cherry Pick” Contracts and Leases. Favorable contracts and leases can be assumed while unfavorable contracts can be rejected and not acquired with the purchased assets. For example, if an oil and gas property is subject to an unfavorable production sales contract, the purchaser can leave the contract behind to be rejected by the seller in its bankruptcy case. Accordingly, the contract will be rejected and terminated and the property sold to the purchaser free and clear of any contract obligation that the purchaser does not wish to assume.
- Stalking Horse Protections. A purchaser should attempt to be the stalking horse bidder and obtain the protection of a break up fee if the properties are ultimately sold to a higher bidder at auction. The purchaser also may be able to negotiate for the payment of work fees relating to purchaser’s costs of due diligence efforts.
Disadvantages of Bankruptcy Acquisitions
A structured bankruptcy to implement an acquisition of oil and gas properties can impose some disadvantages that primarily relate to the requirements of a public process, competitive bidding and court approval.
- Exposure to the Market and Competitive Bids. Bankruptcy acquisitions are undertaken in a public process which generally requires exposure to the market and competitive bidding. The seller in bankruptcy is entitled to shop the stalking horse’s bid and the sale will be subject to court approval. Because a bankruptcy acquisition is generally subject to competitive bidding, the sale may not be consummated with the original bidder. For this reason, the original stalking horse bidder should negotiate for break up fee protection.
- Timing and Delays. Because the sale of properties in bankruptcy is subject to court review and a competitive bidding process, it may take more time to close the sale. In addition, delays may occur if creditor objections need to be resolved.
- Negative Publicity. A bankruptcy filing may create negative publicity. A sale outside of bankruptcy avoids this negative publicity; however, a bankruptcy acquisition can be accomplished relatively quickly to transition the oil and gas properties to new ownership.
- Seller’s Business Judgment. The business judgment of the seller is subject to review by the bankruptcy court and can be questioned by creditors and potential third-party bidders. Accordingly, no one should expect to negotiate a “sweet heart/brother-in-law deal” where the properties may be sold for less than market value. Because the sale is open to scrutiny, there are no “private deals” and the total consideration offered is a matter of public record for review by creditors and competitors alike.
Careful consideration should be given to implementing a sale of assets in bankruptcy. After weighing the pros and cons of an acquisition structured in bankruptcy, the benefits of a sale free and clear that cannot be challenged later may outweigh the additional procedural requirements imposed by the bankruptcy process.