At the risk of stating the obvious, the collapse of oil and gas prices in the last several quarters has had a profound impact on the industry. Some E & P companies have been able to weather this storm, but other have not been so fortunate. In the time between 2014 and September 14, 2016, 102 oil and gas producers with cumulative debts of over $67 billion, 13 midstream companies with cumulative debts of over $17 billion and 132 oilfield service companies with cumulative debts of over $14 billion have filed bankruptcy petitions.

According to Debtwire Analytics, at least 135 additional oil and gas companies remain at risk of filing in the coming months.

This month’s article, coincidentally, discusses the likelihood of, and various reasons for, additional bankruptcy filings in the next 12 to 18 months.

Individuals Continue Filing for Bankruptcy

Outside of the energy sector, the slow recovery from the 2008 recession caused a significant increase in individual bankruptcy filings, peaking in 2010 before declining over the last few years. Nevertheless, individual bankruptcy filings still occur in large numbers.

Based on data regarding the per capita rate of bankruptcy filings as of June 2015 and the most recent population figures, the following estimates non-business bankruptcy filings in each state in the Illinois Basin and the Marcellus/Utica:

Illinois 58,871

Ohio 39,688

Indiana 27,794

Pennsylvania 22,610

Kentucky 15,691

West Virginia 3,264

Why is this information important?

First, some of the pitfalls.

When a bankruptcy is filed, something called the automatic stay goes into effect. The purpose of the automatic stay is to freeze the debtor’s financial situation and allow the debtor, or in some cases a court appointed trustee, to take stock of the situation in order to maximize the return to creditors. Any act taken in violation of the automatic stay is void.

This all sounds logical. After all, when an individual or entity is at a financial point where bankruptcy becomes feasible or even necessary, their or its “situation” has probably become rather chaotic. However, the ramifications of the automatic stay are limited only by the imagination of the attorney trying to enforce it.

If you are an E & P company and one of your mineral owners, or the other side of a farmout agreement or joint operating agreement, files bankruptcy, depending on the state where the mineral are located, any one of the following could happen.

  • The trustee in bankruptcy could reject the existing oil and gas lease, or farmout agreement, or surface use agreement.
  • If payments to you from the other party to a farmout or joint operating agreement are deemed by the bankruptcy court to be what are known as preferential payments, you could be ordered to return those payments.
  • Any payments you make after a bankruptcy petition is filed, technically speaking, could have been paid to the wrong person or entity. You would be required to make the payment to the correct entity without any guarantee of immediate reimbursement for the amounts first paid.
  • Failure to pay the royalties to the proper person could jeopardize the existence of the lease.
  • Any modifications of the lease can be done only with bankruptcy court approval, which could take months to accomplish and which would require the assistance of a bankruptcy attorney licensed where the mineral owner resides, which may not be where the minerals are located.
  • Claims against the mineral owners may not ever be paid and there is a very limited right to set off such claims against amounts due to the mineral owner.
  • If the lessor’s property is mortgaged, a bankruptcy filing could eventually, but not automatically, result in foreclosure. Alternatively, bankruptcy law in certain circumstances allows for the sale of property free and clear of all liens and encumbrances, including existing oil and gas leases.
  • Theoretically, the very act of drilling and recovering oil or gas could be considered a violation of the automatic stay.

The Goose that Laid the Golden Egg?

Now, some of the opportunities. Bankruptcy filings can be the goose that laid the golden egg.

Credit bidding in bankruptcy can enable lenders to purchase producing assets at a fraction of their market price. In one case, the lender purchased assets at a price equivalent of $1.58 per Mcfe where the comparable market price was $2.73 Mcfe. In another, the sales price was $3.60 per Boe and the comparable market price was $21.72 Boe.

The mandated purpose of filing bankruptcy is to maximize the return to creditors. Leased but non-producing acreage has no value to a company that cannot afford the costs of development and so can sometimes be acquired for a fraction of its actual value.

Knowledge is Power

Suffice it to say that an understanding of bankruptcy law and the consequences of a bankruptcy filing are essential to avoid the pitfalls or, hopefully, to take advantage of the opportunities. Over the next few months we will attempt to provide a very basic primer on bankruptcy law as it impacts the oil and gas industry in the Marcellus/Utica region and the Illinois Basin.