As predicted at the Commercial Finance Association’s Fourth Annual Energy Summit on September 16th, we should start seeing more and more oil & gas companies struggle to survive in the wake of continued low commodity pricing. While we witnessed some rebound in pricing towards the end of the summer, the price of oil again dipped to under $50 a barrel in September and the price of gas continues near historic lows, at just under $3.00 MMBtu. As Philip Cook, the Chief Financial Officer of Samson Resources Corporation, recently stated:
“Oil and gas companies across the United States and around the world are feeling the pressure from the downward spiral in commodity prices, and the fate of many of these companies is yet to be determined. Access to capital is the lifeblood of exploration and production companies. With increasing leverage because of a constant need for capital, together with the recent rising cost of capital in the industry, operating in the current environment has been—and likely will remain—challenging . . . . Some companies will attempt to wait out the current conditions, hoping for a rebound in commodity pricing and increased access to low-cost capital; others will succumb to market pressures and be forced to sell at depressed prices or otherwise permanently halt operations. Other companies will take a proactive approach and work to reshape their operations and balance sheet in a manner that will allow them to weather the macroeconomic environment in all circumstances.”
Declaration of Philip Cook In Support of Chapter 11 Petitions and First Day Motions (Docket No. 2) at pg.1; In re Samson Resources Corp., Case No. 15-11934 (Bankr. D. Del. Sept. 17, 2015) (emphasis added).
The proactive approach mentioned above is the one that Samson Resources Corporation (“Samson” or “Company”) appears to have chosen, when it filed for chapter 11 bankruptcy on September 17, 2015. See In re Samson Resources Corp., Case No. 15-11934 (Bankr. D. Del. Sept. 17, 2015). The bankruptcy filing followed lengthy and meaningful negotiations with Samson’s major constituencies. As a result, Samson was in a position to immediately file a prenegotiated plan of reorganization shortly after it commenced its case. The restructuring plan proposes to tackle the two main issues that have plagued Samson; liquidity and substantial debt obligations. To whit, the plan proposes to eliminate over $3 billion in long-term debt and raise $450 million in new capital. This Article will explore how Samson was able to accomplish this feat.
Headquartered in Tulsa, Oklahoma, Samson is an onshore oil and gas exploration and production (E&P) company, with interests in various oil and gas leases primarily in Colorado, Louisiana, North Dakota, Oklahoma, Texas and Wyoming. Specifically, the Company and its affiliates operate, or have royalty or working interests in, approximately 8,700 oil and gas production sites.
In 2014, Samson produced approximately 530 million cubic feet equivalents (MMcfe/d) of gas and oil per day from its producing wells. However, the Company has recently suspended exploration and drilling operations in light of its current financial distress and the turmoil in the industry.
Like other E&P companies, Samson began to experience significant liquidity constraints, when commodity prices plummeted in the latter half of 2014. Lower pricing resulted in lower revenue, which, in turn, meant that the Company could not service its substantial long-term debt obligations and continue profitable operations, which required significant capital expenditures. Moreover, the lower pricing reduced the borrowing base under Samson’s primary credit facility, which limited Samson’s ability to borrow its way out of its problems.
In an attempt to improve its liquidity, Samson undertook initiatives to reduce operating expenses, like suspending drilling activities, limiting capital spending and reducing its workforce by 35%. It also attempted to improve liquidity by pursuing divestiture of certain noncore assets and drawing down the remaining availability under its primary credit facility. However, it became apparent that these steps would not be sufficient to allow the Company to weather the current storm.
Merriam-Webster’s Dictionary defines a “fulcrum” as being the support on which a lever moves when it is used to lift something. The classic example is the fulcrum of a seesaw, which simultaneously supports one side pivoting upward and another side pivoting downward.
The term “fulcrum debt” (also known as “fulcrum security”) derives from this concept. The terminology is generally used in situations where a borrower or debtor that has multiple tranches of debt is undergoing, or will undergo, a restructuring. Inside of bankruptcy, pursuant to the absolute priority rule, (a) secured creditors generally are entitled to recover the full amount of their debt before unsecured creditors receive any recovery and (b) unsecured creditors generally are entitled to recover the full amount of their debt before any equity owners receive any recovery.
This priority scheme is often challenged, however, in instances where the debt stack of a borrower includes several tranches of debt, with varying degrees of priority, and the borrower owns insufficient assets to satisfy all such debt. In such instances, often only the senior-most tranches may be entitled to a full recovery, leaving lower priority creditors with only a partial recovery or no recovery at all.
The least senior debt that is at least partially entitled to a recovery is generally considered to be the fulcrum debt. Using the seesaw analogy, the fulcrum debt is the midpoint where the seesaw tilts upward for creditors entitled to a full recovery and downward for everyone else. Falling in the middle, the fulcrum debt supports both sides of the seesaw. Another way of looking at it is that the fulcrum debt is the tranche of debt found at the threshold of where a borrower’s assets exceed its liabilities.
Why is it important to identify the fulcrum debt? In a restructuring scenario, where a debtor wishes to remain a going concern but does not have enough enterprise value to provide full recovery to all creditors, a restructuring strategy commonly employed is to convert the fulcrum debt to equity, as such debt is the lowest point entitled to any recovery from the debtor. All other junior debt is “out of the money,” and while the senior secured debt must still be satisfied in full, the Bankruptcy Code enables a reorganized debtor to do so over time, thereby permitting the fulcrum debt to immediately take ownership with little or no new capital. See 11 U.S.C. § 1129(b)(2)(A)(i).
Why is this strategy good for a debtor? As demonstrated in Samson’s case, a debt for equity conversion can enable a debtor to eliminate substantial long-term liabilities and maintain scalable operations. In the energy sector, where a substantial number of companies are overburdened with debt and need fresh capital to sustain operations, the debt-for equity swap with fulcrum debt may provide a viable means of survival.
Samson’s Prebankruptcy Negotiations
When Samson realized it would need to take additional steps besides cost-cutting and divestiture initiatives, it began negotiating with its primary constituencies regarding a potential restructuring plan.
Samson has three primary tranches of long-term debt; a first-priority, secured revolving credit facility, which is owed approximately $950 million; a second priority, secured term loan facility, which is owed approximately $1 billion; and outstanding senior unsecured notes, in the principal amount of $2.25 billion. In addition, Samson has significant equity investors like Kohlberg Kravis Roberts, which 3 years earlier lead the acquisition of the Company for $7.2 billion. The pre-bankruptcy negotiations involved all of these groups and progressed as follows.
After negotiating loan default waivers with its first lien lenders, Samson began negotiations with its second lien lenders, which appeared to hold the fulcrum debt of the Company. Samson and its second lien lenders eventually arrived at a proposal that provided for (a) an in-court restructuring, (b) the conversion of the entire fulcrum debt into equity in the reorganized Company and (c) rights offerings of both debt and equity securities that would raise at least $450 million in new capital upon Samson’s emergence from bankruptcy. The rights offerings were backstopped (or guaranteed) by the second lien lenders. On account of the estimated enterprise value of the Company, this proposal also eliminated the debt owed to the senior unsecured noteholders and all existing equity in the Company.
At the same time it was negotiating with the fulcrum debt, Samson also requested that the senior unsecured noteholders come up with an alternative restructuring proposal, as they appeared to be the stakeholders (outside of equity) that theoretically stood to lose the most from an in-court restructuring. The noteholders arrived at a proposal that required (a) an out-of-court exchange of the current senior unsecured notes for new secured notes, at an 80% discount and (b) a new money investment of $650 million. Under this latter proposal, both the surviving secured notes and the new money investment would be granted priority liens ahead of the fulcrum debt. And, because this proposal involved no bankruptcy filing, existing equity ownership would remain in tack.
There were several reasons why Samson ultimately chose to pursue the proposal with the second lien lenders. Under that proposal, Samson stood to eliminate over $3 billion in long-term debt, as its last two tranches of debt (the second lien debt and senior unsecured notes) would be extinguished. This proposal also assures that Samson will raise at least $450 million in fresh capital, which is projected to be sufficient to sustain scalable operations in the not-so-short-term future.
Unlike the fulcrum debt proposal, the noteholders’ proposal still left Samson with $3 billion in long-term debt and contained too many contingencies, including an almost unanimous noteholder consent requirement and unlikely concessions from the first lien credit facility (which would remain in place after the bankruptcy). Furthermore, the legality of the noteholders’ exchange offer, which allowed fresh liens to jump ahead of existing liens, was likely to be challenged vigorously by the fulcrum debt, and such a challenge would jeopardize the entire restructuring process.
In addition, even though their entire $7 billion investment would be wiped out, equity supported the fulcrum debt proposal, which—unlike the noteholders’ proposal—did not contemplate equity investing new capital in Samson.
Having enough support from its major constituencies and in an attempt to speed up the in-court restructuring process, Samson filed its prenegotiated plan with the fulcrum debt on the same day that it filed bankruptcy. In proceeding in such a fast-track manner, Samson appears to be confident that it has vetted out all viable options and has reached the best possible result for the Company.
In Samson’s case, the fulcrum debt was in a unique position of being able to help the Company arrive at a viable restructuring plan. The fulcrum debt not only could agree to eliminate its own debt, but it could cut off all junior creditors from receiving any recovery. The net effect of the proposed debt-for-equity conversion is the delevereging of the Company’s balance sheet by over $3 billion, substantially reducing Samson’s future debt servicing obligations.
But, the second lien lenders’ status in the debt stack does not tell the full story. To remain a going concern, Samson still required a capital infusion of substantial amounts of money. The fulcrum debt, however, was not required to invest any more money pursuant to the Bankruptcy Code. So, what factors convinced the second lien lenders to invest sufficient amounts of new capital in Samson?
The answer to the above question is not difficult to surmise. The estimated enterprise value of Samson (approximately $1.4 billion) may have warranted a larger recovery to the senior unsecured notes in the form of equity, and perhaps the second lien lenders did not want to share such a large ownership in the Company. Perhaps the second lien lenders considered the fact that they were inheriting a company that 3 years earlier was acquired at over $7 billion, and they were persuaded that the capital infusion was necessary to recoup the Company’s diminished enterprise value. Perhaps the first lien lenders required sufficient new investments in determining whether to continue to work with Samson or exercise their own remedies, like forcing Samson to sell its assets at depressed values (as Philip Cook mentioned). Or, perhaps the second lien lenders were influenced by the alternative proposal by the senior unsecured noteholders that would have left the fulcrum debt primed and essentially worthless. These and other practical factors may have played a role in the decision-making process.
The real point is that, by negotiating with all of its major constituencies at the same time, Samson effectively used its leverage amongst competing groups to arrive at the best possible restructuring plan. Now, the Company is in a good position to press forward with a fast-track bankruptcy process. While the restructuring process is still in its early stages, if everything goes as planned, Samson’s case may well provide a useful road map for other oil and gas companies facing similar leverage and liquidity issues.