As we have recently highlighted and discussed in depth elsewhere in relation to the UKCS (click here), the confidence of North Sea oil & gas contractors is at an all-time low.
As the prolonged slump in oil prices continues, the pressure on working capital in the industry is becoming increasingly acute. Many in the sector are looking nervously at their counterparties (whether that be co-venturers or their suppliers, for example). This is particularly the case where fields are coming to the end of their economic life, cessation of production is accelerated and the looming cost of decommissioning transforms licence interests from assets to liabilities.
As licensees are jointly and severally liable under a licence/concession, the insolvency of one licensee can result in significant liabilities being left with its co-venturers. These liabilities could in turn cause the insolvency of the co-venturer/s, which could lead to 'domino effect' insolvencies across various licence/concession areas. For example, this risk is exacerbated where licensees have not hedged against low prices, or where an existing hedging arrangement is due to expire. In such circumstances, a company may very quickly be in breach of its borrowing covenants and/or unable to obtain sufficient reserve funding to meet its ongoing commitments.
In this context, it is vital for any company in the industry to be alert to its own possible financial distress or that of its co-venturers, offtakers or suppliers, thereby improving the chances of a solvent solution. By taking some of the steps set out below, a company can put itself on the front foot and be prepared to strengthen its position if the worst happens.
Look out for early warning signs
The following are just a few of the warning signs of impending insolvency or financial difficulties that a company may encounter:
- requests for a change in trading terms/contractual terms;
- difficulty contacting key personnel;
- high staff turnover, particularly key personnel;
- breaches of performance obligations;
- contractors and sub-contractors not being paid on time or at all;
- changes in accounting reference dates or late filing of accounts; and/or
- rumours in the market place.
The more of these warning signs that are present, the more likely it is that an underperforming company is becoming seriously distressed, or approaching the point of no return. As a company progresses along this 'distress curve', its decline can accelerate, meaning that taking advice and appropriate action as early as possible is invaluable in protecting your company's position.
Follow up on your suspicions
If there are early warning signs then take steps to verify the position:
- carry out winding up searches at the Companies Court;
- speak to your company's external legal and financial advisers to see what information they can discover – often they will have access to information and contacts not readily available in the marketplace;
- consider whether the relationship is strong enough to ask the co-venturer/offtaker/supplier direct and get an honest answer;
- consider and/or seek advice as to what rights your company has under relevant contractual documentation to demand financial information; and
- if your company has a contractual right to demand financial information, this should be exercised; and even if this contractual right does not exist, consider demanding the information anyway.
Assess the strengths and weaknesses of your position quickly
Whether acting on rumour or after hearing of the appointment of an insolvency practitioner (IP), or a company taking advice from an IP:
- consider what termination rights there are in contracts to which your company is party – whether automatic or by election and what the practical consequences of exercising them will be;
- confirm what monies your company is owed and what your company owes and whether there is a contractual right to set off these sums;
- know what alternative arrangements your company needs to put in place to ensure it can meet its obligations to third parties;
- ascertain how long it will take to put in place alternative arrangements; and
- understand what the possible implications are for your company's contractual obligations to other parties.
Where your company has concerns about the solvency of another company, consider asking for additional protection, such as:
- the use of trust accounts for ring fencing contract monies;
- performance bonds and letters of credit;
- parent company guarantees; and/or
- clauses granting your company step-in rights or allowing payments to be made direct to sub-contractors.
If there are questions as to the solvency of a co-venturer, consider the contractual default provisions and the regulatory regime in the context of any insolvency proceedings (for example, under the Joint Operating Agreement as well as the licence/concession). Of particular relevance in the UKCS, your company should seek, at an early stage in the life of a licence, to enter into a Decommissioning Security Agreement with co-venturers. The point at which co-venturers are showing signs of distress is arguably too late.
Your company's primary objective may be to facilitate the continuation of a particular project whether, for example, by exercising rights pursuant to a forfeiture clause, forced or optional transfer of operatorship, taking increased equity through a project withdrawal or by utilising some other commercial arrangement. However, your company's options in respect of an insolvent party have to be considered on a case by case basis to ensure that any action is appropriate and enforceable. There is little to be gained from entering into an agreement that will be immediately challenged by an IP who has been appointed as administrator or liquidator.
Be proactive - Contact the insolvency practitioner immediately upon hearing of an appointment, and continue that communication
On hearing of a recent or imminent insolvency appointment (which for companies is likely to be liquidation, administration, the entering into a Company Voluntary Arrangement (CVA) or, more rarely, administrative receivership):
- Make immediate contact with the IP who has been (or will be) appointed. Explain the position your company is in and get an understanding of what their proposals are for the insolvency. Consider what implications this has for your company. If you are a significant stakeholder they may approach your company first.
- Where your company is claiming ownership of any assets in the possession of the insolvent party (via retention of title provisions or otherwise), make sure that the IP is informed of this immediately. Recent case law has placed the onus firmly on the party claiming title to make that claim, and prove it. If this is not done, and done quickly, there is a significant risk that your assets could be sold by an IP who reasonably assumed that they belonged to the company that possessed them.
- Appoint one person in your organisation to be the main point of contact for communications to and from the IP. This is likely to result in a far more cohesive and effective approach from both sides.
- IPs take notice of creditors who are co-operative and helpful in providing relevant information, but also persistent and pro-active in exercising their rights. They like to deal with people who take a flexible and commercial approach to matters.
Know your rights
It is a common misconception that when a company goes into insolvency it is released from its contractual obligations - this is not the case. However, an IP's approach to meeting contractual obligations is likely to be very different to the company’s approach pre-insolvency and the effectiveness of the remedies available to your company is reduced.
Enforcement of contractual rights can also be more difficult if, as in administration, the company is subject to a moratorium. In these circumstances consent of the administrator or leave of court is required to bring any action. However contractual rights to terminate can still be exercised.
Generally, IPs will only decide to meet contractual obligations where there is a benefit to the company’s creditors, by either generating revenue or preserving business value. If there is no benefit then they are unlikely to perform the contract (and a liquidator may simply disclaim it if they consider it onerous). Then, any claim a creditor has merely adds to the unsecured debts of an already insolvent company.
Understand your own position
In the event of the insolvency of a co-venturer, an offtaker or an entity in your company's supply chain, a company's directors need to understand what their own financial position is. In particular, directors need to understand whether their company is able to pay its debts, both on a cash flow and balance sheet basis.
The longer a company that is unable to pay its debts continues to trade, the higher the risk of directors becoming personally liable. Once a company becomes unable to pay its debts, the duties of a director switch from acting in the interests of the company's shareholders to acting in the interests of its creditors. This can become particularly sensitive for directors of multiple companies within a group structure.
The sooner in the 'distress curve' that a company takes advice, the more likely it is that an insolvency process can be avoided, and a restructuring can be achieved, to the benefit of all parties.
If directors have concerns that their company is unable to pay its debts, they should seek immediate advice and ensure that regular minuted board meetings are held to ensure (and demonstrate) that the interests of the company's creditors are being protected.
Seek appropriate advice
In addition to the commercial issues it causes, insolvency law is highly technical and is governed by detailed legislation. It is worth noting that each of the insolvency processes differ. Therefore legal and financial advisers with restructuring and insolvency experience should be instructed to guide you through the insolvency process.
The early involvement of expert advice provides the best chance of mitigating the impact of an insolvency process or achieving a solvent restructuring and avoiding a process altogether.