By: Paul Arrow, Esq. 

January 2016

2015 was a rough year for the oil and gas industry.  The primary source of the trouble was (and continues to be) the dramatic fall in crude oil prices. In 2014, the price of U.S. crude oil averaged approximately $91 per barrel.  In 2015, the price dropped to an average of approximately $49 per barrel.  As of this writing, the price was approximately $36 per barrel. The continuing price drop puts tremendous pressure on producers.  It also negatively affects the myriad service providers that support the oil and gas industry.  Not surprisingly, according to the Federal Reserve’s 2015 review of large syndicated loans, 15% of such loans to the oil and gas industry, totaling approximately $34.2 billion, were classified as substandard and in danger of default.  By comparison, in 2014 the substandard oil and gas industry loans accounted for only 3.6% of the total, or $6.9 billion. As a result, a record number of oil and gas related entities commenced bankruptcy cases in 2015.  All told, those bankruptcies involved approximately $16 billion in assets.  By all accounts, the trend will continue and even increase into 2016.

Companies doing business with oil and gas entities need to be aware of a number of issues that can arise in a bankruptcy case, not only to protect their rights but also to avoid costly missteps. For example, immediately upon the commencement of a bankruptcy case an automatic stay is imposed.  The stay generally prohibits actions against a debtor and its property, including actions to terminate agreements such as product supply contracts.  A bankruptcy court can order relief from the stay upon an appropriate showing of cause.  Importantly, a violation of the stay can be costly, resulting in compensatory and possibly punitive damages against the violating party.

In addition, a debtor in bankruptcy generally has the option to assume or reject its contractual agreements. This also includes product supply agreements. If an agreement is to be assumed, the debtor must cure all existing defaults, provide adequate assurance of future performance, and compensate the non-debtor party for any pecuniary loss on account of default.  On the other hand, if the debtor elects to reject a contract, the non-debtor party is left with a general unsecured claim for damages as result of breach of the contract.  Either way, the debtor must obtain the approval of the bankruptcy court, and the non-debtor party has the opportunity to weigh in.  It is important for the non-debtor party to protect its rights in connection with the process.

Oil and gas industry bankruptcies may also offer opportunity for companies in the industry.  Often, the result of a bankruptcy case is the sale of the debtor’s assets.  A bankruptcy case provides an attractive method for acquisition of such assets.  Primarily, under certain circumstances assets may be purchased free and clear of interests, including liens, claims and encumbrances.  The opportunity to obtain such “clean” assets can be valuable.  Moreover, assets may be purchased out of a bankruptcy case at prices lower than might otherwise be available. Typically, a debtor seeks court approval of a sale to a pre-selected buyer. Bankruptcy courts, however, require a competitive bidding process.  Accordingly, qualified bidders may present competing offers for the assets.  The procedures in connection with these sales are usually very detailed and spelled out in orders of the court.  Any potential purchaser must strictly comply with those procedures.

This article appeared in Oil & Gas Financial Journal on February 5, 2016.