Dealing with Counterparty/Bankruptcy Risk in the

Upstream Oil and Gas Industry

Bruce RuzinskyJackson Walker L.L.P.

bruzinsky@jw.com • 713.752.4204

Monica BlackerJackson Walker L.L.P.

mblacker@jw.com • 214.953.5824

Reducing Counterparty Risk Pre-Bankruptcy

• Perfecting rights related to oil and gas leases and joint operating agreements– Operator and non-operator liens– Analyze your rights under JOAs and other

operative agreements– Possible traps under Producer’s lien statutes

Special Protections and Safe Harbor Contracts

• Farmouts– Defined in 101(21A) of the Bankruptcy Code– Exception from property of the estate

• Forward Contracts– Defined in 101(25) of the Bankruptcy Code– Given certain “safe harbor” protections– Forward contract merchants may immediately set off or net

amounts owed– Exception from ipso facto clause prohibition– Certain Super-Defenses

Recent SemCrude Decision• District Court held that bankruptcy court did not err in finding that

purchasers of oil from the debtor (which the debtor had purchased on credit from oil producers) took the oil free and clear of the producers' liens as either: (i) buyers for value pursuant to U.C.C. § 9-317 or (ii) buyers in the ordinary course of business pursuant to U.C.C. § 9-320.

• District Court’s decision turns significantly on the failure of the producers to record their liens, it is prudent as part of the due diligence on the creditworthiness of a counterparty to check for recorded liens.

• Producers can take away a couple of lessons: (i) to the extent they want the priority of their liens to be recognized, they may consider recording them, and (ii) the automatic liens may not be sufficient to protect their interests, so they may want to evaluate a buyer’s credit and put in place additional risk-mitigation measures.

Post-Bankruptcy Basics

• Notice of Bankruptcy Filing, Now What?– Possible Reclamation Rights or Administrative

Claims under 503(b)– Automatic Stay in Place that Limits Actions– Leases and Executory Contracts– Bar Date– Use of Cash Collateral and/or DIP Financing– Avoidance Action– Plans and Disclosure Statements

Reclamation Rights and 503(b) Claims

• Reclamation rights arise under the UCC and Section 2.702(b) of the Tex. Bus.& Comm. Code– Seller can reclaim goods delivered within 10 days of notice

• Bankruptcy Code §546 (c) provides a longer reclamation period – Seller can demand goods up to 45 days after receipt by debtor

or not later than 20 days after the commencement of the case if the 45 day period expires after the bankruptcy is filed

• Administrative Claim• Section 503(b)(9) grants an administrative expense claim to a

seller for goods received by the debtor within 20 days of the case and sold in the ordinary course of business

Automatic Stay• The filing of the bankruptcy case acts as an automatic

stay of the “commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case.” §362

• Only applies to property of the estate as defined by §541

Executory Contracts and Leases

• A debtor can assume or reject an unexpired lease or executory contract under § 365(a)

• Character of Oil and Gas Leases– “Executory contract” not defined– Various states have differing views• JOAs are executory contracts

• Timing and Twilight Periods

Avoidance Actions

• Chapter 5 of the Bankruptcy Code provides a trustee (or debtor in possession) with certain avoidance powers– Preferences §547

• Statutory defenses– Fraudulent transfers §548– Payments made under Forward Contracts and Swap

Agreements may be protected from avoidance actions under certain safe harbor protections

Plans and Disclosure Statements• The Disclosure Statement in a chapter 11 case is

designed to give creditors adequate information that would enable them to make an informed judgment about their treatment under the plan

• The Debtor has the exclusive right to file a plan for 120 days after the petition date and 180 days to solicit– The plan includes classification of claims and their treatment– Creditors who are impaired are entitled to vote– Class of claims deemed to accept a plan if creditors that hold at least

2/3 in amount and more than ½ in number of the allowed claims vote to accept

– Parties in interest may object– Confirmation of a plan discharges debtor from debts arising prior to

confirmation

If you forget everything we said…at least remember these:

• Know Who You Are Doing Business With:– Don’t let your counterparty get too far behind in payments– Move to a prepay situation if bankruptcy is imminent

• Get a Bankruptcy Lawyer involved– There are many deadlines that come fast (i.e., bar date, use of

cash collateral, rejection or assumption of contracts)– Watch for negative notice

• Get Your Lien Documents filed