Oil and Gas Restructuring and Bankruptcy:

Leases, Treatment of JOAs, Lien Rights and

Priorities, DIP Financing

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THURSDAY, NOVEMBER 12, 2020

Presenting a live 90-minute webinar with interactive Q&A

John D. Beck, Counsel, Hogan Lovells US, New York & Houston

Daniel F. Crowley, III, Director, Houlihan Lokey, New York

David W. Locascio, Partner, Hogan Lovells US, Houston

Richard L. Wynne, Partner, Hogan Lovells US, Los Angeles & New York

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Oil and Gas Restructuring and Bankruptcy

• E&P Trends and Market Observations

• Oil and Gas Bankruptcy and Restructuring: Strategic Overview

• Venue Issues

• Debtor in Possession Financing for E&P Companies

• Distressed Oil and Gas M&A Issues

• Special Issues: Treatment of Gathering/ Processing Agreements

• Special Issues: Treatment of Joint Operating Agreements, Leases, and Liens

Oil and Gas Bankruptcy and Restructuring

Hogan Lovells | 6

E&P Trends & Market Observations

Houlihan Lokey | 8

Oil & Gas Prices

HH | Historical vs Strip ($/mmbtu)WTI | Historical vs Strip ($/bbl)

Source: Bloomberg, EIA

Note: Market pricing as of 10/27/20; reflects monthly averages

$-

$25

$50

$75

$100

$125

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Historical Spot 1/1/2020 Strip 10/27/2020 Strip

$1.00

$2.20

$3.40

$4.60

$5.80

$7.00

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Historical Spot 1/1/2020 Strip 10/27/2020 Strip

Houlihan Lokey | 9

Equity Market

Exhibit C | XOP Performance Relative to S&P 500 (Indexed)Exhibit B | Energy as % of S&P 500

Exhibit A | U.S. Upstream Initial Public Offerings (1)

-

$1.0

$2.0

$3.0

$4.0

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

2014 2015 2016 2017 2018 2019 2020

Gro

ss P

roceeds (

$bn)

E&P

SPAC

Minerals

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

-

25%

50%

75%

100%

125%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source: PLS, Bloomberg as of 10/27/2020; (1) Excludes IPOs

Houlihan Lokey | 10

High Yield Market

Activity Since 2014

Source: PLS, Bloomberg as of 10/27/2020

Note: Excludes investment grade bond issuances and high-yield issuances

Houlihan Lokey | 11

RBL Redetermination Trends | Spring ’20 vs. Fall ‘19

Gas WeightedOil Weighted

(1) Lonestar borrowing based lowered by an additional 21% in connection with July 2020 forbearance agreement

(2) Average and Median calculations are based on the effective Borrowing Base inclusive of future step downs

(16%)

(20%)

(0%)

(0%)

(4%)

(5%)

(8%)

(11%)

(14%)

(17%)

(19%)

(20%)

(35%)

(36%)

(37%)

(42%)

(45%) (40%) (35%) (30%) (25%) (20%) (15%) (10%) (5%) 0%

GAS - WEIGHTED MEDIAN

GAS - WEIGHTED AVERAGE

Cabot

Range Resources

Goodrich

Montage Resources

Ascent Utica

Comstock Resources

Southwestern Energy

CNX Resources

PDC Energy

SilverBow Resources

Diversified Gas & Oil

Panhandle

Antero Resources

Gulfport Energy

% Increase / (Decrease) of BB Additional Step-Down % Additional Step-Down 2 %

(23%)

(30%)

(42%)

(48%)

(54%)

(30%)

(28%)

(0%)

(0%)

(0%)

(1%)

(6%)

(12%)

(14%)

(14%)

(15%)

(18%)

(18%)

(28%)

(31%)

(31%)

(32%)

(32%)

(42%)

(46%)

(48%)

(50%)

(60%)

(67%)

(70%) (60%) (50%) (40%) (30%) (20%) (10%) 0%

OIL - WEIGHTED MEDIAN (2)

OIL - WEIGHTED AVERAGE (2)

Matador Resources

Parsley Energy

WPX

Lonestar Resources (1)

Kosmos Energy

Ring Energy

Talos Energy Inc

W&T Offshore

Earthstone

Magnolia Oil and Gas

Northern Oil and Gas

Battalion Oil

Laredo Petroleum

Penn Virginia

Bonanza Creek

SM Energy

Extraction Oil & Gas

Callon Petroleum

Centennial Resource Development

Amplify Energy

Chaparral Energy

California Resources

Contango

HighPoint Resources

Oasis Petroleum

Berry Petroleum

SandRidge Energy

% Increase / (Decrease) of BB Additional Step-Down % Additional Step-Down 2 %

Houlihan Lokey | 12

M&A&D Activity

Exhibit B | M&A Activity (1,2)

Exhibit A | A&D Activity (1)

Source: PLS; (1) Excludes deals

Houlihan Lokey | 13

M&A vs. A&D Activity

Aggregate Deal Value (1,2)

Source: PLS; (1) Excludes deals

Houlihan Lokey | 14

Enterprise Value Correlations

Exhibit C | Multiple vs. Production GrowthExhibit B | Multiple vs. Debt Capitalization (1)

Exhibit A | Multiple vs. Enterprise Value

Source: Capital IQ as of 10/20/20; Note: Based on 60 U.S. and Canadian public E&Ps with >$50mm market cap and analyst estimates of production and EBITDA through FY22; Note:

Exhibit A bubble size based on enterprise value; (1) Book value of debt utilized

R² = 0.63

3.0x

4.0x

5.0x

6.0x

7.0x

$0 $5 $10 $15 $20 $25

2021E

EV

/ E

BIT

DA

Enterprise Value ($bn)

R² = 0.16

3.0x

4.0x

5.0x

6.0x

7.0x

0% 20% 40% 60% 80% 100%

2021E

EV

/ E

BIT

DA

Debt to Enterprise Value

R² = 0.02

3.0x

4.0x

5.0x

6.0x

7.0x

-10.0% -5.0% 0.0% 5.0% 10.0%

2021E

EV

/ E

BIT

DA

Production Growth (2021-2022)

Oil and Gas Bankruptcy and Restructuring: Strategic Overview

Hogan Lovells | 16

• Oil and gas is the archetypical boom and bust industry, and now seems to be in a prolonged challenging period.

• As shown by Dan Crowley, there have been huge, historic price gyrations, including going negative on April 20, 2020.

Strategic Overview

Hogan Lovells | 17

Hogan Lovells | 18

• What are we seeing with trends– how many producers have filed, and what are the strategies behind the recent filings?

• In particular, what are the pro’s and cons of filing for Chapter 11 versus out of court workouts and consensual restructurings?

• What are the panel’s predictions for future restructuring trends?

Strategic Overview

| 19

Key Deal Themes

“The addition of Parsley’s high-quality assets

enhances Pioneer’s investment framework by

improving our free cash flow profile and

strengthening our ability to return capital to

shareholders.” – Pioneer, October 20, 2020

”“The combined company… will benefit from

enhanced scale, improved margins, higher free

cash flow and the financial strength to

accelerate the return of cash to shareholders

through an industry-first “fixed plus

variable” dividend strategy.” – Devon

Energy, September 28, 2020

“

”

“Hancock Whitney Corporation today

announced it has agreed to sell $497

million of energy loans to certain funds and

accounts managed by Oaktree Capital

Management, L.P.” – Hancock Whitney, July

17, 2020

”“Morgan Stanley today announced a new

commitment to reach net-zero financed

emissions by 2050.” – Morgan Stanley,

September 21, 2020

“

”

“ ““The company will target an average reinvestment level of less than 70 percent of cash from operations to ensure sufficient free cash flow generation to fund compelling

returns of capital to shareholders.” –

ConocoPhillips, October 19, 2020

”“And this is worth mentioning again, with any

pricing windfall, we will be extremely

disciplined with our capital programs and

limit growth in any given year to no more

than 5%.” – Richard Muncrief, CEO of WPX

Energy, September 28, 2020

“

”

“

Houlihan Lokey

| 20Hogan Lovells

MONTANA2

NORTH DAKOTA2

WYOMING4

CALIFORNIA7

NEVADA1

TEXAS269

COLORADO17

UTAH4

LOUISIANA32

NEBRASKA1

KANSAS3

NEW YORK24

GEORGIA1

ALABAMA2

MISSISSIPPI2

NO. CAROLINA1

ARIZONA3

DELAWARE64

NEW JERSEY1

OKLAHOMA15

MASSACHUSETTS1

MINNESOTA2

TENNESSEE1

PENNSYLVANIA11

VIRGINIA1

W. VIRGINIA2

OHIO6

MICHIGAN3

NEW MEXICO6

ALASKA3

SECTOR BREAKDOWN

E&P: 230

Oilfield Services: 233

Midstream: 31

KENTUCKY3

2015 – 2020 U.S. Oil & Gas Bankruptcy Filings By State

Hogan Lovells | 21

• What can we determine from this data?

• First, its an enormous amount of the large and medium sized Chapter 11 cases nationwide

• 494 total Chapter 11 cases, with about $300 billion in debt

• Relatively few midstream companies- 31 with $20 billion in debt

• Almost evenly split between E&P and oilfield services,

• 230 E&P versus 233 oilfield services companies

• $175 billion in E&P debt versus $100 billion for oilfield service companies

The New Normal

Hogan Lovells | 22

• Pro’s and cons of Chapter 11 cases versus out of court workouts

• Chapter 11 is best for complex, multi-party, multi-dispute cases where the underlying business is sound, but has a balance sheet problem, or operational problems that are fixable

• It is also a necessary measuring tool or yardstick for out of court workouts, and to force holdouts to consent to a deal or have one imposed by the court

Strategic Overview

Hogan Lovells | 23

• Management remains in control [usually]

• All creditor actions stayed, and usually consolidated into one forum

• Company chooses the forum, can select most favorable option for legal and strategic reasons

• Company obtains new powers as a pseudo-bankruptcy trustee

• Company obtains the ability to delever the balance sheet, by court order if can’t obtain consent, full or partial debt/equity conversions are common, and can eliminate or reduce expensive debt

Strategic Overview: Chapter 11 Pros

Hogan Lovells | 24

• Can obtain a breathing spell, has 120 day “Exclusive” period to file a restructuring/reorganization plan, which can be extended

• Can obtain new senior DIP credit

• Can eliminate contractual or contingent liabilities that are a significant future drag-lease by lease, contract by contract decisions to assume/reject/abandon

• Can create new management and employee incentive plans

• Can remove the pressure to sell assets at below market prices, or obtain debt at above market cost

Strategic Overview: Chapter 11 Pros (cont.)

Hogan Lovells | 25

• The company and its future control is effectively “In Play”

• Unless it’s a pre-pack or pre-arranged, final outcome is uncertain

• Bankruptcy court control is extensive and rulings often not appealable-either legally or practically

• Interaction of Ch. 11 required timelines, and volatile pricing environment can result in significant valuation changes, for better or worse

• Very expensive process-have to pay own professionals--lawyers, financial advisors—as well as lender and creditor committee professionals

• It is a fishbowl, everything normally becomes public

• DIP lenders (if needed for liquidity) can obtain significant rights of control and can force the sale of assets/whole company

Strategic Overview: Chapter 11 Cons

Hogan Lovells | 26

Strategic Overview: Near Term Predictions

Hogan Lovells | 27

• Impact of next fall borrowing base Redeterminations? 15% drop or more

• Hedging

• Switch from debt to equity based financing structures

• Reserve based borrowing- what will be the new normal?

Strategic Overview: Near Term Predictions

Hogan Lovells | 28

• Higher pricing

• Tighter covenants/smaller new debt baskets, tighter cash controls and possible sweeps

• Restrictions on CapEx

• Redefined value-will PUD’s be included in the borrowing bases?

• Higher and more stringent hedging requirements

Reserve Based Lending Predictions for E&P Companies

Venue Issues

• Over the last five years more and more oil and gas debtors filing their Chapter 11 proceedings in Texas as opposed to the more traditional venues in Delaware and New York.

• Why? Comfort is the easy answer, but it’s a combination of legal and strategic issues

• There are fundamentally different legal regimes in various states as to how they treat oil and gas leases, royalty agreements or interests, gathering agreements and even typical trade credit agreements with service providers

Venue Issues

Hogan Lovells | 30

MONTANA2

NORTH DAKOTA2

WYOMING4

CALIFORNIA7

NEVADA1

TEXAS269

COLORADO17

UTAH4

LOUISIANA32

NEBRASKA1

KANSAS3

NEW YORK24

GEORGIA1

ALABAMA2

MISSISSIPPI2

NO. CAROLINA1

ARIZONA3

DELAWARE64

NEW JERSEY1

OKLAHOMA15

MASSACHUSETTS1

MINNESOTA2

TENNESSEE1

PENNSYLVANIA11

VIRGINIA1

W. VIRGINIA2

OHIO6

MICHIGAN3

NEW MEXICO6

ALASKA3

SECTOR BREAKDOWN

E&P: 230

Oilfield Services: 233

Midstream: 31

KENTUCKY3

2015 – 2020 U.S. Oil & Gas Bankruptcy Filings By State

Hogan Lovells | 31

Hogan Lovells | 32

• Many of the players involved in oil and gas cases are located in or near Texas, and there is a well developed body of oil and gas law in Texas, along with experienced professionals

• Many of the issues related to oil and gas deal with state and local laws. Local bankruptcy courts have extensive experience with these issues

• Certainty. The Houston bankruptcy courts adopted a local rule where only two judges are assigned all of the large chapter 11 cases

• Another contributing factor is Judge Chapman’s ruling in In re Sabine (discussed later in the presentation) and likely Judge Sontchi’s recent ruling in Extraction Oil that some gathering agreements did not create covenants running with the land and thus were executory contracts that could be rejected

Venue Issues (cont.)

Debtor in Possession Financing for E&P Companies

Hogan Lovells | 34

• A Debtor with sufficient cash on hand can operate in bankruptcy by using its cash collateral if authorized by the bankruptcy court

• But the debtor may require additional credit through debtor-in-possession financing (“DIP Financing”), with special incentives and protections for the DIP Financing lender

• Cash starved or highly leveraged E&P companies may only have DIP Financing as an option, due to Lender’s concerns about making loans to them without the extra protections that can be offered in a Chapter 11 Case

• Cash collateral orders and debtor-in-possession financing orders set forth the terms, protections and provisions of such use of cash collateral and DIP Financing

DIP Financing Overview

Hogan Lovells | 35

• DIP Financing under Section 364 of the Bankruptcy Code contemplates additional “new money” advances not otherwise available to the debtor

• This “new money” can be made available by the debtor’s pre-petition lender or from a new lender who begins lending money to the debtor after the commencement of the case

• If the debtor is unable to find a lender willing to extend unsecured credit allowable as an administrative expense, Section 364(c) authorizes the court, after notice and a hearing, to grant to such lender:

– a super-priority administrative claim (having priority over all other administrative expenses);

– a lien on property of the estate that is not otherwise subject to a lien;

– or a junior lien on property of the estate that is subject to a lien.

DIP Financing Overview (cont.)

Hogan Lovells | 36

• Priming of pre-petition liens is allowed under Section 364(d) of the Bankruptcy Code if:

– Debtor is unable to obtain needed credit otherwise

– Adequate protection is provided to the holder of the preexisting lien for the interest on the property of the estate which the priming lien or equal lien is granted

– True priming liens are rarely granted because of the difficulty of providing adequate protection for the lien being primed

– At times allowed if sufficient “equity cushion” to the primed lienholder only where such equity cushion is sufficient to protect both the pre-petition lender and the DIP lender

DIP Financing Overview (cont.)

• A DIP lender can impose significant control over the debtors’ bankruptcy case by including in the DIP credit agreement milestones and other covenants requiring the debtor to take certain actions, and within certain time periods, or risk defaulting under the DIP credit agreement and the DIP lender taking enforcement action against the collateral.

• Common controls include:

– Access to extensive financial and operational reporting

– Budgetary requirements

– Ability to review the Debtors’ court filings in advance

– Milestones for important bankruptcy events (e.g., confirmation of a plan)

– Requirement to run a sale process and a consent right over the bidding procedures

– Seek releases of claims against the DIP lender (incl. in capacity as a prepetition lenders)

DIP Financing - Strategic DIP Actions

Hogan Lovells | 37

Hogan Lovells | 38

• Roll-up

– Many courts will allow a portion of prepetition debt to be refinanced by and “rolled-up” into the post-petition DIP Facility, providing the prepetition debt all the protection of a DIP Facility

• Credit bidding-Loan to Own

– The DIP obligations may be credit bid against a purchase of the assets conversion to exit facility or equity

• Equity Sweeteners or Exit Facility Conversion Rights

– The DIP Facility may provide preferential rights to purchase equity or participate in an equity offering

– The DIP Facility can be converted into an exit facility or converted to equity in the reorganized company

DIP Financing - Strategic DIP Actions (cont.)

Hogan Lovells | 39

Due to the nature of the collateral, DIP financing for E&P companies differs from traditional Chapter 11 DIP financing

DIP Financing – E&P

Hogan Lovells | 40

• With reserve-based lending, the collateral is based on the value of the reserves and repayment comes from the production proceeds

• Unlike traditional financing, an E&P company’s assets are constantly changing. Here are a few examples:

– Borrower may have an interest in a lease to a certain depth and later acquire interests at other depths

– The mortgage may be limited to certain depths

– Borrower may enter into a farmout agreement and earn acreage

– Borrower’s leasehold interest may expire as to certain acreage

DIP Financing – E&P (cont.)

Hogan Lovells | 41

The goal for DIP financing is to have as lean a budget as possible; just enough to cover existing operating expenses

DIP Financing – Budgets

Hogan Lovells | 42

• When does it make sense to budget for new drilling activity?

– Valuable leases sometimes have continuous drilling obligations that require new drilling

– The debtor may be a party to a farm-in agreement. The value of maintaining that contract may be worth the capital spend on drilling new wells

DIP Financing (cont.)

Hogan Lovells | 43

• In 2018, Gastar Exploration Inc. sought approval of a DIP facility that included a make whole premium that was payable in the event of the DIP facility was repaid prior to its maturity, other than repayment with proceeds of an asset sale or pursuant to an acceptable plan

DIP Financing - Other Trends in E&P

Distressed Oil and Gas M&A Issues

• Section 363. As an introductory matter, when people talk about asset sales in bankruptcy, they usually refer to “Section 363 sales.” This is because Section 363(b) of the Bankruptcy Code is the Bankruptcy Code section that permits Debtors to sell assets out of the ordinary course.

– Specifically, Section 363(b) states as follows: “The trustee [or debtor in possession] after notice and a hearing, may use, sell, or lease other than in the ordinary course of business, property of the estate.”

• Sound Business Purpose. A “sound business purpose” is required for a bankruptcy court to authorize the sale of all the debtor’s assets under Bankruptcy Code section 363, and can be broken down into several components:

– sound business reason;

– accurate and reasonable notice;

– adequate price; and

– good faith (e.g., sufficient efforts made to solicit several offers).

• The Key is Court Approval. The key phrase in this provision is “after notice and a hearing.”

– The fact that a court ultimately blesses every part of the sale – the procedures, the process, the Debtors’ business judgment, the Buyer’s good faith, the sale “free and clear,” etc. – is what makes this type of sale the cleanest from a buyer and seller’s perspective, even though it is potentially more costly and time consuming than an out-of-court transaction.

– Because the sale is done on notice to all parties in interest, they will have an opportunity to object and be heard by the court. As a result, potential problems with the sale and the process are raised before the sale is consummated and they can be addressed and hopefully resolved through negotiation or, if appropriate, overruled by the court on an expedited basis.

The most common type of Distressed M&A Transaction is the Section 363 Sale of Assets

In-Court Transactions: Sale of Assets

Hogan Lovells | 45

There are five primary reasons to consummate distressed asset sales via Section 363 Sales: Free and Clear; Fiduciary Duty; Finality; (Good) Faith; and, Freedom to Reject Contracts/Leases

1. Free and Clear. Any sale, as approved by the Court through the entry of a Court Order, will typically include language in the Court Order approving the sale saying that the sale is “Free and Clear” of any liens, encumbrances, etc., which gives comfort to the buyer.

– Section 363(f). “The trustee may sell property under section (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if –

(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;

(2) such entity consents;

(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens

on such property;

(4) such interest is in bona fide dispute; or

(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

THE FIVE “Fs”

In-Court Transactions: Sale of Assets – Why Do It?

Hogan Lovells | 46

2. Fiduciary Duty. The Seller’s Board will run a sale/marketing process that is pre-approved by the Court after notice and a hearing, and so long as the Seller conducts itself in accordance with such procedures, its Board should be protected in acting in accordance with its fiduciary duties to maximize value for its stakeholders. Given that the Board is essentially a lame duck after the sale, this blessing is very important and Board members will focus on it.

3. Finality. Any sale will require Court approval (after notice and a hearing), meaning that, other than any appeals, the Buyer and Seller should not be subject to later litigation/second guessing. This is important because out-of-court sales carry potential litigation risk, including fraudulent conveyance. The Court’s approval of the sale will be memorialized in a written sale order signed by the Court setting forth the various important protections of the sale including the FREE & CLEAR language. While “successor liability” risk is not eliminated, it is substantially reduced.

THE FIVE “Fs” (continued)

In-Court Transactions: Sale of Assets – Why Do It? (cont.)

Hogan Lovells | 47

4. (Good) Faith. Any sale order will typically include a provision finding the Buyer is acting in “good faith” under Section 363(m).

– Section 363(m). “The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.”

5. Freedom to Reject Contracts. Because the Seller is in Chapter 11, it can reject contracts it no longer wants (or that the Buyer doesn’t want when it buys the assets). The Buyer should also be able to assume any of the Debtors’ contracts so long as there is no specific Bankruptcy Code prohibition and the Buyer can show adequate assurance of future performance (i.e., that it has the financial wherewithal to both pay any “cure” amounts and perform the contract on a go-forward basis).

THE FIVE “Fs” (continued)

In-Court Transactions: Sale of Assets – Why Do It? (cont.)

Hogan Lovells | 48

• Maximizing Value. In order for a Debtor to sell its assets pursuant to Section 363, it must show that such sale “maximizes value” for its stakeholders. This concept can depend on timing of sale, consideration paid by buyer, assurance of consummation of Buyer, etc. In other words, it does not always mean the price paid by the winning bidder in the auction process is the highest amount.

• Court Approval of Procedures. The best way to ensure that the Debtors can make such a showing is to have the Court bless not just the final sale, but pre-approve the process of marketing and selling the assets. Therefore, the Debtors will seek approval of their “bidding procedures” and “auction process,” before or at around the time they begin their process.

• Stalking Horse. If the Debtors have a “Stalking Horse,” the Debtors will likely ask the Court to approve the Stalking Horse as the “bid to bid against,” and seek approval of the Stalking Horse’s break-up fee, payment of expenses, and bid protections/approved procedures (which will have been previously negotiated with the “Stalking Horse”).

• Naked Auctions. If the Debtors are running a process without a “Stalking Horse” – a so called “naked auction” – the Debtors will ask the Court to bless their whole process, from marketing to possible selection of a stalking horse (including, potentially, pre-approval of a termination fee, expense reimbursement, bid protections, etc., to any potential stalking horse) to auction to sale hearing.

In either case, getting Court approval of these procedures helps to ensure that the ultimate sale order will contain the necessary provisions to provide comfort to the buyer and seller.

In-Court Transactions: Sale of Assets - Process

Hogan Lovells | 49

At some level, every plan of reorganization that envisions a “conversion” of debt to equity in the reorganized company is, in effect, a “sale of equity” to the creditors.

• “Sales of Equity” means actual “sales” that are not simply conversions of prepetition debt to equity under a plan of reorganization. In such a transaction, the Debtor’s prepetition common stock would be extinguished under a plan of reorganization and new common stock would be authorized and issued to the buyer. The new common stock would not be subject to pre-existing liabilities discharged under the plan of reorganization.

• Sometimes, companies in Chapter 11 will propose a plan of reorganization that converts debt to equity (as noted in previous bullet) but will also permit parties to bid on such equity if they are willing to pay more for it than the estimated recovery for such debt converting to equity (i.e., based on the Debtor’s stated enterprise value under the plan). This is called a “plan sponsor” auction, and is fairly uncommon. However, if the Debtor does engage in such an auction, it usually occurs pursuant to the same procedures used with regard to Sales of Assets and will require court approval. This may be used as a tool to elude a secured creditor’s “credit bidding” rights in the context of a sale of assets that constitute the creditor’s collateral.

In-Court Transactions: Sale of Equity – Plans and Plan Sponsors, Generally

Hogan Lovells | 50

Example One: No Stalking Horse (bid procedures approved before marketing)

In-Court Transactions: Sample Timelines

Day 1: File motion to approve bid procedures

Day 21: Receive approval of bid procedures

Day 21-90: Diligence by potential bidders/ bidders formulate bids (usually includes interim deadline for submission of non-binding indications of interest, diligence sessions with management for bidders that submit such proposals, etc.

Day 91: Deadline to submit binding bids

Day 93: Debtor selects a lead bidder (potentially providing “stalking horse” benefits and protections)

Day 95: Auction

Day 97: Sale Hearing

Day 100+ Consummation of Sale

Hogan Lovells | 51

Example Two: Stalking Horse (bid procedures approved after Company negotiates Stalking Horse Agreement)

In-Court Transactions: Sample Timelines (cont.)

Day 1: Debtor files motion seeking approval of Stalking Horse bid, break-up fee, expense reimbursement, and bid procedures

Day 21: Receive approval of motion, including bid procedures and timing*

Day 21-60:** Diligence by potential competing bidders/ competing bidders formulate bids (usually this period is less than the period in a “Naked Auction” because Stalking Horse will not want process to go too long and such a shorter time period is defensible because presumably Debtor has been in discussions with Stalking Horse for a period of time)

Day 61: Deadline to submit competing bids

Day 63: Debtor selects a lead bidder

Day 65: Auction

Day 67: Sale Hearing

Day 70+ Consummation of Sale

*The Debtor usually agrees to a no shop in the definitive agreement with the Stalking Horse until the bid procedures and buyer protections (break-up fee and expense reimbursement) are approved by the Court.**The Length of this period may depend on the extent of any pre-bankruptcy marketing process as well as exigent circumstances that may compel a faster process (i.e., a “melting ice cube”.)

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• Break-up Fee and/or Expense Reimbursement to Stalking Horse Bidder

– Market rate? When paid? How triggered?

• Period During Which Process is Open to Other Bidders

• Forms of Consideration

– Cash, debt, equity, credit bidding

• Consolidating Bids for Different Assets

• Qualifying Bidder Criteria

– Financial wherewithal, deposit, no diligence or financing outs

• Minimum Overbid

• Running the Auction

– Bid increments, announcement of lead bid

• Back-up Bidders?

– How long required to stand by?

• Attendees at Auction/too much noise?

• Role And Consultation rights of Official Creditors Committee, DIP Lenders and Other Significant Parties in Interest

• What constitutes “highest and best”?

– Factors – timing of closing commitments, ability to close, form of consideration, assumption of liabilities, treatment of employees, regulatory risks (antitrust, CFIUS), etc.

• General “Fiduciary Duty/Fiduciary Out” for Debtors to Change Procedures

In-Court Transactions: Bid Procedures Issues

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• Concept. Secured creditor bids some amount of secured debt it holds in an auction. Amount (value) of bid is equal to the face amount of the debt that is bid, regardless of what the secured creditor paid for debt (i.e., if creditor paid 50 cents on the dollar to own the debt, it still is permitted to bid the full par claim).

– Section 363(k): At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

• Strategy. Credit bidding is a strategy sometimes used by opportunistic “loan to own” lenders, and has become more popular recently. It also is often a defensive strategy to prevent below market value sales of a secured creditor’s collateral. It is sometimes combined with a credit bidder being the Debtors’ Chapter 11 DIP Financing Lender to ensure as much control of process as possible.

• Limitations/Pitfalls. In recent years, there have been a spate of cases addressing the limits and applicability of credit bidding in various factual scenarios. The United States Supreme Court – in a unanimous one-page decision in RadLAX Gateway Hotel v. Amalgamated Bank -- reaffirmed the ability of secured creditors to credit bid in the sale of their collateral pursuant to a plan under Section 363(k) . But courts have found that the right to credit bid is not unqualified.

– The secured creditor cannot credit bid for assets that are not its collateral

– Avoid acting in bad faith, collusion or trying to rush or compromise the sale process

– See Fisker Automotive, Free-Lance Star, Aeropostale (credit bidding limited to amount paid for debt)

In-Court Transactions: Credit Bidding

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I am thinking about buying some oil and gas assets out of bankruptcy, but they have a lot of existing environmental and plugging and abandonment liability related to them.

Chapter 11 Sales: Purchasing Distressed Oil and Gas Assets (cont.)

Special Issues: Treatment of

Gathering/ Processing

Agreements

• Gathering/processing agreements (including obligations therein) may be characterized as covenants running with the land (or equitable servitudes) or, alternatively, as executory contracts that are subject to rejection.

• Key Issues:

– Ability to reject under Bankruptcy Code section 365

– Ability to sell estate property free and clear of such interests under Bankruptcy Code section 363

Treatment of Gathering / Processing Agreements

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• Characterization depends on state law definitions/interpretation

• If rejection is permitted:

– Considerations of leverage in negotiating new gathering/processing arrangements

– Issues relating to the calculation of damage claims:

– Claim calculations may be subject to dispute

– Claims may be subject to cap under Bankruptcy Code section 502(b)(6)

– Section 502(b)(6) caps the amount a party may claim as a result of the debtor's rejection of the lease in order to prevent that party's damage claim from becoming so large it prevents other unsecured creditors from recovering

Treatment of Gathering / Processing Agreements (cont.)

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• Debtor sought to reject an unfavorable gas gathering and dedication agreement governed by Texas law. The contract stated it was binding on successors and assigns and that it constituted a covenant running with land.

• Counterparty objected, claiming that contracts constituted (or contained) covenants running with land (property interests) that could not be rejected or expunged without adversary proceeding.

• Judge Chapman granted motion to reject as exercise of reasonable business judgment but stopped short of ruling that the dedications were not covenants running with the land because of procedural posture.

In re Sabine Oil & Gas Corp. (Bankr. S.D.N.Y. 2016)

Treatment of Gathering / Processing Agreements (cont.)

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• Court indicated evidence suggested the dedication was not a covenant running with land.

– There are 5 factors a contract must satisfy in order to be a covenant running with the land: privity of estate; the covenant must touch and concern the land; the covenant must relate to a thing in existence or specifically bind the parties and their assigns; the parties must intend the covenant to run with the land; and, the successor to the burden must have notice.

• The scope of this ruling is not all-encompassing.

– The issue concerning the treatment of the dedication provisions—and specifically whether they are conveyances running with the land—is a fact-intensive determination that may vary considerably from case to case.

– The state law of the location of the wells and the governing law of the contracts will also drive certain differences in the analyses - all of the Sabine contracts were subject to Texas law.

• The holdings in In re Sabine were affirmed by the 2nd Circuit.

In re Sabine Oil & Gas Corp. (Bankr. S.D.N.Y. 2016)

Treatment of Gathering / Processing Agreements (cont.)

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– Sabine has been disagreed with by:

– Bankruptcy Court for the District of Colorado (2019)

– Midlands Midstream, LLC v. Badlands Energy, Inc. (In re Badlands Energy, Inc.), 608 B.R. 854, 875–76 (Bankr. D. Colo. 2019).

– Bankruptcy Court Southern District of Texas (2019)

– In re Alta Mesa Res., Inc., 613 B.R. 90, 99 (Bankr. S.D. Tex. 2019)

– Badlands and Alta Mesa each found that the agreements at issue created valid real property covenants under applicable state law and were thus not executory contracts that could be rejected in bankruptcy.

Treatment of Gathering / Processing Agreements (cont.)

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• On October 14, 2020, the Honorable Christopher Sontchi, issued an opinion in the Extraction Oil and Gas bankruptcy case relying on Sabine and finding that certain oil, gas and water gathering agreements did not create covenants running with the land under Colorado law and are thus subject to rejection in Extraction’s chapter 11 proceedings.

• Facts:

– Prior to the bankruptcy, Extraction entered into agreements to transport hydrocarbons directly to market in Oklahoma and dispose of produced water generated in connection with its operations. During the bankruptcy case and in connection with an asset sale of substantially all of its assets, Extraction filed a motion seeking to reject the agreements and commenced adversary proceedings against the various midstream counterparties seeking declaratory judgments that the agreements did not create covenants that run with the land under Colorado law.

Treatment of Gathering / Processing Agreements (cont.)

Extraction Oil & Gas (Bankr. D. Del. 2020)

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• Holdings:

– Judge Sontchi analyzed the gathering services provided under the Agreements and the related dedications and ultimately concluded that the commodity produced by Extraction and gathered under the Agreements did not touch and concern Extraction’s mineral estate; it concerned only personal property and did not affect the physical use of real property or closely relate to real property.

– Judge Sontchi found that horizontal privity applied and was not present because even though Extraction conveyed easements and other property rights to the relevant counterparties, the rights constituted interests in a severed surface estate rather than in Extraction’s mineral estates.

Treatment of Gathering / Processing Agreements (cont.)

Extraction Oil & Gas (Bankr. D. Del. 2020) (cont.)

Special Issues: Treatment of Joint

Operating Agreements,

Leases, and Liens

• What JOA issues should I be concerned about in the context of a bankruptcy proceeding?

– JOAs are typically executory contracts and, until assumption, are not enforceable against debtors (only enforceable vs. counterparty).

– The Bankruptcy Code permits the chapter 11 debtor in possession to assume or reject an executory contract at any time before confirmation of a plan of reorganization.

– Failure to pay or collect joint interest billings might come with consequences (such as penalties, replacement as operator, or termination), so debtors may request court authority to perform under these agreements in the ordinary course until the debtor has selected the contracts to assume or reject.

– Debtor has to pay for reasonable value of service it receives under the contract until assumption.

– Depending on the circumstances, such as the services provided and initial contract pricing, this reasonable value may or may not be what is specified in the contract.

Joint Operating Agreements

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• Where the operator under the JOA files for bankruptcy, the operator may be deemed to have resigned under the terms of the JOA. However, because such a change in the debtor operator’s rights may violate the automatic stay, JOAs will commonly provide that, in the event of the operator’s bankruptcy, the operator and the non-operators will form an interim operating committee that will control operations until the debtor elects either to accept or reject the JOA.

– If a debtor-operator rejects a JOA in its bankruptcy case, non-operators receive a general unsecured claim for damages under the JOA.

– If a debtor wants to assume a JOA in its bankruptcy case, the debtor must cure any defaults under the JOA.

Joint Operating Agreements (cont.)

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• What happens to third party claims related to work performed for the operator?

– Generally, state statutes provide secured claims for contractors who provide services to E&P companies

• In connection with a sale of the debtor’s assets, the debtor may seek to assume and assign the JOA to a third-party purchaser. In such a circumstance, counterparties to the JOA can demand adequate assurance that the third-party purchaser has the ability to perform under the JOA prior to the court’s approval of the sale transaction.

Joint Operating Agreements (cont.)

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• Overriding Royalty Interest (ORRI)

– ORRIs are carved out of, and subject to, the working interest in a property. Like the landowner holding the royalty interest, they are more likely to support assumption of the lease and oppose its rejection because of the potential future earnings.

– How the bankruptcy court treats each interest (or other applicable non-bank notes) involves a factual analysis that can differ district by district as the courts apply state law. The result of that analysis is what determines the rights each interest holder owns (SeeATP Oil & Gas).

• Net Profits Interest (NPI)

– NPIs are generally not considered real property interests and would not be protected from attaching to the bankruptcy estate in the event of an operator bankruptcy.

– Bankruptcy courts may consider NPIs financings and not conveyances of real property, meaning the NPI owner would simply be a personal property owner and another creditor of the debtor.

Treatment of ORRIs and NPIs

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• Unrecorded Farmout Agreements

– Parties often fail to record notice of the farmout. As a result, the farmee’s rights under the farmout may not be protected against a third-party bona fide purchaser or the bankruptcy of the farmor.

– A farmee must provide notice of the farmout and protect its operator’s lien rights by perfecting its interest under the farmout. This issue can be resolved by recording a memorandum of the farmout agreement in the county where the lands are located.

– Without a formal assignment of interest from the farmor, the records may not be clear as to whether the farmee has in fact earned an interest under a farmout agreement. To resolve this issue, the conditions for earning an assignment and when the assignment will be delivered to the farmee should be clearly drafted in the farmout.

– The election of the farmor to retain an overriding royalty interest or convert it to a BIAPO (back-in after payout) working interest affects the rights of both parties and their successors-in-interest. Therefore, the farmor’s election must be clear from the recorded farmout that was submitted to the recorder’s office.

Treatment of Farmout Agreements

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• The Bankruptcy Code excludes certain “production payments” from property of the debtor’s estate.

• Under Bankruptcy Code Section 541, estate property does not include interest in liquid or gaseous hydrocarbons that have been transferred pursuant to a farmout or other written conveyance.

• However, there is a risk that the above interests can be recharacterized as debt claims or another non-qualifying interest, including where the interest holder provides services or conducts operations on the subject property.

Treatment of Farmout Agreements (cont.)

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Presenter Biographies

+1 212.497.7845, New Yorkdcrowley@hl.com

Industry Focus

Oil and gas

Education

B.A. in Economics from Columbia College

▪ Dan is a member of Houlihan Lokey’s Oil & Gas Group, and a regular presenter on current trends in the oil and gas industry.

▪ Mr. Crowley has approximately 15 years of experience executing complex transactions, including financial recapitalization / restructuring, financing, and M&A / A&D transactions.

▪ Mr. Crowley’s notable recent oil and gas recapitalization / restructuring transactions relate to the following companies, among others: Fieldwood Energy, Tapstone Energy, Sheridan I, Sheridan II, Jones Energy, All American Oil & Gas, Energy Corporation of America, Sabine Oil & Gas, Energy XXI, Magnum Hunter, Endeavour International, Southern Pacific, BPZ Resources, Quicksilver Resources, and ATP Oil & Gas.

▪ Mr. Crowley’s notable recent oil and gas financing and M&A / A&D transactions relate to the following companies, among others: Midstates Petroleum, ERG Resources, Samson Resources II, Trident Resources, and TC Pipelines.

• Partner, Houston

Dan Crowley IIIDirector, Houlihan Lokey, New York

Houlihan Lokey | 73

+1 713 632 1430, Houston

dave.locascio@hoganlovells.com

Practices

Infrastructure, Energy, Resources, and Projects

Education

J.D., Northwestern University School of Law, 1989

B.S., University of Illinois at Urbana-Champaign, 1984

▪ Whether representing an energy company in a complex acquisition, joint venture, or financing; an infrastructure company in greenfield development or finance; or a lender or underwriter providing unsecured or secured financing, Dave Locascio brings a business perspective to each transaction.

▪ Having experienced prior downturns in the upstream oil and gas, and power sectors, Dave understands the difficulties facing companies and lenders as they navigate through uncertain times. He works with clients to proactively address looming challenges and to protect companies and lenders from the potential adverse actions of counterparties.

▪ Dave represents clients in upstream oil and gas projects; gas, oil, or CO2 pipelines; liquefied natural gas (LNG) export and import facilities; and oil and refined products refinery or storage facilities. He helps major energy companies in the acquisition, joint venture, development, and financing of such projects.

▪ Dave serves as the head of the firm's U.S. P3 practice. He has been at the forefront of the developing U.S. public-private partnership (P3) industry, having worked on a multitude of U.S. P3 projects over the last several years. Since he has acted as consortium, lenders and monoline counsel in P3 projects, he understands the different concerns and perspectives of the participants and helps his clients focus on and understand the issues material to them.

▪ In helping a range of parties develop and finance conventional and renewable power generation, both domestically and internationally, Dave knows the distinctive transactional and regulatory aspects of regional power markets.

• Partner, Houston

David LocascioPartner, Houston

Hogan Lovells| 74

+1 310 785 4602, Los Angeles

richard.wynne@hoganlovells.com

Practices

Business Restructuring and Insolvency

Education

J.D., Columbia Law School, 1982

B.A., with distinction, Indiana University, 1979

▪ Richard Wynne has a national reputation for successfully representing company and creditor/bondholder clients in complex restructurings in a wide variety of industries, including extensive experience in oil and gas restructurings. He focuses on solving clients' most challenging problems by designing and implementing negotiations and litigation strategy, and serving as lead trial counsel.

▪ Richard's results-oriented approach was noted in Chambers 2017: "It was hard to see a goal line rather than a direction; being able to maneuver through that complex process was one of the skills few lawyers have, and Rick is on that short list."

▪ Richard's recent engagements include Mattel, Inc. as the largest creditor and Creditors Committee Co-Chair in the Toys R Us Chapter 11 case; Synopsys, plan co-proponent in the ATopTech chapter 11 case; acting as lead debtor's counsel for Achaogen, Inc., All American Oil & Gas, Inc., American Apparel and Relativity Media, LLC; representing FGIC, leading creditor and Creditors' Committee Chair in ResCap; the Ad Hoc Bondholders Committee in Chemtura; the Non-Agent Secured Lenders Committee in Adelphia; and Universal and Fox in the Rhythm & Hues case.

▪ In a decisive recent victory, federal bankruptcy Judge Wiles ordered Netflix to pay Relativity Media all its US$800,000 in attorney fees. Netflix argued that "Relativity should not be allowed to recover the cost of a Cadillac (or a Ferrari) if a Honda Civic would have done the job." Judge Wiles responded: "A complicated, fast-paced 'bet the company' litigation requires counsel of higher caliber and expense than a routine case with little at stake. A party may not need a Ferrari to go to the corner grocery store, but winning a Grand Prix race is a different matter."

• Partner, Houston

Richard Wynne Partner, Los Angeles

Hogan Lovells| 75

+1 212 918 3076, New York+1 713 632 1422, Houston

john.beck@hoganlovells.com

Practices

Business Restructuring and Insolvency

Education

J.D., summa cum laude, Order of the Coif, Texas Tech University School of Law, 2010

B.B.A., University of Texas at Tyler, 2007

▪ John has a wide array of both in and out of court experience, equipping him with the knowledge to achieve economically efficient results for his clients in whatever forum is required. John has engaged in numerous financial restructurings involving, among other things, refinancing senior debt, converting debt to equity, and implementing exchange offers, as well as pre-packaged and pre-negotiated bankruptcy filings. However, because not all distressed situations can be resolved consensually, John also has extensive litigation experience representing both debtors and creditors in bankruptcy and state court proceedings, including Chapter 11 bankruptcy and state court enforcement actions.

▪ John’s oil and gas related experience includes: All American Oil & Gas in its chapter 11 filing; the private equity sponsor of Milagro Oil & Gas; the largest unsecured creditor and member of the creditors’ committee in Valaris plc, the largest offshore drilling contractor; Signal International, an offshore services company, in its chapter 11 filing; company counsel in several out-of-court restructurings of E&P companies; and advisor to a large mid-stream provider in connection with multiple E&P bankruptcy filings.

▪ Prior to private practice, John had the prestigious honor of serving as judicial clerk to the Honorable Phil Johnson of the Supreme Court of Texas. Since that time, John has immersed himself in the exciting world of distressed investment and restructuring and was named a Rising Star for the New York Metro Area by Super Lawyers from 2014 to 2020 and a member of Class VIII of the NextGen Leadership Program of the International Insolvency Institute.

• Partner, Houston

John BeckCounsel, New York

Hogan Lovells | 76

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