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This Is Real Law: Collateral Damage: Falling Energy Prices Pose New Risks for Lenders

Where energy prices are going in 2015 is anyone’s guess. According to Goldman Sachs Group Inc., Barclays and the Tokyo-based Marubeni Corp., for example, the price of crude oil could soon plummet to $30 per barrel. Other predictions are even more extreme. Oil as cheap as $20 a barrel could be on the way, a Citigroup analyst declared recently.

Then there’s the sunny outlook of OPEC’s Secretary General Abdell El-Badri, who says that oil has the potential to climb back towards $200 per barrel due to dwindling investment in new supplies. “If you don’t invest in oil and gas, you will see more than $200,” he stated in January.

Meanwhile, a Bloomberg Intelligence survey of U.S. investment specialists suggests that an average price for oil is likely to be somewhere between $35 to $80 per barrel—a range that still leaves plenty of room for speculation.

“The only thing that’s certain is more uncertainty,” Bloomberg Business asserted in February. “Oil will crash. Unless prices surge. Definitely one or the other.”

For his part, former Governor Rick Perry of Texas picked the gloomier prospect in a speech he delivered to a conservative forum in Austin shortly before leaving office. “This is going to be a painful period of time,” he suggested.

That outlook could easily extend to far beyond the Lone Star State. At the other end of the country, oil-rich Alaska is also reeling from the collapse in prices. Taxes paid by oil companies there account for 90 percent of the state’s operating budget, “and those revenues have sunk with stomach-churning suddenness and depth, echoing other oil-patch states, like Texas, but with uniquely Alaskan scale and implications,” observed The New York Times.

Prices for natural gas haven’t fared much better, despite the onset of cold weather throughout most of North America, and that has added to the growing list of headaches for those associated with the energy sector.

Many financial institutions in particular have found themselves in a whole new world of risk as a result of plummeting energy prices.

Indeed, as more and more drilling rigs go idle and job losses in the industry continue to mount, a lot of businesses may fall into bankruptcy, leaving some commercial banks and their legal counsel to learn the hard way what they should have done earlier to protect their security interests in energy-related collateral.

A New Reality

One of the worst nightmare scenarios for lenders is, of course, the possibility of seeing a security interest in oil and gas assets wiped out. Yet, according to one expert, the conditions exist for that to happen to many institutions that deal with oil and gas companies.

“Unfortunately, when a lot of institutions were originating loans that are out there now, energy prices were going up, up, up, and so people were perhaps not as focused as they should have been on dotting i’s and crossing t’s in the documentation,” says Barkley Clark, a partner at Stinson Leonard Street, LLP in Washington, D.C., and an authority on commercial and financial services law.

“But now, with the value of collateral dropping and the risk that an oil and gas operator may suddenly file for Chapter 7 or Chapter 11 bankruptcy protection, you’ve got to be sure about a lot of things in your paperwork. In fact, there are all kinds of extra layers of complexity in energy financing, and if you mess up any part of it you can go really quickly from being in okay shape in yesterday’s world to out of a ton of money in today’s reality.”

It’s precisely to avoid the latter scenario that Clark says financial institutions and their attorneys need to get started now to ensure that they have the strongest possible position with respect to perfection, priority and enforcement of their oil and gas security interests. Will they stand up in the debtor’s bankruptcy?

An important step in that direction, he adds, is having a solid grasp of the oil and gas provisions in Article 9 of the Uniform Commercial Code (UCC) and other relevant statutes that govern liens in oil and gas assets.

Special Rules

The UCC in particular is a subject that Clark has written about extensively, often with Barbara Clark, who is a former federal prosecutor and commercial litigator and now a partner with the Commercial Law Institute in Greenwood, Virginia. Like Barkley Clark, she is regarded as an authority on analysis and advice for shoring up assets and enforcing security interests, and the effect of bankruptcy law on secured transactions.

Together, Barkley Clark and Barbara Clark are co-authors of Clarks’ The Law of Secured Transactions Under the Uniform Commercial Code—a three-volume treatise with extensive discussion of the nuts-and-bolts workings of Article 9, which are vital to understanding the specialized area of oil and gas financing—as well as several other treatises that are used by attorneys and financial institutions and have been cited by many federal and state appellate courts.

They also publish the authoritative Clarks’ Secured Transactions Monthly, a newsletter that identifies and critiques important developments, including new case law of interest, for those concerned with perfecting security interests.

And with Matthew Clark, a Colorado-based commercial litigator with Faegre Baker Daniels LLP, they are co-authors of the recently released eBook Clarks’ Oil and Gas Financing Under the UCC: Perfecting and Enforcing Security Interests, which they promote as “a timely resource for anyone who deals with security interests or liens in oil and gas collateral.” The text of this eBook now comprises Chapter 13 of Clarks’ The Law of Secured Transactions Under the Uniform Commercial Code.

“There are some special rules that apply to oil and gas collateral that even seasoned practitioners might not be familiar with,” explains Matthew Clark. “Our book is intended to help those who deal with any aspect of an oil- and gas-secured transaction—from giving or taking security interests to defining default and pursuing borrowers and guarantors for any deficiency, holding foreclosure sales, and more.”

He adds: “It’s really aimed at lenders, but we think it will also be of value to a wider readership, including mineral estate owners, operators, contractors and of course the attorneys who represent them in connection with oil and gas projects or litigation concerning oil and gas security interests.”

Critical Tasks

The Clarks’ analysis in Oil and Gas Financing Under the UCC is deliberately practical, covering oil and gas law fundamentals, case law and how oil and gas financing works, for example. They also provide tools to facilitate loan documentation audits.

Those audits are important, but there are at least a couple of other critical tasks that must be completed initially.

“First, lenders need to look at which of their customers are in the oil and gas industry or are dependent upon it,” Matthew Clark explains. “Once you figure out that, the next step is to get a sense of those debtors’ relative strength. What sort of companies is a lender dealing with and what did they provide as security interests? Are the companies entirely dependent on oil and gas? If they are, they’re much more vulnerable. Lenders should review their portfolios generally. After that is when you really get into the details by diving into the documentation.”

“Number one: did you get the debtor’s name correct in the UCC filing records?” Barkley Clark immediately asks. “Then, did you describe the collateral accurately? Did you file in the right place or places? There’s been plenty of bankruptcy litigation over those and other very basic points. But you need to go through it all carefully to see what kind of exposure is there. And you may need to employ counsel to be certain that you cover everything.”

If that seems like a lot of work, consider the alternative: each new headline about falling energy prices may also be a signal that a bank’s security interests in energy financing are in even greater peril.

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