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By: Cameron Kinvig
LEXIS PRACTICE ADVISOR RESEARCH PATH: Financial Restructuring & Bankruptcy > Identifying Bankruptcy Risk > Oil and Gas Agreements > Practice Notes
With oil prices at multi-year lows, the upstream oil and gas industry is reeling. Many exploration and production concerns, as well as oilfield and offshore service providers, have filed for bankruptcy. Many more are likely to do so in the next 12 to 18 months, while others may be quickly and quietly liquidated due to lack of commercial prospects.
BECAUSE OF THE GLOBAL NATURE OF THE OIL AND GAS industry today, these bankruptcies and liquidations present challenges that would not have arisen even 20 years ago. For members of a company’s board of directors (“directors”) and legal practitioners, the transnational nature of the industry requires an understanding of the challenges unique to European oil and gas concerns and the shifts in director duties that are required when a multinational entity approaches insolvency. This article discusses these issues and presents some best practices for multinational oil and gas companies that are entering insolvency proceedings in Europe, the United States, or both.
Politicians, commentators, and practitioners may be tempted to believe the free-fall in oil prices has had the greatest effect on U.S.-based shale-oil producers, but this is not the case. International producers and service providers—many of which are based in Europe—are feeling the sting of price declines more acutely than similar entities based in the United States.
One reason for this is that many European oil producers count on offshore and emerging market oilfields for future growth. Operations in those regions typically carry higher costs, for expenses like floating drill and supply ships, building out and maintaining offshore pipelines, and providing countryspecific security, housing, medical care, and expatriate staffing. These drilling operations also require more extensive support infrastructure, meaning a larger segment of the energy economy is affected when drilling is halted due to price declines.
Compared to U.S. entities, European producers are often unable to quickly shed costs. Whether through layoffs, work stoppages, equipment idling, or general cost cutting, U.S. entities can lower costs with relative ease. In contrast, many European oil and gas operations have heavily unionized workforces—even at the management level—and are located in countries that offer significant layoff protections for workers. In some instances, it may take months for a reduction-in-force to be accomplished, and mandatory payouts may continue long after that. It is often challenging for European entities to plan far enough in advance to realize sufficient cost and cash flow savings to stay afloat.
Compounding the cost issue is the reality that European insolvency laws generally do not allow for true reorganization of struggling companies. And European banks are usually less willing to work with a company to help it right its ship and continue operation through such means as covenant waivers or bridge financing during reorganization. Thus, directors are left with stark choices and fewer options than they would have within the United States. The results in Europe are often quick sales at a distressed value or eventual liquidation.
These challenges can have direct ramifications on U.S.-based subsidiaries of European-based businesses, and can ultimately limit the options available to U.S.-based management when a European parent faces financial hardship.
The interplay between energy businesses based in the United States, Europe, and other countries is complex. Free exchange of workers, goods, services, subsidiaries, joint ventures, and partnerships spans the globe. Although it provides economic efficiency and greater market access during good times, the global span of business interests across countries with differing insolvency laws creates significant challenges during times of financial turmoil. Directors of a parent and separate subsidiaries may find that they owe different duties to different constituencies depending on the jurisdiction in which an entity is located. If the same core group of directors serves in that capacity across the multinational subsidiary spectrum, questions of duties owed can become extremely complex.
When a U.S.-based entity is solvent, a director of the company generally owes fiduciary duties to the corporation directly and to its shareholders as the derivative beneficiaries of the corporation’s growth and solvent financial standing. Directors owe duties of care and loyalty to both the company and its shareholders; they must make informed and well-reasoned decisions and act in good faith. If directors fulfill these duties, their decisions are afforded protection by the so-called business judgment rule. Duties shift, however, when a U.S.- based company becomes insolvent.
In North American Catholic Education Programming Foundation, Inc. v. Gheewalla, the Delaware Supreme Court (relied on as a bellwether for corporate legal standards) stated that once a corporation becomes insolvent, director duties shift from the company and shareholders alone to the company and all of its associated stakeholders—shareholders, creditors, and employees alike. See 930 A.2d 92 (Del. 2007). Director duties no longer involve mere care and loyalty, but also include the duty to preserve and maximize asset value for the benefit of all stakeholders. Id. While it was once thought that fiduciary duties began to shift as a corporation approached the “zone of insolvency,” Gheewalla made it clear that this was not the case. Fiduciary duties shift only when insolvency occurs, not before.
Gheewalla also made it clear that directors have no liability for so-called deepening insolvency—which occurs when a company continues in business, dissipating its assets, after insolvency has occurred—as long as directors’ actions fall within the business judgment rule. This is in contrast to the liability that often arises under similar circumstances in European jurisdictions, as discussed below.
European countries share many integrated laws, but unfortunately, there is no uniform European insolvency law, process, or proceeding. The overriding theme is that European directors of oil and gas companies are given much less leeway once they determine that their company is insolvent, because they can be held liable under “deepening insolvency” theories of liability. The following are brief summaries of laws regarding director duties in European countries with a significant presence in the international oil and gas industry.
Director Duties in the UK: The Companies Act of 20061 states that a director of a company owes duties to the company itself but does not generally owe a duty to the shareholders of that company. A director’s duties under the Companies Act of 2006 are as follows.
Director Duties in the Netherlands:2
Director Duties in France:3 Director duties in France are relatively straightforward and much more forgiving than in other parts of Europe.
Director Duties in Norway:4 Board membership in Norway is more heavily regulated than in many other parts of Europe, with many requirements regarding independence and board composition, as well as the duty to create and utilize a “corporate assembly” in certain situations. The corporate assembly generally comprises various corporate and employee stakeholders.
It is not hard to imagine a scenario where directors of a multinational oil and gas company have conflicting duties between different national jurisdictions. Complicated questions arise when, for instance, a U.S. multinational with a UK subsidiary is insolvent, but is still spending heavily in an effort to turn its business around. Or, when a French multinational with U.S. and Dutch subsidiaries decides to pay large employee bonuses or shareholder dividends when it appears the company is balance sheet insolvent and may not be able to meet its obligations within the next 12-month period.
There are many other steps directors should take when an entity is nearing insolvency, but these nine actions are a good baseline from which to operate. Combined with an understanding of the interplay between bankruptcy filings in the United States and administrative filings in Europe (discussed in the next section), these steps help form a full picture of the ramifications of actions taken leading up to a bankruptcy or administrative filing.
The events leading to insolvency can be complicated and trying for directors, but bankruptcy and administrative filings are even more challenging. These filings often involve others taking control of the business, making inquiries into decisions previously made, and making demands upon directors that may or may not be proper. Directors must be very cognizant of how the U.S. bankruptcy system and the European administrative filing system operate, and understand the interplay between the two, so they do not find themselves stuck between an administrator on the one hand and their fiduciary duties on the other.
As is well known, corporate bankruptcy proceedings within the United States mainly focus on two different chapters of the Bankruptcy Code: Chapter 11 (for reorganizations and some sales) and Chapter 7 (for liquidations).
In Chapter 11, a debtor is allowed to remain in possession of its assets and operations and is given an opportunity to reorganize or sell its business in an orderly fashion. A debtor in Chapter 11 is often given the time necessary to accomplish these goals thanks to DIP financing provided by senior or other lenders. A Chapter 11 filing places the company under the control of its current management and allows those individuals to make an attempt at reorganization. This is all done under the watchful eyes of the U.S. Bankruptcy Court system and multiple constituencies. This complex system of checks and balances gives significant cover for both directors and officers, allowing them to effectively negate European owners that may want either party to take improper steps.
Conversely, a debtor in Chapter 7 bankruptcy is not allowed to remain in possession of its business and assets. A Chapter 7 trustee is immediately appointed and generally shuts down the business and liquidates its assets for the greatest benefit to creditors.5 The Chapter 7 trustee is most similar to the European concept of an “administrator” and has wide latitude to do whatever he or she deems necessary to achieve the greatest return for creditors. This includes actively challenging determinations of asset ownership or control made by European parents or administrators prior to the bankruptcy filing.
While vastly different, either scenario can provide welcome relief for directors who feel they are being pressured to act improperly in an insolvency scenario. (Note that although a foreign-headquartered company can file a Chapter 15 bankruptcy in the United States to aid in reorganizing its U.S.- based subsidiaries, this is not discussed here because European insolvency proceedings focus much more on liquidation rather than on true reorganization.)
European insolvency proceedings focus largely on the rapid liquidation of a company’s assets by a court-appointed administrator, much like a U.S. Chapter 7 proceeding. Unlike in the United States, a European administrator may be a representative of the company’s financial advisor or may be appointed directly by the company’s senior lenders. While technically independent, the administrator largely works with senior creditors and largely outside of the control of any European court.6
European administration may or may not involve a very brief (sometimes less than seven days) period of shopping the company for sale as a going concern, depending on cash availability and commercial prospects. The process may also, in some instances, involve a very short period of time prior to the administrative filing called the moratorium (often 20 days) where all creditor actions are “stayed” through a judicial notice of impending administration while the company attempts to sell itself. This brief period is really the only “reorganization” opportunity given in most European jurisdictions.
However, once an administrator is appointed, the results are generally swift and decisive. Unless there are significant ongoing (and marginally profitable) operations, or a buyer waiting in the wings, the business and its operations are often immediately shut down. The vast majority of employees, if not all of them, are immediately fired. Within days, electricity is shut off, computers are shut down and sold, files are retrieved or abandoned, and office space is given back to landlords to avoid “deepening insolvency” concerns. At this juncture, the administrator’s sole job is to gather and sell corporate assets for whatever value possible—often at fire-sale prices—even if ownership between subsidiaries is somewhat questionable. A distribution scheme for funds realized from asset sales comes much later and often provides some limited benefit to unsecured creditors and employees before secured creditors are paid in full.
What happens when a European company with a U.S. subsidiary files for administration? The European subsidiary will likely be liquidated pursuant to local law, with the stock or membership interests of the U.S. corporation being an asset of the European entity. But what happens to the U.S. operation? Assuming it has sufficient cash, assets, and operations to continue in business for a time, the European administrator may allow the entity to remain operating and may attempt to sell it to bring additional cash into the administrative estate. This may be in the best interests of the European company as shareholder, but directors must determine whether this scenario is in the best interests of the U.S. subsidiary and all of its stakeholders. It may not be—especially if the business is cash rich but losing significant money every month. Directors must make independent decisions in this regard, separate from the direction of a European administrator as stockholder.
Directors may also face an instance where it is clear that the U.S. subsidiary cannot continue in business due to lack of cash or business prospects. It may be tempting for some European administrators—as controlling shareholder—to urge U.S. directors not to file for immediate bankruptcy or to delay in doing so, so that the administrator can seize contested assets or otherwise enjoy benefits that the U.S. subsidiary may provide. Directors must be wary of this tactic and take appropriate independent action to timely protect the assets and interests of the U.S. entity’s creditors. This scenario shows the true benefit of the U.S. bankruptcy system, which will do much to protect assets and creditors and help directors fulfill their duties.
A situation may also arise where a U.S. entity remains solvent while its European parent is liquidated through administration. The European administrator may improperly demand that directors pay cash dividends to the parent or may otherwise attempt to raid the subsidiary’s assets for the benefit of the parent. Although the entity may be solvent, and directors owe a derivative duty to shareholders via the corporation, directors must carefully navigate such a situation in light of their duties of good faith and fair dealing and their duties owed to the corporation as a whole. Independent outside counsel should certainly be consulted.
Finally, directors may be faced with a scenario where a European administrator, as shareholder of a solvent or nearly solvent U.S. subsidiary, attempts to quickly liquidate the subsidiary in an effort to obtain a rapid cash dividend for the parent. Directors must, in this instance, remember that the duty owed to the corporation includes the duty to act in good faith toward corporate stakeholders, including creditors. It would be unwise to acquiesce to such a demand absent independent legal advice. If such a demand is persistently made, a bankruptcy filing may be required to protect corporate interests and the value of corporate assets.
While there are myriad other iterations of the above-discussed scenarios, these few scenarios illustrate the complex interplay between European and U.S. insolvency proceedings that directors must understand. More than anything, directors in a multinational insolvency scenario should (1) retain local counsel and financial advice early in the process, (2) ensure they remain independent of undue outside influences, (3) document concerns raised and steps taken to address the same, and (4) remain vigilant for any scenario that would compromise their duties for the benefit of a third party. International insolvency can be a minefield. Diligence, prudence, and the presence of good advisors will help directors fulfill their duties, make the best decisions possible, and avoid liability.
With the price of crude oil having dropped precipitously, no fewer than 42 North American oil and gas producers filed for bankruptcy relief last year, with a combined debt of $17.85 billion. The year 2016 is expected to be no better for oil and gas companies. The next edition of The Lexis Practice Advisor Journal will feature an article exploring some of the economic and geopolitical issues that have led to the current low price environment and then will take an in-depth look at some of the most significant issues that arise with respect to distressed oil and gas M&A outside of or during the course of a bankruptcy case. These issues include oil and gas leases, joint operating agreements, and reserve based loans. In addition, the article will examine current distressed M&A trends with respect to the oil and gas industry.
Cameron Kinvig, JD, is a Content Manager for Lexis Practice Advisor
1. See Companies Act2006, c. 46 (Eng.), available at http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf. 2. See Roman Tarlavski and Jan Willem Huizink, Duties & Responsibilities of Directors, cms reich-rohrwig hainz, at 74 (Jan. 1, 2015), available at http://www.cms-lawnow.com/ publications/2015/01/duties-and-responsibilities-of-directors. 3. See Jacques Isnard, Duties & Responsibilities of Directors, cms reich-rohrwig hainz, at 42 (Jan. 1, 2015), available at http://www.cms-lawnow.com/publications/2015/01/duties-and-responsibilities-of-directors. 4. See Henning E. Asheim and Lars Tormodsgard, Liability of Directors of Companies in Difficulty, international law office (Dec. 7, 2009), http://www.internationallawoffice.com/Newsletters/Company-Commercial/Norway/Arntzen-de-Besche-Advokatfirma-AS/ Liability-of-directors-of-companies-in-difficulty. 5. See 11 U.S.C. §§ 707, 721 (2012). 6. See Lindsee P. Granfield, Sean A. O’Neal, and Timothy S. Mehok, International Insolvency and Bankruptcy in international corporate practice: a practitioner’s guide to global succ ess, at 29-9,10 (May 2010), available at http://www.cgsh.com/files/Publication/a0a16588-98fb-44b1-be6e-1144b38967c6/Presentation/PublicationAttachment/ d36713eb-52ce-422d-86bd-12360d4ca284/Intl%20Insolvency-Bankruptcy%20Article.pdf.