FAQs: Considerations for the Energy Industry and Its Lenders in the Face of COVID-19

With the COVID-19 pandemic rapidly evolving and driving down demand for crude oil along with planned production increases by Saudi Arabia, we’ve witnessed a dramatic decline in commodity prices. Many U.S. energy companies are now facing a perilous situation due to the prolonged effects of low commodity prices on their balance sheets and the uncertainty that they will be able to generate enough free cash flows required for operations and the service of debts. Below is a summary of frequently asked questions posed by U.S. energy companies as a result of the current environment, as well as some considerations and proposed solutions for addressing these issues.

What steps should U.S. energy companies be taking right now? 

• Evaluate your capital structure with a focus on liquidity, maturities, and their overall debt levels—a solid understanding of applicable financial covenants and reporting/notice requirements should allow companies to remain in compliance or to evaluate the need to prepare notices requesting amendments
• To the extent a company’s capital structure is complicated by multiple levels of debt, energy companies should have a full appreciation for the difficulties they may encounter in the current environment and should be prepared for all possible scenarios—open commitments or operational needs requiring debt funding should be reconsidered in light of today’s uncertainty
• Assess whether you have flexibility to draw down on lines of credit and execute on various restructuring strategies such as asset sales, equity cures, or increases to debt/lien capacities. A complete understanding of all available options can be leverage in the event amendments need to be negotiated
• Consider additional requirements that may be requested by lenders in your next redetermination and prepare and think creatively about how to solve issues that may arise
• Weigh all of the options available to maintain your leases, especially if the pandemic continues for a prolonged period of time, including the payment of shut-ins or the invocation of a force majeure—a plan to account for and secure stored assets should also be considered in the event that martial law is imposed

How should energy companies be thinking about consolidation?

• Remain vigilant of alternative liquidity opportunities such as farmouts, DrillCo funding, and participation agreements—additional consideration should be given to spinout or carveout opportunities, especially as they relate to produced water, royalty, and/or midstream assets. However, consolidation may be a limited option for many energy companies given the current market
• Weigh partnerships with strategic partners as markets stabilize to identify assets that are either undervalued or can be restructured in a way that maximizes arbitrage opportunities
• Investigate the options available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), including potential loans under the Small Business Administration for smaller energy companies with fewer than 500 employees

Are there any considerations specific to the publicly traded companies?

• Involuntary leaves of absence may trigger federal and/or state Worker Adjustment and Retraining Notification (WARN) notice requirements
• Under federal law, unless limited exceptions apply, employers must provide 60 days’ advance notice of a temporary shutdown if the shutdown will (i) affect 50 or more employees at a single site of employment, and (ii) result in at least a 50% reduction in hours of work of individual employees during the month of the shutdown
• Federal law grants an exception to employers required to temporarily shut down a site of employment due to a “natural disaster” and/or “unforeseeable business circumstances,” such as the COVID-19 pandemic; however, state WARN acts may differ
• Many public energy companies should be aware of possible deficiency letters from the NYSE and NASDAQ due to their stock trading below $1 for more than 30 consecutive trading days. Additional guidance can be found here.
• Public companies of all sizes and with widely varying financial performance and structural defenses may be faced with a proxy contest
• When an activist surfaces, issuers and their advisers frequently debate the merits of adopting a rights plan to increase the issuer’s leverage in dealing with the activist—experienced outside counsel should be retained immediately to consider all of a company’s options available to it in order to defend against takeovers
• Ensure that proper notification and disclosure procedures are followed based on recent SEC guidance for shareholder meetings that are held in a virtual format
• Conduct regular self-assessments to evaluate their risk profiles—examples of things to focus on include available value-creation strategies; environmental, social, and corporate governance issues; executive compensation and the company’s relationship with key stakeholders
• If a public company files for bankruptcy, it will be entitled to utilize the “modified reporting” program instead of standard periodic reporting. Public companies in bankruptcy are able to file the monthly operating reports required under the Bankruptcy Code in place of Exchange Act periodic reports like 10-Ks and 10-Qs. These companies are still required to file Form 8-Ks to disclose material events, as well as the proxy, going-private, and tender-offer requirements of the Exchange Act.

Are there any considerations specific to the midstream industry?

• Focus on the relative strength of their gathering, processing, and storage agreements and evaluate all of the potential commercial risks, such as the rejection of these agreements as executory contracts in bankruptcy proceedings
• Judge the relative strength of the liens available under applicable state law—examples include tariff/carrier liens, warehouseman liens, real property liens, M&M and/or UCC liens
• Reconsider creditworthiness of buyers as consolidations begin to occur and reevaluate the options available, should a proposed transaction arise that would require the assumption of an inordinate amount of risk
• For companies with available capital, consider opportunistic acquisitions of midstream assets from producers and creative pricing structures around those acquisitions, including reducing up-front purchase price in exchange for reduced fees and drilling/production incentives, which have the benefit of helping producers lower lease operating expense in the longer term in case of an extended low-commodity-price environment

What steps should lenders be taking right now?

• Gather key credit documents and make sure that complete copies of all agreements are organized in one location
• Weigh the additional requirements that may be requested by borrowers in their next redetermination and prepare and think creatively about how to solve issues that may arise—one example is how parties to a loan agreement should handle the receipt of government bailouts
• Confirm the perfected status of loans, for secured lenders, and hire outside counsel with actual operating experience and access to budget-friendly solutions (such as Winston’s Innovation Center) to review and confirm that borrower’s intended collateral is secured and that complete supplements were accomplished in accordance with their borrower’s drilling schedule

What steps should private equity funds be taking right now?

• Monitor continuity and disaster-recovery plans
• Consider how the current outbreak may impact relationships with current investors or current offerings—Winston is prepared to assist our PE clients and has provided additional guidance in a checklist that can found here.

Are there any major lessons from the first wave of bankruptcies that we should consider?

• Bankruptcies are incredibly costly but energy companies should consider that the person funding the bankruptcy has a large degree of control over the restructuring process, including (subject to certain exceptions) the exclusive right to propose a plan—to the extent companies have excess capacity in their capital structures, companies should consider all options available to them in order to maintain liquidity
• While bankruptcies may last from 6–12 months (or more), a stay from the collection of debts by a company’s creditors may actually work to improve the value of the underlying assets by buying precious time required for prices to recover and markets to stabilize

View all of our COVID-19 perspectives here. Contact a member of our COVID-19 Legal Task Force here.