Since the 1930s, secured lenders have had the right to choose to participate in the auction or sale of the collateral that secures their loans using the outstanding loan balance as their currency. This is called “credit bidding.” As many bankruptcies today result in a sales process, either through a “363 auction” or a sale through a plan, the practice has become a commonly used tool. This paper will evaluate credit bidding in oil and gas exploration and production company bankruptcy cases and answer a number of key questions, including: How often does credit bidding occur? Does it have a positive or negative effect on the value received? How can stakeholders in a bankruptcy case guard against unfair shifting of value through credit bidding?
Traditionally, credit bidding has been used as a defensive strategy by lenders to protect the value of their collateral from being sold at artificially low or distressed prices. Take the example of a bank that lends $100 million to an oil and gas exploration and production company at the top of a commodity cycle. The bank will receive a lien on all of the oil and gas properties and interests. The company underperforms, prices drop to a low point in the cycle, and the company files for bankruptcy with a goal of selling the assets. The auction process yields a high offer of $50 million. The bank then has the right to either let the offer stand and get $50 million, or they can credit bid their claim for higher than the $50 million. With the credit bid, they would take ownership of the property, hold it until they think the market has recovered, and then sell it at its recovered value.
But in today’s market, the dynamics have changed. Credit bidding is not always being used in the traditional sense to protect the lender, but instead it is often used in a “Loan to Own” strategy. Investors are acquiring distressed debt at less than its face amount, and using that debt to control the bankruptcy process with a goal of owning the company when it exits bankruptcy. So take the same scenario, except this time an investor approaches the bank and pays $45 million for the $100 million debt. The investor can exert pressure on the company to file for bankruptcy, force a quick auction, and have a sizable claim to use as a credit bid.
Since the bankruptcy code was enacted in 1978, the markets have changed dramatically. The playing field has shifted. In fact, there have been numerous studies conducted by universities and other professionals that have indicated that secured creditors have pervasive control of the bankruptcy process.1,2,3 Control can be exerted through stringent covenants contained in DIP loans, claims bought at cents on the dollar, and pre-existing relationships between the parties.
Debtors in bankruptcy have two paths to sell assets: Section 363, or Section 1129. Each has its benefits and problems and each path has begun to develop case law that impacts the credit bidding process.4 The value obtained from a sales process will be impacted by a number of factors including:
With this information as a backdrop, we began an analysis to determine how often credit bidding occurs, if it is impacting the value that is received at auction, and if there are ways to protect the estate from any actions that would harm a sale process.
There were eight cases filed from January 1, 2009 through December 31, 2013, by publicly traded U.S. based oil and gas exploration and production companies.5 Out of those bankruptcies, a sale transaction was attempted in six cases. We evaluated those cases to determine if the prices obtained at auction were comparable to those realized in similar transactions in the same time period. We used transactions reported by IHS Herold for this analysis. It should be noted that each case is unique and in some cases there are multiple issues that can impact the value obtained. Sixty-seven percent of the sales transactions evaluated included a credit bid.
The following is a brief recap of what happened in each situation.
Transmeridian Exploration Incorporated (“Transmeridian”) filed for Chapter 11 on March 20, 2009. The company’s primary asset was a license to explore for oil in Kazakhstan. Transmeridian believed that the area covered by the license contained 30 to 50 million barrels of oil, but had not begun exploration activities at the time of the filing. Bid procedures for the sale of the Kazakh subsidiary were filed with the court on April 15, 2009. The initial bidding procedures motion described an offer of $35 million in notes for the Kazakh subsidiary. Revised bidding procedures were filed on June 2, 2009, and approved on June 5. The company held an auction on July 17, 2009, and three bidders attended. The winning bidder was a company controlled by the Transmeridian restructuring advisor for the Kazakh subsidiary. The winning bid included: (a) $60 million in cash, (b) Transmeridian’s choice of $35 million in notes or $17.5 million in cash, (c) $500,000 to cover legal fees, and (d) a credit bid of $8.5 million (including both trade debt and forgiveness of professional fees).
The auction process added $60 million in cash. This was a material improvement over the original non-cash offer.
Delta Petroleum Corporation (“Delta”) spent months prior to the bankruptcy filing marketing the assets of the corporation, but eventually had to file for bankruptcy on December 16, 2011. The majority of Delta’s oil and gas assets were located in the Piceance formation in the Rocky Mountains. The company reported that its proved reserves were 651 billion cubic feet equivalent (“Bcfe”). The debtor in possession financing was provided by the existing debt holders, and they took an active part in the auction process with the goal to credit bid their debt and to manage the process. Nine parties participated in the auction. At the auction the debtor accepted both bids and proposals for plan sponsorship.
The debtor eventually chose a plan of reorganization with a sponsor. The plan called for the conversion of the senior notes into equity of the new company. Figure 2 shows the Delta transaction as compared to other transactions that occurred during the same time period in the Rocky Mountains.
ATP Oil and Gas Corporation (“ATP”) filed for bankruptcy in Houston on August 27, 2012. The company’s assets were mainly in the deep water of the Gulf of Mexico. The company reported reserves of 177.1 million barrels of oil equivalent (“MMboe”). There were numerous issues encountered during the case, many of which impacted the value of the reserves. Those issues remained unresolved at the time of the auction.
When the case was initially filed, the debtor and its management believed that a plan of reorganization would be possible. The DIP lenders (made up largely of existing pre-petition lenders) required milestones for completion of certain activities. When those milestones were repeatedly missed, the DIP lenders insisted on a sales process. A bidding procedures motion was filed on January 22, 2013, and the auction took place on May 7, 2013. The DIP lender and a handful of bidders participated in the auction with offers for select assets. The DIP lenders won the auction with a credit bid of $580 million and cash of $56.8 million. The DIP lenders had a total loan balance of $792.5 million at the time of the auction. Figure 3 shows the ATP transaction as compared to other Gulf of Mexico transactions that occurred during the same time period.
On April 1, 2013, GMX Resources Inc. (“GMX”) filed for Chapter 11. The majority of GMX proved assets were in the Haynesville, Bossier, and Bakken reservoirs. On December 31, 2012, just a few months prior to the bankruptcy, the company reported having 167 billion cubic feet (“Bcf”) of gas and 8.1 million barrels (“MMBbl”) of oil. From very early in the case, the secured creditors insisted the company put itself up for auction in order to receive debtor in possession (“DIP”) financing. The court approved the bidding procedures on June 11, 2013, and the auction was held on August 23, 2013. Two bidders attended the auction.
The note holders bid the full face amount of their bonds, even though the market value of the bonds was likely to be much less than par. The note holders won the auction without another bid. Eventually the sale of the assets was converted into a debt for equity exchange under a plan of reorganization. Figure 4 shows the GMX transaction as compared to other transactions that occurred during the same time period in the Haynesville Shale formation.
TXCO Resources, Inc. and certain affiliates (“TXCO”) filed for Chapter 11 on May 17, 2009. TXCO operated in South Texas, largely in the Maverick Basin. At December 31, 2008, TXCO reported reserves of 36 Bcf and 7.6 MMbbl, with gas comprising 44% of total reserves and oil accounting for 56% of reserves. TXCO pursued a dual path restructuring, contemplating a sale of the company and a stand-alone plan of reorganization. On September 23, 2009, Global Hunter Securities was hired to advise TXCO. Newfield Exploration Company made a $223 million, or $16.40/boe, offer for the company’s assets on October 15, 2009. Ultimately, an auction was held in January 2010. Newfield and Anadarko E&P Company emerged as the joint winners with a total bid of $310 million or $22.79/boe. In this case, a robust auction process led to an increase of $87 million, or 39%, in the value of the debtors’ assets.
Figure 5 shows the TXCO transaction as compared to other transactions during the same time period in South Texas.
On October 1, 2009, Edge Petroleum Corporation (“Edge”) and its affiliates filed for Chapter 11. Edge had proved reserves of approximately 91.7 Bcfe at filing. More than 80% of the company’s reserves were in South Texas, in the Vicksburg, Queen City, and Deep Frio formations. Edge also had reserves in Southeast Texas, New Mexico, Arkansas, Mississippi, Alabama, and South Louisiana. The company had struggled for several years and engaged a financial advisor to assist with a sale of the company’s assets prior to filing. Edge entered into an agreement to sell its assets prior to filing. The offer was used as a stalking horse bid. The stalking horse bid for $191 million, or $2.08/Mcfe, was filed along with other first day motions on October 1, 2009. The order approving the bidding procedures was signed on October 5, 2009. The auction was held on December 7. Two bidders attended the auction, the stalking horse bidder and Mariner Energy. Mariner’s offer of $260 million for the company’s assets was selected as the winning bid.
The auction process significantly increased the cash available to pay down debt. The winning bid was $69 million higher than the stalking horse bid. Even after deducting the $6.5 million break-up fee due to the stalking horse bidder, proceeds available to Edge increased by $62.5 million.
Figure 6 shows the Edge transaction as compared to other transactions during the same time period in South Texas.
The above table summarizes our findings. Out of the six companies reviewed, four included credit bidding. As the chart above shows, there is a substantial price difference between other transactions and those involving credit bids.
It is clear that in the instances where credit bidding was present, the value that the estate received was markedly less than the average market price of comparable transactions. It is hard to discern if that is the result of the credit bidding itself, or that creditors asserted a credit bid because the value realized at auction was so low.
Some of the ways that stakeholders can protect themselves from having credit bids diminish the amount received at auction are to: