Special Considerations for Protecting Interests under Water Agreements in Bankruptcy

By Rahul D. Vashi, Anna G. Rotman, Chris Heasley, Shubi Arora, Kenneth A. Young, Fraser F. Wayne, and John C. Elkins (Kirkland & Ellis)

Rahul D. Vashi
Anna G. Rotman
Chris Heasley
Shubi Arora
Kenneth A. Young
Fraser F. Wayne
John C. Elkins

Midstream service providers in the oil and gas space typically expend substantial upfront capital investment to build pipeline systems to gather and transport hydrocarbons and produced water for oil and gas producers, and rely on the fee structures in their service contracts to recoup their investments. One common method used by midstream companies to protect their investments is to create (or attempt to create) in their service contracts a dedication of production from the oil and gas producer structured as a covenant that runs with the land.

Beginning with Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC (In re Sabine Oil & Gas Corp.), 567 B.R. 869 (S.D.N.Y. 2017), bankruptcy courts have delivered divided opinions on whether midstream gathering and transportation contracts can be rejected, resulting in substantial uncertainty about whether midstream service providers can rely on their contractual terms. The major decisions regarding the treatment of midstream contracts in bankruptcy have focused on contracts for the gathering and transportation of hydrocarbons, and whether the contracts should not be rejectable because the oil and gas producer properly granted to the midstream company a covenant running with the land in its oil and gas properties.

Providers of produced water gathering and transportation services have typically relied on the same contractual protections as those that provide hydrocarbon gathering and transportation services. However, to date, midstream water contracts purporting to contain covenants running with the land have not been tested, and there is reason to believe that such agreements may be treated differently than their oil and gas counterparts. This article discusses certain issues and considerations that are specific to midstream water agreements and may affect whether such agreements are determined to be rejectable under the Bankruptcy Code.

The full article is available here.

When Arbitration Meets Bankruptcy: Considering Arbitration Options in the Wake of a Growing Rise in Corporate Insolvencies

By Shana A. Elberg, Christine A. Okike, & Jennifer Permesly (Skadden)

Shana A. Elberg
Christine A. Okike
Jennifer Permesly

The economic hardships brought about by the COVID-19 pandemic have impacted companies globally, leading many to consider both in-court and out-of-court restructurings. This trend will likely continue as the long-term effects of COVID-19 play out, and companies with arbitration clauses in their commercial agreements may wish to consider the impact of insolvency on their options for pursuing pending or future arbitrations. Under bankruptcy law, the initiation of insolvency proceedings results in an automatic stay of all civil proceedings brought against the debtor, including claims brought in arbitration. An arbitration counterparty may ask a bankruptcy court to lift the stay, which the court is permitted to do under the Bankruptcy Code “for cause.” The decision to lift the stay is ultimately a matter of the bankruptcy court’s discretion, though federal circuit courts have held that a stay of an arbitration involving a noncore matter generally must be lifted. The balance is particularly weighted in favor of arbitration in the international context.   Although the stay of arbitration is intended to apply extraterritorially, it is not always clear that arbitration tribunals seated outside the US, or counterparties located outside the US and not subject to the bankruptcy court’s jurisdiction, will consider themselves bound by the stay.  Companies considering their options for pursuing cross-border arbitrations against an insolvent debtor must therefore consider the relevant laws in at least three regimes: the seat of the arbitration, the place in which the debtor has declared insolvency and any countries in which enforcement of the award may ultimately be sought.

The full article is available here.

Oversecured Creditor’s Right to Contractual Default-Rate Interest Allowed Under State Law

By Stacey L. Corr-Irvine and Mark G. Douglas (Jones Day)

Stacey L. Corr-Irvine
Mark G. Douglas

It is generally well understood that an “oversecured” creditor is entitled to interest and, to the extent provided for under a loan agreement, related fees and charges as part of its secured claim in a bankruptcy case. Although section 506(b) of the Bankruptcy Code provides that fees, costs or charges allowed as part of a secured claim must be “reasonable,” the provision does not expressly impose any restrictions on the amount or nature of interest allowable as part of a secured claim. A Bankruptcy Appellate Panel for the Eighth Circuit recently considered whether a secured creditor is entitled to contractual default-rate interest under section 506(b).

In In re Family Pharmacy, Inc., 614 B.R. 58 (B.A.P. 8th Cir. 2020), the panel reversed a bankruptcy court’s order disallowing a secured creditor’s claim for interest at the default rate under the parties’ contract using a penalty-type analysis generally applied to liquidated damages provisions. According to the panel, such an analysis cannot be applied to default interest provisions. The panel also held that the bankruptcy court erred when it held that the default interest rate was unenforceable based on “equitable considerations.”

The full article is available here.

Second Circuit Affirms Enforceability of Swaps’ Flip Provisions

By Shmuel Vasser (Dechert)

Shmuel Vasser

Swaps, like other financial contracts (repurchase agreements, securities contracts, commodities contracts, forward agreements and master netting agreements), receive special treatment under the Bankruptcy Code.  Their acceleration, liquidation and termination is not prohibited as an ipso facto clause and the exercise of setoff rights is not subject to the automatic stay.  Transfers made in connection with these contracts are also exempt from avoidance as preferences and constructive fraudulent transfers as well as actual fraudulent transfer under state law.  But their scope is not always free from doubt.  Are provisions that modify the debtor’s priority of payment upon bankruptcy protected as well?  Are provisions that the swap incorporates by reference protected?  Must the swap counterparty itself exercise the right to liquidate, terminate and accelerate the swap?  The Second Circuit just answered these questions.

The full article is available here.

Secured Creditor’s “Net Economic Damages” Estimate of Disputed Claims “Plainly Insufficient” to Establish Collateral Value

By Paul M. Green and Mark G. Douglas (Jones Day)

Paul M. Green
Mark G. Douglas

Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets (and even creditor claims) are valued will determine a wide range of issues, from a secured creditor’s right to adequate protection, postpetition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the “best interests” test or whether a “cram-down” plan can be confirmed despite the objections of dissenting creditors. Depending on the context, bankruptcy courts rely on a wide variety of standards to value estate assets, including retail, wholesale, liquidation, forced sale, going-concern, or reorganization value. Certain assets, however, may be especially difficult to value because valuation depends on factors that may be difficult to quantify, such as the likelihood of success in litigating estate causes of action.

The U.S. Court of Appeals for the First Circuit recently addressed this issue in In re Montreal, Maine & Atlantic Railway, Ltd., 956 F.3d 1 (1st Cir. 2020) (“MMA Railway”). The First Circuit affirmed a ruling that a secured creditor failed to satisfy its burden of establishing that collateral in the form of indemnification claims settled by the estate had any value entitled to adequate protection. According to the court, with respect to a disputed claim, a showing of possible damages is not enough. Instead, the creditor must establish the likely validity of the claim and the likelihood of recovery.

MMA Railway is a cautionary tale for secured creditors. Creditors bear the ultimate burden of proof in establishing the value of their collateral under section 506(a) of the Bankruptcy Code—a determination that has important consequences in many contexts in a bankruptcy case. The First Circuit’s ruling highlights the importance of building a strong evidentiary record to support valuation. It also indicates that certain types of collateral (e.g., disputed litigation claims) are more difficult to value than others.

The full article is available here.

Update on Corporate Bankruptcy Tax Refund Litigation

By Michael L. Cook (Schulte Roth & Zabel)

Michael L. Cook

Federal courts regularly resolve consolidated corporate tax refund disputes in bankruptcy cases.  In the current economic downturn, the ownership of a large tax refund paid to an affiliated group of corporate debtors can be significant.  See, e.g., FDIC v. AmFin Corp., 757 F.3d 530, 532 (6th Cir. 2014) ($170 million refund).  If a corporate debtor’s parent owns the refund, it is part of the parent’s bankruptcy estate, and the subsidiary may be an unsecured creditor for any claimed benefits.  But if the debtor parent is an agent or trustee for its affiliates, the parent cannot use the refund to repay its creditors.

Corporate parents and their subsidiaries often file a consolidated tax return.  That enables affiliates to offset their losses against each other so as to reduce the group’s overall tax liability.  Because only the corporate parent may file a consolidated return, any refund is also paid to the parent, not to individual affiliates.  Affiliated groups, therefore, usually enter into tax sharing or allocation agreements.  These agreements – or their absence – have generated a spate of litigation.

The Circuit Courts of Appeals had been sharply split on how to resolve tax refund ownership issues until the U.S. Supreme Court resolved the issue this past February in Rodriguez v. FDIC (In re Western Bancorp, Inc.), 589 U.S. ___, 140 S. Ct. 713 (Feb. 25, 2020).  Without deciding the merits, the Court remanded the case to the Tenth Circuit, directing it to apply state law to resolve the refund ownership dispute between the parent’s bankruptcy trustee and a subsidiary.  The Supreme Court also rejected a purported federal default rule promulgated by the Ninth Circuit in 1973 that had been adopted by a few other Circuits, describing it as inappropriate federal “common lawmaking.”  On May 26, 2020, following the Supreme Court’s remand, the Tenth Circuit, applied Colorado law, construed the relevant group tax sharing agreement, and held for the subsidiary bank, now in the hands of a FDIC receiver.

This article describes relevant issues litigated over the past fifty years.  It also notes open issues that will continue to be litigated following the Rodriguez decision.

The full article is available here.

Claims, Classes, Voting, Confirmation and the Cross-Class Cram-Down

By Tomas Richter (Clifford Chance) and Adrian Thery (Garrigues)

Tomas Richter
Adrian Thery

Under EU Directive 2019/1023 promulgated in June 2019, the 27 Member States of the European Union must enact rules supporting preventive restructurings of businesses threatened by insolvency. The restructuring frameworks to be enacted are in a large part modelled after the U.S. Chapter 11 yet they are not carbon copies of it. Also, the 27 Member States have widely differing insolvency laws against whose background the preventive restructuring frameworks must operate, and significantly diverging institutions by which they will have to be applied. The implementation tasks will be both varied and formidable.

However, certain threshold questions are very similar across jurisdictions when it comes to particular topics relevant to corporate restructurings. In the context of agreeing to and adopting a restructuring plan, some of the key questions arise in relation to classification of investors’ claims and interests, grouping these claims and interests into classes, voting in the classes, and obtaining an official approval of the restructuring plan after investors have expressed their opinions on it via the voting mechanism.

The purpose of this first guidance note, published by INSOL Europe, is to flag some of the key issues that national legislators will want to consider in this particular context when implementing the restructuring frameworks prescribed by Title II of the Directive, and, at least at times, also to respectfully suggest which approaches, in the authors’ humble opinions, might perhaps be explored more productively than others.

The full article is available here.

Where Past is Prologue: Applying Lessons from the Past to Protect ABL Lenders in a World of Future Distress

By Shana A. Elberg, Seth E. Jacobson, & George R. Howard (Skadden)

Shana A. Elberg
Seth E. Jacobson
George R. Howard

Today, U.S. borrowers are more indebted than ever before. Borrowers have become increasingly aggressive in using secured leverage, and in taking advantage of “cov-lite” loan documents to engage in creative (and sometimes controversial) transactions to transfer assets beyond the reach of existing secured lenders by way of distributions to shareholders or contributions to unrestricted subsidiaries and then utilize those assets to raise additional secured financing. While the debt levels and cov-lite structures of leveraged loans may create risks for many stakeholders, lenders under asset-based loan facilities (“ABL facilities”) should be well-positioned to weather any storm. ABL facilities typically offer lenders greater protections in a liquidation scenario. In addition, ABL facilities often are a critical lynchpin of debtor-in-possession financing facilities when borrowers are looking to effectuate comprehensive restructurings through chapter 11. There are several tools available to ABL lenders to protect their credit position in the event that a borrower finds itself in a distressed situation. Lenders should position themselves to understand and use the chapter 11 process to ensure their debt claims retain, and even gain, protections in bankruptcy.

The full article is available here.

Bankruptcy Claim Dischargeability and Public Externalities: Evidence from a Natural Experiment

By Michael Ohlrogge (New York University School of Law)

Michael Ohlrogge

In 2009, the Seventh Circuit ruled in U.S. v. Apex Oil that certain types of injunctions requiring firms to clean up previously released toxic chemicals were not dischargeable in bankruptcy.  The result of this was to expose lenders, even those with security interests, to larger losses in the event a firm they extended credit to entered bankruptcy with significant outstanding environmental cleanup obligations. I document that lenders tightened the covenants on loans they extended to firms impacted the decision. In particular, lenders added new requirements that borrowers’ facilities and operations be inspected by outside environmental engineering firms in order to assess the safety with which they handle toxic chemicals.

Using an array of statistical tests and data from federal environmental agencies, I show that firms impacted by the decision responded to these new pressures from lenders by taking meaningful steps to reduce their risks of causing catastrophic pollution spills. In particular, firms reduced volume of toxic chemicals they release on-site by approximately 15%. In place of these releases, firms substituted off-site treatment by specialized facilities generally considered to be safer for the environment.  These results point to important ways in which bankruptcy law and other legal rules that impact recovery for firms’ creditors can work to shape the positive or negative externalities those firms generate.

The full article is available here.

Covenant of Good Faith and Fair Dealing Examined: La Paloma

By Ronit J. Berkovich and Fraser Andrews (Weil)

Ronit J. Berkovich
Fraser Andrews

On January 13, 2020, the United States Bankruptcy Court for the District of Delaware issued an opinion in In re La Paloma Generating Company, LLC., Case No. 16-12700 [Adv. Pro. No.19-50110], which examined the implied covenant of good faith and fair dealing in the context of an intercreditor agreement (ICA) governing the relationship between the First Lien Lender (First Lien Lender) and the Second Lien Lenders (Second Lien Lenders) to the Debtors.  The bankruptcy court held a party cannot be in breach of the covenant of good faith and fair dealing under New York law when merely enforcing a contractual right, in this case the First Lien Lender enforcing the ICA.

The full article is available here.

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