Two recent court decisions may affect an equity sponsor’s options when deciding whether and how to put money into - or take money out of - a portfolio company. The first may expand the scope of “inequitable conduct” that, in certain Chapter 11 settings, could lead a court to equitably subordinate a loan made by a sponsor to its portfolio company, placing the loan behind all of the company’s other debt in the payment queue. The second decision muddies the waters of precedent under the U.S. Bankruptcy Code on the issue of the avoidability of non-U.S.

This alert describes certain information regarding the recently filed bankruptcy case of Emerald Oil, Inc. and is an example of current developments in the energy industry.

Emerald Oil, Inc. and its subsidiaries (collectively referred to as the “Debtors”) filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code on March 22, 2016 in the District of Delaware, pursuant to which the Debtors plan to sell substantially all of their assets (the “Assets”) in a possible auction in July 2016.

With the steep collapse of oil and gas prices in the last eighteen months, dozens of exploration and production companies have declared bankruptcy and many more companies are expected to file for bankruptcy protection unless prices rebound dramatically. As the prospect of further bankruptcies looms, it is important for parties to understand how to adequately protect their security interests and the nature of competing liens that could prevent them from fully realizing on the value of the collateral securing their counterparty’s obligations.

An overvalued property may now have a bigger impact on a secured creditor’s bottom-line during bankruptcy.  Splitting with the Seventh Circuit, the Fifth Circuit in Southwest Securities, FSB v.

Securities Alert February 1, 2016 E&P Restructurings: Focus on Uptiering Transactions By: Jennifer Wisinski, Paul Amiel, Bill Nelson and Kristina Trauger Times are tough, very tough, for many mid-cap and small-cap exploration and production (“E&P”) companies. Crude oil prices have fallen from more than $100/barrel in July 2014 to a twelve-year low of less than $30/barrel in January 2016. Natural gas prices are at a three-year low. The growing consensus is that depressed prices will experience a slow recovery that may continue into the 2020s.

Two recent court decisions may result in a broadening of the range of options available to an equity sponsor in respect of an insolvent portfolio company. The first decision may provide increased flexibility in structuring asset sales in certain chapter 11 settings, by utilizing escrows and other techniques to potentially avoid the need to apply asset-sale proceeds strictly in accordance with creditor priorities under the U.S. Bankruptcy Code.

It is a basic feature of sales under section 363 of the U.S. Bankruptcy Code, that the purchaser takes free and clear of all claims and interests, such claims and interests attach to the proceeds of the sale in accordance with their priorities.

When a portfolio company underperforms, a sponsor may consider various options to address the perceived performance issues, including changes to a portfolio company’s management team, cost structure, capital structure or other parameters, depending on the nature of the issue(s) at hand. When changes in capital structure may be desirable, often in the context of excessive debt and related liquidity issues, a sponsor’s choices may include a consensual workout outside of bankruptcy, or a court-supervised restructuring under Chapter 11 of the U.S.

Bankruptcy courts in the U.S. are widely viewed as favorable fora for debtors, trustees and creditors’ committees to pursue creative and difficult causes of actions against deep-pockets lenders and others in an attempt to augment the resources available for distributions to creditors. In yet another case, however, the District Court for the Southern District of New York (after withdrawing the litigation from the bankruptcy court), recently dismissed many of the claims asserted by the Lehman debtors against J.P. Morgan Chase Bank, N.A.

Sophisticated real estate lenders spend significant amounts of time and energy attempting to insulate themselves from potential bankruptcy filings by their borrowers. A primary reason, which many an experienced real estate lender has found out the hard way, is the risk that a debtor in bankruptcy may “cram down” a plan of reorganization over its lender’s objection. Under a typical cramdown plan, a debtor may stretch out payments to its secured creditor for several years and attempt to replace its negotiated interest rate with a new, below- market rate of interest.