Facing continued, depressed pricing and increased regulatory pressures, oil and gas companies are in the midst of a bust cycle that could leave long-lasting impacts on the industry. Since the beginning of 2016, 35 North American energy companies have filed for bankruptcy, and more could be on the way in the coming months.

While some companies have been damaged so badly they have been forced to file for Chapter 7 bankruptcy and liquidate all assets, many are attempting to file for Chapter 11 in hopes of rebuilding their businesses.

But filing for Chapter 11 bankruptcy is a difficult scenario. The road to recovery is long, complex and unlikely. It’s not unheard of for major corporations to emerge from Chapter 11 and reassert themselves in the market, but getting there requires meticulous planning and a certain amount of good fortune.

There are steps companies should take to give the best chance of survival and almost all begin before filing for bankruptcy.

1. Determine post-reorganization positive cash flow. Once a company enters a Chapter 11 bankruptcy, it will require positive cash flow to make the restructured entity viable. But, unlike what some assume, the time to ensure this cash flow is before the bankruptcy filing, not when restructuring is underway.

Determining whether a company will have positive cash flow post-bankruptcy requires the expertise of a specialized accountant as few, if any, in-house accounting departments have the know-how to properly determine this. A real assessment of potential cash flow is not a quick turnaround procedure and should take about 60 days to complete. In an industry with volatile pricing like oil and gas, the need for careful analysis is even more necessary. Also, while companies might want to be optimistic about future pricing, a dose of reality is necessary. Cash flow must be based on conservative pricing estimates to convince lenders and creditors that the reorganization will be viable.

If the ultimate determination is that a company will not be able to achieve positive cash flow, then an outside source of liquidity will need to be secured. Securing this loan will require a number of agreements between a company’s numerous lenders. Typically, this loan can be secured, but securing the loan will not ensure a successful reorganization.

2. Understand your employment obligations. Generally senior management will begin reducing staff before bankruptcy is a certainty. When revenue is down and resources are strained, labor reductions are often the first place employers look to reduce costs.

However, when a company has determined bankruptcy is its only way forward, further labor reductions might be needed; and distinct classes of employees receive different considerations under the law.

With at-will employees, the process is relatively straightforward—either party can terminate the relationship at any time for any reason, outside of unlawful discrimination. When employees are covered by a collective bargaining agreement or some other type of employment agreement, however, employers have a more complex road forward. While bankruptcy gives the employer the opportunity to reject and renegotiate existing employment agreements and collective bargaining agreements (CBAs), rejecting CBAs is fraught with potential pitfalls that must be carefully considered. Ultimately, the decision of what to do with employment agreements must be weighed against how burdensome the cost would be to assume the existing agreements after bankruptcy.

Employees will also likely file claims for unpaid wages and employee benefit contributions not paid during the bankruptcy process. These claims will typically be considered priority claims, and an employer will be required to pay them in full as a condition of the court-approved reorganization terms without the employee’s consent.

3. Determine your pension and other post-employment benefit (OPEB) commitments. Along with the employment considerations above, a company is best prepared for a bankruptcy-led restructure when it has conducted a thorough review of its obligations to employee pension and retiree benefit packages.

Guaranteed Benefit Pension Plans are protected by the Employee Retirement and Income Security Act (ERISA). The complexities of negotiating these obligations under bankruptcy law are numerous, and the financial impact they can have is significant. Understanding what obligations a company has, the implications of certain types of claims the Pension Benefit Guaranty Corp., pension plans and former and existing employees can bring to maintain these plans, and anticipating the impact of those financial commitments are critical to the health of a restructured entity.

4. Review all existing contracts for rejection or assumption. As the recent Sabine Oil & Gas Corp. and Quicksilver Resources Inc. bankruptcy cases have demonstrated, how contracts should be treated in bankruptcy is a key issue. Collective bargaining and employment agreements are a form of contract, but there are numerous other contracts that exist between oil and gas producers, pipeline companies, contractors and various other third parties. When filing for Chapter 11, there are two types of contracts that must be considered:

  • Executory agreements and leases—contracts and leases under which critical work remains to be completed, such as real estate leases and gathering agreements—must be assumed or rejected before a reorganization plan will be approved the court. When these contracts are assumed they will be binding following the bankruptcy filing. Companies can generally reject any executor contract releasing them from obligations, but the counterparties will have claims for rejection damages. Most rejection claims are treated as prepetition unsecured claims, a major benefit for the company in bankruptcy. Failure to reject or assume executory contracts before a reorganization plan ultimately means those contracts must be honored.
  • Forward contracts—agreements that govern the future sale of goods—enjoy a “favored” status in bankruptcy courts to protect those who hedge market risk and enter into important financial obligations. With these contracts, which are particularly common in the energy industry, the law considers it “business as usual” even if the company is going through a bankruptcy.

Understanding the types of contracts that a company has and whether they can be rejected or assumed is a key determination in the lead-up to a Chapter 11 filing.

Bankruptcy is a new reality for many energy companies, and the process can be a complicated one. But preparation allows for managed expectations and smart evaluation as companies work to create reorganized versions of themselves. A tight pre-bankruptcy process is the key to ultimately having a successful reorganization.

William Schorling and Matthew Burger are part of Buchanan, Ingersoll & Rooney’s energy practice.