The significant fall in oil prices, coupled with cost reductions now being made by the oil majors to their E&P budgets, has created a gloomy outlook for the offshore oil service industry.
As a consequence of this, financial institutions and other debt investors who have funded offshore projects and assets may have to consider the options available to best protect their investment.
EVENTS OF DEFAULT – CAUSE OF DISTRESS
In deteriorating market conditions, events of default under the financing arrangements will typically arise when the borrower is unable to comply with the financial covenants given to the lenders; in particular, the requirement that the market value of the financed asset is in excess of the outstanding loan amount. Given the steep decline in values of offshore assets it may be
difficult to source collateral to make up any shortfall.
As offshore asset values fall, lenders often have to choose between supporting the distressed project by granting waivers and amendments to the loan agreement, or enforcing security immediately when a default materialises.
RESTRUCTURING THE BUSINESS AS A GOING CONCERN
If the offshore unit is engaged in a long-term employment con-tract and the financing is, or can be, secured by the cash flow from a reputable third party in addition to the asset value, it is likely to be in the lenders’ best interests to consider a restructuring plan to maintain or utilise this cash flow.
Where this choice is considered, the main objective will be to ensure that the performance of the unit under the contract remains acceptable for the third party charterer. This may be a challenge
where, due to the fall in oil prices, the contract is an expensive one for charterers to maintain. Lenders may therefore need to consider becoming more directly involved in the day-to-day operations of the company, either by requiring regular information to be provided and/or by seeking to negotiate rights to exercise direct influence over the operation of the unit.
If the offshore unit is unemployed or is operating in a market dominated by short-term
contracts, the asset value will typically be the main security underpinning the financing. Where a default occurs, a lender may be tempted to try and dispose of the asset as quickly as possible. Often, however, the proceeds from distress sales are reduced because such sales take place in circumstances where the market knows of a default.
In these situations, it may be in the lenders’ interests to allow the borrower to continue operating the unit as a going concern. The lenders will need to deter-mine whether there is a realistic prospect of asset values improving over time, as well as to assess the ability of the current management of the company to operate and market the unit effectively. Again, lenders may wish to exercise direct control over the borrower by replacing or supporting the current management team with their own representatives. Continued operations will in any event require a re-assessment of the financial model, and typically short- or long-term waivers of covenants that
the borrower has failed to comply with. The quid pro quo for the lenders will typically be additional covenants, additional security, prepayment requirements and waiver fees. However, it is important to strike a balance between imposing new requirements and achieving an overall structure that makes continued operation viable. Project stakeholders may also be required to inject new equity, take a haircut on the loan returns or convert part of the loan into equity.
In seeking to find a restructuring solution, lenders will have to take into account the involvement and considerations of other stakeholders on the debt and equity side. In the initial stages of the negotiations it is important to put in place the standstill arrangements and a framework for the exchange of information and negotiation. As the process evolves, the decision for lenders
turns on what realistic alternatives there are to bankruptcy and enforcement of security.
ENFORCEMENT OF SECURITY
Enforcement of security constitutes the lenders’ fall-back position. It is not always straightforward, and the asset disposal possibilities need to be assessed against the (negotiated) alternatives. In addition to the expected proceeds from the sale of the unit, lenders will need to take into account the time and cost of the enforcement procedures.
Enforcement of a vessel mortgage will depend on the procedural rules in the jurisdiction where the unit is located and on the requirements of the flag state where the mortgage is registered. In certain jurisdictions, such enforcement processes may be time-consuming, costly and unpredictable. A more efficient alternative may be to foreclose on the shares and take possession of the owning company, appoint representatives to the board/management and to sell the asset as the owner. However, lenders who assume responsibility for the company may also need to advance further cash in the short term to pay operating expenses for crew, supplies and the sales process. In our experience some lenders are reluctant to follow this approach when the outstanding loan is higher than the value of the vessel. The reason for this is partially to avoid the risk that the lender will be deemed responsible for all cost and liabilities incurred in connection with the operation of the vessel as it is in reality operated in the sole interest of the lender. Another reason is that applicable accounting rules may require the lender to put the vessel on its balance sheet.
Lenders need to know whether they can achieve their preferred solution where there are other significant creditors, or where there are relevant insolvency regulations. In the latter event, it is important to note that insolvency regulations differ significantly between jurisdictions. When faced with imminent bankruptcy, companies in some jurisdictions, including the US, Japan, Singapore
and Korea, can seek Court protection against creditors for a limited period whilst considering whether the company can be rescued, sold or rehabilitated. Where this possibility exists, lenders need to ensure that they act quickly to avoid the risk of restructuring or enforcement processes being taken out of their hands.
We face a period of uncertainty in the offshore sector, which some operations will struggle to survive. Lenders will have to make some challenging assessments and compromises to protect their interests where events of default occur. Understanding the options available, and making decisive choices at the right time, will be necessary to ensure that lenders are able to best protect their investment.