July 16, 2019 − Publicly-traded Emerge Energy Services LP (formerly NYSE: EMES and now OTC: EMESZ) and four affiliated Debtors ("Emerge Energy" or the "Debtors") filed for Chapter 11 protection with the U.S. Bankruptcy Court in the District of Delaware, lead case number 19-11563. The Debtors, a Delaware limited partnership that is engaged in the business of mining, processing, and distributing silica sand proppant used for hydraulic fracturing, are represented by John H. Knight of Richards, Layton & Finger LLP. Further board-authorized engagements include Latham & Watkins as general bankruptcy counsel, (ii) Houlihan Lokey Capital Inc. as financial advisor and (iii) Kurtzman Carson Consultants LLC as claims agent.
The Debtors' Lead petition notes between 200 and 1,000 creditors; estimated assets of $329.4mn and estimated liabilities of $266.1mn. Documents filed with the Court list the Debtors' three largest unsecured creditors as (i) Trinity Industries Leasing ($8.9mn trade debt), (ii) Market & Johnson Inc. ($6.2mn trade debt) and (iii) CIT Group/Equipment Financing, Inc ($4.1mn trade debt). All 30 of the Debtors' top 30 unsecured creditors have claims in excess of $200k; 15 have claims in excess of $1.0mn.
Second Frac Sand Chapter 11 in Under a Week
On July 11, 2019, privately-held Shale Support Global Holdings, LLC and seven affiliated Debtors ("Shale Support") filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Southern District of Texas, lead case number 19-33884. Shale Support is also a producer of frac sand and finds itself in Chapter 11 for largely similar reasons including (i) lower demand from under-capacity and cash-strapped energy sector clients, (i) lower prices in a highly competitive market and (iii) the burden of fixed railcar leasing costs. We cover this Chapter 11 separately.
Restructuring Support Agreement
On April 18, 2019, the Debtors entered into a restructuring support agreement (the "RSA") with Insight Equity (the sole member of the Debtors' general partner and, as at December 31, 2017, holder of 23.1% of the Debtors' equity), holders of its first lien revolving loan (the "Revolving Loan Lenders") and holders of its second lien notes (the "Noteholders") further to which the parties agreed on a restructuring path for the Debtors. In short, the Revolving Loan Lenders will get paid in full in cash from an exit facility and the Noteholders will end up with 95% or 100% of the equity in the emerged Debtors (depending on whether unsecured creditors vote to support the Plan). Key RSA terms include:
- Global Settlement Fund: Only if the class of holders of general unsecured claims vote to accept the Plan, the Noteholders have agreed to carve-out from their collateral a global settlement fund representing 5% of the new equity interests in the Reorganized Partnership, plus new warrants to acquire an additional 15% of such new equity interests (the “Global Settlement Fund”).
- Revolving Loan Lenders: The Revolving Loan Lenders will be refinanced in full in cash by a new exit facility.
- Noteholders: If the class of general unsecured creditors votes to accept the Chapter 11 Plan, then the Noteholders will convert a material portion of their secured claims in exchange for 95% of the new equity interests in the Reorganized Partnership, subject to dilution by the new warrants. If the class of general unsecured creditors votes to reject the Chapter 11 Plan, then the Noteholders will convert a material portion of their secured claims in exchange for 100% of the new equity interests in the Reorganized Partnership and the Global Settlement Fund will be eliminated.
- General Unsecured Creditors: If the class of general unsecured creditors votes to accept the Chapter 11 Plan, then such class will receive its portion of the Global Settlement Fund as set forth in the Chapter 11 Plan. If the class of general unsecured creditors votes to reject the Chapter 11 Plan, then such class shall not receive any recovery or property under the Chapter 11 Plan and the Global Settlement Fund will be eliminated.
- Existing Equity Holders: If the class of general unsecured creditors votes to accept the Chapter 11 Plan, then this class of equity holders will receive its portion of the Global Settlement Fund as set forth in the Chapter 11 Plan that was not allocated to the class of general unsecured creditors. If the class of general unsecured creditors votes to reject the Chapter 11 Plan, then this class of equity holders shall not receive any recovery or property under the Chapter 11 Plan and the Global Settlement Fund will be eliminated.
- Chapter 11 Plan Milestones:
- File Chapter 11 Plan, Disclosure Statement, and Disclosure Statement Motion on or before July 25, 2019;
- Disclosure Statement Order on or before September 3, 2019;
- Plan solicitation on or before September 3, 2019;
- Confirmation Order on or before October 8, 2019; and
- Plan Effective Date on or before October 23, 2019.
Events Leading to the Chapter 11 Filing
In a declaration in support of the Chapter 11 filing (the “Gaston Declaration”), Bryan Gaston, the Debtors' Restructuring Officer detailed the events leading to the Debtors’ Chapter 11 filing. In particular, the Gaston Declaration highlights the impact of two macro-economic factors that have led to an over-supply of frac sand and a resulting price erosion: (i) a decline in well completion activities by frac sand end-users and (ii) heightened competition from "in-basin" frac sand competitors (in-basin sand is directly mined, processed and delivered in the basin where customer consumption occurs). The Gaston Declaration also highlights the continuing impact of company-specific problems at a newly acquired and developed Texas in-basin site; where a levee breach has shut down several critical operating lines.
As was also the case in respect of Shale Support's Chapter 11 filing, reduced operating revenues have made existing leasing arrangements in respect of idle railcars (and fixed costs exceeding $3.0mn per month for Emerge Energy) untenable. For these Debtors, the railcar glut is worsened by a move away from the sale of its Wisconsin-mined NWS (northern white sand), heavily reliant on railcars for delivery, to customer preferred in-basin frac sand. Key amongst the Debtors' first day motions is a motion to reject certain railcar leases [Docket No. 9].
The Gaston Declaration states: "Demand for frac sand decreased during 2015 and 2016 as a result of an industry downturn due to low commodity prices. Commodity prices stabilized in the middle of 2016, however, leading to an improvement in drilling activity during the third quarter of 2016, and into 2017 and early 2018. The market for frac sand began to soften again in early August 2018, due to a decline in well completion activities resulting from the exhaustion of capital budgets for oil and gas exploration and production companies. These factors, along with the new production from in-basin frac sand competitors…led the frac sand market to quickly turn from a state of short- supply in the first half of 2018 to over-supply in the second half of 2018. As a result of the imbalance between supply and demand, select in-basin markets for frac sand experienced price erosion as did NWS as a whole.
While experiencing these negative macro-economic factors and a decline in demand for NWS, in April 2017 the Debtors acquired a site in San Antonio, Texas which had operated a small sand mine for decades. The Debtors then undertook a large capital expenditure project to develop this San Antonio site into a large, premier in-basin frac sand facility. The project, however, experienced certain complications and continues to produce below the facility’s nameplate capacity in its sixth full month of operation, in spite of reasonably strong customer demand and pricing. Exasperating the issue further, the facility has temporarily ceased mining operations at the facility’s A and B mines [as]…the result of a levee breach incident that occurred on Friday June 21, 2019….The full extent of damage to the C-line cannot be fully assessed until the water and sediment from the incident has abated or been cleared, but given the extent and nature of the incident all equipment and operations related to the C-line are expected to require replacement and this part of the facility’s operation is expected to be idle for an extended period of time. Although lines A and B were not directly impacted by the levee breach, there are shared water and related retaining structures that, pursuant to the Section 103(k) order, cannot be operated and, as a result, prevents the Debtors from operating lines A and B pending completion of remedial steps to ensure that these areas are safe to operate."
As to the railcar leases, Gaston continues: "Even with the signing of the RSA, however, the Debtors (with the support of their secured lenders) continued to negotiate with their material railcar and terminal lessors for months in the hopes of consummating an out-of-court restructuring. While the Debtors reached agreement with three counterparties, it became clear that there were no viable out-of-court restructuring option for the Debtors to pursue as compared to the benefits that chapter 11 would provide—most importantly the ability to reject burdensome contracts and leases under Section 365 of the Bankruptcy Code. Accordingly, when faced with a lack of viable restructuring options and dwindling liquidity, and after extensive discussions with their advisors, the Debtors determined that filing for chapter 11 was in their best interest and in the best interest of their creditors and other stakeholders."
Prepetition Capital Structure
- Revolving Loan Agreement (First Lien): Certain of the Debtors are parties to a January 2018 revolving credit and security agreement, (the “Revolving Loan Agreement”) with HPS Investment Partners, LLC (“HPS”), as administrative and collateral agent. As of the Petition date, the Revolving Loan Agreement had an aggregate outstanding principal amount of approximately $66.7mn, comprised of $3.5mn in the form of letters of credit and approximately $63.2mn in an aggregate outstanding principal amount in the form of outstanding loans, plus accrued but unpaid interest, fees, costs, and expenses. These obligations are secured by senior, first priority security interests in, and liens upon, substantially all of the Debtors’ assets.
- Notes Purchase Agreement (Second Lien): Certain of the Debtors are parties to a January 2018 Notes Purchase Agreement, (the “Notes Purchase Agreement”), with HPS, as administrative and collateral agent. As of the Petition date, the Notes Purchase Agreement had an aggregate outstanding principal amount of approximately $215.8mn, plus accrued but unpaid interest, fees, costs, and expenses. These obligations are secured by second priority security interests in, and liens upon, substantially all of the Debtors’ assets, which liens are junior in priority to the security interests and liens arising in connection with the Revolving Loan.
- Unpaid Trade Debt & Related Obligations: As at the Petition date, the Debtors unsecured trade debt was in excess of $56.0mn.
About the Debtors
The Debtors are a publicly-traded Delaware limited partnership that is engaged in the business of mining, processing, and distributing silica sand proppant, a key component in the hydraulic fracturing (“fracking”) of oil and gas wells. Proppant is sand or similar particulate material suspended in water or other fluid injected into wells at high pressure to keep fissures open to stimulate the extraction of hydrocarbons. The Debtors conduct their mining and processing operations from facilities located in Wisconsin and Texas. In addition to mining and processing silica sand primarily for use in the oil and gas industry, the Debtors also, to a lesser degree, sell their sand for use in building products and foundry operations.
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