September 12, 2019 – The Debtor's Official Committee of Unsecured Creditors (the “Committee”) vigorously objected to the Debtors’ debtor-in-possession ("DIP") financing motion [Docket No. 300], arguing that the current (interim) DIP financing from holders of the Debtors' 7.25% Senior Secured First Lien Notes due 2023 (the "First Lien Notes") is an "unabashed power grab by the Debtors’ prepetition secured creditors: by combining a roll-up with a tight timeline, severe limitations on the Committee’s ability to investigate secured creditors’ liens and statutory waivers, it propels these cases toward an outcome that benefits the secured creditors at the expense of unsecured creditors." This objection has been joined by Delaware Trust Company in its capacity as indenture trustee for several of the Debtors' senior notes [Docket No. 303]. A separate, similar objection (described below) was filed by an ad hoc group of the Debtors' noteholders (the “Ad Hoc Group”) [Docket No. 301].
The Committee proceeds to argue that alternative DIP financing offered by the Ad Hoc Group is superior as it "offers the Debtors the same DIP financing as the Proposed DIP Financing, but without the immediate $175 million roll-up, the grudging deadlines and the close-fisted budget for the Committee’s lien investigation, or the waivers of the Debtors’ statutory rights."
Previously, on August 15, 2019, the Court issued an interim order authorizing the Debtors to access $50.0mn in “new money” DIP financing from holders of the First Lien Notes [Docket No. 144].
The current Committee objection states: “One month after the Debtors’ bankruptcy filing, their unsecured noteholders are willing to provide them with postpetition financing (the ‘Alternative DIP Proposal’) to replace the burdensome loan that the Debtors obtained on an interim basis (the ‘Proposed DIP Financing’). The Debtors nevertheless persist in seeking approval of the Proposed DIP Financing. The Proposed DIP Financing harms the estates in various ways. Most egregiously, it would transform over one-third of the prepetition secured notes into superpriority administrative claims that the Debtors would be required to pay — together with $175 million of new debt — in full in cash to emerge. Nothing in the Bankruptcy Code authorizes this feature of the Proposed DIP Financing, and courts have uniformly disfavored roll-ups for the good reason that roll-ups ‘immediately remove an important tool from the debtor’s arsenal, the ability to cram down the secured lender.’
The Proposed DIP Financing is an unabashed power grab by the Debtors’ prepetition secured creditors: by combining a roll-up with a tight timeline, severe limitations on the Committee’s ability to investigate secured creditors’ liens and statutory waivers, it propels these cases toward an outcome that benefits the secured creditors at the expense of unsecured creditors. This strategic ploy is all the more inappropriate because a primary purpose for the Debtors’ postpetition financing, even by the Debtors’ own admission, is to preserve the secured creditors’ collateral by satisfying the Debtors’ minimum drilling requirements under their oil and gas leases. In other words, under the ‘generous’ financing being proposed by the prepetition secured creditors, the Debtors are being forced to pay the secured creditors cash interest on a substantial portion of their prepetition secured debt while spending most of the balance of the loan proceeds (other than restructuring expenses) on capital expenditures to salvage the value of the same secured creditors’ collateral.
In contrast, the Alternative DIP Proposal offers the Debtors the same DIP financing as the Proposed DIP Financing, but without the immediate $175 million roll-up, the grudging deadlines and the close-fisted budget for the Committee’s lien investigation, or the waivers of the Debtors’ statutory rights. Indeed, it contemplates continuation of the same drilling program to avoid the loss of the prepetition secured creditors’ collateral that would otherwise be occasioned without such financing. Moreover, the Debtors have a clear path to accept the Alternative DIP Proposal without a priming fight and, in any event, have ample unencumbered assets to win such a fight. Yet the Debtors have disdained the Alternative DIP Proposal: by all accounts, they have not used it as leverage to obtain concessions from their secured creditors, even as those same secured creditors desperately need the Debtors to have sufficient liquidity to maintain the value of their prepetition collateral package.”
Objection of Ad Hoc Group
Also objecting to the current DIP financing is the Ad Hoc Group itself [Docket No. 301], which objects (again, see "Further Background" for details of earlier objection) on grounds similar to those argued by the Committee. The Ad Hoc Group states in its objection: "At the ‘first day’ hearing, the Debtors filed and prosecuted an ‘emergency” motion for post-petition financing (the ‘Currently Proposed DIP Financing’) even though the Debtors did not need the money and did not need the consent of any party to use sufficient cash collateral. The filing of the Motion was not in the estates’ best interests. The estates faced no ‘immediate and irreparable harm’—at least not until the Debtors filed their Motion. The Court approved the Motion on an interim basis, rescuing the estates from the threat of the Debtors’ self-imposed harm.
Now, at the ‘second day’ hearing, the Debtors are requesting approval, on a final basis, of post-petition financing that seeks to satisfy $200 million of prepetition claims, including by ‘rolling-up’ into superpriority status $175 million of prepetition claims held by the putative DIP Lenders. The Debtors do not know if prosecution of the Motion maximizes the value of the estates, and they have done zero analysis of the impact this ‘roll-up’ threatens to prospects for a successful reorganization. And yet they proceed apace.
The Debtors’ determination is particularly unacceptable in view of the fact that a superior alternative post-petition financing was offered to the Debtors by the Ad Hoc Group (the ‘Alternative DIP Financing’). The Debtors refused to alter course. Once again, the Debtors’ conduct fell short of what is required of a debtor remaining in possession of its assets under chapter 11. The Alternative DIP Financing offered significant incremental value to the Debtors’ estates. No roll-up. No waiver of valuable estate powers under sections 506(c) and 552(b) of the Bankruptcy Code. No payment of the Secured Notes’ professional fees and expenses. No restrictive ‘challenge period’ or limitation on use of proceeds to challenge the Secured Noteholders’ claims—especially important in these cases where exceedingly valuable claims exist, a fact conceded by the Secured Noteholders themselves on at least two occasions.
On August 13, 2019, the Ad Hoc Group objected [Docket No. 74] to the Debtors' request for interim DIP financing on numerous grounds: accusing the Debtors of ignoring their pleas for a place at the pre-petition table; accusing the holders of the First Lien Notes (and current DIP lenders) of unilateral and unlawful efforts to skew creditor recoveries; and accusing the Debtors' board (and in particular its nominally independent directors) of being asleep at the switch, focusing on efforts to protect themselves as opposed to the bankrupt estates (eg obsessing with releases) and otherwise complicit in improper payments to executives.
As previously reported: "On August 13, 2019, certain holders of the Debtors' unsecured notes (the “Ad Hoc Group”) objected [Docket No. 74] to the Debtors' DIP financing motion on numerous grounds. The objection (see summary below), overruled in the interim order, was probably more intended to put the Debtors and Court on notice of the Ad Hoc Group's extreme unhappiness ("the Debtors’ request to approve debtor in possession financing from these same parties [ie the secured, first lien noteholders] requires close scrutiny") than any real desire to keep the Debtors from the urgently needed $50.0mn in new money. In any event, the objection spent much of its time on issues not directly related to the DIP financing itself, using the opportunity to assail the Debtors board, management and general disregard for the holders of the Debtors' $1.75bn of unsecured debt, inter alia, accusing the Debtors of ignoring their pleas for a place at the pre-petition table; accusing the holders of the First Lien Notes of unilateral and unlawful efforts to skew creditor recoveries pre- and-post Petition; and accusing the Debtors' board (and in particular its nominally independent directors) of being asleep at the switch…and when not asleep, obsessing on efforts to protect themselves (eg releases) and otherwise complicit in improper payments to executives.
These objections are not going to go away with the issuance of an interim DIP financing order.
The Debtors' DIP financing motion [Docket No. 26] stated: "After a hard-fought, arm’s length negotiation with the Secured Notes Ad Hoc Group, the parties ultimately agreed to the terms of a superpriority, priming, senior secured delayed-draw term loan credit facility (the ‘DIP Facility’ and the loans thereunder, the “DIP Loans”), in an aggregate principal amount of $350 million, consisting of: (i) a new money term loan credit facility in the aggregate principal amount of $175 million (the “New Money Facility” and the loans thereunder, the “New Money Loans”), backstopped by the members of the Secured Notes Ad Hoc Group, $50 million of which will be available for the Debtors to draw on an interim basis (the “Interim DIP Draw”); and (ii) subject to the entry of the Final Order and the Challenge Period (as defined in the Interim Order), a roll-up of $175 million of the obligations arising under the Secured Notes Indenture held by the DIP Lenders (as defined below), or held by funds or accounts managed or held by such DIP Lenders(the “Roll-Up Loans”). As described in more detail herein, a portion of the Interim DIP Draw will be used to effect a Discharge of First-Out Obligations (as defined below)by repaying $7.9 million in principal amount outstanding under the Prepetition Credit Agreement (as defined below) and cash collateralizing an approximately $17.1million Prepetition L/C (as defined below), which if drawn upon by the beneficiary would give rise to a secured claim against the Debtors’ estates.
The Debtors' DIP financing motion states: “…the Debtors currently project that absent the DIP Loans and assuming the Debtors would be able to utilize all cash collateral without restriction, they will fall below minimum liquidity levels needed to safely operate by January 2020. The Debtors’ preexisting cash balances and cash generated from operations simply are not sufficient to fund business operations and the administration of these cases, and a significant cash infusion is critical to the continued operation of the Debtors’ businesses and the preservation of going concern value."
Key Terms of the DIP Financing
- Borrower: Sanchez Energy Corporation
- Guarantors: Each of the Restricted Subsidiaries (as defined in the DIP Credit Agreement and collectively, with the Borrower, the “Loan Parties”).
- Administrative Agent: Wilmington Savings Fund Society, FSB (the “DIP Agent”).
- DIP Lenders: The financial institutions listed in Schedule 2.01 of the DIP Credit Agreement (the “DIP Lenders” and together with the DIP Agent, collectively, the “DIP Secured Parties”).
- Term: 9 months following the Petition Date.
- Principal Amount of Loan: The aggregate principal amount of the DIP Facility shall be $350.0mn consisting of: (i) New Money Loans: $175.0mn ($50.0mn on an interim basis) and (ii) Roll-Up Loans: $175.0mn.
- Interest Rates: The DIP Facility shall bear interest at the following rates: (i) New Money Loans: LIBOR plus 8.0% per annum (the “Applicable Margin”), (ii) Roll-Up Loans: 7.25% per annum (i.e., the contract non-default rate provided under the Secured Notes Indenture).
- Default Rate: (i) New Money Loans: Applicable Margin plus 2.00% per annum and (ii) Roll-Up Loans: 8.25% per annum.
- DIP Agent and DIP Lender Expenses: All reasonable and documented out of pocket costs and expenses of the DIP Agent incurred in connection with the preparation and execution and delivery of, and any amendment, waiver, supplement or modification to, the DIP Credit Agreement and the other Loan Documents and any other documents prepared in connection herewith or therewith, and the consummation and administration of the transactions contemplated hereby and thereby.
- Professional Fees and Expenses: Reasonable and documented fees and expenses of the professionals retained by any of the DIP Agent and the DIP Lenders, including, without limitation, the reasonable and documented fees and expenses.
- Agent Fee Letter: Certain fees to the DIP Agent in the amounts and at the times specified in the letter agreement between the Borrower and the DIP Agent.
- Backstop Fee: A one-time backstop fee to each Initial Lender (as defined in the DIP Credit Agreement) equal to the product of (i) 5.00% and (ii) each Initial Lender’s commitment for the New Money Loans.
- Commitment Fee: A Commitment Fee in the amount of 0.5% per annum, payable monthly upon entry of the Final Order on account of any New Money Commitments that are not drawn.
- Exit Fee: A nonrefundable exit fee in an amount equal to 1.00% of the aggregate amount of the New Money Loans.
Pre-Petition Capital Structure
First-Out Senior Secured Revolving Credit Facility
7.25% Senior Secured Notes
Aggregate Secured Debt
7.75% Senior Notes
6.125% Senior Notes
Aggregate Unsecured Debt
Aggregate Total Debt
Objection of Unsecured Noteholders
On August 13, 2019, certain holders of the Debtors' unsecured notes (the “Ad Hoc Group”) objected [Docket No. 74] to the Debtors' request for DIP financing on numerous grounds: accusing the Debtors of ignoring their pleas for a place at the pre-petition table; accusing the holders of the Debtors' 7.25% Senior Secured First Lien Notes due 2023 (the "First Lien Notes," the holders of which are also the Debtors' DIP lenders) of unilateral and unlawful efforts to skew creditor recoveries; and accusing the Debtors' board (and in particular its nominally independent directors) of being asleep at the switch, focusing on efforts to protect themselves as opposed to the bankrupt estates (eg obsessing with releases) and otherwise complicit in improper payments to executives.
The Ad Hoc Group is comprised of holders of more than 65% of the aggregate amount of the Debtors' (i) 7.75% senior notes and (ii) 6.125% senior notes (the “Unsecured Notes”). Given the vitriolic nature of the objection (including its frontal attack on the competence of the Debtors' "utterly futile" independent Directors), the quantum of debt held by the Ad Hoc Group (the Unsecured Notes total $1.75bn, vis-a-vis $500.0mn of First Lien Notes) and the Debtors' $2.16bn in assets (as per their Petition, there is clearly a lot to play for after the $500.0mn of First Lien Notes is made whole), this objection underscores hardening battle lines between the Debtors (allied with the First Lien Noteholders) and the Ad Hoc Group.
The Objection states, “Few bankruptcy estates demand close judicial supervision under the Bankruptcy Code as these Debtors’ estates do. Beginning in December 2018, and for more than seven months the Ad Hoc Group repeatedly requested that the Debtors engage meaningfully with the Ad Hoc Group—so that losses could be curtailed and value maximized without paying any creditor more than full compensation for its claims and without leakage to insiders, affiliates, and/or opportunistic third-parties. At first, the Debtors ignored the Ad Hoc Group’s requests (literally— for three months), and then deflected, while significant and egregious sums of cash were paid on account of executive compensation (in a fashion that could never have been approved under section 503(c) of the Bankruptcy Code) and to affiliates who appear to have happily capitalized on Sanchez Energy’s financial distress and conflicted governance.
During this same period prior to the filing of these chapter 11 cases, the holders of the Debtors’ 7.25% Senior Secured First Lien Notes due 2023 ('First Lien Notes') also took certain actions. Most notably, on June 26, 2019—squarely within the § 547, 90-day preference period and when all parties understood that bankruptcy was inevitable—the First Lien Noteholders sought to improve significantly their position relative to all other creditors. When the Debtors refused to facilitate the transfer, the First Lien Noteholders acted unilaterally, causing their collateral agent to attempt an involuntary transfer of eight oil, gas, and mineral leases for which any lien securing the First Lien Notes was unperfected. This action takes on particular significance because included in those eight leases is Debtor SN Catarina’s single most valuable lease—the 'HIL' lease. The Ad Hoc Group believes this unilateral step was of no legal effect, but assuming that an involuntary transfer of property actually occurred, the transfer was not in the “ordinary course of business” and is avoidable under section 547(e)(2)(B) of the Bankruptcy Code.
For this reason alone, among others, the Debtors’ request to approve debtor in possession financing from these same parties requires close scrutiny.
Through this all, as the estates’ residual stakeholders, the Ad Hoc Group stood ready and willing to support a fair and reasonable restructuring. The Ad Hoc Group proposed to address the Debtors’ capital needs in order to maximize value and offered very generous treatment to the First Lien Noteholders in order to minimize the administrative burn of lengthy and contested chapter 11 cases. The Ad Hoc Group’s efforts to do so, captured in proposals sent to the Debtors on May 7 and July 12, and to the First Lien Noteholders on July 10 and July 26, proved unsuccessful. The First Lien Noteholders—their screaming collateral shortcomings and exposure to avoidance actions notwithstanding—demanded a greater paydown, and while the Debtors now have the ability to restructure favorably the First Lien Noteholders’ obligations, the Debtors have showed no inclination to do so, focusing instead on entrenching, and procuring releases for, management.
The prepetition process devolved into a complete failure. Now all parties enter these chapter 11 cases with a heavy lift before them. Significant issues need to be investigated and resolved with redress against various parties.
On the eve of bankruptcy, the Debtors’ executives awarded themselves excessive bonuses and golden parachutes in a (conservative—ignoring targeted compensation) estimated dollar amount of $36.6 million—approximately $16.9 million in bonuses and $19.6 million in golden parachutes—that countermand section 503(c) of the Bankruptcy Code.
One thing is clear: the incumbency of purportedly independent directors, Mssrs. Eugene Davis and Adam Zylman—appointed in the wake of a shareholder suit being filed against Sanchez Energy for excessive director compensation—has proven utterly futile. Indeed, many of the occurrences described above—including the ‘eve of bankruptcy’ executive compensation and passively allowing SNMP to unilaterally jack up midstream tariffs—took place after the appointment of such individuals. Under no circumstances should this purported ‘Special Committee’ be allowed to ‘investigate, pursue, settle, and/or otherwise resolve any and all potential claims or causes of action the Debtors may have related to SOG, SNMP, or any of their respective affiliates or joint ventures’ as the Debtors have positioned them to do.”
About the Debtors
Sanchez Energy Corporation (OTC Pink: SNEC) is an independent exploration and production company focused on the acquisition and development of U.S. onshore unconventional oil and natural gas resources, with a current focus on the Eagle Ford Shale in South Texas. Through organic and significant acquisition activities, the Debtors have assembled a strategic, highly concentrated position in the Eagle Ford Shale and are generally considered among the most active operators in the basin. The Debtors, along with certain of their non-Debtor subsidiaries, also hold certain other producing properties and undeveloped acreage, including in the Tuscaloosa Marine Shale (the “TMS”) in Mississippi and Louisiana.
For more information about Sanchez Energy Corporation, see: www.sanchezenergycorp.com and the Debtors' SEC filings.
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