Arsenal Resources Development LLC – Court Confirms Pre-packaged Plan as Debtors Set to Emerge from Second Chapter 11 in Under a Year

December 19, 2019 – The Court hearing the Arsenal Resources Development cases confirmed [Docket No. 216] the Debtors’ First Amended Joint Pre-Packaged Plan of Reorganization.

On November 8, 2019, Arsenal Resources Development LLC and 16 affiliated Debtors (“ARD” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the District of Delaware, lead case number 19-12347. In their lead Petition, the Debtors, an independent exploration and production company engaged in the acquisition and development of unconventional natural gas resources in the Appalachian Basin, noted between 1,000 and 5,000 creditors; estimated assets between $500.0mn and $1.0bn; and estimated liabilities between $500.0mn and $1.0bn (documents filed more specifically referencing $507.0mn in funded debt).

For the Debtors this was deja vu all over again, having emerged from an earlier pre-packaged Chapter 11 as recently as February 2019. In that instance, it was affiliate Debtor Arsenal Energy Holdings (f/k/a Mountaineer Energy Holdings) that sough bankruptcy protection, emerging off the back of a recapitalization which included (i) the equitization of more than $860.0mn of subordinated notes and (ii) new credit facilities including  "a new term loan facility in an original principal amount of $220 million (the ‘New Term Loan Facility’) and a new reserve based revolving loan facility with an initial aggregate commitment of $135 million and an aggregate commitment of $145 million after the completion of the Recapitalization (the ‘New RBL Facility’)" [cited from the then Debtor's Disclosure Statement]. Unfortunately, the $860.0mn in debt reduction was not enough with the Debtors summing up their recidivism as follows: "the Company’s business plan was frustrated by two significant factors: (1) a significant drop in natural gas realized prices, which led to a material decline in revenue, and (2) a decline in the strip price curve as well as bank pricing to determine the borrowing base, which led to a stagnating borrowing base under the RBL Facility and constrained liquidity."

The first Chapter 11 took only 9 days to complete; an accomplishment that (having now been almost as quickly followed by a Chapter 22) will undoubtedly lead to some discussion as to the role of the new wave of superfast prepacks; on the one hand distressed companies (and their creditors) benefiting from a cheaper and less disruptive Chapter 11 (the benefits arguably carrying through to these filings) but on the other hand clearly drawing into question the parameters of the first reorganization and whether they were rushed. This time around, the Debtors took things a bit slower (seven weeks) and seemed to have run a smooth, steady process allowing them to emerge on schedule (goal from outset has been new year's eve) and  minus $400.0mn in debt. Clearly everyone wants to avoid the ignominy of a Chapter 33 three-peat. For those wondering, yes, Punxsutawney, Pennsylvania of groundhog day fame sits in the Appalachian Basin, an hour's drive from the Debtors' Wexford, Pennsylvania headquarters up route 85.

Overview of the Plan and Restructuring Support Agreement 

The Debtors’ memorandum in support of plan confirmation [Docket No. 202] states, “With almost complete consensus for the recapitalization embodied in the Plan, the Debtors seek approval of the adequacy of the Disclosure Statement, the Solicitation and the Solicitation Procedures and confirmation of the Plan. The Plan — which is consistent with the terms of the Restructuring Support Agreement, dated as of November 6, 2019 (the ‘RSA’), among the Debtors and the Consenting Stakeholders—is supported by the Consenting Stakeholders, all Holders of Claims that were entitled to vote and all parties to the Gathering Agreements…. level of support is not surprising given the benefits of the Plan. The Plan fully equitizes the Term Loan Claims and the Seller Notes Claims (representing over $361 million in funded debt), repays the OpCo RBL Claims and all OpCo General Unsecured Claims and allows the reorganized Company to access up to $230 million of new liquidity through the New RBL Facility and the New Capital Commitment, both of which will be funded on the Effective Date.”

The Debtors' Disclosure Statement provides: "On November 6, 2019, the Company and all of its principal lenders in the Company’s three tranches of debt, as well as a majority of its existing equity holders (collectively, the 'Consenting Stakeholders'), executed a Restructuring Support Agreement (the 'RSA') pursuant to which the Consenting Stakeholders agreed, among other things, to support and/or vote in favor of the Joint Pre-Packaged Plan of Reorganization (the 'Plan') filed on the Petition Date.

As contemplated by the RSA, on November 7, 2019, the Company solicited votes on the Plan, and the Seller Noteholders and Term Loan Lenders (the only creditors entitled to vote on the Plan) voted unanimously in favor of the Plan.In light of that consensus, the Debtors commenced these chapter 11 cases (the 'Chapter 11 Cases') on November 8, 2019 (the 'Petition Date'). Similar to the First Recapitalization, the Plan and RSA contemplate that the OpCo Debtors’ employees, vendors, suppliers and other trade creditors will be paid in the ordinary course of business. With regard to the recapitalization component of the Plan, the RSA and the Plan provide for a substantial deleveraging of the Company’s balance sheet (an estimated debt reduction of over $400 million in principal amount), upon consummation of the following capital transactions: 

1. a commitment from the existing RBL Lenders to provide a $90 million debtor-in-possession facility (the 'DIP Facility'), and a $130 million exit facility (the 'New RBL Facility'); 
2. the conversion of over $360 million in principal amount of prepetition secured debt into 100% of the equity of the reorganized Debtors (subject to dilution by the New Capital Commitment); and 
3. the commitment from Chambers and Mercuria to recapitalize the Debtors via a new $100 million equity investment (the 'New Capital Commitment')."

Equity Holdings

Pre-petition equity holders who will be exiting as stakeholders include MEC Advisory Limited of Hong Kong, First Reserve Corporation and Goldman Sachs. 

The Debtors' Disclosure Statement provides the following detail as to how the equity of the emerged Debtors is to be distributed amongst the Debtors pre-petition lenders: "On the Plan Effective Date, the following number of Class A Units (the ‘Exchange Units’) shall be issued to the Consenting Seller Noteholders and Consenting Term Loan Lenders (collectively, the ‘Initial Members’) in connection with the consummation of the Restructuring Transactions as follows: 

(a) 111,651,357 Class A Units to Chambers Energy Capital II, LP (‘CEC II’), 

(b) 13,673,282 Class A Units to Chambers Energy Capital II TE, LP (‘CEC II TE’), 

(c) 25,780,361 Class A Units to Chambers Energy Capital III, LP (‘CEC III’, and together with CEC II and CEC II TE, ‘Chambers’), 

(d) 128,321,603 Class A Units to Mercuria Energy Company, LLC (or its nominee) (‘Mercuria’), and 

(e) 22,783,397 Class A Units to LR-Mountaineer Holding, L.P. (‘Lime Rock’). The Class A Units will be voting Units. 

In addition to the Exchange Units, Arsenal shall issue on the Plan Effective Date, in exchange for $100,000,000 of cash, additional Class A Units (the ‘New Equity Units’) to Chambers and Mercuria as follows: Chambers and Mercuria shall purchase 115,384,615 New Equity Units and 38,461,538 New Equity Units, respectively, for $100,000,000, such purchase price to be paid 75% by Chambers and 25% by Mercuria…”

Each of Chambers, Mercuria and Limerock will be entitled to appoint a single member to the emerged Debtors’ four-member board.

The following is revised a summary of classes, claims, voting rights and expected recoveries (defined terms are as defined in the Plan and/or Disclosure Statement) The only material change in the amended plan relates to Class 3A (“ARE Gathering Agreement Claims”) as highlighted below.

AEH Claims

• Class 1A (“AEH Seller Notes Claims”) is impaired and not entitled to vote on the Plan. The aggregate amount of claim is $129.8mn.
• Class 1B (“AEH General Unsecured Claims”) is impaired and deemed to reject the Plan. The aggregate amount of claim is $0.
• Class 1C (“AEH Equity Interests”) is impaired and deemed to reject the Plan. The aggregate amount of claim is N/A.

ARIH Claims

• Class 2A (“ARIH General Unsecured Claims”) is unimpaired and presumed to accept the Plan. The aggregate amount of claim is $0.
• Class 2B (“ARIH Equity Interests”) is impaired and deemed to reject the Plan. The aggregate amount of claim is N/A.

ARE Claims

• Class 3A (“ARE Gathering Agreement Claims”) Class 3A is impaired by the Plan. TCO has consented to the treatment described in the amended Plan and agreed to support confirmation of the Plan. Solely for purposes of the Plan, the ARE Gathering Agreement Claims shall be Allowed in the amount of $476 million, and such ARE Gathering Agreement Claims shall not be subject to disallowance, setoff, recoupment, subordination, recharacterization or reduction of any kind, including pursuant to section 502(d)of the Bankruptcy Code. In full and final satisfaction, settlement, discharge and release of, and in exchange for, all Allowed ARE Gathering Agreement Claims TCO shall be entitled to receive the TCO Gathering Agreement Payment, to be paid by Reorganized ARDH1 or another Reorganized OpCo Debtor in cash in full within 10 days of the occurrence of the Effective Date. In addition and notwithstanding any other provision contained in the Plan, TCO shall be entitled to draw and retain the full amount under the TCO L/C, and the Debtors and/or Reorganized Debtors, on behalf of themselves and their respective Estates, waive any Avoidance Actions which could be brought against any Person or Entity, including TCO, in connection therewith.
• Class 3B (“ARE Term Loan Claims”) is impaired and entitled to vote on the Plan. The aggregate amount of claim is $242.3mn.
• Class 3C (“ARE General Unsecured Claims”) is impaired and deemed to reject the Plan. The aggregate amount of claim is $0.
• Class 3D (“ARE Equity Interests”) is impaired and deemed to reject the Plan. The aggregate amount of claim is N/A.

ARDH2 Claim

• Class 4A (“ARDH2 Seller Notes Claims”) is impaired and entitled to vote on the Plan. The aggregate amount of claim is $129.8mn. ARDH2 Seller Notes Claims shall be entitled to receive the following treatment: (i) If each Holder of an Allowed Claim in each of Classes 1A and 4A submits a ballot to accept the Plan: 7,570,392 New ARDH1 Class A Interests shall be issued to Chambers Energy Capital II, LP (or its successors or assigns), on account of the Allowed ARDH2 Seller Notes Claims it beneficially owns; 927,101 New ARDH1 Class A Interests shall be issued to Chambers Energy Capital II TE, LP (or its successors or assigns), on account of the Allowed ARDH2 Seller Notes Claims it beneficially owns; 25,780,361 New ARDH1 Class A Interests shall be issued to Chambers Energy Capital III, LP (or its successors or assigns), on account of the Allowed ARDH2 Seller Notes Claims it beneficially owns; and 22,783,397 New ARDH1 Class A Interests shall be issued to LRMH (or its successors or assigns), on account of the Allowed ARDH2 Seller Notes Claims it beneficially owns; or (ii) If each Holder of an Allowed Claim in each of Classes 1A and 4A does not submit a ballot to accept the Plan, all Seller Notes Claims shall be cancelled, released and discharged without any distribution.
• Class 4B (“ARDH2 General Unsecured Claims”) is impaired and deemed to reject the Plan. The aggregate amount of claim is $0.
• Class 4C (“ARDH2 Equity Interests”) is impaired and deemed to reject the Plan. The aggregate amount of claim is $0.

ARDH1 Claims

• Class 5A (“ARDH1 Term Loan Claims”) is impaired and entitled to vote on the Plan. The aggregate amount of claim is $242.3mn. Holders shall receive: (i) If each Holder of an Allowed Claim in each of Classes 1A and 4A submits a ballot to accept the Plan: 104,080,965 New ARDH1 Class A Interests shall be issued to Chambers Energy Capital II, LP (or its successors or assigns), on account of the ARDH1 Term Loan Claims it beneficially owns; 12,746,181 New ARDH1 Class A Interests shall be issued to Chambers Energy Capital II TE, LP (or its successors or assigns), on account of the ARDH1 Term Loan Claims it beneficially owns; and 128,321,603 New ARDH1 Class A Interests shall be issued to Mercuria (or its successors or assigns), on account of the ARDH1 Term Loan Claims it beneficially owns; or (ii) If each Holder of an Allowed Claim in each of Classes 1A and 4A does not submit a ballot to accept the Plan, each Holder of an Allowed ARDH1 Term Loan Claim shall receive its Pro Rata share of 196,436,500 New ARDH1 Class A Interests.
• Class 5B (“ARDH1 General Unsecured Claims”) is impaired and deemed to reject the Plan. The aggregate amount of claim is $0.
• Class 5C (“ARDH1 Equity Interests”) is impaired and deemed to reject the Plan. The aggregate amount of claim is N/A.

OpCo Claims

• Class 6A (“OpCo RBL Claims”) is unimpaired and presumed to accept the Plan. The aggregate amount of claim is $145mn.
• Class 6B (“OpCo General Unsecured Claims”) is unimpaired and presumed to accept the Plan. The aggregate amount of claim is $40.3mn.
• Class 6C (“OpCo Equity Interests”) is unimpaired and presumed to accept the Plan. The aggregate amount of claim is N/A.

Other Claims Against Debtors

• Class 7A (“Other Secured Claims”) is unimpaired and presumed to accept the Plan. The aggregate amount of claim is $0.
• Class 7B (“Other Priority Claims”) is unimpaired and presumed to accept the Plan. The aggregate amount of claim is $1.7mn.
• Class 7C (“Intercompany Claims”) is unimpaired/impaired and presumed to accept/deemed to reject the Plan. The aggregate amount of claim is N/A.
• Class 7D (“Section 510(b) Claims”) is impaired and deemed to reject the Plan. The aggregate amount of claim is N/A.

Pre-Petition Funded Debt

As at the Petition date, Debtors’ capital structure included the following principal amount of funded debt (totalling, giving effect to rounding, $506.0mn):

Voting Result

On November 8, 2019, the Debtors' claims agent notified the Court of the results of Plan voting [Docket No. 21]. There were four voting classes that were entitled to vote on the Plan and each of them voted  unanimously to accept. The voting results were as follows:

• Class 1A (“AEH Seller Note Claims”) – 4 claims holders, representing $127,964,760.19 in amount and 100% in number, accepted the Plan.
• Class 3B (“ARE Term Loan Claims”) – 3 claims holders, representing $232,873,898 in amount and 100% in number, accepted the Plan.
• Class 4A (“ARDH2 Seller Note Claims”) – 4 claims holders, representing $127,964,760.19 in amount and 100% in number, accepted the Plan.
• Class 5A (“ARDH1 Term Loan Claims”) – 3 claims holders, representing $232,873,898 in amount and 100% in number, accepted the Plan.

Events Leading to the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Goetz Declaration”) [Docket No. 3], Allen Goetz, the Debtors' Chief Financial Officer, detailed the events leading to ARD's Chapter 11 filing. The Goetz Declaration provides:

"Like other similarly situated exploration & production ('E&P') companies, during fiscal year 2018 the Company found itself in a financially untenable position largely caused by declining gas prices. Consequently, it negotiated a significant recapitalization transaction with its key financial stakeholders.

On February 14, 2019, AEH consummated a standalone restructuring through a pre-packaged plan of reorganization (the ‘Prior Plan’) that exchanged more than $860 million of subordinated debt for a majority of the equity of reorganized AEH.

…the Prior Plan was the final step in the First Recapitalization transaction which, in addition to equitizing the subordinated debt under the Prior Plan, included the Company (a) obtaining $110 million of new capital, (b) refinancing the 2014 Credit Facilities, and (c) entering into the Joint Development Agreement (components (a) through (c) were effectuated consensually out of court prior to consummation of the Prior Plan). 

Despite the Company’s efforts, it was unable to consensually amend any of the Gathering Agreements in connection with the First Recapitalization.

After the First Recapitalization, the Company’s business plan contemplated pursuing an active development program in targeted areas located in Eastern Harrison, Western Taylor and Northern Barbour counties, which are referred to as the ‘Simpson’ areas. The Joint Development Agreement gave the Company access to additional funding to pursue this program, with the intent of filling unutilized transportation capacity and satisfying the Company’s MVCs through the increase in production. 

As of October 31, 2019, the Company had drilled 18 wells, completed 11 wells, and started producing from 8 wells. In addition, the Company completed construction of the following two critical infrastructure projects: (1) the Company’s first gathering line in Eastern Harrison County, West Virginia, which provides pipeline access to 11 wells on the Pritt North and South pads and acts as the first link in the Company’s ‘Simpson’ gathering system and (2) the Neptune water pipeline, which is an approximate 17 mile, 20” water pipeline that extends through the Company’s western acreage position and will provide fresh water for future completion activities. 

As a result of drilling and the proved developed producing reserve growth, the Company anticipated increasing its availability under the RBL Facility by growing the ‘borrowing base’. Upon achieving those results, the Company expected that it would be in a position to use the additional borrowing capacity to further expand its drilling program and continue to grow its producing production base. 

Unfortunately, notwithstanding these achievements, the Company’s business plan was frustrated by two significant factors: (1) a significant drop in natural gas realized prices, which led to a material decline in revenue, and (2) a decline in the strip price curve as well as bank pricing to determine the borrowing base, which led to a stagnating borrowing base under the RBL Facility and constrained liquidity. 

Moreover, the Company was unable to amend a gas marketing agreement, which would have freed up approximately $28 million of availability under the RBL Facility by replacing the outstanding TCO letter of credit currently issued under the RBL Facility. Without access to this additional liquidity, and due to lower commodity prices, the Company curtailed its drilling program, which created strain on the Company’s forecast and further limited the Company’s access to capital. 

As a result, despite the Debtors’ substantial efforts to reduce long-term debt, access new sources of capital and expand their drilling program through the First Recapitalization and the Prior Plan, the Debtors’ obligations under their existing debt facilities and the Gathering Agreements became unsustainable. Concurrently, the decline in commodity prices and resulting impact on revenue led to a dramatic reduction in the Company’s liquidity.

About the Debtors

The Debtors are an independent exploration and production company engaged in the acquisition and development of unconventional natural gas resources in the Appalachian Basin. The Debtors conduct operations through certain operating subsidiaries owned, directly and indirectly, by Arsenal Resources Development LLC (“ARD”, together with its wholly-owned subsidiaries, the “OpCo Debtors”).

One or more of the OpCo Debtors employs the Company’s workforce, owns the Company’s working interests and corresponding infrastructure, and produces and markets gas for sale. Accordingly, all of the Company’s vendors, suppliers and other trade creditors contract with one or more OpCo Debtors.

The Debtors' website adds: "Arsenal Resources is headquartered in Pittsburgh, with office locations in West Virginia. We live where we work, strategically focusing on dry natural gas assets in the Southern Appalachian Basin.

Following the initial 2011 purchase of 50,000 acres in West Virginia, our company embarked on a series of successful natural-gas operations in which we increased production performance by 40 percent, while reducing cost-per-foot by 44 percent.

Building upon this conspicuous success, we strategically explored additional acquisition opportunities, ultimately increasing our core position to approximately 208,000 net acres."

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