Zombie Energy Companies [Gaille Energy Blog Issue 14]
- Posted by scottgaille
- On January 16, 2016
- 0 Comments
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The term “zombie company” describes firms that “are still trading, and so half living, but not able to invest or grow to pay off their debts, which is why they are also considered half dead” (Wikipedia – “Zombie Company”). The oil crash is now minting an army of zombie companies. The typical “zombie energy company” has mortgages exceeding the value of its assets.
A recent Form 8-K filing for an Eagle Ford shale operator sums up this type of situation:
“The Company’s debt defaults generally were the result of deteriorating economic conditions being faced by the Company in the wake of the 2014-15 oil price decline, which resulted in reduced revenues and an environment in which the Company was unable to refinance its debt or obtain any other material funding. . . . Despite extensive marketing efforts, the Company’s financial advisors were unable to identify any counterparty willing to engage in such a transaction in the low commodity price environment. Based on the results of the market processes run by the Company and its advisors, the Company has reached the conclusion that the market value of its assets currently is considerably less than the . . . principal and interest owed to the Senior Secured Note Holders.”
This is akin to a mortgage crisis, when property values plummet so far that homeowners owe more than their properties are worth. In such cases, homeowners may simply turn the keys over to the bank. Energy companies are increasingly finding themselves with a similar incentive. The Eagle Ford Form 8-K continues: “The Senior Secured Note Holders maintain [mortgages] and hold first liens on all of the Company’s assets, including all of its oil and gas leases and wells. . . . [and] are moving forward with exercising . . . foreclosure remedies.”
When energy companies owe more on their mortgages than their assets are worth, bankruptcy offers little hope for the company, or its other creditors. Filing for bankruptcy incurs considerable legal fees, and, at best delays the inevitable outcome of the secured lender taking everything. The secured lender does not need bankruptcy. It simply auctions the assets on the courthouse steps pursuant to state foreclosure laws.
This sets the stage for companies to be abandoned. A firm’s entire slate of officers and directors may resign in the wake of foreclosure, leaving the company with no employees. Even then, its stock continues to trade, and the empty shell of the corporation lives on – at least until franchise taxes go unpaid and the state terminates its existence.
About the only way such a zombie company can be resurrected is if it has an attractive net operating loss. Lenders cannot foreclose on net operating losses. If the NOLs are large enough, new investors may have an incentive to take the zombie through a restructuring process, converting the remaining debts to equity, so the corporation can be used for future acquisitions and developments – in a tax-advantaged position when compared to a newly-formed company.
About the Gaille Energy Blog. The Gaille Energy Blog discusses innovative proposals in the field of energy law, with a new issue being posted each Friday at http://www.gaillelaw.com. Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).