Oil and Gas Investor: Energy Lender Liability Beware

Energy lenders must keep borrowers at arm’s length while they face COVID-19 challenges or risk lender liability.

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[Editor's note: A version of this story appears in the June 2021 issue of Oil and Gas Investor magazine.]

For thousands of middle-market companies with debt below $100 million, the borrower-lender relationship involves a relatively simple capital structure, with a bank loan secured by a first lien and a mix of preferred and common equity. Such middle-market bank loans typically involve one lead bank, which may partner with a few other banks, and are illiquid investments that are not traded like broadly syndicated leveraged loans for larger borrowers. Middle-market borrowers are typically owner-operated family businesses or portfolio companies of private equity sponsors. Therefore, upon default, neither the lenders nor the owners can readily exit their investment in these private companies, so they must find a negotiated resolution to avoid bankruptcy.

During these negotiations, lenders may find that they enjoy an unfair advantage where the troubled borrower relies on the bank loan for its liquidity to fund day-to-day operations, the owners are unable to invest additional capital and refinancing options are limited. While all parties will generally prefer avoiding bankruptcy, lenders may discover that borrowers’ lack of familiarity with bankruptcy law often makes them deeply concerned about the stigma and risks involved in a bankruptcy filing, which leaves room for negotiation of an out-of-court solution. When lenders overreach at the negotiating table, however, they risk lender liability.

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