Proceeds from Ultra Petroleum’s holdco debt were used to purchase assets for the opco in a way that potentially means there is no intercompany receivable, Reorg Research has learned. The method involved first a tax-remote entity and then ultimately a capital contribution to the opco, according to sources familiar with the transaction.

When Ultra Petroleum filed for chapter 11 bankruptcy proceedings without any agreement in place with lenders to its operating company, the bonds at the parent company had already started to creep up from the single digits. At the first day hearing, the parties discussed the fact the holdco debt was not contractually subordinated but was still structurally subordinated, and investors began to scrutinize the potential claims for different creditors. The holdco bonds have been pushed into the 30s, where they remain, while several hundred million in opco and revolver debt has traded in the 80s context.

It is not specifically detailed in public documents how the $1.3 billion in total financing that the debtors raised from the issuance of two bonds - an $850 million 6.125% note and a $450 million, 5.75% note - was dropped down to the opco for the acquisitions of additional assets in the Pinedale region and the acreage in the Uinta basin in Utah.

The holdco debt was issued to capital markets in high-yield notes by Ultra Petroleum Corp. and was then contributed to a Luxembourg entity for tax purposes, according to sources. That money was then issued as note from the Lux entity to UP Energy Corp., a Nevada corporation, sources said. UP Energy Corp. then made a capital contribution to UP Resources Inc., the opco borrower. Subsequently, the Lux structure was unwound prior to filing, according to these sources, so the corporate structure chart does not show that it ever existed, and it is not mentioned in the company’s Securities and Exchange Commission filings.

In this way, and if structured and documented correctly, the money went in as capital and not  a loan to the opco. This indicates that it is still structurally subordinated, and there would be no pari passu interco note on which holdco has a claim.

“If you have a consolidated balance sheet and you don’t know what the claims will be, it becomes an absolute mess,” says Allen Wilen, a CPA and partner who leads the restructuring group at the accounting and consulting firm EisnerAmper. "Usually there’s a reason for the structure, and usually it has something to do with shifting U.S. tax liabilities. If there’s not a reason for the complexity of structure, nobody’s doing it."

The amounts were accounted for in the company’s 10-K for year-end 2015. An item for the year ended Dec. 31 shows $1.461 billion in the assets section as “investment in unconsolidated affiliates,” and then as of Dec. 31, 2015, the liabilities section contains a $1.789 billion item as “advances to unconsolidated affiliates.”
 
"If you can show how the initial dollars came into the holdco, the next question will be … where it went from there," commented Wilen, who is currently not a party to the UPL case. "If you follow the money, you’ll find the answer."

Pre- and Postpetition Background

The company’s fiscal year 2014 annual report explains:
 
Similarly,
 
Currently, the Uinta assets sit at UPL Three Rivers Holdings LLC, an operating company that sits below Ultra Resources Inc., the opco notes issuer. The Pinedale assets sit at UPL Pinedale LLC, another opco sitting below Ultra Resources. The company’s Utah assets sit at Ultra Resources Inc., which issued the opco debt. The Pinedale assets are core assets that have cash breakevens a little under $1.90/mcf, according to the company.  As of Dec. 31, 2015, 91% of the company’s net producing wells were located at Pinedale, 6% at Three Rivers and 3% at Marcellus, and 95% of the company’s proved reserves were at the Pinedale field.
 
According to conversations with Reorg, in addition to the intercompany issue, other potential sources of holdco being considered are a guarantee from the accounts receivables, NOLs, directors and officers insurance, marshaling claims and chapter 5 causes of action.

While there is no argument that there was a pari passu interco note, there is some consideration for the holdcos at the company, as within that $65 million in accounts receivables, about $20 million of it is a guaranteed payable from opco to holdco, according to sources, creating an unsecured claim at opco.

As for NOLs, the company’s first day declaration discloses that there are “NOLs in the amount of approximately $900 million and certain other Tax  Attributes, which translate to the potential for material future tax savings or other tax structuring possibilities.” Roughly $400 million of these NOLs are subject to an annual limitation of about $140 million. A new ownership change, according to the declaration, would probably impose a more onerous restriction.

D&O insurance can also be a potential source of value for the estate, depending on provisions contained in the policy or the lack thereof. For example, if there is no explicit language concerning “priority of payments,” the holdco creditors may successfully argue that any policy proceeds belong to the estate.

In MF Global, former officers and directors of the entity saw their request to access D&O insurance policy proceeds challenged, and the objectors argued that the debtors - MFGH and MFGI - had a contractual claim to the proceeds and that the use of proceeds would harm the estate. Ultimately, the court imposed a $30 million “soft cap” on the advances or payments permitted under the D&O policy.

The potential marshaling argument stems from the fact that the opco noteholders may have access to claims at two different debtors. Under the “marshaling” doctrine, courts may provide equitable relief when a creditor has two liens or funds to which it may look for the satisfaction of its debt, and another creditor has a lien on only one of those assets or funds. Under the “marshaling” doctrine, the creditor that has a lien on both of such funds must first look to the fund or source on which the other creditor has no lien or interest. The holdco noteholders would carry the burden of proof to establish the elements of marshaling and must also show that there will be no prejudice to the creditor that has access to two debtors, if the doctrine is applied.

Under section 548 of the Bankruptcy Code, which governs the avoidance of fraudulent transfers, the trustee can avoid a transfer of interest of the debtor in property that was made within two years before the filing of the date of the petition if it is shown that the debtor made such transfer or incurred such obligation with actual intent to hinder, delay or defraud any entity to which the debtor was or became indebted, on or after the date that such transfer was made, or received less than a reasonably equivalent value in exchange for the transfer and: 1) the debtor was insolvent on the date the transfer was made or became insolvent as a result of the transfer; 2) the debtor was left with property that was “an unreasonably small capital” for the debtor’s business, 3) “intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured” or 4) the debtor made the transfer for the benefit of an insider.

Here, the Pinedale assets were sold within two years; the purchase and sale agreement is dated Aug. 13, 2014, and the deal closed Sept. 25, according to UPL’s annual report.

However, potential claimants still need to prove insolvency. As of fiscal year end 2014, UPL had $8.9 million of cash on its balance sheet with $211.7 million of equity, and while that equity turned to negative $2.9 billion by fiscal year end 2015, the court’s determination of whether the transaction led to insolvency, or whether the debtor was left undercapitalized, will likely be highly fact-specific.

In aggregate, because of the uncertain nature of these claims, the market will probably have to estimate the probability-weighted value of the claims to determine potential holdco recoveries, or “risk” them, as opposed to taking them at face value, while also taking into account potential PV-10 value, which has been helped by market optimism regarding commodity prices as of late.