Business Leasing and Finance News (BLFN)
MARCH - APRIL 2009
By David G. Mayer
As the stock market shows signs of moving higher, a recent article gave me a hope that we may be near the bottom of the current recession.
The article identifies “scattered bits of good news from malls to metals markets" and the author suggests there is “some reason to believe that the economy may be getting closer to a bottom.” Although consumers continue to cut back, the pace is slowing. After hitting a 12-year low, the stock market rose 9.01 percent in the week of March 9th, the best week since November. Citigroup, J.P. Morgan Chase & Co., and Bank of America Corp. even reported that their underlying businesses made an operating profit in the first months of the year. See Signs of Stability Drive Up Stocks, The Wall Street Journal SW Ed., Front Page (March 14, 2009).
If you are a Star Trek fan like I am (but not quite a “Trekkie”) you will appreciate the idea that turning around our enormous economy is akin to turning a Starship. It takes time and lots of energy (not to mention about $11 trillion in national debt). As an aside, did you know that “$11 trillion one dollar bills would circle the earth about 77 times[?]…. If stacked one atop the other 11 trillion one dollar bills would reach more than three and a half times the distance to the moon.” See U.S. Debt Reaches Record Eleven Trillion Dollars, Ozarks First.com.
I am not alone in seeing this glimmer of hope. A recent CIT study, "U.S. Middle Market Outlook 2009: Navigating the Credit Crunch," found that four out of five middle market executives polled expect the economy to reach the bottom this year. See CIT: Middle-Market Executives Anticipate Financial Crisis to Bottom in 2009, Monitor Daily (March 5, 2009).
Unfortunately, the news has not been uniform. Just days before the first article in The Wall Street Journal, the writers in another article observed that the “credit markets are seizing up again amid new anxieties about the global financial system.” See New Fears As Credit Markets Tighten Up, The Wall Street Journal, SW Ed., Front Page, Col. 6 (March 9, 2009). Until the financial markets start rolling again, our economy will remain a broken reflective of past mistakes.
We all know that no one can turn around the economy will not turn around without lenders and lessors funding deals. Each of us can look for any signs of stabilization in our banking system and recovery of our economy. We can share that information with others. If we rebuild even a shred of confidence in our systems we may thereby inject some oil into the rusted wheels of commerce to make them turn again. From where I sit, lending and leasing show almost no sign of rolling forward again in any significant way.
Still, I would rather be one of the guys to share even scattered bits of good news, to help restore some confidence in our economy and financial institutions. Perhaps you could do the same and together we can hasten the day when the current recession and banking crisis finally gives way to a new era of sustainable prosperity.
1. Stimulus Cash Grants Hold Promise to Energize Wind Power Industry
Has the new stimulus law given the renewable energy industry the boost it needs to develop and finance projects, including wind farms? Also known as the American Recovery and Reinvestment Act of 2009 (Act), the stimulus package creates new opportunities for monetizing energy tax credits for “facilities” that generate electricity from renewable sources. So how do you get the U.S Treasury to show you the money? Under the right circumstances, certain taxpayers can receive a cash grant in lieu of energy tax credits – a grant that may supplement or supplant most of the equity needed to jump start a renewable energy project.
*Term to Know: The term "facility" under section 45(d)(1) Internal Revenue Code of 1986, as amended (IRC), means each separate wind turbine, together with the tower on which the turbine is mounted and the supporting pad on which the tower is situated. See Rev. Rul. 94-31, 1994-1 C.B. 16 (May 23, 1994), with respect to electricity produced from wind energy.
Production Tax Credit Takes Back Seat
Before President Obama signed the Act into law, companies planning to build facilities that generate electricity from renewable energy sources (such as wind, closed and open loop biomass, geothermal, qualified hydropower, marine and hydrokinetic, and waste-to-energy facilities) faced almost impenetrable barriers to converting the production tax credit (PTC) for such facilities into up-front cash for construction or as “equity” to support financing. Three important reasons made this limitation true:
, the PTC under section 45
of the IRC is spread over 10 years; so it does not provide the full tax benefit for “tax equity” (investor with the tax bill to use tax credit benefits) immediately when a project is placed in service.
Second, the amount of PTC in a year is dependent on both the amount of the production and price of electricity determined for the year, so tax equity investors could not accurately or dependably predict the amount of the credit to be earned.
Third, the PTC is earned by the person that produces the electricity, as opposed to the owner of the facility, so sale and leaseback transactions could not be used to transfer the credit.
Companies that could not use the PTC could attempt to transfer the credit through complex partnership arrangements (usually called the “partnership flip” structure) under which the credit transferee made equity investments in a partnership in exchange for a very substantial percentage interest in the profits, losses, and PTC for most or all of the PTC period. The transfer method was far from efficient because the tax benefits were difficult to predict and the performance of the facility could affect the tax partner’s (tax equity’s) net return.
*Term to Know: The “partnership flip” structure refers to a tax partnership arrangement between a project company (owner, developer, and manager of a facility) and its investor(s) that allows the investor(s) to receive the agreed after-tax internal rate of return derived from the PTC over a period that is typically 10 years.
After 10 years, a “flip” occurs under the partnership arrangement at which time the project company receives an agreed portion of the economic benefits of the project. The flip occurs around the date that the section 45 credits can no longer be claimed with respect to the wind energy project. A complex area of tax and partnership law, the Internal Revenue Service (IRS) promulgated Rev. Proc. 2007-65 to create a “safe harbor” (no IRS letter ruling required) for partnerships to use the partnership flip structure for wind projects.
Cash Grants May Drive New Investment
The Act significantly changes the cash and tax equity landscape by allowing a taxpayer to claim a 30 percent energy investment tax credit under IRC section 48(a)(5) (ETC) in lieu of the PTC or to receive a cash grant from the U.S. Treasury (Cash Grant). The Cash Grant would equal the amount of the ETC, which the taxpayer could claim in lieu of the PTC. See IRC § 48(d)(3)(A).
The Cash Grant, which is not included in income, allows the company building a qualified facility to obtain cash from the IRS equal to 30 percent of the eligible costs of the facility.
*Technical Point: Cash Grants may not be made to any state or local government, tax-exempt organization, or cooperative (or a partnership or other pass-thru entity having such any such entity as a partner or member). See Act §1603(g)(4).
The Act extended the “sunset dates” (date on which benefits ended) for the PTC and the election to claim an ETC in lieu of a PTC, such that:
Wind facilities must be placed in service before 2013;
Most other listed facilities must be placed in service before 2014;
An ETC is available for wind turbines with a nameplate capacity of less than 100 kilowatts through 2016; and
The ETC can be converted to a Cash Grant only for eligible facilities (i) placed in service in 2009 or 2010 or (ii) under construction in 2009 or 2010 and placed in service on or before the extended sunset dates above for certain eligible facilities.
*Insight Point: The ETC may be claimed when the facility is placed in service. With regard to the Cash Grant, you can expect the claim documentation to be relatively simple (compared to completing your tax return). As required by the Act, you should receive the Cash Grant within 60 days of when the facility is placed in service.
Even without the Cash Grant-in-lieu-of-an-ETC provision, an ETC should improve the after-tax equity return of the financing of a facility as compared to the use of a PTC. The ETC value is claimed almost immediately depending on when the taxpayer actually files its tax returns, whereas the PTC is claimed over 10 years.
*Term to Know: Although section 45 of the IRC does not define “placed in service,” the IRS, for this purpose, generally considers property to be placed in service in the taxable year that the property is placed in a condition or state of readiness and available for a specifically assigned function. See §§ 1.46-3(d)(1)(ii) and 1.167(a)-11(e)(1)(i) of the tax regulations promulgated by the IRC.
If the construction period for the facility is greater than a year, the credit can be claimed as a progress expenditure credit as expenditures are incurred. See IRC section 48(b), applying rules similar to the rules of subsections (c)(4) and (d) of IRC section 46 (as in effect the day before enactment of the Revenue Reconciliation Act of 1990).
*Structuring Point: A company that anticipates taking a Cash Grant-in-lieu-of-the ETC may be able to claim the progress expenditure credit and then repay the amount of the credit at the time it seeks the Cash Grant-in-lieu-of-the-credit.
The amount of the ETC is predictable (to the extent that the cost of construction is predictable). It is available to the facility owner. Therefore, a company can sell its facility to a company with a tax credit appetite and lease it back. If the company that operates the facility wants to receive the Cash Grant directly, a lessor can elect to pass the credit through to the lessee. If the sale occurs within three months of when the facility is placed in service, the owner-lessor will receive the benefit of the credit soon after the facility is placed in service and will be able to recover the cost basis of acquiring the facility over a period of time. The tax benefits should enable the lessor to offer the lessee a lower lease rate.
*Technical Point: The tax basis for depreciation is reduced by half of the value of the credit or Cash Grant. If the facility is placed in service this year or “bonus” depreciation is extended, the owner-lessor may be able to recover half of the cost basis of the facility in the year that it is placed in service. See IRC §§ 48(d)(3)(B) and 50(c).
The Act repealed the general rule disallowing the PTC for the portion of the cost a facility that was financed with the proceeds of tax-exempt private activity bonds or government subsidized financing. See Act § 48(a)(4)(D).
*Opportunity Point: This repeal allows for a full double dip, subsidized financing and a credit or Cash Grant for the same costs.
However, it is essential to understand the time frame for this opportunity. The repeal applies to periods after December 31, 2008, under rules similar to those of section 48(m) of the IRC (as in effect on the day before the date of enactment of the Revenue Reconciliation Act of 1990). This rule means that you cannot claim the portion of the costs attributable to pre-2009 construction (if self constructed) or orders placed before 2009 (if facility is purchased) for subsidized energy financing.
Government Extends a Hand
For a limited time, the U.S. Treasury has extended to investors, financiers, and developers an unprecedented opportunity to monetize tax benefits as part of financing or leasing wind energy and other renewable energy facilities. Although the recession has put significant hurdles in the path of new investment and development, these incentives may work if developers satisfy criteria that attract investors, suppliers and financiers. Among all these criteria, the most important one is to bring an off-taker to the table with the demand and economic wherewithal to buy the power generated by these facilities over a long term. Without them, the Act cannot provide sufficient economic incentive to re-energize a lethargic industry with great promise for the future.
Thanks to George Schutzer, Co-chair of the Tax and Wealth Preservation Practice at Patton Boggs, for contributing this article and to Sean Clancy, a partner in the Tax Department, for editing this article.
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2. Financing Opportunities Survive Heavy Turbulence in Business Aviation Markets
Amid the pressure of the recession and heavy criticism from Capitol Hill, the business aviation industry has encountered a massive downdraft in its fortunes.
According to UBS, “[o]ur measure of absolute business conditions dropped 9 percent… indicating a severely depressed market characterized by way too much supply, plummeting pricing, and tight financing.” As evidence of this conclusion, UBS stated that inventory of business aircraft hit an all-time high in February and new aircraft position listings fell 16 percent taking into account the collapse of Eclipse. Further, UBS found that new aircraft delivery positions amount to more than three times prior-year levels including Eclipse, or more than five times prior year levels excluding Eclipse. On a rolling 12-month basis, cycles dropped 14 percent from the prior year. See No Recovery in Sight, Reducing Forecast, Business Jet Monthly, UBS (March 16, 2009).
The business aviation industry is not the only one encountering severe turbulence. Troubled financial markets in the U.S. continue to adversely impact the global economy. Banks and other financial institutions face short-term funding pressures in part due to impaired capital and balance sheets resulting from huge losses, illiquid mortgages, and nearly worthless asset-backed securities. What started as a housing crisis has developed into a full-blown recession that could end this year if the U.S. government succeeds in bolstering the banking system. It is no wonder that consumer confidence has plummeted and turned sales activity from a roaring brook into a creek-bed dribble. See Bernanke: Recession May End in 2009 if Banks Stabilize, Fox News.com (March 15, 2009).
Changing Landscape for Financing Business Jets
As the U.S. government races to meet economic challenges, lenders and lessors (financiers) are trying to protect their portfolios and minimize losses while continuing to make prudent extensions of credit. For those who do extend new credit, they must manage volatile pricing for the few deals they fund. Financiers may require more thorough due diligence to qualify for loans or leases and may also impose stricter terms and conditions in documentation.
With such gloomy news, sales of business jets have been severely impacted. The results have become painfully obvious to buyers and sellers:
*Insight Point: OEMs may resist this type of provision, but they can expect their potential customers to attempt to win this point.
Progress payment financing terms may spawn more complex structures, include lower advance rates, and enforce restrictions on loan-to-value ratios.
Financing structures may require more equity with a corresponding reduction in finance amounts. Financiers design these structures to assure that the debtor will sacrifice its equity to pay liquidated damages to a seller should the buyer be unwilling or unable to complete a purchase transaction for a new aircraft.
*Warning: Buyers have discovered that manufacturers will, in virtually every case, impose contractually agreed liquidated damages for failure to complete a purchase. On a significant corporate jet, the pain of liquidated damages can mean a payment in the millions of dollars. Buyers and sellers should focus on liquidated damages provisions to minimize such penalties.
Diligence levels have increased. Financiers will conduct more thorough background checks and greater credit due diligence, possibly resulting in slower response time for credit approvals and potential disruptions of anticipated or contracted transaction timing. Accordingly, prospective buyers/lessees, dealers/brokers, and aircraft OEMs would be well advised to involve financial services providers in the acquisition process as early as possible.
*Tip: If a qualified debtor is willing to accept shorter term funding with more rapid amortization, the structure may mitigate higher borrowing costs or lease rates and limit potential credit concerns.
Thinking Differently: Identifying Opportunities in a Down Market
Aircraft prices may continue to erode and may not yet have hit bottom. Even if prices have not reached bottom, buying opportunities may exist for countercyclical and creditworthy buyers.
*Opportunity Point: Dealers, users, and operators (buyers) that buy an aircraft could have potential upside when market values improve (but the upside will probably not be as lofty as they were during the recent overheated market).
The more pressing new question is: How do buyers finance these purchases? Creditworthy buyers can enter financially optimized transactions. Given that the parties may not have agreed to a pre-established commitment related to the structure of a transaction, the parties can use their creativity and experience to design an optimized transaction within the applicable approval criteria of the financier.
*Warning: In any structure that involves a sale or lease, watch out for any trigger of sales or use taxes. These taxes can increase the purchase price or total lease cost significantly.
Owners often need to use business aircraft. Contemporaneously, they want to free up capital (for lack of borrowing capability or other reason). To address both situations, owners may stop or reduce flying their aircraft to the extent possible to cut costs and to avoid selling their aircraft in the down market. Alternatively, they may arrange for third parties to fly their aircraft to generate revenue to minimize their cost burden.
*Warning: As an owner, you should manage the cost and use of the aircraft by third parties to control excessive hours and cycles on the aircraft. Otherwise, you may find that the third party use can unexpectedly diminish the aircraft’s residual value and increase your maintenance costs.
Owners can enter into various types of deals to produce some liquidity and minimize their aircraft costs:
Lease the aircraft to third parties with acceptable credit under thorough lease documentation including “hell and high water” clauses;
Sublease the aircraft to third parties with acceptable credit under thorough lease documentation including “hell and high water” clauses; or
Contract with charter/management companies to use aircraft in charter service. This helps ensure that an aircraft is properly used and maintained while also contributing revenue, thereby reducing the owner’s operating costs.
*Tip: Funding sources for sale leasebacks of older aircraft may be more difficult to locate. As a customer (owner) do not be surprised if you cannot overcome a financier’s concerns about the high cycles and hours, low residual value, and lack of marketability of the aircraft under current economic conditions, especially when evaluated relative to newer aircraft. You can use the following rule of thumb to initially determine your chances of securing financing: When the age of the aircraft plus the term of the proposed financing exceeds 25, you will find that financing becomes very difficult to obtain. You can call this the “Rule of 25.”
Documentation Gets Tougher
Today, some financiers may have capital constraints. For those with funding capacity, documentation may (and probably should):
Impose cost on lessee or borrower (debtor) of fees for outside counsel and professional services in the transaction to the extent outside resources are used (which a debtor should expect in more complex or creative structures);
Include or enhance financial covenants to improve risk management and establish triggers for defaults or at least pre-warning of a debtor’s distress or asset distress that may, in the case of the asset, be evidenced by deterioration of the loan-to-value ratio required for the transaction approval;
Tighten maintenance requirements, increase reporting on maintenance compliance and protect residual value through residual value true-ups and regular appraisals (a true-up refers to the use of other collateral such as a letter of credit to maintain the residual value a lessor assumed in approving and documenting the pricing for the transaction);
Assure access of financiers to the debtor and its aircraft with fewer limits than traditionally included in documents to discuss financial condition, inspect the aircraft, and confirm document compliance;
Reduce cure periods for payment and covenant defaults (to allow closer monitoring of the debtor);
Require title insurance should the title to the aircraft be questionable or should the seller refuse to provide a warranty bill of sale; and
Include cross-default provisions to other financings to trigger early detection of financial distress.
*Tip: As a financier, if your customer shows signs of financial distress you should resist any urge, without careful analysis, to declare a default. You may benefit by keeping the aircraft in the hands of your customer to avoid taking depreciating assets into your inventory (on a repossession or foreclosure). This approach may, if you move quickly, enable you to find solutions to potential distress before your customer fails to make payments when due, even if you have to restructure your deal.
Some financiers have not altered their documentation, assuming that the forms of the past will work for the current recession. If documentation is already rigorous, these changes may not be essential, but if not, financiers should review all of their documents to meet the challenges and structures required in the current market.
*Tip: As a financier, step back and consider whether you should review your documents and procedures free of old paradigms, methodologies, and assumptions in a strategic effort to protect your interests.
Although market conditions remain weak and transactions have slowed to a crawl, UBS offers some reason for hope: “Our 12-month outlook score continued its move higher and . . . reflects respondents’ view that the market could be near bottoming. Overall, our composite index moved 37 percent higher this month, driven by improvements in our “customer interest” and “12-month outlook” component scores.”
No one can assure us when the market will stabilize or bottom out, but for those with cash or access to credit, this market may present opportunities to buy low and eventually sell high. However, as the market environment has down-shifted so dramatically in the last six months, taking the leap of faith to buy now may still carry risk.
Even when the desire to acquire an aircraft does exist, the financing to make the acquisition possible may be more challenging. As in all markets, cash is king, but the opportunity to structure a deal with an asset-based financier does exist, assuming a potential borrower or lessee starts the process early enough to allow time to discern and satisfy the financier’s requirements. Keep in mind that the way to a financier’s heart (and its funds) is to structure a deal that enables the financier to prudently manage risk and includes significant compensation to do so.
Thanks to David Labrozzi, President, GE Capital Solutions, Corporate Aircraft (GE); and Keith Hayes, National Sales Manager, GE; and Michael Amalfitano, Managing Director, Executive Head of Corporate Aircraft Finance at Bank of America Leasing (BofA), for their contributions to and editing of this article. For more information, see GE’s business aircraft Web site and BofA’s external client Web portal. Thanks also to Tony Kioussis of GE and Will Wilson of BofA for their assistance in writing this article.
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3. Need for Natural Gas Storage Rises as Banking Crisis Keeps Financiers on the Sideline
Natural gas is one of the most important sources of energy in the United States. Underground storage of natural gas continues to rise in the U.S. and the rate of withdrawal of natural gas has continued to drop. This situation may have occurred despite colder weather conditions in the 2008-09 winter season, combined with high gas production volumes, and less demand for natural gas caused by the recession. Regardless of the reasons, natural gas storage is here to stay and may be needed more than ever.
Underground natural gas storage facilities provide the means for owners, suppliers, transporters, and investors, among others to park (temporarily hold), transfer, and store natural gas. These functions enable the natural gas market to increase the reliability of deliveries to the market, manage temporary disruptions of natural gas production, and cope with interruptions of gas deliveries and/or peak demand for delivery of natural gas supplies to end users.
*Term to Know: Working gas is the volume of gas in the reservoir above the level of base gas. Working gas is available to, and is delivered to natural gas storage facilities by, gas owners, suppliers, and other commodity sources in the marketplace.
According to the Energy Information Agency's (EIA) Weekly Natural Gas Storage Report, working gas in storage totaled 1,651 billion cubic feet (Bcf) as of March 13, 2009. The storage volumes and the related withdrawals set out below provide a snap shot of storage as of that day. Stocks were 326 Bcf higher than last year at this date and 228 Bcf above the five-year average of 1,423 Bcf. The following figure illustrates the storage levels and other data points:
Working Gas in Underground Storage, Lower 48
More Storage Data Notes and Definitions
The following figure depicts the storage regions described in the left column of the chart above:
Source: EIA Notes and Definitions
How Natural Gas Is Stored
Natural gas is stored underground commonly in salt caverns, aquifers, or, most commonly, in depleted natural gas reservoirs. Gaseous natural gas can also be converted to liquefied natural gas (sometimes referred to as LNG). Once converted, LNG takes much less space to store and can be transported by tanker anywhere in the world where demand exists.
Demand for Storage of Natural Gas Is Expected to Rise
Over the next several years, EIA predicts that storage volumes will remain about level with capacity today. Thereafter, the demand for natural gas storage is expected to rise. Given the clean burning nature of natural gas, it can provide a significant source of energy as the U.S. increasingly relies on intermittent energy sources, such as wind and solar energy. See Market globalization drives pace of Gulf Coast gas storage development, Pipeline & Gas Journal (May, 2008).
Underground gas storage is the most efficient and technically viable means to store natural gas. Historically, natural gas was stored for use during the winter, when demand and prices peaked. Until the recent past, natural gas was mainly used for heating residences and industrial applications. Now consumers and businesses located around the U.S. use natural gas in various ways, including electric power generation, which requires a high rate of short-term storage injections and withdrawals. Natural gas consumption for electric power generation has nearly doubled in the last 10 years.
Pad Gas Leasing and Other Financing in Short Supply
The credit crunch today affects almost everyone in the natural gas storage industry. Financing for gas storage projects has slowed to a crawl. However, ongoing development activity continues in selected cases and is funded primarily by equity sources rather than debt or leases.
Although the gas storage industry shows interest in a financing structure including a pad gas lease or cushion gas lease, such a lease only supplements equity and/or debt financing and cannot replace either of them.
*Term to Know: Pad gas (also called base gas or cushion gas) is the volume of gas intended as permanent inventory in a storage reservoir to maintain adequate pressure and deliverability rates throughout the withdrawal season. A pad gas lease is an arrangement in which a passive financier purchases pad gas and arranges for the developer/project company to use it in the operation of a storage facility for a period of time in exchange for rent payments.
Pad gas leases offer several advantages. They typically:
spread the lessee’s cost of using the pad gas over a longer period of time than a project financing;
decrease the equity needed for a project because the lease enables an owner/lessor to purchase the pad gas (and take title) instead of the project company; and
customize payment structures and renewal, purchase, and/or termination options so the lessee can choose whether to renew or terminate the lease or purchase the pad gas during or at the end of the lease term.
Pad gas leases may entail some disadvantages. They may:
reduce the collateral available for a lender financing the facility because the lessor owns the pad gas and, if properly structured, the lessee has no interest in the pad gas other than as a lessee;
create commodity price risk on lease termination or expiration because the price of gas must be fixed at the inception despite the price volatility in gas markets (but lessees, who bear the gas price fluctuation risk, can mitigate the risk with gas hedges); and
accounting changes that may cause lessees to show the leases as an asset and liability on their balance sheet instead of an off-balance sheet operating lease, under Financial Accounting Board Standard No. 13
(a change that is still at least a couple years away). See IASB and FASB Launch Public Consultation on a Future Standard on Lease Accounting, http://www.fasb.org/news/nr031909.shtml
(FASB Press Release, March 19, 2009)
On balance, pad gas leases can support an overall capital structure to finance the development of natural gas storage facilities.
*Warning: Federal and state agencies, including the Federal Energy Regulatory Commission (FERC), impose significant regulation on natural gas storage and shipping. Developers, lenders, and lessors should, at an early stage of a development or financing, use specialized regulatory counsel, environmental consultants and engineering experts to respond to questions of and make filings with these agencies. See The Market Under Regulation, www.Naturalgas.org (2009).
Reality Check: Where the Money Is
As with other project and secured financings in the midst of the current banking crisis, banks and other financiers have tightened the availability of, and requirements to obtain, loans for development and expansion of gas storage facilities. As a result, some developers have been forced to suspend development activities, cancel projects or finance projects with 100 percent equity until the market for project financing opens up again.
*Opportunity Point: Developers with strong balance sheets, such as utilities, private equity source, and sovereign wealth funds may see a golden opportunity to increase their presence in the market. For example, they may actively search to acquire distressed projects in addition to developing new projects of their own.
Acquisitions and Divestitures Gain Momentum
With traditional debt financing in short supply, project owners have turned to acquisitions and divestitures to raise fresh capital or realize value from their facilities. Potential acquirers with a long-term view of the gas storage market have attempted to acquire gas storage projects at a steep discount with apparent success. These projects are located throughout the country and include Gulf Coast salt cavern projects, Appalachian and Rocky Mountain reservoir projects, and North American reservoir portfolios.
For any of these transactions, the debtor/seller must demonstrate that it has: (i) a highly experienced and qualified management team (unless the buyer plans to replace management); (ii) abundant off-take commitments or contracts from creditworthy customers; (iii) strong coverage ratios in their projections and; (iv) with respect to a debt financing, a substantial amount of management equity invested (or planned to be invested) in the project. As a buyer or financier of a project, you should carefully vet the project operation or leadership team as part of determining the value proposition of a project.
Market Forces May Stunt Development
Trends indicate that the U.S. will need more natural gas storage, but the absence of traditional project financing in 2009 may stunt capacity growth. In the near term, project owners seem to want to sell or buy projects to raise capital and potentially redeploy the capital into other projects.
One of the near-term questions is whether the economy will improve in time to develop and finance sufficient storage to meet the demand. One analyst said recently: “[w]ith US gas storage inventories well above 1.6 Tcf [trillion cubic feet] as the withdrawal season winds down, most observers are anticipating a major gas glut in 2009, one that could test the capacity limits of the domestic gas storage system.” See US natural gas storage may face big 2009 capacity test: analysts, New York (Platts) (March 13, 2009). The analyst leaves little doubt - natural gas storage must expand to keep pace with bulging supplies. Project developers and owners can address this need – but only if the financiers and economy cooperate.
Thanks to Andrew Franks of AFEnergy, LLC and James Muchmore, Scott Wallace, and Eric White of Patton Boggs LLP, for contributing to and editing this article.
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4. BLFN’s Finance 101: What is the “Automatic Stay” in Bankruptcy?
With bankruptcies on the rise, many creditors and lessors are dealing first hand with the automatic stay that is granted to any debtor upon the filing of its bankruptcy petition. Knowing how the automatic stay works and how to obtain relief from the stay are important considerations for any lender or lessor in this economy.
The Automatic Stay
The automatic stay is governed by Section 362 of the Bankruptcy Code. See 11 U.S.C. §362. It acts as an automatic court-ordered injunction restraining creditors from continuing any collection efforts or judicial process against the debtor. The automatic stay offers broad protection to the debtor or bankruptcy trustee by providing immediate breathing room from creditors. A Chapter 11 debtor in possession (or bankruptcy trustee) has time to develop a reorganization or repayment plan while all collection activity and foreclosure actions are halted by the stay. The stay provides a Chapter 7 bankruptcy trustee with the breathing room necessary to collect the property of the bankruptcy estate and to make an orderly liquidation of such property. Though creditors may cringe at the thought of being enjoined from enforcing their rights and remedies, the stay benefits and protects creditors by protecting the assets of the bankruptcy estate from disorderly and piecemeal distribution. Under Section 362(a), the stay is effective automatically the instant the bankruptcy petition is filed with the court. No court order or hearing is required. Generally, the stay is effective for the duration of the debtor’s bankruptcy case, or with respect to specific items of property, so long as such property continues to be property of the bankruptcy estate. §362(c)(1) and (2). The duration of the stay may be modified by the court and individual creditors may seek court-ordered relief from the stay at any time.
The stay is only effective in connection with property of the debtor’s bankruptcy estate. If the property is not the debtor’s or it is no longer part of the bankruptcy estate, the stay is not applicable. For instance, the stay is not applicable to property that has been foreclosed upon prior to the filing of the bankruptcy petition because the debtor has no interest in the property at the time of filing and the property does not become part of the bankruptcy estate.
Generally, the stay protects only the bankruptcy debtor. Actions may be brought against guarantors, subsidiaries, and affiliates that are not debtors and against, general partners where only the partnership is the debtor, and actions may be continued against a codefendant of the debtor except in limited circumstances.
Scope of the Automatic Stay
The automatic stay is very broad in scope. Section 362(a) specifically lists eight acts or actions that are subject to the stay while section 362(b) provides a list of specific exceptions when the stay does not apply. Section 362(a) is drafted to be non-exclusive so that if an action is not expressly excluded from the stay under section 362(b), then it is stayed under Section 362(a). §362(a) (“Except as provided in subsection (b) . . .”).
Almost all remedies a creditor would want to take to collect a debt when a debtor is in default are expressly subject to the stay under Section 362(a), including: the commencing or continuing of judicial, administrative, or other proceedings against the debtor; actions to obtain possession of or to exercise control over debtor’s property; actions to create, perfect, or enforce any lien against property of the bankruptcy estate; and set-off of indebtedness owed to the debtor that arose before the commencement of the bankruptcy case.
*Tip: Because the scope of the automatic stay is very broad, once the petition is filed and the automatic stay is in effect, you cannot take any actions to perfect or enforce a lien.
For example, if your security interest is unperfected because the debtor’s name on the financing statement is seriously misleading, the stay precludes you from filing an amended financing statement to correct the name of the debtor. However, continuation statements are allowed. See § 546(b)(1)(B). Also, certain acts to perfect security interests during unexpired perfection periods may be excepted from the stay. See § 362(b)(3).
Section 362(b) lists certain actions that are excepted from the automatic stay. The exceptions are narrow and not likely to apply to many commercial lending or lease agreements, except perfection of certain security interests during unexpired perfection periods (§ 362(b)(3); actions by a lessor to obtain possession of leased nonresidential real property if the lease expired prior to the filing of the bankruptcy petition (§ 362(b)(10); and certain setoffs by a swap participant relating to one or more swap agreements; and setoff under certain master netting arrangements (§ 362(b)(27)).
*Tip: As a creditor, if you receive notice of a debtor’s bankruptcy filing, you should engage counsel early to evaluate whether the stay applies and the possibility of obtaining relief from the stay.
If the collateral is part of the bankruptcy estate and none of the 362(b) exceptions apply, then it is likely you are subject to the stay. Engaging bankruptcy or restructuring counsel early in the process, even when you first anticipate the debtor is in financial trouble, will help you evaluate a possible workout or restructure to avoid a bankruptcy filing.
Lenders, lessors, and conditional vendors of aircraft equipment financed or leased to air carriers are excepted from the automatic stay under certain circumstances in Chapter 11 bankruptcy proceedings. See §1110. Under Section 1110, a lender, lessor, or conditional vendor will not be subject to the stay and may take possession of the “equipment” or enforce any rights or remedies under the security agreement or lease, unless, within 60 days of commencing the case, the debtor in possession or the Chapter 11 trustee agrees to perform all obligations under the security agreement or lease, and cures all defaults within certain proscribed time periods. “Equipment” is defined under Section 1110 to include an aircraft, aircraft engine, propeller, appliance, or spare part that is subject to a secured interest cash granted by, leased to, or conditionally sold to a debtor that, at the time such transaction is entered into, holds an air carrier operating certificate issued pursuant to Chapter 447 of Title 49. Documented vessels are also included in the Section 1110 definition of “equipment.”
Obtaining Relief from the Automatic Stay
Once a creditor determines the automatic stay is applicable, they should focus on obtaining court-ordered relief from the stay. Section 362(d) allows a party to obtain court-ordered relief from the stay: (1) for “cause”; (2) when the debtor lacks equity in property and is not necessary for an effective reorganization; or (3) under limited circumstances when the property is single asset real estate. A party in interest must petition the court for relief from the stay, and after notice and a hearing the court may grant relief by terminating, annulling, modifying, or conditioning the stay. §362(d).
Relief from the stay for “cause” expressly includes “lack of adequate protection of an interest in property.” §362(d)(1). Under Section 361, adequate protection may be provided by: (1) cash or periodic cash payments; (2) additional or replacement liens; or (3) other relief resulting in the “indubitable equivalent” in favor of the entity with an interest in the property to the extent that the stay results in a decrease in the value of that interest in the property. Commonly, courts will determine adequate protection based on the “equity cushion” of a creditor’s secured debt. If the value of the collateral is greater than the outstanding debt by a comfortable margin then the creditor is adequately protected. If the value of the collateral is depreciating and the equity cushion is near depletion, the court may grant relief by ordering periodic payments equivalent to the decrease in value of the creditor’s interest in the collateral.
A creditor may also show that it lacks adequate protection because the property is not properly insured, the taxes or senior liens are not being paid with respect to such property, or because the property is not being maintained. The creditor may have to show a combination of these factors and/or show that the circumstances as a whole are sufficient to jeopardize the creditor’s interest in the property. In re Anthem Communities/RBG, LLC, 267 B.R. 867, 871 (Bankr. D. Colo. 2001).
*Technical Point: A creditor that has no equity cushion or is undersecured will only be entitled to adequate protection with respect to the value of the collateral itself, not the income or interest that the creditor would earn if permitted to foreclose on the collateral and reinvest the proceeds of the foreclosure. United Savings Association of Texas v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365 (1988). However, creditors that have equity or are oversecured are allowed interest, fees, and expenses on their claim under Section 506(b).
Lack of adequate protection is just one form of “cause” in which a court may grant relief from the automatic stay. Other grounds “for cause” include the debtor commencing the bankruptcy case in bad faith or for the purpose of delaying the secured creditor from enforcing its rights, or allowing litigation or arbitration involving the debtor to proceed in another forum when the judgment will not impact the property of the estate. Because “cause” is a very broad and fact-based concept, courts often have wide latitude in determining whether to grant relief for cause.
Under 362(d)(2), relief from the stay may be granted if a two prong test is satisfied: (1) the debtor has no equity in the property, and (2) the subject property is not necessary to an effective reorganization. A debtor lacks equity in the subject property if the total of all debt secured by the property is greater than the value of the property. The creditor has the burden of proving that the debtor has no equity in the subject property. §362(g). Property is deemed necessary for an effective reorganization whenever it is necessary either in the operation of the business or in a plan to further the interests of the estate through rehabilitation or liquidation. In re Keller, 45 B.R. 469, 472 (Bankr. N.D. Iowa 1984). The debtor has the burden of proving that the property is necessary for an effective organization and must show that there is a reasonable possibility of a successful reorganization within a reasonable time. It is often difficult for a creditor to obtain relief from the stay under Section 362(d)(2) in a Chapter 11 reorganization case because most of the property of the debtor in possession is likely to be “necessary” for reorganization and for the debtor’s business. Collier on Bankruptcy, 15th Ed., Vol. 3, § 362.07[b] (2008).
Relief from the stay may be obtained under limited circumstances when the property is single asset real estate. §362(d)(3). “Single asset real estate” is defined as real property constituting a single property or project, other than residential property with fewer than four residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than operating the real property. §101(51B). The court must grant relief from the stay with respect to an act by a secured creditor of single asset real estate unless the debtor, within a proscribed time under Section 362(d)(3), either files a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time, or the debtor has commenced monthly interest payments equal to the then-applicable non-default contract rate of interest on the value of the creditor’s interest in the real estate. §362(d)(3).
Creditors with a secured interest in real property may also obtain relief from the stay if the court finds that the filing of the bankruptcy petition was part of a scheme to delay, hinder, and defraud creditors that involved either transfer of all or part ownership of, or other interest in, such real property without the consent of the secured creditor or court approval, or multiple bankruptcy filings affecting such real property.
Violations of the Automatic Stay
A creditor’s actions that are in violation of the automatic stay are generally void and given no legal effect. This is true even if the creditor did not have notice or realize the stay was in effect. Some courts have held that actions in violation of the stay are merely voidable. In these jurisdictions an action in violation of the stay is void only if the debtor objects to the action.
Willful violation of the stay may result in the recovery of damages or contempt of court. Under Section 362(k)(1), “an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.” If a creditor is aware of the debtor’s filing of a bankruptcy petition, any intentional act in violation of the stay will be considered willful. Courts disagree as to whether “individual” in Section 362(k)(1) means only debtors who are natural persons or whether it includes corporate debtors and bankruptcy trustees. To recover actual damages, the debtor must prove injury or loss resulting from the violation of the stay.
The court may find a creditor in contempt for a knowing and willful violation of the stay. Because the automatic stay is treated as a court order, the court may impose sanctions for contempt of court for a willful violation of the order.
*Tip: As a creditor, if you learn your debtor has filed a bankruptcy petition, it is a best practice to cease activity with respect to the collateral until counsel has been able to evaluate the applicability of the stay and the possibility of obtaining court ordered relief from the stay.
The automatic stay is of critical importance in bankruptcy cases because it provides debtors and trustees with the breathing room necessary for an orderly reorganization or liquidation. It is also important to creditors because it protects their interests in property from disorderly distributions. The scope of the stay is very broad, but creditors and their counsel should evaluate each item of collateral and each legal proceeding to determine the possibility of obtaining relief from the stay and to avoid any penalties for actions in violation of the stay.
For more on the automatic stay, see The Bankruptcy Code’s Automatic Stay, Current Developments in Bankruptcy & Reorganization (30th Annual), by Michael L. Cook and Jessica L. Fainman, Practicing Law Institute Course Handbook (April 7, 2008) at Chapter 10; Collier on Bankruptcy, 15th Ed., Vol. 3, Ch. 362 (2008).
Thanks to Tyson Wanjura in the Dallas office of Patton Boggs LLP for contributing this article and to Jeff LeForce in the Dallas office Bankruptcy Practice Group for editing this article.
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About Patton Boggs LLP; NEW>>PB Capital Resource Center; Publications and Radio Interview; Speeches
About Patton Boggs LLP
Patton Boggs LLP is a law firm of approximately 600 attorneys and other professionals located in Washington DC, Northern Virginia, New Jersey, New York, Dallas, Denver, Anchorage, and internationally in Doha, Qatar, Abu Dhabi, and United Arab Emirates.
Patton Boggs has major practice areas in Business, Intellectual Property, Public Policy, and Litigation. These areas are composed of many practice groups designed specifically to meet client needs and the trends in developing legal markets. David G. Mayer often focuses on capital equipment and facility financing and development in energy, transportation, infrastructure, aviation and technology transactions, work-outs, and litigation.
The firm provides a broad array of skills in domestic and international business transactions, including equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, aviation and transactions law, federal leasing, project finance, real estate, health care, pharmaceuticals, technology transactions, and public policy work.
The equipment finance practice at Patton Boggs regularly involves the buying, selling, financing, and leasing of personal property of all kinds, including business aircraft, energy facilities, power plants (including wind farms and other renewable energy facilities), and technology and health care assets.
When these transactions encounter defaults or other disputes, Patton Boggs responds with a team of business transaction lawyers, who have extensive restructuring and workout experience; litigators, who manage court actions and alternative dispute resolution proceedings; and bankruptcy lawyers, who assist in restructuring transactions, handle workouts, advise on potential bankruptcy filings, and litigate and otherwise participate in the entire bankruptcy process.
NEW>>PB Capital Resource Center
Click here to download Patton Boggs overview [pdf]
In its final form, the American Economic Recovery and Reinvestment Act of 2009 (H.R. 1) bill passed February 13 is the largest combined spending and tax bill in American history, with a total of $789.5 billion in spending and tax cuts. The bill will impact a wide range of businesses and industries from healthcare to energy to education and transportation.
To provide a sense of the package's overall funding levels, Patton Boggs has prepared a general overview of the bill by subject area (please note we are not reporting on every aspect of the bill).
PB Podcast and Capital Thinking Internet Radio Show – PB Partner Kevin O’Neill hosts both a weekly podcast series and a weekly Internet radio show that deliver the latest news and insight into policy, law, and politics in Washington. The PB podcast series is updated every Monday and is available on the firm’s website and iTunes. Capital Thinking, Patton Boggs’ weekly Internet radio show, airs live every Thursday at 9 a.m. ET on VoiceAmerica Business network. Top guests, including politicians, business leaders, and public policy advisors, join Kevin to discuss how legislation in Washington impacts businesses in the U.S.
Capital Markets Website – PB Capital Markets is the firm’s dedicated website offering current political news and in-depth analysis of the most important legislation pertaining to the crisis in the financial services and banking industries today. Topics include discussions of unprecedented federal legislation, including TARP , TARP Reform, and EESA. To read these materials and much more, click on Capital Markets.
Capital Thinking Magazine – For insightful interviews with business and political leaders and more in-depth information on business, finance, politics, and the law, pick up a copy of Patton Boggs’ Capital Thinking magazine. Published quarterly, Capital Thinking features articles from top business and legal minds providing readers with actionable tips on timely topics.
Partial List of Publications and Radio Interview
The following is a partial list of articles written or co-authored by David G. Mayer and a mention of a radio show appearance by David G. Mayer:
Capital Thinking Internet Radio (Patton Boggs Podcast), with host Kevin O’Neill: Interview of David G. Mayer on March 12, 2009 regarding trends in financing and development of natural gas storage facilities. To listen to the interview, click on Mayer Interview.
U.S. Court of Appeals Upholds Graves Amendment in Garcia v. Vanguard, by Connie Ariagno and David G. Mayer, with the assistance of Tyson Wanjura, LNJ Leasing Newsletter (Dec. 2008).
Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Dec. 2007).
Navigating the New Reality of Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Nov. 2007).
Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).
Financial Institutions Conference in Las Colinas, Texas at Four Seasons Resort and Club, April 5-7, 2009. On Tuesday, April 7, 2009 (11a.m – 12:00 p.m.) Harry Kaplan, President, Frost Leasing, will moderate a panel titled - Workouts and Bankruptcy. The panel consists of David G. Mayer, Partner, Patton Boggs LLP (Dallas); Jimmy Locke, Senior EVP, Credit Administration, Frost Bank; and Jeff LeForce, Partner, Patton Boggs LLP (Dallas).
ELFA Legal Forum in Orlando, Florida at Hyatt Grand Cypress, April 19-21, 2009. On Tuesday, April 21, 2009 (9 a.m. – 10:00 a.m.) Join Doug Adler, Member, Vedder Price; David G. Mayer, Partner, Patton Boggs LLP (Dallas); and Rafael Castillo-Triana, Principal in The Alta Group, for a panel discussion titled - International Leasing Legal Practice: Current Changes and Opportunities.
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Thanks to BLFN’s Team
I would like to thank BLFN’s team at Patton Boggs LLP. The team includes Joel Bannister, an Associate in Dallas, and the Patton Boggs staff: our staff Senior Writer, Jennifer Becker; our Marketing Manager, Mark Holub; our Project Manager, Melissa Green; our Subscription Coordinator, Penny Utley; and our designer Kiasha Sullivan. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and web site reviewer for BLFN, and our Chief Marketing Officer, Mary Kimber, for assisting BLFN through our firm’s editing, design, and posting process.
All the best,
David G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Dallas, Texas 75201
(214) 758-1545 phone)
(214) 758-1550 (fax)
© David G. Mayer 2009
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