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Distressed projects – what choices are available to lenders?

Distressed projects – what choices are available to lenders?
The significant fall in oil prices, coupled with cost reductions now being made by the oil majors to their E&P budgets, has created a gloomy outlook for the offshore oil service industry. Consequently, financial institutions and other debt investors who have funded offshore projects and assets may have to consider the options available to best protect their investment.

Cause of distress

In deteriorating market conditions, events of default will typically arise in offshore projects when the borrower is unable to comply with the financial covenants given to the lenders; in particular, the requirement that the market value of the financed asset is in excess of the outstanding loan amount. Given the steep decline in values of offshore assets it may be difficult to source collateral to make up any shortfall.

As offshore asset values fall, lenders often have to choose between supporting the distressed project by granting waivers and amendments to the loan agreement, or enforcing security immediately a default materialises.

Restructuring the business as a going concern

If the unit is engaged in a long-term employment contract and the financing is, or can be, secured by the cash flow from a reputable third party in addition to the asset value, it is likely to be in the lenders’ best interests to consider a restructuring plan in order to either maintain or utilise this cash flow.

Where this choice is considered, the main objective will be to ensure that the performance of the offshore unit under the contract remains acceptable for the third party charterer. This may be a challenge where, due to the fall in oil prices, the contract is an expensive one for charterers to maintain. Lenders may therefore need to consider becoming more directly involved in the day-to-day operations of the company, either by requiring regular information to be provided and/or by seeking to negotiate rights to exercise direct influence over the operation of the unit.

If the offshore unit is unemployed or is operating in a market dominated by short-term contracts, the asset value will typically be the main security underpinning the financing. Where a default occurs, a lender may be tempted to try and dispose of the asset as quickly as possible. Often, however, the proceeds from distress sales are reduced because such sales take place in circumstances where the market knows of a default.

It may therefore be in lenders' interests to allow the borrower to continue operating the unit as a going concern. In such cases, lenders will need to determine whether there is a realistic prospect of asset values improving over time. They will also need to assess the ability of the current management of the company to effectively operate and market the unit. Again, lenders may wish to exercise a degree of direct control over the borrower by replacing or supporting the current management team with their own representatives.

Continued operations will in any event require a re-assessment of the financial model, and typically short- or long-term waivers of covenants that the borrower has failed to comply with. The quid pro quo for the lenders granting such waivers will typically be additional covenants, additional security, prepayment requirements and waiver fees. However, it is important to strike a balance between imposing new requirements and achieving an overall structure that makes continued operation viable. Project stakeholders may also be required to inject new equity, taking a haircut on the debt or converting part of it into equity.

In seeking to find a restructuring solution, lenders will also have to take into account the involvement and considerations of other stakeholders on the debt and equity side. In the initial stages of the negotiations it is important that the standstill arrangements are put in place and a framework for the exchange of information and negotiation created. As the process evolves, the decision for lenders turns on what realistic alternatives there are to bankruptcy and enforcement of security.

Enforcement of security

Enforcement of security constitutes the lenders’ fall-back position in the event of default by the borrowers. It is not always straightforward and the asset disposal possibilities need to be assessed against the negotiated alternatives. In addition to the expected proceeds from the sale of the unit, lenders will need to take into account the time, cost and expected outcome of the enforcement procedures.

Enforcement of a vessel mortgage will depend on the procedural rules in the jurisdiction where the unit is located and on the requirements of the flag state where the mortgage is registered. In certain jurisdictions, such enforcement processes may be time-consuming, costly and unpredictable. A more efficient alternative may be to foreclose on the shares and take possession of the owning company, appoint representatives of the lenders to the board/management and sell the asset as the owner. However, lenders who assume responsibility for the company may also need to advance further cash in the short term to pay operating expenses for crew, supplies and the sales process.

Lenders need to know whether they can achieve their preferred solution where there are other significant creditors, or where there are relevant insolvency regulations. In the latter event, lenders need to be aware that insolvency regulations differ significantly between jurisdictions. When faced with imminent bankruptcy, companies in some jurisdictions, including the US, Japan and Korea, can seek Court protection against creditors for a limited period whilst consideration is given to whether the company can be rescued, sold or rehabilitated. Where this possibility exists, lenders need to ensure that they act sufficiently quickly to avoid the risk of restructuring or enforcement processes being taken out of their hands.


The only certainty is that the future in today’s offshore service industry is uncertain. Lenders will have to make some challenging assessments and compromises to protect their interests where events of default occur. Understanding the options available, and making decisive choices at the right time, will be necessary to ensure that lenders are able to best protect their investment.

Contributed by Finn Bjørnstad and Joe McGladdery (Wikborg Rein LLP)

Finn Bjørnstad, Partner, Wikborg Rein LLP, [email protected] / +44 77 1412 6300

Joe McGladdery, Partner, Wikborg Rein LLP, [email protected] / +44 77 1311 3115