CASE SUMMARY: California Resources Proposes $1.1B DIP; RSA Plan Would Allocate at Least 91% of Pre-Dilution Reorganized Equity to 2017 Term Lenders, JV Settlement Would Allocate Additional Debt, Equity to Ares

Background

According to the first day declaration of CEO Todd Stevens, CRC was incorporated in 2014 as a subsidiary of Occidental Petroleum and spun off that same year with $6 billion in funded debt. The company operates properties “exclusively within California” and has offices throughout the state and in Houston. Stevens asserts that CRC is the largest oil and gas producer in California, operating more than 12,000 wells across 135 fields, with 644 million barrels of oil equivalent, or MMboe, in proved reserves.
 
Stevens says that the debtors’ largest producing asset is the Elk Hills field, one of the largest fields in the continental United States by total recoverable and proved reserves. Elk Hills accounts for over half of California’s natural gas production, according to Stevens. Nondebtor Elk Hills Power LLC, or EHP, owns a power plant and cryogenic plant at Elk Hills; EHP is a joint venture between debtor California Resources Elk Hills LLC, or CREH, and nondebtor ECR Corporate Holdings LP, a portfolio company of Ares Management.

The debtors’ organizational structure is shown below:
 
Additional large joint ventures that the first day declaration does not mention are the company’s development JVs including Benefit Street Partners, or BSP, Alpine, and Macquarie Infrastructure and Real Assets, or MIRA. CRC disclosed in its recent 10-Q that the cumulative investment of these JVs through March 31, 2020, is $200 million for BSP, $223 million for Alpine and $140 million for MIRA. The company consolidates the results of the Ares JV and BSP JV in its financial statements.

The 2014 spinoff coincided with “a severe dislocation in commodity markets,” according to Stevens, leading CRC to cut capex and delever through liability management and asset monetization. Although commodity prices partially recovered in 2017, allowing CRC to increase activity and investment, declines beginning in 2018, which accelerated in 2020 as a result of the Covid-19 pandemic, forced CRC to reduce its rig count “and focus on value preservation,” Stevens says.

In 2018, the debtors “found themselves in need of financing,” Stevens indicates, and in February 2018, the debtors transferred the Elk Hills plant assets to EHP in exchange for $750 million cash from ECR. As part of its investment, ECR received preferred and common equity interests in the joint venture. EHP agreed to make monthly distributions of 13.5% a year on the debtors’ $750 million contribution, as well as monthly distributions of excess cash flow to ECR and CREH, at 4.75% and 92.25%, respectively. The agreement gives CREH the right to redeem most of ECR’s equity interest in EHP by repaying ECR’s $750 million contribution, plus other payments (including accrued but unpaid distributions).

According to Stevens, the debtors have evaluated whether this arrangement should be recharacterized as secured financing as well as whether to “bypass” the joint venture by rejecting the relevant agreements and using other facilities for power and gas processing. Ultimately, the debtors concluded that “while rejection and bypass may be a possible alternative to assuming the EHP Agreements, it would be very difficult to achieve from an operational perspective and would carry significant operational risks.” “Rejecting the EHP Agreements would also destroy much of the value of the joint venture - and the Debtors’ stake in it,” Stevens says (emphasis added).

Throughout 2019 and early 2020, the debtors considered options to strengthen their balance sheet. In August 2019, the company amended its RBL facility to provide flexibility with certain royalty transactions, according to Stevens. In February, Stevens adds, the debtors launched an offer to exchange a portion of its second lien notes and senior unsecured notes into interests in an entity that would hold a term royalty interest in certain oil and gas assets or new term loans and warrants. The offers, if fully subscribed, would have reduced the debtors’ net debt by about $1 billion, but on March 16 the debtors pulled the offers “as a result of substantial disruptive developments in the commodity and financial markets at that time that rendered the Offers inadvisable and impractical,” according to Stevens.

Restructuring Support Agreement

Proposed Plan and Rights Offering

According to the restructuring term sheet attached to the RSA, RBL facility claims would be paid in full, while 2017 first-out term loan claims would be bifurcated into a secured claim of $537 million and a deficiency claim of $792 million. Holders of the secured portion of the 2017 term loan claim would receive 91% of the common stock in the reorganized debtors, subject to dilution by a $450 million equity rights offering, a rights offering backstop premium and a management incentive plan of up to 10% of reorganized equity. The holders of the secured portion of the 2017 term loan claim would also receive 91% of the subscription rights offered under the equity rights offering.

Holders of the deficiency claims on account of the 2017 term loan would be combined with 2016 term loan claims, second lien notes and unsecured notes into a single “Deficiency/Unsecured Debt Claims” plan class. According to the term sheet, the 2017 deficiency claim would represent 20% of the aggregate Deficiency/Unsecured Debt Claims. If the deficiency/unsecured debt claims class votes to accept the plan, then the class would receive 9% of the common stock in the reorganized debtors (subject to dilution by the rights offering, backstop premium and MIP) and 9% of the subscription rights offered under the equity rights offering. If the class votes to reject the plan, the class would “receive their share of the common stock in the reorganized CRC that the Court determines the class is entitled to under the Bankruptcy Code’s ‘best interests of creditors’ test,” according to the first day declaration.

However, the RSA term sheet words this differing treatment depending on voting as follows:
   
As noted above, the $450 million equity rights offering contemplated by the RSA would allow participants to purchase new common stock at a 35% discount to the reorganized equity value, which is listed as $1.65 billion in the term sheet. The RSA provides that this plan equity value would be reduced to $1.3 billion, if during the five trading days preceding the business day prior to the approval of a disclosure statement, the average closing price of the ICE Brent strip price for the period of December 2020 to November 2021 trades below $40 a barrel. Some 25% of the equity rights offering will be reserved for the rights offering backstop parties, and backstop parties would also receive a fee of 8% of the total rights offering amount, payable in the form of new common stock. If the backstop agreement is terminated, the backstop parties would receive cash of $22.5 million.

Elk Hills Settlement

The RSA also contemplates a settlement with EHP (the Elk Hills cryogenic and power plant JV) and Ares. Under this settlement, as embodied in a motion for interim and final approval filed today, after interim approval of the settlement, EHP would pay to Ares cash distributions on its Class B preferred units at a rate of 9.5% a year, calculated on a liquidation preference of $835.1 million, in addition to cash distributions on account of Class A and Class C common units consistent with historical practices. After final approval of the settlement, Ares would grant a “conversion right” to the debtors. Under the conversion right, the reorganized debtors would have the right to acquire the preferred and common units of EHP owned by Ares in exchange for $300 million in new notes plus 21% of the reorganized debtors’ common stock, subject to dilution by the management incentive plan but not the equity rights offering. In terms of timing of the conversion right, the term sheet states that at any time on and after the settlement effective date, California Resources would have the right to convert the securities; however, the term sheet further states that the company “shall exercise its Conversion Right on the Plan Effective Date.”

The new notes would be secured by EHP or a successor entity holding the Elk Hills facilities and guaranteed by an intermediate special purpose entity holding 100% of the secured notes issuer. The notes would be guaranteed by the reorganized debtors. The notes would mature in seven years and pay 6% interest, rising to 7% at the fourth anniversary of issuance and 8% at the fifth anniversary.

Upon final approval of the settlement agreement, the debtors and Ares would provide each other with mutual releases of all past and present claims with respect to the EHP transactions.

Before the Elk Hills settlement agreement effective date, the settlement agreement may be terminated by written notice from either Ares or the debtors (with the support of required consenting creditors) if:
 

• The interim Elk Hills settlement order is not entered by July 20 (the fifth day after the petition date) or does not otherwise satisfy the consent rights set forth in the RSA;
   
• The RSA is terminated before the final Elk Hills settlement order is approved;
   
• The final DIP order has not been entered prior to, or is not conditioned on, the final Elk Hills settlement order;
   
• Definitive documents required by the RSA are not in agreed form prior to entry of the final Elk Hills settlement order; or
   
• The final Elk Hills settlement order is not entered by Aug. 24 (the 40th day after the petition date) in form and substance reasonably acceptable to Ares, the debtors and required consenting creditors.
   

According to the settlement motion, the settlement “will allow the parties to avoid costly, time-consuming, and distracting litigation” and “resolves all issues regarding the treatment of the EHP Agreements, the Recharacterization Claim, the Bypass Plan and the other EHP Disputes, enabling the Debtors and their management team to focus their efforts and other resources on their core business and the timely confirmation of a plan of reorganization.”

Governance

A governance term sheet attached to the RSA contemplates a nine-member board of directors initially composed of (i) the CEO; (ii) one director selected by Ares; (iii) one director selected by Fidelity; (iv) one director selected by GTAM; and (v) other directors selected by the required consenting creditors. The chairman would be an independent member and not employed by Ares, Fidelity, GTAM or the reorganized debtors, and be selected by the required consenting creditors.

DIP Financing Motion / Cash Collateral Motion

In the DIP financing motion, the debtors seek approval of up to $1.133 billion in DIP financing with a six-month maturity, consisting of:
 

• A senior secured superpriority DIP credit facility of up to $483 million bearing interest at L+4.5% (with a 2% default premium), consisting of:
   
  • A $400.1 million new-money revolving subfacility, including $150.1 million “to deem RBL Letters of Credit ... as being issued under the Senior New Money Subfacility” and a sublimit of not more than $35 million for additional letters of credit; and
     
  • A $82.9 million senior rollup term loan subfacility, which would be used to repay a portion of the prepetition RBL obligations; and
     
• A junior secured superpriority DIP term loan facility of $650 million bearing interest at L+9% (with a 2% default premium), which would be available in a single draw and used, with the senior rollup term loan subfacility, to refinance the prepetition RBL.

In addition to satisfying the prepetition RBL, DIP facility proceeds may be used to pay fees under the facilities, pay administrative expenses, make adequate protection payments, and fund working capital, capital expenditures and general corporate purposes during the pendency of the chapter 11 cases.

The senior DIP credit agreement provides for an upfront fee of 1%, a commitment fee of 0.5%, letter of credit fees, and administrative agent and arranger fees for the senior DIP agent. The junior DIP credit agreement provides for an upfront fee of 1%, a fronting fee equal to the lesser of 0.375% and $500,000, and undisclosed administrative agent fees for the junior DIP agent.

In support of the proposed DIP financing, the debtors filed the declaration of Bruce Mendelsohn, partner and head of global restructuring at Perella Weinberg, who states that the debtors do not have sufficient available sources of working capital and financing to operate their businesses or to maintain their properties in the ordinary course of business, let alone pursue the various options available to create value for stakeholders, without the proposed DIP financing and the authorized use of cash collateral.

Adequate Protection

The company proposes the following adequate protection to its prepetition RBL lenders: junior postpetition security interests and liens on all DIP collateral, superpriority administrative expense claims, payment of all prepetition accrued and unpaid interest, fees and costs and payment of postpetition interest, fees and costs on outstanding prepetition RBL obligations at the nondefault rate. The 2017 term loan claims, 2016 term loan claims and second liens claims would receive adequate protection liens and superpriority claims in order of prepetition priority.

In addition, the debtors propose typical stipulations regarding the extent, validity and priority of prepetition secured lenders’ claims and liens, a waiver of the estates’ right to seek to surcharge collateral pursuant to Bankruptcy Code section 506(c) and a waiver of the “equities of the case” exception under section 552(b).

The post-default carve-out for professional fees is $7 million.

DIP Budget

The proposed 13-week budget for the use of the DIP facility is shown below:
 
The proposed monthly budget through January 2021 for the use of the DIP facility is shown below:
 
DIP Milestones

The DIP financing is subject to the following milestones:
 

• July 20 (5 days after the petition date): Entry of the interim DIP order and the interim Elk Hill settlement order;
   
• July 29 (14 days after the petition date): Filing of plan and disclosure statement;
   
• Aug. 24 (40 days after the petition date): Entry of the final DIP order and the final Elk Hill settlement order, entry of order approving the backstop commitment agreement and filing of plan supplement;
   
• Aug. 28 (44 days after the petition date): Approval of the disclosure statement;
   
• Oct. 28 (105 days after the petition date): Entry of disclosure statement approval order and confirmation order; and
   
• Nov. 27 (135 days after the petition date): Plan effective date.

Exit Facilities

The exit financing term sheet attached to the RSA contemplates a five-year second lien exit term facility of up to $200 million, which would be used to repay the junior DIP facility. During the first two years after emergence, the junior exit facility would accrue cash interest at L+9% or PIK interest at L+10.5%, at the debtors’ option. After the first two years, the junior exit facility would accrue cash interest at L+9%, with no PIK option. A LIBOR floor of 1% applies only after the second year. A 2% default premium applies. The second lien exit facility term sheet provides for a 1% upfront fee, a fronting fee of up to $500,000 and undisclosed agent fees. The facility may be repaid at par for the first 90 days after the closing date, 105% between 90 days the first anniversary, 103% between the first and second anniversary, 102% between the second and third anniversary, 101% between the third and fourth anniversary, and at par thereafter.

The RSA also provides that the debtors and RSA parties shall work together to agree on a first lien exit facility. If that facility cannot be agreed upon by the date that is 30 days before the first scheduled confirmation hearing, the debtors would have the right to pursue any first lien exit facility “reasonably acceptable to the Required Consenting Creditors,” so long as such facility provides for minimum liquidity of no less than $300 million, is arranged, led and agented by “one or more traditional commercial banks and up to 25% may be syndicated to non-bank investors,” has a final maturity on or after the third anniversary of issuance, has an interest margin not exceeding 4%, and provides for repayment without premium or penalty.

Other Motions

The debtors also filed various standard first day motions, including the following:
 

• Motion for joint administration
  • The cases will be jointly administered under case No. 20-33568.
• Motion to establish trading procedures
  • CRC seeks to establish trading procedures for its common stock, to be able to object to and prevent transfers if necessary to preserve net operating losses. The motion says that as of Dec. 31, 2019, the debtors had federal NOL carryovers of approximately $1.3 billion, state NOL carryforwards of approximately $2.5 billion, disallowed business interest carryforwards of approximately $467 million, an indeterminate amount of net unrealized built-in loss and tax credit carryforwards of approximately $76 million.
• Motion to file consolidated creditor lists
• Motion to pay prepetition claims of certain vendors
• Motion to pay employee wages and benefits
  • The debtors outline the interim and final relief requested under the motion as follows:

• Motion to use cash management system
  • The company has bank accounts with JPMorgan and Bank of America.
• Motion to perform under hedging arrangements
• Motion to honor royalty obligations
  • The debtors seek authority to pay approximately $24 million in accrued but unpaid royalty payments to holders of royalty interests, $30.3 million in expense obligations, $8.1 million in non-operating working interest payments and $9.7 million in joint interest billing payments.
• Motion to maintain insurance programs
• Motion to continue surety bond program
• Motion to pay taxes and fees
• Motion to provide utilities with adequate assurance
• Application to appoint Epiq Corporate Restructuring as claims agent