Transocean Ltd.
Past Offshore Driller Bankruptcies Show Cash Protections Can Be Weakened by Complex Cash Management Systems, Org Charts; Similar Concerns Could Implicate Transocean
Wed 09/23/2020 15:29 PM
Offshore driller bankruptcy filings frequently use multi-entity cash management systems that reflect offshore drillers' complex organizational structures and capital structures laden with debt borrowed by and (in some cases) secured by varying buckets of assets and corporate boxes. Organization-wide cash management systems often result in cash flows from cash-generating drilling entities being moved to other operating entities. In addition, drillships are typically located at different entities from other corporate functions. Furthermore, because the timing of cash flows is driven by contract schedules, cash generally moves out of cash-generating operating entities to entities that require cash to, among other things, maintain idle rigs. Given strict bankruptcy filing rules on cash management and creditors’ interest in siloing as much of their collateral as possible, these factors present complex questions for a contemplated offshore driller bankruptcy filing.
Continue reading for the Americas Core Credit by Reorg team's analysis of offshore driller bankruptcy filings, and request a trial to access our coverage of Transocean and other similar situations.
The location of that cash at the time of filing and the composition of collateral packages affect not only ultimate recoveries but also the direction of bankruptcy cases, including the structure of debtor-in-possession financing and cash collateral, raising particularly thorny questions regarding adequate protection.
In this article, we analyze prior and current offshore drilling bankruptcies, with a particular focus on how companies manage cash and the associated cash collateral fights that ensued, with an eye toward potential disputes in current and future cases.
Of particular note, offshore drilling companies preparing for bankruptcy have sought to augment their cash reserves prior to filing. One way drillers have done this is to draw down on existing credit facilities. If those funds are unrestricted, the companies have moved these funds to accounts held at non-lender banks, presumably in order to avoid perfection by control at the lender bank. Where cash would otherwise be tied to certain drilling rigs, contracts and in turn cash flow associated with contracts can be entered into with non-obligor entities, and cash can be moved away from those secured creditors. In addition, debtors may make prepetition modifications to their cash management system to facilitate this process, including the opening of new header accounts into which the unencumbered cash is deposited, modifying the company’s cash pool protocols and funding an administrative account to pay for chapter 11 expenses. If the debtor does not have enough unrestricted cash to operate while in bankruptcy, it will seek to use a lender’s cash collateral or obtain new financing.
In the Pacific Drilling chapter 11 cases, debtholders held security interests in certain cash assets. Secured creditors were denied blanket cash collateral or adequate protection on all organizational cash, since the majority of the debtors’ cash was held at the parent entity and was unencumbered. Cash collateral was limited to transfers to and from operating entities in order to satisfy minimum cash needs.
In Diamond Offshore’s ongoing bankruptcy cases, collateral supporting the prepetition secured RCF - the only secured debt - was limited to 65% equity interest in an intermediate holdco entity. Customer contracts are with debtor entities that own rigs, and therefore the guarantees from rig-owning entities do not include cash generated from contracts. In both the Diamond Offshore and Noble Corp. cases, debtors transferred cash to nonguarantor entities shortly before filing for chapter 11.
In both the Valaris and Noble Corp. cases, neither company entered chapter 11 with secured debt. To date, debtholders in both cases have not yet waged fights at the cash management level. Valaris entered into a commitment for a $500 million DIP with noteholders that revolving lenders object to, and the revolving lenders have offered a competing DIP. Noble Corp.’s proposed plan would allow prepetition lenders to participate in the exit facility and receive a partial cash paydown.
These examples are explained further below. As will be clear, the expectations of secured creditors regarding their ability to maintain control over cash (and thus drive case control via DIP and cash collateral orders) can be frustrated by prepetition reorganization of cash management that can move substantial pools of cash into unencumbered positions in offshore drillers’ wide and unwieldy organization structures.
Transocean, which has not filed for chapter 11 and has not indicated that it plans to, possesses both secured and unsecured debt. In the event of a bankruptcy filing, the company and its creditors may utilize some of the above strategies. As explained below, secured note indentures indicate that the company can transfer cash from its operating entities prior to triggering a cash sweep covenant that requires rig-level entities to sweep cash into accounts pledged to collateral agents. The availability of these transfers means the company might not keep substantial amounts of cash at the rig-level entities in excess of operating costs and any amortization reserves.
Pacific Drilling
Pacific Drilling filed for chapter 11 on Nov. 12, 2017. The company’s prepetition debt was secured by different ships and divided between different ship groups as detailed in the first day filings and shown in the organizational chart HERE. At the time of filing, Pacific Drilling owned seven ships split into three ship groups:
Fewer than 50% of the debtors’ ships were contracted at the time of filing for chapter 11 including two of the debtors’ ships in group A and the ship with the largest contract in terms of length and day rate, Sharav, in group B. Ship group C had no ships working at the time of filing.
As detailed in the initial cash management motion, ship groups A and C were expected to be net cash consumers and ship group B a net cash contributor during the 13-week cash flow period. Specifically, ship group A required $36.1 million, ship group C required $5 million, and the ship group B debtors were expected to generate $36.7 million in cash during the 13 week period.
In order to manage cash flow throughout the organization, the debtors described a cash-pooling system in which cash from each of the ship groups would flow through a pool leader, Pacific Drilling (Gibraltar) Ltd., that would serve as the central intercompany bank within the organization. The debtors disclosed as of the petition date that $250 million in unencumbered cash was held at Pacific Drilling (Gibraltar) Ltd. When funds were received by different entities - whether from drilling contracts, services agreements, third-party and intercompany contracts or otherwise - the debtors transferred such funds from the receiving account, directly or through one or more intercompany transfers, ultimately to the pool leader accounts. A transfer of funds from the pool leader to or on behalf of a cash pool participant created an intercompany loan from the pool leader to such cash pool participant, according to the cash management motion.
Additionally, cash flowed within the ship groups, with the drilling entity often being separate from the entity that borrowed the debt.
The debtors asserted that their business was not conducted “silo-by-silo,” but rather as a single business unit, with no single debtor entity able to conduct business on its own, adding that as such, use of an integrated cash management system is “essential” to the preservation of Pacific Drilling’s value and its ability to operate. The debtors explained that the cash management system was funded not only with cash collateral but also with the over $250 million of unencumbered cash. Although the debtors repeatedly acknowledged that most of their cash on hand was unencumbered, the debtors said they were expected to acquire cash after the petition date that may relate to drillships, contracts or insurance policies that constitute prepetition collateral and therefore requested authorization to use cash collateral acquired after the petition date “solely to the extent constituting Prepetition Collateral …, while preserving their rights and the rights of the Prepetition Secured Parties to contest whether cash acquired by the Debtors after the Petition Date is Cash Collateral.”
The debtors and creditors argued that the secured creditors were entitled to adequate protection for the debtors’ use of their cash collateral. However, Judge Wiles would not approve the motion at the first day hearing, stating that the debtors had not shown that they needed to use cash collateral because of the amount of unencumbered cash on hand, and that in any event secured creditors were not entitled to adequate protection, since the interim budget showed that the cash would be used to maintain existing operations, which would only increase the value of the lenders’ collateral, not diminish it.
The various creditor groups argued that the record did show that the vessels are depreciating assets, but Judge Wiles responded, “if you have a vessel that is earning more than its daily expenses, allowing that to continue does nothing but enhance your collateral, it seems to me. And the notion that you should get the benefit of that without bearing any of the costs, strikes me as silly,” adding, “the motion papers are seeking adequate protection for the use of cash collateral, there is nothing in there that gives any indication about the diminution in value of the vessels themselves.”
In the cash management order that was approved by Judge Wiles, cash collateral was limited to the cash that was used to pay expenses to “Authorized Expenditures” of the applicable ship group; “Authorized Expenditures” were defined by certain line items in the debtors’ weekly liquidity reporting to stakeholders. The secured lenders were granted adequate protection claims equal to the total diminution in cash collateral at the ship group after the petition date minus authorized expenditures for such ship group after the petition date, and debtors for specific ship groups were granted superpriority liens in all property of their respective ship group.
Judge Wiles’ final order limited the amount of cash moved out of various entities. According to the order, “No Ship Group may hold a Net Positive Position against the Pool Leader in excess of $25 million at any time,” adding that in order to comply with this provision, the debtors may keep cash at bank accounts owned by a ship group, rather than the pool leader.
The order was approved by Judge Wiles after the debtors removed a provision that called for a section 506(c) waiver.
Diamond Offshore
Diamond Offshore commenced its chapter 11 cases on April 26. Diamond Offshore Drilling, Inc.’s, or DODI’s, prepetition capital structure consisted of a senior revolving credit facility and senior notes, as seen below
Diamond Foreign Asset Co., or DFAC, was the foreign borrower under the debtors’ secured revolving credit facility, and Diamond Offshore Drilling Inc., or DOID, was the U.S. borrower. The facility was guaranteed by DOID and several subsidiaries - Diamond Offshore Services Co., or DOSC, Diamond Offshore Ltd., or DOL, Diamond Rig Investments Ltd. and Diamond Offshore International Ltd. Both DOSC and DOL were subsidiary rig owners. As of the petition date, the debtors also had outstanding $2 billion in senior unsecured notes issued by Diamond Offshore. None of the notes were guaranteed by any of Diamond Offshore’s subsidiaries.
Diamond’s prepetition organization structure is below:
(Click HERE to enlarge.)
Shortly before filing their chapter 11 cases, the debtor borrower entities drew down $436 million in cash under the revolving credit facility, which was secured by a 65% equity interest in debtor DFAC, an internal holdco that had no assets other than intercompany claims, and direct and indirect interests in subsidiaries, including rig-owning subsidiaries DOL, which is a debtor U.K. entity, and Diamond Offshore Drilling Ltd., which is a nondebtor Cayman Islands entity.
Prior to its chapter 11 filing, Diamond Offshore used an integrated cash management system to fund both third-party and intercompany transactions in the ordinary course of business. The cash management system was organized around a foreign cash pool maintained at Diamond Offshore International Ltd., or DOIL, a subsidiary of DFAC, and a U.S. cash pool maintained at Diamond Offshore Finance Co., or DOFC, a subsidiary of Diamond Offshore. DOFC also acted as cash pool leader for DOIL. DOIL is a guarantor of the revolver, but DOFC is not a guarantor. The vast majority of the company’s global drilling operations revenue was sent first to collection accounts held by affiliate parties to drilling contracts and then to concentration accounts with the revolving credit facility lender banks that were held in the name of the applicable cash pool leader.
In the cash management motion, the debtors listed the operating entities that maintained the cash collection account and were also parties to the drilling contract, shown below. Other than Diamond Offshore Drilling (UK) Ltd., or DODUK, these operating entities are rig-owning entities, and none of the entities, including DODUK, guarantees the revolver.
The cash pools funded, among other things, the expenses of operating entities that did not generate sufficient revenue as well as the storage and maintenance costs for inactive rigs. The balance of the company’s revenue was sent to special concentration accounts held by operating entities to pay expenses in local currency. The cash pool leaders also funded the operations of four regional operating groups by distributing funds to regional group operating accounts.
The company also had a cash pool protocol under which each company maintained an aggregate intercompany balance against the applicable cash pool leader and no other company entity. The cash pool leaders also maintained an aggregate intercompany balance between themselves that was adjusted to account for intercompany transactions between cash pool leaders and other company entities. Immediately prior to filing their bankruptcy cases the debtors modified the cash pool protocol by opening new header accounts at a non-lender bank and transferred all of the debtors’ unrestricted cash, including the $436 million drawn down from the revolving facility, from the cash pool leader concentration accounts at the lender banks to new header accounts at a non-lender bank. In addition, one of the header accounts was designated as a segregated account to fund all bankruptcy administrative expenses.
Diamond Offshore’s cash management system is diagrammed below:
Although the debtors did not request cash collateral or DIP financing relief in connection with their chapter 11 filing, they sought protections through the cash management motion, including approval to continue the company’s cash pool protocol, as modified, and to make intercompany transactions in the ordinary course of business. The debtors also sought superpriority claim status for each net positive intercompany receivable owed by one company to another to “ensure that no Debtor or its creditors are unduly prejudiced from ordinary course Intercompany Cash Transactions during the Chapter 11 Cases.” The debtors agreed to continue, consistent with their prepetition protocol, maintaining records of all intercompany transfers.
The revolving credit facility lenders objected, and the ad hoc noteholder group argued that they were oversecured because (i) their claims were structurally senior to all intercompany superpriority claims and (ii) DFAC and its subsidiaries held $224.6 million in cash and possessed substantial operating assets (including drilling rigs and day rate contracts). The lenders sought adequate protection for the alleged diminution in value of their equity resulting from the holdco subsidiaries’ use of cash and assets in the form of (i) superpriority liens and claims for net positive asset transfers from any loan obligor or holdco subsidiary, (ii) payment of prepetition fees and interest, including postpetition interest at the default rate, during the chapter 11 cases, and (iii) payment of professional fees and expenses.
In response, the debtors argued that the lenders’ security interest in the holdo equity represented, “at best, a contingent right to DFAC’s residual value.” They accused the lenders of trying to characterize a share pledge as a “properly perfected floating lien” and seeking relief based on a “substantive consolidation . .. that has not occurred.” The debtors noted that they were “not using, selling, or leasing” the holdco equity and therefore there was “nothing to adequately protect.” The debtors also argued that the lenders were adequately protected because the value of the subsidiaries’ assets exceeded the outstanding balance of the revolving credit facility. An ad hoc group of noteholders joined in the debtors’ response, arguing that the lenders’ requested relief would both “frustrate” the debtors’ ability to conserve cash and limit restructuring “optionality.”
The parties ultimately agreed to restrictions on intercompany transfers, enhanced reporting requirements and adequate protection, in the form of professional fees, for the lenders. The debtors agreed to provide weekly reports of all intercompany transactions and advance notice of (i) any prepetition claim payment greater than $250,000, (ii) the opening or closing of any bank account, and (iii) material changes to the cash management system. The debtors also agreed to maintain minimum balances in each lender account equal to the balances as of the petition date and to obtain a court order before using such sums. The debtors further agreed to refrain from having DOIL make payments on the intercompany DOSC note.
The intercompany protocol was expanded to include all intercompany transactions, not just those settled in cash. The parties agreed to document each intercompany transaction by an intercompany payable or receivable to the extent not settled, to treat the net receivable owed to any debtor entity by a nondebtor affiliate as a claim of the debtor’s estate. Superpriority claim status was granted to any net postpetition receivable owed to a company entity by another company entity. Furthermore, for the purposes of calculating any intercompany superior priority claim, transfers sent to a cash pool leader for the account of a company entity were treated as receivables owed by the cash pool leader to that entity. Finally, the lenders received adequate protection in the form of pre- and postpetition professional fees.
Valaris
Valaris entered chapter 11 on Aug. 20. Similarly to Noble, Valaris’ prepetition capital structure was completely unsecured. The prepetition revolving credit facility, with $551 million principal outstanding at the petition date, is structurally senior to $6.5 billion of senior notes. Valaris plc and Pride International Inc. are borrowers under the prepetition RCF and rig-owning entities throughout the structure provide guarantees to the facility.
As indicated by the summary organization structure below, the senior note obligor entities, with the exception of holdco Valaris plc, do not directly or indirectly own rigs. The summary prepetition organization chart includes color coding that delineates entities that serve as obligors to the respective securities in Valaris’ capital structure:
As seen in the detailed organization structure linked above, Valaris’ rigs are located at entities across the complex. ENSCO Global Ltd., a Cayman/UK entity, holds indirect ownership stakes in all the entities holding legacy Ensco rigs. Rowan No. 1 Ltd., a U.K. entity, holds indirect ownership stakes in all the entities holding legacy Rowan rigs and the ARO Drilling joint venture, with the exception of the Valaris JU-144 jackup rig (formerly Rowan EXL II). While as part of Valaris’ “internal reorganization,” Valaris plc replaced Rowan Cos. Ltd. (formerly Rowan Co. plc) and Rowan Co. LLC (formerly Rowan Co. Inc.) as obligors under the legacy Rowan indentures, the legacy Rowan rigs are located below the Rowan No. 1 entity with the exception of JU-144. The RCF guarantor entities are located beneath both ENSCO Global Ltd. and Rowan No. 1 Ltd.
Below is a list of the RCF guarantors along with their rig ownership and any estimated contract days connected with those rigs:
A rig-level summary of Valaris’ contracts, based on Valaris’ April 22 fleet status report and disclosures made in Aug. 17 cleansing materials, is shown below:
Valaris’ detailed organization structure shows that certain entities charter rigs owned by entities in the structure. For example, the structure indicates drillship DS-12 is owned by Pride Global II Ltd. and chartered by Pride Global II Ltd., Sonamer Perfuracoes Ltd. and Ensco Vistas Ltd.
At the time they filed their chapter 11 petitions, Valaris held approximately $60 million at debtor entities and approximately $115 million at nondebtor entities. Valaris held $45.5 million at a Valaris plc header account and $400,000 at RCF obligor-only entities. As explained in further detail below, the debtors filed a motion for debtor-in-possession financing to be provided by senior noteholders but did not seek immediate approval of the financing because they had sufficient cash to operate during the first month of bankruptcy.
According to Valaris’ cash management motion, Valaris plc and its subsidiaries form a single integrated enterprise and the company utilizes a non-siloed cash management system. Cash receipts from an operating debtor are first deposited in accounts owned by that debtor and then moved to a header or cash pool account owned by Valaris plc. The cash pool account functions as a concentration account, with cash transferred from the cash pool account on an as-needed basis to disbursement accounts to fund enterprise-level and individual debtor expenses.
Pursuant to the cash management motion, the debtors sought authority to continue to operate the cash pool in a manner consistent with prebankruptcy practices. This included authority for Valaris plc to continue to make intercompany transfers to its direct and indirect subsidiaries, including nondebtor affiliates, to and from the cash pool account in the ordinary course to fund operational transactions and intercompany financing and to pay for shared management services. The debtors further requested that each intercompany transfer be granted administrative expense status under Bankruptcy Code section 503(b) but not superpriority status on the grounds that such relief was necessary to ensure that each debtor entity continues to bear repayment responsibility for ordinary course transactions. At the same time, the debtors sought to reserve the right to dispute and claw back or avoid those transactions. The debtors also sought a declaration that any claim secured by right of set-off under Bankruptcy Code section 506(a) would be secured regardless of whether a bank imposes an administrative freeze.
The cash management motion was uncontested and the bankruptcy court entered the interim order proposed by the debtors. The final order negotiated with the unsecured creditors’ committee added protections for creditors. These protections included prohibiting any changes to the cash management system that would have a “material adverse effect” on unsecured creditors, providing advance notice to the UCC of any intercompany transactions in excess of $2.5 million on a monthly basis and any transfers to non-debtor Ensco Services Ltd. in excess of $27.5 million monthly. The order also prohibited the debtors from entering into any intercompany financing transactions with nondebtors without further court order and reserves the rights of all parties to seek to recharacterize any intercompany balance or transaction.
Valaris entered chapter 11 choosing DIP financing provided by noteholders. The revolving credit facility lenders have objected to the DIP motion, arguing that the proposed DIP would provide new-money investors with a “shockingly high return” of approximately $1.13 billion as of the plan’s effective date in return for the $500 million new-money investment. The revolving lenders argue that the debtors unreasonably rejected their own, better revolving DIP facility offer, which had lower interest rates and fees. Furthermore, they argue that tying the DIP facility and RSA together raises a question as to whether the DIP lender parties are trying to lock in a sub rosa plan of reorganization. The revolving lenders add that their proposal is “more consistent with post-emergence precedents” in the industry, such as Noble Corp.’s proposed plan.
Transocean
Following its exchanges earlier this month and in August, Transocean’s pro forma capital structure includes an undrawn $1.3 billion secured revolving credit facility, $3.1 billion of rig-level secured notes and $5 billion of unsecured notes. All of Transocean’s unsecured notes are issued by Transocean Inc. and are guaranteed by Transocean Ltd., while $926 million of unsecured notes are most structurally senior on account of guarantees from three “Mid Holdings” entities, $1.7 billion are next most structurally senior on account of guarantees from three separate holding entities and the remaining $2.4 billion of unsecured notes include no additional guarantees. Below is Transocean’s pro forma Sept. 10 capital structure:
(Click HERE to enlarge.)
Concurrent with the August exchange, Transocean announced the commencement of “a series of internal reorganization transactions involving the transfer of certain assets and liabilities of certain indirect, wholly-owned subsidiaries of Transocean Inc., including the transfer of the harsh environment floaters Transocean Endurance and Transocean Equinox and the indebtedness secured thereby to a newly created indirect subsidiary of Transocean.” An organization structure reflecting these changes is shown below:
Transocean’s $3.1 billion of secured notes are each issued at separate rig-level entities and, with the exception of the 5.52% secured notes due 2022, include guarantees from Transocean Inc. and Transocean Ltd. These notes are secured by assets and earnings associated with individual drilling unit(s) and/or pledges of the equity of entities that own or operate the drillship/rig. Details on the secured notes’ respective obligor entities, collateral and the backlogs attached to the respective rig collateral are shown below:
Similarly, a summary of the RCF obligors, collateral and associated backlogs is shown below. Based on the company’s disclosures, Deepwater Skyros appears to carry the largest backlog at $288 million. Day rates are not provided for Transocean Barents and Transocean Spitsbergen.
Transocean’s four largest publicly disclosed contracts were signed with Shell in 2012, holding July 15 backlog values of approximately $1.32 billion, $1.26 billion, $1.02 billion and $975 million. The largest contract is with drillship Deepwater Poseidon, which secures the 6.875% secured notes due 2027.This maiden contract commenced in September 2018 and expires in February 2028. The second-largest contract is with drillship Deepwater Pontus, which secures the 6.125% secured notes due 2025. This maiden contract commenced in October 2017 and expires in October 2027. The third-largest contract is with drillship Deepwater Proteus, which secures the 6.25% secured notes due 2024. This maiden contract commenced in August 2016 and expires in May 2026. The fourth-largest contract is with drillship Deepwater Thalassa, which secures the 7.75% secured notes due 2024. This maiden contract commenced in July 2016 and expires in February 2026. All four drillships are in the Gulf of Mexico.
Additionally, the company’s rigs Endurance and Equinox, which were recently the subject of the internal reorganization discussed above, benefit from above-market contracts with Equinor. If these entities are no longer indirect subsidiaries of Transocean Holdings, as shown in the organizational chart above, cash generated by these rigs could be transferred to entities that would not be subsidiaries of any of the guarantor entities.
Reorg does not have details on Transocean’s cash management system or the entity location of its rig contracts. However, a cash sweep covenant in all of the publicly available secured note indentures indicates that the company might have the ability to move cash from rig-level entities prior to triggering such cash sweep. If so, the company might not keep substantial amounts of cash at the rig-level entities in excess of operating costs and any amortization reserves. The cash sweep covenants provide that if Transocean’s total leverage ratio exceeds 10x, the company must sweep rig-level cash accounts, such as bareboat and earnings accounts, in favor of the applicable collateral agent. Such cash received in respect of collateral rig drilling contracts in excess of amounts necessary to operate the collateral rigs and to fund debt service reserve accounts is required to be deposited into a pledged earnings account for the benefit of the applicable secured noteholders.
--Paul Gunther, Adam Rhodes, Andrew Swapp, Mark Fischer
Continue reading for the Americas Core Credit by Reorg team's analysis of offshore driller bankruptcy filings, and request a trial to access our coverage of Transocean and other similar situations.
The location of that cash at the time of filing and the composition of collateral packages affect not only ultimate recoveries but also the direction of bankruptcy cases, including the structure of debtor-in-possession financing and cash collateral, raising particularly thorny questions regarding adequate protection.
In this article, we analyze prior and current offshore drilling bankruptcies, with a particular focus on how companies manage cash and the associated cash collateral fights that ensued, with an eye toward potential disputes in current and future cases.
Of particular note, offshore drilling companies preparing for bankruptcy have sought to augment their cash reserves prior to filing. One way drillers have done this is to draw down on existing credit facilities. If those funds are unrestricted, the companies have moved these funds to accounts held at non-lender banks, presumably in order to avoid perfection by control at the lender bank. Where cash would otherwise be tied to certain drilling rigs, contracts and in turn cash flow associated with contracts can be entered into with non-obligor entities, and cash can be moved away from those secured creditors. In addition, debtors may make prepetition modifications to their cash management system to facilitate this process, including the opening of new header accounts into which the unencumbered cash is deposited, modifying the company’s cash pool protocols and funding an administrative account to pay for chapter 11 expenses. If the debtor does not have enough unrestricted cash to operate while in bankruptcy, it will seek to use a lender’s cash collateral or obtain new financing.
In the Pacific Drilling chapter 11 cases, debtholders held security interests in certain cash assets. Secured creditors were denied blanket cash collateral or adequate protection on all organizational cash, since the majority of the debtors’ cash was held at the parent entity and was unencumbered. Cash collateral was limited to transfers to and from operating entities in order to satisfy minimum cash needs.
In Diamond Offshore’s ongoing bankruptcy cases, collateral supporting the prepetition secured RCF - the only secured debt - was limited to 65% equity interest in an intermediate holdco entity. Customer contracts are with debtor entities that own rigs, and therefore the guarantees from rig-owning entities do not include cash generated from contracts. In both the Diamond Offshore and Noble Corp. cases, debtors transferred cash to nonguarantor entities shortly before filing for chapter 11.
In both the Valaris and Noble Corp. cases, neither company entered chapter 11 with secured debt. To date, debtholders in both cases have not yet waged fights at the cash management level. Valaris entered into a commitment for a $500 million DIP with noteholders that revolving lenders object to, and the revolving lenders have offered a competing DIP. Noble Corp.’s proposed plan would allow prepetition lenders to participate in the exit facility and receive a partial cash paydown.
These examples are explained further below. As will be clear, the expectations of secured creditors regarding their ability to maintain control over cash (and thus drive case control via DIP and cash collateral orders) can be frustrated by prepetition reorganization of cash management that can move substantial pools of cash into unencumbered positions in offshore drillers’ wide and unwieldy organization structures.
Transocean, which has not filed for chapter 11 and has not indicated that it plans to, possesses both secured and unsecured debt. In the event of a bankruptcy filing, the company and its creditors may utilize some of the above strategies. As explained below, secured note indentures indicate that the company can transfer cash from its operating entities prior to triggering a cash sweep covenant that requires rig-level entities to sweep cash into accounts pledged to collateral agents. The availability of these transfers means the company might not keep substantial amounts of cash at the rig-level entities in excess of operating costs and any amortization reserves.
Pacific Drilling
Pacific Drilling filed for chapter 11 on Nov. 12, 2017. The company’s prepetition debt was secured by different ships and divided between different ship groups as detailed in the first day filings and shown in the organizational chart HERE. At the time of filing, Pacific Drilling owned seven ships split into three ship groups:
- Ship group A: $1.9 billion of outstanding debt, consisting of a $500 million revolving credit facility, $750 million in 5.375% 2020 senior secured notes and a $750 million 2018 secured term loan. The Ship Group A debt was secured by liens on the following ships: Pacific Bora, Pacific Mistral, Pacific Scirocco and Pacific Santa Ana.
- Ship group B: $661.5 million, split between a commercial tranche which bears interest at LIBOR plus 3.75% and other sub-tranches bearing interest at LIBOR plus 1.50%. The Ship Group B debt was secured by liens on the following ships: Pacific Sharav and Pacific Meltem.
- Ship group C: $498 million of 2017 secured notes that paid interest at 7.25%. Ship Group C debt was secured by liens on the following ship: Pacific Khamsin.
Fewer than 50% of the debtors’ ships were contracted at the time of filing for chapter 11 including two of the debtors’ ships in group A and the ship with the largest contract in terms of length and day rate, Sharav, in group B. Ship group C had no ships working at the time of filing.
As detailed in the initial cash management motion, ship groups A and C were expected to be net cash consumers and ship group B a net cash contributor during the 13-week cash flow period. Specifically, ship group A required $36.1 million, ship group C required $5 million, and the ship group B debtors were expected to generate $36.7 million in cash during the 13 week period.
In order to manage cash flow throughout the organization, the debtors described a cash-pooling system in which cash from each of the ship groups would flow through a pool leader, Pacific Drilling (Gibraltar) Ltd., that would serve as the central intercompany bank within the organization. The debtors disclosed as of the petition date that $250 million in unencumbered cash was held at Pacific Drilling (Gibraltar) Ltd. When funds were received by different entities - whether from drilling contracts, services agreements, third-party and intercompany contracts or otherwise - the debtors transferred such funds from the receiving account, directly or through one or more intercompany transfers, ultimately to the pool leader accounts. A transfer of funds from the pool leader to or on behalf of a cash pool participant created an intercompany loan from the pool leader to such cash pool participant, according to the cash management motion.
Additionally, cash flowed within the ship groups, with the drilling entity often being separate from the entity that borrowed the debt.
The debtors asserted that their business was not conducted “silo-by-silo,” but rather as a single business unit, with no single debtor entity able to conduct business on its own, adding that as such, use of an integrated cash management system is “essential” to the preservation of Pacific Drilling’s value and its ability to operate. The debtors explained that the cash management system was funded not only with cash collateral but also with the over $250 million of unencumbered cash. Although the debtors repeatedly acknowledged that most of their cash on hand was unencumbered, the debtors said they were expected to acquire cash after the petition date that may relate to drillships, contracts or insurance policies that constitute prepetition collateral and therefore requested authorization to use cash collateral acquired after the petition date “solely to the extent constituting Prepetition Collateral …, while preserving their rights and the rights of the Prepetition Secured Parties to contest whether cash acquired by the Debtors after the Petition Date is Cash Collateral.”
The debtors and creditors argued that the secured creditors were entitled to adequate protection for the debtors’ use of their cash collateral. However, Judge Wiles would not approve the motion at the first day hearing, stating that the debtors had not shown that they needed to use cash collateral because of the amount of unencumbered cash on hand, and that in any event secured creditors were not entitled to adequate protection, since the interim budget showed that the cash would be used to maintain existing operations, which would only increase the value of the lenders’ collateral, not diminish it.
The various creditor groups argued that the record did show that the vessels are depreciating assets, but Judge Wiles responded, “if you have a vessel that is earning more than its daily expenses, allowing that to continue does nothing but enhance your collateral, it seems to me. And the notion that you should get the benefit of that without bearing any of the costs, strikes me as silly,” adding, “the motion papers are seeking adequate protection for the use of cash collateral, there is nothing in there that gives any indication about the diminution in value of the vessels themselves.”
In the cash management order that was approved by Judge Wiles, cash collateral was limited to the cash that was used to pay expenses to “Authorized Expenditures” of the applicable ship group; “Authorized Expenditures” were defined by certain line items in the debtors’ weekly liquidity reporting to stakeholders. The secured lenders were granted adequate protection claims equal to the total diminution in cash collateral at the ship group after the petition date minus authorized expenditures for such ship group after the petition date, and debtors for specific ship groups were granted superpriority liens in all property of their respective ship group.
Judge Wiles’ final order limited the amount of cash moved out of various entities. According to the order, “No Ship Group may hold a Net Positive Position against the Pool Leader in excess of $25 million at any time,” adding that in order to comply with this provision, the debtors may keep cash at bank accounts owned by a ship group, rather than the pool leader.
The order was approved by Judge Wiles after the debtors removed a provision that called for a section 506(c) waiver.
Diamond Offshore
Diamond Offshore commenced its chapter 11 cases on April 26. Diamond Offshore Drilling, Inc.’s, or DODI’s, prepetition capital structure consisted of a senior revolving credit facility and senior notes, as seen below
Diamond Foreign Asset Co., or DFAC, was the foreign borrower under the debtors’ secured revolving credit facility, and Diamond Offshore Drilling Inc., or DOID, was the U.S. borrower. The facility was guaranteed by DOID and several subsidiaries - Diamond Offshore Services Co., or DOSC, Diamond Offshore Ltd., or DOL, Diamond Rig Investments Ltd. and Diamond Offshore International Ltd. Both DOSC and DOL were subsidiary rig owners. As of the petition date, the debtors also had outstanding $2 billion in senior unsecured notes issued by Diamond Offshore. None of the notes were guaranteed by any of Diamond Offshore’s subsidiaries.
Diamond’s prepetition organization structure is below:
(Click HERE to enlarge.)
Shortly before filing their chapter 11 cases, the debtor borrower entities drew down $436 million in cash under the revolving credit facility, which was secured by a 65% equity interest in debtor DFAC, an internal holdco that had no assets other than intercompany claims, and direct and indirect interests in subsidiaries, including rig-owning subsidiaries DOL, which is a debtor U.K. entity, and Diamond Offshore Drilling Ltd., which is a nondebtor Cayman Islands entity.
Prior to its chapter 11 filing, Diamond Offshore used an integrated cash management system to fund both third-party and intercompany transactions in the ordinary course of business. The cash management system was organized around a foreign cash pool maintained at Diamond Offshore International Ltd., or DOIL, a subsidiary of DFAC, and a U.S. cash pool maintained at Diamond Offshore Finance Co., or DOFC, a subsidiary of Diamond Offshore. DOFC also acted as cash pool leader for DOIL. DOIL is a guarantor of the revolver, but DOFC is not a guarantor. The vast majority of the company’s global drilling operations revenue was sent first to collection accounts held by affiliate parties to drilling contracts and then to concentration accounts with the revolving credit facility lender banks that were held in the name of the applicable cash pool leader.
In the cash management motion, the debtors listed the operating entities that maintained the cash collection account and were also parties to the drilling contract, shown below. Other than Diamond Offshore Drilling (UK) Ltd., or DODUK, these operating entities are rig-owning entities, and none of the entities, including DODUK, guarantees the revolver.
The cash pools funded, among other things, the expenses of operating entities that did not generate sufficient revenue as well as the storage and maintenance costs for inactive rigs. The balance of the company’s revenue was sent to special concentration accounts held by operating entities to pay expenses in local currency. The cash pool leaders also funded the operations of four regional operating groups by distributing funds to regional group operating accounts.
The company also had a cash pool protocol under which each company maintained an aggregate intercompany balance against the applicable cash pool leader and no other company entity. The cash pool leaders also maintained an aggregate intercompany balance between themselves that was adjusted to account for intercompany transactions between cash pool leaders and other company entities. Immediately prior to filing their bankruptcy cases the debtors modified the cash pool protocol by opening new header accounts at a non-lender bank and transferred all of the debtors’ unrestricted cash, including the $436 million drawn down from the revolving facility, from the cash pool leader concentration accounts at the lender banks to new header accounts at a non-lender bank. In addition, one of the header accounts was designated as a segregated account to fund all bankruptcy administrative expenses.
Diamond Offshore’s cash management system is diagrammed below:
(Click HERE to enlarge.)
Although the debtors did not request cash collateral or DIP financing relief in connection with their chapter 11 filing, they sought protections through the cash management motion, including approval to continue the company’s cash pool protocol, as modified, and to make intercompany transactions in the ordinary course of business. The debtors also sought superpriority claim status for each net positive intercompany receivable owed by one company to another to “ensure that no Debtor or its creditors are unduly prejudiced from ordinary course Intercompany Cash Transactions during the Chapter 11 Cases.” The debtors agreed to continue, consistent with their prepetition protocol, maintaining records of all intercompany transfers.
The revolving credit facility lenders objected, and the ad hoc noteholder group argued that they were oversecured because (i) their claims were structurally senior to all intercompany superpriority claims and (ii) DFAC and its subsidiaries held $224.6 million in cash and possessed substantial operating assets (including drilling rigs and day rate contracts). The lenders sought adequate protection for the alleged diminution in value of their equity resulting from the holdco subsidiaries’ use of cash and assets in the form of (i) superpriority liens and claims for net positive asset transfers from any loan obligor or holdco subsidiary, (ii) payment of prepetition fees and interest, including postpetition interest at the default rate, during the chapter 11 cases, and (iii) payment of professional fees and expenses.
In response, the debtors argued that the lenders’ security interest in the holdo equity represented, “at best, a contingent right to DFAC’s residual value.” They accused the lenders of trying to characterize a share pledge as a “properly perfected floating lien” and seeking relief based on a “substantive consolidation . .. that has not occurred.” The debtors noted that they were “not using, selling, or leasing” the holdco equity and therefore there was “nothing to adequately protect.” The debtors also argued that the lenders were adequately protected because the value of the subsidiaries’ assets exceeded the outstanding balance of the revolving credit facility. An ad hoc group of noteholders joined in the debtors’ response, arguing that the lenders’ requested relief would both “frustrate” the debtors’ ability to conserve cash and limit restructuring “optionality.”
The parties ultimately agreed to restrictions on intercompany transfers, enhanced reporting requirements and adequate protection, in the form of professional fees, for the lenders. The debtors agreed to provide weekly reports of all intercompany transactions and advance notice of (i) any prepetition claim payment greater than $250,000, (ii) the opening or closing of any bank account, and (iii) material changes to the cash management system. The debtors also agreed to maintain minimum balances in each lender account equal to the balances as of the petition date and to obtain a court order before using such sums. The debtors further agreed to refrain from having DOIL make payments on the intercompany DOSC note.
The intercompany protocol was expanded to include all intercompany transactions, not just those settled in cash. The parties agreed to document each intercompany transaction by an intercompany payable or receivable to the extent not settled, to treat the net receivable owed to any debtor entity by a nondebtor affiliate as a claim of the debtor’s estate. Superpriority claim status was granted to any net postpetition receivable owed to a company entity by another company entity. Furthermore, for the purposes of calculating any intercompany superior priority claim, transfers sent to a cash pool leader for the account of a company entity were treated as receivables owed by the cash pool leader to that entity. Finally, the lenders received adequate protection in the form of pre- and postpetition professional fees.
Valaris
Valaris entered chapter 11 on Aug. 20. Similarly to Noble, Valaris’ prepetition capital structure was completely unsecured. The prepetition revolving credit facility, with $551 million principal outstanding at the petition date, is structurally senior to $6.5 billion of senior notes. Valaris plc and Pride International Inc. are borrowers under the prepetition RCF and rig-owning entities throughout the structure provide guarantees to the facility.
As indicated by the summary organization structure below, the senior note obligor entities, with the exception of holdco Valaris plc, do not directly or indirectly own rigs. The summary prepetition organization chart includes color coding that delineates entities that serve as obligors to the respective securities in Valaris’ capital structure:
(A more detailed organizational chart is available HERE.)
As seen in the detailed organization structure linked above, Valaris’ rigs are located at entities across the complex. ENSCO Global Ltd., a Cayman/UK entity, holds indirect ownership stakes in all the entities holding legacy Ensco rigs. Rowan No. 1 Ltd., a U.K. entity, holds indirect ownership stakes in all the entities holding legacy Rowan rigs and the ARO Drilling joint venture, with the exception of the Valaris JU-144 jackup rig (formerly Rowan EXL II). While as part of Valaris’ “internal reorganization,” Valaris plc replaced Rowan Cos. Ltd. (formerly Rowan Co. plc) and Rowan Co. LLC (formerly Rowan Co. Inc.) as obligors under the legacy Rowan indentures, the legacy Rowan rigs are located below the Rowan No. 1 entity with the exception of JU-144. The RCF guarantor entities are located beneath both ENSCO Global Ltd. and Rowan No. 1 Ltd.
Below is a list of the RCF guarantors along with their rig ownership and any estimated contract days connected with those rigs:
A rig-level summary of Valaris’ contracts, based on Valaris’ April 22 fleet status report and disclosures made in Aug. 17 cleansing materials, is shown below:
Valaris’ detailed organization structure shows that certain entities charter rigs owned by entities in the structure. For example, the structure indicates drillship DS-12 is owned by Pride Global II Ltd. and chartered by Pride Global II Ltd., Sonamer Perfuracoes Ltd. and Ensco Vistas Ltd.
At the time they filed their chapter 11 petitions, Valaris held approximately $60 million at debtor entities and approximately $115 million at nondebtor entities. Valaris held $45.5 million at a Valaris plc header account and $400,000 at RCF obligor-only entities. As explained in further detail below, the debtors filed a motion for debtor-in-possession financing to be provided by senior noteholders but did not seek immediate approval of the financing because they had sufficient cash to operate during the first month of bankruptcy.
According to Valaris’ cash management motion, Valaris plc and its subsidiaries form a single integrated enterprise and the company utilizes a non-siloed cash management system. Cash receipts from an operating debtor are first deposited in accounts owned by that debtor and then moved to a header or cash pool account owned by Valaris plc. The cash pool account functions as a concentration account, with cash transferred from the cash pool account on an as-needed basis to disbursement accounts to fund enterprise-level and individual debtor expenses.
Pursuant to the cash management motion, the debtors sought authority to continue to operate the cash pool in a manner consistent with prebankruptcy practices. This included authority for Valaris plc to continue to make intercompany transfers to its direct and indirect subsidiaries, including nondebtor affiliates, to and from the cash pool account in the ordinary course to fund operational transactions and intercompany financing and to pay for shared management services. The debtors further requested that each intercompany transfer be granted administrative expense status under Bankruptcy Code section 503(b) but not superpriority status on the grounds that such relief was necessary to ensure that each debtor entity continues to bear repayment responsibility for ordinary course transactions. At the same time, the debtors sought to reserve the right to dispute and claw back or avoid those transactions. The debtors also sought a declaration that any claim secured by right of set-off under Bankruptcy Code section 506(a) would be secured regardless of whether a bank imposes an administrative freeze.
The cash management motion was uncontested and the bankruptcy court entered the interim order proposed by the debtors. The final order negotiated with the unsecured creditors’ committee added protections for creditors. These protections included prohibiting any changes to the cash management system that would have a “material adverse effect” on unsecured creditors, providing advance notice to the UCC of any intercompany transactions in excess of $2.5 million on a monthly basis and any transfers to non-debtor Ensco Services Ltd. in excess of $27.5 million monthly. The order also prohibited the debtors from entering into any intercompany financing transactions with nondebtors without further court order and reserves the rights of all parties to seek to recharacterize any intercompany balance or transaction.
Valaris entered chapter 11 choosing DIP financing provided by noteholders. The revolving credit facility lenders have objected to the DIP motion, arguing that the proposed DIP would provide new-money investors with a “shockingly high return” of approximately $1.13 billion as of the plan’s effective date in return for the $500 million new-money investment. The revolving lenders argue that the debtors unreasonably rejected their own, better revolving DIP facility offer, which had lower interest rates and fees. Furthermore, they argue that tying the DIP facility and RSA together raises a question as to whether the DIP lender parties are trying to lock in a sub rosa plan of reorganization. The revolving lenders add that their proposal is “more consistent with post-emergence precedents” in the industry, such as Noble Corp.’s proposed plan.
Transocean
Following its exchanges earlier this month and in August, Transocean’s pro forma capital structure includes an undrawn $1.3 billion secured revolving credit facility, $3.1 billion of rig-level secured notes and $5 billion of unsecured notes. All of Transocean’s unsecured notes are issued by Transocean Inc. and are guaranteed by Transocean Ltd., while $926 million of unsecured notes are most structurally senior on account of guarantees from three “Mid Holdings” entities, $1.7 billion are next most structurally senior on account of guarantees from three separate holding entities and the remaining $2.4 billion of unsecured notes include no additional guarantees. Below is Transocean’s pro forma Sept. 10 capital structure:
(Click HERE to enlarge.)
Concurrent with the August exchange, Transocean announced the commencement of “a series of internal reorganization transactions involving the transfer of certain assets and liabilities of certain indirect, wholly-owned subsidiaries of Transocean Inc., including the transfer of the harsh environment floaters Transocean Endurance and Transocean Equinox and the indebtedness secured thereby to a newly created indirect subsidiary of Transocean.” An organization structure reflecting these changes is shown below:
(Click HERE to see Transocean’s detailed organizational structure.)
Transocean’s $3.1 billion of secured notes are each issued at separate rig-level entities and, with the exception of the 5.52% secured notes due 2022, include guarantees from Transocean Inc. and Transocean Ltd. These notes are secured by assets and earnings associated with individual drilling unit(s) and/or pledges of the equity of entities that own or operate the drillship/rig. Details on the secured notes’ respective obligor entities, collateral and the backlogs attached to the respective rig collateral are shown below:
(Click HERE to enlarge.)
Similarly, a summary of the RCF obligors, collateral and associated backlogs is shown below. Based on the company’s disclosures, Deepwater Skyros appears to carry the largest backlog at $288 million. Day rates are not provided for Transocean Barents and Transocean Spitsbergen.
(Click HERE to enlarge.)
Transocean’s four largest publicly disclosed contracts were signed with Shell in 2012, holding July 15 backlog values of approximately $1.32 billion, $1.26 billion, $1.02 billion and $975 million. The largest contract is with drillship Deepwater Poseidon, which secures the 6.875% secured notes due 2027.This maiden contract commenced in September 2018 and expires in February 2028. The second-largest contract is with drillship Deepwater Pontus, which secures the 6.125% secured notes due 2025. This maiden contract commenced in October 2017 and expires in October 2027. The third-largest contract is with drillship Deepwater Proteus, which secures the 6.25% secured notes due 2024. This maiden contract commenced in August 2016 and expires in May 2026. The fourth-largest contract is with drillship Deepwater Thalassa, which secures the 7.75% secured notes due 2024. This maiden contract commenced in July 2016 and expires in February 2026. All four drillships are in the Gulf of Mexico.
Additionally, the company’s rigs Endurance and Equinox, which were recently the subject of the internal reorganization discussed above, benefit from above-market contracts with Equinor. If these entities are no longer indirect subsidiaries of Transocean Holdings, as shown in the organizational chart above, cash generated by these rigs could be transferred to entities that would not be subsidiaries of any of the guarantor entities.
Reorg does not have details on Transocean’s cash management system or the entity location of its rig contracts. However, a cash sweep covenant in all of the publicly available secured note indentures indicates that the company might have the ability to move cash from rig-level entities prior to triggering such cash sweep. If so, the company might not keep substantial amounts of cash at the rig-level entities in excess of operating costs and any amortization reserves. The cash sweep covenants provide that if Transocean’s total leverage ratio exceeds 10x, the company must sweep rig-level cash accounts, such as bareboat and earnings accounts, in favor of the applicable collateral agent. Such cash received in respect of collateral rig drilling contracts in excess of amounts necessary to operate the collateral rigs and to fund debt service reserve accounts is required to be deposited into a pledged earnings account for the benefit of the applicable secured noteholders.
--Paul Gunther, Adam Rhodes, Andrew Swapp, Mark Fischer
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