April 9, 2020
By Paul D. Bradford and Merrill E. Jones
Because the upcoming Borrowing Base season promises to be memorable, we wanted to highlight some key concepts related to mortgage and title coverage and Borrowing Base deficiencies.
Required Mortgage and Title Coverage:
Typically, a Loan Agreement requires Borrower to maintain under mortgage properties with an aggregate value not less than a stated threshold. This is most often stated as a percentage of the aggregate present value according to the most-recent reserve report, and is sometimes stated as a percentage of the Borrowing Base.
In addition to the required mortgage coverage, a Loan Agreement often requires Borrower to furnish acceptable title information for properties with an aggregate value not less than a stated threshold.
Mortgage and Title Analysis:
With current oil and gas price volatility and the probable reduction in demand, it is prudent to conduct a mortgage and title analysis in connection with your Borrowing Base redetermination. In this analysis, HFB or Bank would compare the most-recent reserve report to previous mortgage analyses and mortgage filings to confirm which properties are covered by the mortgages. By calculating the percentage of the aggregate present value covered by the mortgages and percentage of title reviewed, Bank can determine whether Borrower is in compliance with the required mortgage and title coverage provisions discussed above or if Bank should require Borrower to mortgage additional collateral.
Additional Mortgages:
If the Mortgage Analysis determines that mortgages on additional oil and gas properties are required, then we may want to expedite the negotiation, execution, and recordation of the additional mortgages and the preparation of mortgage exhibits, so that relevant periods for voiding the new mortgages under applicable bankruptcy and insolvency laws will begin to run. Generally, mortgages recorded within 90 days prior to a bankruptcy filing can be voided as a preference. There are also circumstances under state and federal bankruptcy law where additional mortgages granted while insolvent within the prior one or two years could be voided as fraudulent transfers. Because of these time periods, we would typically focus efforts on getting additional mortgages filed and conduct title review afterwards.
If a Borrowing Base deficiency exists or is threatened, Borrower may be willing to mortgage additional collateral above the required threshold to provide some cushion. Bank should consider requiring a higher percentage as a condition for any forbearance or waivers.
Borrowing Base Deficiencies:
The recent decline in commodity prices and corresponding changes to the Bank’s price decks may give rise to a Borrowing Base deficiency.
If Bank declares a Borrowing Base deficiency under the Loan Agreement, Borrower would be required to remedy the deficiency pursuant to the specific elections under the Loan Agreement. These elections often include lump sum payment, installment payments over three to six months, or mortgaging additional collateral acceptable to Bank. A Borrowing Base deficiency often has implications for the Borrower, such as a higher interest rate until the deficiency is cured and limitations on distributions.
An alternative to a Borrowing Base deficiency to consider is imposition of a monthly commitment reduction. One advantage is that monthly commitment reductions may allow a Borrower to work its way back to a conforming Borrowing Base without a deficiency or event of default being declared. A deficiency or event of default would have to be noted by the auditors in audited financial statements and could have adverse consequences under an equity commitment.