Drilling Down on Strategic Alternatives

in the Current Energy Crisis

Part II: Boards of Directors and Corporate Governance April 22, 2015

12:00-1:00 pm Central

WEBINAR SERIES

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Housekeeping Items

• This Webinar is Being Recorded� A recording of today’s webinar will be emailed to

attendees after the webinar. We will also have the recording on our website (www.burlesonllp.com)

� We Welcome Questions� Enter questions into the Questions Pane and we will

respond in the Q&A session at the end

• Think of Something Later?� Email marketing@burlesonllp.com

DISCLAIMER: The viewing of online seminars and the use of the Internet for communications with Burleson LLP, Gibson, Dunn & Crutcher LLP, and OFSCap will not establish an attorney-client or other relationship and messages containing confidential or time-sensitive information should not be sent. In order to protect past, present or potential clients, we cannot treat unsolicited e-mails as confidences or secrets. Nothing contained herein shall constitute legal or other professional advice from, or to create an attorney-client or other relationship with, any of Burleson LLP, Gibson, Dunn & Crutcher LLP or OFSCap. Parties are urged to consult their own advisors for such advice.

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Speakers

Trent Rosenthal | Restructuring & Reorganization Partner – Burleson LLP● Board Certified in Business Bankruptcy Law by the Texas Board of Legal Specialization● Over 3 decades of experience in restructuring and bankruptcy law● Handled numerous oil & gas restructurings and workouts

James (“Jim”) C. Row, CFA | Managing Director & Founder – OFSCap, LLC● Background in energy investment banking (international/domestic)● Securities and valuation expert● Former E&P operator and CFO

Michael Rosenthal | Restructuring & Reorganization Partner – Gibson, Dunn & Crutcher LLP● Co-Chair , Gibson Dunn Global Restructuring and Reorganization Practice Group● Represents debtors/creditors in complex, high profile national & cross-border restructurings and chapter 11 cases● Provides insolvency-related board advice to large public and privately held companies● Experience with corporate separateness and successor strategies and defenses

Rick Burleson (moderator) | Firm Managing Partner – Burleson LLP● Over 30 years experience in the oil & gas industry● Founded Burleson LLP in 2005 with a handful of seasoned energy lawyers. ● Burleson LLP has established a reputation for depth of knowledge and expertise in oil & gas law, and has built

comprehensive capabilities in a range of corporate practice areas

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Agenda

• Fiduciary Duties of Directors, Officers, and Controlling Shareholders• Zone of Insolvency• Strategies to Limit D&O Liability• Special Committees• Practical Advice Under Controlling Law

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Goals

• Give you a better understanding of corporate governance issue facing Officers and Directors today• Highlight specific action items and concerns• Provide practical advice that Officers and Directors

can use every day

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Initial Legal Considerations for Board of Directors

• Hire competent restructuring team• Review organizational and financial documents, including loan

agreements• Review historical operations and expense reduction options• Consider current and near term liquidity requirements• Consider points of leverage with lenders, including leverage

Chapter 11 provides• Obtain debtor in possession financing (if Chapter 11 filing is a

possibility)• Conduct and keep records of board meetings, discussions and

decisions

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Fiduciary Duty - Duty of Care & Duty of Loyalty

• Duty of Care� Directors and Officers must be diligent and informed,

and exercise prudent & unbiased business judgment� Directors are entitled to rely in good faith and with

ordinary care on reports prepared by Officers of the company or outside experts within the area of their expertise

• Duty of Loyalty � Obligates Directors and Officers to act in good faith and

in the best interests of the company, and to deal fairly with the company

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Business Judgment Rule Protection

• Business Judgment Rule� A presumption that in making a business decision the

Directors and Officers of a corporation acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company

� Focused on process, not result� To circumvent the protection of the business judgment rule, a

plaintiff must show that the Directors or Officers breached the duty of care or loyalty, or acted in bad faith

� Only protection for the duty of care

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Business Judgment Standard of Review

• Deference is given to the Directors and Officers if they:� Are interested and independent� Are informed of all material information reasonably available � Act in good faith� Have a reasonable belief their acts are in the company’s best interests

• In Delaware, a court will not substitute its judgment for that of the Board if the Board’s decision can be attributed to any rational business purpose

� Delaware courts have held that action (or inaction) will constitute a breach of the Director’s or Officer’s fiduciary duty of care only if the conduct rises to the level of gross negligence

• In Texas, the business judgment rule precludes judicial interference with the business judgment of Directors and Officers absent a showing of fraud or an ultra vires act.

� In Texas, gross negligence on the part of Directors is not protected by the business judgment rule

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Entire Fairness Test

• Standard for assessing transactions where the business judgment rule is inapplicable• Fair dealing and fair price• Factors considered in assessing entire fairness and

good faith of a transaction:� Adequacy of consideration� Degree to which the Director represented the

corporation� Disclosure to and knowledge of the full board of

directors or shareholders� Necessity of the transaction to the corporation

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Standard of Officers’ Fiduciary Duties

• Could be argued that standard for Officers is more stringent than standard for Directors• Theory grounded in Officers’ intimate involvement in

function and operations of corporation, and first-hand knowledge of business decisions• Officers must exhibit greater care in making a

business decision• Unlike Directors, Officer not entitled to rely on

advice of experts within the sphere of their expertise

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Liability of Controlling Shareholders

• Serving on board of portfolio company presents two sets of constituents to which fiduciary duties are owed – conflicts of interest arise in numerous contexts – at a minimum, entire fairness applies

• Delaware LLCs can limit fiduciary duty• Abstain from certain votes and create special board committees to

evaluate potential conflict transactions• If director breaches duty of loyalty at direction of the controlling

shareholder or sponsor, the shareholder or sponsor may have liability for aiding and abetting the breach

• Controlling shareholders cannot usurp corporate opportunities, ie, proposed activities, in which corporation has ability to engage, related to corporation’s present or prospective business

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Practical Advice for Directors and Officers

• Process used by Directors is important• Directors must spend more time and effort than in

normal times• Events unfold quickly in major restructurings• Opportunities can pass quickly if not acted upon

promptly• Special Board Committees are common and

generally wise• Focus on cash flows and process

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Practical Advice for Directors and Officers

Today vs. 2014• Given current oil and gas prices, does the corporation have the ability

to meet maturing obligations as they come due?• Cash flow is king• The company may not have ability to meet maturing obligations

beyond the immediate time period• Fair Market Value (FMV)

� The FMV of assets today is different� Challenge of FMV� Caution: FMV “Look Back”

• Directors are entitled to rely on advice of experts

Don’t Run Out of Cash!

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How Do Duties Change When Company is Insolvent?• Directors owe fiduciary duty to the entire corporate

enterprise• Directors should act in manner to preserve and

maximize the value of the corporation• When company is insolvent (or, in some states, in

zone of insolvency), creditors as well as shareholders can derivatively (not directly) enforce breaches

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Gheewalla Case: Insolvency is the Test

• Delaware Supreme Court: zone of insolvency is irrelevant• Creditors do not have the right to enforce a board’s

fiduciary duties unless the company is insolvent, not just in the zone of insolvency

� North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007)

• Practice tip: Always prudent to assume when making decisions that court might find the corporation was insolvent because insolvency is determined in hindsight

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Assessing Insolvency

• Equitable Insolvency� Do debt obligations create a foreseeable danger to the

company’s ability to pay those debts as they mature in the ordinary course of business

• Balance Sheet Insolvency� Do liabilities exceed Fair Market Value of Assets

Courts View Insolvency in Hindsight

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Equitable Insolvency – Cash Flow Test

• Reasonable projection of all debt obligations coming due• Reasonable projections of revenue, operating expense,

and capital expenditures• Contingent items like lawsuits• Accounts receivable analysis, write-offs, reputation of

counterparties• Ability to sell assets at what price• Ability to generate additional liquidity through private

investors, public investors, renegotiated debt covenants

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Balance Sheet Test for Insolvency

• All known liabilities according to GAAP as well as probable liabilities• The value of assets determined by:

� Discounted cash flow approach� Value based on comparison with other transactions � The replacement cost approach minus depreciation

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Strategies to Avoid and Defend

• Do not engage in actions that could cause loss of the business judgment rule; if entire fairness applies, Directors have affirmative obligation to demonstrate compliance with fiduciary duties

• Special Committees should be used to evaluate and approve potentially interested/conflicted transactions

• Assume all actions will be scrutinized and second guessed• Focus on process and documentation

� Regular board meetings and updates are essential� Keep minutes� Have active discussion about relevant issues� Receive full reports from management� Assess all potential risks and options

• Establish an early warning system to detect the first signs of financial distress

• Disclose all material facts

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Strategies to Avoid and Defend

• Be sensitive to impact of decisions on creditors and shareholders• Treat similarly situated creditors alike• Pay close attention to transactions with

management and other insiders• Do not unduly delay engaging workout advisors

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Directors - Indemnification and Insurance• Evaluate applicable state law

� Indemnification governed by law of state of incorporation

• Corporation can indemnify for certain acts� Limitations

• Not for breach of the duty of loyalty• Not for the acts or omissions not in good faith, involving intentional

misconduct, or a knowing violation of law• Not for willful or negligent conduct in paying dividends or repurchasing stock• Not for the improper personal benefit or self-dealing• Not for an act or omission for which the liability of a director is expressly

provided by an applicable statute

• Protection through D&O Insurance� Side A coverage is critical

• Contractual indemnity provides additional protection for Officers and Directors

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Take Aways

• Directors should not “swing for the fences” or engage in courses of action that deepen corporate insolvency

• Focus is on “enterprise value” which can only be determined with “input” of realistic forecast

• Fairness Opinions should not rely purely on management projections

• Even wholly-owned subsidiary may require independent financial and legal advisors

• Different and well qualified financial experts may come to widely different valuation opinions

• Remember, financial advisors may need to testify in court• Maintain D&O liability insurance

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Q&A Session• Please Submit Questions via Questions Pane on

Your Screen• Please Be Patient As We Try to Answer All

Questions• Thank You For Attending!

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Join Us For Our Next Webinar…

• Part III: Finding Hidden Value• Wednesday, May 13, 2015• 12:00-1:00 p.m. Central Time• Registration Link:

� https://attendee.gotowebinar.com/register/1706497387608630529

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Contact Information

Rick Burleson [Online Bio]Firm Managing Partner – Burleson LLPPhone: 713.358.1701Email: rburleson@burlesonllp.com

Trent Rosenthal [Online Bio]Restructuring & Bankruptcy Partner – Burleson LLP Phone: 713.358.1724Email: trosenthal@burlesonllp.com

James (“Jim”) C. Row, CFA [Online Bio]Managing Director & Founder – OFSCap, LLCPhone: 713.823.2900Email: jrow@ofscap.com

Michael Rosenthal [Online Bio]Restructuring & Reorganization Partner – Gibson, Dunn & CrutcherPhone: 212.351.3969Email: mrosenthal@gibsondunn.com