Oil & Gas Distress Drives Dispute Upswing: Industry stress increases demand for aligned sector and legal expertise

Tuesday, October 4, 2016 - 15:14

Facing significant global pressure, the oil & gas industry is experiencing increased litigation and arbitration, along with substantial restructuring activity and transactions involving non-core assets. Stewart Perry, an insolvency and reorganisation specialist with Clyde & Co, and Diane Hughes, who specialises in forensic accounting and litigation support at AlixPartners, recently discussed the current landscape in the oil & gas sector and beyond. Their remarks below have been edited for length and style.

Perry: I know you have a large team of advisers focused on the oil & gas sector at the moment. What are they mostly engaged on?

Hughes: My colleagues are engaged in a wide range of activities in this sector. Whilst the oil price hit a seven-month high this month, there is little optimism for the rest of 2016 and, therefore, much continued uncertainty across the value chain. Company side, we are advising on cost-structure improvements, whether through operating and overhead cost reduction or procurement and outsourcing strategies. We are also seeing transaction activity, in particular selling out of noncore businesses. Another busy area is disputes. It is hard to discern trends, but certainly parties appear in general to be seeking to avoid obligations, resulting in claims through both litigation and arbitration.

Perry: We’re busy in those areas, too, especially the disputes work. Have you noticed a significant increase in requests for forensic accountants from clients in the sector?

Hughes: We are seeing a rise in companies prepared to contemplate litigation with an early focus on the potential economic benefits. These potential disputes are varied in origin but definitely have been driven by the fact that the sector is stressed. One noticeable feature in the oil & gas sector is that the quantum of damages tends to be a big number. Recently, we’ve been engaged in several investment treaty arbitrations. These have been related to situations in countries in Eastern Europe, Asia and Africa. I’m sure that you are fully aware that businesses in the oil & gas sector are based in, or trade through and with, countries with unstable regimes. Where you have contracts being awarded by governments in these regimes, those contracts are more prone to getting cancelled, simply not honoured or unilaterally renegotiated, particularly if the government suddenly changes. Big sums of money are involved, often because of the large upfront investment required prior to generating returns, and these investors end up as claimants. I think the uptick in arbitration is largely because so many transactions in the oil & gas market are based on cross-border contracts. This is increasingly so because of saturation in national markets. The United States is a good example of this; refineries that traditionally might have just sold in-country have been forced to start trading internationally by virtue of the increase in alternative fuels and the fracking boom in the U.S. The refineries may not have deep experience in international trade. If contracts with new nonlocal partners are not properly honoured, in performance or payment terms, then for the first time, they’ve got international issues.

Perry: In your experience, are the people who are investing in these foreign countries, and the people having to go internationally for the first time, all looking at contracts with arbitration provisions?

Hughes: I believe so, yes. Lately, the disputes in which AlixPartners has been engaged in have been arbitrated. My partners are currently, or have been most recently, involved in arbitrations in London, Paris, Switzerland and Singapore.

Perry: Do you have any advice for arbitrating parties appointing experts?

Hughes: One piece of advice I would offer (uncynically) is that it’s really important to obtain the view of your forensic accountant as early as possible. One of the practical issues that we’ve been experiencing is that we’ve had extremely limited notice on large and complex claims well into the arbitral process. You know, instructions such as, “Can we send you the other expert’s report? We would like your report in three weeks.” I mean, it’s fantastic, and thanks for the work, but I have to tell you that three months’ notice would usually have been really helpful. This is not because we would be working for that whole time but because it allows proper thought to be given to the basis of damages and for the expert to give the party and lawyers appointing him/her an initial steer and a clear scope. The expert might require technical input or documents not readily available. Moreover, sector-specific experts are often independent operators without support who might not have immediate availability to consider the issues.

Perry: I would like that too! Is there anything else you’d suggest?

Hughes: I mentioned just now technical/sector specialists. I think in cases where two experts are needed, it really assists the client from a practical and cost perspective when you have both the industry expert and the numbers expert coming from the same firm. This is because the industry expert you need typically isn’t promoting themselves as an expert for the purposes of dispute resolution. At AlixPartners, our specialist disputes team invests significant time internally bringing our sector expert colleagues up to speed with the outputs required by the legal team. I think that’s quite powerful because oil & gas is one sector that has many different aspects to it and sometimes a dispute can involve a very precise bit of downstream expertise or a very precise bit of refining expertise. The nature of the sector is that most of these experts are not used to producing reports for court and with a view that they can withstand cross-examination, so we can work with them to ensure they fit the bill. Also, liability and damages can be inextricably linked – the very fact that costs have been incurred or losses suffered supports (if only partially) the point that a defendant is liable for the thing that is alleged (acting in bad faith or negligence or motive for breach, etc.). The oil & gas sector is one where joint venture arrangements are common. So, for instance, we may be asked to assist on a claim where one JV partner didn’t keep their side of the deal, and this throws the whole project. It is critical for the claiming party to show that it was reasonable to expect certain outputs from the defending JV partner and to demonstrate how the venture would have operated and performed differently had the defending party not ‘let the side down’. The sector and damages experts need to work closely together, often on iterations of expert evidence as factual evidence emerges. You might think that this point applies in all types of dispute, but actually there are an awful lot of disputes that don’t involve an expert in a particular sector – for example, where the pure legal argument, if successful, requires a straightforward damages calculation.

Perry: You mentioned liability claims where one party has failed to perform a duty. Are there any such cases that you are currently working on?

Hughes: Yes, we are currently working on an arbitration in an African country that concerns prospecting for oil & gas. The government of that country refused to pay an oil company that was contracted to prospect in several sites. Obviously, the machinery is phenomenally expensive and after the company completed two of the sites without finding oil, the government refused to pay, claiming that the contractor didn’t go about it properly, and then it disallowed work in the remaining sites. Unsurprisingly, the oil company insists that it did follow the correct processes. So the case has required experts in oil prospecting to determine whether there were any issues on site, etc.

Perry: So, aside from arbitration, what are you seeing in the distressed sphere?

Hughes: Well, it is public knowledge that AlixPartners was appointed in 2015 as administrators of Afren plc. In fact, I understand that Clyde & Co has been writing to us on behalf of its creditors, so I will make no comments on that case. However, I will say that there has been a rise in the number of companies in distress where wrongdoing on the part of directors or employees or advisers becomes apparent. So there are more investigations and more claims, as well as more stakeholders to deal with. Given the jurisdictions I mentioned earlier, the finding of likely wrongdoing presents major challenges for officeholders and, therefore, issues for the creditors: It’s especially challenging to prioritise investigations and claims, particularly when there might also be regulators and law enforcement bodies in different jurisdictions becoming involved and placing information demands on a shrinking team. It is also often the case that the wider knowledge of the alleged wrongdoers can be useful to the recovery of legitimate assets. In long-established large businesses, business practices of old are often entrenched and implicitly accepted even to the detriment of the business. Individual deals are high-value and deal partners may be complicit in side deals. We have seen instances where there is limited awareness that regulations or laws have been breached. Nevertheless, it is frequently the case that key individuals have removed themselves to difficult-to-reach jurisdictions.

Perry: So there’s greater incidence of fraud?

Hughes: It can certainly seem that way. You may be based in a broadly honest regime, but you can’t avoid having to deal with cross-border transactions. And, you know, fraud is very topical isn’t it? What with the Anti-Corruption Summit that took place in London this May and David Cameron’s announcement on the need for foreign companies that own properties in the UK to declare their assets in a public register. Creditors could be tied up for years if they pursue assets and monies in corrupt regimes, but equally they seem more determined than ever to show legitimate cause and apply political pressure. Of course, some might say that considering the risk of fraud is really an investment due-diligence point; yet whilst people might go into these situations with their eyes open, saying, “Well, we’re quite happy to take a massive risk in the portfolio,” it never feels like that when it goes wrong.

Perry: This reminds me of the financial crash in 2008 when everyone actually stopped and realised that the documents they had didn’t really fit the purpose, but it hadn’t been looked at properly for years because no one really thought it was ever going to go bad. You look at these situations now and a lot of this is about how the normal contractual documents between the parties are not really fit for purpose when it comes to an insolvency situation.

Hughes: No, and what I think is interesting in an insolvency situation is that the lawyers and accountants are much more likely to be engaged in something deeply commercial and strategic rather than the formal claims processes – which is equally interesting work for the likes of you and I. You may have two or three things on the go at the same time, which can be amazingly challenging. So you need your advisers to be people who understand, for example, that it might be important to use connections in a particular way, or use the law in a different country, or use a combination of different insolvency options with more traditional routes. Quite often you find that you are up against individuals who are not overtly wealthy but, when you start digging, you find that they are, or indeed vice versa. At the small end of the spectrum, the insolvencies we are seeing are companies that are perhaps the noncritical, or the less critical, suppliers to the oil & gas sector, because they are the ones being cut out by the big players.

Perry: We’re seeing a lot of that too.

Hughes: This point applies in any sector in difficulty. I think it’s easy to forget that when a big company goes into administration, like British Home Stores (BHS) in the UK retail market, it causes a ripple effect – for example, the subsequent collapse of Pretty Polly tights has been blamed on the demise of BHS. So any sector that’s experiencing distress causes associated distress. That would be typically where, in oil & gas, the kind of midmarket and the smaller suppliers are impacted. However, distress can lead to opportunity too. The best parts of businesses go to new owners, and those suppliers that can survive the impact will probably be leaner and have potential to take a greater market share in the future.

Perry: Our M&A team is certainly being kept busy with the number of sales and rationalisations happening, and I think they will only be getting busier. Diane, many thanks for your time and for sharing your insights with us.

Stewart Perry is a partner at international law firm Clyde & Co, where he is a member of the Insolvency and Reorganisation team in London. He can be reached at stewart.perry@clydeco.comDiane Hughes is a London-based managing director in the Financial Advisory Services practice of AlixPartners, a global advisory firm. She can be reached at dihughes@alixpartners.com.