O&G: Constellation and Broader Examples

Overview of Brazilian O&G restructurings

As one of the world’s largest and most important industries, oil and gas encompasses an extensive range of activities and businesses relating to resource exploitation, production, refinement, transportation and marketing, in addition to associated onshore and offshore services.

With a growing demand for oil products in the aftermath of the second world war, many countries began to explore for petroleum resources within their own territories to avoid depending on imports of fuel or crude oil. With this need for a greater supply of oil products, Brazil began to scale up its activity in the field of oil and gas.

Although oil exploration dates back as far as the mid-nineteenth century in Brazil, it was only with the founding of state-owned company Petróleo Brasileiro SA – Petrobras in 1958 that this sector became a prominent part of the country’s economy. Petrobras held a monopoly over petroleum in Brazil until 1995, when the introduction of constitutional amendment 09/95 allowed for competition within the sector, resulting in several local and international players focusing on the Brazilian market.

The discovery of pre-salt structures in concession areas in the Santos Basin in 2005 was a game changer for Brazil’s oil and gas industry. Law No. 9,478 allowed the market regulator, the National Petroleum Agency, to open bidding rounds for private companies to exploit Brazilian oil and gas reserves. This, and the positive outlook for domestic oil production, attracted investors and large oil and gas companies^[2] to the Brazilian market.

Despite a promising start with significant investment in the early stages of pre-salt exploration in 2012, the Brazilian oil and gas industry was soon faced with corruption scandals involving Petrobras and other companies in the oil and gas and infrastructure sectors. These allegations led to an anti-corruption investigation known as Operation Car Wash (Operação Lava Jato). Additionally, by 2014, Brazil was experiencing an economic recession, as well as political and social instability.

At the same time, the price of oil began to fall sharply in international markets (the price for the Brent oil barrel dropped from more than US$100 in early 2014 to a range from US$30 to US$50 during 2016).

The combination of the anti-corruption investigation into Petrobras and other companies in the oil and gas sector, the economic crisis, political and social instability and an unprecedented drop in oil prices created a perfect storm.

In these complex circumstances, Brazilian oil and gas companies have started to address the matter of restructuring their debts.

Companies such as OGX Petróleo e Gás Participações (OGX), Sete Brasil Participações SA and Constellation Group filed for judicial reorganisation in Brazil (in 2013, 2016 and 2018 respectively), after unsuccessful out-of-court negotiations and restructuring with main creditors, bondholders and financial institutions. These cases have brought up important discussions relating to Law No. 11,101/2005 (the Brazilian Bankruptcy Law), some of which have led or contributed to a recent amendment to the Brazilian Bankruptcy Law, as described further below.

The leading case filed by Brazilian oil and gas companies involved OGX and was regarded as the largest and one of the most complex judicial reorganisation proceedings at the time. Brazilian courts had to consider legal issues relating to bondholders’ participation and voting at creditors’ meetings, foreign subsidiaries filing for insolvency protection in Brazil and cross-border insolvency proceedings. This case also marked the first time a Brazilian company entered into a plan support agreement (PSA) with its main creditors to provide the framework for a judicial reorganisation and the restructuring of financial debts through an unprecedented debt-to-equity conversion.

Prior to presenting the judicial reorganisation plan, OGX entered into a PSA with (1) bondholders who represented the majority of the outstanding bonds issued by OGX subsidiary OGX Austria GmbH, guaranteed by OGX to the value of approximately US$3.8 billion, (2) OGX’s controlling shareholders, and (3) OSX Brasil SA and its subsidiaries, which were affiliates of OGX (having the same controlling shareholder), and which later filed for their own judicial reorganisation.

As is outlined in the Constellation case, a PSA provides greater certainty in restructurings. It typically establishes that creditors must approve the judicial reorganisation plan to the extent that the plan follows the guidelines agreed in the PSA, which also tends to be viewed positively by the market as a pre-arrangement with the main creditors means a more expeditious approval of the restructuring plan in court. Creditors also benefit from the existence of PSAs, which provide payment terms, interest rates and payment schedules that are applicable for all creditors and more certainty regarding restructuring timelines and outcomes.

Discussions have also raised the matter of the individualisation of bondholder claims and the corresponding right to participate and vote in creditors’ meetings, and the inclusion of foreign entities in Brazilian insolvency proceedings.

OGX’s and Constellation Group’s bondholders faced the issue of individualised bondholder claims, as well as difficulties with segregating their claims to individually participate and vote in creditors’ meetings, rather than being represented by an indenture trustee. Despite a market with increasingly complex financing structures with overseas subsidiaries that involve multiple collateral guarantees and jurisdictions, the Brazilian Bankruptcy Law does not provide for individualisation procedures for bondholders’ claims, leaving the courts to decide on how to implement this.

Additionally, there were previously no provisions recognising foreign proceedings or authorising foreign entities of Brazilian groups to file for judicial reorganisation in Brazil. Oil and gas companies are capital intensive and their financing structures are usually complex and sophisticated, typically involving bonds and asset project finance with offshore structures. This offshore element was a challenge in the restructuring of such companies. Both OGX and Sete Brasil argued that their Austrian and Dutch subsidiaries – created for bonds issuance – should be accepted in judicial reorganisation proceedings.

Initially, the courts denied OGX and Sete Brasil’s Austrian and Dutch subsidiaries the right to file for judicial reorganisation, but these decisions were later overturned by the Rio de Janeiro Court of Appeals. In the latter decision, the court stated that requests for inclusion of foreign subsidiaries should be granted when the group’s centre of main interest (COMI) is in Brazil and when these subsidiaries work only as financial vehicles for the Brazilian parent company, usually for issuing bonds and receiving revenue.^[3]

As well as the legal issues mentioned above, the Constellation case also addressed cross-border insolvency proceedings, a matter not regulated by Brazilian law at that time. Indeed, the recognition of foreign proceedings has been only recently regulated because of the reforms to the Brazilian Bankruptcy Law in 2020, as is explained below.

Constellation Group

When experiencing economic crises, Brazilian companies that have previously issued bonds in international markets may face more complex bankruptcy, judicial or out-of-court reorganisation proceedings. In such a situation, several unprecedented case law issues can arise. These questions were discussed in court during the judicial reorganisation of Constellation Group.

Constellation Group (formerly known as QGOG Constellation) is an oil and gas drilling company, part of a highly integrated and complex corporate structure comprising several different entities across multiple jurisdictions founded by Grupo Queiroz Galvão, one of Brazil’s largest privately held conglomerates, which was involved in the Operation Car Wash investigations.

In light of the crisis in the oil and gas market and the nature of its complex drilling operations, Constellation Group determined that it would need increased financial resources to maintain its operational structure.

The economic recession, political instability and budget deficits affecting Brazil led to a decrease in foreign investment in Brazilian operations. Notwithstanding this difficult situation, Constellation Group managed to raise debt to finance its activities, arising essentially from bank loans and bond issuances, as well as project financing raised by Amaralina Star Ltd, Laguna Star Ltd and Brava Star Ltd.

As a result of this debt raise, Constellation Group’s indebtedness could be summarised as follows:^[4]

• Several banks and financial parties entered into a US$943.9 million secured syndicated credit facility to finance the Amaralina Star and Laguna Star drillships (the A&L Project Loan Facility) and a US$475 million secured syndicated credit facility to finance the Brava Star drillship (the Brava Project Loan Facility: with the A&L Project Loan Facility, the A/L/B Project Financings). The A/L/B Project Financings were governed by New York Law and were secured by mortgages, assignments of certain receivables and other collateral.
• Constellation Oil Services Holding SA issued senior unsecured notes in the amount of US$95.432 million due November 2019 (2019 Notes) and senior secured notes in the amount of US$604.568 million due in 2024 (2024 Notes), both under New York law-governed indentures. The 2024 Notes were secured by mortgages, pledges on certain accounts and other collateral.
• Banco Bradesco SA, Grand Cayman Branch granted advances in principal amounts of up to US$150 million and US$75 million via two unsecured working capital facilities, both governed by New York law.

Given the material indebtedness of the Constellation Group (most of it US-dollar denominated), the ‘perfect storm’ hitting the oil and gas sector in Brazil (as described above) and after an unsuccessful attempt to restructure a portion of its debt out of court (the 2019 Notes were the object of an exchange offer that resulted in the 2024 Notes, but was not sufficient to avoid the filing for judicial reorganisation), on 29 November 2018, Constellation Group negotiated with its main financial creditors and entered into a PSA with the 10 financial institutions involved in the A/L/B Project Financings, and with Banco Bradesco SA’s Grand Cayman branch. The PSA established the restructuring conditions for the financial debt and recognised Brazilian jurisdiction over Constellation Group’s future judicial reorganisation – which was important, given the presence of several offshore entities where most of the debt (and assets) was located – and also agreed with the group’s entities filing for reorganisation in substantive consolidation, which was and still is one of the most polemic subjects in Brazilian reorganisations. The group obtained the support of 48.3 per cent of secured creditors and 60.2 per cent of unsecured creditors.

Aiming to continue its business operations in Brazil, Luxembourg-based holding company Constellation Oil Services Holding SA filed for judicial reorganisation on 6 December 2018 with 17 other Brazilian and foreign affiliates of Constellation Group. The case was assigned to the 1st Business Court of Rio de Janeiro.

Constellation Group requested substantive consolidation, arguing that cross-guarantees and cross-defaults existed in the companies’ debt instruments, and therefore all affiliated companies should be considered a single economic group for restructuring purposes. The request for substantive consolidation was granted for all the entities involved.

The Public Prosecutor’s Office filed an appeal against the decision, contesting Constellation Group’s substantive consolidation. Alperton Capital and PIMCO, which were not parties to the PSA, also filed appeals against the decision.

Alperton Capital, a co-owner of Amaralina Star and Laguna Star (both based in the British Virgin Islands (BVI)), alleged that it owned 45 per cent of both special purpose vehicles (SPVs) and therefore the companies did not have proper corporate authority to file for judicial reorganisation in Brazil. Moreover, Alperton Capital argued a lack of certainty regarding Constellation Group’s COMI and that Brazilian courts did not have jurisdiction over the judicial reorganisation.

Meanwhile, PIMCO challenged the decision granting the judicial reorganisation of foreign subsidiaries in Brazil, reiterating Alperton Capital’s arguments. Furthermore, PIMCO contended that both SPVs were independent companies incorporated abroad with their own assets and operational activities, which was not in line with precedents that granted inclusion of foreign entities that were mere vehicles for issuance of bonds.

The Rio de Janeiro Court of Appeals decided the following:

• three foreign companies (Olinda Star Ltd, Arazi SARL and Lancaster Projects Corp) should be excluded from Constellation Group’s judicial reorganisation proceeding, as they lacked the necessary labour creditors or assets to make them eligible to be debtors in Brazil; and
• the decision whether to adopt substantive consolidation was an economic decision to be made by creditors at the general creditors’ meeting before voting on the plan. In this respect, having the PSA addressing the issue of substantive consolidation and, therefore, already counting on the support of 48.3 per cent of secured creditors and 60.2 per cent of unsecured creditors, was extremely important to Constellation Group.

In February 2019, Constellation Group submitted its amended judicial reorganisation plan, including the PSA that secured its majority support from creditors. The PSA settled the negotiations with commercial banks, export credit agencies and bondholders for the restructuring of Constellation Group’s capital structure.

Although the general creditors’ meeting was initially scheduled for March 2019, it was postponed to June 2019 because of continuing disputes with Alperton Capital and PIMCO regarding the plan and issues around the creditor lists.

PIMCO informed the general creditors’ meeting that its claims were held by 89 individual creditors, all of whom were independent entities. All 89 bondholders represented by PIMCO voted individually against substantive consolidation and the plan’s approval, and Constellation Group was unable to obtain a majority of secured claim class headcount votes.

Despite this setback, the 1st Business Court of Rio de Janeiro ratified the plan, ruling that those 89 votes were abusive and PIMCO should be considered a single voter.

The Constellation Group’s restructuring required a highly coordinated effort. The group filed for judicial reorganisation in Brazil, along with Chapter 15 in the United States Bankruptcy Court and joint provisional liquidation in the BVI.

On 7 December 2018, Serviços de Petróleo Constellation SA commenced the jointly administered Chapter 15 cases, with nine other companies from the group. The companies also sought the United States Bankruptcy Court’s recognition of the joint judicial reorganisation proceedings of each Chapter 15 debtor^[5] pending in the 1st Business Court of Rio de Janeiro. The United States Bankruptcy Court recognised Brazil as the COMI for these companies, except for those previously excluded from the proceeding (Olinda Star Ltd, Arazi SARL and Lancaster Projects Corp) by the Rio de Janeiro Court of Appeals.

On the same day as the Chapter 15 filings, the companies incorporated in the BVI^[6] filed an originating and ordinary application in the BVI Commercial Court under Section 170 of the BVI Insolvency Act 2003. These proceedings were instigated to (1) protect the BVI debtors in that jurisdiction, (2) provide support to the Brazilian judicial reorganisation proceeding pending in the 1st Business Court of Rio de Janeiro, and (3) ensure the successful and global implementation of the Constellation Group’s restructuring.^[7]

Joint provisional liquidators were appointed for soft-touch provisional liquidations of the BVI debtors to represent and protect the creditors’ collective interests – especially during restructuring negotiations – and avoid undue dissipation of debtors’ assets.

As well as the proceeding being recognised in foreign courts, the PSA was essential for the restructuring and the overall success of this case. It involved multiple jurisdictions, banks and bondholders with significant claims, and a commitment from the most relevant creditors to invest in Constellation Group so that it could continue operating.

The out-of-court negotiations prior to filing the proceedings in Brazil, the United States and the BVI allowed Constellation Group to present a viable restructuring plan in court. This also avoided enforcement proceedings for all collateral guarantees governed by New York law granted to the group’s financial creditors and bondholders, which could have worsened its financial situation and resulted in liquidation proceedings.

The outbreak of the covid-19 pandemic and its effect on the oil and gas industry resulted in Constellation Group filing an amendment to its judicial reorganisation plan, which was ratified by the 1st Business Court of Rio de Janeiro in June 2020. Constellation Group informed the court recently of a settlement with creditors to amend certain terms of the judicial reorganisation plan, leading to the suspension of obligations contained in the June 2020 plan.

Lessons from restructuring oil and gas companies

Until the Brazilian Bankruptcy Law underwent reforms in 2020, Brazil had not adopted the UNCITRAL Model Law on cross-border insolvency, having no statutory definition for the COMI. This is crucial for establishing the competent jurisdiction for the main insolvency proceedings of corporate groups that have subsidiaries incorporated in different countries.

Notwithstanding the lack of statutory provisions, the financing structure of the oil and gas companies led the courts to face a factual matter (that the oil and gas companies issued bonds through offshore entities to finance their activities and that drilling units were also incorporated as offshore entities located in more creditor-friendly jurisdictions), ultimately recognising that these entities’ COMI was in Brazil and could therefore be part of restructuring proceedings there.

Even though Constellation Group’s judicial reorganisation was filed before the amendment of the Brazilian Bankruptcy Law, the filing in Brazil allowed foreign companies to seek recognition for the proceeding in jurisdictions with a statutory definition of ‘COMI’. This facilitated uniform rulings and allowed creditors to negotiate and supervise the Brazilian proceeding. This joint effort was crucial for the restructuring of approximately 5.8 billion reais of debt.

Following the case law and ever-increasing globalisation, the Brazilian Bankruptcy Law was amended by Law No. 14,112/2020. Among other changes, it incorporated the UNCITRAL Model Law to recognise foreign insolvency proceedings in Brazil and cooperation between jurisdictions.

The Brazilian Bankruptcy Law adopted the following main principles:

• facilitating foreign representatives’ access to Brazilian processes;
• recognising foreign decisions and the possibility of local courts granting assistance measures via preliminary injunctions or after recognising foreign proceedings; and
• cooperation between courts that have jurisdiction where relevant assets are located, and coordination of competing procedures.

Cross-border insolvency provisions will provide more legal certainty to cases that concern multiple jurisdictions, significant indebtedness and cross-guarantees over different companies’ assets, as the companies’ liabilities will be analysed by the court with jurisdiction over the COMI.

With the incorporation of the UNCITRAL Model Law into the Brazilian Bankruptcy Law and considering the precedents set by the OGX, Sete Brasil and Constellation cases, the COMI is now more clearly defined. These precedents have established that the COMI is where a company conducts its main business activities and where its assets are held. Therefore, merely operating in a given territory – as can happen when foreign companies run offshore drilling operations – is insufficient for authorising judicial protection requests in other jurisdictions.

The reform of the Brazilian Bankruptcy Law has closed legal loopholes and is expected to give both debtors and creditors – especially foreign creditors – more confidence regarding insolvency proceedings in Brazil. However, precedents (especially in the oil and gas industry) have shown that the adoption of the UNCITRAL Model Law was more than a timely measure, but a real necessity for the effectiveness of cross-border insolvency in Brazil.

Another relevant mechanism that Constellation Group employed in its successful judicial reorganisation was entering into a PSA with its main financial creditors to obtain support for the restructuring proceeding. As was also seen in the OGX case, Constellation Group’s PSA established a framework for the group’s restructuring under the judicial reorganisation plan, subject to specific obligations and precedent conditions being met.

Although there is no statutory regulation for PSAs in the Brazilian Bankruptcy Law and notwithstanding disputes regarding their legality (based on the argument that such agreements consist of pre-arranged voting commitments that would arguably be prohibited by the Brazilian Bankruptcy Law), the PSA turned out to be an effective mechanism in both cases. It allowed the companies to reorganise their existing debts, gain support from their main creditors for judicial reorganisation and provide for a more expeditious proceeding in a jurisdiction where reorganisation proceedings regularly last significantly longer than the 180-day period proposed by the legislator.

The Constellation case demonstrates that prior negotiations and mutually agreed terms can lead to successful judicial reorganisation proceedings. It also shows that long, drawn-out discussions that unilaterally impose new repayment conditions on defaulted claims are not required – the plan was confirmed less than a year after the filing of the judicial reorganisation request.

Nevertheless, the legal issue regarding the individualisation of bondholders’ claims and how to count the corresponding votes remains controversial. In this particular case, the 89 PIMCO entities were considered to be a single entity for voting purposes, with the 1st Business Court of Rio de Janeiro disregarding the individual votes, having reasoned that they were abusive.

PIMCO then challenged the court’s decision, alleging that votes were counted individually for each debtor in all other Brazilian judicial reorganisation proceedings involving international bonds. They argued that this happened even when debtors were represented by the same manager, adviser and attorney, as in cases involving Oi, OGX, Tonon Bioenergia and Aralco.

These allegations were also communicated to the United States Bankruptcy Court. In considering the allegations with the pending appeals in Brazil, the court ordered a stay of enforcement for Constellation Group’s judicial reorganisation plan in the United States.

By the end of 2019, Constellation Group and PIMCO reached an agreement, under which PIMCO withdrew all its appeals, opening the way for Constellation Group’s plan to be enforced in the United States. Although a positive step for the Constellation case, the settlement avoided a decision by the Court of Appeals, which could be an important precedent for similar discussions.

Procedures for the individualisation of bondholders’ claims and voting procedures for these investors were not provided for in the Brazilian Bankruptcy Law reform. However, discussions around this theme have been present in cases concerning companies with complex financing structures, such as OGX, Oi, Constellation Group and Samarco. At this point, the rules regarding foreign investors’ individual participation in judicial reorganisations in Brazil are being settled in the courts.

Footnotes