By: Gary Quinnett/Attorney & Counselor at Law
March/April 2010

Something about this subject touches the primitive mind. We take it personally when people owe us money. By the time a client comes to me for help in collecting the debt, promises of payment have been made and broken, and my client is frequently more than a little upset about it. 

How damaging is a bad debt to your P&L? Suppose that you are unable to collect on a $50,000 debt. It requires $250,000 in sales revenue to offset that loss, assuming a 20 percent margin.

In this article, I’ll suggest some tips on how to avoid this unpleasantness. But first, let’s take a look inside the mind of Dave T., the CEO of a small independent oil and gas company.

Suppose that Dave is facing a revenue shortfall. Before deciding which bills get paid, he may start to wonder if he should file for bankruptcy. He can file Chapter 11, write off all or nearly all of his unsecured debts (debts that are not secured with collateral),re-negotiate the terms of his secured debt, and emerge in 12 months or so with a healthy balance sheet.It’s true that bankruptcy doesn’t have the social stigma that it once had; however, Dave decides to temporarily shelve the idea of filing.
Next, Dave looks at his bank accounts to determine whether he can reposition some funds; (i.e., rob Peter to pay Paul). For example, can he move funds from a drilling account to an operating account? While this might seem appealing at first glance, many stateshave laws that impose civil and criminal penalties for it. Nevertheless, some businessmen decide to take this route.

With all of this in mind, Dave decides to triage his bills into three “buckets”:

Suppose that you are unable to collect on a $50,000 debt. It requires $250,000 in sales revenue to offset that loss, assuming a 20 percent margin.

Bucket 1: Bills that must be paid in the entire amount for the month. These bills include royalties, utilities, rent, remaining wages (after any layoffs), and payments on a note that is secured by a production mortgage. Also, Dave will pay off liens and judgments.

Bucket 2: Bills that will be partially paid for the month. Dave owes a drilling contractor $100,000. Since the contractor has unique technology for horizontal wells, Dave wants to preserve the relationship. He will have his CFO call the drilling contractor and promise $10,000 payments for the next 10 months. Dave instructs the CFO to promise more work to the contractor if he agrees to the compromise.

Bucket 3: Bills that will not be paid this month. Most of the bills from energy service companies are in this bucket. Dave will instruct his staff not to accept or return calls from these companies if they inquire about payment — he reasons that he can always replace these vendors down the road.
Dave’s story is fictional, but I’ve seen it play out many times. As you work to get your invoices paid, be mindful of three goals: (1) preserve the business relationship with the debtor if at all possible, (2) stay out of court, and (3) use tools that remain viable even if the debtor files for bankruptcy.

Tip 1: Know the oil and gas well lien. In my experience, nothing will make the debtor cry “uncle” faster than a properly filed oil and gas well lien.
In most states, liens are available to operators, contractors and subcontractors who performed work on, or furnished machinery or supplies for a well or pipeline.

Why is the lien so powerful? First, the oil and gas well lien converts unsecured debt into secured debt. With a properly filed lien, you now have collateral in the well on the leasehold. You have a superior position relative to other creditors and are therefore less vulnerable to harm caused by the debtor’s potential bankruptcy.

Second, it constrains borrowing on the part of the debtor. Banks and other lenders require that wells remain free of all liens. If a loan is in place and a lien is subsequently filed on the debtor’s collateral, the debtor is in default, subjecting them to summary foreclosure. In addition, if the operator seeks a new loan, the lender will require that all liens are cleared.

Finally, liens apply pressure by suspending production payments to the debtor. Frequently, oil and gas purchasers will suspend payments — up to the lien amount — until the lien is released; in the majority of cases, this suspension of funds provides sufficient “motivation” for payment of the debt.

While the oil and gas well lien is a powerful tool, there’s a catch: you must file your lien statement within the required filing period.

What if the debtor files bankruptcy before you file a lien? Once a bankruptcy petition is filed, the general rule is that all efforts to collect the debt must stop. However, so long as the filing period has not expired, the bankruptcy court may make an exception and allow you to file the lien after the bankruptcy process started.

What if the time to file a lien has expired? You likely have a breach of contract action available, so long as the debt is not protected by the statute of limitations.

Once a lawsuit is filed, typically one of two things will happen as long as the debtor does not file a bona fide counterclaim: either the debtor will attempt to settle for less than the amount owed, or they will simply not answer and you will be awarded a default judgment.

After you prevail in court, you can then garnish the debtor’s property held by others, including debtors’ bank accounts and monies held by the oil and gas purchaser. Other remedies available include asking the sheriff to seize and sell assets to satisfy the judgment, or the filing of judgment liens.

The oil and gas well lien is not always available because of the nature of the agreement. Suppose that you sell oilfield pipe equipment to an operator, and that operator uses the equipment in the company yard, rather than on a well or pipeline. In these cases, you have other liens available to you (such as the UCC lien).

A final note about liens: recently, operators and contractors have been revising their master service agreements (MSAs). Pay special attention to the negative lien clause, which is an MSA provision that prohibits liens by contractors and subcontractors. On one hand, the operator wants to negotiate a broad negative lien clause. On the other, the contractor or subcontractor wants the ability to file the lien should the occasion arise. At the end of the day, the party that has the most bargaining power will gain the upper hand.

Tip 2: Be deliberate about your credit policy. Unless you require 100 percent up-front payment, then you will need to extend credit. Remember to have a written policy that your staff understands and implements. Such a policy should identify risky agreements and mitigate risk wherever possible, using tools such as partial up-front payments and personal guarantees.

If the payment due date comes and goes without payment by the customer, then start your collection efforts right away. For example, AT&T sends me an electronic notice 5 days before a payment is due. Have template letters formatted for mailing at 5, 30 and 45 days past the due date.

At some point, someone from your company should call the debtor. One goal of that initial conversation is to affirm the debt. In other words, your staff member will want to ensure that there is no bona fide reason for non-payment, such as a real problem with your product or service. 

It is also crucial to memorialize everything. Write a note to your file any time you speak with a debtor that includes the five Ws: who, what, when, where and why. Also, send a letter to the debtor after every meaningful conversation. Something like, “as we discussed, you agreed to send us $5,000 now and the remaining balance in 30 days.” Suppose that your customer owes you $50,000. Further suppose that your good friend the oil and gas well lien cannot help you since the debt is 12 months old.

In order to avoid a breach of contract lawsuit, the debtor agrees to sign a promissory note, which provides for regular monthly payments on the principal and interest. A shrewd business owner will also require a “confession of judgment clause” in the note as an enforcement tool, which allows your attorney to appear before a judge and secure a judgment without filing a lawsuit.

Tip 3: Draft agreements that include all the material terms. Many companies use an informal, written proposal that acts as a contract. Your proposals, at a minimum, should state:

Dates — the date the offer is delivered to the customer, the date the offer ends, and the date the offer is accepted.

Signature, printed name, and title of person that is accepting the offer.

Interest rate of orders more than 30 days past due.

Return policy, including a restocking fee.

Lease name and legal description (including section calls).

Some debtors require gentle prodding, while others simply will not act until muscle is applied. In either case, there are tools to help you, ranging from the gentle (demand letter) to the coercive (involuntary bankruptcy). It is important that you retain legal counsel that knows best how to defend your interests should such a situation arise.

About the Author: Gary Quinnett has a long history in the oilfield, beginning with a landman position in 1982. He holds a law degree and business degree from the University of Oklahoma. You can reach him at (405) 312.1331 or gary@GQ-law.com or www.oilfieldlawyer.biz.