Be Careful What You Ask (or Don't Ask) For in Bankruptcy

Bonding companies and debtors can learn an important lesson from the U.S. Bankruptcy Court for the Middle District of Louisiana’s recent opinion on how surety bond claims are treated once a bankruptcy plan is confirmed.

In the case, Falcon V, L.L.C. (Falcon) and its affiliated debtors filed for chapter 11 bankruptcy in May 2019. Falcon engaged in oil and gas exploration and development in Louisiana. Argonaut Insurance Company (Argonaut) issued four performance bonds to fulfill Falcon’s oil and gas lease obligations. Argonaut gave Falcon $10,575,000 in bonding, of which $3.2 million was secured by cash. The key events during the bankruptcy were:

• The court approved Falcon’s request to continue the surety bond program. Falcon noted in its motion that the premiums were needed to preserve the estate.
• The court approved Falcon’s disclosure statement noting that it would continue all bonding currently in place.
• Falcon confirmed a chapter 11 plan that called for it to assume all contracts not yet completed, called executory contracts.
• Argonaut did not object to the disclosure statement nor confirmation of the plan.
• Argonaut filed a proof of claim that it was owed $10,575,000, $3,213,720.55 of it secured by cash and the other $7,361,279.45 unsecured.
• Argonaut's proof of claim recited that the surety bond program was a financial accommodation but reserved its rights with respect to the program’s description as executory contracts.

After emerging from bankruptcy, Falcon made premium payments on two of its four bonds. Argonaut demanded that Falcon either get the bonds released or provide over $7.3 million of added collateral. Falcon said this demand violated the bankruptcy discharge injunction. Argonaut asked the bankruptcy court to order that the surety bond program was an executory contract assumed by Falcon’s confirmed plan. The court denied the motion and made several key holdings:

• The surety bond program is not an executory contract – once Argonaut posted bonds before the bankruptcy case, it owed nothing further to Falcon.
• Even if the surety bond program were an executory contract, it is a financial accommodation (as Argonaut noted in its proof of claim) that cannot be assumed under the bankruptcy code.
• An executory contract that includes a financial accommodation cannot be assumed even if the debtor consents.
• Argonaut’s secured claim for $3.2 million was reinstated, but the confirmed plan did not give Argonaut added security for its claim.
• Argonaut’s unsecured claim for over $7.3 million was disallowed by the confirmed plan because:
  • The claim was contingent.
  • The claim was for reimbursement.
  • Argonaut was co-liable for the amount with Falcon.
• Argonaut’s violation of the discharge injunction was not willful because Falcon’s disclosure statement noted that it planned to maintain the bonds, but the confirmed plan did not do so.

Lessons for Bonding Companies

Surety bond programs offer financial assurance that lease obligations will be performed. These bonds are necessary for oil and gas companies. The bonding company often requires collateral, but most of the time, it’s not up to the full amount of the bonds. Once the bond is posted, the bonding company’s obligations to the debtor are complete.

Surety bond programs are not executory contracts. To protect their interests, bonding companies should be careful of the steps taken in bankruptcy. Here, Argonaut had a secured claim for Falcon’s collateral. Argonaut filed a proof of claim stating as much. Falcon filed a plan that did not give any further security to Argonaut’s claim, and Argonaut did not object. Instead, Argonaut got exactly what it asked for in its proof of claim.

Lessons for Debtors

On the flipside, debtors should be mindful of how they describe future obligations in their disclosure statement. While the confirmed plan controls, a finding of civil contempt for violation of the plan discharge requires “no fair ground of doubt.” Falcon’s statements in the disclosure statement about continuing the surety bond program created such doubt.

Please contact Rick Shelby or any other member of Phelps’ Bankruptcy team if you have questions or need compliance advice and guidance.