Distressed Coal—Will the Cycle Ever Turn?
Unprecedented Challenges for the Coal Industry
As evidenced by the recent spate of coal mining companies filing for bankruptcy protection (e.g., Alpha Natural Resources Inc., Patriot Coal, Walter Energy Inc., James River Coal Co., Trinity Coal Corp., Americas Energy Co., Clearwater Resources LP and Consolidated Energy), the coal mining industry is facing a period of historic stress. Although coal's preeminence as a fuel source has been declining for more than 150 years, a confluence of recent factors has contributed to a likely unprecedented level of difficulty in this industry. These factors include: (i) increasing competition from energy sources that can be used as an alternative to coal; (ii) implementation of new environmental regulations; (iii) decreasing global demand for coal caused, in part, by the economic slowdown in China; (iv) decreasing institutional investment in the coal industry due to corporate responsibility initiatives relating to environmental concerns; and (v) legacy employee and retiree pension and health care costs. Considering the forgoing factors, it is not surprising that the price of coal has dropped dramatically, falling more than 70 percent in the past four years.
However, it may be too soon to write the final obituary for coal mining companies. Coal, even in long-term decline, will almost certainly continue to supply a critical component of the world’s energy needs for many years to come. Therefore, there are reasons to be relatively optimistic that distressed coal mining companies can be successfully restructured and possibly even provide interesting investment opportunities. That being said, the futures of coal companies are particularly difficult to predict given the uncertainty as to where the price of coal and commodities in general will be over the next couple of years. Given the challenges surrounding the coal industry, it is particularly important that lenders to and investors in coal companies are familiar with both the common bankruptcy and restructuring issues as well as issues specific to the coal industry, as outlined below.
Specific Employee Health Issues
In addition to the employee and retiree obligations and regulations that need to be considered when dealing with the restructuring of any corporation, coal mining companies are subject to additional healthcare obligations and regulations that may add additional costs to a coal company's restructuring. The Coal Industry Retiree Health Benefits Act of 1992 (the Coal Act) requires most coal companies to contribute to a national health benefit fund that provides financial support to cover certain retired employees’ health costs. The Federal Mine Safety and Health Act of 1977 (the Black Lung Act) permits certain coal miners affected by pneumoconiosis (black lung disease) to file claims with the Division of Coal Mine Worker’s Compensation of the Department of Labor. If the Department of Labor determines that the claim is valid, it will attempt to hold the respective coal company responsible. If the company is in bankruptcy, a trust established by the Treasury Department will pay the benefits and costs to the employee and will seek reimbursement from the company’s bankruptcy estate. Whether or not a court authorizes a coal company to reject or modify its Coal Act and/or Black Lung Act obligations is a fact-driven question that will vary on a case by case basis.  Obligations under these statutes can be sizeable and have the potential to dwarf other unsecured claims that may jeopardize a coal company’s ability to reorganize. Additionally, these obligations may complicate a restructuring by adding a number of additional constituencies to the process.
Effect of Environmental Regulations on Coal Bankruptcies
Restructuring coal mining companies often gives rise to conflicts between the goals of the Bankruptcy Code and the enforcement of numerous environmental laws that are applicable to these companies. While a key purpose of bankruptcy and restructuring is to provide the debtor company with the opportunity for a fresh start by leaving many of its prior obligations behind, modern environmental law aims to prevent and remediate environmental harms often by holding companies accountable for prior acts. The federal government’s interest in environmental remediation has resulted in the promulgation of provisions in the Bankruptcy Code exempting government-mandated environmental cleanup actions from the automatic stay, thereby excusing certain environmental liabilities from being discharged. This creates uncertainty as to whether a mining company in bankruptcy can sell assets free and clear of environmental and other potential successor liabilities. Since the actual coal mines often require enormously costly environmental cleanup, it is imperative to understand what, if any, of these liabilities remain attached to the mines after a restructuring.
One area of environmental regulation of significant concern to coal mining companies is bonding and self-reclamation. Pursuant to federal, state and local laws, a company engaged in coal mining must restore its mined land to its natural or economically usable state (a Reclamation Obligation). Individual state laws typically require coal companies to post collateral to secure their Reclamation Obligations. Some states permit companies to forgo the requirement to post collateral necessary to satisfy their Reclamation Obligations if the company is able to meet certain financial and liquidity tests. The rationale for this exception, referred to as “self-bonding,” is that a healthy coal company does not present a significant risk that it will fail to satisfy its Reclamation Obligations. While a company’s ability to self-bond will increase its liquidity and profitability during positive economic circumstances, when a company becomes distressed, it is likely no longer able to satisfy the applicable state’s self-bonding requirements. Furthermore, states with significant mining activities may take defensive actions to limit self-bonding even before a bankruptcy filing. While potentially important to protect the environment, the inability to self-bond will put increased pressure on the balance sheet of already stressed coal companies by forcing them to purchase a bond from an outside source.
Security Interest and Lien Analysis
The perfection of security in a coal company's natural resources can be complicated, and perfection documentation is often extensive. Financing of coal companies often includes complex and detailed mortgages on the various mining and commodity operations. Furthermore, a coal company will often have mines across multiple states, each of which has its own local laws pertaining to the perfection of a security interest. Lenders to a coal company should be sure to conduct satisfactory diligence relating to the forgoing matters. Additional diligence of collateral may also include determining (i) whether the lender has a lien on the borrower’s cash prior to an occurrence of an event of default (i.e., a deposit account control agreement); and (ii) whether the borrower’s debt is subject to springing liens upon the occurrence of an event of default.
Springing liens are a component of security interests worthy of particular diligence since they provide that the lender will be entitled to a lien on certain collateral upon the occurrence of a specific triggering event. For example, a loan agreement may include a springing lien that causes a lien to be placed on the borrower’s assets if certain events of default occur (e.g., a credit rating falls below a specified level or a leverage ratio rises above a certain level). Springing liens have the ability to change the lien coverage of a loan obligation radically by either increasing the related security package if the loan receives the benefit of the new lien or inversely causing the loan to only have a second lien behind other obligations benefiting from the new lien. Note that a springing lien that is implemented in close proximity to the date of a bankruptcy filing risks being challenged as a preference and potentially as a fraudulent conveyance.
Another related concern is springing maturities that contributed to Quicksilver Resources' (Quicksilver) filing for bankruptcy protection. Quicksilver's combined credit agreements provided that the company had to refinance its senior subordinated notes by January 2016 to avoid triggering the early maturity of its second-lien term loans that were otherwise due in 2019. The combined credit agreements additionally provided that if the second lien term loans were to mature, a springing maturity on senior revolving loans would mature as well. After unsuccessfully trying to restructure outside of court, Quicksilver filed for Chapter 11 bankruptcy protection on March 17, 2015.
Another consideration for coal company lenders to contemplate is the complication of potential debt-for-equity conversions as the outcome of a restructuring. Both a bankruptcy process as well as an out-of-court restructuring often result in the debt of the debtor being converted into equity of the debtor or that of a new company holding the prior company’s assets, resulting in the creditors functionally owning the company.
Although control of the equity may be an investor’s desired outcome, there are potential pitfalls to such an arrangement, particularly with regard to a coal mining company. Given the highly regulated nature of the coal mining industry, lenders need to be familiar with all regulatory approvals relating to ownership of a coal company.
Additionally, lenders in a potential debt-for-equity conversion scenario should be aware that even if the bankruptcy process successfully expunges all liabilities associated with the company, new liabilities (including those that are specific to the coal industry) are likely to accrue starting immediately after the bankruptcy plan becomes effective. It is therefore vital that significant equity holders of a coal company utilize limited liability vehicles that are effectively structured to shield the investors from liability.
Master Limited Partnerships
Although not very common in the coal industry, many energy companies, including some coal companies, utilize master limited partnerships (MLPs) in their corporate structure. MLPs are publicly traded investment vehicles that provide certain tax benefits and generally a high yield to their investors. A company's utilization of the MLP structure may implicate various additional restructuring issues, such as ascertaining that the assets were properly transferred to the MLP and potential claims of MLP shareholders. For further information on this topic, please see "The Price of Oil and the Potential for MLP Restructurings and Insolvencies."
The distressed trading of a coal company's debt on documentation published by the Loan Syndications and Trading Association may involve the buyer's reliance on its seller’s predecessor purchase agreement (an "upstream agreement"). While not unique to the coal industry, properly reviewing the terms of upstream agreements, particularly when purchasing from potential insiders, is an important consideration for buyers of distressed coal company loans.
Some companies involved in the coal industry are privately held. Privately held companies generally are not subject to many of the reporting requirements mandated by the Securities and Exchange Commission resulting in less publicly available information. Consideration should be given to what level of additional diligence is required when engaging in transactions with privately held companies assuming the probable lack of publicly available information.
Over the past few years, across all industries, many new credit agreements have tended to return to the type of borrower friendly and lighter covenant protections that were common before 2009. These covenant-light credit agreements may allow the borrower to incur additional secured and unsecured debt that would otherwise be prohibited by a credit agreement with more robust covenant obligations. A company’s ability to incur and layer additional debt is an important concern that should be closely examined by potential investors prior to investing into a particular tranche of an issuer’s debt.
Conclusion—The Future of the Coal Mining Industry
Coal companies seeking to restructure their business, either under the protections afforded by the Bankruptcy Code or out of court, face a series of specific employment, environmental, regulatory and financing issues. Lenders and investors in the coal industry should also take into account the various regulatory issues that are unique to the coal industry.
Although the coal industry is in decline and facing multiple challenges, coal still accounts for approximately 39 percent of US electricity production and even more than that worldwide and will remain a significant economic driver for many years to come. It should be noted that many of the issues facing the coal mining industry today were previously successfully dealt with in other sectors, such as airlines, chemicals and auto parts. However, before that will happen, many of these companies and their lenders will need to go through a potentially painful restructuring process. Through careful analysis and well-executed restructurings, there is likely to be some light for coal companies and their investors at the end of this seemingly dark tunnel.
 See http://www.nytimes.com/2015/07/18/business/energy-environment/coal-miners-struggle-to-survive-in-an-industry-battered-by-layoffs-and-bankruptcy.html?_r=0.
 Recent environmental regulations include: (i) a final rule regulating coal combustion residues which establishes a comprehensive set of requirements for the disposal of coal combustion residuals (aka coal ash) in landfills and surface impoundments; (ii) the Maximum Achievable Control Technology standard (MACT) (which established a more severe set of emission regulations for certain large industrial facilities that are considered "major" sources of hazardous material emissions); (iii) the Cross-State Air Pollution Rule (which requires states to reduce power plant emissions that contribute to ozone and/or fine particle pollution in other states); and (iv) the Clean Power Plan. (President Obama also recently announced plans to reduce carbon dioxide emissions from existing fossil fuel power plants to 68 percent of their 2005 levels by 2030.) See http://www2.epa.gov/coalash/coal-ash-rule;http://www3.epa.gov/airtoxics/112g/112gpg.html; http://www.epa.gov/airtransport/CSAPR/; http://www.washingtonpost.com/news/energy-environment/wp/2015/08/01/what-you-need-to-know-about-obamas-biggest-global-warming-move-yet-the-clean-power-plan/.
 See http://www.businessinsider.com/global-coal-demand-is-slowing-fast-2015-6.
 For example, Norway’s parliament voted to have its $890 billion government pension fund divest many of its fossil fuel investments. See http://www.nytimes.com/2015/06/06/science/norway-in-push-against-climate-change-will-divest-from-coal.html.
 See http://www.wsj.com/articles/met-coal-hits-lowest-price-in-a-decade-1434577741.
 See 26 U. S. C. §9702(a), available at https://www.law.cornell.edu/uscode/text/26/9702.
 See The Federal Mine Safety and Health Act of 1977 (Public Law 91-173, as amended by Public Law 95-164), available at http://www.msha.gov/REGS/ACT/ACTTC.HTM; 26 U. S. C. §9501 available at https://www.law.cornell.edu/uscode/text/26/9501
 For example, a bankruptcy court in Kentucky allowed a coal company to renegotiate its collective bargaining agreement and Coal Act obligations, and authorized the company to reject its collective bargaining agreement obligations and modify its Coal Act obligations. See In re Horizon Natural Res. Co., 316 B.R. 268 (E.D. Ky. 2004). A West Virginia bankruptcy court, also tasked with deciding if a coal mining company could reject its collective bargaining agreement, however, denied the coal company’s request to be authorized to reject its collective bargaining agreement. See Lady H Coal Co., 193 B.R. 233 (Bankr. S.D.W.Va. 1996). The court in Kentucky had found that the coal company’s proposed modification of its obligations satisfied section 1113’s requirements to negotiate with the union in good faith; the court in West Virginia found that the debtor failed to meet the substantive requirements of section 1113 of the Bankruptcy Code and that it was unclear if the proposal made by the debtor to its employees was fair and equitable or negotiated in good faith.
 See In re Distrigas Corp., 66 B.R. 382, 384 (Bankr. D. Mass. 1986) (“On the one hand, bankruptcy’s interest in reorganization and a fresh start …. On the other side is a strong and growing recognition of society’s interest in protecting the environment…”).
 Under section 362 of the Bankruptcy Code, the moment a bankruptcy petition is filed, the automatic stay operates to stay acts to collect any debt owed by the debtor, including actions by creditors, collection agencies, and government entities.
 See 11 U.S.C. § 362(b)(4); U.S. v. Nicolet, Inc., 857 F.2d 202, 207 (1990) (finding that the Bankruptcy Code’s automatic stay exclusions provisions “embody Congress’ recognition that enforcement of the environmental protection laws merits a higher priority than the debtor’s rights to a ‘cease fire’ or the creditors’ rights to an orderly administration of the estate”). See In re General Motors Corp., 407 B.R. 463, 504 (Bankr. S.D.N.Y. 2009) (“Viewed nationally, the case law is split in this area, both at the Circuit Court level and in the bankruptcy courts. Some courts have held that section 363(f) provides a basis for selling free and clear of successor liability claims, and others have held that it does not.”).
 Alabama, Arkansas, Colorado, Illinois, Indiana, Louisiana, Mississippi, New Mexico, North Dakota, Ohio, Pennsylvania, Texas, Utah, West Virginia and Wyoming all permit self-bonding. See http://imcc.isa.us/Self%20Bonding%20Survey.pdf
 In re MPM Silicones, LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).
 See Quicksilver Resources Inc., SEC Form 10Q filing (filed May 12, 2014).
 The Chapter 11 filing automatically accelerated Quicksilver’s obligations under its combined credit agreements but also stayed all collection actions during the pendency of the bankruptcy. See Quicksilver Resources Inc., SEC Form 10Q filing (filed Aug. 10, 2015); In re Quicksilver Resources Inc., Case No. 15-10585.
 See http://www.federalreserve.gov/aboutthefed/fac-20150903.pdf
 See http://www.eia.gov/tools/faqs/faq.cfm?id=427&t=3; http://www.worldcoal.org/resources/coal-statistics/.