Energy firms’ legal risks rise as oil prices sputter

By Ellen M. Gilmer, Pamela King | 06/24/2015 08:42 AM EDT

Oil and gas companies shielding themselves from the effects of low commodity prices should tread carefully to avoid litigation, energy attorneys warned in recent talks with industry.

Oil and gas companies shielding themselves from the effects of low commodity prices should tread carefully to avoid litigation, energy attorneys warned in recent talks with industry.

While trimming the payroll and cutting other costs may help companies weather the oil price downturn, money-saving missteps could easily land them in court. Houston-based attorneys from Baker & McKenzie outlined the legal risks in a webinar last month, warning of common mistakes financially strapped energy firms make when downsizing and negotiating contracts.

According to partner Brendan Cook, litigation has increased because the oil price slump has spurred investment cutbacks and led to rig shutdowns and canceled projects.


"When people are squeezed and they can’t work it out at the bargaining table, they can’t work it out in the boardroom, you go to the courtroom," he said.

Smaller producers and oil field service companies are particularly at risk, said Natalie Regoli, a partner in the firm’s energy practice, because major companies invest more conservatively and have diverse portfolios.

"Some in the oil field services sector are highly leveraged and servicing their debt, especially after the redeterminations, can be problematic," she said in an email to EnergyWire.

"The lesson is to be more fiscally conservative, but we have to keep in mind that the price decline was very fast and very severe. Even with more fiscal restraint, it would have still been painful."

Now, lawyers like Regoli and Cook are trying to ease the pain for at-risk oil companies by recommending best practices to cut costs without triggering lawsuits. Last month’s webinar was the second such presentation Baker & McKenzie has hosted on the oil price downturn this year, and the Institute for Energy Law has hosted at least two similar events in the past month alone.

Trimming the payroll

One common legal pitfall for struggling companies is employment litigation that tends to follow major workforce reductions.

The outlook for the oil field services sector has been particularly bleak. In the past six months, Schlumberger Ltd. has announced a total of 20,000 cuts. Merging rivals Halliburton Co. and Baker Hughes Inc. have each announced plans to lay off about 10,000 workers.

Experts say those cuts could be a recipe for skyrocketing litigation.

"I know when there’s a layoff because my phone will explode," said Rex Burch, a Houston-based attorney who represents plaintiffs in wage and hour disputes.

One potential target is compensation. Faulty pay practices have long been a sore spot for the energy business, which is facing an ongoing Labor Department investigation into overtime pay violations and misclassification of workers as independent contractors (EnergyWire, Dec. 2, 2013). So far, the probe has resulted in multimillion-dollar back wage payouts to oil and gas staff in New Mexico, Texas, Pennsylvania and West Virginia.

Clients who have just been through a layoff usually don’t know to pursue compensation lawsuits, but they are looking for a way to bridge the financial gap between jobs, Burch said. Wage and hour claims are often the solution: Burch recalled one client who had been offered an $1,800 severance package but who was owed an estimated $40,000 in unpaid wages.

"The termination of somebody’s employment is really a catalyst in a person’s life," said Steve Griffith, a New Orleans-based employment attorney at Baker, Donelson, Bearman, Caldwell & Berkowitz PC. "What we often see is somebody who will walk into a plaintiff lawyer’s office and say, ‘I’ve lost my job. Do I have any options?’ And they’ll brainstorm."

In a cyclical industry like oil and gas, Griffith said, laid-off workers typically hope for new job opportunities and seek out work in other industries before seeking legal recourse. The employment laws at play can contribute to further delay. Workers seeking to file discrimination suits must first file claims with the Equal Employment Opportunity Commission, and workers alleging wage-and-hour violations under the Fair Labor Standards Act have a three-year statute of limitations to file suit.

"The longer that somebody’s out of work, the more desperate they may become and the more likely it is that they’ll go see a lawyer," Griffith said.

According to Emily Harbison, a labor and employment attorney at Baker & McKenzie, companies make themselves vulnerable to lawsuits when they perform layoffs too quickly and fail to consider whether their choices are based on discriminatory factors.

Instead, she said, firms should develop and rely on objective criteria, including performance ratings, disciplinary action, attendance, productivity and seniority. Salary can also be a legitimate factor in deciding layoffs, but Harbison warned that some states prohibit its consideration if salary correlates to age — meaning companies should be wary of laying off high-salaried workers if they also represent an older age group.

The best approach? Early planning, she said.

"Some [clients] realize that layoffs may be coming and are trying to position themselves as best as possible by planning ahead and making sure their ducks are in a row," Harbison said in an email. "When downsizing, it’s best to start as early as possible to make sure you are following all federal, state and local requirements."


Energy companies’ various contracts can also become a breeding ground for litigation during an industry downturn, experts say. From service contracts to equipment rental to production agreements, cash-strapped companies often face tough decisions to either meet their end of the bargain, suffer financial penalties or face litigation.

Because rig contracts manage the use of extremely expensive equipment — during the boom, day rates for offshore machines ran as high as $600,000 or $700,000 — long-term commitments serve as a form of collateral, said Ryan Isherwood, a director with Deloitte Consulting LLP. But since rental rates are influenced by oil prices, producers are sometimes locked into agreements that become unaffordable during a downturn.

Some contracts include provisions that allow operators to buy themselves out at a stiff penalty, which can be a godsend at a time when U.S. energy producers have cut 995 rigs in the past year, according to Baker Hughes data. During its fourth-quarter earnings call, Apache Corp. announced that it had chosen to shut down some rigs under long-term contract, incurring early-termination fees of about $50 million.

In cases where those clauses haven’t been pre-determined, the parties can still broker a new rate, Isherwood said. So far, he added, operators and suppliers have taken a collaborative approach to those negotiations.

"It’s a tough dance," he said.

But companies on either side of the contract tend to allow for wiggle room in contracts during a market slump, Baker & McKenzie’s Cook said, because they want to avoid costly litigation.

That’s been true for Mike Knapp, vice president of land for MDS Energy Ltd. His small, Pennsylvania-based firm drills wells for some larger companies in the state and hasn’t faced pressure to meet rigid contract terms during downtimes.

"Working with some of the larger companies that we do, they don’t beat us up too much when times are lean, and we don’t gouge them when times are good," he told EnergyWire, adding that the larger companies would prefer that contractors can afford to keep more experienced workers and keep up with maintenance because those factors ultimately save money by reducing downtime.

"In the end, they realize they save more money and have less headaches," he said. "We’re lucky to work with people that realize that. Others are not so lucky."

Companies are also getting savvier in their contract negotiations by not overcommitting resources, Isherwood said.

"As industry gets smarter over the years, the way they overshoot tends to become less extreme," he said.

To further protect themselves, Cook said oil and gas companies should draft alternative dispute resolution clauses that force both parties to sidestep the courtroom. Arbitration is typically much cheaper than litigation and gives the parties more control over the timetable.

"You’re either going to have to work something out … if you get backed into a corner," Cook said. "Otherwise, you’re going to be talking about the B word: bankruptcy."