UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ALASKA

Stewart Petroleum Company's motion for sale of property came before the court for hearing on May 7 and 8, 1997. It is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(M), (N) and (O). This court has jurisdiction in accordance with 28 U.S.C. § 1334 and the district court's order of reference. The motion, as amended in the order and judgment entered simultaneously herewith, is granted and the property shall be sold in accordance with the terms of the purchase agreement. This memorandum and the accompanying order and judgment constitute the court's findings of fact and conclusions of law in accordance with Fed. R. Bankr. P. 9014 and 7052 and Fed. R. Civ. P. 52(a).

Background

The debtor, Stewart Petroleum Company, is an independent oil company with three producing oil wells in the West McArthur River Unit (WMRU) located in the Cook Inlet in Alaska. Stewart's operating history and the events leading up to its current chapter 11 status are accurately set forth in the debtor's Fifth Amended Disclosure Statement. They will be briefly summarized here.

Stewart's primary operations involve the development of oil wells in the WMRU. The debtor has leased areas in the WMRU from the State of Alaska and currently has three producing wells located there. These wells have been costly and difficult to develop. There have been numerous unforseen cost overruns, sometimes amounting to millions of dollars. Stewart has been chronically undercapitalized throughout its history due to these overruns and other significant problems, not the least of which is declining oil production.

      4 ABR 530  Stewart has financed its operations by a variety of methods. Stewart sold fractional working interests in the WMRU wells to over 200 different investors. Most of these transactions were not recorded with the Alaska Department of Natural Resources. According to the State, Stewart retains record title to an undivided 60.80125% of the working interests in the WMRU wells, despite the sales. Stewart has managed the wells "in trust" for the working interest owners whose interests were not recorded with the State (the unrecorded working interests). Stewart has also obtained financing through a variety of creative arrangements with Polar Bear Investments, John Blocker and others.

Despite its efforts, Stewart has remained under-capitalized and in constant financial jeopardy. Following the filing of an involuntary petition on September 13, 1996, a stipulated order was entered on October 10, 1996, which allowed Kenneth Battley, an experienced bankruptcy trustee, to become Managing Agent and take control of the debtor. William Stewart, the president and founder of Stewart Petroleum, left the company. A consensual order for relief under Chapter 11 was entered on January 27, 1997. Steven Hartung, a certified public accountant and former Mark-Air executive, joined Battley and was retained as president of Stewart. Hartung has provided the impetus for the sale the court approves today.

Stewart's initial reorganizational efforts were directed toward consideration of the drilling of a water injection well in the WMRU. The possibility of a water injection well was considered by creditors and Stewart's new management because production in the WMRU wells has been in rapid decline and may become unprofitable altogether within eighteen months. Studies were undertaken to consider feasibility of the water injection well. At the same time, Stewart's new management looked for possible purchasers for its holdings in the WMRU. Negotiations with Forcenergy, Inc. (Forcenergy) ensued. Forcenergy, a Florida based petroleum company active in both the Gulf of Mexico and the Cook Inlet, made a promising purchase offer. Its offer forms the basis for the debtor's Fifth Amended Plan of Reorganization and the pending motion for sale. The offer was formally accepted by the debtor on May 6, 1997.

The proposed sale is described in Stewart's Fifth Amended Disclosure Statement. The actual purchase agreement is multi-faceted and       4 ABR 531  complex. Subject to a number of adjustments set forth in the agreement, Stewart will receive up to $23,250,000 for its conveyance of 100% of the working interests in the WMRU wells, as well as Stewart's interest in six non-producing oil and gas leases with the State of Alaska. The purchase price will be adjusted downward should Stewart be unable to convey 100%. For example, under the agreement Stewart would obtain $15,225,000 for a conveyance of 75% of the working interests. The purchase price increases for each percentage above 75% of working interests that Stewart is able to transfer. Forcenergy will pay a premium for the interests if Stewart is able to transfer 100% of the working interests. Thus, it is to Stewart's advantage to transfer the maximum amount of working interests in the WMRU wells.

Stewart is responsible for any "Property Defect" incurred during its operations prior to closing. This term is broadly defined in the agreement. Any condition that could adversely change the value of the property being purchased must be remedied prior to the closing date or the debtor could face a diminution in the purchase price or termination of the purchase agreement. The more quickly the sale closes, the less exposure the estate faces through continued operations.

The debtor offered testimony from a number of witnesses in support of the sale. Paul White, Stewart's operating foreman, has substantial experience both in the oil industry and with the debtor's WMRU wells. He detailed the history of the debtor's development of the wells, including the frequent and costly problems that have been encountered. He pointed out the numerous mechanical risks associated with the wells. These risks can lead to costly repairs and maintenance and, at worst, environmental remediation expenses for spills and pollution in the Cook Inlet. Additionally, White noted the need for capital if Stewart is to continue development of the WMRU, particularly with a possible water injection well.

Conrad J. Perry, a mechanical engineer with 21 years of oil and gas experience, testified regarding the possible development of a water injection well for Stewart. Perry has reviewed Stewart's records for the drilling and seismic information necessary to properly evaluate the viability of such a project. He found Stewart's database insufficient to make such an evaluation. He testified that the cost of       4 ABR 532  acquiring the proper information would be in the range of one to five million dollars. Assuming a water injection well was drilled, it would be expensive and dangerous to develop due to the high angles associated with Stewart's wells. The injection well could be a boon to Stewart, leading to increased production or, alternatively, it could reduce or eliminate current production from the existing wells. Perry estimated the cost of the water injection well to be from $5,000,000 to $7,000,000. He thought that a total of $14,000,000 should be readily available to meet the needs of the project, in case of unexpected problems.

Jonathan Krautz, a petroleum engineer with Huddleston and Company, testified as to his evaluation of the risk-adjusted value of the WMRU development. Krautz adjusted his value for mechanical risks such as pipe corrosion, deviation problems and equipment failures, as well as for problems with the oil structure itself. Assuming that the price of oil was $18 per barrel and based upon Stewart's historic operating costs of $400,000 per month, Krautz found the value of 100% of the WMRU working interests to be $16,795,380 as of January 1, 1997. Since Krautz's calculation in December of 1996, the price of oil has fallen. Based upon Stewart's current net of about $15.07 per barrel, his fair market value appraisal would fall to about $9.06 million.

Steven L. Hartung, the debtor's president, spoke in favor of the sale. Hartung has extensive business experience and has diligently reviewed the debtor's financial status and the prospect of continued operations. After his review, Hartung concluded that Stewart's continued operation of the WMRU wells was not feasible for a number of reasons. First, the debtor has insufficient unencumbered capital to complete a viable injection well. Despite the $4 million bank balance the debtor has on hand, those funds are encumbered and the debtor's alternative collateral is insufficient to provide adequate protection to secured creditors. The debtor does not have access to the capital necessary to continue the project from either existing working interests or other sources. Because confirmation of a plan will be delayed, Hartung supports immediate approval of the sale. Forcenergy has interests in the Cook Inlet that surround the debtor's holdings. Hartung and others, including attorney Stewart Hoge for Ssangyong Oil, have repeatedly       4 ABR 533  attempted to market the debtor's holdings to other parties, without success. Forcenergy has been the only viable purchaser to emerge.

The sale to Forcenergy would create a substantial cash fund to pay Stewart's unsecured creditors and the holders of unrecorded working interests. If settlements with Polar Bear, Ssangyong and John Blocker are approved and all recorded working interests join in the sale, Stewart's unsecured creditors with claims of about $13 million and the unrecorded working interest holders with investments of nearly $17 million could share in approximately $13 million of sale proceeds. The balance of the sale proceeds would be payable to secured creditors, recorded working interests and administrative expense claimants.

Analysis

Notice of Stewart's motion has been adequate and given in accordance with Rules 6004 and 2002 of the Federal Rules of Bankruptcy Procedure. The debtor mailed notice of the hearing on the sale to all creditors and working interests on April 14, 1997. Additionally, the debtor mailed a complete copy of its amended motion for sale and its fifth amended disclosure statement (which contained a draft of the purchase and sale agreement), to the entire matrix. The sale has been exhaustively noticed.

Hearings on Stewart's motion to sell were conducted on May 7 and 8, 1997. While some modification to the terms of the purchase and sale agreement occurred after it was noticed, the completed purchase agreement was circulated among all the parties who attended the hearing. Mr. Hartung testified as to the changes in the agreement. All major interests were represented at the hearing and none objected to the amendments to the purchase agreement.

11 U.S.C. § 363(b) allows the debtor, after notice and hearing, to sell property of the estate outside of the ordinary course of business. 11 U.S.C. § 363(f) allows a sale under § 363(b) to be free and clear of any interest in the property under certain conditions. Under § 363(f)(2), property of the estate may be sold free and clear of any interest in such property if the party holding the interest consents. Here, the bulk of the working interests in the WMRU wells were held in trust by Stewart and not recorded in any manner with the Alaska       4 ABR 534  Department of Natural Resources. Stewart holds record title to an undivided 60.80125% of the working interests in each of the WMRU leases. All unrecorded working interests have been given notice of the proposed sale. Thomas Yerbich, attorney for the unrecorded working interests component of the association of working interests, unequivocally endorses the sale free and clear of their interests. Moreover, under 11 U.S.C. § 363(f)(4), the property can be sold free and clear of interests which are in bona fide dispute. The unrecorded working interests may be avoided by the debtor pursuant to the avoidance powers contained in 11 U.S.C. § 544(a)(3). In re Cascade Oil, 65 B.R. 35 (Bankr. D. Kan. 1986). As such, these interests are in dispute and can be sold under § 363(f)(4).

Stewart's sale to Forcenergy is outside the ordinary course of business. Further, the sale to Forcenergy consists of Stewart's primary assets, and is being considered outside the context of confirmation of its chapter 11 plan.

A sale of substantially all of debtor's property outside the ordinary course of business, and without a Chapter 11 disclosure statement and plan, must be closely scrutinized. . . .

In approving any sale outside the ordinary course of business, the court must not only articulate a sufficient business reason for the sale, it must further find it is in the best interest of the estate, i.e. it is fair and reasonable, that it has been given adequate marketing, and that it has been negotiated and proposed in good faith, that the purchaser is proceeding in good faith, and that it is an "arms-length" transaction.

In re Wilde Horse Enterprises, Inc., 136 B.R. 830, 841 (Bankr. C.D. Cal. 1991) (citations omitted).

Under the circumstances present in this case, I find there are good and sufficient business reasons justifying a sale out of the ordinary course of business under 11 U.S.C. § 362(b). The risks presented by Stewart's continued operations in the WMRU wells are overwhelming. First and foremost, oil is a commodity which, like any other commodity, is subject to price fluctuations. The decline in oil prices alone, from January to May of 1997, could justify a price reduction of over $7 million in the sale of WMRU assets. Additionally,       4 ABR 535  Stewart lacks the capital to compete with such well-heeled industry giants as British Petroleum, ARCO, Unocal or even Forcenergy, which is itself a $1 billion company. Third, the debtor's operating history has illustrated the extraordinary risks associated with development of off-shore petroleum reserves. The mechanical problems unique to angled drilling are substantial and have at times been overwhelming to Stewart. The debtor does not have the capital necessary for continued development of the WMRU field. Currently, production revenues from the field are the only source of capital available to the debtor. They are in sharp decline and may cease altogether in the near future. These revenues are insufficient to further develop the WMRU wells, let alone the debtor's non-producing leases.

Finally, there are a host of conditions that must be met to close the sale to Forcenergy. The conditions include the maintenance of certain pressure levels at the wells and satisfaction of certain water to oil ratios. The purchase agreement provides that the bottom hole reservoir pressure of the WMRU wells must be in excess of 2000 psi for a specified period prior to the closing date. Additionally, the water to fluid ratio must test less than 45% for Well #1A, 77% for Well #2A and 88% for Well #3. The pressure levels and water to fluid ratios may change at any time. The longer Stewart remains an operator, the more likely it is that the sale could fail or that Stewart will face costly operating problems. In sum, the debtor faces a number of uncontrollable variables that cannot be eliminated until the sale closes.

Good business reasons exist to justify this sale. Further, the sale is in the best interests of the estate and its creditors. It may be the only way for Stewart to provide any certainty of a return to its creditors and the working interest holders. Stewart's assets are unique and the market for them is limited. There has been adequate marketing of these assets. Forcenergy, due to its other Cook Inlet holdings, is a logical purchaser. Other energy companies were contacted regarding a possible sale, but expressed very little interest. There is absolutely no evidence to suggest bad faith by either the purchaser or Stewart's current management. Steven Hartung is an honest and credible witness. He has no association with Stewart's past management. I believe his testimony. Hartung has negotiated a good-faith, arms-length       4 ABR 536  agreement with Forcenergy, a good faith purchaser, under very difficult circumstances. The Wilde Horse criteria are amply satisfied.

While it is unusual in a chapter 11 case for a sale of this magnitude to be consummated outside the context of confirmation, the bankruptcy court can authorize such a sale under § 363(b) given the proper set of circumstances. The Second Circuit considered this issue in In re Lionel Corp., 722 F.2d 1063 (2nd Cir. 1983). There, the bankruptcy court allowed the sale of the debtor's primary asset, stock in Dale corporation, to be sold for $50 million prior to confirmation of a plan of reorganization. The stock was not declining in value and the equity interests of Lionel actively opposed its sale. The Second Circuit reversed, finding that the lower court's ruling effectively violated the protections afforded equity interests in the chapter 11 process. Additionally, as the stock was not declining in value, there was no emergency need to sell, nor was there a good business reason for the sale. At the same time, the court recognized that bankruptcy courts must have the freedom to tailor orders to meet differing circumstances. It went to great lengths to limit its finding to the unique circumstances of the Lionel case, and recognized the need for a liberal reading of § 363(b). Lionel Corp., 722 F.2d at 1069.

The Lionel case is very different from the situation at bar. First of all, William Stewart owns the stock of Stewart Petroleum and does not oppose the sale. The true equity interests here, however, are represented by the association of working interests. The vast majority of these interests endorse the sale. In fact, virtually every major interest in this case, including the secured creditors, the recorded working interests, the unrecorded working interests, the overriding royalty interests and the unsecured creditors, endorse the sale. While a number of objections to sale were filed, most have been resolved through stipulated changes to the sale order. The working interests of Stewart Petroleum in the WMRU wells face a very real danger of deterioration in value due to declines in production and inadequate capitalization, as well as the other risk factors that have been previously discussed. There is a legitimate need to sell on an expedited basis, and the sale is overwhelmingly in the best interests of the estate. Under these circumstances, the policies underlying the chapter 11 confirmation       4 ABR 537  process necessarily yield to the court's powers under § 363. Sale of the debtor's assets under these circumstances is consistent with Lionel and the Ninth Circuit's pre-Code decision, Financial Associates v. Loeffler (In re Equity Funding Corp. of America), 492 F.2d 793, 794 (9th Cir. 1974), cert. denied, 419 U.S. 964 (1974).

Conclusion

Stewart's sale of assets to Forcenergy is authorized by the Bankruptcy Code and is in the best interests of the estate. It will be approved. A separate order and judgment will be entered, consistent with this memorandum.

DATED: May 12, 1997.

BY THE COURT
DONALD MacDONALD IV
United States Bankruptcy Judge