Legislation

Examining new BOEM supplemental bonding requirements for OCS decommissioning obligations: Part 4 In context of the Bureau of Ocean Energy Management’s new NTL 2016-N01, the recently in force Notice to Lessees and Operators in the outer continental shelf (OCS) laying out strict new financial demands of operators and leaseholders to cover decommissioning liability on the OCS, Oil & Gas 360® took a call from the Surety & Fidelity Association taking issue with the idea that the capacity of the surety industry to cover the Gulf of Mexico OCS liability is limited. “As a simple economic fact, there is not sufficient capacity in the entire bonding industry to issue the bonds needed to cover the current cumulative P&A and Decommissioning liabilities that BOEM has estimated at $40 billion,” was the quote in a previous Oil & Gas 360® story about the new requirements. Robert J. Duke is the general counsel for the Surety & Fidelity Association of America, a surety industry trade association that has been in force since 1908. Oil & Gas 360® spoke with Duke and others in the surety industry about the changing requirements for supplemental security for operators on the OCS. Duke said his organization’s membership is about 400 underwriting companies, which includes multiple companies under about 150-200 parent companies. Those are the companies that collectively write the majority of surety and fidelity bonds in the United States. Duke said he estimates that the number of sureties that work in the energy and mineral space is probably somewhere between a dozen and 20. Surety basics in the context of federal leaseholders and operators operating on the OCS “A surety provides a bond—it’s guaranteeing an obligation. In this case, the payment of and meeting of your decommissioning obligation,” Duke explained. “A surety will provide a bond only to those entities through its financial and operational review that it determines through its assessment can perform that obligation. They want to avoid the loss. The underwriting is more akin to a credit product than an insurance product. So just like you would provide a loan only to those you think could repay you, it’s the same with a bond. You’re going to provide a bond only to those you think can meet the decommissioning obligation. “That’s why I was alluding to credit quality. If an operator comes to a surety and says ‘we just got this letter from BOEM, and our supplemental requirement is $5 million’, a surety is going to review the operator’s financial wherewithal, it’s going to review the economics of the particular lease and well operation, and the surety will make a determination as to if it believes the operator can meet the $5 million obligation down the road? “If they believe they can, they will provide the bond, and if they believe they can’t [meet the obligation], they likely won’t provide the bond. If it’s a gray area they may require some collateral. Collateral certainly is an option [to the surety], I just don’t think it’s an across the board option.” Oil & Gas 360® also spoke to Adam S. Pessin, President and CEO of Tokio Marine HCC – Surety Group, one of the larger carriers in the class. Pessin’s group works with OCS oil and gas operators. “If you have appropriate and competent management, if you have appropriate capital structure, and if the asset quality is appropriate, the surety markets are very much open on an unsecured basis for these operators,” Pessin said. “It’s your parties that have problems in one or more of those three areas that wind up in a situation where security might be required by the surety providers.” Is there enough capacity within the surety universe to provide bonding for the estimated decom liability? Duke said in the industry overall there is plenty of capacity to cover the BOEM’s estimated $40 billion in decommissioning liability in the Gulf of Mexico. “There’s enough capacity in the surety market to absorb that,” he said, “but it comes down to the credit quality of the bond principal—that’s the operators themselves and the economics of the particular well. “So of that $40 billion that the industry has available to extend, the question is: are they willing to extend it? When you look at the available capacity, the more important issue is: will the operators qualify for it?” Dual obligee scenario could relieve some pressure “I think that BOEM has to some degree recognized this issue, because they are considering this idea of ‘dual obligee.’ Particularly in instances where a major operator—a Chevron or a Shell, for example—has conveyed an interest to an independent, and there is already an existing private bond. Not a bond to BOEM, but a bond from the independent to the major operator,” Duke said. “I know the independents have expressed concern that if they have to also provide a bond to BOEM, that would be double bonding. And BOEM seemed willing to say that ‘if somehow we can get onto the private bond, then that may be sufficient to meeting the additional security requirement’.” Duke said his association has been providing suggestions to BOEM as to what would be workable language in that scenario. “If we can get language that all parties like, then that will alleviate some of the need to provide supplemental security up to $40 billion.” http://www.oilandgas360.com/surety-industry-weighs-new-ocs-supplemental-bonding-requirements/

Most readers are familiar with the concept that performance bond sureties expect to recoup, from their principals, every dollar of cost incurred in responding to demands on the bond. And most readers are aware that the typical general indemnity agreement (GIA) gives the surety extensive rights, against the persons and companies signing on as indemnitors, to recover every dollar spent. But one surety was stopped short when it sought to recover costs of an arbitration from its principal, after the surety signed a three-party arbitration agreement, post-project, providing that all parties would be responsible for their own costs. A dispute arose between subcontractor and prime contractor, and the prime contractor also made demands against the sub’s surety. The prime and sub commenced arbitration. Then, prime, sub and surety entered into what the decision refers to as an amended arbitration panel agreement, and the surety joined the arbitration. This later agreement included the following: “Each party shall be responsible for and bear the costs of its own attorney’s fees and expenses and an equal portion of the panel’s costs and expenses.” The arbitration ended with an award in favor of the sub and surety and against the prime. The surety turned around and demanded that the sub reimburse the surety for $748,843.85 in arbitration costs, citing the terms of the GIA calling for that result. But the sub argued in response that the amended arbitration panel agreement had superseded the GIA, and the surety was thus not entitled to recover any such costs from the sub. A US District Court judge agreed with the sub, at least denying the surety’s request for summary judgment based on the terms of the GIA. The court noted: “It is a well-settled tenet of contract law that a latter-signed contract between parties on the same subject modifies a pre-existing contract.” And it stated that if the surety had wanted to preserve its rights under the GIA, when entering into the amended arbitration panel agreement, the surety “should have executed contractual amendments or other documents clarifying the status of [the sub’s] duty to indemnify [the surety].” This is basic contract law. The surety will undoubtedly remember should this scenario arise again. The case is Western Surety Co. v. S3H, Inc., 2016 U.S. Dist. LEXIS 101769 (D. Nev., Aug. 3, 2016), available here (LEXIS subscription required). Commonsense Construction Law LLC – Stan Martin http://www.lexology.com/library/detail.aspx?g=fe318f4e-7fd4-49ac-8acd-0e589b03be01

On September 12, 2016, the Nationwide Multistate Licensing System (“NMLS” or “the System”) will begin receiving and tracking Electronic Surety Bonds (“ESB”). In an unprecedented departure from the traditional uploading of a copy of a surety bond document to the applicant’s or licensee’s record followed by the delivery of the paper bond to the state, regulators in Idaho, Indiana, Iowa, Massachusetts, Texas, Vermont, Washington, and Wisconsin have publicly announced the adoption of ESB in 2016 for several license types. This is the first group of states to “bond on line,” but all states are expected to have a common bond process through the NMLS. Many states require licensed financial services businesses to get a surety bond so that state regulators or consumers may file claims against the bond to cover fines or penalties assessed, or provide restitution to consumers if the licensee fails to comply with licensing or regulatory requirements. The NMLS reports that 177 license authorities currently managed on the system require a licensed company to maintain a surety bond as a condition of licensure. States have even imposed bond requirements on individual mortgage loan originators (“MLOs”), in accordance with the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (the “SAFE Act”), but allow for MLOs to be covered under a company bond. NMLS was created to serve as a comprehensive system of record for licensing information. However, as it relates to surety bonds, the System’s current functionality is antiquated, limited, and does not allow for the tracking of bond requirements, or the maintenance of bond information validated by authorized surety companies and/or bond producers. State regulators have also cited the tracking of surety bond compliance as a reason for processing delays in license applications, amendment filings, and renewal approvals. For those reasons, the State Regulatory Registry LLC, which administers the NMLS, believed a fully electronic surety bond process would provide efficiencies for both industry and regulators. The first phase of this ESB process entailed the creation of an account by each participating surety company and association with those accounts by surety bond producers. The second phase, which will begin September 2016, entails implementation of bond issuance, tracking, and maintenance. If you have not already done so, and especially if you are licensed or intend to become licensed in one of the eight states listed above that will be implementing this new functionality in September, you should ensure that your surety bond company has created an account in the system and be aware of the new application and conversion deadlines that are listed on the NMLS ESB Adoption Map and Table. http://www.lexology.com/library/detail.aspx?g=6c836cd3-60de-4fa2-bb0d-1c64a4447e3c