When a Business Faltered, Small Investors Stood Their Ground

Individual investors can feel powerless when their stock investments go awry. But sometimes it pays to fight back.

Consider the case of Breitburn Energy Partners, a company with oil and gas properties in the United States that is structured for tax advantages as a master limited partnership. Hammered by the collapse in energy prices, Breitburn stopped making income distributions on its common units in fall 2015. Then it filed for bankruptcy in May, saying it had $4.7 billion in assets and $3.4 billion in liabilities on its balance sheet.

Since it ceased making distributions, Breitburn’s publicly traded partnership units have collapsed from around $2 each to 26 cents. That is a disastrous decline, but it pales before the potential hit from a whopping tax bill, a result of the company’s plan to restructure its debts in bankruptcy. In such a deal, the taxman considers the amount of debt forgiven by a company’s creditors to be a form of income granted to its unit holders.

This is known as cancellation-of-debt income. And court documents show Breitburn’s holders could owe taxes of approximately $14 on each unit they hold.

Adding insult to injury, at least for individual unit-holders, Breitburn’s executives are not facing this tax problem. They dumped most of their units in the weeks following the company’s bankruptcy filing, eliminating any potential tax they would have owed.

And then there’s the final blow in this series of ugly events: Breitburn characterizes the company as “hopelessly insolvent,” meaning it expects nothing to be left for the equity holders after its assets are distributed.

Such an outcome is not unusual for equity investors in a bankrupt company, of course. But Breitburn’s individual investors are just a tad suspicious of their company’s assessment. They point to Breitburn filings indicating that the value of its assets exceeded its liabilities by $1.3 billion and note that energy prices have recovered since Breitburn filed for bankruptcy.

“Management is trying to steal the company from the equity holders,” said John Myrick, a Breitburn holder who works in television post production in Los Angeles. “We know there’s value there.”

Officials at Breitburn did not respond to messages seeking comment. But in court filings, the company has said the $1.3 billion in excess value it cited was a stale figure that didn’t reflect the depleted value of the company’s assets.

Unfortunately for Mr. Myrick and other Breitburn equity holders, they are battling a longstanding bias against them in bankruptcy proceedings. Equity investors rarely have a say in corporate restructurings, typically dominated by major debtholders. As a result, stockholders must accept valuations of a company’s assets without being able to verify them. This can allow debtholders and other creditors to obtain valuable assets for far less than they are worth.

Fearing just this outcome, Mr. Myrick and a throng of other small investors hired lawyers to help them win a role in the restructuring process. How they prevailed is instructive.

“These companies will take advantage of people,” Mr. Myrick said. “We are going to hold them accountable.”

Like many Breitburn investors, he bought his units mainly for their generous monthly income distributions. He also liked that Breitburn was “an American company that employed American workers.” Another plus, he thought, was that Breitburn executives owned a lot of the common units, aligning their interests with those of outside holders.

After the company stopped making distributions, Mr. Myrick became concerned about Breitburn’s future. In January, he met with Antonio D’Amico, head of Breitburn’s investor relations, who told him the company’s hedge portfolio and vast asset base was structured to survive the energy downturn intact.

On May 9, the company filed its first quarter financial report. Falling revenues and rising losses showed the effects of the commodities crash, but Breitburn’s balance sheet also noted its $4.7 billion in assets and $1.3 billion of shareholders equity. Mr. Myrick said the filing encouraged him.

A week later, Breitburn filed for bankruptcy.

Mr. Myrick was stunned. His shock turned to anger when he saw top Breitburn executives dumping virtually all their common units. Among the sellers were Halbert Washburn, chief executive; Mark Pease, president; and Willis Washburn, a senior vice president. David Kilpatrick, a Breitburn director, also sold his entire position.

The insiders were exiting, Mr. Myrick suspected, because they knew they would be subject to significant cancellation of debt income and a monster tax bill if they held on.

More troubling, the sales meant that as the company reorganized, the interests of Breitburn’s management were no longer aligned with those of the remaining common unit holders.

Moreover, Breitburn executives stood to receive new equity in the company through an incentive pay plan submitted to the bankruptcy court. Their grants would not be subject to a debt cancellation tax and came on top of a sweet $10.7 million executive bonus program adopted just weeks before the Breitburn bankruptcy filing.

“When Breitburn’s directors and officers elected to sell virtually all of their common units, Breitburn became a story of taxation without representation,” said Vincent Indelicato, a lawyer at Proskauer Rose in New York who represents the holders.

The actions by Breitburn management infuriated the outside investors. So they started writing letters to Stuart M. Bernstein, the federal judge overseeing the company’s bankruptcy in Manhattan, asking that he allow them to form an equity committee to participate in the reorganization talks.

Breitburn objected to the idea, as did the United States Trustee, a unit of the Justice Department charged with monitoring the nation’s bankruptcy courts.

But the unit-holders’ lawyers argued that such a committee would level the playing field for investors seeking “to vindicate their rights against constituencies with adverse economic interests and unlimited budgets.”

The Securities and Exchange Commission also weighed in to support an equity committee in the bankruptcy; the agency countered Breitburn’s argument that it is hopelessly insolvent.

Happily, Judge Bernstein ruled in favor of the investors in October, allowing the formation of an equity committee. Proskauer Rose will represent it.

“The retail holders, like John, had enough courage to throw the proverbial tea into the harbor by writing over 100 letters to the court,” Mr. Indelicato said. “They alone gave equity a voice and earned a seat at the negotiating table.”

It’s too soon to say whether Breitburn’s equity holders will reap any payout in the restructuring. But there is a lesson here for individual investors: If your company tries to run you over, stand your ground. Who knows, you might just win.