NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Organization of Trust
SandRidge Mississippian Trust I (the “Trust”) is a statutory trust formed under the Delaware Statutory Trust Act pursuant to a trust agreement, as amended and restated, by and among SandRidge Energy, Inc. (“SandRidge”), as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee (the “Trustee”), and The Corporation Trust Company, as Delaware Trustee (the “Delaware Trustee”).
The Trust held Royalty Interests in specified oil and natural gas properties located in the Mississippian formation in Alfalfa, Garfield, Grant and Woods counties in Oklahoma (the “Underlying Properties”), until the sale of the Royalty Interests in April 2021 (the “Asset Sale”) as discussed below in “—Early Termination of the Trust; Sale of Trust Assets.” The Royalty Interests were conveyed by SandRidge to the Trust concurrent with the initial public offering of the Trust’s common units (“Trust units”) in April 2011. As consideration for conveyance of the Royalty Interests, the Trust remitted the proceeds of the offering, along with 3,750,000 Trust units and 7,000,000 subordinated units, which subsequently converted to common units in July 2014 as a result of SandRidge having met its drilling obligation to the Trust in April 2013, to certain wholly owned subsidiaries of SandRidge. At June 30, 2021, SandRidge owned 7,528,063 Trust units, or approximately 26.9% of all Trust units.
The Trust is passive in nature and neither the Trust nor the Trustee had any control over, or responsibility for, any operating or capital costs related to the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. The trust agreement generally limits the Trust’s business activities to owning the Royalty Interests and any activity reasonably related thereto, including activities required or permitted by the terms of the conveyances related to the Royalty Interests.
Prior to the Asset Sale, the Trust made quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Due to the timing of the payment of production proceeds to the Trust, each distribution covered production from a three-month period consisting of the first two months of the most recently ended quarter and the final month of the quarter preceding it.
Early Termination of the Trust; Sale of Trust Assets. As described in the Trust’s annual and quarterly reports filed with the Securities and Exchange Commission (the “SEC”), the trust agreement requires the Trust to dissolve and commence winding up of its business and affairs if cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than $1.0 million. As cash available for distribution for the four consecutive quarters ended September 30, 2020, on a cumulative basis, totaled approximately $815,000, the Trust was required to dissolve and commence winding up beginning as of the close of business on November 13, 2020. Accordingly, the Trustee was required to sell all of the Trust’s assets, either by private sale or public auction, and distribute the net proceeds of the sale to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities, including the establishment of cash reserves in such amounts as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act. Among such contingent, conditional or unmatured claims for which the Trustee has made provision out of the net proceeds of the sale are the Trust’s potential liabilities with respect to the Securities Litigation described under “Legal Proceedings” in Note 5. Such a reserve could reduce or eliminate the amount of, or delay the timing of payment of, sale proceeds that may be distributed to unitholders. Additionally, the sale process involved costs that reduce the amount of distributable income to unitholders.
As required by the trust agreement, the Trustee engaged a third-party advisor to assist with the marketing and sale of the Trust’s assets. As provided in the trust agreement, SandRidge had a right of first refusal with respect to any sale of assets to a third party, which SandRidge elected to exercise. The Trust and SandRidge Exploration and Production, LLC (the “Purchaser”), a wholly owned subsidiary of SandRidge, entered into a Purchase and Sale Agreement (the “Agreement”) for the sale of all of the Royalty Interests to the Purchaser for a purchase price of $4,850,000. The sale closed on April 22, 2021, with an effective date of April 1, 2021. Accordingly, because the Agreement entitles the Purchaser to the revenues from the oil and natural gas production attributable to the Royalty Interests since April 1, 2021, the Trust will not receive any further proceeds from such production and therefore will not make any further regular quarterly cash distributions to the Trust unitholders. The Trust will remain in existence until the filing of a certificate of cancellation with the Secretary of State of the State of Delaware following the completion of the winding up process. See Note 3 for further information regarding the withholding of the net proceeds of the Asset Sale to provide for the Trust’s potential liabilities with respect to the Securities Litigation described in Note 5.
2. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Accounting. The financial statements of the Trust differ from financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as the Trust records revenues when cash is received (rather than when earned) and expenses when paid (rather than when incurred) and may also establish cash reserves for contingencies, which would not be accrued in financial statements prepared in accordance with GAAP. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the Securities and Exchange Commission (“SEC”) as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. Amortization of investment in royalty interests, calculated on a unit-of-production basis, and any impairments are charged directly to trust corpus. Distributions to unitholders are recorded when declared.
Significant Accounting Policies. Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, which may require such entities to accrue or defer revenues and expenses in a period other than when such revenues are received or expenses are paid. Because the Trust’s financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable to the Trust’s financial statements.
The Trust is treated for federal and applicable state income tax purposes as a partnership. For U.S. federal income tax purposes, a partnership is not a taxable entity and incurs no U.S. federal income tax liability. With respect to state taxation, a partnership is typically treated in the same manner as it is for U.S. federal income tax purposes.
Impairment of Investment in Royalty Interests. As a result of the sale process discussed in “Early Termination of the Trust; Sale of Trust Assets,” during the six-month periods ended June 30, 2021 and 2020 the Trust recorded impairments to the carrying value of the Investment in Royalty Interests of $0.9 million and $3.3 million, respectively. The impairments resulted in non-cash charges to trust corpus and did not affect the Trust’s distributable income. Prior to the Asset Sale, on a quarterly basis, the Trust evaluated the carrying value of the investment in royalty interests by comparing the undiscounted cash flows expected to be realized from the Royalty Interests to the carrying value. If the expected future undiscounted cash flows were less than the carrying value, the Trust would recognize an impairment loss for the difference between the carrying value and the estimated fair value of the Royalty Interests, which is determined using future cash flows of the net oil, natural gas and natural gas liquids (“NGL”) reserves attributable to the Royalty Interests, discounted at a rate based upon the weighted average cost of capital of publicly traded royalty trusts. The weighted average cost of capital is based upon inputs that are readily available in the public market. The future cash flows of the net oil, natural gas and NGL reserves attributable to the Royalty Interests utilized the oil and natural gas futures prices readily available in the public market adjusted for differentials and estimated quantities of oil, natural gas and NGL reserves that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions.
Distributable Income Per Unit. Distributable income per unit amounts as calculated for the periods presented in the accompanying unaudited statements of distributable income may differ from declared distribution amounts per unit due to rounding, interest income and the timing of the Trust’s payment of Trust administrative expenses.
Financial Statements of Royalty Trusts. Amortization of investment in royalty interests, calculated on a unit-of-production basis, and any impairments are charged directly to trust corpus. Included in the Amortization of Investment in Royalty Interests for the three and six months ended June 30, 2021 is $4.4 million of non-cash disposition relating to the sale of interest on April 22, 2021. Distributions to unitholders are recorded when declared.
Interim Financial Statements. The accompanying unaudited interim financial statements have been prepared in accordance with the accounting policies stated in the audited financial statements contained in the 2020 Form 10-K and reflect all adjustments that are, in the opinion of the Trustee, necessary to state fairly the information in the Trust’s unaudited interim financial statements. The accompanying statement of assets and trust corpus as of December 31, 2020 has been derived from audited financial statements. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the 2020 Form 10-K.
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
3. Distributions to Unitholders
Prior to the Asset Sale, the Trust made quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Distributions cover a three-month production period. As the effective date of the Asset Sale was April 1, 2021, the Trust will not receive any further proceeds from the oil and natural gas production attributable to the Royalty Interests and therefore will not make any further regular quarterly cash distributions to the Trust unitholders. Because of the statutory requirement to provide for the Trust’s potential liabilities with respect to the Securities Litigation described in Note 5, the Trustee is withholding as part of its cash reserve the net proceeds from the Asset Sale. After the Securities Litigation has been resolved, the Trustee will distribute any remaining cash reserves following the payment of the Trust’s estimated remaining expenses and liabilities. A summary of the Trust’s distributions to unitholders during the three- and six-month periods ended June 30, 2021 and the year ended December 31, 2020 is as follows:
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Total
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Distribution
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Covered
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Distribution
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Per Common
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Production Period
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Date Declared
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Date Paid
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Paid
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Unit
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Calendar Quarter 2021
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First Quarter
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September 1, 2020 — November 30, 2020
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January 28, 2021
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February 26, 2021
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$
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80,000
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$
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0.0029
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Second Quarter
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December 1, 2020 — February 28, 2021
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April 28, 2021
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May 28, 2021
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$
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308,000
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$
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0.0110
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Total
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Distribution
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Covered
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Distribution
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Per Common
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Production Period
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Date Declared
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Date Paid
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Paid
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Unit
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Calendar Quarter 2020
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First Quarter
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September 1, 2019 — November 30, 2019
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January 23, 2020
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February 28, 2020
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$
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456,400
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$
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0.0163
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Second Quarter
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December 1, 2019 — February 29, 2020
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April 23, 2020
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May 27, 2020
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$
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358,400
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$
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0.0128
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Third Quarter
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March 1, 2020 — May 31, 2020
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July 23, 2020
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N/A
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$
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—
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$
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—
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Fourth Quarter
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June 1, 2020 — August 31, 2020
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October 23, 2020
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N/A
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$
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—
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$
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—
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4. Related Party Transactions
Trustee Administrative Fee. Under the terms of the trust agreement, the Trust pays the Trustee an annual administrative fee, which for 2020 totaled $162,000. The annual fee can be adjusted for inflation by no more than 3% in any year. The Trustee’s administrative fees paid during the three-month period ended June 30, 2021 totaled approximately $41,000 compared to approximately $40,000 for the three-month period ended June 30, 2020. The Trustee’s administrative fees paid during the six-month period ended June 30, 2021 totaled approximately $82,000 compared to approximately $81,000 for the six-month period ended June 30, 2020.
Registration Rights Agreement. The Trust is party to a registration rights agreement pursuant to which the Trust has agreed to register the offering of the Trust units held by SandRidge and certain of its affiliates and permitted transferees upon request by SandRidge. The holders have the right to require the Trust to file no more than five registration statements in aggregate, one of which has been filed to date. The Trust does not bear any expenses associated with such transactions.
Administrative Services Agreement. The Trust is party to an administrative services agreement with SandRidge that obligates the Trust to pay SandRidge an annual administrative services fee for accounting, tax preparation, bookkeeping and informational services performed by SandRidge on behalf of the Trust. For its services under the administrative services agreement, SandRidge receives an annual fee of $200,000, which is payable in equal quarterly installments and will remain fixed for the life of the Trust. SandRidge is also entitled to receive reimbursement for its out-of-pocket fees, costs and expenses incurred in connection with the provision of any of the services under the administrative services agreement. The administrative services agreement will terminate on the earliest to
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
occur of: (i) the date the Trust is finally wound up and liquidated in accordance with the trust agreement, (ii) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust, (iii) pertaining to services to be provided with respect to any Underlying Properties transferred by SandRidge, the date that either SandRidge or the Trustee may designate by delivering 90-days’ prior written notice, provided that the transferee of such Underlying Properties assumes responsibility to perform the services in place of SandRidge and (iv) a date mutually agreed to by SandRidge and the Trustee. Administrative fees paid to SandRidge for each of the three-month periods ended June 30, 2021 and 2020, totaled $50,000. Administrative fees paid to SandRidge for each of the six-month periods ended June 30, 2021 and 2020 totaled $100,000.
5. Commitments and Contingencies
Loan Commitment. Pursuant to the trust agreement, if at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, SandRidge will, at the Trustee’s request, loan funds to the Trust necessary to pay such expenses. Any funds loaned by SandRidge pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trust’s business, and may not be used to satisfy Trust indebtedness, or to make distributions. If SandRidge loans funds pursuant to this commitment, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. Any such loan will be on an unsecured basis, and the terms of such loan will be substantially the same as that which would be obtained in an arm’s length transaction between SandRidge and an unaffiliated third party. No such loan from SandRidge was outstanding at June 30, 2021 or December 31, 2020.
Risks and Uncertainties. Prior to the Asset Sale, the Trust’s revenue and distributions were substantially dependent upon the prevailing and future prices for oil, natural gas and NGL, each of which depended on numerous factors beyond the Trust’s control such as overall oil, natural gas and NGL production and inventories in relevant markets, economic conditions, the global political environment, regulatory developments and competition from other energy sources. Oil, natural gas and NGL prices historically have been volatile and may be subject to significant fluctuations in the future.
The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust.
Legal Proceedings. On June 9, 2015, the Duane & Virginia Lanier Trust, on behalf of itself and all other similarly situated unitholders of the Trust, filed a putative class action complaint in the U.S. District Court for the Western District of Oklahoma against the Trust, SandRidge and certain current and former executive officers of SandRidge, among other defendants (the “Securities Litigation”). The complaint, which was amended on November 11, 2016 (adding Ivan Nibur, Lawrence Ross, Jase Luna, and Mathew Willenbuncher as lead plaintiffs) and supplemented on May 1, 2017, asserts a variety of federal securities claims on behalf of a putative class of (a) purchasers of common units of the Trust in or traceable to its initial public offering on or about April 7, 2011, and (b) purchasers of common units of SandRidge Mississippian Trust II (“SDR”) in or traceable to its initial public offering on or about April 17, 2012. The claims are based on allegations that SandRidge and certain of its current and former officers and directors, among other defendants, including the Trust, are responsible for making false and misleading statements, and omitting material information, concerning a variety of subjects, including oil and gas reserves. The plaintiffs seek class certification, an order rescinding the Trust’s initial public offering and an unspecified amount of damages, plus interest, attorneys’ fees and costs. As a result of its reorganization in bankruptcy in 2016, SandRidge is a nominal defendant only.
On August 30, 2017, the Court entered an order dismissing the plaintiffs’ claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. As a result of the Court’s order, the only claims remaining in the litigation are the plaintiffs’ claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder (the “Exchange Act Claims”). In addition, because of the Court’s order, the only remaining defendants in the litigation are the Trust, James D. Bennett, Matthew K. Grubb, Tom L. Ward, and SandRidge as a nominal defendant only.
On September 11, 2017, the Court entered a subsequent order granting in part and denying in part the remaining defendants’ motions to dismiss the Exchange Act Claims and finding that the plaintiffs may pursue certain of the Exchange Act Claims against the respective remaining defendants. In November 2017, the plaintiffs’ counsel informed counsel to the Trust that, notwithstanding the dismissal of all claims against SDR, the remaining claims in the litigation against the Trust are being asserted not only by purchasers of common units of the Trust, but also by purchasers of common units of SDR.
On January 19, 2018, the Trust filed a Motion for Partial Judgment on the Pleadings as to any claims against it brought by purchasers of common units of SDR, arguing that non-purchasers of common units in the Trust lack statutory standing to pursue
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
claims against the Trust. On January 18, 2019, the Court granted the Trust's motion dismissing claims brought by purchasers of common units of SDR.
On July 2, 2018, defendants filed a motion for partial judgment on the pleadings, arguing that all claims asserted on behalf of the members of the putative class are barred by the statute of limitations. On March 26, 2019, the Court denied the motion without prejudice should discovery reveal a basis for again challenging the timeliness of plaintiffs' claims.
Discovery closed on June 19, 2019. Following a hearing on class certification on September 6, 2019, the motion for class certification remains pending.
On April 2, 2020, the Trust filed a Motion for Summary Judgment as to Plaintiffs’ remaining claims against the Trust, arguing that there is no evidence of requisite intent by the Trust, and further, that the alleged acts and omissions of other defendants are not properly attributable to the Trust. That motion remains pending.
On August 5, 2020, the Plaintiffs filed a motion for leave to file a second amended complaint against the Trust. That motion remains pending.
Regardless of the outcome of the litigation, the Trust may incur expenses in defending the litigation, and any such expenses may increase the Trust’s administrative expenses significantly. The Trust will estimate and, if the Trustee deems it appropriate, begin reserving funds for potential losses that may arise out of litigation to the extent that such losses are probable and can be reasonably estimated. Significant judgment will be required in making any such estimates and any final liabilities of the Trust may ultimately be materially different than any estimates. The Trust is currently unable to assess the probability of loss or estimate a range of any potential loss the Trust may incur in connection with the Securities Litigation, and, except as discussed in Note 3 above, has not established any reserves relating to the Securities Litigation. As discussed in Note 3 above, the Trustee is withholding as part of its cash reserve the net proceeds from the Asset Sale to provide for the Trust’s potential liabilities under the Securities Litigation, as required by the Delaware Statutory Trust Act in connection with the early termination of the Trust. The Trust has not yet fully analyzed any rights it may have to indemnities that may be applicable or any claims it may make in connection with the Securities Litigation.