Legacy Reserves LP (LGCY) is entering into a new MLP to raise money and stay solvent, but when other energy companies have done the same thing it has ended in bankruptcy

Master limited partnerships offer a simple, structured solution for a company to raise the cash it needs.

Despite posting solid 3Q earnings, Legacy finds itself in a position where it doesn’t have enough liquidity to handle prior loan obligations, and it’s running out of options. (For more on Legacy's 3Q earnings, see: Legacy Upgraded by Analysts after CEO Chat.)

Legacy Needs a Capital Infusion

Like other companies in the transport segment of the energy sector, Legacy has found itself in need of extra liquidity in order to service existing debt and continue to maintain and expand its pipelines. 

In pursuing this MLP, Legacy management clearly hopes they’ll be able to raise the capital they need without undertaking further restructuring or layoffs. Although the restructuring plan that the company has chosen is working to an extent, Legacy is unable to make further structural changes to cut costs without paring down the services it offers. 

But MLPs can be a dangerous instrument for a handful of reasons, and this latest move could call into question Legacy's continued solvency. 

Others Haven't Fared So Well

More than one oil and gas company have ended up bankrupt after entering into an MLP when they were in a situation similar to Legacy.

For instance, Linn Energy was forced into bankruptcy by its partners in May 2016. (For more on Linn Energy, see: 5 Energy Companies Crushed by Low Oil in 2016.)

The arrangement is a dangerous one, since partners get preferential treatment when it comes to making payments. Legacy could easily find itself in a position where it has to ignore other obligations in order to service the MLP. 

In return for quick access to capital, Legacy will need to prioritize the way that it handles payments. It remains to be seen whether or not it will work out for the company, but the risks are real.