| Commitments, Contingencies, and Related Party Transactions | 11.
COMMITMENTS, CONTINGENCIES, AND RELATED PARTY TRANSACTIONS Commitments Lessor
Operating Leases. Contingencies Litigation APEG
Energy II, L.P. (“APEG II”) and its general partner, APEG Energy II, GP (together with APEG II, “APEG”)
are involved in litigation with the Company and its former Chief Executive Officer, David Veltri, as described below. APEG II
holds approximately 43% of the Company’s outstanding common stock and was its secured lender prior to the maturity on July
30, 2019 of a credit facility the Company had with APEG II. The costs associated with the ongoing litigation have been a significant
use of the Company’s existing cash. While the Company has historically funded all litigation costs out of operated cash
flow, continued excessive legal fees associated with litigation could impair the Company’s liquidity profile and ability
to fund significant drilling obligations. APEG
II Litigation On
February 14, 2019, the Company’s Board of Directors received a letter from APEG II, the largest shareholder of the Company
and, at that time, the Company’s secured lender under the credit facility, urging the Company to work with APEG II and other
shareholders to establish a seven-person, independent board of directors, establish a corporate business plan and reduce the Company’s
corporate general and administrative expenses. APEG II owns approximately 43% of the Company’s outstanding common stock
and was owed approximately $936,000 in outstanding principal under the credit facility prior to its expiration. On
February 25, 2019, APEG II provided an access termination notice to the Company’s bank under its collateral documents, and
the bank confirmed to the Company that access to its collateral accounts was terminated. On February 26, 2019, APEG II provided
account disposition instructions to the Company’s subsidiary’s bank instructing the bank to deliver to APEG II all
of the funds held in the collateral accounts, which totaled approximately $1.8 million. The funds were wired by the bank to APEG
II on March 1, 2019. On
March 1, 2019, David Veltri, our former Chief Executive Officer and President, filed a lawsuit against APEG II in the Company’s
name (the “Texas Litigation”) by filing an Original Petition and Application for Temporary Restraining Order, Temporary
Injunction, Permanent Injunction, and Appointment of Receiver, Case No. 2019-15528 (the “Action”), in the District
Court of Harris County Texas, 190th Judicial District (the “State Court”), naming APEG II and its general partner
as defendants. The State Court granted the motion for a temporary restraining order (“TRO”) and ordered APEG to return
immediately approximately $1.8 million in cash previously wired to APEG II. On
March 4, 2019, APEG II filed a Notice of Removal and an Emergency Motion to Stay or Modify State Court Temporary Restraining Order
in the United States District Court for the Sothern District of Texas, Houston Division, Case No. 4:19-cv-00754 (the “Texas
Federal Court”), in order to remove the Texas Litigation from the State Court to the Federal District Court and to stay
or modify the TRO. Following a hearing on March 4, 2019, the Texas Federal Court vacated the TRO. On March 7, 2019, at the continued
hearing on emergency motions, the Court ordered APEG to return our funds, less the outstanding balance due to APEG II under the
credit facility of approximately $936,000, and the Company received back approximately $850,000. On February 25, 2019, the Board
meeting at which it voted to terminate for cause Mr. Veltri from his position as Chief Executive Officer and President
as a result of using Company funds in excess of, and inconsistent with, certain authority granted by the Board and other reasons.
Mr. Veltri, along with Mr. Hoffman, called into question whether or not such action was properly taken
at the Board meeting. On March 8, 2019, the Company’s Audit Committee, as an official committee of the Board, represented
by independent counsel retained by the Audit Committee, intervened by filing in the Texas Litigation an Emergency Motion of the
Official Audit Committee of the Board of U.S. Energy Requesting Company Protections Necessary for Releasing Funds Pending Internal
Investigation (the “AC Motion”). The AC Motion requested that the Texas Federal Court order that all of the Company’s
funds, financial, and monetary matters be placed under the control of the Company’s Chief Financial Officer and that control
of these functions be removed from the Company’s Chief Executive Officer, who the Audit Committee believed had been
properly terminated by the Board on February 25, 2019. On
March 12, 2019, the Texas Federal Court granted the AC Motion and issued an additional Management Order, ordering that any disbursement
made by the Company must be approved in writing by the Audit Committee in advance. Additionally, the Management Order stated that
the Company’s Chief Financial Officer must be appointed as the sole signatory on all of the Company’s bank accounts. Litigation
with Former Chief Executive Officer In connection with the above described litigation
with APEG II, APEG II then initiated a second lawsuit on March 18, 2019 as a shareholder derivative action in Colorado
against Mr. Veltri, the Company’s former Chief Executive Officer, Chairman of the Board, and President as a result of his
refusal to recognize the Board’s decision to terminate him for cause (the “Colorado Litigation”). The
Company was named as a nominal defendant in the Colorado litigation, Civil Action No. 1:19-cv-00801 before the United States
District Court for the District of Colorado (the “Colorado Federal Court”), filed on March 18, 2019. The
APEG II complaint in the Colorado Litigation alleged that Mr. Veltri’s employment was terminated by the Board of Directors
and sought an injunction and temporary restraining order against Mr. Veltri to prevent him from continuing to act as Chief Executive
Officer, President and Chairman, which he claimed he was entitled to continue doing. Mr. Veltri currently remains a member of
the Board of Directors of the Company. Meanwhile, APEG II asserted claims against
the Company directly in the Texas Litigation, while in roughly the same period, counsel for Mr. Veltri withdrew from the Texas
Litigation, leaving the Company without counsel with respect to the claims asserted in the Company’s name and the APEG II
claims asserted against the Company in the Texas Litigation. The Texas Federal Court ordered the Audit Committee to identify counsel
to represent or act in the name of the Company in the Texas Litigation on or by April 30, 2019. On that date, the Audit Committee
took over the control of the defense of the Company, prosecution of its claims against APEG II, and filed third-party claims on
behalf of the Company against Mr. Veltri and John Hoffman, asserting that Mr. Veltri was responsible for any damages that
APEG II claims, including attorneys’ fees, and that Mr. Veltri and Mr. Hoffman should be removed from the Board of
Directors in accordance with the laws of the State of Wyoming, the state of the Company’s incorporation. On May 22, 2019,
the Company and APEG II entered into a settlement agreement with Mr, Hoffman pursuant to which Mr. Hoffman agreed
to resign from the Board of Directors and committees thereof, and the Company agreed to pay up to $50,000 of Mr. Hoffman’s
legal fees incurred with respect to the Texas Litigation. Further, the Company released Mr. Hoffman from any claims
related to the Texas Litigation, APEG II released the Company from any claims that may have been caused by Mr. Hoffman, and Mr.
Hoffman released the Company and two of the Company’s current directors from any and all claims Mr. Hoffman may
have. In the Colorado Litigation, the Colorado Federal
Court entered an order on May 16, 2019 (the “Order”) granting interim preliminary injunctive relief to APEG II against
Mr. Veltri, holding that Mr. Veltri, without authorization, continued to hold himself out to be and continued to act as
the Company’s President and Chief Executive Officer. Pursuant to the Order, Mr. Veltri was preliminarily enjoined from acting
as, or holding himself out to be, the Company’s President and/or Chief Executive Officer. Ryan Smith, the Chief Financial
Officer of the Company, was appointed temporary custodian of the Company with the charge to act as the Company’s interim
Chief Executive Officer. On May 30, 2019, and following briefing by
the parties to the Colorado Litigation, the Colorado Federal Court issued a subsequent order (the “Second Order”),
appointing C. Randel Lewis as custodian of the Company pursuant to the Wyoming Business Corporation Act and to take over
for Mr. Smith to act as the Company’s interim Chief Executive Officer and to serve on the Board of Directors as Chairman.
As noted in the Second Order, two of the Company’s Board members had moved in the Board meeting on February 25,
2019 to terminate Mr. Veltri as President and Chief Executive Officer for cause by a vote of two to one. However, there was a
dispute among the Board members as to whether the Board meeting was properly called and whether Mr. Veltri should have been allowed
to vote on his own termination. The outcome of the vote on Mr. Veltri’s termination was in dispute as Mr. Veltri contended
that he should have voted on his termination, and had he voted, Mr. Veltri would have voted against his own termination, thus
creating a board deadlock preventing his termination. Specifically, Mr. Veltri contended the Board, which consisted of four members
at that time, remained deadlocked on the issue, which prompted APEG II to file the above-mentioned suit against Mr. Veltri to
have him removed as the Company’s President and Chief Executive Officer. The Second Order noted that the primary purpose
of having Mr. Lewis serve as custodian was to resolve the aforementioned Board deadlock. Pursuant to the Second
Order, Mr. Lewis, as custodian, was ordered to act in place of the Board to appoint one independent director to replace Mr. Hoffman. On June 13, 2019, Mr. Lewis appointed Catherine J. Boggs to serve as an independent director until the next
annual meeting of the Company’s shareholders. Following such annual meeting, the Board of Directors is to vote on a new
Chief Executive Officer to replace Mr. Lewis in that role, and which tenure may last only so long as it takes the Colorado Federal
Court to resolve the disputes in the Colorado Litigation, and Mr. Lewis will be discharged from serving as the Company’s
custodian, Interim Chief Executive Officer and as a member of the Board. Following the issuance of the Second Order,
the Audit Committee of the Company, which had been continuing its investigation into Mr. Veltri’s actions while he served
as President and Chief Executive Officer, engaged an independent accounting firm to conduct a forensic accounting of the Company’s
books and records in an effort to determine whether certain of Mr. Veltri’s actions regarding his use of Company funds
was appropriate and authorized. See “ Audit Committee Investigation –Recent Developments—Audit
Committee Investigation Both the Texas Litigation and the Colorado
Litigation remain pending. Audit Committee
Investigation Following the termination
of the Company’s former Chief Executive Officer, President and Chairman of the Board on February 25, 2019, the Company’s
independent auditors, Plante & Moran PLLC, informed the Audit Committee that the auditors had found at least one instance
of irregularities in the submission and payment of expense reports with respect to the former Chief Executive Officer. The Company’s
Audit Committee engaged independent legal counsel, which engaged an independent accounting firm to conduct a forensic accounting
investigation of the Company’s expense reporting system in relation to issues raised by the Company’s independent
auditors regarding potential financial improprieties related to expense reports, including examining expense reports and third-party
expenditures made by or through the former Chief Executive Officer or his staff. The investigation was expanded into an forensic
investigation of the integrity of the Company’s computer-based record keeping after Mr. Veltri and Mr. Hoffman managed
to reset the security codes to give them complete control of the Company’s books and records temporarily and exclude our
other officers and directors ability to access those records during that period, which further raised concerns with respect
to material weaknesses in the Company’s internal control over financial reporting. The scope of the forensic accounting
and investigation covered the period from January 1, 2017 through March 31, 2019. The Company’s Audit Committee has taken
certain steps in response to the forensic accounting investigation. See “ Item 9A. Controls and Procedures—Changes
in Control Over Financial Reporting-Management’s Remediation Plan The
forensic accounting investigation was completed on June 13, 2019 and resulted in the finding of a number of irregularities and
reimbursements for personal expenses or expenses that were unrelated to furthering the Company’s business. An expense report
was submitted in October 2018 that included $1,537.08 for the registration of a vehicle owned by an affiliated entity of Mr. Hoffman, as well as insurance premiums for the vehicle totaling $813. Mr. Hoffman repaid the Company in full for such
amounts in connection with his resignation and settlement agreement with the Company in May 2019. It is possible that these payments
by the Company on behalf of Mr. Hoffman could be deemed to be in violation of Section 402 of the Sarbanes-Oxley Act of
2002. However, the Company has not made a determination as of the date hereof if such payments resulted in a violation of that
provision. If, however, it is determined these payments violated the prohibitions of Section 402, the Company could be subject
to investigation and/or litigation that could involve significant time and costs and may not be resolved favorably. The Company
is unable to predict the extent of its ultimate liability with respect to these payments. The costs and other effects of any future
litigation, government investigations, legal and administrative cases and proceedings, settlements, judgments and investigations,
claims and changes in this matter could have a material adverse effect on the Company’s financial condition and operating
results. In
addition, the investigation found that the former Chief Executive Officer, David Veltri, had expense reports that consistently
lacked detailed receipts and descriptions of the business purpose of each expense. The expense reimbursements did not go through
a review process or require Board approval or approval from any other employee, as the Company did not have in place any expense
report policy or other process for pre-approving expenses prior to incurring such expense. Mr. Veltri was the sole signatory on
the Company’s bank accounts and effectively had sole authority to approve his own expense reports when he provided reimbursement
checks to himself and controlled all funds of the Company. The
forensic accounting investigation and the Company’s internal investigation also identified numerous expense items on Mr.
Veltri’s expense reports that appeared to be personal in nature, or lacked adequate documentation showing that such expense
was for legitimate business purposes. These expense items totaled at least $81,014, of which $32,194 was incurred during the year
ended December 31, 2017, $34,203 was incurred during the year ended December 31, 2018 and $14,617 was incurred during 2019 prior
to Mr. Veltri’s termination. The Company is reclassifying the entire $81,014 reimbursed to Mr. Veltri as additional compensation
and taxable income. In addition, The Company has accrued payroll taxes payable on the additional compensation, however, we have
not accrued penalties and interest that may be assessed because the amount of such penalties and interest cannot be reasonably
determined. The
report also indicated that Mr. Veltri used the Company’s vendors for his own personal benefit. Mr. Veltri bypassed the Company’s
accounts payable process by paying third-party vendors personally through expense reports and then approved his own expense reports,
which limited the visibility of the payments and review by the Company’s accounting personnel. Mr. Veltri personally obtained
reimbursements for several charges incurred by a consultant hired by the Company, which consultant potentially had a conflict
of interest with the Company. The reimbursements totaled $2,710, and such reimbursements were highly unusual since the consultant
included its expenses directly on its own invoices. The independent accounting firm conducting the forensic accounting investigation
called into question other payments made to the consultant because of the vagueness of the work descriptions and project details
provided by the consultant, and the independent accounting firm questioned Mr. Veltri’s judgment and the legitimacy of the
services provided by the consultant for which the Company paid a total of $38,774. The forensic investigation revealed that Mr.
Veltri may have made personal loans to the owners of the consulting firm, which indicates that a conflict of interest existed
between Mr. Veltri’s personal interests and the Company’s best interests. Mr.
Veltri also incurred $47,156 in third-party professional fees in connection with a potential transaction with a company controlled
by a former Board member, which transaction and related expenses in evaluating the potential transaction were not approved
by the Board. The professional fees when incurred were treated as unevaluated prospect cost and included in unproved oil and
gas properties. At December 31, 2018, the total amount of the fees was impaired and transferred to the full cost pool. Mr.
Veltri also entered into an agreement to acquire some oil and natural gas properties for which the Board authorized $250,000,
which amount was fully refundable, subject to the funds being held in escrow pending the closing of the acquisition. Mr. Veltri
wired the funds directly into the seller’s account, rather than escrowing such funds, and also paid the seller an additional
$124,328, which amount was not authorized by the Board, as well as $40,578 for professional services. The transaction never closed,
and the Company is currently seeking a refund of such funds from the seller. While the Company is pursuing collection of the
deposit, the Company has established an allowance for the entire $374 thousand due from the seller due to the uncertainty of collection
of the deposit. See Note 8 Write-off of Deposit Lessee
Operating Leases.
Year Amount
2019 $ 72
2020 73
2021 74
2022 76
2023 6 Rent
expense was $80 thousand and $85 thousand for the years ended December 31, 2018, and 2017, respectively. |
