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Oil and Gas Sale and Purchase Agreements
SPAs for International Oil and Gas Acquisitions and Divestitures
By John LaMaster, Caroline-Lucy Moran
Globe Law and Business LtdCopyright © 2017 Globe Law and Business Ltd
All rights reserved.
Joanna KayPeter Roberts Orrick LLP
This chapter outlines the factors that are key to determining the best transaction structure for the sale and purchase of oil and gas interests. The first part of the chapter reviews the preliminary considerations that will help the parties to select the structure of a particular transaction. The second part compares the two principal sale structures used in the industry: share sales and asset sales. The third part examines the different types of asset sale structure that are common in the oil and gas industry. The fourth and last section considers the essential elements of the sales process, from the initial decision to sell through to completion.
1. Preliminary considerations in structuring a transaction
A wide range of factors can affect the structure selection process for a particular transaction. The extent to which any particular factor could influence the decision-making process will also vary from one transaction to another. However, a number of preliminary considerations will help to shape the structuring analysis that is carried out at the outset of a proposed transaction.
1.1 The nature of the interest for sale
The oil and gas industry is extremely diverse. It spans the upstream, midstream and downstream, oilfield services and infrastructure sectors, involves both public (government) and private (company) interests, and includes such varied disciplines as joint venture formation, exploration, project development, production, storage, transportation, processing, commodity trading, financing, intellectual property and compliance. Against this colourful backdrop, it is possible to see how the underlying nature of the interest for sale will affect the structure of a given transaction.
Where a transaction relates to early stage upstream interests, the valuation of the interest and the form that the actual sale and purchase takes will be heavily influenced by the concession obligations that the buyer assumes and the seller transfers to the buyer as a consequence of the transaction. This is one of the reasons why upstream transactions are often based on farmout or earn-in arrangements. Similarly, the underlying joint venture that will regulate the parties' relationship once the transaction has completed will have a material bearing on the transaction documents. It is common to see voting compacts included in upstream sale and purchase agreements (SPAs), as well as in agreements between the seller and buyer, that vary the joint venture position in respect of cost contributions, work obligations, cost recovery entitlements, and environmental and decommissioning liabilities.
In the midstream and infrastructure sectors, oil and gas transactions tend to focus more heavily on physical assets such as pipelines and storage. A transaction may be structured as a share sale or an asset sale, but the focus of the due diligence and the protections incorporated in the SPA will be on the assets themselves, whereas joint venture and concession issues could be less prominent.
In the downstream and oilfield services sectors, the focus changes once again. There, the value of the interest will often reside in less tangible assets such as the book of business that has been built up and the intellectual property developed and owned by a target company. These businesses lend themselves more to a share sale structure.
1.2 The rationale for the sale
Just as the nature of the interest being sold varies from one transaction to another, so too do the motivations that inform the seller's decision to sell and the buyer's decision to buy a particular interest.
The primary motivation for any seller will be to realise value from the divestment of its interest in a particular asset or target company. However, a number of other factors may also underlie the seller's decision to sell. These include:
the desire by the seller to reduce costs within its organisation or in connection with that particular asset or target company;
the desire to mitigate the extent to which a seller is exposed to any downturn in the performance of the asset or target company, whether that downturn is financial, technical, geological or commercial;
the desire to manage better the political risk associated with a particular asset or target company – for example, by selling it to a bigger company with greater leverage in the relevant jurisdiction or better local connections;
as part of a wider strategic review or sector re-focus;
to comply with regulatory requirements;
as a form of portfolio management to free up cash for the seller to diversify or refocus its business; or
as a means of bringing in a new set of skills and expertise to enable the asset or target company to develop further.
By selling all or part of its interest in an asset or target company a seller may be able to realise one or more of these objectives.
A buyer will similarly want to realise value as a result of its acquisition of an interest. That value is unlikely to be realised directly. Instead, the value is generated for the buyer through the upside potential that the asset or target company offers. The acquisition could allow the buyer to establish a presence in a new sector or market that complements its existing portfolio. There may be strategic reasons for the acquisition, such as the ability to acquire transportation rights or to gain access to data that is relevant to the buyer's existing business. Or the acquisition of a new asset or target company may offer the buyer tax savings that can be used to benefit the buyer's wider portfolio.
Whatever they are, the underlying motivations of the seller and the buyer will help to shape the structure of a transaction. These motivations will need to be recognised and reconciled within the transaction documentation.
1.3 Regulated companies
Where a transaction involves a public takeover, the structure of the transaction will likely need to comply with certain regulatory requirements. A public takeover is the acquisition of control of a company that is listed on a regulated market.
In the United Kingdom, takeovers are governed by the City Code on Takeovers and Mergers. The code will apply to offers for, and other transactions involving a change in control of, companies with their registered office in (or that are considered to be resident in) the UK, the Channel Islands or the Isle of Man, if any of their securities are admitted to trading on a regulated market or a multilateral trading facility in the UK or on any stock exchange in the Channel Islands or the Isle of Man. The code will also apply to all companies whose shares are traded on AIM or ISDX, regardless of whether they have their central management and control overseas. The code does not apply to private companies, unless there has previously been some marketing of their shares to the public.
The code applies to takeover and merger transactions, however they are effected, including by means of a statutory merger or court-approved scheme of arrangement. The code imposes a set of statutory rules on all such transactions creating the form, structure and timetable of the transaction in order to ensure the fair and equitable treatment of shareholders in the target company.
A number of other UK statutory and regulatory provisions will also apply to a transaction where a target company is publicly listed. These include:
insider dealing provisions under the Criminal Justice Act 1993 and the Financial Services Act 2000;
market abuse and financial regulations under the Financial Services and the Markets Act 2000;
shareholder consents under the Listing Rules;
disclosure and transparency obligations under the Disclosure and Transparency Rules and the Prospectus Rules; and
merger controls under the Competition Act 1998, the Enterprise Act 2002 and the EU Merger Regulation.
Public takeovers are in the minority of M&A activity in the oil and gas industry and the issues that need to be taken into account in connection with a public takeover will differ from one jurisdiction to another as they are driven by the legislation specific to a particular jurisdiction. Consequently, the rest of this chapter focuses on structuring private M&A transactions.
2. Share sales and asset sales
The most fundamental decision that the parties will need to make when structuring a transaction is whether to structure it as a share sale or an asset sale.
Under a share sale structure the interest that is being sold is the shares in the company that owns the asset(s) that the buyer wishes to acquire:
In a share sale, the share purchase agreement effects an indirect transfer of the underlying interest through the sale of the share capital of the target company that holds the relevant interest. The buyer acquires all of the assets, rights and liabilities of the target company, known and unknown, including those arising prior to the acquisition (unless anything is specifically excluded from the sale). The buyer will therefore need to investigate carefully the financial, legal, tax and commercial position of the target company in order to identify and quantify the risks associated with the acquisition of that company.
Under an asset sale structure the interest that is being sold is the asset itself:
In an asset sale there is a direct transfer of the relevant interest. The buyer will acquire only an asset (and its corresponding rights and liabilities) and any associated financial or strategic value. The SPA will specify exactly what asset is being sold to the buyer, allowing the buyer to avoid the inadvertent acquisition of other assets (and their corresponding rights and liabilities).
The key factors that will influence the parties' decision as to whether to structure the transaction as a share sale or an asset sale are outlined below.
The tax implications of a transaction will be among the most influential factors in structuring the acquisition or disposal of an interest. Share sales and asset sales have very different tax consequences. As a broad generalisation, the advantages of a share sale will usually be preferable from a seller's tax perspective, whereas the advantages of an asset sale will usually be preferable from a buyer's tax perspective. However, the specific circumstances of the companies and interests involved will be determining. The chapter "Tax aspects of oil and gas mergers and acquisitions" addresses a transaction's tax implications in more detail.
It is also generally assumed that a share transfer is the key to securing accumulated tax losses that sit in the target company and that the buyer could then secure and benefit from. This simple expectation, however, will always need careful verification.
Asset sales are generally perceived to be more complex than share sales. This is because an asset sale requires the buyer to identify each of the assets that it wishes to acquire and each of the liabilities that it is willing to assume (and, correspondingly, any assets or liabilities that it might not wish to acquire). This complexity is a downside, in that the buyer must balance against the additional flexibility that an asset sale otherwise affords a buyer (eg, of because the ability to select only those assets that it perceives to be of value). Before committing to buy an asset, the buyer will need to assess carefully the contractual arrangements associated with a particular interest to ensure that it acquires all of the rights that it needs to maintain (or enhance) the value of that interest. Furthermore, in an asset sale there may be a number of different types of asset being transferred (eg, concession interests, trading arrangements, real property and/or intellectual property). Each different type of asset may have a different procedure or registration requirement in order to effect a valid transfer of that asset. This means that the transfer process in an asset sale is also more complex than in a share sale.
In theory, the sales process for a share sale is more straightforward than the sales process for an asset sale. It will involve the transfer of only one asset: the shares in the target company. The transfer of title to those shares from the seller to the buyer will be effected by the simple registration of the buyer as the new owner in the members' registry of the target company. However, in reality a share sale can be extremely complex. Where a business has grown organically, the assets and services required to operate that business may not all be situated neatly in a single target company ready for sale. A pre-sale reorganisation may therefore be required to clean up an existing subsidiary to ready it for sale or to establish a new special purpose vehicle to package up assets that were formerly sitting in a number of different subsidiaries prior to the sale process. In turn, the buyer may require a post-sale reorganisation. This may be driven by the need to move the target company to a more appropriate place in the group structure of the buyer (since the tax structuring of the original acquisition may have resulted in the target company sitting in a suboptimal place from an operational perspective). Equally, where the target company was previously a trading company in the seller's group, the buyer may wish to transfer the constituent assets into a known or clean entity and liquidate the target company in order to remove from its books a company that it knows little about. Whether effected pre or post-sale, any reorganisation of the target company will need proper documentation. Intra-group transfer arrangements may be structured as either an asset sale or a share sale; typically, the documents will be much shorter than in a true arm's length sale. Care will also need to be taken in the structuring of the consideration of any intra-group transfer to ensure that there is no unintended under-valuation of the transferred interests that could trigger company law issues and either invalidate the transaction or expose the directors to civil or criminal liabilities.
2.3 Third-party consents
Asset sales involve a change in the party that owns the asset. As noted above, where a transaction involves a number of assets, the nature of the assets could be quite diverse and may require the consent of one or more third parties in order to effect the assignment or novation of the assets from the seller to the buyer. This can add time to the sale process and potentially creates an opportunity for those third parties to impose new terms to gain advantage from the change, or even to refuse to effect the transfer.
In a share sale, the interest remains owned by the target company so there is no direct transfer of the interest. This means that the relationship between the target company and its contractual counterparties in respect of the interest does not change. This considerably reduces the number of third-party consents that may be required to effect a transfer of the target company and therefore reduces the risk of value impairment of the underlying business as a result of the transfer. Consequently, share sales are often simpler to implement than asset sales.
In certain circumstances, however, the requirement to obtain consent may be triggered not only by a change in ownership of the interest itself, but also on a share sale as a result of a change in ownership of the ultimate owner of the interest, through so-called 'change of control' clauses. In the oil and gas industry, the underlying concession that grants title to the upstream interest will often contain such a change of control clause. Thus, host government consent will often be required regardless of whether a sale is structured as an asset sale or a share sale. The other contractual arrangements related to the target company that is being transferred will also need to be analysed carefully to identify any change of control clauses.
2.4 Pre-emption rights
In oil and gas acquisition transactions, joint operating agreements (JOAs) and other joint venture structures commonly include a pre-emption right. Pre-emption rights compel a seller to offer the interests under the JOA or joint venture agreement that it is proposing to sell to the buyer first to its existing co-venturers on the same terms and conditions as those agreed to by the buyer. Only if those existing co-venturers do not wish to exercise their rights to take up the seller's interest can the seller then sell the interests to the buyer. The ostensible purpose of pre-emption rights is to control the entry of a new participant into the joint venture or to limit the ability of an existing participant to build a participating interest stake that gives it complete voting control under the JOA or joint venture agreement.
Typically, pre-emption rights under a JOA or joint venture agreement are triggered only in an asset sale. If a pre-emption right applies, the buyer will need to ensure that any co-venturer's right to pre-empt a transfer under the JOA or joint venture agreement is waived as a condition precedent to the buyer's obligation to acquire the interest.
Excerpted from Oil and Gas Sale and Purchase Agreements by John LaMaster, Caroline-Lucy Moran. Copyright © 2017 Globe Law and Business Ltd. Excerpted by permission of Globe Law and Business Ltd.
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