A necessary complication with unnecessary and unintended consequences
ABOUT THE GUIDE
- This is the second volume of McCullough Robertson's Energy and Resources M&A Transaction Guide developed for the resources sector.
ABOUT EDITION 1
- An upstream pre-emption provision is simple in concept but riddled with complications and unintended consequences if treated as little more than a boiler plate provision of the joint venture agreement or other relationship agreement. Care needs to be taken to ensure that pre-emptive rights are well thought through and appropriately drafted and reviewed from time to time.
- We'll wrap up this second volume of the Guide with a Masterclass in Brisbane and Sydney in 2018 where you can ask our expert panel any questions related to undertaking an M&A transaction. Dates will be announced in 2018, but you can register your interest for Brisbane here and Sydney here.
There is nothing more frustrating for a seller of a joint venture interest than to have potential bidders withdraw from a sale process because the pre-emptive rights held by the seller's co-owners mean that those potential bidders do not consider that they have any prospects of success. It is particularly concerning when the seller needs to have a bona fide offer from a third party bidder before triggering the pre-emptive process and engaging with the co-owners with a view to having them actually exercise their pre-emptive rights.
Pre-emptive rights are arrangements which give the joint venture owners or partners of a seller the last right or option to acquire its interest in the project. It is only after that option lapses without being exercised that a bidder for that interest can be certain that its bid will succeed and it will acquire the joint venture interest on offer.
In July last year in the first volume of this Guide we published a paper which identified some of the pitfalls that needed to be considered when negotiating pre-emptive provisions for a modern day joint venture.
In that article we mentioned briefly that if pre-emptions are going to form part of the joint venture agreement between the parties then they need to cover off on upstream share sales. If this does not happen, the pre-emptive rights will be limited to a sale of the actual joint venture interest held by the seller but not the sale of the seller or any of its holding companies.
This would allow for an easy circumvention of those pre-emption rights by a third party bidder should that bidder be prepared to be a little hostile in the acquisition process.
Normally these upstream pre-emption provisions will be triggered when there is a control transaction.
A challenging aspect for those negotiating these types of provisions is identifying what types of control transactions would trigger a pre-emptive right. If there is an upstream pre-emption provision in the joint venture agreement then, at a basic level, the sale of the company which is the joint venture party should trigger a pre-emptive right in favour of the other joint venture participants.
An upstream pre-emption provision is simple in concept but riddled with complications and unintended consequences if treated simply as a boiler plate provision of the joint venture agreement or other relationship agreement between parties to a particular investment or project.
For example, by simply adopting the Corporations Act 2001 (Cth) definition of 'Control' to determine whether there is a change of control will result in the possible unintended consequence of pre-emptive rights being triggered when there is an internal restructure of a corporate group which owns the joint venture interest. For instance, the addition of a new shelf company as a holding company of the company which owns the joint venture interest will trigger a pre-emptive right even though there is no change to the ultimate economic or equitable ownership of the corporate group.
Conversely, the Corporations Act 2001 (Cth) ignores holders of non-share equity interests which, in some cases, carry the same rights and privileges as shareholders. That means the economic ownership of a joint venture interest could be transferred without triggering a change of control and therefore a pre-emptive right in favour of the other participants.
The following are examples of where transactions within a corporate group may or may not trigger a pre-emptive right (most of which are intentional):
- the change of control occurs to a company listed on the Australian Stock Exchange or other similar exchange (and which listed company directly or indirectly owns the joint venture interest) – these transactions are normally specific carve outs to change of control triggers
- the rights are only triggered if the change of control happens to the actual company within the corporate group which holds the joint venture interest (and not to any of its holding companies)
- again the rights are only triggered when the change of control happens to companies in the ownership chain which are incorporated in Australia meaning you ignore any changes in control to offshore parents and holding companies within the ownership chain
- the rights do not apply if the joint venture interests represent less than, say, 50% of all the assets being acquired as part of the control transaction, and
- specific exemptions may also be carved out, for example, where there is a merger of two or more of the joint venture partners.
Some practical matters that should be considered when drafting or reviewing these types of provisions include:
- that the impact of any upstream transaction should be tested against the ownership structure at the time that the participant becomes a joint venture participant and not as at the date the joint venture commences given that some participants will only become participants in the joint venture at later dates
- that there be some flexibility in the testing times to allow, for example, a new testing point if there is a change of control to a joint venture participant but the pre-emptive rights are not exercised. That is to say that subsequent transactions should be tested against the point in time when that change of control took place
- that the change of control provisions are not so restrictive so as to prevent internal reorganisations within a corporate group or a chain of companies, particularly where joint venture interests represent only a portion of the group's overall assets and activities, and
- conversely, as well, that any such carve-out for particular transactions such as the transfer to a related body corporate be carefully drafted so to ensure the carve-out is strictly limited to internal reorganisations and the addition of new corporate entities to wholly owned corporate groups.
In most cases when the pre-emptive right is triggered the price at which the interest in the joint venture must be offered for sale by the participant is determined by an independent valuation. Difficulties arise from time to time when the price paid pursuant to the transaction giving rise to the change of control pre-emption right reflects an amount which is significantly greater or less than the market value which is independently determined.
For this reason, sale transactions are often structured by way of an asset sale because pre-emptive rights for asset sales are normally based on the price agreed with a third party and not before independent valuation. However, the better approach might well be to have the pre-emptive rights structured in a way that allows for the flexibility of a share sale which triggers a pre-emptive right in favour of the other Joint Ventures for effectively the same price offered by the third party purchaser and not by reference to an independent valuation.
On balance, it would seem that upstream pre-emptive rights are, unfortunately, a necessary evil. Care needs to be taken to ensure that they are well thought through and appropriately drafted and reviewed from time to time.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.