Canada: The Court Interprets Affilate Exemptions In A Right Of First Refusal

Last Updated: November 15 2016
Article by Ashley Weldon

Background

In Northrock Resources v. ExxonMobil Canada Energy1, ("Northrock v Exxon") the Saskatchewan Court considered the application of rights of first refusal ("ROFR") clauses and affiliate exemptions in the context of the sale of oil and gas assets. Northrock Resources ("Northrock") and ExxonMobil Canada Energy ("Exxon") were parties to two sets of non-CAPL operating agreements covering certain oil and gas assets in the Battrum and Cantuar areas of Saskatchewan ("B&C Interests"). Both sets of agreements contained ROFRs with certain exemptions, including transfers to an affiliate of a party. Specifically, the ROFR clauses prevented a party from disposing all or a part of its interest under the relevant operating agreement without giving the other party an opportunity to acquire the assets on the same terms as the prospective purchaser. However, an exemption to this provision permitted a party to transfer all or a portion of its interest to an affiliate of that party without complying with the ROFR provision.

In 2005, Exxon decided to divest itself of the B&C Interests using a bidding process. An offering memorandum in the data room expressed that Exxon was "interested in entertaining tax effective structures for the transaction(s)" and two transaction structures were possible; namely, a busted butterfly or an asset sale. The busted butterfly was a two-prong transaction whereby the B&C Interests would be transferred to wholly-owned subsidiaries (the "Exxon Subs") of Exxon and then the purchaser would buy the shares of the wholly-owned subsidiaries, obtaining control of the entities that owned the assets. This structure offered a significant tax advantage to Exxon. Conversely, under the asset sale, the B&C Interests and all of the associated tax pools would be transferred directly from Exxon to the purchaser or its nominee, providing more of a tax advantage for most purchasers.

Accordingly, most prospective purchasers offered less cash consideration under the busted butterfly structure. However, Crescent Point General Partner Corp. ("Crescent Point") did not discount its offer as Crescent Point was a specified investment flow-through trust and had no ability to make use of any tax benefit from the tax pools to be transferred with the assets. Accordingly, Crescent Point's bid was the same whether by asset sale or busted butterfly, with a preference for a busted butterfly, which was Exxon's stated preference.

After two rounds of bids, Crescent Point was selected as the successful bidder on the basis of the busted butterfly structure. The deal closed in 2006 and Northrock was advised of the transfer from Exxon to the Exxon Subs on the basis of the affiliate exception. However, no ROFR notices were issued on the sale of the shares of the Exxon Subs to Crescent Point. Northrock subsequently initiated a claim against Exxon, Exxon Subs and Crescent Point, raising many issues including breach of contract and breach of the duty of good faith. The foundation of Northrock's claims was that Exxon's transfer of its interests to the Exxon Subs and the subsequent sale of the shares of the Exxon subs from Exxon to Crescent Point were in fact a single transaction — a sale of the interests from Exxon to Crescent Point structured to avoid Northrock's ROFRs.

Breach of Contract

In addressing the claim for breach of contract, the Court found that there was no ambiguity about the meaning of the ROFR provisions. Rather, both ROFRs provided for exceptions for transfers to affiliates and the Exxon Subs fell within the definition of "affiliate". Further, neither ROFR provisions were triggered by the sale of the shares of the owner of an interest. The Court noted that the parties were sophisticated actors in the oil industry and they did not bargain to include provisions that would trigger a ROFR in this circumstance:

"[...] the parties to the agreements did not intend that every circumstances of a party divesting itself of an interest would trigger a ROFR. In negotiating a ROFR provision they chose which divestitures would be singled out for a restriction on a right of a party to deal with its own property"2

The Court concluded that the transaction did not trigger the ROFR provisions of either operating agreement and Exxon did not breach its agreement with Northrock by failing to provide ROFR notices.

Duty of Good Faith

On the issue of the duty of good faith, the Court made reference to the Supreme Court of Canada's decision in Bhasin v. Hrynew3, which recognized a general duty of honest contractual performance. The Court also reviewed other leading cases regarding the duty of good faith and ROFRs, including GATX Corp. v. Hawker Siddeley Canada Inc.,4 Glimmer Resources Inc. v. Exall Resources Ltd.5 and Chase Manhattan Bank of Canada v. Sunoma Energy Corp.6 After reviewing these cases, the Court found that a breach of a duty of good faith could be established where a party is shown to have lied or misled, thereby breaching the duty of honest performance. Further, such a breach may be established:

[...] where a party is shown to have structured a transaction for the purpose of avoiding a ROFR. If, on the other hand, a structure was chosen for reasons other than to avoid a ROFR, then the choice of that structure does not constitute a breach of the duty of good faith.7

The Court found that in this case:

[t]he defendants did not lie. The defendants did not mislead. The defendants did not use the busted butterfly structure for the purpose of avoiding the ROFRs. Rather, they used it for other legitimate purposes, albeit recognizing that it would have (in their view) the side effect of not triggering ROFR notices [...]8

Lastly, in dismissing Northrock's claim for inducing breach of contract and conspiracy, the Court found that the predominant purpose of Exxon and the Exxon Subs was not to cause injury but rather to achieve beneficial tax results and the predominant purpose of Crescent Point was to be the successful bidder. Accordingly, the conduct of the defendants was found not to be unlawful and the claim for conspiracy and breach of contract both failed.

Implications

This case provides some guidance from the Saskatchewan Court as to whether a ROFR obligation is triggered in the context of a busted butterfly transaction where there is an affiliate exemption. The fact that there was ultimately a change of control of the ownership of the assets did not itself constitute a breach of the ROFR provisions. Rather, if parties would like a different outcome, they should provide that a ROFR is triggered on a change of control of a party. This case reaffirms the findings in the earlier leading cases; namely, there is no breach of the duty of good faith if the chosen structure of the transaction avoids a ROFR, as long as avoiding the ROFR was not the purpose of that particular structure. However, because the Court did not have to go any further, this case does not address what the outcome would have been had the avoidance of a ROFR been a contributing factor in choosing the structure of the transaction. The answer as to whether that would have amounted to a breach of duty of good faith has been left to another day.

Footnotes

1. 2016 SKQB188

2. Ibid at para. 54.

3. 2014 SCC 71.

4. (1996), 27 BLR (2d) 251 (Ont. Ct. J.).

5. (1997), 35 BLR (2d) 297 (Ont. Ct. J.).

6. 2002 ABCA 286, 317 AR 308.

7. Northrock v Exxon, supra note 1 at para. 66-67.

8. Ibid at para. 104.

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.

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