Energy and Resources M&A Transaction Guide
'Dodgy' documents – managing deal risk and contractual exposure
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 6
- In Edition 6, we look more closely at managing deal risk and contractual exposure through the rectification of 'dodgy' documents.
- This is the final edition in volume 2 of our Energy and Resources M&A Transaction Guide. Don't forget to register for our Masterclass in Brisbane (23 May) or Sydney (18 May), where you can ask our expert panel any questions related to undertaking an M&A transaction. Register now for Brisbane here and Sydney here.
For buyers and sellers alike, there is nothing more frustrating than the wasted time, cost and effort of a transaction which does not proceed because a party fails to manage their exposure under existing contractual arrangements. For this reason, it is essential that both parties comprehensively understand the assets and commitments the subject of a proposed transaction, so as to avoid missing contract red flags or misunderstanding an existing contractual framework.
In this edition, we look at the key considerations for both sellers and buyers:
- so as to avoid transactions falling over because a project or asset is governed or affected by 'dodgy' documents or contractual arrangements, and
- to manage risk under existing 'dodgy' documents whether by, in the case of the seller, achieving a clean exit or, in the case of the buyer, ensuring only known liabilities are assumed on completion of the acquisition.
Transactions falling over because of 'dodgy' documents
From the seller's perspective: Get your house in order
Before committing to any sale process, a seller must ensure their house is in order. For an informed buyer, the key to understanding a resources project, in respect of both asset sales and share sales, is comprehensive due diligence. If, as a seller, your house is in order and the documents impacting the resources project are clear, this process is more manageable, cost effective and timely for all parties involved.
From a practical perspective, some active steps a seller might take include updating the project documents to reflect the current legal and beneficial ownership of assets, terminating unused or relic documents and references, assigning and amending documents to reflect current arrangements with relevant third parties (such as service contracts) and, if necessary, updating the various legal registers.
In the first volume of our Energy and Resources M&A Transaction Guide, we discussed general inhibitors for M&A transactions involving joint venture documents. This guide may be useful for sellers to consider during a review of old joint venture documents.
A seller's reluctance to modify out-of-date documents may result in a buyer being unclear about the asset they are acquiring or the ownership rights which might affect that asset. This issue often arises where a seller wishing to sell their interest is not the sole owner of the relevant asset or project. In these cases, it is more difficult for a seller to interest potential buyers if there is no obvious pathway to develop or improve an asset or project because of limitations or restrictions under existing ownership documents. If it is possible to update existing ownership arrangements, sellers should consider engaging with the other owners ahead of commencing transaction discussions so as to avoid unnecessary transaction costs, as well as wasted time and effort.
From the buyer's perspective: Due Diligence
Gathering, understanding and evaluating information about a project (including project documents) is the cornerstone to determine whether an acquisition represents a sound commercial investment.
A successful buyer will need to live with the project documents from the closing of its acquisition and will need to clearly understand their obligations and rights going forward. Buyers should particularly ensure they understand existing ownership rights or limitations, key decision thresholds under any existing ownership documents (particularly in relation to the rights of any other owners) and the funding requirements for the asset or project moving forward.
To be forewarned is to be forearmed, meaning that, having undertaken a comprehensive due diligence process, a buyer is better equipped to assess the commercial risks of the transaction (including their obligations going forward) against the value of the project and when negotiating appropriate warranties in the sale agreement.
From the buyer's perspective: Pre-emption rights
Where the proposed acquisition is of a joint venture interest which is subject to a pre-emption right, there is always a risk that an M&A transaction may be derailed by one of the existing participants. The form, requirements and timeframes of pre emption processes vary across resources projects as these rights are usually bespoke, having been negotiated extensively between the participants. We often see older joint venture documents provide for simplistic but unclear processes. In contrast, modern joint venture agreements set out more structured arrangements, but those arrangements can often be drawn out and inefficient.
The best outcome is to obtain a waiver of any pre emption rights from the continuing participants. If no upfront waiver from the continuing participants is received, then it is important to ensure the requirements of the relevant clause are followed, as failure to comply with the pre-emption process may render a pre-emption offer invalid. Having to undertake a second round of pre-emption offers may prevent the sale transaction proceeding and as such, a buyer should ensure the form and timing of the pre-emption provisions are dealt with appropriately in the transaction documentation to achieve deal certainty. The risks associated with pre emption clauses should be ascertained as part of the due diligence process.
In some instances, the pre-emption rights in a joint venture agreement may be defective to the point that they may allow a buyer to complete a transaction without triggering those rights. A simple example of this is where the rights are not triggered by an upstream share sale of an asset owner, but are triggered in the case of an asset sale by the asset owner. Despite this seeming like an easier option, a buyer would be well cautioned to consider carefully whether or not to undertake the transaction in a way that circumvented the rights of the other participants by, using the current example, undertaking an upstream transaction. Unlike a seller, a buyer will need to establish a sensible working relationship with the continuing participants in the interests of maximising the collective return of all participants from the project and the investment. A bad start to that relationship will not be terribly helpful in this regard.
A buyer uncomfortable with the terms of a joint venture agreement whether because they are defective, uncertain or unworkable, should consider making amendments to that agreement a condition to completion of an M&A transaction. A buyer would be wrong to think that agreement could be reached with the continuing participants to amendments to the joint venture agreement after acquiring an ownership interest from the sellers.
'Dodgy' documents and risk management – balancing buyer and seller interests
From the Seller's perspective: Making a clean break
Traditionally a seller will obtain a release from the continuing participants on and from the completion of the transaction.
In an active market, sellers with substantial bargaining power should (and, in our experience, do) seek that the buyer assume all the seller's liabilities under project documents, third party contracts and even environmental liabilities that may arise in respect of the project (both before and after completion). This is particularly beneficial for sellers who are diversifying their interests in mining. The payment for this assumption of liabilities might be a reduction in the purchase price; however that adjustment may be worth it for sellers wishing a clean break from the project.
From the Seller's perspective: PPSR – to release or not to release?
Depending on the scope of a manager's engagement with a project, a seller could have hundreds of security interests registered over it on the Personal Property Securities Register (Register). While the steps involved in actually discharging a registration from the Register are relatively simple and straight forward (once financial or other obligations have been satisfied), engaging numerous third parties to release those security interests on or before completion of an M&A transaction can be time consuming and could therefore delay completion of a transaction.
In our experience, sellers are making specific provisions in their transaction documents as a way to manage their obligation to obtain a full or partial discharge of security interests over the assets the subject of the sale. Specifically, registrations relating to limited or specific assets (i.e. not registrations over all present and after acquired property) could be maintained and transferred to the buyer subject to a promise by the seller to procure the secured party to discharge the security interest if there is a claim by the secured third party.
This concept of a continuing security interest would need to be included in the sale agreement with the prospective buyer.
From the Buyer's perspective: Managing exposure to assumed risks and liabilities
Every buyer faces a certain amount of risk and uncertainty when taking on a new project. In documenting a transaction, a buyer should specifically consider the nature of any liabilities to be assumed if it proceeds with a transaction, including those which are inherent in the project or assumed by virtue of becoming the asset owner (for example, statutory rehabilitation obligations) and work to minimise those risks, where possible, going forward. Buyers should particularly be wary of assuming responsibility for generic categories of liability which might be described as 'related to' the asset or project and understand the seller's intention with the liabilities imparted here.
It is becoming more common for buyers to maintain insurance to transfer risks that they do not wish to assume. However, the problem is that insurance companies are facing an uncertain future (particularly in the mining industry) and are having difficulties quantifying the risk or liabilities assumed by a buyer. This difficulty in quantifying liabilities is particularly relevant for environmental risk. In some cases, insurance companies will exclude environmental liabilities from coverage.
While the seller has accepted liability for a particular risk following completion, it may be that a buyer will assume the primary liability for that risk on and from completion. As a consequence, a buyer may seek protection (in the form of cash or guarantee) from a seller to secure the seller's post completion obligations relating to that risk. The form of security that is to be taken should be identified and incorporated into the sale documentation.
The responsibility is on all parties to achieve a positive outcome
To allow for a smooth M&A transaction in the resources sector, the seller needs to ensure the project for sale and the contractual arrangements relevant to the project are in good order and that the due diligence process allows potential buyers to gain a comprehensive understanding of the project and the relevant contractual arrangements for that project. It is important that all parties work together to the extent necessary to find sensible solutions to problems identified, including rectifying 'dodgy' documents if required and allocating post completion risks between the seller and the buyer.
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.