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.

MASTERCLASS

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.

Energy and Resources M&A Transaction Guide

Upstream change of control triggers A necessary complication with unnecessary and unintended consequences

1 November 2017

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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.

For further information on any of the issues raised in this alert please contact:

Damien Clarke on +61 7 3233 8951

Louise Horrocks on +61 7 3233 8734

Peter Williams on +61 7 3233 8825

Melissa Hill on +61 7 3233 8953

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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 2

Regardless of whether you are selling or buying, the crafting of warranties requires careful consideration and negotiation. In this Edition, we look at some ways you can limit your liability without killing the deal.

MASTERCLASS

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.

In the first volume of our Energy and Resources M&A Transaction Guide, we discussed potential deal killers in the context of energy and resources industry mergers and acquisitions. In this edition of the second volume, we take a closer look at liability limitation concepts and how to limit your liability without killing the deal. We will start by looking at general principles of liability limitation, and then consider how the chain of responsibility legislation recently introduced in Queensland impacts on these matters.

Liability limitation concepts

Parties to a sale transaction use warranties to attempt to fill the void between the knowledge of the buyer and the seller. Even the most comprehensive due diligence review cannot hope to capture all potentially relevant matters, nor can it possibly identify the way in which a party may act in the future. Warranties allow a party to give comfort to another party that a state of affairs exists, will continue existing, or will exist in the future (that is, at completion of the transaction).

In addition to bridging the knowledge gap, warranties allow for the allocation of risk between the parties, with the party giving the warranty bearing the risk that the warranty is incorrect.

Typically, sellers will offer warranties as to their legal capacity, title, compliance with the law and accounting policies, the state of repair of assets or enforceability of rights and entitlements. Buyers will normally warrant that they are legally capable to enter into and perform their contracted obligations.

Parties will often spend significant time and effort negotiating the warranties and the limitations on those warranties. Generally, parties to sale transactions look to limit their liability using:

knowledge qualifiers for warranties (that is, statements like ‘to the best of the seller’s knowledge’)

disclosures made in due diligence or in the transaction documents (including disclosure letters), and

liability caps and time limits.

Energy and Resources M&A Transaction Guide

Liability limitation concepts in contracts How to limit your liability without killing the deal

15 November 2017

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Warranties: knowledge qualifiers and disclosures

It is becoming common for sellers to qualify warranties by those matters of which the seller has actual knowledge. A knowledge qualifier further protects the seller because to succeed in a warranty claim a buyer has to establish a breach of the warranty and also that the seller had knowledge of the circumstances leading to the breach. In these circumstances, buyers should seek to include a definition of the knowledge qualifier in the transaction document to require the seller to have taken reasonable care to discover the relevant facts before it can get the benefit of the qualifier (for example, phrases like ‘to the best of the seller’s knowledge’ include all matters within the knowledge of the seller after making reasonable enquiries and undertaking reasonable searches).

Warranties provide the seller with an incentive to reveal relevant information about the target or assets because a disclosure made to the buyer cannot form the basis of a claim. Once the warranties are agreed, the seller will make its specific disclosures, often in a disclosure letter. Specific disclosures will cross-reference particular warranties included in the transaction document. What specific disclosures to make and how much information to disclose requires a careful balancing act by the seller and its personnel: should all information the seller has be disclosed or only those matters in which the seller believes the buyer will be interested? The answer to this question will depend on the nature of the deal. Although, subject to the terms of the transaction document, disclosures made generally need to be full and fair and provide sufficient detail to enable the buyer to assess the disclosure.

Liability caps and time limitations

Other standard mechanisms to limit liability in a sale and purchase agreement include:

a cap on the seller’s total liability to the buyer

a minimum threshold and an aggregate threshold that must be met before the buyer can make a claim, and

a timeframe within which any claim must be made against the seller.

These mechanisms to limit liability are negotiated between the buyer and the seller. Recent experience shows that caps can range from 30% to 100% of the purchase price. Timeframes for claims are usually split between claims for title warranties, claims for tax warranties and claims for the remaining warranties.

Regardless of the limit you are able to negotiate, it is important to carefully review all warranties to ensure that as the seller, you are able to give the warranties subject to any disclosures, and as the buyer, that the warranties give you sufficient comfort and protection following completion.

Despite the time often spent negotiating caps and other limits, claims for breach of warranty should always be considered as actions of last resort (particularly given the costs risks associated with litigation).

Impact of the chain of responsibility legislation

The new Queensland chain of responsibility legislation creates a series of new risks for parties to energy and resources transactions. Any new risks inevitably lead to novel warranties to neutralise, or at least apportion, those risks.

There has been a lot written about the changes to the Environmental Protection Act 1994 (Qld) introduced by the Environmental Protection (Chain of Responsibility) Amendment Act 2016 (Qld). In essence, this legislation gives the Government greater powers to enforce environmental obligations against parties other than the current owner and operator of resource projects. Relevantly for

energy and resources transactions, if the current owner of a resource project is unable to discharge its environmental obligations, there are now circumstances in which the Government is entitled to look past the current owner to other parties to seek the fulfilment of environmental obligations.

The extent of this new risk is difficult to quantify because it largely depends on the individual circumstances of each transaction and, as the legislation is new, there are few examples to draw on. The starting position is that the Department of Environment and Heritage Protection (Department) can issue an environmental protection order (EPO) to a company carrying out the environmentally relevant activity (let’s say mining) and the related bodies corporate of that company. The new legislation also allows an EPO to be issued to ‘related persons’ of the original company.

A company’s ‘related persons’ include the company’s parent company, landowners (in certain circumstances) and persons with a ‘relevant connection’. According to the Department’s Guideline on issuing ‘chain of responsibility’ EPOs (Guideline), a person has a relevant connection with a company if the person:

is capable of significantly benefitting financially or has significantly benefitted financially from the carrying out of a relevant activity by the company, or

the person is, or has been at any time during the previous two years, in a position to influence the company’s conduct in relation to the way in which, or extent to which, the company complies with its obligations under the Environmental Protection Act 1994 (Qld).

If a person is considered to be a ‘related person’, there are still a series of determinations the Department needs to make before issuing an EPO but regardless, this new legislation creates risks for both buyers and sellers that need to be managed.

It is generally thought, but remains untested, that at a minimum the seller may be liable for environmental failures of the buyer for up to two years after the transaction, simply because they were in a position to influence conduct.

A seller providing vendor finance may even have future exposure because of the control that seller continues to hold. For example, a seller might retain some control over the activities of the new owner to, for example, protect the seller’s ongoing royalty. Considered in light of the chain of responsibility legislation, any input into the activities of the new owner may now mean the seller has a ‘relevant connection’ to the new owner and continues to bear the risk of failure of the new owner to meet the environmental obligations at the mine.

Some techniques which may help reduce a seller’s exposure under the chain of responsibility legislation include:

extensive due diligence on the buyer to get comfortable that the buyer is able to meet the required obligations

requiring the buyer to warrant that it has sufficient financial and technical capabilities to perform the obligations going forward

an indemnity from the buyer’s parent company, or

ensuring any vendor finance and post completion arrangements do not amount to a significant financial benefit.

From the other perspective, buyers are liable for any environmental issues that may arise after they take over the mine. Buyers could consider:

deferring payment of part of the purchase price to be held in escrow until sufficient time has passed

having the seller’s parent company provide an indemnity for compliance with pre-completion environmental liabilities

ensuring environmental due diligence is thorough, and

accepting the environmental liability for the time prior to completion and adjusting the purchase price accordingly.

As a general rule, it is important to consider what your potential risks are following the sale (including risks of the other party’s future behaviour) and how to put yourself in the best position going forward. It is also important to keep in mind that we are still seeing how this legislation will play out and how the Department may try to enforce environmental obligations.

Conclusion

Given the obvious tension between the position of a seller and a buyer, limitation of liability in a transaction needs to be done in a way that does not kill the deal. While parties may be anxious to press on and just get the deal done, care must be taken to cover off on potential liability traps at the time of signing and in the future. This is made more challenging by the new chain of responsibility legislation, and the way it potentially spreads risk far and wide. Regardless of whether you are selling or buying, the crafting of warranties requires careful consideration and negotiation.

For further information on any of the issues raised in this alert please contact:

Damien Clarke on +61 7 3233 8951

Louise Horrocks on +61 7 3233 8734

Peter Williams on +61 7 3233 8825

Melissa Hill on +61 7 3233 8953

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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 3

Recent Australian case law has

brought the doctrine of good

faith back into the spotlight.

This article will give a high level

overview of the status of the

doctrine of good faith for

common law in Australia and

will discuss the pros and cons

of an express inclusion or

exclusion of the doctrine of

good faith in your contract.

MASTERCLASSES

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.

Recent Australian case law has brought the doctrine of good faith back

into the spotlight, and has continued to confuse this often

misunderstood and misapplied area of law.

The doctrine of good faith is a very relevant consideration for M&A transactions.

Transaction term sheets and heads of agreement often include a provision

requiring parties to act in good faith when negotiating the more definitive

transaction agreements. Also, when acquiring an interest in an existing joint

venture the acquiring entity will be bound by the terms of the existing relationship

document (e.g. a joint venture agreement) and that document may in some

instances include obligations to act in good faith when dealing with the other joint

venture participants. Even if that document is silent on the issue, obligations of

good faith may nevertheless apply in certain circumstances.

This article will give a high level overview of the status of the doctrine of good

faith for common law (not statute) in Australia and will discuss the pros and cons

of an express inclusion or exclusion of the doctrine of good faith in your contract.

Good faith position in Australia

The doctrine of good faith in Australia remains largely a construct of common law,

with the obligation to act in good faith being implied either by a Court at the

pleading of an applicant, or otherwise included as an express term in a contract.

WHAT IS GOOD FAITH?

The first hurdle in grappling with the principal of good faith is that there is no

agreement in Australia as to what the obligation to ‘act in good faith’ entails.

Some schools of thought find the doctrine of good faith to be an obligation to

cooperate to achieve the outcome agreed in the contract. Others see the

obligation as one of having regard to fairness in the consideration of another

parties’ interests1, and recent case law suggests that it may be better to view good

1 Jeannie Paterson, Andrew Robertson and Arlen Duke, Principals of Contract Law, (Law Book Co

of Australasia, 5th ed, 2015)

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The good the bad and the uncertain – the doctrine of good faith in Australia

7 December 2017

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faith as a norm underlying and shaping other duties, such as a duty to act honestly in dealings.2

Despite there being no settled position on what constitutes good faith, Courts have expressed the

obligation of good faith as requiring parties:

to cooperate in achieving the contractual objects

to comply with honest standards of conduct, and

to comply with standards of conduct that are reasonable having regard to the interests of the

other parties.3

Importantly, the obligation of good faith does not require a party to act against its own interests.4

The recent Victorian Court of Appeal decision in Masters Home Improvement Pty Ltd v North East

Solutions Pty Ltd5 (Masters Case) demonstrates the lack of certainty around the concept of good

faith.

The Masters Case involved a dispute between Masters Home Improvements (Masters),

a Woolworths subsidiary, accused of a breach of an express obligation in an agreement to lease

which required Masters and North East Solutions (North East) to ‘… act[ing] reasonably and in good

faith …’6 to resolve differences they may have in relation to certain costs to be borne by North East

and the contribution of Masters to those costs. Failure to agree triggered a termination right.

After failed negotiations, Masters exercised its right to terminate. North East then brought

proceedings, alleging Masters had breached its obligation to act reasonably and in good faith, and

arguing that Masters terminated the agreement to lease for other commercial reasons. The trial

judge agreed with North East, finding the express obligation of good faith had been breached by

Masters and awarded North East $10.875 million in damages. Unsurprisingly, Masters appealed this

decision.

The Victorian Court of Appeal disagreed with the trial judge and found that:

there was not a sufficient basis for finding that Masters had breached the express obligation of

good faith, and

the steps the trial judge suggested Masters should have taken to comply with the obligation

would take the obligation of good faith too far.

Helpfully, the Court of Appeal summarised the duty of good faith as required by the clause in the

agreement to lease as:

an obligation to act honestly and with fidelity to the bargain

an obligation to not undermine the agreed bargain or the substance of the contractual benefit

bargained for, and

an obligation to act reasonably and with fair dealing, having regard to the interests of the other

party (but not to the extent of subordinating their own interests) and the provisions, aims and

purposes of the contract (which are to be objectively ascertained).7

2 Mineralogy v Sino Iron Pty Ltd (No 6) [2015] FCA 825 at [1009]

3 For example, Cordon Investments Pty Ltd v Lesdor Properties Pty Ltd [2012] NSWCA 184 at [145]

4 Paciocco v Australia and New Zealand Banking Group Limited [2015] FCAFC 50 at [289-290] 5 [2017] VSCA 88

5 Masters Home Improvement Pty Ltd v North East Solutions Pty Ltd [2017] VSCA 88 at [19]

6 Masters Home Improvement Pty Ltd v North East Solutions Pty Ltd [2017] VSCA 88 at [369]

7 Masters Home Improvement Pty Ltd v North East Solutions Pty Ltd [2017] VSCA 88 at [99]

3

The Court of Appeal did not agree with the trial judge that the conduct of Masters constituted a

breach of good faith. It is worth noting that on appeal the contractual obligation of good faith was

not questioned, simply that Masters’ conduct did not amount to a breach of that contractual

obligation. That said, this decision highlights the risk of relying on express obligations of good faith

as the basis for protecting your interests.

IMPLYING GOOD FAITH

More often than not, a contract will not include an express duty of good faith, leaving parties to

argue whether a good faith obligation should be implied, which itself is a difficult task. As a general

concept, an implied term must:

be reasonable and equitable

be necessary to give business efficacy to a contract

be so obvious it goes without saying

be capable of clear expression, and

not contradict the express terms.8

The inconsistency surrounding the content of a duty of good faith is compounded by disagreement

over when such a duty should be implied into a contract. Some courts have suggested that an

implied obligation of good faith may arise where one of the parties to a contract is at a substantial

disadvantage to the other in the context of the situation.9 This position has been narrowed in

Victoria, with authority suggesting that an obligation of good faith should not be implied

indiscriminately into all commercial contracts.10

This restrictive notion (of not implying a duty of good faith indiscriminately into commercial

contracts) is more widely accepted with the Federal Court finding the terms and context of the

contract must be examined before an obligation of good faith can be implied.11

What are your options?

With the position at law unclear, and restricted circumstances where good faith can be implied into

a contract, how this issue is addressed in a contract is fundamentally important. Often, the inclusion

of an obligation to act in good faith in performance of a specific clause in a contract or in a contract

as a whole can be the result of an impasse between the parties during the negotiation phase. For

example, parties may be unable to agree on a market valuation process or option terms, and as

such they include a future obligation to negotiate in good faith. However, as seen with the Masters

Case, this approach has its risks.

8 BP Refinery (Westernport) Pty Ltd v President, Councillors and Ratepayers of the Shire of Hastings (1977) 180 CLR 266

at [40] 9 Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL [2005] VSCA 228 at [4]

10 Androvitsaneas v Members First Broker Network [2013] VSCA 212 at [108]

11 Mineralogy v Sino Iron Pty Ltd (No 6) [2015] FCA 825 at [1006] and [1007]

4

As such, there are several options available to you:

Your options Pros Cons

Expressly include good faith Offers a certain level of

protection against overly

aggressive and punitive

contractual performance.

Sets a context for the

performance of the

agreement – one of mutual

interest and regard.

Increases the prospects of a

disagreement if used as a

substitute for specific

drafting.

Can limit your options

during contractual

performance due to

uncertainty regarding the

actual content of the duty

of good faith.

Expressly exclude good faith Reduces the risk of an

obligation of good faith

being implied by a court in

the future.

Requires parties to address

complex issues now, rather

than pushing them down

the road.

Can be interpreted as an

indicator of future conduct

and tactics.

Cannot exclude statutory

obligations not to act

unconscionably or in a

manner which would

mislead or deceive.

Remain silent Between sophisticated

parties the likelihood of

court imposing an

obligation of good faith is

minimal.

Can rely on statutory

protections against the

worst types of conduct.

Exposes an agreement to

future common law

developments (at present,

there is no real indication of

the direction the courts will

take the doctrine of good

faith).

Parties may seek to imply a

term in any future dispute –

another potential cause of

action.

What to do

The pros and cons to the various ways in which good faith may be dealt with in contractual

arrangements, as well as the general uncertainty in the application of the duty to act in good faith in

the context of contractual arrangements means that the consideration of good faith obligations

between parties to a contract remains a live issue.

A strategy that may offer a commercial outcome is the limited use of express obligations of good

faith, for example, including an express obligation to act in good faith in very specific circumstances,

or in a specific provision of a contractual obligation. This approach would go a certain way to

excluding good faith from the rest of the agreement, while also offering protections afforded by the

doctrine of good faith in circumstances where it may be difficult or impossible to remove the risk of

the conduct of the other party.

46158134v3 5

Parties negotiating M&A transactions should not assume that there is a doctrine of good faith

governing counterparty conduct, and although ideas of good faith may be appealing at the outset

of a contractual relationship, in the absence of certainty in this area, such obligations may give rise

to unintended consequences.

For further information on any of the issues raised in this edition, please contact:

Damien Clarke on +61 7 3233 8951

Louise Horrocks on +61 7 3233 8734

Peter Williams on +61 7 3233 8825

Melissa Hill on +61 7 3233 8953

Andrew Bukowski on +61 7 3233 8592

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for

information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any

issue dealt with in this publication.

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 4

In Edition 4, we look more closely at representations and warranties in M&A transactions.

MASTERCLASSES

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.

Negotiations around risk allocation form an integral part of any M&A transaction, with sellers seeking (to the greatest extent possible) to secure a clean exit and buyers seeking to hold sellers to account for their pre-contractual representations as to the state of the business or project. Often this results in a heavily negotiated set of representations and warranties in the transaction document, which the seller is obliged to stand behind or, in some cases, is supported by insurance.

In this article we take a closer look at typical representations and warranties in M&A transactions.

Key areas of warranty protection

Warranties typically fall into two categories, those relating to the seller and those relating to the business or assets for sale. Most M&A transactions will include the following key warranty areas:

Seller That the seller has the ability to enter into and perform the transaction document.

Title to the assets That the seller has title to the assets and is able to transfer those assets free of encumbrances.

Accounts That the accounts are a true and accurate record of the business accounts.

Records That current and full records (including financial records) exist and have been maintained in accordance with applicable laws.

Plant and Equipment That the plant and equipment being acquired are in good repair and are all the assets required to operate the business.

Tax That all tax liabilities have been disclosed, all taxes in relation to pre-completion liabilities have been or will be paid and all taxation laws complied with.

Energy and Resources M&A Transaction Guide

Digging deeper into representations and warranties

7 February 2018

4

Environment That all environmental laws have been complied with and that there is no liability under any laws or in relation to any environmental approvals.

Employees That all relevant employment laws have been complied with and all employees and their entitlements have been disclosed.

Trading Arrangements That all material contracts have been disclosed, there are no existing breaches of the contracts and the contracts cannot be terminated as a result of the completion of the transaction.

Intellectual Property That all IP is lawfully used by the company.

Accuracy of Information

That all material information has been disclosed.

Limiting warranties

While this list sets out the types of warranties you would expect to see in an M&A transaction, sellers will naturally seek to limit their post-completion risk exposure as much as possible. A way in which to do this is for a seller to qualify the warranties given. For example, warranties can be given 'to the best of the Seller’s knowledge' or 'so far as the Sellers are aware'. These limitations have been further considered in Edition 2 of this Guide.

Seller’s pre-contractual disclosures

During negotiations, a seller is likely to make various statements regarding the affairs of the company and the state of the business, for example in relation to the production capacity or profitability of the business. Such information can constitute a representation made by the seller to the buyer, which if untrue, can be the basis of a claim against the seller. This means that, in addition to seeking to limit warranties to the knowledge of the seller, a seller will also seek to ensure the agreement of the parties only includes those representations and warranties expressly contained in the transaction document. For sellers, care must be taken to ensure these clauses expressly exclude any statements not set out in the transaction document and for buyers, care needs to be taken to ensure all statements being relied upon are set out in the transaction document.

Indemnities for breach of warranty

Another matter to be aware of when negotiating your transaction document is that the jurisdiction of your transaction may impact on whether an indemnity will be given in respect of breaches of warranties under the sale agreement. An indemnity is essentially an agreement to cover loss and damage suffered by another and provides a separate right of action in addition to a buyer’s contractual rights in the event of a breach of a warranty. An indemnity claim is generally considered to be an easier right of action for a buyer to pursue.

Generally speaking, what we are seeing is that indemnification in respect of warranty claims in:

US based contracts, is standard

Australian based contracts, has become relatively commonplace, and

UK based contracts, is uncommon.

A potential explanation for the above trends may lay in the approach taken by the judicial systems of the respective jurisdictions on the question of costs following litigation. In the US, the courts are bound by what is known as the ‘American Rule’, the basic premise of which is that legal fees are not ordinarily recoverable by the successful litigant in federal litigation in the absence of a statutory provision to the contrary. This means that an express indemnity by the seller covering the legal costs of a successful warranty claim by the buyer is highly desirable in a US based sale and purchase agreement.

Courts in the UK (and Australia) are bound by what is known as the ‘English Rule’, which in contrast to the American Rule, provides that costs follow the event (i.e. the unsuccessful litigant is required to pay the successful litigant’s costs). Therefore the inclusion of an express indemnity is not required to the same extent as it is in the US.

Remedies for breach of warranty

Under general law, the remedy available to a buyer for a breach of warranty by a seller is typically damages (unless the warranty is considered a condition of the contract). Importantly, a buyer does not have a general law right to terminate the contract as a result of a breach of warranty by a seller (again, unless the warranty is a condition of the contract). Therefore, if the parties agree that termination of the contract is a remedy that is available to the buyer following breach of warranty by a seller, the contract must expressly state that the buyer may terminate the contract for breach of warranty.

Warranty and indemnity insurance

Warranty and indemnity insurance (W&I Insurance) is a means by which the seller can facilitate a clean exit from the business. W&I Insurance is also useful from a buyer’s perspective, as it provides a certain level of security knowing that if a claim arises post-completion in relation to a warranty, the buyer can turn to the W&I Insurance to compensate it for its losses. W&I Insurance is particularly useful:

for sellers, to circumvent the need for an escrow or a holdback arrangement under the transaction document, and

for buyers, to provide greater protection by potentially providing a higher liability cap and extended periods of warranties than a seller may be willing to offer, and also greater certainty that any claims can be paid, particularly where the seller is in financial difficulty or leaving the jurisdiction following completion of the transaction.

W&I Insurance can be either:

a buyer-side policy, under which the buyer is the insured party and makes a claim directly against the insurance policy (not against the seller) in the event of a breach of warranty, or

a seller-side policy, under which the seller is the insured party and makes a claim against the insurance policy in the event of a successful claim by the buyer.

A hybrid version of the above, known as ‘seller-initiated buyer-side’ policy is also becoming more common, under which the seller arranges W&I Insurance prior to or at the time of signing the transaction document and hands the process (along with the premium) over to the buyer once the transaction has sufficiently progressed. The recourse under this arrangement is the same as the buyer-side policy (i.e. the buyer is the insured party and makes a claim directly against the insurance policy).

In Australia the premium for W&I Insurance is typically around 1- 1.5% of the consideration of the transaction and can take up to one month to implement. As premiums vary across jurisdictions, consideration should be given to the jurisdiction in which the W&I Insurance is purchased.

Once the parties have agreed to take out W&I Insurance, the parties will need to consider whether W&I Insurance will cover the entire amount of any liability arising from a breach of a seller warranty or whether the seller will be responsible for a given amount of the liability before W&I Insurance responds. Careful consideration also needs to be given to any exclusions from the W&I Insurance and whether those are acceptable.

Conclusion

Representations and warranties are highly negotiated parts of transaction documents. Care needs to be taken to ensure that the transactions documents reflect the agreed position and that once representations and warranties are agreed, the parties to the transaction understand their continuing rights and obligations following completion.

For further information on any of the issues raised in this alert please contact:

Damien Clarke on + 61 7 3233 8951

Louise Horrocks on + 61 7 3233 8734

Peter Williams on +61 7 3233 8825

Melissa Hill on + 61 7 3233 8953

Andreea Turcas on +61 7 3233 8552

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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 5

In Edition 5, we look more closely at what happens when parties break their promises of confidentiality to each other in M&A transactions.

MASTERCLASSES

We’ll wrap up this second volume of the Guide with a Masterclass in Brisbane on Wednesday 23 May 2018 and Sydney on Friday 18 May 2018, where you can ask our expert panel any questions related to undertaking an M&A transaction. Register now for Brisbane here and Sydney here.

A successful M&A transaction is often kick started with the circulation of a confidentiality agreement. Although often passed off as merely a formality, confidentiality agreements can be vital to the progress and completion of an M&A transaction. The terms of a confidentiality agreement can have wide reaching implications, including once the M&A transaction has completed.

In Edition 6 of Volume 1 of the Guide, we considered how a well-drafted confidentiality clause in joint venture agreements and other principal documents can assist a transaction. In this article, we will consider confidentiality agreements (or non-disclosure agreements) more closely, including what happens when parties do not comply.

A quick refresher

It goes without saying that a confidentiality agreement is essential if you are the disclosing party. Ordinarily entered into at the start of the due diligence process or competitive bid process, a confidentiality agreement will make it so that a bidder is not permitted to disclose that information to any unauthorised third party or to profit from the use of that information in an unauthorised way.

In terms of what should be included in the document, it is particularly important to consider the definition of ‘approved purpose’ (i.e. the purpose for which the recipient can use the confidential information). If this definition is too wide it may allow the bidder to use the confidential information beyond what was intended by the discloser. Equally, if you are the bidder, the wording of this definition is important as it must allow enough scope for your intended use of the information, including the ability to provide that information to your employees and advisors as required.

It is good practice for the confidentiality agreement to fall away once the sale agreement has been signed so both parties should seek to limit the term of the confidentiality agreement to the period prior to the transaction documents being executed.

Energy and Resources M&A Transaction Guide

Confidentiality – what happens when parties do not comply

3 April 2018

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Enticing bidders

In our experience, an onerous confidentiality agreement is a sure fire way to put off bidders. Confidentiality agreements with standard terms are often signed without requiring amendment (and are less likely to need sign off by management) and can set the tone for reasonable negotiations between the parties (which may expedite your transaction).

In some situations both parties may be disclosing confidential information. These types of confidentiality agreements (also known as ‘two-way’ or mutual confidentiality agreements) are unusual in a M&A transaction except where there will be a continuing relationship between the discloser and the bidder (for example, where the sale is for part of an asset which will continue to be owned by the discloser or where the discloser provides vendor finance). Whatever the purpose, mutual disclosure obligations may provide the bidder with comfort that the provisions of the confidentiality agreement are not one sided.

For sales of joint venture interests, a discloser should confirm what type of confidentiality agreement is actually required under the joint venture agreement. Some joint venture agreements only require a bidder to sign a confidentiality deed poll in favour of the other participants. Limiting confidential documents to a deed poll will accelerate finalisation of that document (and therefore the transaction) and would also be beneficial for bidders who may be sensitive about disclosing their identity to other participants.

What happens when a bidder does not comply?

Where a confidentiality agreement has been properly executed, an unauthorised disclosure of confidential information by the recipient would constitute a breach of contract. In many cases the document itself will set out a dispute resolution mechanism. In the absence of this type of clause, the usual breach of contract remedies are available to the discloser, which may include seeking an injunction to prevent any threatened disclosure.

As well as a claim in contract, it might also be possible for the discloser to claim against a bidder in equity for a breach of a duty of confidence. Successfully arguing this position would mean that the discloser would have access to a range of additional equitable remedies which would not be available for the common law breach of contract claim. Notably this would include an account of any profits that had been generated from the breach.

It is clear from recent case law that this claim is not available in situations where there is a written confidentiality agreement, especially where that document includes an ‘entire agreement’ clause. It is important to keep this in mind when negotiating a confidentiality agreement - for the discloser to negotiate out of the document and the bidder to negotiate its inclusion.

What happens when a bidder’s representative does not comply?

It is standard for a confidentiality agreement to extend to a bidder and its directors, officers, employees, agents and advisors (Representatives) who need to access various types of information in the process of negotiating a potential M&A transaction. A discloser should ensure that the bidder is responsible under the terms of the confidentiality agreement for any breach by those Representatives. In that way, the same remedies will be available to a discloser who suffers damage as a result of a Representative not complying with the confidentiality agreement.

A bidder should seek to protect itself by:

limiting the wording so that it provides ‘reasonable endeavours’ to ensure that its Representatives do not breach the confidentiality agreement, and

limiting the application of some of the clauses of the confidentiality agreement from applying to its Representatives (such as standstill provisions or non-solicit provisions) or wholly in circumstances where the Representative is also a party to the transaction.

While remedies are available to a discloser where a bidder or its Representative has breached the terms of the confidentiality agreement, a discloser would need to weigh the financial pros and cons before taking action given the high burden of proof to demonstrate that the relevant damage was caused by the breach.

Final thoughts

Negotiations of confidentiality agreements can really set the tone of the forthcoming M&A transaction. It is important for parties to take a few extra moments to consider confidentiality agreements for the reasons set out in this article, including to get bidders through the door.

For further information on any of the issues raised in this alert please contact:

Damien Clarke on + 61 7 3233 8951

Louise Horrocks on + 61 7 3233 8734

Melissa Hill on + 61 7 3233 8953

Meg Morgan on +61 7 3233 8582

Lara Rush on +61 7 3233 8781

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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.

MASTERCLASSES

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.

Energy and Resources M&A Transaction Guide

‘Dodgy’ documents – managing deal risk and contractual exposure

2 May 2018

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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.

For further information on any of the issues raised in this alert please contact:

Damien Clarke on + 61 7 3233 8951

Louise Horrocks on + 61 7 3233 8734

Peter Williams on +61 7 3233 8825

Melissa Hill on + 61 7 3233 8953

Meg Morgan on + 61 7 3233 8582

Lara Rush on +61 7 3233 8781

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.