Revocation of production licence on an insolvency event

In the current economic climate, the low price of oil has hit highly leveraged North Sea oil and gas exploration companies hard. Some are already in financial difficulties, others are likely to follow. In these circumstances it ought to be remembered that there is another party that has rights over the licence on an insolvency event affecting a licensee. The Secretary of State for the Department of Energy and Climate Change (the “Secretary of State”) possesses certain discretionary powers of revocation under the terms of oil and gas production licences. Affected companies will often be one of a number of licensees. The relevant legislation gives the Secretary of State power to revoke the licence as to all licensees if an insolvency event occurs with respect to any of the licensees, or to revoke the licence only in respect of the insolvent licensee. Although it is believed that the Secretary of State will only use the power as a last resort, all licensees should consider whether revocation is a possibility and how it may affect their rights and obligations under the licence.

When can the Secretary of State revoke a licence?

In addition to the events discussed below, there are a number of events specified in the model clauses that apply to all licences which may trigger a right for the Secretary of State to revoke a licence where a licensee is solvent. These events are outside the scope of this article.

On insolvency of a licensee

The model clauses incorporated in licences granted after the 20th licensing round provide that, if the licensee is a company, the Secretary of State may revoke the licence in the event of:

• the making of any arrangement or composition with the company’s creditors (this would include Company Voluntary Arrangements)
• the appointment of a receiver
• the appointment of an administrator
• compulsory or voluntary liquidation

whether the insolvency event occurs in Great Britain or a substantially corresponding event occurs in another jurisdiction. There is no time limit within which the Secretary of State must exercise the power to revoke the licence and there is no “grace” period within which the licensee may cure the default before the revocation becomes effective.

Licences granted before the 20th licensing round do not expressly give the Secretary of State a power to revoke the licence on the appointment of an administrator. The appointment of an administrator may nevertheless trigger a change of control of the licensee and thereby a right for the Secretary of State to revoke the licence (see below). If so, licences granted before the 20th licensing round may also be at risk of being revoked if an administrator has been appointed with respect to the licensee.

On change of control of a licensee

If a licensee is a company and there is a change of control of the licensee, the Secretary of State may serve a notice on the licensee that it proposes to revoke the licence unless the licensee effects a further change of control as is specified in the Secretary of State’s notice. Such further change must be effected within three months of the date of service of the notice.

There is a change of control of the licensee whenever a person has control of the licensee who did not have such control when the licence was originally granted. Where rights have been assigned, a change of control will also occur whenever a person takes control over an assignee who did not control that assignee when the rights were assigned.

Subsections (2) and (4) to (6) of section 416 of the Income and Corporation Taxes Act 1988 (as modified by the model clauses) apply for the purpose of determining whether a person has or had control over the licensee. Under these provisions, a person has control of a company if he is able to exercise (or is entitled to acquire) direct or indirect control over the company’s affairs. In particular, a person has control of a company if he possesses or is entitled to acquire:

• one-third or more of the share capital, issued share capital or the voting power in the company
• on income distribution, issued share capital which would entitle him to receive one-third or more of the distributed amount
• on winding-up of the company or in any other circumstances, rights that would entitle him to receive one-third or more of the assets of the company available for distribution among the participants.

The definition of “control” as set out in ICTA is wide. The administrator may be seen as being able to exercise control over the licensee. Therefore, the appointment of an administrator with respect to a licensee may be viewed as a change of control of the licensee triggering the Secretary of State’s power to revoke the licence.

Effect on the non-defaulting licensees’ rights and obligations

The revocation of the licence under the above powers is with respect to the licence as a whole (but see below on the new power of partial revocation). On revocation of the licence, all rights granted under the licence are terminated. The licensees remain jointly and severally liable for any obligations or liabilities incurred by them before the revocation.

The rights and obligations of the licensees as between themselves are usually governed by a joint operating agreement (and where appropriate, other agreements such as a trust deed or unit operating agreement). The standard Oil and Gas UK Joint Operating Agreement provides that a party’s interest may be forfeited in the event of the party’s insolvency. Insolvency includes the appointment of an administrator or the filing of a notice of intention to appoint an administrator. It should be noted that not all operating agreements provide a right to forfeit on insolvency. It is unclear how this right will be affected by the Secretary of State’s right to revoke the licence in the same circumstances. It is likely that the Secretary of State would consult the non-defaulting licensees before exercising his power of revocation. It is hoped that, as part of the consultation, he would consider the non-defaulting licensees’ right to forfeit the defaulting licensee’s interest.

The relevant operating agreements will usually contain a covenant by each of the licensees to do everything within its control to keep the licence in full force and effect. There may also be an express obligation on each of the licensees to refrain from doing anything within its control that may cause the Secretary of State to revoke the licence. If insolvency is considered to be an event within a licensee’s control, which is doubtful, then the non-defaulting parties to the agreements may have a claim against the defaulting licensee for breach of covenant.

Revocation of the licence due to insolvency of one of the licensees may be perceived as unfair by the remaining non-defaulting licensees. It is arguable whether the Secretary of State has sufficient powers to ensure a fair reissue of the revoked licence. If he does, it is still unclear how such reissue will work in practice. In order for the Secretary of State to invite an out-of-round application, the company or companies seeking such application must have a strong case as to why it is necessary. In most cases the Hydrocarbons Licensing Directive, as implemented by the Hydrocarbons Licensing Directive Regulations 1995, will still require the Secretary of State to follow the usual procedures. These include an invitation for applications in the Official Journal at least 90 days in advance. It may therefore be that the remaining licensees will be forced to wait for the next licensing round to reapply for a licence if they want to continue production.

Can the revocation be challenged?

The revocation provisions may not survive scrutiny against the requirement of the Human Rights Act 1998 that acts of public authorities must be compatible with the rights granted by the European Convention on Human Rights (the “ECHR”). Withdrawal of a licence to engage in an economic activity may be a determination which requires a fair and public hearing by an independent and impartial tribunal. The Secretary of State is not an independent and impartial party (in fact, he is a party to the licence) and there is no hearing. Whether the availability of judicial review will satisfy the requirements under the Human Rights Act 1998 has never been considered in this context. Article 1 of the First Protocol to the ECHR affords protection to property rights, so it may be possible that revocation of the licence constitutes expropriation without adequate compensation. However, a fair re-licensing of the area may be considered an appropriate safeguard.

Should a court, if it considers that the licence is a contract, grant relief against forfeiture effected by the revocation, either by allowing the licensee to cure the default or by allowing it to recover compensation if the licence is revoked? If the Secretary of State exercises its power to revoke in the future, it is possible that a challenge may be mounted on the grounds that it is either a breach of the licensee’s human rights or, alternatively, a penalty and therefore not enforceable.

Concern about the potential for such a challenge may have encouraged the government to introduce a new partial right of revocation under the Energy Act 2008.

Partial revocation under the Energy Act 2008

Section 77 (Part 4) and Schedule 3 of the Energy Act 2008 came into force on 26 January 2009. The Schedule retrospectively amends certain existing licences granted under the Petroleum (Production) Act 1934 and the Petroleum Act 1998. It gives the Secretary of State a controversial power partially to revoke (i.e. with respect to a single licensee, rather than revocation of the licence as a whole) a licence in certain circumstances. The power of partial revocation may only be exercised where the relevant event happened after 26 January 2009.

This power is exercisable in relation to a company affected by an insolvency event on the same grounds as for the revocation of the entire licence (see above). The Secretary of State also has a power partially to revoke a licence in the event of a change of control of a licensee and in respect of a licensee who ceases to have a fixed place of business in the UK from which operations under the licence are carried out.

Where a licence interest is revoked in relation to an individual licensee, such licensee will remain jointly and severally liable for any obligations arising before the partial revocation. After partial revocation, the rights, obligations and liabilities associated with the licence will continue to have effect in respect of all the remaining licensees. The remaining licensees may have little or no ability to avoid an increased share of future costs under the licence. It is likely that the Secretary of State would consult the non-defaulting licensees before exercising his power of partial revocation, but it is unclear how such consultation will work in practice.

It would be sensible for all companies to consider whether to amend their joint operating agreements to provide for circumstances where such a partial revocation takes place.

Before the relevant section of the Energy Act 2008 came into force, Oil and Gas UK expressed concern on behalf of the industry that the new powers to partially revoke a licence or reverse a licence transfer may introduce legal uncertainty regarding title. This may lengthen and further complicate the licence transfer process. It will be interesting to see whether and how the Secretary of State uses his new power of partial revocation, especially in light of the Government’s policy of actively encouraging new entrants to invest in North Sea oil and gas fields.