Joint Operating Agreements: Change in control and pre-emption rights

Joint operating agreements ("JOAs") are unincorporated joint venture agreements typically entered into by parties to oil and gas licences or contracts with governments for oil and gas rights. They usually contain clauses anticipating future potential transfers of a party’s interests in those license or government contracts.

Change of control provisions are found in many JOAs. However, there is little legal authority in relation to the operation of such provisions when the deal involves the sale of various interests in different licences or government contracts (being, for the purposes of JOA transfer provisions, a "package deal"). In Santos Offshore Pty Ltd v Apache Oil Australia Pty Limited [2015] WASC 242 the Australian courts recently considered the interpretation and application of pre-emption and change in control provisions of a JOA concerning the sale of a company which held various interests in different licences. As the relevant clauses were almost identical to those in the AIPN Model Form JOA, the decision may have wider resonance throughout the oil & gas industry.

Background

In 2010, Santos entered into a JOA with Apache Oil, Apache East Spar and Apache Kersail (together, the "Apache Parties") (the "Spar JOA") governing their relationship in the Western Australian Petroleum Production Licence WA-4-R. The Apache Parties were subsidiaries of Apache Energy Limited ("Apache Energy"), which in turn was part of the Apache Group.

In April 2015, the Apache Group and others entered into a sale and purchase agreement with Viraciti Energy Pty Ltd ("Viraciti") (the "Viraciti SPA"), pursuant to which Viraciti would acquire, among other things, all of the shares and voting rights in Apache Energy (and in turn, the Apache Parties’ Participating Interests in the Spar JOA).

It was accepted that completion of the Viraciti SPA would result in a Change in Control of the Apache Parties (see footnote 1 below). In these circumstances, the Spar JOA provided a right of pre-emption to the other parties. Therefore, and purportedly in accordance with the provisions of the Spar JOA, each of the Apache Parties issued separate pre-emption notices (the "Notices") to Santos (on almost identical terms) advising of the proposed Change in Control and offering to sell the relevant Participating Interests.

Santos argued that the Notices were invalid and sought an order requiring the Apache Parties to reissue valid Notices.

The Notices

Each of the Notices included certain terms and conditions of the Viraciti SPA that the Apache Parties claimed were relevant to the Participating Interests, and which the Apache Parties said were adjusted "to reflect and replicate the same legal and commercial outcomes for [Santos] in relation to the Participating Interests as the legal and commercial outcomes for Viraciti."

Specifically, each Notice set out a "Cash Value" for each Participating Interest, and 12 conditions on which the offer to sell was made. Santos challenged the proposed "Cash Value", as well as 5 of the conditions, as failing to comply with the requirements of the pre-emption rights provisions of the Spar JOA.

The Spar JOA

The pre-emption rights clauses in the Spar JOA contained terms which were almost identical to those in clause 12.3.C, Optional Alternative #1, of the AIPN Model Form JOA.

Relevant for present purposes, clause 12.3(C) of the Spar JOA provided that, once the final terms and conditions of a Change in Control have been negotiated, "the Acquired Party shall disclose the final terms and conditions as are relevant to its Participating Interest...". Those familiar with the AIPN Model Form JOA will recognise this language from clause 12.3.C.1 of Optional Alternative #1.

Further, clause 12.3(F) of the Spar JOA provided that each of the other JOA parties had the right to acquire the Acquired Party’s Participating Interest for the "Cash Value" on "the equivalent terms and conditions set out in the Clause 12.3(C) notice [i.e. the Notice] for cash". The relevant provision of Optional Alternative #1 in the AIPN Model Form JOA is clause 12.3.C.3, although the AIPN Model uses the term "final" instead of "equivalent."

Among other things, the court was asked to interpret both these clauses.

The Decision

The decision provides some useful insight into the way a court or tribunal might interpret the pre-emption rights clauses, and the purpose of such clauses.

Purpose of pre-emption rights regime

In providing some context for its decision, the Supreme Court of Western Australia (a court of first instance) gave an overview of the structure and operation of the rights of pre-emption in the Spar JOA. The judge cited with approval a previous Australian decision, in which the purpose of pre-emption rights was described (see footnote 2 below):

"Given the importance of the identity, financial capacity and reliability of the participants in a joint venture, pre-emptive rights operate to ensure that existing participants are empowered to exclude new participants by purchasing the outgoing participant’s interest if they so desire."

Therefore, the court was cognisant not to restrict the operation of the clause, or otherwise permit the application of pre-emption rights to be avoided, as this would erode the benefit conferred by the grant of a right of pre-emption. Indeed, the terms considered by the court (separating the assets the subject of pre-emption when the third party transaction involves a package of assets, and ascribing a cash value to those assets when the consideration under the third party transaction is for consideration other than cash) are those which parties to joint operating agreements expressly include to ensure that pre-emption rights cannot be avoided.

Clause 12.3(C) of the Spar JOA (clause 12.3.C.1 of AIPN Model Form JOA)

When considering the extent of the terms and conditions that were "relevant" to the Participating Interest, the court recognised that every term and condition in a Change in Control agreement might be viewed as being ‘relevant’. However, the court limited the scope of the clause, and decided that the "relevant" terms and conditions must be those that "bear upon, or operate upon, or are otherwise closely connected or related to, the Participating Interest". The court felt that a wider construction might render the rights of pre-emption more difficult to exercise.

Clause 12.3(F) of the Spar JOA (clause 12.3.C.3 of AIPN Model Form JOA)

Regarding the interpretation of clause 12.3(F) of the Spar JOA, the court disagreed with the Apache Parties’ argument that "each other Party shall have a right to acquire the Participating Interest…for the Cash Value on the equivalent terms and conditions set out in the [Notice] for cash" meant that the terms and conditions must produce the same legal and commercial outcome for Santos in relation to the Participating Interests as under the Viraciti SPA. Instead, the court held that the phrase related solely to the determination of the consideration (i.e. the cash) to be paid for the Participating Interest. In other words, the reference to "equivalent terms and conditions" (or "final terms and conditions" in clause 12.3.C.3 of the AIPN Model Form JOA) aims to produce an equivalent cash price for the Participating Interest, rather than some other form of consideration as may have been applied under the Change in Control transaction.

When reaching its conclusion, the court considered it was implicit that the terms of the Change in Control agreement would require some modification to enable those terms to operate in the context of a pre-emption rights regime. However, any modifications were limited to (i) those required to carve out the Participating Interests from the rest of the interests being sold under the Viraciti SPA, and (ii) to clarify that the Participating Interest will be acquired for cash (determined in accordance with the definition of "Cash Value" in the Spar JOA (see footnote 3 below)) rather than some other consideration as may have been contemplated in the Viraciti SPA. The application of the clause is no wider than this.

Comment

While this was a decision of the Supreme Court of Western Australian concerning a JOA subject to Australian law, the principles of contractual interpretation and construction adopted by the court were ultimately derived from the well-known English authorities of Investors Compensation Scheme v West Bromwich Building Society and, more recently, Rainy Sky v Kookmin Bank (see footnote 4 below).

Therefore, the reasoning of the court is likely to be relevant to the interpretation and application of similar clauses under English law. As such, the decision provides useful guidance on the way corresponding provisions in the AIPN Model Form JOA, or any other JOA which contains similar pre-emption rights clauses, might also be interpreted and applied by English courts and/or arbitral tribunals applying English law.

The case is a reminder to companies preparing pre-emption notices for co-venturers, that where the terms of the JOA require, it is important to include all final terms of the third party transaction that are relevant to the participating interest being sold. In circumstances where the proposed third party transaction is a package deal, or for consideration other than cash, this will not always be straightforward.

The provisions which deal with package or non-cash transfers are included in JOAs to ensure that third party deals cannot be structured in such a way to circumvent pre-emption rights, and they therefore allow modifications to the third party transaction to create a "pre-emptable" deal. The case appears to confirm however that such modifications are only permitted to the extent required to separate the participating interests from the rest of the interests being sold, and to ascribe a cash value to those participating interests. The provisions are not intended to give sellers a right to further modify the terms on which the pre-emption deal may be completed.

1 The Spar JOA defined a Change in Control as any direct or indirect change in the Control (i.e. the ownership, directly or indirectly or more than 50% of the voting rights) whether through a merger, sale of shares or other equity interests or otherwise.

2 Beaconsfield Gold NL v Allstate Prospecting Pty Ltd [2006] VSC 320 at [33]

3 The Spar JOA defined Cash Value as the market value (expressed in U.S. dollars) of the Participating Interest subject to the proposed Transfer or Change of Control, based upon an amount in cash a willing buyer would pay a willing seller in an arm’s length transaction; provided that, in the case of a Change of Control, the Cash Value shall be computed to yield the transferor the same after-tax cash proceeds that would have been obtained from the merger or stock sale comprising the Change in Control transactions.

4 Save that it appears the English approach might be moving away from too heavy a reliance on the importance of commercial common sense as an aide to construction and interpretation. For more information on the latest trends in contractual interpretation, see the decision in Arnold v Britton & Ors [2015] UKSC 36, discussed in our Law-Now.