This article provides an overview of the issues that can arise when a pre-emption process based on the AIPN Model International JOA (2012 version) is triggered following an ‘upstream’ change of control. Possible changes to make the process more efficient and reduce transaction costs are also discussed.
When an upstream sale/change of control occurs, providing a pre-emption notice that complies with the requirements in the AIPN Model JOA can be difficult. This is because:
- the terms and conditions of the upstream sale may not be relevant to a sale of the pre-emption interest and may need to be amended to be capable of acceptance; and
- confidentiality restrictions can make it difficult to disclose terms and conditions of sale in the upstream sale agreement. This can result in a redacted sale agreement being provided that is difficult to understand and not capable of acceptance.
These issues can result in disputes between the JOA parties regarding the validity of the pre-emption notice and terms and conditions of the pre-emption sale. These disputes can take up management time and result in additional transaction costs including in relation to expert determination and/or litigation.
Possible ways to make the change of control pre-emption process more efficient and reduce transaction costs include:
- engage with the JV partner who has the pre-emption right before the pre-emption notice is issued or even before completion of the upstream sale;
- the upstream sale agreement including / allocating a value for the pre-emption interest. Although, if the joint venture partner does not agree that this reflects market value, a pre-emption price dispute may arise;
- the JOA including specific terms and conditions of sale (other than price) that apply if pre-emption rights are exercised following an upstream change of control; and
- the upstream sale agreement including an adjustment to the upstream purchase price if the pre-emption price received is lower than the value included in the upstream sale agreement.
Legal advisers should be consulted early in the sale process to assist with determining whether pre-emption rights will apply and, if so, whether to deal with them in the upstream sale agreement.
Our client (Buyer) purchased a global upstream oil and gas business. The purchase occurred by acquiring a foreign holding company (Target) of various subsidiaries that owned oil and gas assets around the world. One of the subsidiaries was an Australian company (AusCo) that held a participating interest in offshore oil and gas assets (Participating Interest) pursuant to a joint operating agreement (JOA) with a third party (JV Partner). The JOA was based on the AIPN Model International Joint Operating Agreement (2012 version) (AIPN Model JOA).
Under the JOA, a ‘Change of Control’ of AusCo gave the JV Partner a right to acquire AusCo’s Participating Interest (Pre-emption Right). Following completion of the Buyer’s acquisition of Target, the JV Partner exercised the Pre-emption Right and acquired the Participating Interest. However, the Pre-emption Right process was complex, time consuming and gave rise to disputes and considerable transaction costs.
The following sections provide an overview of the key issues that arose when AusCo sought to comply with the Pre-emption Right process in the JOA. We also suggest possible ways to make the process more efficient, reduce the risk of disputes and reduce pre-emption transaction costs.
Change of Control pre-emption provisions in the JOA
The JOA contained Change in Control pre-emption provisions based on the AIPN JOA. Key aspects of the provisions were as follows:
- A pre-emption notice must be issued once “the final terms and conditions of a Change in Control have been fully negotiated”. In other words, the pre-emption notice is issued once the upstream sale agreement is agreed.
- The pre-emption notice “must include all such final terms and conditions as are relevant to the acquisition of the Participating Interest and the determination of the Cash Value”.
- The pre-emption notice “must be accompanied by a copy of all instruments or relevant portions of instruments establishing such terms and conditions”.
- The pre-emption right is a right to acquire the Participating Interest for the Cash Value, on “the final terms and conditions negotiated with the proposed Acquirer that are relevant to the acquisition of the Acquired Party’s Participating Interest”.
- The terms and conditions of the applicable instruments should be modified “as necessary to reflect the acquisition of the Acquired Party’s Participating Interest for cash”. (Note: The JOA did not contain any details regarding modifications that could be made).
- ‘Cash Value’ means the market value of the Participating Interest, based on the amount in cash that would be paid by in an arm’s length transaction.
Extracts of relevant provisions from the AIPN JOA are set out in the Appendix.
Following execution of the upstream sale agreement, AusCo provided the JV Partner with a pre-emption notice under the JOA (Pre-emption Notice). The Pre-emption Notice included a Cash Value for AusCo’s Party’s Participating Interest and a redacted version of the upstream sale agreement (Redacted SPA).
In response to the Pre-emption Notice, the JV Partner issued a notice of dispute in respect of validity of the Pre-emption Notice (Pre-emption Dispute Notice) and a notice of dispute in respect of the Cash Value for AusCo’s Participating Interest (Cash Value Dispute Notice). The JV Partner did not confirm in the Pre-emption Dispute Notice or Cash Value Dispute Notice whether it would proceed with pre-emption, on the basis that the pre-emption notice was invalid and should be withdrawn, and that the Cash Value assigned did not represent fair market value.
Pre-emption Notice dispute
The Pre-emption Dispute Notice asserted that the Pre-emption Notice was invalid, and so incapable of acceptance, on the basis that (a) the Redacted SPA contained terms and conditions which were not relevant to the acquisition of the Participating Interest; and (b) some obligations in the Redacted SPA could not be complied with by the JV Partner because they were either irrelevant or redacted so incapable of performance.
On the other hand, the Buyer’s and AusCo’s view was that the Pre-emption Notice was valid because it provided “terms and conditions as are relevant to the acquisition of such Party's Participating Interest” and “relevant portions of instruments establishing such terms and conditions”.
While the Pre-emption Notice dispute was not formally resolved, once the Cash Value Dispute was determined (see ‘Cash Value Dispute’ below), the JV Partner confirmed exercise of the Pre-emption Right and the parties agreed terms and conditions of sale for the Participating Interest.
Cash Value Dispute
The Cash Value Dispute Notice asserted that the Cash Value included in the Pre-emption Notice was not determined by reference to the correct market value as at the time of the Pre-emption Notice and the JV Partner’s assessment of the ‘correct’ Cash Value was much lower.
The parties were unable to agree on a Cash Value within the specified timeframes in the JOA and therefore the expert determination process for the Cash Value under the JOA was followed (see Appendix for further details). The parties invested a significant amount of time and resources in the expert determination process, including preparing and submitting to the expert detailed written submissions and supporting materials (including analysis, valuation metrics, project development plans and market outlooks), making oral presentations to the expert, reviewing the expert’s draft determination, providing further materials to the expert and engaging in discussions with the expert.
The Cash Value determined by the expert was an amount below the Cash Value proposed in the Pre-emption Notice. As discussed above, following the expert determination of the Cash Value, the JV Partner confirmed it wished to exercise its pre-emption right and the parties agreed terms and conditions of sale for the Participating Interest.
Timing in engaging JV Partner as to Change of Control
Depending on the materiality of the asset that is subject to the pre-emption right, there may be value in engaging with the JV Partner before the Pre-emption Notice is provided or even before completion of the upstream sale as this may allow the buyer (and seller) to gauge whether this right is likely to be exercised. While the timing of this is a sensitive strategic decision, it may be that possessing this knowledge earlier in the sale process may be beneficial as it could enable the buyer (and seller) to consider how best to find a solution to a dispute before it actually materialises, for example, attempting to find agreement as to Cash Value or in establishing in principle terms of sale. It could also inform the way in which the buyer and seller seek to employ the possible solutions that are suggested below.
Further, in seeking to undertake a negotiation before the Pre-emption Notice is issued to the JV Partner, the parties can avoid triggering the various time limitations and procedural complexities that are prescribed by the JOA. This can assist in creating greater flexibility for the parties and allow them to avoid the complex pre-emption process that can generate considerable transaction costs.
Pre-emption Notice / sale terms
To reduce the risk of a dispute regarding the validity of a pre-emption notice or terms and conditions of sale, the JOA could include specific terms and conditions of sale (see comments below regarding Cash Value) of the Participating Interest that would apply to a pre-emption sale arising from an upstream change of control.
The terms and conditions of sale would be agreed by the parties at the time the JOA is entered into. The risk of a Cash Value dispute however would be likely to remain (see ‘Cash Value’ below for further discussion).
In some cases, pre-emption sale terms and conditions agreed when the JOA is entered into may not be appropriate. For example, the pre-emption assets may have progressed to development or production since the commencement of the JOA. In addition, the pre-emption interest may have liabilities that need to be dealt with through indemnities, warranties and/or adjustments to a cash purchase price. In such cases, it may be more appropriate for the pre-emption terms and conditions of sale to be agreed at the time of the upstream sale and included in the upstream sale agreement. A middle ground may be for the upstream sale agreement to include terms and conditions of sale for the pre-emption interest or confirm that the terms in the JOA apply.
Should terms relating to the pre-emption interest be contained in the upstream sale agreement, consideration should be given as to confidentiality so that the buyer can appropriately manage any confidentiality responsibility to the upstream seller against the JV Partner’s request or right to view the relevant terms and conditions.
It may be possible to avoid a Cash Value dispute by including in the upstream sale agreement a cash value for the pre-emption assets/interest in the upstream sale agreement.
The appropriateness of a cash value number in the upstream sale agreement may depend on when the value is determined. As discussed above, under the JOA, the Cash Value is the market value of the Participating Interest at the date of the pre-emption notice (ie. once the upstream sale agreement is agreed), based upon the amount in cash that a willing buyer would pay a willing seller. The value for the assets included in the upstream sale agreement however may reflect a value at a different date. For example, a ‘locked box’ mechanism in a sale agreement can mean the value of the assets reflects a value at a time before the upstream sale agreement is agreed. This value would therefore not reflect the Cash Value (ie. market value at the date of the pre-emption notice). This may give rise to a Cash Value dispute.
Accordingly, when including a cash value for the Participating Interest in the upstream sale agreement, it should be made clear at what time/date this value has been determined and whether any adjustments are required to reflect a cash market value of the Participating Interest at the date of the pre-emption notice.
Ultimately, a Cash Value dispute is likely if the JV partner wishes to pre-empt and does not agree that the Cash Value included in the Pre-emption Notice reflects the Cash Value. However, this risk can be mitigated if the upstream sale agreement includes a Cash Value for the Participating Interest determined at the date the upstream sale agreement, and the buyer and upstream seller acknowledge that this amount is based on the amount in cash the buyer would pay the upstream seller for the Participating Interest only.
Further, the JOA could provide clear guidance as to the way in which Cash Value is to be determined. This could include:
- stipulating a formula or method that must be used to determine Cash Value; and
- permitting that the value prescribed to the pre-emption interest in an upstream transaction be a valid representation of Cash Value and state this be central to an independent expert’s determination (should a dispute as to Cash Value need to be resolved by an independent expert).
To better protect a buyer from incurring losses from a change of control pre-emption process, the buyer should consider including a purchase price adjustment in the upstream sale agreement that would apply if pre-emption rights are exercised and those assets are acquired at a net cash price that is lower than the value included in the upstream sale agreement. For example, if the Cash Value agreed with the JV partner or determined by the expert is lower than the Cash Value amount included in the Pre-emption Notice, the purchase price payable by the buyer to the upstream seller would be reduced by the difference.
An upstream seller however may resist a purchase price adjustment mechanism for pre-emption rights on the basis that it won’t control the pre-emption process after closing of the upstream sale. It is possible that this could be overcome by providing the seller with certain subrogation rights that allow it to control the pre-emption process. Any arrangement as to costs associated with this process would also need to be considered by the buyer and seller.
An adjustment mechanism may not be appropriate if the materiality of the pre-emption interest is small relative to the other assets that are purchased. In such circumstances, the buyer may need to factor the ‘cost’ of pre-emption into the upstream purchase price.
Extracts of Change of Control and expert determination provisions from the AIPN JOA
“12.3 Any Change in Control of a Party, other than one that results in ongoing Control by an Affiliate, shall be subject to the following procedure.
(a) Once the final terms and conditions of a Change in Control have been fully negotiated, the Acquired Party shall disclose all such final terms and conditions as are relevant to the acquisition of such Party's Participating Interest and the determination of the Cash Value of that Participating Interest (such Cash Value to be determined by reference to the market value as at the date of the notice) in a notice to the other Parties, which notice shall be accompanied by a copy of all instruments or relevant portions of instruments establishing such terms and conditions…
(c) The Acquired Party shall include in its notification to the other Parties a statement of the Cash Value of the Participating Interest subject to the proposed Change in Control, and each other party shall have a right to acquire such Participating Interest for the Cash Value, on the final terms and conditions negotiated with the proposed Acquirer that are relevant to the acquisition of the Acquired Party’s Participating Interest except that the terms and conditions of the applicable instruments shall be modified as necessary to reflect the acquisition of the Acquired Party’s Participating Interest for cash…..
(d) For the purposes of Article [12.3(c)], the Cash Value proposed by the Acquired Party in its notice shall be conclusively deemed correct unless any Party (each a “Disagreeing Party”) gives notice to the Acquired Party with a copy to the other Parties within twenty (20) Days of receipt of the Acquired Party’s notice stating that it does not agree with the Acquired Party's statement of the Cash Value, stating the Cash Value that the Disagreeing Party believes is correct, and providing any supporting information that the Disagreeing Party believes is helpful. In such event, the Acquired Party and Disagreeing Parties shall have fifteen (15) Days in which to attempt to negotiate an agreement on the applicable Cash Value. If no agreement has been reached by the end of such fifteen (15) Day period, either the Acquired Party or any Disagreeing Party shall be entitled to refer the matter to an independent expert as provided in Article [18.3] for determination of the Cash Value within a further twenty (20) Day period (failing which the Cash Value provided by the transferor in the notice under Article [12.3(a)] shall be deemed to be correct).”
"18.3 For any decision referred to an expert under Article [12.3], the Parties hereby agree that such decision shall be conducted expeditiously by an expert selected unanimously by the parties to the Dispute…If the parties to the Dispute are unable to agree upon an expert within ten (10) Days after receipt of the notice of request for an expert determination, then, upon the request of any of the parties to the Dispute, the International Centre for Expertise of the International Chamber of Commerce (ICC) shall appoint such expert and shall administer such expert determination through the ICC’s Rules for Expertise…All Parties agree to cooperate fully in the expeditious conduct of such expert determination and to provide the expert with access to all facilities, books, records, documents, information, and personnel necessary to make a fully informed decision in an expeditious manner.”
“Acquired Party” means a Party subject to a Change in Control.
“Change in Control means a direct or indirect change in Control of a Party (whether through merger, spin-off, sale of shares or other equity interests, or otherwise) through a single transaction or series of related transactions, from one or more transferors to one or more transferees….” [Note: this definition included exclusions for listings/IPOs and demergers]
“Cash Value means the market value (expressed in U S. dollars) of the Participating Interest subject to the proposed Transfer or Change in Control, based upon the amount in cash a willing buyer would pay a willing seller in an arm's length transaction.”