Brexit – Squaring Circle and involving European Court of Justice

Clash of Philosophies

There is a potentially irreconcilable clash of constitutional philosophies between the UK and the EU which results in certain “no go” areas on the EU side for the forthcoming Brexit negotiations.

Perspective of the EU27

EU UK FlagsThe EU27’s approach is driven by the perception that the European Union is not merely representative of a negotiable bundle of international trade treaties but is a supranational entity based on and subject to a constitution created by the Treaty on European Union (TEU) and the Treaty on the Functioning of the European Union (TFEU). From the perspective of the EU and the EU27 , the constitution of the EU goes well beyond international treaties.  The Treaties establish a Union which is based on principles similar to those in Federal States.

Any of the member states of the EU (including the UK) accordingly is, from the perspective of the EU, not only a counterparty to an international treaty but an integral part of an autonomous Union. The driving principle of the European Union – which was correctly identified and repeated by Leave campaigners – is the supremacy of the EU’s legal order over the legal order of its member states, including the supremacy of the EU’s legal order over the constitutions of the member states.

One of the most important principles of the EU is laid down in Article 3 (2) TEU.  This provides that the EU is an area within which its citizens are free and can freely move. This is a general principle which is not restricted to trade but applies in all areas of life. In addition to such general principle Article 3 (3) TEU states that, inter alia, one of the consequences of this area of freedom and free movement is the internal market.

That is the context of the European Union placing the future rights of EU citizens in the UK at the forefront of any of the forthcoming Brexit negotiations.

Since the EU is bound to such constitutional order, any agreement with the UK pursuant to Article 50 TEU needs, from the perspective of the EU, to comply with such constitutional principles. “Constitutionality” is a major issue for the continental European member states since governments and politicians on the continent are used to be bound by constitutions which cannot be overridden by domestic governments or parliaments by simple act of parliament or government. Constitutions can only be amended or overridden if a qualified majority in Parliament and, in some member states, a referendum so approves. In some member states, such as Germany, there are even some constitutional principles which cannotbe changed by Parliament at all.

Perspective of the UK

The UK approach is driven by its perspective that the EU is simply the creation of a bundle of international treaties which establish a common market in which various different principles of free trade and free movement apply, and the contents of which can be freely negotiated between the various parties to such international treaties. Accordingly the UK takes the point of view that the agreements to be entered into pursuant to Article 50 TEU upon Brexit can be freely negotiated and that such negotiations are not subject to or restricted by overriding constitutional principles which are binding on the EU during such exit negotiations.

How to reconcile the differing points of view and how to involve the European Court of Justice

The two above described perspectives of the UK and the EU would appear to be legally irreconcilable, but there is a potential avenue out of such dead-lock by making use of:

(a) the fact that Article 50 (3) TEU does not conclusively state that the UK ceases to be a member state of the EU two years after the Article 50 Notice has been given, but in principle refers to the date on which the relevant withdrawal agreement becomes effective, which effective date can either fall on a date occurring after the two years or on a date occurring prior to the two years.

Accordingly, a simple withdrawal agreement could provide that Brexit becomes effective only once certain specified additional agreements have been finalized and entered into.

(b) the Commission, the European Parliament, the European Council and/or any member state (including the UK) being entitled to request from the European Court of Justice (ECJ) pursuant to Article 218 (11) TFEU legal opinions on any draft agreement – like the agreements between the UK and the EU on their future relationships – to be entered into with a third country (which the UK would be once the withdrawal agreement becomes effective) in order to avoid and/or mitigate concerns relating to the constitutionality of the future relationship agreement with the UK.

It is likely that the EU27 will at some stage call upon the European Court of Justice to opine on the constitutionality of the future relationship agreement(s) with the UK because of the fundamental nature of the agreement(s).

Samples of constitutionally important legal opinions rendered by the European Court of Justice in relation to Agreements which the EU had entered into in the past under Article 218 (11) TFEU (and its predecessors) include, for example:

– ECJ opinions 1/91 and 1/92 on the European Economic Area Agreement and the system of judicial review thereunder,

– ECJ opinion 1/94 relating to the EU agreeing to accede to WTO, GATS and TRIPs

– ECJ opinion 2/13 relating to the accession of the EU to the European Convention on Human Rights

– ECJ opinion 2/15 relating to the Free Trade Agreement with Singapore.

In relation to the Free Trade Agreement with Singapore the ECJ held on 16 May 2017 that such Free Trade Agreement is, because of its far reaching comprehensive content, a so-called “mixed-agreement” and therefore requires the consent of all 28 Member States of the European Union. Depending on the contents of the future relationship agreement between the UK and the EU, such agreement will also need to be ratified by the Parliaments of the EU27 Member States.

Agreements to be negotiated between the UK and the EU

The minimum number of agreements to be negotiated in the context of the UK leaving the EU pursuant to Article 50 is two:

(i) the withdrawal agreement on the details of the withdrawal “taking account of the framework for its future relationship with the Union” and

(ii) an agreement on the details of the future relationship between the EU and the UK.

Even though the minimum number of agreements to be entered into is two, it is likely that there will be more than two agreements since there are areas which need to be dealt with instantaneously (like aviation between the UK and EU27 and a potential accession of the UK to the ECAA Agreement in order to enable the flow of air traffic between the UK and the EU to continue as normal) irrespective of whether other areas may be dealt with at a later stage.

Whereas the withdrawal agreement can be adopted by the EU pursuant to a qualified majority decision pursuant to Article 50 TEU, any agreement on the details of the future relationship will require the “normal” majority contemplated in the TEU and TFEU for the relevant matters concerned, because Article 50 does not apply to such agreements on the details of the future relationship.

From the EU27 perspective, the principal items of the withdrawal agreement are those set out in the Brexit Negotiation Guidelines adopted by the European Council on 29 April 2017, the European Parliament on 5 April 2017 and the Non-Paper of the European Commission of 20 April 2017 and the Commission Recommendation for a Council Decision of 3 May 2017.

Withdrawal Agreement and the date at which it comes into force

The EU and the UK could agree that the withdrawal agreement is ratified in accordance with Article 50 TEU before the lapse of the two-year period but provides that it comes into force only after the agreement on principles for the future relationship has been (i) agreed on working level; (ii) submitted to and reviewed by the European Court of Justice pursuant to Article 218 (11) TFEU, and (iii) been ratified by the UK and the EU – or after the ratification process has been declared by the UK to be defunct.

That would mean that the UK would not cease to be a member state of the EU until there is an agreement on the principles for the future relationship without having to achieve this within the tight two years period.

The UK would also continue to enjoy all rights as a member state under existing international trade and other agreements entered into by the EU with countries around the world, like free trade agreements, air transportation agreements etc. until the ECJ has determined that the principles agreed between the UK and the EU in the agreement on principles for the future relationship are compliant with TEU and TFEU. Once this has been determined, the details of the future relationship could be negotiated in detail between the UK and the EU.

If the UK ceased to be a Member State on 30 March 2019 and “only” some transitory period or implementation period thereafter was agreed on during which certain specified EU rules continue to apply, this would not prevent the UK from losing its rights under existing International Agreements which had been entered into by the EU.

There is clarity in the approach of the EU27. The approach that the UK will take should become clearer after the General Election on 8 June, and later in the year as the UK government begins to identify its Brexit strategy in more detail, and identifies the trade offs it is prepared to make.  The historical and current political climate, as well as the sheer complexity of Brexit, is such that the UK cannot necessarily be expected the trade offs which history will regard as the “right” ones.

By Jens Rinze and Jeremy Cape of Squire Patton Boggs.

European Union Adopts Brexit Negotiation Guidelines

Brexit Bull HornOn April 29, a Special European Council, meeting as 27 member states (as opposed to the full 28 member states, as would usually be present), adopted the Article 50 guidelines (Guidelines) to formally define the EU’s position in Brexit negotiations with the United Kingdom. This follows the resolution of the European Parliament on key principles and conditions for the negotiations, adopted on April 5 (for further information, see the April 7 issue of Corporate & Financial Weekly Digest).

The Guidelines are set out under six headings covering:

  • core principles;
  • a phased approach to the negotiations;
  • agreement on arrangements for an orderly withdrawal;
  • preliminary and preparatory discussions on a framework for the EU-UK future relationship;
  • the principle of sincere cooperation; and
  • the procedural arrangements for negotiations under Article 50.

On May 22, the EU General Affairs Council is expected to authorize the opening of the negotiations, nominate the European Commission as the EU negotiator and adopt negotiating directives.

The Guidelines are available here.

To Brexit or to Bremain? That is the Question on 23 June 2016

A View from BrusselsUK and Europe flag

As the 23 June date for the British referendum about its future in the European Union (EU) comes closer, the EU political leadership in Brussels remains uncertain how best to support the ‘Bremain’ forces in order to avoid the embarrassing and damaging departure of one of its largest and strongest members.

None of the political leaders in Brussels or in other EU capitals want to see the UK leave, but they have learned to be cautious and show restraint when it comes to engaging in EU related discussions in Britain. Often enough they were told to stay neutral (or silent) in order not to make things worse for the pro-EU forces. But they now ask themselves whether their passive stance is a sufficiently supportive strategy for a decision of this magnitude for all partners involved – also because many traditionally pro-EU industry stakeholders in the UK have remained reserved so far, leaving a lot of momentum to the “Leave” side.

Supporting the (B)Remain Camp while Preparing for the Eventuality

The top EU leadership has clearly spoken out in favour of the UK to remain a part of the European family. Already in 2014 European Commission President Juncker has given the financial services dossier to the British EU Commissioner Jonathan Hill, and has recently asked Jonathan Faull, a top level UK EU official in Brussels, to lead the Commission’s high level Brexit task force.

Influential national political leaders, including German Chancellor Angela Merkel, have clearly spelled out that they want the UK to remain, and have grudgingly accepted UK specific political concessions in an EU summit in February 2016 in order to support David Cameron. They are wary of potential Brexit copycats across Europe.

Behind closed doors, EU institutions such as the European Central Bank and the European Commission are preparing itself for the eventuality of the British voting to “leave” on 23 June. They cannot afford not to, given the enormous impact it would have on Europe – akin to the “Grexit” situation in recent years.

A View from the United States

On 22 April 2016, President Obama visited London and argued that he had a right to respond to the claims of Brexit campaigners that Britain would easily be able to negotiate a fresh trade deal with the US. He said,

“They are voicing an opinion about what the United States is going to do, I figured you might want to hear from the president of the United States what I think the United States is going to do. And on that matter, for example, I think it’s fair to say that maybe some point down the line there might be a UK-US trade agreement, but it’s not going to happen any time soon because our focus is in negotiating with a big bloc, the European Union, to get a trade agreement done. The UK is going to be in the back of the queue.”

The Only Certain Thing is Uncertainty

The overall uncertainty related to a potential Brexit is large and little is known about how the separation process between the UK and the European Union would look like in practice. Many questions remain unanswered, including the political dynamics a Leave decision would trigger within and outside the UK.

What seems certain is that if Britain does leave the EU, a multi-year separation and negotiation process will commence.

When Greenland left the European Economic Community in 1985 it took a full three years to complete – and this even though they only had a few really important political issues to solve. The UK has been part of the European Union since 1973 – thus the social, legal and economic entanglement is much higher.

Article By Wolfgang A. Maschek & Helen Kavanagh of Squire Patton Boggs (US) LLP

© Copyright 2016 Squire Patton Boggs (US) LLP

United Kingdom: A Reminder About Careful Drafting of Confidentiality Clauses for Shareholders

Katten Muchin Law Firm

The recent decision by the High Court of England and Wales (Chancery Division) in Richmond Pharmacology Limited (Company) v. Chester Overseas Limited, et al. underscores the need to carefully draft confidentiality clauses and to incorporate specific exceptions where these exceptions are reasonably foreseeable in the future. The case involved a shareholders agreement which contained a standard confidentiality clause requiring the parties to treat as strictly confidential all commercially sensitive information concerning the company subject to certain prescribed exceptions. One of the exceptions allowed disclosure to a professional advisor provided that the advisor agrees to be bound by a similar confidentiality obligation. Unsurprisingly, however, there was no specific exception allowing disclosures to a potential third-party buyer. Under the terms of the clause as drafted, the shareholder was required to obtain consent to make the disclosures. 

Over time Chester Overseas Limited decided to sell its shares and engaged a corporate finance advisor (Advisor) to assist in facilitating the sale. After the initial discussions regarding a management buy-out fell through, the Advisor sought to generate interest from third parties. In doing so, the Advisor took care to obtain nondisclosure agreements from certain of these potential buyers prior to disclosing the sensitive information. 

In its decision, the High Court stated that while the shareholder was entitled to disclose the information to its Advisor pursuant to the professional advisor exception, it was not authorized to disclose the confidential information to third parties.   

While the High Court’s decision regarding the confidentiality clause may not come as a surprise, it does reinforce the need to carefully consider a client’s position in future transactions governed under English law.   

The High Court’s decision is available here.

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“Dual” Employment Contracts for US Executives Working in the UK

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Background

February 2014

Individuals, whether of British or foreign nationality, who reside in the UK are, in principle, taxable on their worldwide employment income. Many US executives who are “seconded” by their US employer to work in the UK may therefore become UK tax resident.

Such US executives who have not been UK resident in the three previous tax years and are not UK domiciled need not pay UK tax on their overseas earnings if they do not bring the income to the UK. Other US executives resident in the UK over the longer term may incur liability for UK tax on their overseas income unless their employer structures their employment duties under separate employment contracts, one with the UK subsidiary for their UK duties and another with the US parent for their overseas duties. These have become known as “dual contracts”. If the non-UK domiciled executive keeps the income earned under the overseas contract outside the UK, no UK income tax should arise on that income. He or she will pay UK income tax on the income earned in the UK under his or her UK contract.

“All Change”

In December 2013 HM Government announced that it would be clamping down on the artificial use of dual contracts for longer-term UK residents and has now published draft legislation that makes offshore employment income in a dual-contract arrangement taxable in the UK in certain cases.

The New Rules

Under the new anti-avoidance rules, which come into force on 6 April 2014, the dual-contract overseas income of US executives resident in the UK will be taxed in the UK if:

  • the executive has a UK employment and one or more foreign employments,
  • the UK employer and the offshore employer either are the same entity or are in the same group,
  • the UK employment and the offshore employment are “related”, and
  • the foreign tax rate that applies to the remuneration from the offshore employment is less than 75 percent of the applicable rate of UK tax. The current top rate of UK income tax is 45 percent, and 75 percent of this rate is 33.75 percent.

The UK employment and the offshore employment will be “related” where, by way of non-exhaustive example:

  • one employment operates by reference to the other employment,
  • the duties performed in both employments are essentially the same (regardless of where those duties are performed),
  • the performance of duties under one contract is dependent on the performance of duties under the other,
  • the executive is a director of either employer, or is otherwise a senior employee or one of the highest earning employees of either employer, or
  • the duties under the dual contracts involve, wholly or partly, the provision of goods or services to the same customers or clients.

Action

US corporations should urgently review the use of dual contracts for their non-UK domiciled executives seconded to their UK subsidiaries before the 6 April 2014 start date. The proposed legislation is widely drafted and has the potential to catch even genuine dual-contract arrangements. If one of the dual contracts is with a group employer in a low-tax jurisdiction, that contract may be especially vulnerable. Dual contracts will not necessarily become extinct, but in the future, careful cross-border tax advice should be sought in their structuring.

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UK Financial Conduct Authority (FCA) Issues First Fine Under New Anti-Money Laundering Regime

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Financial Conduct Authority fines Standard Bank £7.6 million for failures in its anti-money laundering controls, underlining the importance of both having and implementing adequate policies in relation to money laundering.

On 22 January, the UK Financial Conduct Authority (FCA) published a decision notice[1] imposing a £7.6 million fine on Standard Bank PLC, the UK subsidiary of South Africa’s Standard Bank Group.[2] The fine was issued for failures relating to Standard Bank’s anti-money laundering (AML) policies and procedures for corporate customers connected to politically exposed persons (PEPs).[3] This is the first AML fine issued under the FCA’s new penalty regime and the first such fine by the FCA—or its predecessor, the Financial Services Authority—in relation to commercial banking activity.

Under Regulation 20(1) of the Money Laundering Regulations 2007, regulated institutions, such as banks, must establish and maintain “appropriate risk-sensitive policies and procedures” on customer due diligence measures and ongoing monitoring of business relationships, amongst others. The policies must be aimed at preventing money laundering and terrorist financing. Guidance issued by the Joint Money Laundering Steering Group states that enhanced due diligence (EDD) should be applied where a corporate customer is linked to a PEP, such as through a directorship or shareholding, as it is likely that this will put the customer at higher risk of being involved in bribery and corruption.

As part of its investigation into Standard Bank, the FCA reviewed a sample of 48 corporate customer files, which all had a connection with a PEP, and discovered “serious weaknesses” in the application of the bank’s AML policies and procedures. The FCA found that, from 15 December 2007 to 20 July 2011, Standard Bank breached the Money Laundering Regulations 2007 by failing to take reasonable care to ensure that all aspects of its AML policies were applied appropriately and consistently to its corporate customers connected to PEPs. In particular, the FCA found that Standard Bank did not consistently carry out adequate EDD measures before establishing business relationships with corporate customers linked to PEPs and did not conduct the appropriate level of ongoing monitoring for existing business relationships by updating its due diligence. The FCA noted the failings were particularly serious because the bank dealt with corporate customers from jurisdictions regarded as posing a higher risk of money laundering and because the FCA had previously stressed the importance of AML compliance to the industry.[4] The gravity of the failings was underlined by the FCA’s director of enforcement and financial crime, who stated that “[if banks] accept business from high risk customers they must have effective systems, controls and practices in place to manage that risk. Standard Bank clearly failed in this respect”.

This is the first AML case to use the FCA’s new penalty regime, which applies to breaches committed from 6 March 2010 and under which larger fines are expected. The FCA’s decision notice sets out how it determined the level of the fine, by reference to a five-step framework (as outlined in the Decision Procedure and Penalties Manual).[5] The FCA considered the fact that the bank and its senior management cooperated in the investigation and took significant steps to remediate the problems, including seeking advice from external consultants, to be a mitigating factor. In addition, Standard Bank’s decision to settle the matter at an early stage of the investigation resulted in a 30% discount on the fine. The original penalty was £10.9 million.

The FCA’s action against Standard Bank illustrates the increasingly tough approach taken by the UK authorities against financial crime and shows that the FCA is willing and able to enforce AML legislation. Banks and regulated firms are encouraged to ensure that they have effective policies and procedures against money laundering in place and that these are being adhered to.


[1]. View the FCA’s notice here.

[2]. The sale of Standard Bank to the Industrial and Commercial Bank of China has been agreed to and is likely to be completed during the fourth quarter of 2014.

[3]. A “PEP” is defined in the Money Laundering Regulations 2007 as “an individual who is, or has, at any time in the preceding year, been entrusted with a prominent public function”, or immediate family members and known close associates of such individuals.

[4]. The FSA published a Consultation Paper on 22 June 2011, availablehere, focusing on how banks manage money laundering risk in higher risk situations. It also published a Policy Statement on 9 December 2011, available here, providing guidance on the steps firms can take to reduce their financial crime risk.

[5]. View the manual here.

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Caveat Emptor: Due Diligence of the United Kingdom Continental Shelf Oil and Gas Assets

Andrews Kurth

 

This article explores the due diligence of United Kingdom continental shelf (“UKCS”) oil and gas assets from a buyer’s perspective. Good management, organisation, communication, clarity and common sense are the key to a successful due diligence exercise. The scope of the due diligence review will depend on a number of factors, including whether the buyer has any knowledge of or a current participating interest in the target asset, whether the asset is in the exploration or production phase or is an operated asset, the size of the deal and any cost and time restraints. Whether a buyer requires a red flag due diligence report or a comprehensive report on the asset, care must be taken to ensure that no stone is left unturned during the course of the review. Failure to do so may result in undesirable consequences.

Preparation

Before embarking on an extensive review of the documentation provided by the seller, the buyer should seek to determine the scope of the due diligence exercise at the outset to prevent it from becoming a moving target which may lead to inefficiencies and unexpected cost implications. Sometimes the prospective buyer will investigate the asset with a view to purchase. More often than not, due diligence of the asset will amount to no more than a tyre-kicking exercise. The intention of the prospective buyer will therefore ultimately colour the scope of the due diligence undertaken.

As well as considering the information memorandum prepared by the seller (if any), it is also useful for the buyer to geographically place the asset by consulting a map of theUKCS licence interests and blocks. Such preparations will enable the buyer to better piece together the documentation provided in respect of the target asset and request any missing information from the seller.

Data Room

Whether the seller furnishes the buyer with a virtual or a physical data room, the buyer must keep an accurate record of the documents that have been disclosed. If a virtual data room is employed, the buyer must ensure that it is notified when new documents have been provided and, if documents are supplied in soft or hard copy outside of the virtual data room arrangement, details should be kept of these by the buyer as well. This is all essential because all disclosure will later form part of the sale and purchase arrangements between the buyer and seller.

Data rooms for asset disposals typically include legal, financial, technical, commercial and operational documents. One of the first tasks that a buyer should undertake is to review the data room index, if one has been provided, and allocate documents to the various specialists for review; careful coordination is paramount to ensure that all bases are covered. If no index has been supplied, one should be requested from the seller and, if such index is not forthcoming, it is recommended that the buyer compiles an index so that it can keep a running record.

Depending on the scale of the exercise and number of people employed to assist, the coordinator of the due diligence exercise should ensure that team members effectively communicate with each other. Typically, virtual data rooms limit access rights to a small pool of permitted entrants, so responsibilities should be allocated between professionals at an early stage. Data rooms are often poorly organised so it is important that the coordinator is made aware of documents which have been filed out of place in order for them to be allocated to the correct team members for review. This way, no document will be overlooked.

Title Verification

A UKCS asset is typically represented by a licence, a joint study and bidding agreement (“JSBA”) or joint operating agreement (“JOA”) and, in some cases, a working interest assignment. Assets may also be subject to a unitisation and unit operating agreement (“UUOA”), transportation, processing and petroleum sales agreements and other material project contracts.

One of the key objectives of the buyer’s due diligence is to determine whether the seller actually holds an interest in the asset. Often an asset will be described inconsistently in the documentation by which it is governed and may not correspond accurately with the information held by the Department of Energy and Climate Change (“DECC”). This is especially true of those assets historically operated under a JOA which has been subsequently sub-divided to apply to multiple blocks within a licence, or those assets with an alias which has stuck over the passage of time. It is therefore very important that both parties are agreed on the correct identity of the asset being bought and sold from the outset.

Similarly, infrastructure assets are frequently referred to under a variety of guises and are often complex in nature. For instance, the Sullom Voe Terminal, which is one of the largest oil terminals in Europe, handles production from more than twelve oil fields in the east Shetland Basin and approximately twenty different companies presently hold interests in the terminal. This, combined with the fact that it has been 35 years since first oil arrived at the Sullom Voe Terminal, means that tracing title to this infrastructure asset is likely to be a knotty and time-consuming exercise.

Although DECC holds data on all offshore licences, this should by no means act as a substitute for mechanically tracing title to an asset, however tempting this may be. Many UKCS assets date back over 40 years and so tracing title back to their inception can be a lengthy process. The buyer must therefore decide whether it wants to undertake or commission such work, or whether it can take comfort from tracing title back through only a limited number of transfers and seek a full title guarantee from the seller. Extensive title representations and warranties may reduce the scope of title due diligence but often they will be qualified by the information, or lack thereof, disclosed to the buyer in the data room and so are not a reliable remedy if there is a title defect.

There may be some merit in tracing title of each material contract back to the date on which it became effective in order to determine whether or not it is relevant to the transaction. Sometimes contracts in the data room will have been entered into by parties which are neither the seller nor its predecessors in title and, in other cases, may not be relevant to the target asset at all. In these circumstances, and depending on the purchaser’s view of the asset, it may be more efficient to determine which contracts are required to be assigned or novated at the due diligence stage rather than when the parties are seeking to complete the deal.

An additional complication is that a company which was originally the holder of an interest in an asset may have changed its name since it was first registered at Companies House. The buyer should therefore consult the change of name register held by Companies House at the start of the due diligence exercise and take note of any previous names. This will enable the buyer to piece together information relating to the asset more easily.

Title to assets, excluding infrastructure, is evidenced by the relevant licence, JSBA or JOA and, if applicable, UUOA. Typically, a transfer of a participating interest will be evidenced by a JSBA or JOA deed of novation, and if applicable a UUOA deed of novation, which will provide for the transfer of the relevant participating interest from the seller to the buyer. Conversely, not every transfer of a participating interest will be evidenced by a licence assignment. An example of this is where the buyer and seller are already party to the JOA and/or UUOA. If neither the buyer nor the seller is joining or leaving the licence, and the parties are simply adjusting their participating interests under the JOA and/or UUOA, a licence assignment will not be required. In the same way, where a licence governs multiple blocks and the buyer has an interest in another block covered by the licence and the seller is also remaining on the licence, either because it has an interest in another block covered by the licence or because it is only selling part of its interest to the buyer in the relevant block, when the buyer acquires the interest in the relevant block, a licence assignment will not be required.

There is often a question asked as to whether working interest assignments are required to show a complete chain of title to an asset. A working interest assignment evidences the transfer of the beneficial interest in the asset. The more prevalent view is that this type of assignment is no longer necessary to perfect title, especially where there is a JSBA, JOA or UUOA already in place. Its purpose, being a document on which stamp duty was levied, is now obsolete. Although, buyers and sellers still frequently include the working interest assignment in their suite of completion documents by means of convention, it is not obligatory to enter into this assignment to complete an asset transfer. Due to the disproportionate amount of time and energy that buyers and sellers may spend in hunting for non-existent working interest assignments to evidence a complete chain of title, the better view may be to exclude the working interest assignment from the scope of the title due diligence exercise.

Assignment

Pre-emption rights and consent provisions are principal deal-structure considerations and should therefore be given top priority when conducting the due diligence exercise. Their consequences may prevent the proposed deal from going ahead, increase the cost of the transaction if co-venturers are permitted to withhold their consent on the grounds of financial incapability unless some form of financial security is provided by the buyer and/or cause the deal to be restructured as a share sale. It will therefore be important to review the assignment provisions of all the material contracts, and particularly any JSBAs, JOAs and UUOAs, to identify such obstacles at the earliest possible stage.

If an asset is governed by both a JOA and UUOA, care needs to be taken in order to determine whether the pre-emption and/or consent provisions in one or both agreements apply. Often the UUOA will expressly state that the provisions in the UUOA supersede the provisions in the JOA to the extent that they conflict. In this case, the assignment provisions in the UUOA will override the assignment provisions in the JOA in respect of the area covered by the JOA which forms part of the unit area. Any remaining area that is solely governed by the JOA will be subject to the JOA pre-emption and consent provisions. If it is not clear from the documentation whether the provisions in the UUOA or JOA will prevail, the better approach for a buyer to take may be to err on the side of caution; in other words, to apply the more onerous pre-emption and/or consent provisions to the whole of the asset transfer or consider restructuring the transaction as a share sale.

Material Contracts

The scope of the due diligence review of material contracts is likely to be determined by the materiality threshold proposed by the buyer with respect to contract value. The buyer should review all material contracts in order to ascertain whether the seller has the necessary rights under such contracts and identify potential liabilities, risks and onerous provisions that affect the valuation of the asset or, worse still, could prevent the deal.

It is important that the correct selling entity holds an interest in the relevant material contract and any inconsistencies should be highlighted to the buyer so that the seller can arrange for any necessary inter-group transfers in good time if required. The buyer should also be vigilant to any poison pills that kill the contracts in the event of a change of party or change of control.

If time, cost and scope permit, it can be invaluable to prepare full and accurate contract summaries of all material contracts. The simplest and most efficient way of doing this is to table contract summary templates for the various categories of contract. For instance, there could be separate templates for licences; JSBAs, JOAs and UUOAs; petroleum sales agreements; transportation and processing arrangements; and sundry agreements, if applicable. Templates are useful aides to those reviewing the asset documentation. Firstly, they ensure that all members of the team focus and report on every provision of the contract within the scope of the due diligence exercise. Secondly, and especially for large scale due diligence reviews, they are important for the purposes of consistency and efficiency. The buyer’s due diligence report should be informative, concise, on point and appear to have been written by one person. Full, tailored contract summaries help to achieve this purpose.

Contract summaries also serve a bigger purpose. If after the due diligence exercise the buyer decides to enter into a sale and purchase agreement with the seller and proceed to completion, the closing documents will include deeds of assignment and novation for the various material contracts. Complete contract summaries make the task of deducing which material contracts will need to be assigned or novated easier. They also make for a more efficient process as they prevent the buyer from having to re-locate each document in the data room and re-review their provisions.

If the asset is producing or has an approved field development plan, the buyer should expect to see material contracts in the data room relating to petroleum sales agreements and lifting, transportation and processing arrangements. Particularly in respect of some of the older UKCS assets, it is not always clear whether a document is historical or not. Typically, the buyer will exclude historical construction, tie-in commissioning and joint development agreements from its due diligence scope and place less emphasis on reviewing pipeline crossing and proximity agreements, unless it has a particular interest in the provisions of such documents.

It is likely that the data room will include some material contracts which are governed by the laws of another country or state. Depending on the importance of such contracts, the buyer should consider whether to seek advice from local counsel. In addition, in the course of due diligence for an asset acquisition, it is likely that there will be property and tax related documentation and these should be reviewed by specialists in those fields. It may also be necessary to examine the proposed transaction from a competition perspective and so the need for competition lawyers should be considered at an early stage.

During the due diligence exercise, the buyer should be aware of any information which evidences that the seller has been acting in breach of contract or is in breach of its licence obligations. Any current or anticipated claims from third parties or on-going litigation will be of particular interest to the buyer and should be noted. The buyer should also be alerted to whether any contractual provisions will be breached by the acquisition of the target asset if they are ignored by the buyer. For instance, often under seismic data contracts data must be returned or a supplemental fee paid if the identity of the purchasing company alters.

On completion of a transaction, the buyer will want all material contracts to be novated to it from the seller, unless the transaction is structured as a share sale. In some circumstances this may not be possible if third-party consents remain outstanding and so the seller and buyer should use their reasonable endeavours to obtain such consents post completion. Typically, this approach is only taken in respect of those contracts of limited value or importance. The seller will agree to hold such contracts as trustee and agent of the buyer and the buyer will agree to perform such contracts on the seller’s behalf and indemnify the seller against any costs or liabilities it incurs in respect of such arrangement. This split completion approach is not always possible in respect of those agreements which are contractually linked to others or to the transfer of the participating interest. The buyer should therefore bear in mind any linkage provisions that it uncovers in its due diligence exercise.

Decommissioning

The buyer will be keen to discover whether a field-wide decommissioning security agreement is in place for the target asset or whether the JSBA, JOA and/or UUOA include decommissioning security provisions. Where decommissioning security provisions exist, the buyer should consider the type and amount of security required, the credit rating of such security, whether the asset is in the run-down period and/or how the trigger date is calculated. Depending on the terms of the transaction and whether a section 29 notice has been served on the seller before the asset is transferred to the buyer, the buyer may need to provide security for decommissioning under the sale and purchase agreement to the seller as well. Decommissioning arrangements will be a fundamental consideration to the buyer’s valuation of the asset and will therefore always require financial and/or actuarial input.

Encumbrances

The buyer should conduct a charges search at Companies House in order to determine whether the seller should arrange for any outstanding encumbrances over the asset to be released as part of the transaction. The buyer should also be concerned with any third-party royalties over the seller’s interest in the asset. Any royalty payments on production in respect of all petroleum won and saved will have an impact on the financial value of the target asset and so the buyer should factor the existence of these into its valuation.

Likewise, details of any outstanding cash calls, sole risk activity or carried interests may also be important considerations for the buyer and their existence may result in an adjustment of the price the buyer is prepared to pay for the asset.

Questions and Answers

The question and answer process is central to the due diligence exercise and is an important string to the buyer’s bow. By asking the seller questions, the buyer can better understand the seller’s asset from the responses provided and seek to address any holes or limitations in the data room documents. A classic example of the curious incident of the dog that didn’t bark in the night is the unknown existence of an area of mutual interest agreement which, in the most draconian of circumstances, may prevent a buyer from completing its transaction with the seller, or may prevent the buyer from applying for and/or acquiring an interest in another particular licence area post completion of its transaction with the seller.

If draft contracts have been included in the data room the buyer should ask the seller to confirm whether final versions have been executed and, where documents which have been provided during the due diligence exercise refer to others which have not, the buyer should request these missing documents from the seller. The buyer should maintain an accurate list of questions that have been submitted to the seller and the responses received. Sometimes questions will be answered unsatisfactorily and it is therefore important for the buyer to re-phrase or pursue answers to the originals.

The buyer may also choose to contact DECC with questions on an unnamed basis during the due diligence exercise if there appears to be an inconsistency between the asset data held by DECC and the documentation provided by the seller in the data room. In doing so, the buyer must be careful not to breach any provisions contained in any confidentiality or non-disclosure agreement that has been entered into between the buyer and seller in respect of the transaction.

Conclusion

The buyer conducts due diligence so that it can properly evaluate the risks and benefits to it in acquiring a particular asset, re-negotiate the price that it is prepared to pay for the asset, and decide whether or not to go ahead with the purchase. The due diligence report should identify and quantify issues found and propose solutions for the buyer to consider. Depending on the concerns identified, traditional contractual protections in the sale and purchase agreement may be insufficient and, consequently, the buyer may decide to walk away from the deal. The importance of the due diligence exercise is therefore paramount.

Article by:

Rebecca Downes

Of:

Andrews Kurth LLP