Energy and Resources M&A Transaction Guide – General inhibitors for M&A transactions involving joint venture arrangements
ABOUT THE GUIDE
- This is the final series of McCullough Robertson’s six part Energy and Resources M&A Transaction Guide (volume 1) developed for the resources sector.
ABOUT THIS ARTICLE
- We look at restrictions on an M&A transaction caused by conditions requiring reasonable consent, good faith and confidentiality obligations, duties to act in best interests and other unassuming clauses often found in joint venture agreements for the mining and resources sector.
What many might consider to be template provisions of a joint venture agreement can sometimes be a silent killer of a proposed M&A transaction. In a fitting end to our series, this article looks at restrictions on an M&A transaction caused by conditions requiring reasonable consent, good faith and confidentiality obligations, duties to act in best interests and other unassuming clauses often found in joint venture agreements for the mining and resources sector.
Benefits of buyer friendly processes and arrangements
M&A transactions need a competitive environment that attracts multiple buyers in order for sellers to maximise transaction value. Prospective buyers therefore need to be given every opportunity to enter into and continue with the acquisition process until making a formal offer. However, buyers will often be less inclined to become involved in the process (or continue) if they perceive that their bid has limited prospects of success or if the process prevents the buyer from fully understanding the project and its associated risks so that they might not be able to make an informed bid.
Enticing buyers can often start with confidentiality.
Well drafted joint venture confidentiality provisions will enable buyers to sign up to a confidentiality deed poll in favour of the remaining joint venture participants and then be provided with relevant confidential information relating to the project and sale interest.
However, those confidentiality deed polls need not be made available to the other participants. This will allow the buyer to proceed with its due diligence and other investigations with the benefit, at least initially, of anonymity.
There are some confidentiality provisions though which do require upfront disclosure of the details of bidders to the remaining participants and, while not fatal, it does give those joint venture participants holding pre-emption rights an idea of who the potential buyers might be at an early stage in the sale process.
If keeping the identity of the bidder confidential is paramount, there are mechanical processes available which might help prevent this happening. However, those processes can sometimes cut across other general obligations in the joint venture agreement such as the obligation to act in good faith (see below).
Pre-emption rights in joint venture agreements can often trigger concerns for buyers about execution risk. In our earlier article on Pre-emption Pitfalls we made the comment that joint venture arrangements should not allow for minority participants to be given pre-emptive rights when a majority participant is selling. This comment applies equally here in the context of deal inhibitors.
Also, complicated pre-emptive rights which impose unreasonable obligations such as, for example, the requirement for a buyer to provide a performance guarantee from its parent, often has an impact on the preparedness of a bidder to make a bid.
Withholding of consent unreasonably
Separately to pre-emptive rights, some joint venture agreements include a condition that any proposed sale to a third party requires the prior consent of each of the remaining participants. The appropriateness of such a requirement when the remaining participants also have the right to pre-empt is questionable in some respects but, while not overly common, they do exist and can be a further hurdle in the execution of an M&A transaction.
Normally consent in these instances must not be ‘unreasonably’ withheld. The reasoning behind such wording is that remaining participants cannot simply exercise an unrestricted veto right in respect of a proposed transaction without having to provide reasons.
That said, what is ‘reasonable’ or ‘unreasonable’ will always be a question of fact, assessed by an objective standard and given a broad and common sense meaning. While there is no specific criteria which a court must have regard to, whether a refusal or withholding of consent is reasonable or unreasonable will depend on the relevant facts and circumstances, including such matters as the conduct and relationship of the parties, the commercial arrangements between the parties and the actual words used in the agreement.
Should a dispute arise, the onus is on the party requesting consent to show that the other party’s refusal or withholding of consent was unreasonable in the circumstances.
A source of frustration in some M&A transactions is that, apart from good faith obligations (discussed below) there is no obligation on participants to provide reasons for withholding consent nor is it standard for the relevant underlying documentation to set out examples of what constitutes reasonable or unreasonable refusal or withholding of consent. If no agreement can be reached between the parties, it may be necessary to seek a declaration from the courts that the party’s withholding of consent was unreasonable.
Keeping the (Good) Faith
Joint venture participants owe each other a number of duties and obligations and sometimes there is an express requirement in joint venture agreements that participants act in good faith towards the other participants. Despite its common use, what constitutes ‘good faith’ in the context of joint ventures is not entirely settled law in Australia. From the limited case law that does exist, we know that the duty to act in good faith:
- imposes an obligation on participants to cooperate in achieving the objects of the joint venture
- requires participants to act honestly and reasonably whilst having regard to each other’s interests in connection with the joint venture agreement
- will not be breached where a party pursues its own interests, provided that this pursuit is consistent with the basis on which the joint venture was entered, and
- does not require a participant to act in the interests of the other participants or to prioritise another participant’s interests over their own legitimate interests (unlike fiduciary obligations).
In the context of an M&A transaction, an express requirement to act in good faith is unlikely to inhibit the sale by conventional means of a participant’s joint venture interest. In fact, a good faith clause might assist in ensuring the sale process is not frustrated by the continuing participants. However, the provision might apply to restrict a selling participant from adopting a sale process that technically complies with the joint venture agreement but which is not within the spirit of the relationship between the joint venture participants. For example, a selling participant might attempt to circumvent the pre-emption provisions by declaring a trust over its interest in the project to a buyer rather than transferring that interest to the buyer (which transfer would activate the pre-emptive rights of the other participants). In that case, good faith obligations might be the only basis for the other participants to seek redress for that circumvention.
Best interests versus good faith
It is a common misconception that ‘best interests’ of the joint venture is synonymous with the duty to act in good faith. Although it is a distinct obligation, there is no legal definition for the term. It will ultimately be a question of fact, however in our view, what is in the ‘best interests’ of the joint venture are essentially acts or decisions which would assist participants in achieving their collective short-term and long-term commercial or financial objectives and which fulfil the joint venture objectives. For example, an unreasonable proposal for the development of a mine with the intention of exercising an option to buy the other party’s interest in the joint venture for less than market value will not be in the best interests of the joint venture.
Potential buyers are unlikely to be affected by obligations to act in the best interests of the joint venture unless they hold interests in other resource projects which have the potential to compete with the project in question. Where this happens, the buyer will need to get agreement to vary or waive that obligation on a fully disclosed basis.
Dodgy documents generally
Of course, it goes without saying that an unorthodox or out-dated joint venture agreement or other relationship agreement which the parties are reluctant to modify will be a significant inhibitor to an acquisition. The successful buyer will need to live with that documentation from the closing of its acquisition and will want to be clear about their obligations going forward. Provisions requiring particular care and attention in this context include restraints on exploring or exploiting in agreed areas outside the project area, voting rights, related party dealings and dilution provisions.
Perhaps the biggest risk for sellers of interests in joint ventures regulated by older agreements is that the processes and rules are no longer equipped to deal with recent (and not so recent) changes in the law. For example, the recently introduced CGT withholding, the GST going concern exemption, the new rules around the consents required to apply to the relevant departments for tenement transfer approvals, PPSA and timing for approvals generally to allow for an effective pre-emptive process are just a few of these changes to the law and other issues which are not likely to be adequately dealt with in older joint venture documents.
At best these document defects can cause headaches for those involved in M&A transactions. At worst, however, they could result in a reduction in the number of potential buyers or in an M&A transaction not completing at all. Our recommendation is for out-dated joint venture documentation to be upgraded to ensure that joint venture participants who wish to sell are able to do so without unnecessary or unintended restrictions caused by law changes since the joint venture agreement was first entered into.
In any case it is not uncommon for joint venture agreements to be varied as a condition of an M&A transaction. However, that requires the agreement and goodwill of all of the joint venture participants whether or not they are involved in the sale transaction. Where the incoming participant is seen as a welcome addition to the joint venture and the variations to the joint venture that have been requested are reasonable, then the prospects of those variations being agreed are highly probable. Preferably, however, it would be best to avoid the need to seek the indulgence of your fellow joint venture participants for this purpose or at least at the time of a potential sale particularly if those participants do not benefit from that sale.
What does all this mean?
If this article highlights anything, it would be the need to ensure the joint venture documentation is well considered and, where appropriate, updated to keep in line with current law.
Our final instalment in the series – what to consider now
As you will have seen from our six masterclass articles, there is a lot to consider when undertaking an M&A transaction in the energy and resources space. The downturn in resources has seen players pursue innovative methods to complete deals, including bespoke transaction structures (e.g. the dollar dazzler deals) or alternative funding and security arrangements with creditors. However, such transactions will still be subject to constraints that preceded the downturn (e.g. pre-emptive rights, third party consents, creditor restrictions and priorities) as well as some new limitations following the introduction of new law like the Chain of Responsibility.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It 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.