Energy and Resources M&A Transaction Guide – Pre-emptive pitfalls

ABOUT THE GUIDE

• This is the first of McCullough Robertson’s six part Energy and Resources M&A Transaction Guide developed for the resources sector.

ABOUT THIS ARTICLE

• M&A transactions in the resources industry are often inhibited by the pre-emptive rights of participants in joint venture agreements. In this article we set out 10 tips and traps on drafting, negotiating and navigating pre-emptive rights in respect of a proposed disposal of a participant’s interest in a joint venture.

MASTERCLASSES

• We’ll wrap up the series with a Masterclass where you can ask our expert panel any questions related to undertaking a transaction.

Pre-emptive pitfalls

The following is a list of the top 10 issues that should be considered when negotiating a modern day joint venture agreement in the context of potential sales of joint venture interests whether as part of an M&A transaction or otherwise.

1. Minority participants

It is probably no longer appropriate to treat minority participants the same as majority participants. A majority participant should be entitled to sell its interest without first giving minorities (particularly those with a small ownership interest in the joint venture) a pre-emptive right. Majority participants should, in fact, be entitled to force these minority participants to sell their interests when the majority interest is being sold (i.e. drag along). Conversely, a minority participant should have the right to have the majority participant to cause its interest to be sold at the same time as the majority participant’s interest is sold (i.e. tag along).

2. Non-cash offers from bidders

A modern day pre-emptive right should permit non-cash offers from bidders as well as performance based consideration and deferred payment mechanisms. These arrangements should be capable of being matched as part of the offer to the other participants or, where that is not appropriate, independently valued to ensure a cash equivalent offer can be made to the other participants. This should provide the selling participants with a greater opportunity to maximise the sale value of its asset.

3. Change in control trigger

A change in control trigger should be included in any modern day joint venture agreement to ensure participants do not circumvent the pre-emptive rights by undertaking an upstream sale. However, the normal exceptions for change in control for listed vehicles (i.e. when a listed vehicle which directly or indirectly holds a joint venture interest is taken over there is normally no change in control trigger) should be extended to cover circumstances where the joint venture interest held by the corporate group represents only a small part of the asset being sold.

4. Valuation

If a valuation is required whether, for example, to value a non-cash component of the consideration or in the case of a change in control, the provisions should be drafted in a way that ensures that the pre-emptive rights are able to be exercised after the valuation is obtained when the price is known to the party who is considering exercising the option.

5. Related party transfer carve outs

Related party transfer carve outs to pre-emptive rights need to be carefully considered. They must ensure that carve outs are limited to genuine related party transactions and must ensure that the purchasing entity and the joint venture interest remains within the corporate group to which the transferring participant is a member.

6. Double duty

Ensure the drafting generally is in a way that the exercise of the pre-emptive rights by any of the participants does not trigger double duty being duty both on the transaction resulting from the exercise of the right and also on the failed offer made by the original bidder.

7. Discount to the market value price

Applying a discount of, for example, 10% to the market value price of a joint venture interest upon exercise of the pre-emptive rights arising as a consequence of a participant’s default is no longer standard for joint venture agreements. Recent case law supports the view that these types of provisions could be considered to be a penalty and, consequently, are at risk of being unenforceable.

8. Third party offer to purchase the interest on sale

Consider the appropriateness of pre-emptive rights (apart from the case of default or change in control) only being activated where there is a genuine bona fide third party offer to purchase the interest on sale. If no such offer exists then the joint venturers are still free to negotiate a sale and purchase but without the possible acquirer having uncertainty about whether there is genuine competition for the interest being sold.

9. Potential transfer between existing joint venture participants

The decision making provisions in the joint venture agreement need to be considered in the context of the pre-emptive rights and, particularly, in the context of a potential transfer between existing joint venture participants. For example, a 51% approval threshold for material decisions might be appropriate when you have three equal participants but if one of those participants sells to another, it may very well be that a threshold for material decisions at 51% is no longer appropriate.

10. Should pre-emptive rights be provided for in a modern day joint venture agreement

Careful consideration should be given as to whether pre-emptive rights should in fact be provided for in a modern day joint venture agreement. The priority the pre-emptive rights give to fellow joint venture participants do restrict the ability to generate genuine offers from bidders given the heightened deal completion risk for those bidders because of a potential exercise of a pre-emptive right.

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.