Energy and Resources M&A Transaction Guide – What’s hot in M&A deal structuring for energy and resources transactions
ABOUT THE GUIDE
This is series 5 of McCullough Robertson’s six part Energy and Resources M&A Transaction Guide developed for the resources sector.
ABOUT THIS ARTICLE
We look at some of the most significant structuring issues affecting the resources sector, how these could potentially affect an M&A deal and what you can do so that there are ‘no surprises’.
The raft of issues to consider for ‘no surprises’ M&A deal structuring for the energy and resources sector has never been as voluminous or complex. Today we find ourselves in a legal landscape which has been materially altered by a range of significant Federal and State regulatory and revenue changes. While the list of issues to work through can often be daunting, it is not all bad news. With some forward planning, most issues arising currently can be managed or dealt with through appropriate risk management strategies or as part of the broader commercial discussions for the transaction.
CURRENT TRANSACTION TRENDS
Private equity involvement
Current market conditions favour private equity over conventional funding alternatives. On this matter alone, parties should factor in that private equity will often have a five year investment horizon and seek to include contractual arrangements which allow for that exit.
For energy and resources M&A transactions particularly, the conventional model for joint investment has been by way of unincorporated joint ventures. However, it is possible that in time we will see a shift towards partnerships particularly as sellers may achieve a more efficient after tax position on retiring from their partnership investment rather than selling out of a joint venture structure. Private equity investors with a fixed investment time line might find this an advantage worth considering.
Dollar dazzler deals
The recent trend of owners wanting to exit poorly performing projects has introduced a new level of novelty to transaction structures. Deals involving these projects involve not only a nominal purchase price but also include ongoing commitments by the seller to fund ongoing project expenditure. Sellers in these types of transactions would ordinarily negotiate for a share of any future project upside. This could take the form of a royalty on future product sales or a share of the profit on any subsequent sale of the project.
Buyers need to adequately manage the risk that sellers under these arrangements are able to meet their ongoing commitments. This is particularly the case where the seller is a foreign entity and therefore a potential flight risk. Guarantees or other security may be required for the post completion performance obligations of the seller. The ability to enforce guarantees or other securities provided by foreign entities needs to be tested both in Australia and in the home country of the seller.
The revenue costs for these types of transactions are not based on the nominal purchase price. It should not be assumed therefore that stamp duty and GST will be based on that nominal purchase price. This also applies to the foreign seller’s withholding tax requirements which took effect on 1 July 2016 (see below).
Disclaimers of onerous contracts
Liquidators can disclaim onerous contracts and consideration is often had in the case of a sale and purchase as to whether the obligations under, for example, take or pay contracts can be terminated by disclaimer or other insolvency action (e.g. a DOCA).
Being able to isolate those onerous contracts from other assets of a project might provide better value for the seller on the sale of those assets.
FEDERAL REGULATORY AND REVENUE DEVELOPMENTS
Beyond those current market trends, there have been some major regulatory and revenue developments relevant to energy and resources transaction structuring. These include the following:
FIRB changes and increased scrutiny
During late 2015, the legislation and regulations governing foreign investment in Australia was substantially rewritten, including the Foreign Acquisition and Takeovers Act 1975 (Cth).
At a practical level, applicants now are required to pay a much higher application fee (often around $25,000 for energy and resources transactions) and will be subject to a more rigorous approval process than in the past and across a broader range of transactions.
One such grey area which has emerged by targeting a broader range of transactions is with respect to approval for security instruments. Until recently, it was common practice for inbound investors to obtain FIRB approval for the acquisition of a project but not for the obtaining of a charge or security. It may be that we are now moving towards FIRB approval being required also for the charge or security. This will have practical consequences particularly where a joint venture might be established and cross security to be registered as part of those proposed transactional arrangements. One further alternative might even be that, to the extent FIRB approval is required for the obtaining of charges or securities, then the charge or security might be limited only to secure cash proceeds of assets rather than the assets themselves.
10% withholding tax
One of the more significant tax changes for energy and resources M&A transactions is the requirement for buyers to withhold 10% of the purchase consideration and pay that amount to the Australian Tax Office where the buyer cannot demonstrate that it is a tax resident to a standard which is provided for in the relevant legislation.
All M&A transactions will now require special provisions even if the seller is a resident and an Australian taxpayer dealing with these statutory federal obligations.
Inbound investors should consider how they hold their investments as some simple planning might provide access to generous treaty protection. For example, some of Australia’s international investment treaties, including treaties with six of Australia’s top 10 trading partners, provide investors with an avenue by which they can make a claim against Australia for losses suffered if changes to Australian law are enacted which adversely affect their foreign investments in Australia. The extent to which these treaties offer protection to investors is currently being tested through the Courts but the expectation is that these treaties may have application in challenging the enforceability of the Chain of Responsibility legislation (discussed below) on those who seek protection under those treaties.
Stamp duty fluctuations
A common theme in recent amendments to stamp duty law is the ever broadening definition of land. State revenue bodies are now seeking to assess non-land assets like infrastructure and plant and equipment in the value of land when stamping M&A transactions. This is separate to the ongoing changes occurring for some time now to expand on the assessment of all types of mining tenements as either land or dutiable property more broadly. In this space, it is anticipated that New South Wales will shortly move to include exploration licences (which, as of 1 July 2016, ceased to be dutiable property through the abolition of transfer duty in respect of business assets) as land.
As stamp duty assessments are a hard transaction cost it is important to factor these costs into any proposed transaction from the outset.
QUEENSLAND REGULATORY AND REVENUE DEVELOPMENTS
Chain of Responsibility sting
This legislation arrived almost overnight following the Queensland Nickel administration.
Specifically, in the absence of any further changes to this legislation or clarifications through the regulations and Guideline (both yet to be released), sellers will potentially remain on the hook to the Queensland Government for any M&A divestments for those projects for a minimum of two years. At its worst, sellers of Queensland based projects remain exposed to any environmental protection orders issued in respect of the project following completion. This will be well beyond the minimum two year period and could be for some significant period of time following completion where vendor finance and/or royalty arrangements are being utilised as part of the sale.
Alongside the Chain of Responsibility changes, we are aware that the Queensland Government is generally looking to review performance bonds more carefully as well as the financial capability of any providers and parties should expect more questioning in this regard at the time of any ownership changes.
It is worth noting also that the department has the right to vary the amount provided under a performance bond at any time and with the Government’s new emphasis on reviewing arrangements around performance bonds as well as its new right to review the terms of an environmental authority at the time of there being a change in control of ownership of the authority, it is possible that the replacement performance bond to be provided by an incoming buyer of a Queensland energy and resources project may not be the same as that which was in place and identified during due diligence by that buyer.
Increased State Government royalty audit activity
In recent years, collection of State Government mining royalties has moved from the department to the Queensland Office of State Revenue.
Since then, the Office of State Revenue has started to apply certain of its audit programs and data matching capabilities to audit mine producers. Current operators of mines should undertake their own internal review with appropriate legal support to make sure that they are complying with the royalty laws and, in some cases, as we have even seen, overpaying royalties.
Any buyer of a coal producer will need to undertake a thorough due diligence of the mine’s royalty compliance as any historical non-compliance of payment of Government royalties together with interest and penalties will be to the buyer’s account.
Also, while not yet market practice, warranties for Government royalty compliance should extend beyond the usual nominal warranty period of one or two years and be for the longer warranty period normally provided for tax warranties of, say, five years.
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.