2017 CAPL Property Transfer Procedure
Reps and Warranties: Part II
WRITTEN BY
JIM MACLEAN
THE SECOND DRAFT OF THE 2017 CAPL PROPERTY TRANSFER PROCEDURE (“PTP”) WAS MADE AVAILABLE TO INDUSTRY IN LATE JANUARY THROUGH A WEB ENABLED DISTRIBUTION. The package on the CAPL web page includes: (i) an overview of the project scope and the major changes relative to the 2000 PTP; (ii) a detailed matrix that outlines all material changes relative to the 2000 PTP and their rationale; (iii) a clean copy of the text and annotations; (iv) a 34 page coded comment matrix that presents the detailed verbatim comments we received from a modest number of commenting parties, together with our responses to each individual comment; (v) a redline of the second draft relative to the initial July, 2016 draft; (vi) Word versions of the election sheet and the case studies included as Addendums to the PTP to facilitate early use of the PTP for anyone that wishes to use the draft in a new transaction; and (vii) a redline of the second draft relative to the 2000 PTP. While we do not expect that the redline to the 2000 PTP will be reviewed in any detail, we believe that even a cursory glance at that redline will demonstrate convincingly the thought and effort that has been invested in the 2017 document over the last 13 months by our 15-member committee. Last month’s article addressed the common reps in Clause 6.01 and the Vendor’s reps and warranties in Paragraphs 6.02(a)-(t). This month’s article offers additional context about Article 6.00 of the PTP by reviewing the remaining reps and warranties of the Vendor in Paragraphs 602(u)-(bb), the Purchaser’s reps in Clause 6.04 and the remainder of the Article.
Clause 6.02 – Vendor’s Representations and Warranties
Area of Mutual Interest or Area of Exclusion (Paragraph 6.02(u)): Except as identified in a Schedule, no Title and Operating Document includes an area of mutual interest or area of exclusion that is in effect as of the Effective Date.
Few P&S Agreements include this representation. It is an important item, though, particularly if the Purchaser intends to expand its position in the region. There is limited scope for application under new agreements, as the AMI term under those agreements tends to be relatively short. However, care must be taken for old agreements, as they occasionally include large, perpetual AMI obligations. This representation is particularly relevant if the transaction primarily involves undeveloped acreage.
This rep was modified in the 2017 PTP to extend to any area of exclusion obligation. While it is likely that any such obligation assumed by the Vendor would be personal to it, the Vendor should review any such document to ensure that it does not adversely affect the transaction. This reinforces to users why it is important to track these types of obligations carefully in internal records systems.
No Notice of Offset Obligations (Paragraph 6.02(v)): Except as identified in a Schedule, the Vendor has not received a notice from the applicable lessor that any Lease is subject to an offset obligation. The representation is linked to the receipt of a lessor notice for two reasons, even though an offset notice as such is not required under a freehold lease. The first is that a potential Purchaser can conduct an initial due diligence review from public data sources. The second is that Crown offset notices are often discretionary, such that a notice from the Crown is required to trigger the obligation. Some agreements include an additional component in the provision, such as “and is not aware of any particular circumstance that has created such an offset obligation.” However, a Vendor should be cautious about extending the scope of the application of this representation.
It is a good practice for a Vendor to review offsetting lands to determine if there is recent drilling activity that might cause an offset obligation, to make a note of any such well on the applicable lease file and to conduct such further investigations as may be appropriate in the circumstances.
No Commitment to Deliver (Paragraph 6.02(w)): J.V. Agreements sometimes include a requirement that an owner deliver all its production from a designated area to a particular facility. This is typically not addressed in A&D Agreements, even though there could be a large negative impact on a Purchaser’s regional strategy. Purchasers should review this issue very early in their due diligence process, even if this representation is not included. This Paragraph was expanded in the 2017 PTP to address take or pay obligations for use of Tangibles or other facilities in addition to the commitment to deliver. (See also Paragraph 6.02(i).)
This rep includes an exception for Clause 1401 of the 1990 CAPL Operating Procedure. This is because of the limited commitment to deliver obligation with respect to “production facilities” operated thereunder. It is important for users to recall that the 1990 CAPL Operating Procedure and the subsequent updates cover minor production facilities originally designed solely for use in the exploitation of the lands subject to the applicable land agreement. (That obligation was eliminated as of the 2007 CAPL Operating Procedure.)
Not a Disposition of Substantially all Vendor’s Assets (Paragraph 6.02(x)): This rep is included because special shareholder approvals would be required if a Vendor were selling all or substantially all its assets in the transaction. The advice of legal advisors would be required if it were apparent that this were an issue. Leased Vehicles, Equipment and Premises (Paragraph 6.02(y)): This rep was introduced in the 2017 PTP. It will be important for a Purchaser becoming the operator of a property to understand the Tangibles, private property and buildings that are owned and those that are only leased.
No Removal of Assets (Paragraph 6.02(z)): This representation was introduced in the 2017 PTP. Other than for any excess inventory belonging solely to it, the Vendor should not remove from the location of an operated property equipment that is serving the Assets, such as inventory owned for the joint account. (See also the removal obligation under Clause 11.03 if there is any excess inventory.) It is the better practice to remove any such excess inventory on site before the Purchaser’s site visit or to identify it clearly as inventory that will be removed prior to the Closing Date or shortly thereafter.
Quiet Enjoyment (Paragraph 6.02(aa)): Purchasers will often request a “quiet enjoyment” representation from the Vendor. The rep suggested by Purchasers is often too broad, as it may not recognize the interrelationship between the quiet enjoyment rep and the limitations applicable to the Vendor’s delivery of the Assets – the other reps and warranties provided by the Vendor and the Permitted Encumbrances (includes the Title and Operating Documents and Title Defects that have been waived by the Purchaser). Failure to recognize that connection in the quiet enjoyment rep arguably eliminates much of the protection a Vendor intends with those limitations.
Additional Representations (Paragraph 6.02(bb)): Both Clause 6.02 and Clause 6.04 (Paragraph 6.04(f)) anticipate that the Parties may choose to include additional representations in the Head Agreement. Any such additional custom representation is treated in a consistent manner with those in the PTP, as if it had been made under Clause 6.02 or Clause 6.04.
One rep that will probably often be included in a Head Agreement pertains to long term inactive wells and facilities and the measures being taken by Regulatory Authorities at the relevant time to manage the abandonment and reclamation issues associated with orphan wells and facilities. Parties will increasingly choose to address this issue specifically in a rep because of the potential negative impact associated with the acquisition of an inactive well or an inactive multi-well facility under, for example, the Alberta AER requirements. Both Vendors and Purchasers should be aware of the requirements of the applicable Regulatory Authorities on this issue and the consequences of non-compliance. Although a very important issue, this was not included in the list of optional reps in Clause 6.02 because of the need to review the matter on a case-by-case with business and legal advisors if it is an issue and the degree to which the regulatory regime will continue to evolve. (See also the definition of Licencee Rating, Paragraphs 6.02(q) and 6.04(d), together with the associated annotations.)
Purchasers often request additional representations. Examples are reps that: (a) the Vendor has made reasonable inquiries and searches for material documents and information relating to the Assets and for all information reasonably required to ensure that its reps and warranties would not be misleading; (b) the Tangibles are suitable for the production of Petroleum Substances; (c) no Wells need to be abandoned; (d) there are no Environmental Liabilities of which a Purchaser should be aware; (e) to the knowledge of the Vendor, the production and financial data provided to the Purchaser were not materially inaccurate; and (f) the Vendor knows of nothing that would reasonably cause the Purchaser to wish to terminate the transaction. Some of these are far too broad, and attempt to pass business risk to the Vendor. The Vendor is not privy to the Purchaser’s evaluations of the property, for example, and cannot be expected to know how it proposes to operate a property.
A Purchaser might also consider addressing some of the items noted above as part of its due diligence process or as a condition to Closing. Similarly, a Purchaser could also have a remedy for fraud in circumstances in which, for example, the financial information presented by a Vendor to the Purchaser/potential bidders was deliberately misleading.
Clause 6.03 – No Additional Representations or Warranties by Vendor (2000 PTP Clause 6.05)
Subclause 6.03A: This Subclause was added in the 2017 PTP to reinforce that the Purchaser could not claim a breach of a rep insofar as the applicable matter was disclosed in the Agreement.
Agreements sometimes include language stating that the qualification extends to any matter, event or circumstance that was disclosed in the Agreement, in a data room or of which the Purchaser was otherwise aware. Subclause 6.05C offers a more balanced outcome. It allows either Party to raise as a potential defence with respect to a breach of a rep that the other Party did not rely on it.
Subclauses 6.03B and C: Subclause 6.05A of the 2000 PTP was substantially rewritten as Subclauses 6.03B and C of the 2017 document. Subclause 6.03B reinforces the “as is, where is” nature of the transaction by building on the first portion of the former Subclause 6.05A. Subclause 6.03C greatly expands the content that had been included in the last sentence of the former Subclause 6.05A with respect to the Purchaser’s due diligence inspection of the Assets and its analysis of the value of the Assets. Notwithstanding the expanded wording in these Subclauses relative to the 2000 document, the principles remain unchanged. A prudent Purchaser will ask for copies of the Vendor’s environmental records respecting the Assets as part of its normal due diligence process (whether conducted under optional Article 8.00 or prior to execution of the Agreement, as contemplated in the introduction to Article 8.00). A Vendor that withholds records that the Purchaser had requested the opportunity to review potentially finds itself in breach of the rep about the provision of documents (Paragraph 6.02(p)) if it has been selected to apply. Even if that rep were not selected to apply, there could be extreme circumstances in which a conscious decision by the Vendor to withhold records or to disclose selective records that create a misleading presentation of the circumstances could leave it open to a claim for fraud. In this regard, it is important to remember that a claim for fraud is not limited to the normal period prescribed for the survival of representations and warranties under Subclause 6.05A and Subclause 13.01C.
Subclause 6.03D: This Subclause is similar to Subclause 6.05B of the 2000 document. A similar provision is typically used in A&D Agreements.
The Vendor makes no reps respecting the Assets in addition to those provided in Clauses 6.01 and 6.02, including those made in the Head Agreement under Paragraph 6.02(bb). The Vendor has generally provided information in its possession to the Purchaser to assist the Purchaser to conduct its own evaluation of the Assets. The Vendor did so without any intention of guaranteeing that the information was accurate. Excepting fraud on the part of the Vendor and the Vendor’s responsibility for its reps on the basis provided in the Agreement, the acquisition of the Assets is ultimately a business decision of the Purchaser, based on its assessment of the accuracy of all available data. The Vendor has three reasons for the inclusion of this type of Subclause.
Firstly, the Vendor wishes to reinforce that the Purchaser relies on information outside the contract at its own risk. Except as provided in the Agreement, it is responsible for conducting its own evaluation of the Assets. Any information provided by the Vendor, such as a contract summary from a land information system, is intended to assist the Purchaser in its due diligence review, not to replace it.
Secondly, the inclusion of representations/information outside of the Agreement poses difficult proof problems, even if the “parol evidence rule” (a general prohibition on consideration by a court of negotiations/collateral representations outside the contract) could be overcome by the Purchaser. It would be difficult to prove if and how the alleged information was provided and the degree of the Purchaser’s reliance thereon.
The most practical reason, though, is that a Vendor wishes to minimize the possibility that unauthorized personnel and authorized, but uninformed, personnel could make statements that would impact the Parties’ contractual arrangement. It is common for the Purchaser’s representatives to be in contact with many the Vendor’s representatives at any time, requesting various pieces of information. In their desire to assist, the Vendor’s personnel occasionally provide honest, but incorrect advice, largely because the Purchaser’s representatives often request an immediate response.
The probable result of the exclusion of the general release would be the creation of a very formalized process. Each Party would designate a representative through which all questions and answers would be directed in writing. In practice, the cost of such a mechanism seems to exceed the perceived benefit of the change when dealing with credible parties.
Clause 6.04 – Purchaser’s Representations and Warranties (2000 PTP Clause 6.03)
Investment Canada Act (Paragraph 6.04(a)): Notwithstanding the brief references to the Investment Canada Act (Canada) and the Competition Act (Canada) in the PTP, it is unlikely that the PTP would be used in practice for any disposition that would be subject to review under either of those Acts. In the unlikely event that the PTP were used for any Transaction that was reviewable under one or both of those Acts, legal assistance would be required to address the process to be used by the Parties.
The references included in the annotations about those Acts are primarily included to offer a general context for users because of the likely use of this document as a reference document. This offers a context about the requirements that could apply to larger transactions. The Investment Canada Act (Canada) is considered briefly in the annotations on Paragraph 10.01(a), for example. If the transaction is “reviewable” under that Act, Paragraph 10.01(a) will apply.
No Lawsuits or Claims (Paragraph 6.04(b)): This rep was introduced in the 2017 PTP to offer similar protection as that offered to the Purchaser under Paragraph 6.02(b). While unlikely, the Purchaser could be subject to legal proceedings that could threaten its ability to complete the transaction. The Vendor would need to assess the risk of Closing occurring if this were a potential issue.
Acquiring as Principal (Paragraphs 6.04(c)): The Vendor wants to be able to enforce the Purchaser’s ongoing obligations under the Agreement against it. Recognition of potential risks in this area also reinforces to the Vendor’s personnel that ongoing obligations, such as liability and indemnification obligations, are ultimately only as good as the financial viability of the Party that has those obligations.
Wells and Tangibles Transfers (Paragraph 6.04(d)): Given potential restrictions on the transfer of licences under the Regulations, the Purchaser represents that it is eligible to accept a transfer of the licence for Wells and Tangibles anticipated to be operated by it. A Vendor must carefully screen potential buyers and only attempt to dispose of properties to a financially viable Purchaser. The Purchaser sometimes will not be able to make this rep as of the Effective Date. It will need to be modified for those cases, so that the required steps to become eligible have been completed by Closing. This would typically require identification of the eligibility gaps to the Vendor. The rep could have been structured more broadly to apply the eligibility test only as of Closing. This was not done because of the Vendor’s need to understand any eligibility issues in this area early in the transaction.
As noted in the annotations on the definition of Licencee Rating, Clause 3.04, Clause 3.06, Paragraph 6.02(q) and Paragraph 10.03(c), the onus is on the Parties to work with their business and legal advisors to add custom content in their Head Agreement to address their circumstances and needs if there are any contemplated issues about the transfer of Well licences in addition to the condition to Closing in Paragraph 10.03(c). The fluidity of the Regulations on this area over time and across jurisdictions was also such that any more specific handling of the issue in this document would potentially create unintended consequences for the Parties over time.
Simplifying the other procedural aspects of the overall transaction through use of the PTP facilitates a more focused examination of this important business issue by the Parties’ representatives relative to what would be the case without the PTP.
Financial Capacity (Paragraph 6.04(e)): Subject to any condition to Closing respecting financing, the Purchaser represents that it has the available funds to make the payments required by it at Closing and to perform any other financial commitments required under the Head Agreement.
Clause 6.05 – Survival of Representations and Warranties (2000 PTP Clause 6.04)
Subclause 6.05A: The representations and warranties are to be true on the Effective Date, at execution of the Agreement and at the Closing Time. A rep that was true at the Effective Date would be of little comfort to a Purchaser if it was not also true at Closing.
The representations and warranties will not survive Closing unless the provision states that they are to survive beyond Closing. Although the inclusion of a limited survival period is generally accepted, the duration of the period has sometimes been a matter of negotiation. The norm has become 12 months for material transactions, with six months sometimes used for minor transactions involving non-operated properties or only undeveloped lands.
The survival period was modified from a negotiated number of months to one year in the 2017 document to reflect the most typical outcome. Parties that prefer a different survival period in this Subclause and Subclause 13.01C remain free to negotiate a different time period.
This Subclause does not go so far as to state that the representations and warranties cease to have any effect at the end of the prescribed period because of the exception for fraud noted in Subclause 6.05B and the related annotations.
The survival period for representations and warranties in this Subclause does not enable the Vendor to avoid its contractual obligations for J.V. and royalty audits under Subclause 4.02C, however.
Subclause 6.05B: If a representation or warranty was made fraudulently, the limited survival period probably would not prevent a Party from subsequently pursuing its full legal rights within the normal legal limitation period prescribed under the Limitations Act. However, the inclusion of the exception for fraud provides Purchasers with additional comfort, and should be of no concern to a Vendor that is processing its divestitures properly.
A Party claiming a breach of a representation or warranty after Closing must do so by providing notice with reasonable particulars about the alleged breach within the prescribed period, subject to the qualification for fraud noted above. It has no basis to make any further claim for that breach if it misses the prescribed period within which to make a claim.
Subclause 6.05C: Vendors occasionally include a provision whereby a Purchaser would be prohibited from commencing an action for any rep if the Purchaser had any knowledge that would cause it to question the truth of that rep. A Purchaser pursuing a claim for damages for the breach of a rep would be required to convince a court that there had been a breach of the rep to its detriment and, if so, to prove that the damages suffered by it resulted from its reliance on the rep.
It would seem difficult for a Purchaser to make this argument if it had knowledge at the time that indicated that it was not relying on the rep. Although the defence might also be available at common law in the absence of this Subclause, the document states that a Party may offer as a possible defence that the other Party was aware, prior to Closing, of the matter that forms the basis of its claim for breach of a rep and that it chose to proceed with Closing anyway. However, the success of the defence would ultimately depend on the facts.Purchasers sometimes request amendments to provisions like Clauses 6.03 and 6.05 whereby there is a recognition that the Parties have, in fact, relied on the representations and warranties made by the other Party under this Article. This is inappropriate. The other Party would not have relied on the representation if it knew that it was untrue, but Closed anyway.
Subclause 6.05D: This Subclause was introduced in the 2017 document to try to mitigate the risk that the survival periods for representations and warranties under this Clause and Clause 13.01 might not be effective because of the potential application of Subsection 7(2) of the Limitations Act (Alberta).
There has been some uncertainty as to whether that Subsection might impact the typical practice to include survival periods on reps and warranties in commercial agreements. This topic was considered in the 2015 Alberta case of NOV Enerflow v. Enerflow Industries Inc. The Court found that sophisticated contracting parties are free to agree to expiration dates for reps and warranties in a contract. It also found that a party making a claim for breach of one or more reps and warranties could not make a very broad claim initially and then modify its claim to add additional breaches of unrelated reps and warranties after expiry of the survival period for the reps and warranties.
Takin’ Care of Business
The representations and warranties provision has historically been one of the most heavily negotiated provisions of A&D Agreements with respect to both the types of representations that are to be included and their wording. As noted in last month’s article, the PTP mitigates the potential for this to occur for the transactions for which the PTP is designed by providing a common framework that allows the Parties to focus on the more substantive business issues associated with their transaction.
We will be issuing what is expected to be the final industry draft of the PTP in June.
Published: The Negotiator, June 2017
Disclaimer –All articles printed under an author’s, association’s or corporation’s name represent the views of the author; publication or posting neither implies approval of the opinions expressed, nor accuracy of the facts stated.
