Energy & Resources Alert

The decision in Santos demonstrates the care that must be taken by participants when negotiating pre-emptive rights clause in joint venture agreements.

Joint ventures are an essential component of the mining and the oil and gas industries, enabling significant risks and capital expenditure to be defrayed across multiple partners. Naturally, before parties agree to participate in a joint venture they carefully negotiate and document (either in a joint venture or operating agreement (for unincorporated joint ventures) or a shareholders' agreement (for incorporated joint ventures)) the terms upon which they intend to govern their commercial relationship. A key risk frequently, if not always, regulated is what rights continuing parties may have when a participant elects to sell their interest in the joint venture to a third party – these often include pre-emptive rights. This is because understanding a potential partner's reputation and financial capacity is paramount to ensuring the venture's overall success and, by extension, each existing participant's investment. The role of pre-emptive rights is therefore, in a sense, a precautionary one as they give participants a level of control over who their future joint venture partners may be. In drafting pre-emptive rights clauses, participants are necessarily grappling with future potentialities. As a consequence, the clauses can be, and often are, complex. Therefore, when it comes time for a participant to sell their interest, complying with the terms of the preemptive rights clause may be harder than it first appears. Such was the issue recently considered in the decision of the Supreme Court of Western Australia in Santos Offshore Pty Ltd v Apache Oil Australia Pty Ltd.

Santos Offshore Pty Ltd v Apache Oil Australia Pty Ltd

In this case, Apache Energy Ltd (Apache) had negotiated an upstream share sale transaction (Sale Transaction) with Viraciti Energy Pty Ltd (Viraciti) under which Viraciti would acquire Apache. The Sale Transaction would also cause a change of control in three of Apache's subsidiaries (the Apache Participants) who held interests in various joint ventures with Santos Offshore Pty Ltd (Santos). The joint operating agreement between the Apache Participants and Santos (JOA) required the Apache Participants to effectively pass through the terms of the Sale Transaction as they applied to the joint venture assets held by the Apache Participants. This required Apache to determine what it considered to be the applicable terms (Sale Terms) and set these out in notices to Santos and participants in the joint venture (ie the Apache Participants). Energy & Resources Alert | October 2015 2 Santos considered that some of the Sale Terms did not comply with the requirements of the JOA. Importantly, the JOA required that the Sale Terms be capable of being wholly accepted by Santos. Santos argued that it was not capable of complying with some of the Sale Terms, that some of the Sale Terms were not applicable to the joint venture interest and that others had been incorrectly passed through. The Supreme Court of Western Australia agreed with Santos' submissions. It found that the notices did not comply with the JOA and were therefore invalid. Furthermore the Court considered that the invalid terms and conditions in the notices could not be severed from the notices. Therefore each notice was wholly invalid. Notably, the Court did not consider that the case was appropriate for specific performance to be ordered, as the Apache Participants had not evinced an intention to avoid their obligations under the JOA but had simply sought to do so on an incorrect basis. Therefore, in order to complete the Sale Transaction the Apache Participants will either need to reissue compliant notices or seek a waiver from Santos. Apache has appealed the decision, which has not yet been listed for hearing.

Lessons from Santos

The decision in Santos demonstrates the care that must be taken by participants when negotiating pre-emptive rights clause. Parties should be mindful to ensure that the preemptive rights clause does not conflict with other clauses in the agreement, such as tag along or drag along clauses. Parties should also consider whether the clause can work practically, including whether the offer can only be accepted by the joint venture participants, or whether it can be accepted by a related entity of the joint venturer participants or other third parties. In addition, when preparing notices selling participants should be cautious to comply with the relevant requirements. Commercial consideration may also be given to consider whether waivers of each other participant's preemptive rights could be sought. The decision in Santos is another salutary lesson that when drafting pre-emptive rights clauses, parties must be careful to avoid ambiguous language which may give rise to (or enable) disputes between the parties. In some circumstances, less may be more, and simple terms and conditions that are capable of being easily applied may, in the end, be more advantageous to all of the parties, rather than endeavouring to anticipate all of the possible eventualities in advance.