Mineral, Oil and Gas – Legal Due Diligence Issues in an Acquisition or Listing

CNPupdate

 

Mineral, Oil and Gas – Legal Due Diligence Issues in an Acquisition or Listing


Date Published: 1 December 2015 


Authors and Contributors: Stephen Soh and Loh Yong Hui.




 

Introduction

CNPLaw LLP, formerly known as Colin Ng & Partners LLP, has recently been involved in a number of transactions involving mineral, oil and gas (“MOG”) companies (as defined in the SGX-ST Listing Manual) in the Asia Pacific.

The MOG projects can be characterised into four general structures, namely, concession, production sharing agreement, joint venture and technical service agreement. In addition, the MOG project can be broken down into three phases, exploration, development and exploitation. A summary of the structures and phases will be discussed below.

The type of structure of the MOG project will influence the scope and focus of the legal due diligence conducted. We will discuss the legal due diligence issues which commonly arise in the context of an acquisition or listing of a MOG asset and highlight specific issues we had encountered.

 

Structure of a MOG Project

The structures vary according to the party who actually holds the licence and the scope of responsibility of the parties involved.

 

Concession

The MOG concession is usually granted by the government of the host nation through the governmental mining authority. The grant of the concession may be documented by a concession agreement, which will stipulate the conditions for exploration and the rules governing the production agreement if the MOG project is successful. There is usually a concession rental fee, which is calculated on a per unit area basis. It is also common for the government to impose exploration obligations, such as a minimum amount of financial expenditure and a minimum number of exploration wells.

 

Production Sharing Agreement

A production sharing agreement is entered into between the parties to a MOG project and the host country, primarily setting out the allocation of the production to each party, after they have each recovered the costs and expenses incurred in the exploration and development of the project. The host country or a state-owned entity will usually remain the owners of the resource or retain the rights to the concession.

 

Joint Venture

A joint venture is usually entered into between a foreign company and a company from the host country. The MOG project will be primarily operated by the joint venture company and it is undertaken to facilitate the sharing of risk, finances and technology between joint venture parties.

 

Technical Service Agreement

In a technical service agreement, the company provides a limited scope of work to an entity which holds the relevant licence to the MOG resource. The obligations are usually well defined with a fixed duration and a fixed fee per unit resource extracted.

 

Phases of a MOG Project

Exploration

The primary intent of this phase is to perform geological and technical studies on the designated area to determine if there are sufficient resources to be extracted and also to determine if the project is commercially viable.

 

Development

This phase is focused on the application for an exploitation licence and the development of the mine into a commercially viable project.

 

Exploitation

Once the exploitation licence has been obtained, the exploitation phase commences. The focus at this juncture is to recoup the expenses and investments by the various parties and the monetisation of the resources that can be extracted.

 

Legal Due Diligence Issues

The issues discussed below will cover the more pertinent issues that may arise in a legal due diligence exercise associated with a MOG project.

 

Licensing

Who Owns the Licence

The ownership of the licence varies according to the structure of the project and in the case of a production sharing agreement and technical service agreement, the licence may be held by an entity which does not undertake the day to day operations of the MOG project. In such a scenario, the contractual arrangement between the licence holder and the operating entity is essential and will be discussed later in the article.

 

Validity Period of the Licence

The licences, in any of the phases, have a validity period and usually cater for extension(s) of the validity period. One common issue is the requirements with regard for an application for the extension of the licence as this directly affects the time available to complete the particular phase of the MOG project.

 

Obligations under the Licence

For the exploration and development phase, the obligations are largely geared towards advancing the project to the next phase and this would include submitting the applicable reports (discussed below) within the validity period of the licence. Depending on the licence, there may be an imposition of a minimum amount of financial expenditure and/or a minimum number of exploratory wells.

The legal due diligence will be focused on whether the licence holder is on track to obtain the next licence or are they at risk of not meeting their obligations. This will involve an assessment of the obligations, which obligations have been fulfilled and what are the steps necessary for the unfulfilled obligations.

 

Consequences of Breach of Licence

In the unfortunate event that obligations under the licence are not met, there may be financial penalties imposed, revocation of part of the licence or revocation of the entire licence. However, a grace period may be provided to address the non-compliance or an appeal procedure provided so as to appeal against the decision by the licensing authority.

In order to advise on the legal risk involved, the legal due diligence will have to map out the above in detail from the onset.

 

Change of Control

In many jurisdictions, where there is a change in the control of the entity holding the licence, prior approval from the licensing authority is required. This would be particularly relevant in the acquisition and even a listing in relation to a MOG project.

The licensing authority would primarily look into the qualifications of the transferee, the transfer terms and the transferor’s compliance with its obligations under the licence.

 

Contractual

The contractual aspect is more pertinent to the production sharing agreement (“PSA”), joint venture agreement and technical service agreement. This discussion is focused primarily on the PSA as it is a common structure for MOG projects in Asia.

 

Structure

The parties to a PSA can be differentiated based on their scope of obligations. In most cases, the entity that holds the licence is from the host country or a state-owned entity and the contractual obligation of the other parties are largely derived from the obligations under the licence.

The PSA is a structure which enables the parties to be responsible for different aspects of the MOG project and serves to document the agreement in respect of the bearing of the cost and expenses, the recouping the costs and expenses incurred and the allocation of profits.

 

Licence

In some PSAs, the entity which holds or is applying for the licences (“A”) is not the entity which prepares the application for the licences and subsequently operates the project (“B”). A’s obligations under the licence can be said to be sub-contracted to B. Therefore, this article’s discussion on Licensing, Reports and Land is applicable to B as well.

 

Management and Reporting Structure

Depending on the PSA, a management committee which includes personnel from A may have oversight over the key aspects of the MOG project, such as budgeting and the application process for the licence. The PSA may also designate a project management group which includes personnel from A and has oversight of the operations of the MOG project.

The above committee and groups usually have the right to report their findings directly to A.

 

Non-assignment and Novation

A non-assignment clause is often incorporated because the identities of the contracting party are essential to the PSA and parties are unlikely to want to work with a party not approved by them.

This issue is also applicable to A. We had encountered a transfer of the licence away from A pursuant to internal restructuring of A’s group but not the consequential novation of the ancillary contracts. This scenario should have been adequately addressed in the drafting of the ancillary contracts and therefore required additional remedial action.

 

Financing and cost-recovery

This covers the parties’ obligations to bear the cost and if the project is successful, how the cost is recovered and the allocation of profits. If the project is not successful, it deals with how the loss is borne between the parties.

In many PSAs, the cost is characterised into exploration cost, development cost and operation cost and the recovery of the cost is based on a proportion of the resources sold until all cost has been recovered. The recovery of the cost may include interest incurred on the cost as well.

There are many permutations and formulas used to determine each party’s contribution and recovery. The role of legal due diligence is to ensure that the client understands the legal risk involved.

 

Non-compliance and Termination

What amounts to non-compliance or termination, and the consequences of non-compliance or termination is essential to the assessment of risk in the legal due diligence process.

In most PSAs, non-compliance may not directly result in the termination of the entire PSA, but it could lead to consequences such as forfeiture of part of the resource available for extraction, bearing of additional cost and reduced profit sharing. Where the PSA is terminated, there may be reimbursement of cost and/or payment of liquidated damages.

 

Resource Reports

In both the exploration and development phase, an important task is to estimate the quantity and quality of the resources available for extraction. This is done by geological surveying and exploration and the technical information is aggregated into a resource report. The resource report has to be in accordance with the applicable standards, including both international and/or national standards. The standards which are commonly used internationally include:

  1. National Instrument 43-101 Standards of Disclosure for Minerals Projects (“NI43-101“);
  2. Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves (“JORC Code“);
  3. Pan European Reserves and Resources Reporting Committee Code for Reporting of Exploration Results, Mineral Resources and Mineral Reserves (“PERC Code“); and
  4. Code for Technical Assessment and Valuation of Mineral and Petroleum Assets and Securities for Independent Expert Reports (“VALMIN Code“), for valuation.

 

Other Reports

The following reports and studies are necessary for the application for the exploitation licence and would also contribute to the continuing obligations of the licence holder.

 

Mining Proposal and Feasibility Studies

The mining feasibility study is an evaluation of the proposed mining project to determine whether the resources can be mined economically and the mining proposal is the detailed plan for the engineering and construction of the project.

The details of the above are not usually within the scope of the legal due diligence, however, it has a significant impact on the timeline of the project and is necessary in the submission of the application to the relevant authority in order to obtain an exploitation licence.

The study and reports can also be used as a tool to satisfy certain pre-listing requirements in some stock exchanges and as an important marketing tool to attract potential investors and lenders.

 

Social Impact Report

The social impact report is intended to provide an accurate representation of current social conditions, identify the potential impacts of the project, develop mitigation measures to address the impact and to development management and monitoring measures to be implemented throughout the life of the project.

Based on the social impact report, there is an obligation on the licence holder to carry out the mitigation, management and monitoring measures set out therein.

The social impact report will cover industrial relations and related issues such as the labour unions, employment, training and retrenchment issues. Another important aspect is community relations, which cover issues such as resettlement, community development, health development and dispute resolution. In addition to compliance with the measures stipulated in the report, industrial and/or community unrest could negatively impact operations.

 

Environmental Impact Report

The environmental impact report is intended to provide an accurate representation of current environmental conditions, identify the potential impacts of the project, develop mitigation measures to address the impact and to development management and monitoring measures to be implemented.

Based on the environmental impact report, there is an obligation on the licence holder to carry out the mitigation, management and monitoring measures set out therein.

The environmental impact report will cover issues relating to the forest and waterways. We have encountered a situation where part of the resource concession overlapped with protected forest and waterways and this meant that a portion of the resource could not be extracted.

Another issue that will be covered is pollution. A MOG project may pollute the environment in the extraction process and is also likely to produce industrial waste that may harm the environment if not properly processed. In addition to the obligation to comply with the measures in the report, there may also an additional general obligation to comply with environmental laws, possibly governed by an authority separate from the mining authority.

 

Land

Licence Boundaries

The boundaries are fundamental to the licence and issues which arise have to be identified, addressed and if possible, resolved.

The boundaries require accurate mapping of the region and geographical coordinates. This may not be the case in developing countries and there may be conflicting information between the different agencies, which may render the boundaries unclear. There may also be overlapping boundaries with other neighbouring concessions, which may be due to record-keeping errors by the issuing authority or lack of accuracy of geographical co-ordinates.

 

Land Rights

In most jurisdictions, the lands rights can be categorised as ownership rights, possession rights and use rights. In order to operate a MOG project, the necessary land rights will have to be obtained from the relevant parties.

Many MOG projects are located on private land and the licence holder needs to negotiate and enter into agreements with the landholders to determine the conditions on which to use the land. This may include the resettlement of residents and compensation.

From a legal due diligence perspective, it is essential to review the documentation evidencing the obtaining of the necessary land use rights and ensure compliance with the conditions attached to these rights.

 

Land Restoration

Land restoration refers to the process of rehabilitating the land after the MOG project has been completed. In many jurisdictions, the relevant authority would require a land restoration deposit to ensure compliance with land restoration compliance. Any non-compliance would result in the deduction of the deposit.

Land restoration is a process which is managed throughout the life of a project and not only at the end. By way of illustration, the management and storage of soil material removed during the project are essential to the fulfilment of land restoration obligations at the end of the project.

 

General

Expropriation of Assets

In most jurisdictions, the government retains residual rights to revoke the licence and/or expropriate the asset due to national interest, national security or related considerations. This may be so even if the licence holder has complied with all related obligations. In some jurisdictions, the government may also have the right to participate in the MOG project, thereby sharing in the profits and obtaining a measure of control over the project.

The risk mentioned above may be mitigated by bilateral investment treaties entered into between the relevant countries. The bilateral investment treatises often provide protection to the foreign investors in the jurisdiction, which may include protection against the expropriation of assets unless authorised by law and if so authorised, for there to be suitable compensation. In the event of disputes in relation to these treatises, it is common for these to be referred to the International Centre for Settlement of Investment Disputes for adjudication.

 

Change of Laws

There is an entire range of laws and regulations involved in MOG projects and several governmental authorities are involved. It is not uncommon for there to be changes in laws and regulations, and there may even be conflicting laws and regulations.

It is essential that in the course of legal due diligence, such issues are taken into account, addressed and if possible, resolved.


Disclaimer: This update is provided to you for general information and should not be relied upon as legal advice.

 

CNPLaw’s Mergers and Acquisitions Lawyer

Stephen Soh Legal Parnter at CNPLaw LLP image

Partner

Stephen heads the firm’s technology, media and entertainment team and co-heads the corporate finance team. He has more than two decades of experience, acquired both in-house and in private practice.



Each M&A deal entails the confluence of multiple legal disciplines. That is why we take great care when assembling a team for each deal, ensuring that there is an optimal mix of specialisation in the clients’ identified areas of concern, such as taxemployment and intellectual property, and necessary industry-specific experience.

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