1 Overview of M&A transactions

1.1 Emergence of local champions

2015 was a relatively robust year for M&A transactions in Nigeria's oil and gas industry. The majority of the transactions involved divestments by international oil companies (IOCs) of onshore oil and gas assets to Nigerian oil and gas companies, some of which (such as Seplat, Lekoil, Seven Energy and Oando) have emerged as "local champions" at the forefront of the onshore aspects of the upstream oil and gas industry.

The surge in M&A activity has been driven in part by funding from the domestic debt market and a favourable regulatory disposition in furtherance of the Nigerian government's (Government) policy objective of increasing Nigerian companies' participation in the oil and gas sector and developing their technical and operational capacity. The Government's objective has been achieved in part through (a) the enactment of the Nigerian Oil and Gas Industry Content Development Act 2010 (the Local Content Act) and (b) the marginal field licensing regime, under which Nigerian oil and gas companies bid for the rights to develop underutilised oil and gas fields licensed to IOCs by entering into a farm-out agreement with the relevant oil mining leaseholder.

1.2 IOCs' divestment programme

The majority of IOCs operating in Nigeria (including Royal Dutch Shell, Total, Eni and Chevron) have divested some of their onshore assets, partly in response to the regulatory developments referred to above, and as a result of a confluence of additional factors, which include: (a) the slump in global oil prices which has prompted divestment of non-core assets in order to unlock capital to fund strategic projects; (b) economic incentives of developing frontier projects (such as deep water exploration plays); and (c) desire to reduce risk exposure associated with onshore oil and gas operations (including legal and reputational risks associated with environmental disputes, economic losses resulting from oil theft, and increased costs of securing oil and gas infrastructure and personnel).

We have set out, from an English law perspective, an overview of key considerations for oil and gas industry participants, financiers and investors to bear in mind when structuring corporate and financing transactions in Nigeria's oil and gas sector.

2 Acquisition of onshore oil and gas assets

2.1 Acquisition structures and transaction process

The majority of M&A transactions have been structured as a sale of participating interests in oil and gas licences or associated infrastructure. A sale of shares in companies that own oil and gas assets is an alternative structure that has been used on previous transactions. The transaction process, whilst largely deal-specific and seller-driven, has typically been structured as an auction process in order for sellers to control the transaction documents and timetable and to capitalise on the competitive pressure on bidders in order to obtain the best price and sale terms.

Commercial and legal considerations will ultimately determine the acquisition structure. For example, sellers may prefer a share sale in order to effect a "clean break" from the target company by transferring the target company's obligations and liabilities (including environmental, tax and decommissioning liabilities) to the buyer. Buyers, on the other hand, may prefer an asset sale in order to: (a) acquire a pre-agreed class of assets, which lends itself to a more streamlined due diligence process; and (b) structure around "financial assistance" restrictions that may otherwise prevent the target company from granting security over its assets in furtherance of raising acquisition finance.

2.2 Due diligence process

Purchasers of oil and gas assets and their financiers will need to conduct an extensive due diligence process to fully understand the target asset's obligations, liabilities, production history and projections. Lenders will also need to complete "know your customer" checks on borrowers, beneficial owners and affiliated entities in order to ensure that they are not lending to sanctioned entities, politically exposed persons or in furtherance of money laundering activities.

2.3 Nature of acquisition vehicle

Acquisitions have been made directly by Nigerian oil companies or through bid consortia, which help members spread risks and costs of the acquisition whilst maximising their respective synergies.

Bid consortia typically include a combination of any of the following classes of companies: (a) indigenous companies that have significant local industry knowledge and/or relationships - if such companies have the requisite level of legal and beneficial ownership of the acquisition vehicle, the acquisition vehicle may be eligible to benefit from the preferred status offered to "Nigerian companies" under the Local Content Act; (b) international independent oil and gas companies with technical expertise and operational resources; or (c) international commodity traders that may provide a pre-agreed crude offtake solution or credit enhancement to the acquisition vehicle (for example, through a limited form of recourse to its balance sheet).

Where a bid consortium structure is adopted, it would be prudent for the members of the consortium to negotiate and document the allocation of risks, rights and obligations, disclosure requirements and management of potentially divergent interests in a shareholders' agreement and other agreements.

2.4 Ministerial Consent to the transfer of oil and gas assets

Nigerian law requires holders of oil and gas licences to obtain prior consent from the Minister of Petroleum Resources (Ministerial Consent) before transferring such rights or interests to a third party. Recent case law (Moni-Pulo Limited v. Brass Exploration Unlimited) and regulatory guidance have indicated that Ministerial Consent will be required for direct transfers of interests in oil and gas assets or sale of shares in an asset holding company or an offshore intermediary company.

This requirement for Ministerial Consent gives rise to a number of issues on M&A transactions, which include: (a) delays to the transaction timetable as there is no stipulated timeline within which Ministerial Consent will be obtained; and (b) increased transaction cost resulting from the payment of a consent fee, which is calculated as a percentage of the value of the transaction.

It would therefore be prudent for parties to an M&A transaction to: (a) make conservative assumptions on the requirements, process and timeline for obtaining Ministerial Consent when developing a transaction timetable; (b) engage with the Minister of Petroleum Resources and go through the process of obtaining Ministerial Consent as a condition precedent to completing the transaction; or (c) pre-agree the process, consequences, scope and duration of extensions to "longstop dates" for the completion of the transaction due to delays in obtaining Ministerial Consent. 

3 Transfer of operatorship under a JOA

A commercial issue that will need to be considered where an operator under a joint operating agreement (JOA) is seeking to transfer its interest to a third party is the determination of the party that will assume the role of operator of joint operations under the JOA.

An operator's transfer of its participating interest will be subject to the provisions on transfer of operatorship under the JOA, which typically provides that an operator's transfer of its interest to a third party will not result in an automatic transfer of the role of operator to the incoming transferee. 

4 Financing the acquisition and operation of oil and gas assets

4.1 Multi-sourced debt financing solutions

4.1.1 Dominance of Nigerian banks

Nigerian banks have led the funding to Nigerian companies for their acquisition of assets divested by the IOCs. The Central Bank of Nigeria's (CBN) recent reforms (through increasing the capitalisation requirement of all Nigerian banks) triggered a wave of consolidation in the banking sector, which has led to the emergence of stronger banks with a larger balance sheet to fund significant transactions (including in the telecoms, power and oil and gas sectors).

In order to prevent over-exposure to the oil and gas sector, the CBN has imposed a restriction on Nigerian banks to limit funding to the oil and gas sector to 20 per cent of their loan portfolio. This regulatory requirement is likely to constrain capacity of the domestic debt market to maintain recent levels of funding to the oil and gas sector and require additional sources of liquidity.

4.1.2 Limited role of international financial institutions

A combination of the increased capacity of the domestic debt market, slump in oil prices, and conservatism towards the perceived high-risk profile of the Nigerian oil and gas industry appear to have reduced the appetite of international financial institutions to fund oil and gas transactions in Nigeria. Some of this funding gap has, however, been plugged by certain development financial institutions (DFIs) (such as the Africa Finance Corporation and African Export-Import Bank) that have provided funding by co-lending with Nigerian banks. Issues to consider where commercial banks co-lend alongside DFIs include the compliance with DFI benchmarks for determining, assessing and managing social and environmental risk related to oil and gas operations.

4.1.3 Increasing role of commodity traders

It has become commonplace for certain commodity traders to fund oil and gas transactions by co-lending alongside commercial banks. This practice has developed in response to (a) borrowers' funding requirements exceeding the capacity of the domestic debt market; (b) commodity traders' interests in locking-in suitable crude offtake arrangements (similar in part to prepayment structures); and (c) lenders' favourable disposition to a funding and crude offtake arrangement in light of the recognition that this arrangement provides additional liquidity to the lending syndicate, a guaranteed source of revenue for the borrower to meet its debt service requirements and an in-built hedge against oil price volatility. 

Intercreditor issues to consider on such funding structures include whether the commodity trader: (a) has a blocking or majority vote vis-à-vis commercial lenders; (b) has any potential conflicts of interest (for example, in relation to its crude offtake arrangements); and (c) should be precluded from voting or have a higher disclosure obligation on matters relating to potential conflicts of interest.

4.2 Financing structures

In order to mitigate the financiers' credit risk and to ensure that financing is in place to complete the M&A transaction, sponsors and lenders may agree on a synchronised funds flow structure, which typically requires payment of equity, followed by disbursement of onshore debt and offshore debt respectively into an escrow account. The escrow account will typically be controlled by an escrow agent and the sale proceeds will be released to the seller upon pre-agreed escrow release conditions.

In order to regulate the foreign exchange market in Nigeria, the CBN has passed regulations requiring Nigerian crude oil exporters to repatriate their export proceeds into a Nigerian domiciliary account within 90 days. The CBN permits withdrawals from these domiciliary accounts for specified purposes (including debt service) and requires its prior approval for other types of withdrawals. Lenders will need to consider these CBN regulatory requirements in detail when assessing repatriation risks in Nigeria and developing project account structures.

4.3 Taking and perfecting security

4.3.1 Ministerial Consent

The creation of security over oil and gas interests (depending on the nature of the security interest) and lenders' exercise of their right of sale in a security enforcement scenario will likely require Ministerial Consent.

4.3.2 Payment of registration fees and stamp duty

Nigerian law requires: (a) security documents to have been stamped in order for these documents to be admissible in a Nigerian court; and (b) security interests created over Nigerian assets to be registered at the companies registry in order to put third parties on notice of the lender's existing security interest in those assets.

Stamp duty and registration fees apply on an ad valorem basis and consequently at a high cost to borrowers. To reduce the high security perfection costs, a practice of "upstamping" has been developed on large financings in the oil and gas sector.

4.3.3 Upstamping practice and risks

Upstamping occurs where a borrower pays stamp duty for a fraction of the secured loan amount and will be required to pay the outstanding amount at a later stage upon pre-agreed events. Lenders involved in upstamping arrangements clearly face several risks, which include: (a) the borrower's upstamping performance risk; (b) security priority risks resulting in a third party perfecting its competing security interest over the borrower's asset prior to the completion of the upstamping; and (c) insolvency moratorium risk resulting from Nigerian law prohibition on companies perfecting security interest during winding-up proceedings.

To mitigate the borrower's upstamping performance risk, lenders may insist on the borrower: (a) paying moneys required for the upstamping into a secured escrow account; or (b) transferring into a "stamp duty reserve account" moneys up to the minimum required balance for the upstamping in accordance with a pre-agreed cash flow waterfall. To mitigate security priority risk, lenders typically include a negative pledge clause in the finance documents preventing the borrower from granting competing security to a third party. There is however a residual legal risk that the borrower may breach the negative pledge provision and the lenders' contractual remedy will be insufficient from a commercial perspective. In developing the upstamping market practice, lenders have had to assess and get comfortable with the reality that some of the risks associated with upstamping can be mitigated better than others, but none of them can be completely avoided.

5 Slump in global oil prices and debt facility restructurings

The majority of facilities provided to Nigerian companies for the acquisition of IOCs' divestments were structured as reserve-based loans (RBL), under which the borrower's debt level is calculated based on a formula linked to the value of total reserves and oil price projections. Given the current slump in oil prices, most of the oil price assumptions included in the borrowing base facilities no longer reflect current and realistic oil price projections.

The effect of a sustained slump in oil prices is that, upon a redetermination of borrowing bases, some borrowers may be required to: (a) make mandatory repayments to bring their "borrowing base amount" in line with their adjusted "borrowing base"; or (b) designate new assets into their borrowing base in order to maintain their current debt profile. In addition, a default under an RBL is likely to trigger cross-defaults under borrowers' other financing arrangements, thereby exacerbating the risk of a draw-stops, accelerations or security enforcement scenarios.

Debt facility restructurings in the Nigerian market have included an extension of the debt maturity date of loans and an increase in the interest rate. It would be prudent for lenders to consider the impact of an extension to the tenor of loan facilities vis-à-vis the expiration of their borrowers' oil and gas licences in order to avoid or mitigate licence renewal risks or related regulatory risks. Borrowers may also need to adjust to increased scrutiny from lenders (for example, to ensure that "equity cure" rights are not used by borrowers to roll-on underperforming loans), and more frequent testing of financial covenants (particularly, loan life coverage ratio and debt service coverage ratio).

6 2016 and beyond

It appears that, in a sustained lower oil price environment, lenders and borrowers will continue to batten down the hatches. In the mid-term, lenders are likely to be preoccupied with the restructuring and monitoring of existing debt facilities. To the extent that they are prepared to provide new loans to oil and gas participants, there is likely to be heightened focus on the creditworthiness of borrowers, scrutiny into the bankability of deals, reduction in the size of debt facilities, increases in the cost of funds, requirement for a higher equity to debt ratio, and pressing for enhanced contractual protection in order to mitigate the increased risks of funding oil and gas transactions.

Oil and gas players are likely to focus on (a) reducing their capital expenditure in order to optimise their balance sheets and (b) preserving their assets by meeting debt service obligations as and when due. Borrowers in serious financial distress may be required to develop formal restructuring plans, which may include injection of new equity, additional debt funding, disposal of non-core assets or divestment from non-strategic sectors of the value chain (for example, reversing an integrated business model). Such divestments could present opportunistic M&A transactions for stronger industry participants. Requirements for additional equity could lead to increased participation of private equity funds in Nigeria's oil and gas sector. The need for additional debt is likely to require existing lenders' consent to the expansion of the scope of "permitted financial indebtedness", alteration of the security package and reordering of the respective creditors' security ranking and priority.

The new Government's proposed reform of the oil and gas sector (particularly in relation to the restructuring of the national oil company, reducing bureaucracy and developing greater transparency), if successfully implemented, is likely to significantly increase the availability of investment and transaction opportunities. It remains to be seen whether the Government's proposed amendments to the fiscal regime in the oil and gas sector, through the passing of the Petroleum Industry Bill, will strike the delicate balance of increasing the Government's take from oil and gas operations whilst providing IOCs and indigenous companies with sufficient economic incentives to attract a wave of much-needed new investments into the oil and gas sector.