ABOUT THE GUIDE
- This is series 3 of McCullough Robertson’s six part Energy and Resources M&A Transaction Guide developed for the resources sector.
ABOUT THIS ARTICLE
- We look at how transactional security interests interact and how they should be managed as a part of an M&A transaction as well as how to avoid the surprise of acquiring an asset that is the subject of a security interest for which you will be liable.
- We’ll wrap up the series with a Masterclass where you can ask our expert panel any questions related to undertaking a transaction. To register for the Brisbane (27 September), Sydney (6 October) or Melbourne (11 October) breakfast events please please click the registration link on the side of the page or click here.
In our previous article we considered the usefulness of royalties as a form of purchase price consideration. Where this occurs, it is standard industry practice for the royalty holder to secure their interests in the royalty over the mining tenement to which the royalty relates. This article looks at how transactional security interests like the royalty security, joint venture cross securities and general financier securities interact and how they should be managed as a part of an M&A transaction as well as examining how to avoid the surprise of acquiring an asset which is the subject of a security interest for which you will be liable.
Security interests and priority
In a modern day M&A transaction, a buyer will be required to navigate a wide range of security interests to ensure they acquire clear title to the asset being acquired. In the energy and resources sector, the landscape of securities will often include joint venture cross securities, general security agreements, specific security agreements (over specified goods or shares), real property mortgages, tenement mortgages and caveats. Some or all of these security interests can be held in favour of the joint venture participants, the seller’s financier(s), a royalty holder, equity investors and a wide range of contracting parties. Some security interests secure financial obligations (like the obligation to repay a loan) while other security interests secure the performance of obligations (like the obligations under a joint venture agreement).
For the acquisitions of an interest in an unincorporated joint venture (a common ownership structure in resources projects), the generally accepted starting position is that the joint venture cross security will rank in priority to any security for finance or security for other obligations. However, this position is not necessarily absolute and can be the subject of negotiation, particularly given the increasing popularity of royalties as a form of purchase price consideration.
A Buyer will be the conduit for negotiations between secured parties where competing priorities are at play, for example, in a situation where the purchase price is funded by a financier, a joint venture cross security is in existence and a royalty is to be granted to the seller as part of the consideration for the transaction.
In negotiating security and priority arrangements in the context of an M&A transaction, it is important to consider the following matters:
- a financier, royalty holder, or other secured party (other than a joint venture participant) should agree to be bound by the pre-emptive provisions in the joint venture agreement when exercising any rights it has in enforcing its security in relation to joint venture assets
- it is important to ensure sufficient carve outs are included in the security documents and priority arrangements to enable the buyer to deal with its assets in the ordinary course of business. For example, it is not practical for a buyer to have to seek a secured party’s consent each time it needs to acquire low value assets
- a financier or other secured party might request a buyer to seek their consent before altering any material contract. This type of arrangement can be time consuming and costly for a buyer. To the extent that a financier will not concede this point, a buyer should attempt to limit this condition by negotiating appropriate materiality thresholds
- cross-default provisions are likely to exist where multiple secured parties are involved. It is important to ensure adequate remedy periods and materiality thresholds are provided for in the security document and priority arrangements to prevent default being triggered across all documents for minor defaults
- a financier will want to ensure that they have the right to step into the shoes of the buyer in respect of material contracts should the buyer default. It is standard to expect the financier to seek that the counterparties to such material contracts enter into tripartite agreements which will cement the arrangements between the parties if such default occurs. Negotiations of tripartite agreements may take some time and sufficient allowance should be made for this in your transaction time line
- while not always possible, remedy periods should be negotiated to allow time for a financier or other secured party with step in rights to step in and remedy previous defaults before a power of sale is able to be enforced
- a liquidator has certain rights to disclaim onerous or unprofitable contracts in the event of a company’s insolvency. A royalty agreement by its very nature is at risk of being disclaimed by a liquidator should the royalty payer become insolvent. A royalty holder can attempt to mitigate this risk, at least in a practical sense, by seeking to secure their interests in the royalty agreement over, for example, the tenement relevant to that royalty, and
- a security interest will ultimately only have affect if and to the extent there is money owing to the secured party and rights of enforcement are triggered by an event of default. A default can be a non-performance of an obligation, but the enforcement of the security interest in that case will be limited to the extent there is money owing under that security. That money owing could include, for example, amounts payable to cover loss or damage resulting from the non-performance. A security interest which secures the performance of non-financial obligations should therefore clearly state that it also secures the financial consequences of any failure to comply with those obligations.
Avoid unwittingly inheriting creditor restrictions
Where a buyer does not obtain clear title to the acquired asset, that asset will remain subject to the pre-existing security interest following completion of the transaction. In that situation the secured party could potentially lay claim to the newly acquired asset where there is a default under the pre-existing security interest (which will most likely be triggered where the seller transfers or sells key assets). This substantial risk is the reason why buyers should undertake thorough due diligence.
Information regarding securities encumbering the asset the subject of an M&A deal should be disclosed by the seller at the outset. However, it is good practice for any due diligence process to incorporate adequate searches to ensure that all security interests affecting the asset are known. This is particularly important in the context of the Personal Property Securities Register (PPSR) where security interests may be registered without the explicit knowledge of the seller.
For energy and resources assets, searches should also be undertaken of the relevant state government department tasked with administering mining tenements (Tenement Register). This can be a confusing system of registrations, resulting in headaches when trying to arrange releases or accommodate the security holders in a transaction.
Set out below are some of the matters to be aware of when conducting searches on the PPSR or Tenement Register as part of due diligence:
- PPSR searches need to be run against the ACN, ABN and the company name of the seller to capture any registrations that may have been incorrectly recorded against just one of these identifiers. Where possible, searches should also be run against the particular assets being acquired (e.g. dozers and some vehicles with specified serial numbers such as VINs)
- when acquiring an interest in a joint venture, searches of the manager of the joint venture should also be conducted. Since the introduction of the Personal Property Securities Act 2009 (Cth), security interests have also commonly been registered over the manager of a joint venture where that manager holds assets of that joint venture
- allow adequate time for search results to be returned from the Tenement Register, and
- ensure that the due diligence process, including searches of the PPSR and Tenement Register, continues right up until the completion day to ensure you are on top of any last minute security interests.
As with all information disclosed in a due diligence process, the details of any securities should feed into the negotiation of the sale document. If you have opted to undergo a lighter due diligence process, address any undisclosed securities in the sale warranties. While not an alternative to due diligence, adequate warranties (e.g. that assets are delivered clear of encumbrances) are imperative even though they are often limited in time and quantum so do not offer absolute protection.
Environmental and compliance bonds
The buyer of a mining tenement will be required to replace any existing financial security held by the state government to prevent or minimise environmental harm or rehabilitate or restore the environment, should the tenement holder fail to meet their environmental obligations.
The timing of this process can cause some issues in M&A transactions as the government department will not release the existing security until the new financial assurance has been provided and the tenement transfer is approved. This means that the tenement transfer has been stamped (which can be a lengthy process itself) and the buyer has satisfied the financial, technical and environmental requirements of the government department. Buyers should also be aware that the transfer of a tenement may trigger a review of the financial security amount, so although you can accommodate for the current amount of financial security, there is no guarantee this won’t change following completion.