The recent downturn in oil prices has generated asset acquisition opportunities as producers re-evaluate their core assets and sell assets to address struggling balance sheets or to repay existing debts. In times such as these, purchasers should remember the old adage caveat emptor (let the buyer beware).
Purchasers will want to ensure that all sale transfers will be approved by the regulatory authorities so that they can rightly operate the assets they seek to acquire. The Alberta Energy Regulator (AER), in its administration of the Licensee Liability Rating Program (LLR Program), will not approve a licence transfer if either the transferee’s or transferor’s Liability Management Rating (LMR Rating) would be less than 1.0 immediately after the transfer is registered. The AER does not provide advance approval to a proposed transfer – it simply either approves or rejects the transfer of a licence when the transfer application is made. Such transfer applications are almost always made after the transaction officially closes.
The LLR Program seeks to prevent the costs of abandonment, reclamation and remediation of conventional oil and gas wells, facilities, pipelines and similar assets (ARR costs) from falling on the public coffers or the industry-funded Orphan Fund if the licensees holding such assets become insolvent or defunct. Under the LLR Program, the AER evaluates whether the deemed liabilities in respect of the ARR costs of the conventional oil and gas wells, facilities, pipelines and similar assets for which it is the licence holder exceed the deemed value of such assets. For the determination of the deemed assets value, the AER takes into account the reported cash flow derived from producing wells, while the deemed liabilities are based on the sum of costs to suspend, abandon, remediate and reclaim the licensee’s wells and facilities. When a licensee’s deemed liabilities exceed its deemed assets, its LMR Rating falls below 1.0 and the licensee is required to put up cash or a letter of credit security deposit in the amount of the deficiency in order to achieve a “securityadjusted” LMR Rating of 1.0 or greater. This security is designed to ensure that a licensee can sufficiently reclaim the licensed lands or facilities at the end of the project life.
In times such as these, a seller may propose to dispose of high-value assets, leaving it with licensed assets whose deemed liabilities exceed their deemed asset value, such that the seller’s LMR Rating will fall below 1.0 after the sale. When the seller attempts to transfer the licences for the sold assets to the purchaser (generally within a few days following closing), it will find that, as a result of the seller’s new LMR Rating, the AER rejects the transfer and the purchaser is left having paid for assets with no licence to operate. A purchaser can protect itself from such circumstances in a sale involving a licence transfer with carefully drafted representations in the purchase and sale agreement, escrowed payments and careful due diligence.
It is even more dangerous for the seller if the purchaser’s LMR Rating is less than 1.0 after the sale because, in that event, the seller will no longer own the assets but will continue to be the licensee and therefore will retain the liability for the ARR costs associated with the licensed assets if the purchaser is incapable of paying them.
Asset purchase and sale agreements typically include a representation and warranty by each of the purchaser and the seller that it meets all qualification requirements under applicable laws to transfer the assets, including that its security-adjusted LMR Rating is greater than or equal to 1.0 and will continue to be greater than 1.0 when the transfers of the licences of the assets are registered with the AER. Whether or not a purchaser provides such a representation, it will want to ensure that the seller provides this representation and warranty regarding its LMR Rating remaining at or above 1.0 before and after the completion of the transaction. However, even if this representation is obtained from a seller, if the seller breaches it and the licence transfer is not approved by the AER, the purchaser may be left in the unfortunate situation of trying to pursue remedies against an impecunious seller.
The AER’s Directive 006 specifies that it will not accept a security deposit provided by one licensee to satisfy the security deposit requirements of another licensee, therefore, a purchaser cannot pay a security deposit to the AER on behalf of a seller. To ensure that a licence transfer is approved by the AER, it is possible that a purchaser could loan the security deposit amount to the seller or account for it in the purchase price, however, this is ill-advised where the solvency of the seller is in question. Such amount becomes an unsecured debt post-closing and the purchaser may find itself having paid more than it bargained for.
A more optimal situation for a purchaser where such concerns about the seller exist is to find a way to withhold payment for the assets until the applicable licence transfers are approved. However, since a seller is very unlikely to initiate an irrevocable transfer application before it receives payment of the purchase price, the best solution may be to provide for payment of the purchase price into escrow, with its release upon the licence transfers being approved by the AER. An escrow arrangement may increase the transaction cost of the purchase and sale, as it would involve the negotiation of an escrow agreement and the appointment of a neutral escrow agent to hold the purchase price, however, an escrow arrangement provides the most certainty to the purchaser that it will actually receive the licences for which it has paid.
If the seller has concerns about the purchaser’s LMR Rating, then it may be necessary for the whole transaction to be closed in escrow, with closing (and therefore transfer of ownership) not occurring unless and until registration of the licence transfers is completed.
If an escrow is contemplated, it should be noted that currently completion of registration of licence transfers takes approximately two business days after the application is filed and any deficiencies are resolved and security deposits paid.
In addition to the above purchaser protection mechanisms, the LLR Program’s ultimate control of the licence transfer process underscores the importance of conducting a sound due diligence review of the seller’s assets and liabilities while ensuring that the sale agreement contemplates the necessary protections that reflect the current economic climate in the oil and gas industry.