Introduction

Queensland’s coal seam gas (CSG) boom spurned a flurry of international takeovers in the last decade. The multi-billion dollar LNG export projects being developed near Gladstone by British Gas, Santos’s GLNG and Arrow Energy all began when global oil majors bought locally listed companies for their upstream gas reserves.

In many cases, the strategy of these international petroleum houses, which are some of the biggest companies globally, was to buy minority shares in the targets’ exploration tenements. This provided them with insight and information about the company’s performance, ‘social licence to operate’ and, importantly, compliance with local laws and regulations.

However, in the rush to secure finite gas reserves this long-term play was not always available and instead acquirers bought their target’s shares in ‘on-market’ takeovers. In these cases, if the target had no head company (to offer warranties and indemnities) the acquirer was exposed to any past non-compliances committed by the target which remained undiscovered at the time of the takeover. Essentially, these acquirers purchased a ‘black box’ of unquantified risk. 

The recent case of Connell v Santos NSW Pty Ltd [2014] NSWLEC 1 (Santos) illustrates what can go wrong when a global energy company - typically accustomed to operational and environmental best practices - acquires a local listing without the opportunity for full and proper due diligence.

This Alert will outline the facts of the case and recent amendments to the relevant law which have drastically increased penalties for companies that fail to comply with conditions of their petroleum title. Recommendations are then made regarding minimising risk and dealing with prior non-compliance. 

Key Points  

  • Large resources houses with sophisticated compliance systems should be ‘on notice’ when taking over small listed operators driven by financial performance.
  • The acquirer should conduct formal due diligence on the target’s operational compliance and obtain indemnities and warranties from any head company under sale documentation regarding past non-compliances.
  • Where this is not possible, the acquirer should complete a compliance audit immediately after the takeover to identify non-compliances.
  • Before taking action (eg reporting or remediating the incident), the seriousness of the non-compliance should be evaluated, and advice sought, to determine an appropriate strategy.

Connell v Santos

Overview of the case 

On 17 November 2011, at the height of the CSG boom, Santos Limited (Santos) purchased all of the shares in Eastern Star Gas (ESG), an explorer operating near Narrabri in New South Wales. As is often the case, the board was replaced with a new board of directors and the 50 employees of ESG began working for a new subsidiary, Santos NSW Pty Ltd (Santos NSW). 

On 10 January 2014, the New South Wales Land and Environment Court (Court) convicted and fined Santos NSW for failing, without reasonable excuse, to comply with the conditions of its exploration licence. Santos was convicted under section 136A(1) of the Petroleum (Onshore) Act 1991 (NSW) (Petroleum Act) which makes it an offence for a corporation (or person) not to comply with the conditions of a petroleum title. The case was the first time that a petroleum company has been prosecuted under section 136A(1) since the provision was inserted into the Petroleum Act in December 2000. 

Although the fines in the case were insubstantial, in 2013 section 136A was amended to drastically increase the penalties for such non-compliances (the new penalties were agreed not to apply in the case due to section 30 of theInterpretation Act 1987 (NSW)). The finding in the case, and these amendments, send a clear message to petroleum companies operating in NSW that breaches of their title conditions will not be tolerated.

The Facts 

ESG was granted an exploration licence (licence) and petroleum assessment lease (lease) by the Department of Primary Industries (Department), to drill for coal seam gas. 

Conditions of the grant of the titles required ESG to:

  • report to the Department any incidents causing or threatening material harm to the environment; and
  • lodge, periodically, an environment management report (EM Report) regarding compliance with a Petroleum Operations Plan (POP) (which set out specific requirements for ESG’s activities).
  • Drilling activities produced highly saline water, which ESG treated by reverse osmosis and discharged into a local waterway as permitted by the titles. However, on 25 June 2011 a seal on a pipeline in the water treatment system burst, causing a spill of 10,000 litres of untreated water which damaged nearby vegetation.

Despite several opportunities (including an invitation from the Department to explain tree die-back), ESG failed to disclose the spill. Following the 2011 takeover, Santos investigated the environmental and safety practices of ESG and discovered that ESG had failed to notify the Department of the 25 June 2011 spill, and other previous spills. The investigation also revealed that ESG had in the EM Report inaccurately specified the total dissolved solids level of water being discharged into the waterway. 

It was discovered that, on several occasions, levels exceeded the requirements of the POP. On 22 November 2012, Santos issued a report to the Department providing details of ESG’s failures and acknowledging its statutory reporting responsibilities. 

Charges

The prosecutor in the case brought four charges against Santos under section 136A(1) of the Petroleum Act. The first charge related to the 25 June 2011 spill. It was for Santos’s failure, without reasonable excuse, to comply with the condition to report any incidents causing or threatening material harm to the environment. 

The other three charges related to Santos’s failure, without reasonable excuse, to comply with the condition of a petroleum title, in that it lodged an EMR with the Director-General of the Department that did not accurately report against the POP. The three charges related to separate EMRs lodged in respect of different periods of ESG’s operations. 

Santos pleaded guilty to each of the four offences. 

Sentencing 

Preston CJ convicted Santos for each offence and sentenced the company to a fine of $52,500. The company was also ordered to pay the prosecutor’s costs, amounting to $110,000. 

The fine was comprised of:

an amount of $30,000 for the failure to report the 25 June spill, reduced (by 25 percent for the guilty plea and five percent for Santos’s assistance) to $21,000; and

three amounts of $15,000 for each inaccurate EMR lodgement, reduced (by 25 percent for the guilty plea and five percent for Santos’s assistance) to $10,500.

About Section 136A of the Petroleum Law 

Section 136A was introduced by the Mining and Petroleum Legislation Amendment Act 2000 which commenced on 22 December 2000. This version of the provision separated offences into two categories: environmental management offences (EMO); and, other offences. The maximum penalty for an EMO dealt with on indictment was $110,000 and for a case dealt with summarily was $22,000. For any other offence, the maximum penalty was $22,000.

The section was amended by the introduction of the Petroleum (Onshore) Amendment (Royalties and Penalties) Bill 2012 which commenced on 1 January 2013. As part of the amendments made, the applicable penalties now depend on whether an EMO has been committed by an individual or a corporation (as opposed to whether the action is brought on indictment). 

Under the amended provision, the maximum penalty available for an EMO is $1.1 million where committed by a corporation and $220,000 where committed by an individual. The maximum penalty for other offences was also increased to $220,000. A condition relates to environmental management where it is so designated by the title or by notice to the holder (section 136A(3)).

In addition to the above, the amendments introduced an inclusive (non-exhaustive) list of factors which the court is to take into consideration when dealing with an offence under this provision, specifically:

  • the extent of harm caused to the environment;
  • the practical measures that may be taken to mitigate and control the harm;
  • the extent to which the person who committed the offence could have foreseen the harm caused; and the extent to which the person who committed the offence had control over the events that gave rise to the offence.

Other remarks of Preston CJ

The ten-fold increases to penalties under section 136A(1) indicate the legislature’s intention that compliance with the section be taken seriously. Preston CJ picked up on this fact, stating:

“The failure of a petroleum title holder to comply with condition of its title, including a condition relating to protection of the environment, thus undermines and frustrates not only the purpose of the statutory scheme provided for by the Act, but also the terms on which the petroleum activities and operation were permitted to be carried out under the title issued by the Minister.”

Recommendations

To ‘plea’ or to ‘flee’, isn’t the right question 

Like Santos, acquiring companies that subsequently discover the mischiefs of their targets are confronted with a choice: make a ‘plea’ for forgiveness with the regulator, or ‘flee’ penalties by vacating or remediating the scene of the non-compliance. However, often this not the right question to ask; remedial action will be nuanced. The first task is to determine whether a breach of a title condition has actually occurred. Title conditions are specifically worded and not every mishap which occurs on site will necessarily result in a breach. 

For example, if a title condition states that the operator must not clear habitat vegetation designated by a map and a contractor accidently deposits dirt in this area, there may not be a breach. Where there is a breach, the next step is to gauge the seriousness of the breach. A degree of common-sense should be applied here. For example, if an operations plan requires discharge water to only contain total dissolved solids measuring 250 parts per million (ppm) and testing reveals 260 ppm, this ‘technical’ breach is unlikely to be something that the regulator wants to know about, let alone prosecute. 

On the other hand, if testing revealed 16,000 ppm, this would obviously be very serious and should be reported immediately. Where a material breach occurs, the temptation may be for the operator, even an acquirer, to try and mitigate or remedy the problem before reporting the breach. The rationale is that taking this action will demonstrate good faith and perhaps reduce the relevant penalty. 

However, most title conditions operate in conjunction with environmental laws which generally require immediate disclosure of any incident causing or threatening material harm to the environment. For example, in Queensland, theEnvironmental Protection Act 1994 (Qld) has a layered scheme for disclosure. Under section 320B an employee, after becoming aware of an event which causes or threatens material environmental harm, must notify their employer (or the administering authority where the employer is not available) within 24 hours of the event. Section 320D then places a duty on the employer to give the administering authority written notice within 24 hours of becoming aware of the event. 

In addition to this, the employer must then, as soon as practicable, give written notice to any occupier of affected land. Where these words are used, strict compliance with them is necessary. Failure to comply may mean that the original breach is aggravated. This was the case in the Santos matter, where ESG omitted to report the event immediately or as soon as practicable, or even when the Department enquired about related damage to local flora. 

Minimising an acquiring company’s risk 

As mentioned earlier, large companies with sophisticated compliance and reporting procedures are at risk when taking over smaller, often listed, companies who are driven more by financial performance. 

Where there is the opportunity, formal due diligence on the operational compliance of the target should always be undertaken to prevent costly liabilities arising later. If the target has a head company, this company should indemnify the acquirer against these risks arising and provide related warranties in the sale documentation.

Where no safeguards are possible before the acquisition, a compliance audit should be completed shortly afterwards and a report of notifiable incidents provided to the regulator with supporting evidence. As in the Santos case, this will increase the chance that applicable penalties are discounted during sentencing.

NSW Moratorium 

New South Wales and Queensland both currently have a permanent ban on the use of BTEX drilling activities. However, New South Wales also currently has a moratorium on:

  • hydraulic fracture stimulation; and
  • the renewal of petroleum exploration licences and the grant of new applications.

The NSW Division of Resources and Energy acknowledges that, as a result of the above, the petroleum industry within the State has seen a marked decline in exploration activity.