Pre-emption pitfalls during changes of control in a joint venture

Participants in joint ventures often seek to control who leaves and enters the joint venture via pre-emptive rights set out in the underlying joint venture agreement. A recent decision (Santos Offshore Pty Ltd v Apache Oil Australia Pty Ltd [2015] WASC 242) demonstrates that sophisticated parties can misinterpret the practical effect of these provisions - even when those provisions are based on equivalent clauses contained in the commonly used AIPN Model Form JOA.

Parties that have agreed to these, or similar, clauses will benefit from the court's guidance on how these clauses should be interpreted - particularly, what parties will need to do if those rights are exercised.

The pre-emption rights in the joint venture

In 2010, Santos, together with various subsidiaries of Apache Energy, entered into a joint operating agreement to exploit a petroleum production licence. The agreement contained pre-emptive rights which were triggered in the event of a transfer of a participant's interest in the joint venture, or a change of its control.

On a change of its control, a participant needed to issue a notice to each other participant setting out:

• the terms and conditions of the change of control event which were relevant to its participating interest; and
• if applicable, its determination of the cash value of its participating interest,

together with a copy of the agreements relating to its change of control. Each other participant would then have the right to acquire the participating interest for the cash value on the equivalent terms and conditions set out in that notice.

The change of control

The pre-emptive rights provision was triggered by the decision to sell Apache Energy to Viraciti Energy, which would result in a change of control for each of the Apache participants.

Each of the Apache participants issued separate, and almost identical, pre-emption notices to Santos, advising it of the proposed change of control and offering to sell their participating interests to Santos. Each notice:

• set out Apache's cash value for each participating interest;
• set out the terms and conditions of the Apache sale agreement, adjusted by Apache so as to reflect the same legal and commercial outcomes for Santos that Viraciti Energy would receive in relation to the participating interests. The notices also contained a number of conditions for the sale of the participating interests to Santos; and
• attached a heavily redacted copy of the Apache sale agreement. Apache claimed the Apache sale agreement contained a number of terms which were not relevant to the offer to sell the participating interests.

Santos argued that the notices were invalid and sought an order from the Court requiring the Apache participants to reissue valid pre-emption notices in accordance with the joint operating agreement.

Interpreting pre-emptive rights clauses

The WA Supreme Court recognised that, having regard to the purpose of pre-emptive rights clauses, there is "a need for caution in adopting a construction which would restrict their operation or which would permit their application to be avoided and this which would erode the benefit conferred by the grant of a right of pre-emption. For the same reason, pre-emptive rights clauses have been construed so as not to render it impossible for a joint venturer to satisfy the requirements of the offer".

In this context, were the notices issued by the Apache participants valid? No.

In coming to that conclusion, the Court dealt with two important questions:

What terms and conditions of the Apache sale agreement were "relevant to" a participating interest, and so needed to be disclosed in a participant's notice?

Only terms and conditions which "bear upon, or operate upon, or are otherwise closely connected or related to" the participating interest had to be disclosed. The Court considered that a wider view would lead to every term and condition in the Apache sale agreement being "relevant to" a participating interest, which was not the intention of the clause.

What does it mean that the other participants have the right to acquire the participating interest for a cash value on the "equivalent terms and conditions" set out in the notice?

The Court held that this is a reference to the terms and conditions that have a bearing on the cash value for the participating interest. This is to ensure that any non-cash consideration contained in a change of control agreement for that participating interest is offered to each other participant on an equivalent cash basis. This did not permit the Apache participants to modify the content or operation of the terms and conditions of the Apache sale agreement, or those terms and conditions relevant to the participating interest, so that Santos would be offered "equivalent" legal and commercial outcomes for Santos as received by Viraciti Energy under the Apache sale agreement.

Practical implications for joint venture participants

The Apache participants have lodged a notice of appeal against this decision, so this might not be the final word on the matter. Until then, joint venture participants issuing notices under pre-emptive rights clauses, or considering whether the pre-emptive rights process more generally has been legitimately followed, should remember that courts will take a purposive approach when interpreting those clauses.

Given the pre-emptive rights provisions in this case mirror those contained in the AIPN Model Form JOA, parties to those, or similar, forms of joint operating agreements should be aware of:

• the extent to which terms and conditions in an agreement relating to a change of control are "relevant to" a participating interest. Essentially, not every term and condition in a change of control agreement is relevant. Parties will need to exercise careful judgment in ensuring that terms and conditions which are closely connected to the participating interest are appropriately disclosed; and
• what "equivalent terms and conditions" for a cash value need to be included in a participant's notice. Practically speaking, these are only the terms that will result in an equivalent cash price for the participating interest being offered to each other participant.