THE SECOND DRAFT OF THE 2017 CAPL PROPERTY    TRANSFER    PROCEDURE (“PTP”) WAS MADE AVAILABLE TO INDUSTRY IN LATE JANUARY THROUGH A WEB ENABLED DISTRIBUTION. The  package  on  the  CAPL  web  page  includes:  (I)  an  overview  of  the project scope and the major changes relative to the 2000 PTP; (ii) a detailed matrix that outlines all  material  changes  relative  to  the  2000  PTP  and  their  rationale;  (iii)  a  clean  copy  of  the  text  and  annotations;  (iv)  a  34  page  coded  comment  matrix   that   presents   the   detailed   verbatim comments we received from a modest number of commenting parties, together with our responses to  each  individual  comment;  (v)  a  redline  of  the  second draft relative to the initial July, 2016 draft; (vi)  Word  versions  of  the  election  sheet  and  the  case  studies  included  as  Addendums  to  the  PTP  to  facilitate  early  use  of  the  PTP  for  anyone  that  wishes to use the draft in a new transaction; and (vii)  a  redline  of  the  second  draft  relative  to  the  2000 PTP. While we do not expect that the redline to the 2000 PTP will be reviewed in any detail, we believe that even a cursory glance at that document will demonstrate convincingly the thought and effort that has been invested in the 2017 document over the last year by our 15-member committee.
This month’s article offers additional context about the PTP by reviewing Clause 6.01 and Paragraphs 6.02(a)-(t). Next month’s article will address the remainder of Article 6.00.

Context for Representations and Warranties Article

The representations and warranties provision has historically been one of the most heavily negotiated provisions of a Purchase and Sale Agreement with respect to both the types of representations that are to be included and their wording.
The Vendor generally wishes to provide the most limited representations and warranties as are acceptable to a Purchaser. It wishes to sell the Assets on an “as is” basis, and wants the future risks associated with the property to be assumed by the Purchaser. The inclusion of broad representations and warranties is inconsistent with the Vendor’s objective of reducing G&A costs by exiting an area.  The potential liability resulting from their breach means that the Vendor is not entirely free of responsibility for the property.
The Purchaser, on the other hand, generally wishes to include the broadest representations and warranties that it can negotiate.  Many of these will pertain to factual matters about either the Vendor or the Assets that the Purchaser is otherwise unable to confirm conveniently.  That being the case, it may be reluctant to proceed with an acquisition if it believes its requests for broader representations and warranties are being unreasonably refused by a Vendor.
One must place a Party’s optimization of its legal position in a larger context, though.  The objective is to sell/purchase a property in the manner that will maximize the degree to which the benefits associated with the transaction exceed the applicable costs and risks.  If differences on this issue are such that the transaction is not completed, the pursuit of one goal has frustrated the objective.
The Agreement is ultimately one part of the product that a Vendor may be attempting to sell in a very competitive market-place.  Personnel must always remember that the form of the document could have a material impact on the assessment of the attractiveness of the product to potential Purchasers.  Reps and warranties that indicate that the Vendor has reasonable confidence in its product should help it in its attempt to obtain the greatest value for its properties.  This is particularly so if it has done an internal review of the property and its continued financial viability is not in doubt.  However, a Vendor must weigh the associated potential risks and benefits for each broader rep and warranty.
The menu of representations and warranties in Clauses 6.01, 6.02 and 6.04 is designed to focus negotiations on the appropriateness of the inclusion of a representation in the Agreement, while significantly reducing the degree to which the choice of wording is debated.
It is also important for users to remember that the remedy available for a breach of a representation or warranty after Closing is in damages.  The representations and warranties are analogous to an indemnification obligation, as their enforceability ultimately depends upon the financial viability of the Party making the representation. If there is a concern about a Vendor’s financial viability, for example, a Purchaser should not rely unduly upon the representations.

Clause 6.01 – Mutual Representations and Warranties

These are reciprocal representations and warranties that pertain to the personality of the Parties.  Including them in a single Clause avoids duplication.
These  representations  relate  to:  (a)  the  standing  of  the  Party  as  a  subsisting  entity;  (b)  the  authority  of  the  Party  to  execute  the  applicable  documents;  (c)  the  execution  and  delivery  of  the  Agreement and completion of the transaction not being in conflict with the governing documents of the Party, the Regulations, court orders,  etc.;  (d)  the  enforceability  of  the  Agreement,  subject  to  certain  qualifications  respecting  bankruptcy,  insolvency,  etc.;  (e)  the other Party not being subject to any finder’s fees; and (f) there being no plan to cease to remain in existence.

Clause 6.02 – Vendor’s Representations and Warranties

General:  The representations and warranties of the Vendor in Clause 6.02 will be a matter of negotiation between the Parties.  This reflects the wide variance in transaction circumstances (i.e., operated property, non-operated property to another owner or operator, non-operated property to a third party, high or low value, ORR holder and corporate philosophies).  Many of these issues pertain more to whether a specific representation should be included at all, rather than its wording.  As was the case with the 2000 PTP, each representation in this Clause has been presented as an option, so that it only applies if selected, even though some of them will be used in the clear majority of transactions.
The menu of potential representations and warranties is designed to provide Parties with greater flexibility for their Transaction, as   shown   on   the   Schedule   of   Elections   and   Modifications included as Addendum I to the PTP.  An election not to include an optional representation is not intended to place either Party in any different position with respect to the subject matter of the representation than is the case for any item that is not included in the menu of representations in this Clause.

Residency for Tax Purposes (6.02(a)): This representation is admittedly structured awkwardly. Unfortunately, it cannot be rewritten to state simply that the Party is a resident of Canada. As a Party can be a resident of more than one country, the Vendor represents that it is not a non-resident.  It is included primarily to provide the Purchaser with a justification for not applying a withholding tax with respect to the amount paid to the Vendor.

Lawsuits and Claims (6.02(b)):  The Purchaser has an expectation that there are no judgments or claims respecting the Vendor’s interest in the Assets, with a requirement to identify any exceptions in a Schedule.  The Parties should clearly address their expectations about any existing lawsuit or claim in the Head Agreement to minimize the possibility of subsequent dispute.
This rep is somewhat broader than the rep that Vendors often prefer to use because of the reference to circumstances that the Vendor reasonably believes would give rise to a claim.  The first portion of the rep that is typically used assumes that a third party is aware of the problem and is pursuing the exercise of legal rights.  The latter reference would apply if the Vendor is aware of the problem, but is not aware of any intention of a third party to pursue a legal remedy.

No Default Notices (6.02(c)): This rep pertains not only to defaults, but notices alleging defaults, and any exceptions are to be identified on a Schedule. The disclosure requirement alerts a Vendor to the need to review the issue.

Compliance with Title and Operating Documents (6.02(d)):  Provisions such as this Paragraph are often drafted so that the reference to “default” is modified by adding a reference to “material”.  Although a default that has a material and adverse impact on the Assets would logically be a “material default”, some Purchasers object to the “material default” reference.  The last phrase addresses the concerns of both Parties by referring to a default that “would reasonably be expected to have a material adverse effect on the total value of the Assets.”

Payment of Royalties and Taxes (6.02(e)):  The Purchaser expects that the Vendor will remain responsible for royalties and taxes associated with the period of the Vendor’s ownership.

Encumbrances (6.02(f)):  The Vendor’s interest in the Assets is subject to the Permitted Encumbrances. Vendors will not give an absolute title warranty. They also avoid any implied warranties of title that otherwise may exist by including an express statement that the Vendor does not warrant title. This rep reinforces to the Vendor why it should be very careful in modifying the definition of Permitted Encumbrances.

No Reduction (6.02(g)):  The Vendor’s interest in a Well may be reduced at payout or upon the recovery of a production penalty, and the Lands might be subject to a farmout agreement.  These potential reductions must be identified in the Land Schedule to qualify as Permitted Encumbrances, and should be noted in any sale brochure.

Authorized Expenditures (6.02(h)):  Procedures must be implemented by the Vendor to ensure that the Purchaser is aware of all new AFEs, operation notices, mail ballots, etc. respecting the Assets.  This should be coordinated through the relevant A&D personnel, who in turn would advise the Land A&D contact.  The better practice is to list all such AFEs or commitments in a Schedule. If any such obligation accrues under the maintenance of business provisions in Article 5.00 following execution of the Agreement, it is a good practice to capture that information on a reference table for the benefit of Accounting and Joint Ventures personnel.
The financial threshold for the Purchaser’s share of a discretionary expenditure was increased from $25,000 to $50,000 in the 2017 document, to reflect the fact that the $25,000 threshold had typically been used since the early 1990s. This threshold is also included in Paragraph 5.03A(a), and is one that Parties may prefer to modify for Transactions or as a corporate preference change.  Users are reminded of this item in the general annotation at the beginning of the PTP and on the sample Schedule of Elections and Modifications included as Addendum I.

Sale Agreements (6.02(I)):  A production sales contract that is not terminable on notice of 31 days or less only falls within the definition of Title and Operating Documents (and the resultant treatment as a Permitted Encumbrance) if it is identified in a Schedule.  Otherwise, the Vendor is representing that there are no such contracts.
A 31-day threshold is used in this Paragraph and Paragraph 6.02(j), as well as Paragraphs (c) and (g) of the definition of Title and Operating Documents.  Parties may prefer to modify it for Transactions or as a corporate preference change to the PTP. Users are reminded of this item in the general annotation at the beginning of the PTP and on the sample Schedule of Elections and Modifications included as Addendum I.

Production   Handling   Agreements (6.02(j)): This   rep   was   introduced in the 2017 PTP.  It is like the preceding representation about sales agreements.  Other than for J.V.  service type agreements that can be terminated on short notice (i.e., the typical 31 days or less termination mechanism), the Vendor represents that there are no service agreements of this type that have not been identified on a Schedule.
Again, any such agreement that satisfies those requirements is a Permitted Encumbrance. The inclusion of this representation reflects the importance of J.V. Agreements to the value of a Transaction.

Various Operational Matters (6.02(k)-(o)):  These reps relate, respectively, to “Environmental   Matters”, “Operations   And   Compliance   With   Regulations”, “Condition   Of   Wells” and “Abandonment of Wells”.
Considering the focus on environmental issues, these representations can be quite contentious in the negotiation of A&D Agreements.  There are several key issues associated with these representations.  The first is the linkage to the Vendor’s knowledge, which is addressed in Clause 1.08.  The second reflects the practical consideration that parties other than the operator generally have very limited direct operational knowledge about a property for the purposes of Paragraphs 6.02(l)-(o), such that non-operators generally will not be willing to include them.
Paragraph 6.02(k) is not qualified by limiting the representation to Assets operated by the Vendor.  While a non-operator Vendor’s knowledge would not be as complete as the operator’s, it is quite possible that such a Vendor would be aware of environmental problems for non-operated Assets that should be disclosed to the Purchaser.
Another potential issue is the reference to “the material requirements of the Regulations as they existed at the relevant time” that is included in Paragraphs 6.02(m), (n) and (o). While Purchasers may object to the materiality qualification, its deletion would require the Vendor to provide an absolute warranty that it is not aware of any violation of the Regulations.  The remedy for a minor violation discovered after Closing would be in damages, and would almost certainly be minimal. However, the consequences could be quite serious if a minor violation was discovered before Closing. Such a violation could literally enable a Purchaser with “cold feet” to terminate the Transaction, a risk if market conditions were volatile. The materiality qualification attempts to balance the interests of the Parties. Any violation which has a material and adverse impact on any of the Assets is logically a material violation.
The other difficulty with the unqualified representation is that regulatory approvals or licences often include performance objectives, rather than standards.  If Regulatory Authorities do not require strict compliance, is it appropriate to provide a Purchaser a remedy for minor violations?
The inclusion of the phrase “as they existed at the relevant time” also reflects the degree to which the regulatory environment has evolved over time.  The test for compliance at any time should be linked to the regulatory regime then in existence, not current regulatory standards, except insofar as current regulatory standards then apply to an outstanding specific problem.
Paragraph 6.02(k) specifically addresses the Vendor’s environmental representations.  Except  as  identified  in  a  Schedule,  the Vendor represents that, to its knowledge, it is not aware of: (a)  any  environmental  orders  or  directives  requiring  expenditures that have not been complied with in all material respects or otherwise satisfied; (b) any outstanding regulatory demands or notices pertaining to the breach of any environmental health or  safety  law  applicable  to  the  Assets;  and  (c)  any  circumstance  it  reasonably  believes  to  be  a  reportable  event  under  the Regulations.

Paragraph 6.02(l) was introduced in the 2017 document, and addresses operations in a wider sense than environmental matters.  To its knowledge, the Vendor has not received any notices respecting the occurrence of a material violation of the Regulations and is not aware of any such material violation that remains outstanding at the Closing Time in circumstances in which the Vendor’s share of costs to remedy the problem exceeds $100,000.  That amount is one that Parties may prefer to modify for Transactions or as a corporate preference change to the PTP. Users are reminded of this item in the general annotation at the beginning of the PTP and on the sample Schedule of Elections and Modifications included as Addendum I.
The Vendor will usually have much greater knowledge under Paragraphs 6.02 (m), (n) and (o) for Assets operated by it at the relevant time than it will about non-operated properties.  These reps were modified in the 2017 PTP to limit them to Wells and Tangibles operated by it.
There are some subtleties associated with Paragraph 6.02(n) respecting the abandonment of Wells.  Notwithstanding that a Vendor may not transfer a well licence for a Well that has been abandoned and that has been reclamation certified, the Parties are free to agree in contract that the Purchaser will assume the Vendor’s potential ongoing financial obligations for that Well through the liability and indemnification provisions, as noted in the annotations on the definition of Well in Clause 1.01.
Whether an abandoned well is a Well for purposes of the Agreement will depend on the selection of the Alternates in the definition of Well and if the well has been identified on a Schedule.  The net effect is that an abandoned well on the Lands may or may not be a Well, depending on how the Parties have negotiated their Agreement.

Provision  of  Documents  (6.02(p)):  The  reps  and  warranties  and  title  review  effort  are  premised  on  the  Vendor  making  the  relevant  documents  and  files  available  for  the  Purchaser’s  review:  (i)  on  the  basis  contemplated  in  Clause  8.01  if  Article  8.00  was  selected  to  apply;  or  (ii)  in  conjunction  with  any  due  diligence  process  conducted  by  the  Purchaser  prior  to  execution  of  the  Agreement  in  circumstances  in  which  optional  Article  8.00  has  not been selected to apply.
The obligation does not extend to all files and documents included in the Miscellaneous Interests because any delivery less than full compliance could provide the Purchaser with an option to terminate the Transaction prior to Closing if it could satisfy the materiality requirement in Paragraph 10.01(c). However, the Purchaser will also often include additional conditions under Article 10.00 (i.e., Paragraph 10.02(d)) under which it is to be provided with access to other types of documents.  The Purchaser will often require similar conditions respecting access to applicable materials if it is being asked to agree to conduct its due diligence review prior to execution of the Agreement, as would be the case if optional Article 8.00 were not being selected.
Therefore, the files to which this obligation pertains are not limited to those relating to title and environmental.  In addition to the land and environmental files, the Purchaser will sometimes also wish to expand the specific list of files made available for review to include such files as J.V.  and marketing agreements, and production and accounting records.  This Paragraph is consistent with the expectations in Paragraph 8.01(a).

Well and Tangibles Transfers (6.02(q)):  This representation is included because of the possibility that the transfer of Wells to the Purchaser would result in the Vendor having a ratio of inactive to active wells that would not satisfy the requirements of applicable Regulatory Authorities, such as the Alberta AER.
The definition of Licencee Rating, this representation, the corresponding rep in Paragraph 6.04(d) and the condition in Paragraph 10.03(c) are structured so that they can apply across multiple jurisdictions.
If the ability to affect a transfer of any licence for any of the Assets is in question, the onus is on the Parties to add custom content in their Head Agreement to address their needs. This might be done, for example, by including additional definitions, a Clause that relates to the specific handling required for their circumstances and the inclusion of additional conditions to Closing.
The situation in which there were recognized problems in effecting the required licence transfers is one that the Parties are required to address in the context of their circumstances. There were two reasons for this approach. The first was the belief that this document should not attempt to predict or prescribe the handling of a critical issue that needs to be assessed and handled by the Parties and their applicable business and legal advisors on a case by case basis. The second was that the fluidity of the Regulations on this area over time and across jurisdictions was such that any more specific handling of the issue in this document would potentially create unintended consequences for the Parties over time.
Simplifying the other procedural aspects of the overall Transaction through use of the PTP facilitates a more focused examination of this critical issue by the Parties’ representatives relative to what would be the case without the PTP.

Records Relating to Operated Tangibles (6.02(r): As noted in last month’s article, this representation is inserted as a potential response to AER Bulletin 2015-34.  Vendors should consider very carefully if they will select it (or any modified version thereof) in conjunction with their review of Clause 3.07. There is uncertainty now, as to what the AER considers as ‘records required by CSA Z662 and the Pipeline Rules’, such that the most prudent approach for pipelines of any age may be for Parties to agree (with the AER if possible) on a list of required records for pipelines to be transferred until there is greater certainty on this issue.
Regulatory Production Penalties and Regulatory Production Allowable (6.02(s)&(t): A Vendor should be required to disclose any regulatory production penalties and any overproduction above regulatory allowables if it is aware of those problems.  As not all off-target wells will result in a production penalty under the Regulations, the representation pertains to only a subset of off-target wells.

“You Say Tomato, I Say Tomato”

The negotiation of the reps and warranties provisions of the typical Purchase & Sale Agreement for a low to modest value, straightforward sale reinforces why the 2017 CAPL Property Transfer Procedure is an important industry initiative.
It is inherently inefficient and expensive to engage in labour intensive reviews of different presentations of similar concepts and debates about how best to say basically the same thing as what had been originally proposed for the typical straightforward low to modest value asset deal.

Far too often, such a debate is, in the words of Lady Macbeth, “a tale… full of sound and fury signifying nothing.”

The PTP will mitigate the potential for this to occur for these Transactions by providing a common framework that shifts the focus from the words of the representation to the more fundamental question of whether the rep should be included in an Agreement at all.
Next month’s article addresses the remaining provisions of Article 6.00 of the draft 2017 PTP, including the Parties’ ability to include additional reps and warranties of the Vendor and Purchaser as required for the circumstances.


Published: The Negotiator, May 2017

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