The scope and extent of the seller’s representations and warranties in a purchase and sale agreement may largely depend upon the relative bargaining power of the parties. Richard Burleson offers some general guidelines.
Richard L. Burleson, Burleson Cooke LLP Houston
In the first installment in this series (Dec. 2007 OGFJ), we began an examination of legal and strategic considerations in a purchase and sale agreement (PSA) by discussing the current state of the market and the elements of such an agreement. We next consider the interplay between parties’ representations and warranties with the indemnities that serve as a remedy in case of a breach of those statements.
In negotiating a purchase and sale agreement involving oil and gas properties, the buyer generally will require the seller to give representations and warranties concerning matters affecting the property and the seller itself. A representation is an express statement of fact made by a party to a contract to induce the other party to enter into the contract. A warranty is a promise that the representation is true. Representations and warranties are a means of allocating risk between the buyer and the seller.
Purchase and sale agreements typically include an indemnification by the parties for liabilities incurred as a result of the inaccuracy or untruthfulness of their respective representations and warranties. Additionally, the purchaser often provides to the seller a broad indemnity with respect to the property from and after the effective date of the transaction, including indemnification of the seller for any and all environmental liabilities on or after the effective date, unlimited by time or the amount of damages that could be suffered by the seller.
The buyer will want to have the representations survive the closing, so that if any inaccuracies in the representations are discovered after the closing date, the buyer will have recourse against the seller pursuant to the applicable indemnification provisions. Sellers will negotiate to limit the effect of the representations and warranties. For example, the seller might limit the survival period, restrict the use of the representations to the buyer only as opposed to the buyer’s successor, or require that any amount of claim for breach of warranty exceed a certain threshold amount before the buyer is entitled to compensation.
Typical representations and warranties include statements that the parties are duly organized, in good standing, and fully authorized to enter into and consummate the transaction, and that the transaction does not conflict with any other agreements to which the seller is a party. The purpose of the no-conflict representation is to assure the buyer that the purchase of the property will not violate or otherwise trigger adverse consequences under any legal or contractual requirement applicable to the seller. This provision may have a broad scope because it requires disclosure not only of legal violations, but also of preferential rights of third parties to purchase the property or other consents, waivers, or approvals that may be required upon the sale of the property.
Another important representation and warranty is the seller’s statement regarding taxes. The buyer must be assured that all tax liabilities of the seller associated with the facilities have been satisfied as of the closing date and the seller should disclose all possible tax issues that may arise in the buyer’s post-acquisition operation of the property. By obtaining assurances that the seller has paid all of its taxes, the buyer reduces the likelihood of incurring successor liability for the seller’s unpaid taxes.
The representation and warranty regarding title is a fundamental element of the purchase and sale agreement. It should include statements (i) that the seller is entitled to receive, throughout the life of the property, free and clear of all royalties, overriding royalties, or other burdens, not less than the specified net revenue interest of all hydrocarbons produced from the property, (ii) that the seller is obligated to bear the specified percentage of costs and expenses for maintenance, development, and operations for the property not greater than the specified working interest; and (iii) that the property is free and clear of liens and encumbrances except those that are permitted by the agreement.
“The buyer will want to have the representations survive the closing, so that if any inaccuracies in the representations are discovered after the closing date, the buyer will have recourse against the seller pursuant to the applicable indemnification provisions.”— Richard L. Burleson
The purchaser will also want representations from the seller to the effect that the leases are in full force and effect as to the relevant lands and depths and a statement that the sellers interest in the property is subject to only certain enumerated contracts.
Another fundamental part of the PSA is the seller’s representations and warranties regarding environmental matters. Typical environmental representations cover matters such as the past use of the property, hazardous materials present on the property and actions or claims by the government or private parties relating to environmental compliance or cleanup.
Sellers will typically resist making representations and warranties regarding environmental matters preferring that the buyer rely on the results of environmental due diligence and investigation. A buyer will view due diligence as supplemental to the seller’s representations and warranties concerning the property and will seek to have the representations survive the closing so that if any inaccuracies in the representations are discovered after the closing, the buyer will have recourse against the seller for damages for breach of contract and rights of contribution under applicable environmental laws.
Each representation and warranty is often prefaced by the phrase “except as disclosed on schedule X to this agreement.” The disclosure schedules delivered by the seller will contain most, if not all, of the relevant information about the property which constitute exceptions to the otherwise “clean” representations made by the seller with regard to itself or the property.
The schedules should be carefully reviewed and studied prior to executing the purchase and sale agreement. If for any reason the parties agree to sign the purchase and sale agreement before delivery of the schedules, the parties should agree that the schedules will be delivered by a date far enough in advance of the closing to permit a thorough review by the buyer and an analysis of the consequences of disclosed items.
From the buyer’s perspective, the seller’s representations are a critical feature of the transaction. They serve as the primary leverage for obtaining disclosure about the seller and the property. They also provide a foundation for the buyer’s right to terminate the acquisition before the closing upon discovery of adverse facts contrary to those represented by the seller. In addition, the buyer’s right to indemnification by the seller after the closing will be based upon a breach of any representations and warranties.
However, the scope and extent of the seller’s representations and warranties may largely depend upon the relative bargaining power of the parties. If property is being marketed in an auction or other competitive bid, for example, the buyer might scale down the representations required of the seller to improve its chances of being the winning bidder. Similarly, to the extent the buyer becomes comfortable, through due diligence, with the assets or the risk associated with a particular aspect of the transaction, it may scale back the representations required of the seller.
Where an agreement does not provide that representations and warranties survive the closing, they extinguish on the closing date and cannot thereafter give rise to any claim of liability. Where an agreement provides that representations and warranties “survive the closing” without setting forth a specific period, they will survive indefinitely and a party can sue for breaches of the representations and warranties until such claims are precluded by the applicable statute of limitations. But if the survival clause states that the representations and warranties survive for a fixed period of time, a party generally cannot sue for breach of the representations and warranties once that time period has elapsed.
The final installment of this article series will be a discussion of the purchase price adjustment mechanisms in a typical oil and gas purchase and sale agreement. As discussed above, the representations and warranties regarding title and environmental matters are critical to every transaction involving oil and gas properties and most negotiations center on these provisions. OGFJ
About the author
Richard L. Burleson [[email protected]] is managing partner at Burleson Cooke LLP, a Houston-based law firm. He has a broad business practice in the areas of mergers and acquisitions, corporate finance, and energy. He earned a BA degree with honors from the University of Texas and has a JD degree from the University of Houston Law Center.
