27 May 2017
The Australian resources sector has recently seen strong interest from the financial institutional investor space. However, organisations in Queensland must structure their sale process thoughtfully and select their buyer very carefully. Under the intentionally pervasive Environmental Protection (Chain of Responsibility) Amendment Act 2016 (Qld) there could be serious issues when financial institutional investors seek to realise their investment on a clean-exit basis.
The law being considered is the Environmental Protection (Chain of Responsibility) Amendment Act 2016 (Qld) (CORA). This Act became law in Queensland in April 2016. In its simplest terms, CORA introduces a risk, which did not previously exist, that a former owner of a mining or petroleum resource project in Queensland could be given an order (called an EPO) to rehabilitate the resource site, or a cost recovery notice (CRN) to pay to the State an amount required for rehabilitation or monitoring. The powers created are designed to be used where the current owner of the project is unable to discharge its environmental rehabilitation obligations (for example, due to insolvency). In these circumstances, the State will look for someone else to discharge the rehabilitation obligations. This can include former owners. CORA cannot be contracted out of - there is no way to avoid its operation.
In light of CORA, any former owner of a resource project will need to understand the circumstances in which they could remain liable for an EPO or CRN after they have exited the investment.
Under CORA the circumstances will be:
A former owner (indeed, any person) can have a relevant connection to the project company if the former owner:
The responsible authority, the Department of Environment and Heritage Protection (DEHP), has issued lengthy and detailed guidelines setting out the circumstances in which it may look to persons other than the project company. DEHP must have regard to the guidelines (Guidelines), but is not obliged to follow them.
Whether a former owner benefitted significantly from the conduct of the relevant resolute activities by the Project company is context dependent; in broad terms the receipt of normal investment returns (including income distributions and capital receipts from sale) commensurate with ownership and the nature of the project will not necessarily satisfy this requirement. The Guidelines suggest that DEHP is looking for something more – outsize returns achieved at the expense of environmental compliance, for example.
The Guidelines make clear that, in the context of potential liability of a former owner, even if a relevant connection between the former owner and the project company is found to exist, they will look for some form of culpability: to be clear, the mere fact of former ownership is not, under the Guidelines, in and of itself sufficient to attract liability under CORA.
The question in the 2-year look back period is simply one of influence and control during the period of ownership; the question of the economic benefit obtained by the former owner is not relevant. The path to the door of a former owner (particularly a majority owner), within this period is much more direct; the forensic examination will focus on the conduct of the former owner vis a vis the project company’s compliance with its environmental obligations.
A few other things to know:
So what might be unique about the context of investment and exit by financial institutional investors that might warrant particular consideration of potential CORA issues? Arguably the following, to greater or lesser degrees:
The strategic goal of the financial institutional investor reflects the desire to achieve a clean-exit from a resource investment and without contingent liability (clearly all vendors want to achieve a confident exit). Therefore, for this class of investors the question of potential statutory legacy liability requires, in every exit, a thorough examination.
A relevant connection between a person and the project company can exist if DEHP is satisfied that (as relevant for present purposes):
For this purpose, a person includes individuals as well as all forms of corporate entities. While somewhat unclear, the law appears to provide a power to DEHP to issue an EPO or CRN to, and impose liability on, a person domiciled outside of Australia.
The law provides guidance as to what DEHP may consider, including, for example:
It is clear that, in the financial institutional investor context, various people or entities could theoretically be considered to have a relevant connection: the general partner, fund or asset manager, key executives or even limited partners.
When addressing the culpability issue, the Guidelines indicate that DEHP will ask: “Did the person whose conduct or relationship is being examined take all reasonable steps in the circumstances?” For example, ensuring that an unfunded rehabilitation obligation would not exist. Reasonable steps is context dependent – a limited partner with little or no influence within a fund structure would not be seen to be in a position to direct the taking of reasonable steps.
In managing the risks associated with former ownership of a resource project, an exiting investor should consider two perspectives:
These perspectives shape the approach to risk mitigation for an existing investor.
So, a well-informed existing investor will, at least, consider the following risk mitigants and processes:
1. Be compliant with environmental obligations (and able to demonstrate that) at the time of exit.
This issue largely goes to the question of culpability: it should be more difficult for DEHP to conclude that a former owner of a resource project is culpable following the exit if, at the time of exit, the project company was (put simply) fully compliant with its environmental obligations. This evidence will be crucial should the project company fail within the two-year look back period.
In an M&A context, for a vendor this means firstly, clearly understanding the extent of any non-compliance issues, secondly, providing full visibility of this to your buyer, and finally, extracting evidence that the buyer understands what they are buying into.
2. Consider whether post-completion financial interest gives the vendor a continuing financial interest in the project company.
The test of a relevant connection includes an assessment of financial benefit; a sale structure that involves payment of all consideration at the time of financial close (i.e. no ongoing royalty or earn-out arrangements) can help avoid a characterisation that the former owner continues to have a significant financial interest in the project.
3. Sell on arms’-length terms.
The Guidelines explain why:
‘A vendor has made normal market value profits from the sale of an operation through an arm’s length transaction. At the time of the sale, the operation was in compliance with its EA. After taking responsibility for the operation, the purchaser failed to carry out maintenance on key infrastructure as required in its EA and has become insolvent. There is a risk that as a result of the failure to carry out maintenance, the infrastructure will fail and cause significant environmental harm.
As the sale of the operation was through an arm’s-length commercial transaction and the vendor received normal market value profits from the sale of the operation, the vendor would not be considered to have a relevant connection on the sole basis of significant financial benefit.’
In competitive sale processes it will be readily apparent that the term, condition and price received by the exiting vendor are arms’ length.
4. Sell to a quality buyer.
The extract from the Guidelines set out in paragraph 3 above indicate that a subsequent failure by new owners to comply (or ensure compliance with) environmental obligations and responsibilities should not put the former owner in the firing line. However, ultimately if the question of CORA arises it is because an unfunded rehabilitation liability occurs and the State does not intend to pick this liability up: on this basis it is in the interest of a vendor to sell to a quality buyer with strong financials and some demonstrable ability to comply with environmental and other corporate obligations.
In a sale context it can only help a vendor’s cause if they have obtained and assembled evidence (as well as warranties) that support their decision as to why they sold to the particular buyer: that they did all they could in the circumstances to satisfy themselves that the project would continue to be appropriately controlled and resourced in relation to forward-looking environmental obligations.
5. Seek ongoing buyer protection.
Typically a well-crafted sale agreement will provide protection for the vendor for post-completion liabilities, including under environmental law. From the vendor’s perspective, this post-completion protection, which by its terms should protect the vendor from a liability imposed on it under CORA, should be available:
Protection for the first two years post exit is, for the reasons given above, particularly important.
It may, in appropriate circumstances, be reasonable to seek further protections during this period – for example, a regime that provides the vendor with protection if the new owner themselves seek to sell the project within this period.
6. Consider the broad approvals process.
In some divestment transactions a purchaser will be required to obtain various regulatory and other approvals, for example:
All of these approvals, to a greater or lesser degree, provide a level of ‘diligence’ or independent assessment in relation to the question of the ‘quality of the buyer’. For example, FIRB will consider the ‘corporate integrity’ of the foreign buyer as part of its assessment procedure.
Conversely, the absence of a requirement to obtain any external approvals will place the onus more squarely on the shoulders of the vendor to satisfy itself about the identity of the person to whom it has selected to sell the project.
Potential liability under CORA is, for the moment in Queensland, a fact of life (its operation will be reviewed in late 2018). To our knowledge it has only been used once. It seems to us that in some circumstances an M&A transaction pursued by a vendor will raise questions about potential legacy liability issues coming back to them – but the risks should be able to be managed through a sensibly run sale process.
This article was originally co-authored by Bruce Adkins.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.