CHAPTER 4 Application of Contract Law Principles To The Purchase and Sale Agreement
| Jurisdiction | United States |
(May 1983)
Application of Contract Law Principles To The Purchase and Sale Agreement
Vinson & Elkins
Houston, Texas
AGREEMENTS RELATING TO
ACQUISITION OF PRODUCING
PROPERTIES
Sales of oil and gas properties are quite common in good and marginal times. Lawyers working in the oil and gas industry often are called upon to play an important role in developing marketing strategies for property packages, preparing information for evaluation and participating in the exchange of communications and negotiations leading to definitive agreement documentation. Upon execution of a purchase and sale agreement which embodies the complete business trade, lawyers typically become the principal parties involved in preparing for the closing.
This presentation is designed to assist men and women acting out their roles as lawyers in the phases of a proposed sale or acquisition of oil and gas assets by unearthing some basic principles of contract common law and applying them to a complex legal document — the Purchase and Sale Agreement — and the negotiations which precede this Agreement.
The Restatement (Second) of Contracts
The main text for this presentation is the American Law Institute's Restatement of the Law (Second) of Contracts. It is a fascinating work. Now that my familiarity with it has increased, thanks to preparation for this meeting, I plan to use it more frequently in my practice and recommend it to you.
Its format is particularly appreciated. Unlike some of the treatises which are intended to lay out the law under isolated topics, the Restatement (Second) weaves together many areas and thereby provides an analytical road map for the topics it addresses. In so doing, it helps mitigate the easily attained feeling that the law of contract is a seamless web of ancient cases involving goods being delivered on a different ship with the same name as another ship or carbolic smoke balls.
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For those of us who are fortunate enough to face the challenges of preparing and enforcing complex contractual arrangements, it is a fact of life that we are expected to divine contractual principles from cases with a single exchange of promises and only the simplest factual situations. For example, "Suppose that A delivered the goods in exchange for B's promise to pay $100 if and when his ship comes in." A. Corbin, Corbin on Contracts — One Volume Edition (§626 at 581). Study of cases like these may be necessary to our initial understanding of contract principles, but our law school systems do not move much beyond this primary method of instruction. We are taught in a way that inclines us to treat each separate contractual law principle in simplistic isolation. Our training has to be overcome for us to "bring it all together" in a multi-promise situation. The Restatement (Second) at least recognizes complexity and, in several places, provides an analytical framework to use in sorting out principal undertakings, ancillary promises and standardized provisions.
The Restatement (Second) does not attempt to report the law of any particular jurisdiction. This contains both advantage and disadvantage. As an advantage, the rules stated have broad common law support. However, you should be careful to note instances where decisions in your jurisdiction do not support the generally accepted restatement of the law.
From a historic perspective, the first contract law restatement was completed in 1932. Revising work commenced in 1962 and finished in 1979, fourteen drafts later. It is interesting that the work was funded by a grant from the A. W. Mellon Educational and Charitable Trust of Pittsburgh, Pennsylvania. It is entirely appropriate, therefore, that this publication be used by those of us in the oil and gas industry.
The timing of the Restatement (Second)'s publication allowed its drafters to coordinate its preparation with development of the Uniform Commercial Code — the other significant collection of contract law to occur in recent times. The comments and notes are replete with cross references to Uniform Commerical Code sections making it relatively easy to use both compilations.
You will find precious few references in this presentation to materials other than the Restatement (Second). This result evolved from the completeness of the Restatement (Second), a 50 minute time limit and my flawed initiative. It is my hope that after going through the analysis with me that you, too, will find the Restatement (Second) an aid to your practice in the oil and gas area.
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Background
Sales of oil and gas properties are not homogenous. They are motivated by all sorts of circumstances — everything from an independent's need for new exploration money to a new conglomerate parent's need to service the debt it incurred to obtain the assets to be sold. They are large, small and in between. They involve interests concentrated in one field and those spread across ten or more states. They involve sophisticated buyers and sellers and some relatively unsophisticated parties — buyers for the most part — who are starting in the oil and gas business.
Generalizations as to legal structure can be made for transactions of considerable size — say, over $10 million. Once a certain economy of scale in value is reached, similar legal strategy, structure and performance concerns arise in the Purchase and Sale Agreement context.
Sales strategies vary in response to market conditions. When the buyer for cash is the scarce commodity, procedures for evaluation of the properties and the subsequent negotiations are done more informally than when the seller is rare and feels it appropriate to play the field before selecting the fortunate buyer. These degrees of formality are reflected in the solicitation of offers exhibits which serve to announce the sale of properties. Three examples are provided as attachments to this paper. A quick look at each of these will help to set the stage for our contract analysis.
In the first example — the letter from Flexible Finance & Co. soliciting indications of interest in Laid Back Resources' properties — the potential buyer, obviously thought to be the more powerful party, is encouraged to "come on by and take a look at these here properties when you'all have time — ya hear."
The seller in the next example — Summary Oil's Procedures — not only has a more manageable group of properties to disclose, but feels the market allows a seller to have a little more dignity. There are more rules, regulations, deadlines and substance to this seller's proposal.
Strict Oil, in the third example, goes all out to let the buyer know who is in control. A buyer reading these procedures for the first time must have the feeling of true exclusivity to be in the company of only a few select prospective purchasers to receive the brochures. Buyers must pass through several phases of the evaluation. A pass at
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Phase I on interest level earns a buyer the non-exclusive right to pay a lot of money and commit its entire acquisition team to an "in-depth" evaluation of producing properties in the Data Room for a three week period. If the buyer's tentative producing values are sufficiently high after this Phase II, it will join a reduced number of prospective buyers in seeing the exploratory romance of Strict Oil. Offers are then expected (on the seller's prescribed form, of course) before a stated deadline. These offers must contain all comments on the seller's form of Purchase and Sale Agreement furnished to the buyers who survived the producing property evaluation.
Each of these selling strategies works with the result that a buyer and a seller happily accomplish their transactions. As you may suspect, the Strict Oil example is based on an experience several years ago when times were better for sellers and the industry as a whole. The other two reflect experiences in more recent times.
All of these examples of selling strategies are based on the understanding that a buyer will do a complete reserve evaluation and be far along in its accounting, contract, title and other legal matters due diligence before accepting the contractually binding obligations of a Purchase and Sale Agreement.
This, I submit, is a change in the way acquisitions in our industry were made in the good old days. Then a seller would call a few friends in the industry to explain the proposed sale, get an offer based on little due diligence and sign an agreement with numerous conditions to closing covering the heart of the transaction — favorable reserve study and favorable title opinions, for example. The buyer, selected without too much competitive evaluation work, was in the driver's seat. I am told that many buyers took advantage of their well conditioned obligations to renegotiate the original purchase price and other terms as the time for closing approached. Sellers and their financial and legal advisors learned from these experiences.
A seller's success in implementing "sign-off and then buy" concept for all due diligence matters is directly related to the market, but it is becoming accepted practice for even a powerfully positioned buyer to leave very few due diligence or evaluation items (including legal due diligence) until after Purchase and Sale Agreement signing. Even with this trend, Purchase and Sale Agreements, particularly those used for the larger transactions, often contain numerous conditions, options and other terms which detract from the iron clad binding nature of contracts as we classically view them. It is generally true, however, that parties view the Purchase and Sale Agreement as a firm obligation to buy and sell.
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The procedures become history at some point and negotiations between one buyer and one seller of a Purchase and Sale Agreement commence. As mentioned previously, the seller often furnishes the first draft of this document as a part...
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