CHAPTER 4 REPRESENTATIONS AND WARRANTIES, COVENANTS AND LEGAL OPINIONS IN OIL AND GAS LOAN TRANSACTIONS
| Jurisdiction | United States |
(Nov 1982)
REPRESENTATIONS AND WARRANTIES, COVENANTS AND LEGAL OPINIONS IN OIL AND GAS LOAN TRANSACTIONS
Thompson & Knight
Dallas, Texas
TABLE OF CONTENTS
I. INTRODUCTION
A. THE PARTIES' CONCERNS
B. CENTRAL FOCUS ON PRODUCING PROPERTIES
C. TWO TYPES OF LOANS
D. APPLICATION TO MINING TRANSACTIONS
E. SUMMARY OF INTRODUCTION
II. REPRESENTATIONS AND WARRANTIES
A. REPRESENTATIONS IN ANY LOAN TRANSACTION
1. Organization and Good Standing
2. No Conflicts or Consents
3. Full Disclosure
B. REPRESENTATIONS ABOUT PRODUCING PROPERTIES
1. Warranty of Title
2. No Claims
3. No Liens
4. Legal Operation
C. VARIATIONS IN WARRANTIES FOR EACH TYPE OF LOAN
D. SUMMARY
III. COVENANTS
A. AFFIRMATIVE COVENANTS IN ANY LOAN TRANSACTION
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1. Maintenance of Records
2. Financial Reports
3. Right to Additional Information
4. Notice of Defaults
5. Compliance with Law and Contracts
6. Evidence of Compliance
B. COVENANT TO PAY TRANSACTION COSTS
C. NEGATIVE COVENANTS IN ANY LOAN TRANSACTION
1. Limitation on Indebtedness
2. Limitation on Mergers
3. Limitation on Dispositions of Funds
4. Financial Ratios
D. SPECIAL AFFIRMATIVE AND NEGATIVE COVENANTS IN OIL AND GAS OR MINERAL LOAN TRANSACTIONS
1. Engineering Reports
2. Production Reports
3. Operation and Property Insurance
4. Liability Insurance
5. Good Standing
6. Maintain Ownership
7. Indebtedness Relating to Properties
8. Liens
9. Miscellaneous
10. Agreement to Pledge
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IV. LEGAL OPINIONS
A. PURPOSE FOR OPINIONS
B. TYPES OF OPINIONS
C. CORPORATE OPINION OF BORROWER'S COUNSEL
1. Due Incorporation, etc
2. Due Qualification
3. Due Authorization
4. Opinion on Legality, Validity and Enforceability of Loan Documents
5. Perfection of Security Instruments
6. No Conflict or Consent
7. No Default
8. Compliance with Loan Documents
9. Pending Litigation
D. QUALIFICATIONS IN OPINIONS
1. Laws Opined On
2. Scope of Examination
3. Assumptions Regarding Other Parties
4. Disclaimer of Opinion About Title
5. General Disclaimers
E. OPINIONS OF THE BANK'S COUNSEL
1. Purpose
2. Scope of Examination
3. Similarity to Opinion of Borrower's Counsel
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F. TITLE OPINIONS
1. Purpose
2. Scope of Examination
3. Points to be Covered
4. Properties Examined
5. Closing Against the Record
V. SUMMARY
APPENDICES
Appendix A—Selected Provisions from a Loan Agreement
Appendix B—Corporate Opinion of Borrower's Counsel
Appendix C—Opinion of Special Counsel for Lender
Appendix D—Opinion of Lender's Counsel
Appendix E—Financing Title Opinion
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I. Introduction.
This paper concerns two features of legal documentation in oil and gas loan transactions: (1) representations, warranties and covenants, and (2) legal opinions.1 These are almost always requirements asked of the borrower, or his counsel, by the lender. Instead of analyzing the wording of these requirements in great detail, I would like to analyze how they relate, or should relate, to the general concerns that borrowers and lenders have in these kinds of transactions. My first task is therefore to identify these concerns. I approach this task without the benefit of business school or other formal training in the lending business. Instead, I am going to describe what I have observed in the course of representing both banks and borrowers in oil and gas lending transactions.
A. The Parties' Concerns.
Compared with the banker, the borrower's concerns are fairly simple. He needs money at an affordable price and he wants to be sure that he can get it when he wants it. He also wants to be sure that he can live with the requirements imposed upon him by his bank. Finally, he wants the process of negotiating and closing the loan to be as painless and inexpensive as possible. The banker's concerns are a little more complicated. First of all, he wants to be sure that he is lending to someone who now is and will remain able to pay him back. This concern might be expressed in loan documentation by a covenant which prevents the borrower from getting in a cash squeeze due to too many purchases of capital goods. Second, the banker needs remedies if his borrower gets into difficulty. The best remedy is usually a mortgage. And third, the banker wants to be able to satisfy these first two concerns and still keep his borrower happy. He is a salesman offering the same product that hundreds of other banks are offering, and an unhappy borrower who is a good credit risk can almost always find another bank which would like to try to make him happy.
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Almost all loan documentation is initially prepared by the banker's counsel, and it generally reflects the banker's first two concerns: insuring creditworthiness and providing remedies. The banker's attorney must, however, keep the banker's third concern in mind, both in drafting and negotiating loan documents. And the borrower's attorney, if he is to effectively represent his client, must understand the banker's concerns and be able to separate those items which are not negotiable, i.e., those items which properly express the banker's legitimate concerns, from those items which are subject to significant negotiation.
B. Central Focus on Producing Properties.
The three concerns described above—insuring continued creditworthiness, providing for adequate remedies, and keeping the borrower's business— are shared by all bankers. What distinguishes the oil and gas banker is his understanding of the particular nature of his borrower's assets. Oil and gas lending almost always centers around producing oil and gas properties owned by the borrower. Properly interpreted engineering evaluations of these properties can show the future income stream from the properties and thus tell the banker how he is going to get repaid. Producing oil and gas properties are also central to the banker's remedies. Either the banker has a mortgage lien upon the properties, or he has the borrower's covenant to give such a lien, or he can obtain a judicial lien after suing on his note. In all cases the present worth of the future net revenue from the producing oil and gas properties shows the banker the value of his security or potential security. Representations and covenants in oil and gas loan transactions therefore pay special attention to or potential security. Representations and covenants in oil and gas loan transactions therefore pay special attention to the borrower's producing oil and gas properties and the borrower's ability to manage these properties.
C. Two Types of Loans.
As I said initially, I hope in this paper to analyze covenants and warranties from the perspective of a banker's three special concerns. I also want to keep in mind the oil and gas banker's particular focus on his borrower's producing properties. Finally, I want to analyze covenants and warranties as they appear in two common kinds of oil and gas loans which require slightly different representations, warranties and covenants. The first type of loan is secured by or otherwise based upon one or more specific producing properties. This is an older type of loan, in which a bank would traditionally require that amortization come out of a specific dedicated percentage of the runs from the producing properties. A more modern type of loan appropriate for
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borrowers with a large number of producing properties is based upon the value of these properties taken as a whole. If a borrower has a large number of properties these are almost certain to be located in a number of states, producing from different fields in different stages of development. The history of title to these properties will also vary and, while there is a higher possibility that title will fail or production will fall off in one or two properties, the possibility of such a failure for a significant percentage of the borrower's properties is reduced. In this second type of loan the borrower will furnish the bank with engineering and production data on all of his producing oil and gas properties, showing anticipated future production from year to year and the estimated prices at which such production can be sold. This information is generally furnished in the form of a report by independent petroleum engineers, such as DeGolyer and MacNaughton or Core Laboratories. The bank's own engineers will then analyze this report and revise any assumptions with which they disagree. The bank will, for instance, have its own assumptions about future price levels. Based on the revised report, the bank will determine the present worth of the future net revenues from the examined properties. The bank will then be willing to lend a percentage (usually fifty to sixty-five percent) of this amount until such time as the underlying engineering data become outdated. In our firm's documentation of revolving credit loans we call this maximum amount that the bank will lend the "borrowing base". If the revolving credit facility is to be kept open for more than a few months the bank will require that the borrowing base be periodically redetermined, based upon new engineering and financial data reflecting depletion from production, new reserves added through exploration and development, and new projections of future prices. Borrowing base loans are often based at least in part on unmortgaged properties. If a borrower has 100 producing properties, for instance, a bank might take a mortgage on the 20 or so properties which together represent 50% of the value of the entire package. Or a bank might not take a mortgage at all. In either case, the borrowing base will be determined based upon the value of all engineered properties.
There are certain representations, warranties and covenants which apply equally to each of these two types of loan, but there are others which must be modified in each situation. For instance, a bank will in both cases want...
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