CHAPTER 5 REPRESENTATIONS AND WARRANTIES IN THE PURCHASE AND SALE AGREEMENT—THE PURCHASER'S PERSPECTIVE
| Jurisdiction | United States |
(May 1983)
REPRESENTATIONS AND WARRANTIES IN THE PURCHASE AND SALE AGREEMENT—THE PURCHASER'S PERSPECTIVE
Holme Roberts & Owen
Denver, Colorado
The perspectives of the seller and purchaser in an acquisition of producing oil and gas properties are very different. The seller is usually disposing of an asset either to raise cash for a specific purpose, such as retirement of bank debt or the drilling of new wells, or occasionally because the seller is leaving the oil business and wishes to liquidate his investment. The seller thus is concerned principally with receiving the purchase price quickly and with restricting his future liability with regard to the properties being sold. The seller wants to liquidate his investment and not have to worry about claims arising from the properties once the closing has occurred.
The purchaser's concerns are more complicated. He is making an investment based on a large volume of data about the properties and an intricate set of assumptions and calculations. For a variety of reasons the purchaser needs assurance that his evaluation of the properties is reasonably
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accurate, but obtaining that assurance involves verifying the data and assumptions used in his evaluation. This task is made difficult because the properties normally will include numerous wells involving large numbers of leases, producing formations and sets of contractual relationships, a complex fact situation with which the purchaser is unfamiliar.
Because the perspectives of the seller and purchaser are so different, this paper will examine in greater detail the purchaser's concerns in acquiring producing oil and gas properties and how those concerns can be satisfied in part by representations and warranties in the purchase agreement. The paper will examine both the purposes of representations and warranties and the various types of representations and warranties that may be useful to a purchaser in an acquisition of producing properties.
I. PURPOSES OF REPRESENTATIONS AND WARRANTIES
A. Special Concerns of the Purchaser.
1. Verification of Evaluation.
The evaluation of producing oil and gas properties is a complex task involving a large number of factors. While it is beyond the scope of this paper to discuss such evaluations in detail, in general they are based upon an analysis of such factors as the production history of the
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property, reserve estimates, historical operating costs and tax burdens, the prices being received for production from the property, and the purchaser's projection of future price increases and estimated future operating costs and tax burdens. Although not directly included in the engineer's calculations, an evaluation also is based on assumptions that the seller has the right to produce the oil and gas from the same land that the engineer ties to the estimated reserves, that the property can continue to be operated in the same fashion as previously over its productive life, that the encumbrances and burdens on production will not change from those used in the evaluation and that the purchaser will be legally entitled to receive the same prices and apply the same tax rates as those used in the evaluation.
Any material discrepancies between the data used in the evaluation and the actual data concerning a property, or any material inaccuracies in the assumptions in the engineering evaluation, could cause the purchaser's evaluation of the property to be materially incorrect, thus jeopardizing the projected rate of return on the purchaser's investment. Of course, the purchaser always runs the risk that his estimates regarding future prices, costs or regulations may prove incorrect, but the prudent purchaser should make diligent efforts to verify that all of the data and assumptions about existing conditions used in the evaluation are
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materially correct. This is especially true in light of the fact that most of the production and cost data is provided by the seller. Moreover, in order to protect his investment the purchaser should have contractual protection that will provide some kind of price adjustment or economic recovery if any material discrepancies in data or assumptions are uncovered.
2. Obligations to Shareholders or Limited Partners.
In addition to concern about verifying the economic evaluation on which the transaction is based, certain purchasers will have additional concerns about making prudent investments. Publicly held corporations owe an obligation to their shareholders that corporate funds be expended in a prudent manner, and their officers and directors thus face potential liability if the economic basis for an acquisition is not verified with reasonable care. Among the most active acquirers today of producing properties are companies that sell publicly registered limited partnership interests and then use partnership contributions for the express purpose of buying producing oil and gas properties. Such companies buy properties on behalf of their limited partnerships, and they are thus under a duty of care to their limited partners similar to that owed by the officers of a corporation to its shareholders.
However, certain characteristics of such companies' business activities give them even greater concerns about
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exercising care in acquisitions. First, they raise funds expressly for purchasing producing properties and thus emphasize lower risk for their investors than they would have in drilling partnerships. Accordingly, the entire basis of the limited partner's investment is buying a share of existing reserves. This is a much more specific objective than that of the shareholder who buys stock in an oil company that may engage in many different aspects of the oil business, and such companies must take special care to be sure they satisfy that specific objective. Moreover, although such companies normally sell partnership interests on a "blind pool" basis in which the investor does not know in which properties he will be investing, if they make an acquisition in which subsequent investors will participate, the Securities and Exchange Commission requires them to issue a "sticker" to their prospectus describing the properties acquired. The sticker includes information on estimates of reserves and future net revenue from the properties, and in such instances partnership interests are being sold on the basis of specific information concerning specific properties. The companies thus must exercise utmost care as to the accuracy of such information. Finally, such companies derive significant amounts of their income from continuing sales of partnership interests, and they are thus very dependent on a reputation for making acquisitions on a
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sound economic basis. One lawsuit charging lack of reasonable care in completing an acquisition could seriously jeopardize their ability to continue to sell partnership interests. Accordingly, this business consideration is a final impetus for such companies to exercise care in buying producing properties.
3. Financing Considerations.
The purchaser is also likely to require a bank loan in order to finance the closing of the acquisition. Banks, of course, are most concerned that the economic assumptions on which they have calculated the collateral value be verified, and with the present mood of caution caused by the Penn Square collapse, purchasers must be ready to provide significant comfort to their lenders that the economic basis for collateral values has been verified and is protected in the purchase agreement. Failure to provide such comfort can delay the closing or perhaps jeopardize the entire transaction if the lender decides it is not secure enough even to make the loan.
B. Protection for Purchaser Outside the Purchase Agreement.
Having examined the special concerns of the purchaser in producing property acquisitions, we next must analyze whether those concerns are satisfied by the legal relationships of the seller and purchaser outside of the
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purchase agreement. The rules of transferor-transferee liability generally provide that the assignor is liable for causes of action which arise with regard to a property prior to the date of the conveyance of that property. Responsibility for an injury caused by an activity or condition on real property is generally placed upon the person controlling and occupying or possessing the property.1 Unless a contract for the assignment of oil and gas leases provides otherwise or the assignor voluntarily puts the assignee into possession, the right of possession remains in the assignor as an incident to holding legal title.2 Accordingly, an assignee is not liable for breaches of lease covenants which have occurred prior to the assignment,3 while an assignor is not liable ordinarily for injuries caused by hazards on the premises and which occur after termination of the assignor's occupation and control of the premises by transfer of possession to another. This general concept also applies to tax liability where the assignor is liable for taxes which are a lien at the time the purchase agreement is executed and, except where the assignee is in possession, for the taxes accruing between the date of the agreement and the date of the closing.4 While these general rules provide the purchaser with a little comfort concerning third party liabilities, taxes and obligations to lessors, they do not give
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the purchaser any real protection if the data or assumptions used in his economic evaluation prove to be incorrect.
Implied warranties also provide little help. In general there appear to be only two narrow areas where warranties may be implied by law to a transfer of producing properties. Assignments of leases which do not specifically disclaim warranties of title may have certain covenants of title implied.5 However, title to oil and...
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