CHAPTER 9 COVENANTS BETWEEN SIGNING AND CLOSING AND CLOSING CONDITION

• Jurisdiction: United States

Oil & Gas Agreements: Purchase & Sale Agreements
(May 2016)
CHAPTER 9
COVENANTS BETWEEN SIGNING AND CLOSING AND CLOSING CONDITION
David M. Patton
Partner
Locke Lord LLP
600 Travis Street, Suite 2800
Houston, Texas 77002
(713) 226-1254

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DAVID M. PATTON is Co-Chair of the Locke Lord LLP's Energy Practice Group in Houston, Texas. He has 39 years of experience in various legal aspects of the oil and gas industry, including acquisitions and sales of assets or equity interests, and drafting and negotiating leases, contracts, and agreements related to field operations. David has represented clients in connection with surface use conflicts, day to day exploration and development activities, and the resolution of oil and gas disputes. He is a frequent participant in continuing legal education programs and is active in the Rocky Mountain Mineral Law Foundation and the State Bar of Texas. David is the immediate Past Chair of the Oil, Gas and Energy Resources Law Section of the State Bar of Texas; a Trustee of the Rocky Mountain Mineral Law Foundation; a Fellow of the Texas Bar Foundation; the 2012 Houston Oil & Gas Law Lawyer of the Year by Best Lawyers; Nationwide Leader, Energy: Oil & Gas (Transactional); Chambers USA's Leading Lawyers in America; and Best Lawyers in America, Oil and Gas Law (2010-2016), and is on the Advisory Board of the Texas Journal of Oil, Gas and Energy Law.

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TABLE OF CONTENTS

I. Introduction

II. Interim Period Covenants

A. What is a Covenant?

B. Factual Context and Purpose

C. Examples and Content of Covenants

1. Access to Records

2. Physical Access to Leases, Wells, Facilities and Equipment

3. Operation of the Assets

4. Restriction on Operations

5. Enforcement of Third Party Provisions

6. Confidentiality

7. Preferential Purchase Rights and Transfer Requirements

8. SEC Matters

9. Casualty or Condemnation Loss

10. Further Assurances

11. Notification

12. Amendment to Schedules

13. Replacement of Bonds, Letters of Credit and Guaranties

14. Non-Competition

15. Successor Operator

16. Pre-Effective Time Recording or Conveyance of Unrecorded Interest

D. Remedies for Breach of Covenant

III. Conditions to Close

A. General

B. Seller's Conditions to Close

1. Representations

2. Performance

3. Pending Matters

4. Execution and Delivery of the Closing Documents

5. Adjustments

6. Casualty Losses

C. Buyer's Conditions to Close

1. Representations

2. Performance

3. Pending Matters

4. Execution and Delivery of the Closing Documents

5. Adjustments

6. Casualty Losses

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7. Financing Out

D. Remedies for Breach of Condition to Close

IV. Post-Closing Covenants

A. General

1. Removal of Signs and Markers

2. Further Cooperation

3. Taxes

B. Non-Solicitation of Employees

V. Hart-Scott-Rodino Antitrust Improvements Act

A. Introduction to HSR

B. First Prong of the Test

1. Person

2. Notice

3. Size of the Transaction

4. Oil and Gas Exemption

VI. Termination Rights and Consequences

A. Termination Rights

B. Remedies for Termination

VII. The Use of Materiality Qualifiers

A. The Misuse of Materiality

B. The Use of Materiality

C. Materiality as Defined by Texas Courts

D. Materiality Qualifiers

E. Other Contexts

F. Material Adverse Effect as Defined by Texas Courts

1. Material vs. Material Adverse Effect

2. Material Adverse Effect

3. "Taken as a Whole" Concept

G. Summary of Materiality Qualifiers

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I. Introduction

The period of time between the execution of an oil and gas asset Purchase and Sale Agreement ("PSA") and termination or closing ("Closing") is customarily referred to as the interim period (the "Interim Period"). With respect to the Interim Period, it is customary for PSA's to contain covenants of the parties to do certain things or not do certain things that relate to ongoing ownership and operation of the assets being sold. It is also customary for a PSA to contain conditions of both seller and buyer to close the transaction. A PSA must also address how preferential rights to purchase ("Preferential Rights") and third-party consents to assignment ("Transfer Requirements") will be handled. If government approvals of the transaction are required, that process should be described. In some instances, a PSA will impose post-Closing ("Post-Closing") covenants. Finally, the PSA should establish consequences and remedies in the event of a breach of a covenant or failure to satisfy a condition, including considerations of the performance deposit (the "Deposit") break fee, specific performance and other legal and equitable remedies. For ease of convention, reference will be made herein to a fictional "Seller" "Buyer" and "Transaction." Likewise, hereafter reference will be made to theoretical "Assets" that are comprised of oil and gas leases, wells, facilities and equipment. The following discussion will provide a practical overview of the foregoing.

II. Interim Period Covenants

A. What is a Covenant?

A covenant means a promise, contract or agreement between two or more persons to do something or refrain from doing something. Like any contract, it must have the proper parties, words of agreement that bind them, a legal purpose and be in the proper form. For purposes of this discussion, it will be assumed that the theoretical PSA referenced herein and the covenants and conditions incorporated constitute a binding contract upon Buyer and Seller.

B. Factual Context and Purpose.

The sale of producing oil and gas Assets is the conveyance of an on-going enterprise that requires operations to continue during the Interim Period so the value of the Assets will be maintained until Closing. Existing wells must be attended to, production sold, proceeds of sale received and properly distributed, royalties paid and regulatory reports made. New wells may be drilled or other capital intensive operations take place during the Interim Period as part of the ordinary course of business of Seller. Title must be kept free and clear and otherwise defended. Laws and regulations must be complied with. It is in the best interest of both Seller and Buyer that the Assets be operated in accordance with the standard of a good and prudent operator until the transfer occurs. If the sale closes, Buyer receives what it bargained for. If the sale does not close and Seller retains the Assets, it has preserved them as it would have had no sale been contemplated.

One purpose of covenants is to create an environment in which Seller can act in its own best interest to preserve value of the Assets as it has historically without unwarranted interference by Buyer. PSA covenants are used to create contractual parameters that keep a

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Seller within lines that protect the leases and wells being acquired without subjecting Buyer to diminished value or liabilities after Closing which it does not expect to assume.

Although clever lawyers often use much longer legalese to do the same thing, the parties to the PSA may create a binding contract with the following simple language: "Seller covenants and agrees with Buyer that during the Interim Period, Seller shall [describe what is to be done or not done]."

C. Examples and Content of Covenants.

The following explores the nature and content of Interim Period selected examples of covenants used by sellers and buyers in sales of producing oil and gas Assets.

1. Access to Records.

Most PSAs provide that during the Interim Period Buyer shall have access to Seller's records as part of Buyer's due diligence process, usually both electronically and physically. The scope of what is intended to be included within records should be well-defined. If a certain category of records is not to be made available, Buyer should ascertain whether those records are relevant before agreeing that they are to be excluded. If privileged records are to be excluded, Buyer should confirm that those documents will not be required in connection with operations after Closing or that they do not relate to any assumed obligations. If physical inspection will occur, it is customary for Seller to make the records available to Buyer and its representatives for review at Seller's offices during normal business hours. If the due diligence period time frame requires more access than 8-5 Monday through Friday, Buyer may reasonably request that the PSA expressly provide for the extra hours of access needed. Seller should require that Buyer not have access or rights to review any records that are subject to a privilege, obligation of confidentiality or contractual commitment of Seller to a third person not to disclose. However, if disclosure or access is prohibited, Seller should be required to use commercially reasonable efforts to obtain permission to grant access to Buyer and its representatives so that Buyer may obtain as much information concerning the matter as is possible while still complying with applicable laws and Seller's contractual obligations. PSA's typically provide that Seller shall not be required to make any payments for the benefit of any third person in order to do so. Sellers almost always disclaim any warranty with respect to the records provided and expressly disclaim all representations as to the accuracy and completeness of the records and other information provided to Buyer during due diligence or the transaction process. In drafting, care should be taken to ensure that Seller's representations concerning facts and its disclaimers of accuracy, completeness and reliance set forth in the access to records provision jive rather than conflict.

2. Physical Access to Leases. Wells. Facilities and Equipment.

It is normal practice that during the Interim Period Seller will provide Buyer with physical access to the lands covered by the leases, and to wells, facilities and equipment that are part of the Assets...