NEGOTIATING LOAN AGREEMENT COVENANTS IN OIL & GAS TRANSACTIONS. ABA Spring Business Law Meeting Loan Documentation Subcommittee

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1 NEGOTIATING LOAN AGREEMENT COVENANTS IN OIL & GAS TRANSACTIONS ABA Spring Business Law Meeting Loan Documentation Subcommittee Tom Pepevnak, Partner March 22, 2012

2 Commonly Negotiated Covenants Acquisitions Dispositions Borrowing Base Financial Other Related Covenants 2

3 ACQUISITIONS Review purchase and sale agreement to ensure acquisition will not violate restrictions of loan agreement Confirm, if necessary, with agent / lender how the loan agreement will treat the acquired assets 3

4 COVENANTS Review negative covenants dealing with acquisitions and investments Check definitions for: Permitted Acquisitions Investments 4

5 PERMITTED ACQUISITIONS? Discuss with company future needs when negotiating loan agreement: Any limits per transaction or yearly? % Total assets often used as threshold increases as company grows Size of miscellaneous basket 5

6 CAN I BUY IT? FINANCING THE ACQUISITION See negative covenants regarding debt and encumbrances Look for Permitted Debt and related definitions Need to see effect on financial covenants 6

7 PERMITTED ENCUMBRANCES Ensure you have: Oil & gas industry-specific form of Permitted Encumbrance Title defects permitted lien Miscellaneous basket (either % of Total Assets / $ amount) Other laundry list permitted encumbrances 7

8 PERMITTED ENCUMBRANCES eg. Security Interests incurred or created in the ordinary course of business and in accordance with sound oil and gas industry practice in the jurisdiction where the business is conducted in respect of the joint operation of Oil and Gas Properties (or related production) in favour of any other Person conducting the development or operation of the property to which such Security Interests relate for the Borrower s or any Material Subsidiary s portion of the costs and expenses of such development or operation provided such costs or expenses are not due or delinquent or, if due or delinquent, any Security Interests which the Borrower or any such Material Subsidiary shall be contesting in good faith 8

9 DISPOSITIONS Review dispositions negative covenant Depending on facts, may need to check mandatory prepayment provisions, financial covenants, collateral requirements and defined terms 9

10 Definition of dispose Permitted Dispositions Usually an annual percentage (5 10%) of Borrowing Base can be disposed of Ordinary course farm-ins and farm-outs Obsolete properties Sale of products derived from extraction of hydro-carbons 10

11 Are there limits on dispositions based on fiscal year / aggregate amount over the term of the loan? Any prior acquisitions made that affect that disposition basket? 11

12 MANDATORY LOAN (P)REPAYMENTS Provision to prepay loans upon disposition of assets or a recovery event (eg. payment for an insured loss) Mandatory prepayment is usually based on net cash proceeds Check defined terms for Asset Sale and Net Cash Proceeds Exception: Reinvestment of the net cash proceeds in the assets of oil business 12

13 FINANCIAL COVENANTS Like other ABL Agreements reservebased lending agreements tend to have fewer financial covenants Lenders focus on Borrowing Base as source of funds to repay loans Often see Debt to Cash Flow Ratio Watch when EBITDA gets counted (quarter end / time of transaction) for revised pricing 13

14 EFFECT ON SECURITY Conventional Canadian oil & gas lending practice is to take security by way of debenture Different approach than in US and registration of mortgage against individual parcels of land Grant of floating charge in favour of lender over properties, with ability for lender to fix charge by registering against specific properties Check requirements for grant / release of the lender s security interest in real, personal and Crown property 14

15 OTHER RESTRICTIONS Is prior notice to lenders needed? Are officers certificates required? No default / Event of Default 15

16 CONSENTS Depending on facts, you may need: Amendments to the loan agreement Specific consent for the acquisition / disposition Waiver of certain restrictive covenants 16

17 CONCLUSION Oil & Gas Transactions affect more terms in loan agreement than appear to be affected at first glance Ensure you thoroughly review loan agreement to see impact of acquisition / disposition 17

18 Questions? 18

19 THANK YOU Tom Pepevnak Partner Calgary