Uganda, UK: Disputed Tax Bills, Consent Matters and Indemnity Claims: Lessons from Tullow v Heritage
15 January 2014
Posted by: Author: Shepherd & Wedderburn LLP
Author: Shepherd & Wedderburn LLP
Tullow Uganda Limited v (1) Heritage Oil and Gas Limited and (2) Heritage Oil Plc  EWHC 1656 (Comm)
In June 2013 the High Court ruled that Heritage Oil and Gas Limited ("Heritage”) was liable to pay to Tullow Uganda Limited ("Tullow”) $313m in respect of payments for tax made by Tullow to the Ugandan government (the "Government”) on Heritage’s behalf. Whether Tullow was right to make such payments, and whether Heritage was due to repay Tullow for them had been strongly disputed. This case provides certain valuable lessons to those involved in natural resources M&A.
Tullow and Heritage each held a 50% interest in a petroleum licence over two Ugandan blocks. In January 2010 the parties entered into a sale and purchase agreement ("SPA”) pursuant to which Tullow would acquire Heritage’s 50% interest in the blocks for a base price of approximately $1.35 billion, with a further $100 million contingent consideration to follow (the"Sale”). Tullow subsequently agreed to a farm-out of two-thirds of its total interest in the blocks to China’s CNOOC and France’s Total SA for approximately $2.9 billion. Completion of the SPA for the Sale by Heritage to Tullow was conditional upon the Government giving its consent.
Under the terms of the SPA, Heritage provided a specific indemnity to Tullow, whereby it agreed that in the event that any non-transfer tax (being all taxes other than stamp duty payable under Ugandan law arising in connection with the SPA, including capital gains tax) was charged to Tullow in connection with the sale, Heritage would pay to Tullow an amount equal to such tax. If Tullow became aware of any such tax claim it was under an obligation to give written notice of the claim to Heritage within 20 business days.
In June 2010, the Ugandan tax authorities issued a tax assessment to Heritage for the sum of $404 million relating to the base price of the Sale. The Government’s consent to the SPA would be granted upon payment of such tax. Heritage disputed that such tax was due, and the Government agreed that it would give its consent to the SPA upon 30% of the disputed tax being paid to the tax authorities as a deposit and the remaining 70% being secured by a bank guarantee.
The parties proceeded to completion of the SPA and the 30% deposit was duly paid by Tullow to the Government on Heritage’s behalf. However, instead of providing a bank guarantee, Tullow paid the balance of the disputed tax into an escrow account in the joint names of Tullow and Heritage with Standard Chartered Bank in London. The Government was not satisfied that payment of the money into the escrow account was sufficient compliance with the requirement to provide a bank guarantee. Accordingly, the Government refused to give its consent to the Sale.
The Government then issued a second tax assessment to Heritage for the sum of $30 million in relation to the contingent consideration payable for the Sale. Heritage appealed against both tax assessments on the grounds that the present capital gains tax regime is different to that in place at the time it signed the initial contract to explore in Uganda. This dispute remains ongoing.
At the same time, the Government issued ‘agency notices’ to Tullow (under a provision of Ugandan tax law which allows demands for payment of unpaid taxes due by a non-resident to be made to any person in possession of assets belonging to that non-resident), which required them to pay the total unpaid balance of the tax demanded on Heritage’s behalf from the funds in the escrow account. The notices stated that they had been copied to Heritage, but Tullow did not itself notify Heritage that it had received the notices.
Tullow initially received Ugandan legal advice that the agency notices were not valid, on the grounds that Heritage’s tax dispute had not been resolved and that the money in the escrow account could not be considered to be in the possession of Tullow, as the agreement of both parties was required to release the funds. Tullow attempted to dispute the agency notices with the Government, but all such attempts were rejected.
The Government then began to assert considerable commercial pressure on Tullow to pay the tax amounts, including refusing to give consent to the Sale until the taxes were paid. This then meant that:
- Tullow were unable to receive any benefit from Heritage’s 50% interest in these blocks, despite having paid approximately $1.45 billion to Heritage for them;
- The proposed $2.9 billion farm out to CNOOC and Total could not be completed; and
The Government also indicated it would refuse to renew any of Tullow’s other exploration licences in relation to blocks in Uganda until the payments for tax were made.Tullow then received further Ugandan legal advice which this time indicated that the Ugandan courts would likely find the agency notices to be valid. Accordingly, in March 2011, Tullow entered into a memorandum of understanding with the Government pursuant to which Tullow agreed to make payment of the sums demanded under the agency notices and the Government agreed to consent to the Sale.
In April 2011 Tullow paid approximately $313 million to the Ugandan tax authorities, and commenced proceedings to recover that amount from Heritage under the tax indemnity in the SPA.
Heritage’s argumentIn defending the action Heritage submitted that, in order for Tullow to be able to rely on the indemnity in the SPA:
i. the agency notices required to have a legal basis and the tax claims being made had to be objectively sustainable, whereas in fact the agency notices were invalid under Ugandan law as per the initial legal advice received by Tullow; and
ii. Tullow required to have a reasonable basis for forming the view that the notices agency notices were valid before making any payment, whereas in fact Tullow had made the payments to the Government with the intention of advancing its own commercial position and without any genuine belief that the notices were valid. Heritage’s contention was that the later legal advice received by Tullow regarding the validity of the agency notices had been contrived in order to justify the tax payment.
In addition, Heritage argued that Tullow did not notify it of the agency notices within the time period set out in the SPA, and as such it had not met the conditions in order to be able to rely on the indemnity.
The court considered the evidence and found as follows:
- there was no call for an objective test to be applied in order to determine whether a claim for tax was within the scope of the tax indemnity in the SPA. Such a test would place an inappropriately heavy burden on the party claiming under the indemnity;
- the taxes did not need to have been validly charged before the indemnity would apply, so long as Tullow believed at the time payment was made that the agency notices were valid, and such belief was not ‘fanciful’ or ‘absurd’;
- at the time Tullow paid the tax, they had received legal advice that the agency notices would likely be found to be valid by a Ugandan court, and as such it could not be said that Tullow’s belief was ‘fanciful’ or ‘absurd’ (and in any event, a Ugandan court would have concluded that the agency notices were valid); and
- the notice provision in the SPA was not a condition precedent to Tullow making a claim under the indemnity. By not giving such notice Tullow had committed only a minor contractual breach. Given that Heritage was already aware of the agency notices, no loss had arisen due to this breach.
Accordingly, the court held that Heritage were liable to Tullow for $313 million pursuant to the terms of the tax indemnity in the SPA.
While this case can be seen to be fact-specific, there are some useful lessons that can be drawn from it. As is common in farm-ins/farm-outs/asset disposals, the completion of the SPA was conditional upon the Government’s consent (and the fact that the parties decided to proceed to completion of the Sale without such consent being granted certainly exacerbated the issues in the case). In transactions of this type, it is not uncommon for the host state to demand payment of taxes, levies or other bonuses before their consent will be granted. In such circumstances, the parties should seek to agree how any such demands are to be dealt with. Purchasers may wish to consider including in the documentation an indemnity from the seller in relation to any such charges or demands (as with the tax indemnity in this case).
However, the case also highlights the need for the drafting of any such indemnities to be clear and unambiguous. Where an indemnity is meant to only arise in certain circumstances or where there are to be limitations on the ability of the indemnified party to recover under an indemnity, this should be set out clearly and expressly in the wording of the indemnity. In addition, thought needs to be given to the situation where the Government’s demand for tax is disputed by one of the parties – is an indemnity to apply in such cases? Again, clear drafting is key to deal with such matters.
In addition, the case demonstrates that, when dealing with matters which require third party consent, care needs to be taken to ensure that any conditions to such consent are met in full. In this case the Government’s consent to the Sale was conditional upon part payment of the disputed tax and the remaining sum being secured by a bank guarantee. Instead of providing such a bank guarantee in relation to the remaining disputed tax, Tullow and Heritage put the money into an escrow account, and accordingly the Government’s consent was refused. Tullow was of course in an awkward position. It wished to complete the acquisition, had an obligation to pay the price due to Heritage at completion and was dealing with a counterparty in Heritage who disputed that the tax demanded was due (and was therefore presumably unwilling to procure the bank guarantee sought by the Ugandan state). However, by seeking to satisfy both the Ugandan authorities and Heritage (by means of the escrow arrangement), Tullow found itself in what could be considered to be an even more awkward position; namely, it had paid over part of the price to Heritage but still had not received Ugandan government consent in respect of the transaction.
Finally, the case acts as a useful reminder as to the necessity of good record keeping. Part of the difficulty the judge had in establishing the facts was that prior to the case, whilst clearing out their office, Tullow’s general counsel had disposed of certain relevant documents. Whilst there was no suggestion that any foul play was involved, and indeed the judge noted that the general counsel was ‘an impressive and honourable witness’, the judge specifically noted the difficulties that had arisen as a result of the partial record keeping.
This article first appeared on lexology.com.