Practical Guide Series on International Oil & Gas M&A – Analysis of Production Sharing Contract Practices and Key Negotiation Points

Who decides whether a discovery qualifies as commercial is itself a negotiation point—options include the resource-holding state, the foreign contractor, or a Joint Management Committee (JMC) jointly formed by both. If consensus cannot be reached on whether a discovery is commercial, does the party asserting commerciality have the right to proceed unilaterally at sole risk? And if so, does the other party retain a back-in right? What conditions must be satisfied to exercise that back-in right (e.g., payment of additional fees)? These are all key negotiation points. 6. Target Resources – Exploration, Development, and Production Resources In some countries, the exploration area stipulated in production sharing contracts (PSCs) is defined with great precision. For example, certain Middle Eastern countries explicitly specify in their PSCs that only hydrocarbon resources discovered within a particular geological formation fall within the scope of exploration, development, and production rights granted to the foreign contractor; any oil or gas discoveries above or below that formation belong exclusively to the resource-holding government. Such contracts are typically adopted by resource-rich countries. I once negotiated a PSC in a Middle Eastern country where the contract expressly stated that only natural gas (including condensate) discovered within a specific geological formation qualified for the foreign contractor’s exploration, development, and production rights; all crude oil or other minerals discovered outside that formation belonged solely to the resource-holding government. 7. JMC – Joint Management Committee The JMC is a decision-making body for major operational matters, jointly established by the resource-holding government (or its national oil company) and the foreign contractor. It holds decision-making authority over work programs, budgets, procurement, litigation, and other significant operational matters. Typically, the JMC comprises an equal number of representatives from the national oil company and the foreign contractor. When multiple foreign contractors are involved, do non-operating foreign contractors have the right to appoint JMC members? The JMC’s decision-making mechanism is also a key negotiation point: should decisions require unanimity, or be made by majority vote weighted according to equity shares? Unanimous consent is more common, yet some PSCs provide that, prior to full recovery of the foreign contractor’s investment, the foreign contractor’s view prevails in case of deadlock; after full investment recovery, the resource-holding government’s view prevails in case of deadlock. 8. Carry – Cost Advance Following a commercial discovery, if the national oil company elects to participate in development and production, it must contribute development costs proportionate to its participation share. However, under certain PSCs, once the national oil company elects participation, the foreign contractor is required to carry (i.e., advance) the national oil company’s share of development costs until hydrocarbons begin flowing. Thereafter, the national oil company repays the carried amount plus interest using its share of produced hydrocarbons. Key negotiation points include the interest rate applied to the carry and the priority order for recovering both the carry amount and accrued interest. 9. Cost Recovery / Production Sharing Ratio This is the most critical negotiation clause in a PSC. The scope and percentage of cost recovery, whether various expense categories bear interest, and the production sharing ratio collectively determine the respective proportions of hydrocarbon products allocated to the resource-holding government and the foreign contractor under the PSC framework—directly impacting both parties’ core interests. Consequently, every percentage point is fiercely contested.

M&A Merger Negotiation Guide

Weibo: Young Lawyers Online Key Negotiation Points in M&A Mergers Theoretically, capital increase-based acquisitions represent cooperation between capital and cash, whereas merger-based acquisitions involve cooperation between capital and capital—making the latter significantly more complex. In practice, the central issue in merger negotiations is determining the equity ownership percentages each merging party’s shareholders will hold in the post-merger entity, as well as the valuation assigned to each merging party’s shareholders’ equity. For instance, suppose Company A and Company B merge: Company A’s registered capital is RMB 10 million, and through due diligence and negotiation, the parties agree to value its shareholders’ entire equity stake at RMB 15 million; Company B’s registered capital is RMB 5 million, and its shareholders’ entire equity stake is valued at RMB 6 million. The total equity contributed to the merged entity thus amounts to RMB 21 million—RMB 15 million from Company A’s shareholders (71.4%) and RMB 6 million from Company B’s shareholders (28.6%). The merged entity’s registered capital equals the sum of the pre-merger registered capitals—RMB 15 million. If this resulting equity split deviates from the pre-agreed post-merger equity structure, a “cash adjustment” mechanism can resolve the discrepancy. For example, if the merging parties had agreed beforehand that the post-merger equity split would be two-thirds for Company A and one-third for Company B, then, given the total equity of RMB 21 million, Company A’s shareholders should contribute RMB 14 million but actually contributed RMB 15 million—over-contributing by RMB 1 million—while Company B’s shareholders should contribute RMB 7 million but actually contributed only RMB 6 million—under-contributing by RMB 1 million. Thus, Company B’s shareholders pay RMB 1 million to Company A’s shareholders as a cash adjustment. As illustrated above, the core issue in merger negotiations is the valuation of each merging party’s shareholders’ equity. Once such valuations are determined, calculating each shareholder’s post-merger equity stake—based on their pre-merger ownership percentage—is straightforward. Therefore, during merger negotiations, the investing party must, based on information obtained during due diligence, negotiate with target company shareholders to determine the equity valuation for each merging party and expressly record those valuations in the merger agreement. As one operational model of equity acquisition, merger-based acquisitions are subject to the same principles discussed under equity transfer acquisitions. Nevertheless, practitioners must correctly grasp and apply its distinctive features. Below, we supplement the discussion with issues specific to merger-based acquisitions: 1. Due Diligence In equity transfer acquisitions, in principle, only the investing party conducts due diligence on the target company, while the target company’s shareholders make disclosures to the investor. In merger-based acquisitions, however, all participating parties—regardless of whether they are investors or targets—must disclose information to, and undergo due diligence by, the other merging parties. 2. Interim Period Oversight In equity transfer acquisitions, only the target company is subject to an interim oversight period, and only the investor enjoys oversight rights—without being subject to oversight by the target company. In merger-based acquisitions, however, both the investor and the target company (indeed, all participating parties) are subject to an interim oversight period, each enjoying oversight rights over the others and bearing corresponding obligations to submit to such oversight.

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