The deal risks of a disputed tax bill: Tullow Uganda v Heritage Oil and Gas


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You should read this if you negotiate M&A or joint venture transactions, particularly those relating to emerging markets, or if you negotiate indemnities generally.

Our follow-up report on the Court of Appeal ruling is now available: M&A in emerging markets - don't lose value through the tax indemnity.

The 20 second summary

How might a disputed tax bill affect your next deal? If a local government charges capital gains tax on the transfer of a natural resources asset, who will have to pay it? As buyer, will you have to pay it before the government will approve your deal? Or as seller will you have to pay it to the buyer under a tax indemnity, even though you dispute the tax is payable?

The recent English high court case of Tullow Uganda Ltd v Heritage Oil and Gas Ltd [2013] EWHC 1656 has lessons for both sides. Lessons as to how to approach local government requirements, how to draft tax indemnities and how local law is applied in practice.

The tax issues were well known, but the parties completed without meeting all the government’s requirements

Tullow Uganda Ltd and Heritage Oil and Gas Ltd each owned 50% of a petroleum exploration licence in Uganda. When Heritage sold its interest to Tullow for c$1.5bn, the deal required the consent of the Ugandan Government - and it required Heritage to pay capital gains tax on the deal of c$405m.

When Heritage disputed that tax was payable, the government made its consent conditional on 30% of the disputed tax being paid as a deposit and the balance being secured by a bank guarantee. But when the sale completed, Tullow paid the balance into an escrow account under the control of Tullow and Heritage instead. The government was not satisfied with these arrangements and refused to consent to the sale.

The government required Tullow to pay Heritage’s disputed tax

Heritage disputed that any tax was payable and that dispute continues – with appeals being lodged in the Ugandan high court. However, at the same time, Tullow was issued with ‘agency notices’ – requiring it to pay the unpaid tax on Heritage’s behalf. These were issued under Uganda tax law on the basis that Tullow was in possession of assets belonging to Heritage – principally the monies in the escrow account.

Tullow’s initial local law advice suggested that the agency notices weren’t valid, not least on the basis that Tullow wasn’t in possession of the monies in the escrow account. Accordingly, Tullow was sceptical as to whether it should pay – and, if it did, whether it could recover from Heritage. However, subsequently, it received local law advice that a Ugandan court would more likely than not find that Tullow was in possession of the monies in the escrow account. It paid the tax - and the government approved the deal.

The court held that Tullow could recover the sum paid from Heritage

The court had to determine whether Tullow could recover from Heritage. Much turned on the drafting of the tax indemnity in the sale agreement. It covered any “Non-transfer tax charged any time to [Tullow]” - and caught taxes regardless of whether they were “chargeable directly or primarily against or attributable directly or primarily to the relevant person or any other person and whether any amount of them is recoverable from any other person”.

The court held that:

  • it was not right to limit the indemnity to tax “validly” charged; and
  • it was not appropriate to impose a wholly objective test as to whether it was reasonable to believe that the tax was payable (along the lines of a ‘balance of probabilities’ test).

It found that Tullow could rely on the indemnity because it believed the notices were valid, and that belief was not fanciful or absurd - nor one which no reasonable person in Tullow’s position could have come to.

The court also held that Tullow’s claim was enforceable, even though the sale agreement required Tullow to give notice of ‘tax claims’ – which it hadn’t done - and included conduct of claims provisions which required it to take such actions as Heritage might reasonably request to defend them. However, the court held that giving notice was not a pre-condition of Heritage being liable. It also held that Tullow’s failure to give notice had not caused Heritage any loss - on the basis of Heritage’s actions after it had received notice; and because, under the conduct of claims provisions, Tullow could have relied on an exemption in relation to actions which may adversely affect either its future liability to tax or its business or financial interests.

Key lessons to learn around drafting indemnities, meeting government requirements and how local law is applied

Consider how indemnities should apply to disputed claims

There will always be limits to the ability of standard drafting to deal with any particular issue in the way a party would like. However, one point always to consider is how you want an indemnity to work in relation to disputed claims. Also, when an issue is known about at the outset, any draft wording should be revisited in detail to ensure it works for the particular scenario. In many cases, further tailored drafting will be appropriate - and the way it interacts with other provisions, such as conduct of claims, will need to be carefully considered.

In this case, further drafting was included to give Heritage control over its dispute with the Ugandan tax authorities. However, the court construed that drafting narrowly to cover just the underlying dispute as to whether capital gains tax was payable by it – which Heritage continues to have conduct of.

Take government requirements very seriously

The success of your deal will often be dependent on an overseas government. Their requirements need to be followed in full. In relation to exits from their jurisdiction, they may be draconian in ensuring that they collect their tax dollar.

Do not rely too heavily on the letter of the law

In any jurisdiction, how the law applies can often be ambiguous. But the risks of this are more acute where a piece of legislation is relatively new. When an English court hears expert evidence as to foreign law, what counts is the likely approach of the foreign courts, not the witness’s personal views as to what the law might be.

In this case, the most reliable evidence was that the monies in the escrow account could well be considered to be assets of Heritage that were in the possession of Tullow. That was on the basis that, as a signatory to the account, Tullow had control over when and to whom the monies were paid. Be aware that courts in other jurisdictions may (or may not) come to a similar conclusion.

These lessons remain valid, whatever the final outcome in this case. Uncertainty - and the delay and cost of litigation – can be seriously detrimental, even to the party who wins in the end. In this case, Heritage have sought leave to appeal: we’ll keep you updated.

Our follow-up report on the Court of Appeal ruling is now availableM&A in emerging markets - don't lose value through the tax indemnity.

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