ACQUISITION STRUCTURES—PART II STOCK vs. ASSET TRANSACTIONS AND BACK-TO-BACK TRANSACTIONS

• Jurisdiction: United States

Oil and Gas Acquisitions
(Nov 1995)
CHAPTER 2B
ACQUISITION STRUCTURES—PART II STOCK vs. ASSET TRANSACTIONS AND BACK-TO-BACK TRANSACTIONS
James M. Piccone
HS Resources, Inc.
Denver, Colorado

This paper discusses two unrelated topics that can arise in major transactions. In a chronological sense, these are among the first and last issues to be addressed. The first, whether the form of transaction will be by way of asset transfer or stock transaction, has to be settled before one can coherently draft the purchase and sale agreement. The second, looking forward to a follow-on sale, looks toward a relationship that follows, and is dependent upon the primary transaction.

There have been numerous papers written on the subject of choosing whether a transaction should be in the form of an asset or stock sale.¹ The topic is included in this Special Institute's proceedings because of its fundamental nature. What can be offered here is possibly a little variation in perspective on the basic points and a focus on several factors that are unique to oil and gas transactions. Because another paper at this institute will cover the tax aspects of the structure question, however, this paper addresses only the non-tax issues.

The second topic, planning for back-to-back transactions, is growing in significance in oil and gas deals and appears to be unique as a topic for a legal discussion.² In today's world of premium-priced transactions, the buyer often incorporates into its acquisition strategy a plan to dispose of some of the acquired properties.³ What is covered in this portion of the paper are some of the problems that should be considered when a follow-on sale is planned. We also

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include a number of example documents for discussion purposes and as an aid in drafting. The subject is admittedly narrow. Hopefully, the unusual focus of the second topic offsets the more routine nature of the first.

I. STOCK VS ASSET TRANSACTIONS (NON-TAX ASPECTS)

This section covers some of the primary non-tax considerations one should think about when considering whether an acquisition should be structured as an asset acquisition or a stock transaction. A few definitional points should first be addressed, however. For purposes of this discussion, an asset transaction is meant to refer to a transaction where the assets of a target company are exchanged for cash, stock or other consideration. This definition is somewhat different than the tax definition since several forms of stock and merger transactions can qualify as asset transactions for tax purposes.⁴ Nevertheless, for the issues discussed here, the non-tax distinction is appropriate.

A stock transaction, conversely, means any transaction where the target entity ends up owned by, or combined by merger with, the acquiring company or one of its affiliates.⁵ Again, a non-tax definition is useful for the topics covered here. It should also be recognized that merger transactions appear to have features of both asset and stock transactions, but practically are similar to stock transactions in respect of the issues discussed here. For example, in some states all of the assets of the non-surviving corporation in a merger are deemed to be transferred to, or vested in the survivor,⁶ causing the transaction to have a technical structure similar to an asset transaction. However, such transfers occur by operation of law and therefore do not trigger many of the problems one tries to avoid in an asset transaction.⁷ Additionally, the primary negative feature of a stock purchase applies to mergers in that all of the liabilities of the non-survivor are transferred to the survivor.⁸ It is not the purpose here to study the nuances of a merger structure, but merely to point out that a merger is structurally somewhat different than either a pure asset or stock purchase transaction, and this distinction should be kept in mind when considering a merger format.

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A. Prior Liabilities

In a simple asset transaction, the liabilities of the seller are not transferred to the purchaser. Certain liabilities, however, may essentially follow the properties. Thus, statutory environmental liabilities under the Comprehensive Environmental Response Compensation and Liability Act ("CERCLA") and similar cleanup laws arising from the seller's activities on the properties may well become the purchaser's liability.⁹ Certain contract liabilities also may follow the property, such as obligations under operating agreements. However, liabilities separate from the properties or involving third persons, such as for personal injury or property damage, will remain with the seller. For example, liability for personal injury from pollution may not become the purchaser's liability in an asset sale, but the cleanup obligation probably will.

The liability distinction between stock and asset transactions can be altered. For example, a purchaser can lessen the risk of incurring unknown liabilities in a stock transaction by performing thorough due diligence. Also, the distinction between an asset sale and a stock sale is often blurred by contract provisions. In an asset sale involving all of the assets of a company, the seller will likely require the purchaser to expressly assume many of the liabilities that it would in a stock sale. These provisions can be very burdensome and result in an asset sale having essentially the same liability risk as a stock sale.¹⁰ Conversely, in a stock sale, the purchase agreement may contain warranties and indemnities that survive the closing and therefore provide protection to the purchaser against certain liabilities. For example, in a stock transaction it would not be uncommon for the selling shareholders to stand behind a warranty that there were no known undisclosed claims or liabilities. Such provisions can bring the liabilities of a stock transaction more in line with those of an asset transaction.

B. Conveyancing Differences

An asset sale requires the delivery of numerous property, contract and other assignments, deeds and bills of sale. In a large transaction these documents can be voluminous, as well as time consuming and expensive to prepare. In contrast, a stock sale involves the simple transfer of stock certificates. Of course, this also can be a large administrative job if there are many shareholders. In a publicly-held company, shares are acquired through a complex tender offer process that often requires the assistance of a professional transfer agent. A sale of all of a public company's assets also involves a great deal of administrative time and effort through the circulation of proxy materials and the solicitation of a shareholder vote. When a publicly-held company is involved, therefore, a stock transfer is not necessarily more simple from the perspective of conveyancing and related documents.

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C. Preferential Purchase Rights

Preferential purchase rights usually are triggered by a transfer of the relevant property, but not by a stock transaction.¹¹ In the case of the most common preferential purchase right provisions (those found in operating agreements), differing results follow under different forms. Transfers by means of stock sale, merger and sale of all or substantially all assets are expressly excluded from the operations of the preferential purchase right provision in the 1989 AAPL Model Form Operating Agreement.¹² In the 1982 form, however, the exclusion applies differently to mergers and asset sales.¹³ Since one is likely to encounter a variety of forms of operating agreement, the stock transaction format usually offers a clear advantage over an asset sale insofar as preferential purchase rights are concerned.

D. Consents

A stock sale also usually offers advantages in connection with obtaining consents and waivers. Most required consents, such as those found in an oil and gas lease, are triggered by an assignment. Consents are generally not triggered by a stock sale. Some government permits, however, require consent of the applicable agency even in the event of a stock sale. Nevertheless, a stock sale structure will generally allow the parties to avoid the need to obtain many consents.

E. Operating Rights

One major advantage of the stock sale format is the ability to retain operation of the acquired properties. Most operating agreements provide that the operator is deemed to have

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resigned if it no longer owns an interest in the property.¹⁴ There is a deemed resignation in an asset sale therefore, but not in a stock sale. Thus, in an asset sale, there is a risk that the purchaser will lose operations on properties where its working interest or the voting provisions do not give it control of the vote for a new operator. The stock sale structure clearly works better here.

F. Intellectual Property—Seismic

Another advantage of the stock sale is that intellectual property rights under license, such as seismic data and computer software, can usually be transferred without consent of or payment to the owner. This is not always the case, however. Some geophysical and geological companies have very sophisticated license agreements that may terminate the license on a change of control. Again, however, the stock sale format is generally likely to offer advantages over an asset sale when it comes to transferring intellectual property licenses.

G. Undesirable Properties

In the asset form of transaction, the buyer acquires only the properties described in the assignments. This makes it theoretically possible for the purchaser to avoid acquiring an undesirable property without knowing it. Of course, a seller of all of its assets will try to require the purchaser to accept all properties, good and bad, so merely identifying an undesirable property will not necessarily protect the purchaser from having to accept it. The purchaser will, however, at least know what it is getting.

In a stock...