CHAPTER 1 DUE DILIGENCE PROCESS AND ITS IMPACT ON THE DEAL
| Jurisdiction | United States |
(Apr 2010)
DUE DILIGENCE PROCESS AND ITS IMPACT ON THE DEAL
Suncor Energy Services, Inc.
Greenwood Village, Colorado
A. John Davis
Holme Roberts & Owen LLP
Salt Lake City, Utah
ALEX RITCHIE is the Senior Corporate Counsel for Suncor Energy (U.S.A.) Inc., based in Green-wood Village and Commerce City, Colorado. Alex joined Suncor in September, 2009, after almost 10 years in the Corporate and Energy and Natural Resources groups at Holme Roberts & Owen LLP, where he made partner in 2006. Since joining Suncor, Alex has focused on acquisition and divestiture transactions, including recent divestitures by Suncor of its U.S. upstream oil and gas assets, as well as other contract matters, environmental matters and retail operations. While at Holme Roberts & Owen, Alex focused on representing oil and gas, mining and renewable companies in mergers, acquisitions, divestitures, joint ventures, and financing transactions as well as operational and securities matters. Alex has taught and written on a number of topics involving joint ventures and mergers and acquisitions, and is currently on the drafting committee of the Rocky Mountain Mineral Law Foundation for the development of new Form 5 LLC forms. Alex is a former Certified Public Accountant and listed as a Colorado Super Lawyers Rising Star.
A. JOHN DAVIS III, a partner in the Energy and Natural Resources Practice Group, joined the Salt Lake City office of Holme Roberts & Owen LLP (HRO) in 2008. Prior to joining HRO, Mr. Davis served on the Board of Directors and as President of Pruitt Gushee, a Salt Lake City Natural Resources law firm. Mr. Davis has over 25 years experience in the areas of oil, gas and mining, environmental law, public lands, real estate and associated litigation. He has a broad range of experience representing clients in natural resources related and real estate transactions, and in environmental due diligence, compliance and permitting matters. Mr. Davis assists and counsels natural resource clients in acquisition financing, access, operational and environmental permitting and compliance matters on federal, Indian tribal, private and state lands as well as NEPA compliance, land exchanges and mineral property development. He has also represented the State of Utah in large land exchange and natural resources development matters and county governments on access, wilderness and other public lands issues. Mr. Davis has extensive experience in complex natural resource, environmental and public lands litigation, including CERCLA (Super-fund) and hazardous waste litigation, and in defending or prosecuting civil cases for oil and gas, mining, and business clients. John frequently practices before the Federal and State Courts in Utah and surrounding states, and in administrative hearings before the Utah Board of Oil Gas and Mining.
THE DUE DILIGENCE PROCESS AND ITS IMPACT ON THE DEAL: A PRIMER ON BAYONETING THE WOUNDED
Alex Ritchie
Suncor Energy (U.S.A.) Inc.
Denver, Colorado
A. John Davis
Holme Roberts & Owen LLP
Salt Lake City, Utah1
SYNOPSIS
A. Introduction
B. The Acquisition & Divestiture Process in the Twenty First Century
1. The Need for Speed
2. The Auction Type Bidding Process
3. The Impact of the Modern Era - Preparing for Due Diligence Before It Begins
C. Objectives of Due Diligence
1. Assumptions Underlying Bid Values
2. The Purchaser's Future Plans
3. Issues That Affect Deal Terms
D. The Planning Phase
1. The Client Meeting - Considerations in Planning Due Diligence
2. Financial Statement Review
3. Establishing Materiality
4. The Due Diligence Checklist and Request List
5. Expertise and Team Resources
6. Deal Terms
7. Confidentiality and Access
8. Agreement on the Scope of the Review and Timeline
E. The Information Gathering and Review Phase
1. The Process Manager and Team Leaders
2. Collecting and Organizing Information
3. Due Diligence Evidence
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F. The Documentation and Reporting Phase
1. Standards of Documentation
2. Informal Reports of Findings
3. Real Time Reports of Material Findings
4. Formal Due Diligence Reports
G. The Impact of Due Diligence on the Deal
A. Introduction
Early in their career, all natural resources transactional attorneys are faced with their first due diligence assignment. A partner typically calls a green associate to his office, where the associate finds a box of documents sitting on the floor. "I want you to conduct due diligence on the documents in this box," states the imposing partner. "What exactly am I looking for?" asks the eager, yet nervous, associate. "You'll know when you find it," the partner says with a grin.2
In times of more rationale schedules, reasonable billing rates and less client scrutiny of bills and efficiency, an associate could learn diligence by actually doing it, with the partner looking over her shoulder offering wisdom and encouragement until she did know what she was looking for. Although times have changed, many young lawyers reading this paper today likely recall a similar experience, except that the partner today likely would direct the young associate towards a folder containing documents in an electronic data room.
The stresses, tensions and risks associated with due diligence multiply in the context of the big deal - the high-stakes, all-asset, equity and merger transactions. This paper focuses on the due diligence process, particularly in the big deal, where the process can be the difference between a successful and unsuccessful acquisition.3 After introducing changes in the way technology has impacted the due diligence process, this paper provides strategies to navigate the various phases of due diligence: (1) planning, (2) information gathering and review, and (3) documentation and reporting. Before entering law school and undertaking the practice of natural resources law, one of the authors of this paper was an independent auditor.4 As experience necessarily influences an attorney's practice, much of this paper discusses standards and practices applicable to financial statement auditing and how those standards and practices apply to the transactional due diligence process.
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B. The Acquisition & Divestiture Process in the Twenty First Century
1. The Need for Speed
This Special Institute on Due Diligence was inspired by a presentation of the Landmen's Section at the 39th Annual Rocky Mountain Mineral Law Institute in 1993 that the Foundation published in a separate bound pamphlet. Since that presentation, the speed at which information travels has dramatically increased the speed of transactions and, by necessity, the speed at which due diligence is completed.5 Virtual data rooms have made information immediately accessible upon the execution of a letter of intent (or in some cases, upon little more than an expression of an interest). Brokers and business development executives are incentivized to close a deal quickly before the deal dies as a result of cold feet, better bids from competitors, re-trading of the purchase price, overstress on the existing business or operations, market criticism, or the much maligned "deal killer," which can be an unacceptable deal term demanded or refused by the other party or, in some cases, an issue discovered in due diligence. Admittedly, greater care and thoroughness in due diligence has seen a resurgence in response to the U.S. banking crisis,6 but the potential liability for inadequate due diligence has never been greater.7
2. The Auction Type Bidding Process
The use of an investment banker and an electronic data room in an auction type bidding process has become more prevalent in recent years as companies seek to maximize bid values when divesting of assets or businesses. When representing companies planning a divestiture, the authors have sat through a number of "kick-off" meetings with an investment banker who distributes its standard data room information checklist. This checklist may require land, reserve, production, engineering, and operational data, and may even require the provision of an ARIES database that will allow a potential bidder's engineers and analysts to run their own projected cash flow models. Once collected and provided by the seller to the investment banker, these "evaluation" materials and data are used by the investment banker to prepare an offering
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document and to populate an electronic data room. The electronic data room may also contain a proposed purchase agreement drafted by seller's counsel and reflecting the comments of the seller and the investment banker. In the authors' experience, the purchase and sale agreement drafted by seller's counsel likely will be more aggressively seller-favorable than desired by the investment banker. The investment banker will argue that the draft agreement is not "market," and the lawyer will argue that it will be market, after the bidders and their counsel provide their comments.
After distribution of the offering document, bidders that execute a confidentiality agreement usually are then permitted to access the "evaluation" materials and data to prepare their bids. Once bids are submitted with a markup of the draft purchase agreement, the seller evaluates the bids with input from the investment banker and its counsel. Although the investment banker and the business development executives will emphasize price and speed to closing, other executives and seller's counsel may attempt to redirect at least some focus of the evaluation on other factors, such as accuracy and completeness of the assets listed, liabilities to be assumed or retained, the financial strength of the bidder and the bidder's plans for the seller's employees.
Assuming the investment banker has properly eliminated from the process those bidders that are on "fishing expeditions" without a clear investment motive or management...
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