CHAPTER 2 DUE DILIGENCE FOR OIL & GAS MERGERS & ACQUISITIONS
| Jurisdiction | United States |
(Apr 2010)
DUE DILIGENCE FOR OIL & GAS MERGERS & ACQUISITIONS
Managing Partner
Burleson Cooke L.L.P.
Houston, Texas
RICHARD L. BURLESON is the Managing Partner at Burleson Cooke L.L.P. in Houston. He has a broad business practice in the areas of mergers and acquisitions, corporate finance and energy. His clients include independent oil and gas companies, private equity groups, senior and mezzanine lenders and other public and privately held businesses in the oil and gas industry. Mr. Burleson's experience centers around structuring acquisitions and divestitures and other M&A transactions, including negotiation and documentation of letters of intent, purchase and sale agreements, equity contribution, subordinated debt, partnership and shareholder agreements, as well as senior secured loan and security agreements.
I. INTRODUCTION.
Due diligence is the critical process required in every transaction in which a potential purchaser undertakes a detailed review and analysis of the assets, liabilities and legal and commercial status of a company and/or its assets it hopes to acquire in order to confirm that it will derive the benefit of the bargain it has entered into with a potential seller. This paper describes in general terms the principal areas of focus that are important to purchasers in connection with transactions involving the definitive acquisition of oil and gas properties or the acquisition or merger with an operating oil and gas company.
A. OBJECTIVES AND BENEFITS OF DUE DILIGENCE.
The overriding goal of due diligence is to ensure that the information relied upon by the purchaser in the deal-making stage of an acquisition is accurate and complete, and that the actual information revealed about the assets or the target company after careful due diligence will support the agreed-upon consideration. An effective due diligence process also enables a purchaser to assess the risks of the transaction and to structure an appropriate purchase price adjustment mechanism into the definitive agreement. The ultimate objective is to help purchasers be certain that the transaction meets their objectives - financially, operationally, legally, and structurally - and to minimize if not eliminate altogether the potential for surprises once the deal is concluded.
In addition to evaluating assets and confirming assumptions used in establishing the purchase price, due diligence enables a purchaser to identify and address title and environmental defects as well as operational and infrastructure complications. Information derived from due diligence is essential for effectively negotiating solutions to identified title and environmental defects as well as providing a baseline for negotiating the definitive agreement, including representations and warranties and related schedules, indemnifications, survival periods, hold-backs, and termination rights.
Practice Tip: Review the Oil and Gas Asset Acquisition Due Diligence Checklist (provided). Although many items may not be applicable - it is a great starting point for organizing the tasks for oil and gas transaction.
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B. DUE DILIGENCE TEAM.
Comprehensive due diligence requires the experience and expertise of a team of professionals having a variety of skill sets required to examine such diverse areas as ownership and corporate structure; facilities; material contracts; accounting; field and site inspections; title and environmental; engineering; and marketing. Due diligence projects are usually conducted by a due diligence team comprised of personnel of the acquiring company, including landmen, geologists, engineers, lawyers, accountants; and marketing personnel, as well as outside consultants including independent landmen, title attorneys and environmental consultants. A team leader, usually a business development professional, is designated by the acquiring company to coordinate the efforts of the various professionals and to report the findings of the due diligence review back to senior members of the management team.
Members of the team have different responsibilities. For example, designated members of the due diligence team having geological and operations experience will typically conduct an evaluation of the assets to be acquired. Usually lawyers or members of the land department conduct litigation and contract review, and oversee any independent due diligence activities such as obtaining title opinions or environmental reports. Landmen also review leases and coordinate surface issues that require attention prior to closing. Outside title lawyers render title opinions or title reports. Either company engineers or independent engineering consultants will review and analyze reserve reports for the wells to be acquired, and the financial professionals will analyze the financial reporting related to the targeted company or its assets. As the due diligence initiative progresses, each group will share the results of its investigations with the team leader.
Often due diligence will begin under the terms of a letter of intent between the parties, executed before completion of the definitive agreement. Therefore, depending on the status of negotiations of the definitive agreement, the identification of due diligence issues discovered early in the negotiations and reported back to the team leader can be critical in structuring the terms of the definitive agreement. At the conclusion of the due diligence process, unresolved issues such as title or environmental defects are assembled, and the appropriate notices are prepared for delivery to the seller which may result in further negotiation or purchase price adjustments that are built into the definitive agreement.
Practice Tip: Formulate, early on, a Working Group and Closing Checklist that identifies all of the members of the due diligence team as well as all relevant parties involved in the transaction, including legal counsel, with detailed contact information. The Closing Checklist should set forth the documents anticipated to be used in the transaction. This exercise serves as a useful roadmap for organizing the due diligence that will be necessary in connection with the transaction.
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A virtual data room is helpful in assembling documents, easily accessible by all throughout the due diligence process.
C. TYPES OF TRANSACTIONS - DUE DILIGENCE.
Different types of transaction and transaction structures require the due diligence team to focus on particular matters or issues. Thus, the process for domestic merger and stock purchases differs from that for asset purchases, which in turn differs for oil and gas production transactions versus transactions involving non-producing or exploratory acreage. Due diligence for cross-border (international) transactions requires yet another level of due diligence to handle the foreign jurisdictional aspects of the transaction. The following is a brief look at the additional review required by these four distinct types of oil and gas transactions.
1. ASSET PURCHASES. In an asset acquisition the focus is directed primarily at the targeted assets to determine such matters as ownership interests and title, existence of encumbrances, status of operations, existence and effect of contracts relating to the assets and environmental liabilities.
2. MERGERS AND STOCK PURCHASES. In addition to the usual due diligence review related to the targeted assets of a company, mergers and stock purchases necessitate the review of corporate governance documents, including stock issuance records, buy/sell agreements, restrictions on transfers, special actions required by stockholders, disclosures and obligations requiring competing bids, securities filing requirements for public companies, and change of control issues in connection with the assignability of contracts.
3. OIL AND GAS TRANSACTIONS. Due diligence requirements related to oil and gas transactions include obtaining accurate lease descriptions and copies of leases; schedules of wells, including the seller's net revenue interest and working interest; reviewing joint operating agreements and participation agreements; verifying the existence of title opinions; identifying the owners of record and burdens on production such as the existence of liens, mortgages, or encumbrances on the property.
4. CROSS-BORDER TRANSACTIONS. The primary concern in cross-border transactions is the differences that exist in various international jurisdictions. Other issues that may be encountered include obtaining governmental consent for the transaction; having the transaction properly filed of record in the foreign jurisdiction; and, in most instances, it is advisable to employ local counsel to assist with the cross-border transaction.
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5. DISTRESSED TRANSACTIONS. The time allotted for distressed acquisitions is often much more compressed than it is for ordinary transactions. It is also more complex and may require subjective analysis. For example, in the course of due diligence the purchaser may need to determine whether there are fundamental flaws in the assets or the business itself or whether there was simply excessive leverage. It is especially important in distressed sales to analyze off-balance sheet contingent liabilities; to determine if key employees will remain; and whether any key intellectual property has been lost due to attrition in the employee ranks.
Practice Tip: It is always important to assemble the schedule of leases and wells as early as possible. But often overlooked is the need to...
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