CHAPTER 5 ACQUISITION FINANCING AND M&A TRANSACTIONS - WHAT YOU NEED TO KNOW AS A BUYER AND AS A SELLER

• Jurisdiction: United States

Oil & Gas Agreements: Purchase & Sale Agreements
(May 2016)
CHAPTER 5
ACQUISITION FINANCING AND M&A TRANSACTIONS - WHAT YOU NEED TO KNOW AS A BUYER AND AS A SELLER
John M. Grand ^*
Partner
Vinson & Elkins LLP
Dallas, TX
David W. Wicklund ^*
Partner
Vinson & Elkins LLP
New York, NY

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JOHN M. GRAND is a partner in the Dallas office of Vinson & Elkins LLP. His practice focuses on energy transactions, private equity investments, and mergers and acquisitions. John has worked on a wide array of transactions in the energy sector, with a particular emphasis on upstream and midstream acquisitions, divestitures, joint ventures, and investments. Recently, John represented Pioneer Natural Resources in its $2.15 billion sale of EFS Midstream, an Eagle Ford Shale midstream company jointly owned with Reliance Holding USA, Inc., to Enterprise Products Partners, and TPG Capital in its $1.8 billion acquisition of natural gas properties in Wyoming's Jonah field from Encana Corporation. He was selected as "Who's Who in Energy (Legal)" by the Houston Business Journal in 2015 and has earned a spot on Super Lawyers' Texas Rising Stars list from 2012-2016. John received a Bachelor of Arts, summa cum laude and with honors, from Centenary College in 2002 and a Juris Doctor (Order of the Coif; Louisiana Law Review) from Louisiana State University Law Center in 2006.

DAVID W. WICKLUND is a partner based in the New York office of Vinson & Elkins LLP. His practice focuses primarily on complex acquisition and leveraged financings. David has experience representing private equity sponsors and their portfolio companies, other public and private borrowers (both investment grade and non-investment grade), and lead arrangers and underwriters in a variety of domestic and cross-border financings, in the context of acquisitions and otherwise. David's experience extends to the areas of syndicated loans, high-yield bond offerings, reserve-based facilities, asset-based facilities, mezzanine facilities, and uni-tranche facilities. He has represented numerous upstream companies on finance matters, including Energy XXI in its $2.3 billion acquisition of EPL Oil & Gas Inc., creating the largest publicly traded independent oil and gas producer on the Gulf of Mexico Shelf and Breitburn Energy Partners LP in a private placement of $650 million of 9.25% senior secured second lien notes. In 2014, David was selected to Super Lawyers' New York Rising Stars list. He received a Bachelor of Arts from Williams College in 2000 and his Juris Doctor from Georgetown University Law Center in 2003.

I. INTRODUCTION

II. THE LEVERAGED ACQUISITION PROCESS FROM START TO FINISH

III. COMMITMENT LETTERS

A. Debt Commitment Letter

1. Type and Amount of Facilities

2. Conditions Precedent

a. Customary Debt Commitment Letter Conditions

b. Consummation of Acquisition

c. No "Material Adverse Effect"

d. Delivery of Financial Information

e. Delivery of a "Bank Book" or Offering Memorandum

f. Other Miscellaneous Conditions

3. Syndication Related Provisions

a. Scope of Syndicate

b. Syndication Assistance

4. Terms of the Facilities

B. Equity Commitment Letters

1. Commitment

2. Conditions to Funding

3. Right of Seller to Enforce the Equity Commitment Letter

4. Direct Pay Rights

5. Other Provisions

C. Guaranties

IV. ACQUISITION AGREEMENT MECHANICS

A. Representations and Warranties

B. Financing Covenants

1. Buyer Financing Covenant

2. Seller Financing Covenant

C. Timing of Closing

D. Financing Conditions, Funding Conditions, No Financing Conditions

E. Termination Provisions

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V. OTHER ISSUES

A. Commodity Hedging

B. Xerox Provisions

VI. CONCLUSION

I. INTRODUCTION

Private equity and other financial investors (which, for purposes of this Article, are referred to as "Funds") raised a record $56.9 billion earmarked for energy transactions in 2015, capping an unprecedented five-year stretch during which Funds raised over $300 billion to invest in energy and other natural resources.¹ In order to achieve desired financial returns, Funds often combine debt financing with equity capital to execute leveraged acquisitions. This leveraged acquisition model has been successfully deployed by Funds for decades, and all signs point to the trend continuing.

II. THE LEVERAGED ACQUISITION PROCESS FROM START TO FINISH

The leveraged acquisition process is a natural evolution of two competing desires--the seller's desire for deal certainty and the Fund's desire to maximize returns. Funds generally enter into acquisition agreements using a shell entity as the buyer. Because the buyer has no assets, the seller would have limited to no recourse against the buyer and the Fund in the event the buyer fails to close or otherwise breaches the acquisition agreement. To protect against this risk, the seller will typically request financial assurances from the Fund. Financial assurances come in the form of either a guaranty from the Fund or commitment letters.

In smaller transactions, a Fund may be willing to backstop the buyer's obligations under the acquisition agreement through a guaranty. However, in most instances the Fund will not be able, or willing, to provide a full backstop. The Fund's partnership agreement may restrict or limit the Fund's ability to provide a guaranty. Additionally, some Funds have internal policies that limit or prevent the Fund from providing a full guaranty. In the transactions in which a Fund does provide a guaranty, the Fund will typically limit the scope of the guaranty to only cover a fixed amount of damages in the event the buyer fails to close or otherwise breaches the acquisition agreement.

Although a guaranty is useful, it does not ensure the buyer will have the funds necessary to close the acquisition agreement. The buyer generally demonstrates its financial wherewithal by providing the seller with (i) a debt commitment letter and (ii) an equity commitment letter. The debt commitment letter evidences the lender's commitment to provide the buyer with debt financing at the closing of the acquisition agreement, and the equity commitment letter evidences the Fund's commitment to provide the buyer with equity financing at the closing. If structured

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properly, the gross proceeds contemplated by the debt commitment letter and the equity commitment letter will equal or exceed the total proceeds necessary for the buyer to satisfy all of its obligations under the acquisition agreement.

III. COMMITMENT LETTERS

A. Debt Commitment Letter

The debt commitment letter is a commitment from a lender or a group of lenders to provide debt financing to the buyer for a specified purpose on agreed terms. While the financing is often syndicated to other financial institutions, if market or other conditions prevent syndication, the lenders providing the commitment are responsible for providing the financing themselves. This gives both the buyer and seller comfort that funds will be available to consummate the acquisition at closing and allows the parties to move quickly towards signing the deal without the distraction of assembling a bank group or marketing bonds. The debt commitment letter also functions to establish a baseline for the financing terms prior to the negotiation of long-form documentation. This allows the buyer to model the "worst-case" financing scenario in deciding whether to pursue a deal. The financial institutions providing the debt commitment letter and underwriting the debt financing are compensated with economics, which are typically set forth in a separate fee letter.

Like any agreement, debt commitment letters vary widely from one to another in complexity and detail. Most debt commitment letters, however, will at least include the following: (i) a description of the type and amount of facilities the lenders are committing to provide to the buyer; (ii) conditions precedent to funding the facilities; (iii) syndication assistance provisions, if applicable; and (iv) a description of the terms of the committed facilities.² A debt commitment letter will also typically include relatively "boilerplate" titles and roles, confidentiality, indemnification, and expense reimbursement provisions, among other things.

1. Type and Amount of Facilities

Debt commitments relating to acquisitions of upstream oil and gas assets typically include a commitment for a revolving, reserve-based facility ("RBL"), which is drawn by the buyer at closing to finance the acquisition and is thereafter available to support the buyer's working capital needs. Debt commitments executed in connection with larger oil and gas acquisitions in recent years have also often included a commitment for a second lien term facility or, if a portion of the acquisition financing will include high-yield bonds, a bridge facility. The inclusion of these facilities was premised on the assumption that the acquired assets could support debt incurrence beyond the typical reserve-based loan. Given the losses suffered by many investors in connection with recent hydrocarbon price declines and increased regulatory scrutiny of energy loans, whether these facilities will remain viable financing options for Funds remains to be seen. In any case, in reviewing this section of the debt commitment letter, both the buyer and seller should take care to confirm that the amounts available at closing under the debt

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commitment letter, together with the amount of equity funding, are adequate to meet the buyer's closing date cash needs.

2. Conditions Precedent

A critical part of any debt commitment letter is the conditions that must be satisfied by the buyer prior to the performance of the lenders' funding obligations. In many cases, the acquisition agreement will not include a financing condition. Because the failure of a financing condition in a debt commitment letter excuses the...