CHAPTER 5 DUE DILIGENCE FOR CORPORATE TRANSACTIONS

• Jurisdiction: United States

Due Diligence in Oil & Gas and Mining Transactions
(Sept 2018)
CHAPTER 5
DUE DILIGENCE FOR CORPORATE TRANSACTIONS
Matthew S. Thompson
Resource Capital Funds
Denver, CO
Mark C. Bussey
Davis Graham & Stubbs LLP
Denver, CO

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MATTHEW S. THOMPSON is the Staff Counsel at Resource Capital Funds (RCF), a private equity group based in Denver that invests exclusively in the mining sector. Since its formation, RCF has made investments in mining projects in 51 countries and across 29 commodities. Matt has been with RCF since 2016. As Staff Counsel, Matt assists RCF's investment professionals with all aspects of legal work related to potential investments and ongoing management of existing investments. He is involved in all stages of the investment process, from term sheets to due diligence and negotiation of transaction documents. Prior to joining RCF, Matt was an Associate Attorney in the Corporate Finance & Acquisition Group of Davis Graham & Stubbs LLP, a Denver law firm. While at DGS, Matt represented clients across a range of industries in M&A, investment and capital markets transactions. Matt specialized in corporate and securities law, mergers and acquisitions, financing, and commercial transactions. Since joining RCF, Matt's focus has been exclusively on transactions in the mining industry. Matt is a graduate of the University of Denver Sturm College of Law, receiving his J.D. in 2009. Matt attended Georgetown University for his undergraduate studies, and has spent two years living abroad, in England and Spain. He is licensed to practice law in Colorado.

MARK C. BUSSEY is a partner in the Finance & Acquisitions Group of Davis Graham & Stubbs LLP in Denver. Mark's practice focuses on mergers and acquisitions, private equity, joint ventures and financings, and securities in a broad range of industries, including oil and gas, mining, financial services, real estate, hospitality, and technology. Mark joined Davis Graham after practicing for three years in the corporate department of Simpson Thacher & Bartlett LLP in New York. A significant portion of Mark's practice involves the representation of public and private companies in structuring, negotiating, and documenting mergers, acquisitions, dispositions, carve-outs, recapitalizations, and reorganizations. Mark also has extensive experience representing private equity sponsors and other private equity investors in acquisitions, investment transactions, and financings, including in connection with leveraged buyouts and minority investments. His practice in this area includes joint venture work, with an emphasis on structuring joint venture arrangements and negotiating limited liability company operating agreements, partnership agreements, and other forms of joint venture agreements. Mark has been recognized as an Emerging Leader by The M&A Advisor and named in The Best Lawyers in America by Woodward/White for Mergers and Acquisitions Law. About Davis Graham & Stubbs: Davis Graham & Stubbs LLP, one of the Rocky Mountain region's preeminent law firms, serves clients nationally and internationally, with a strong focus on corporate finance and governance, mergers and acquisitions, natural resources, environmental law, real estate, and complex litigation. Davis Graham lawyers have extensive experience working with companies in the energy, mining, technology, hospitality, private equity, manufacturing, asset management, and aviation industries. As the exclusive member firm in Colorado for Lex Mundi, the world's leading network of independent law firms, Davis Graham has access to in-depth experience in 100+ countries worldwide.

I. Introduction; Scope of Paper

In the natural resources sector, asset acquisitions are fairly common. Oil and gas companies are always looking to gain acreage and to acquire new opportunities for production and to expand reserves. Mining companies also need to acquire exploration assets in order to expand and to replace depleted reserves. While asset acquisitions are common, and in many cases can be significant transactions, the scope of due diligence required to complete these transactions is typically focused on the assets themselves.

By contrast, corporate acquisitions, in which a purchaser acquires a whole company through a merger or equity purchase, are more involved from a due diligence perspective. This paper focuses on a broad scope of legal due diligence that is conducted in connection with the acquisition of an entire company, rather than the purchase of discrete assets. In a corporate acquisition, the purchaser is worried not just about the value and potential liabilities related to particular properties, but also the obligations, debts and liabilities of the target company as a whole, which will be directly (in the case of a merger) or indirectly (in the case of an equity purchase) inherited by the purchaser at closing. In this sense, a corporate acquisition is riskier than an asset purchase, as a purchaser can leave behind debts and liabilities of the seller in an asset purchase but cannot typically do so in an acquisition of the whole company.¹

The key to effective legal due diligence is to ensure that the lawyers involved in the due diligence process understand their client's industry, the market generally, and the key objectives of the client in the due diligence review.² Of these, perhaps the most important for young lawyers conducting due diligence is to understand the client's objectives in the transaction and to understand the purpose of due diligence-broad goals which can often be overlooked by junior lawyers. Generally, the purpose of due diligence is (1) to validate the purchaser's proposed valuation (by identifying previously unknown liabilities), (2) to assist the purchaser with identifying potential issues in operating the business post-closing, and (3) to identify issues that may require changes to the structure or terms of the deal itself.³

Legal due diligence in corporate transactions involves a wide array of topics for review and many complexities to be considered within each category. This paper is not intended to address all potential areas for review or present all considerations associated with a given topic; rather, it is intended to highlight primary subjects that should be reviewed in a typical corporate acquisition and to identify certain key points of analysis within each area of review. We intend for this discussion to be a starting point. As such, our hope is that this paper will provide a useful baseline for establishing review parameters in areas in which a corporate lawyer will typically have more familiarity, such as review of material agreements, and a big picture overview of certain topics where a corporate lawyer will want to

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involve specialist expertise, such as review of employee benefit plans and target company insurance arrangements.

This paper focuses on laws applicable to a target company that is organized and operates in the United States. Our discussion is also generally oriented towards legal due diligence in the context of a privately-owned target company. In a public company acquisition or investment, the purchaser can, and as a preliminary matter should, review publicly available information, including target company filings with the U.S. Securities and Exchange Commission (SEC), audited financial statements, reserve reports, legal opinions, etc. These materials typically allow the purchaser to identify material aspects of, and potential concerns with, the target business, such that the purchaser can often better orient and streamline its review. Of course, there is no guarantee that a target company's publicly available materials will contain all material information pertaining to the target business, and accordingly the purchaser should take care to ensure that it is identifying and understanding gaps that may exist in the target company's public disclosure.

The core topic of this paper, specific areas for due diligence in corporate transactions, is addressed in Part II. The areas discussed consist of corporate due diligence, real estate, liens, judgments and litigation, debt obligations and guarantees, material agreements, related party transactions, employees and employee benefits, intellectual property, insurance, and permitting and ESG matters. Part III of this paper addresses "reverse" due diligence and due diligence for minority investments, both of which are specific contexts for legal due diligence distinct from the purchaser's review in a corporate acquisition.

II. Specific Due Diligence Areas

A. Corporate Due Diligence

Corporate due diligence is a key area of focus for any corporate acquisition or investment transaction, whether the transaction occurs through a merger, equity purchase or purchase of all or substantially all of a target company's assets. In these transactions, the purchaser acquires all of the assets and assumes all of the liabilities of the target company, other than assets and liabilities that are specifically excluded as part of a negotiated transaction. For that reason, it is important for a purchaser to understand what obligations and liabilities it is assuming in a corporate acquisition of mineral rights or properties. The following are the principal areas of review for corporate due diligence.

Organizational Documents

Corporate due diligence typically starts with a review of the target company's organizational documents (its certificate or articles of incorporation and bylaws, in the case of a corporation, or its certificate of formation or articles of organization and operating agreement, in the case of a limited liability company (LLC)), as these establish the company's existence and outline the fundamental terms by which the company is governed.⁴ In the case of limited liability companies, members are granted substantial flexibility to structure their relationship with each other and with...