CHAPTER 5 ORGANIZING AND EXECUTING EFFECTIVE DUE DILIGENCE . . . QUICKLY!
| Jurisdiction | United States |
(May 2006)
ORGANIZING AND EXECUTING EFFECTIVE DUE DILIGENCE . . . QUICKLY!
Law Offices of Allen D. Cummings
Houston and San Antonio, Texas
Randy Brown
Haynes and Boone, L.L.P.
Houston, Texas
ALLEN D. CUMMINGS
Mr. Cummings focuses his practice on energy transactions and energy litigation. He has practiced law in the energy arena, in corporate legal departments and in private practice, since 1975. He is board certified in Oil, Gas and Mineral Law by the Board of Specialization of the State Bar of Texas. Mr. Cummings has represented producers, large and small - onshore and offshore, in all aspects of exploration, exploitation and production, including title examination, exploration, operating and other participation and sharing agreements, pooling and unitization, production purchases and sales, and financing; represented financial institutions and producers in reserve-based financing and specialized financing vehicles, such as tax credit, net profits and production payment purchases; represented producers and financial institutions in the mediation, arbitration and trial of oil and gas issues; and acted as a mediator solely for oil and gas controversies. He has a J.D. from Southern Methodist University Dedman School of Law, 1974; Order of the Coif; an M.B.A. from the University of Phoenix, 2005; and a B.A. from the State University of New York, 1964. He is admitted to practice in Texas, 1975, and the U.S. District Court, Southern and Eastern Districts of Texas. He is a member of the State Bar of Texas (Past Chair, Oil, Gas and Energy Resources Law Section); Houston Bar Association (Past Chair, Oil, Gas and Mineral Law Section); Houston Producer's Forum; and American Association of Professional Landmen
ROBERT R. (RANDY) BROWN
Randy is the energy land consultant in the Energy Practice Group in the Houston office of the Haynes and Boone law firm. He is a Certified Professional Landman and has over 20 years experience in the energy industry primarily in the land transaction area of upstream and downstream assets and specializes at the firm in designing and executing due diligence programs for acquisition, divestiture, financing and public offering transactions for the firm's clients. He is a past chairman of the AAPL Education Committee and has chaired many continuing education seminars for AAPL and HAPL. Randy is currently the 2nd Vice President of the HAPL. Randy was born in San Antonio, Texas and graduated from the University of Denver in 1976. Prior to joining Haynes and Boone, he was a staff landman for various independent energy companies and has held similar positions with Jackson & Walker and Akin, Gump, Strauss, Hauer & Feld.
TABLE OF CONTENTS
I. INTRODUCTION
II. THE BASIC PARAMETERS OF DUE DILIGENCE REVIEW
III. PRINCIPALS THAT WILL MAKE THE PROCESS MORE EFFECTIVE AND EFFICIENT
IV. HOW THE NATURE OF THE TRANSACTION AFFECTS THE DUE DILIGENCE REVIEW
V. HOW DOES THE CONTRACT LANGUAGE AFFECT DUE DILIGENCE
VI. WHAT HAS TO BE REVIEWED
VII. DOCUMENTING THE DUE DILIGENCE INVESTIGATION
VIII. THE DUE DILIGENCE TEAMS
IX. STAFFING AND ORGANIZING DUE DILIGENCE PERSONNEL
X. THE DUE DILIGENCE MANAGER'S RESPONSIBILITIES
XI. COORDINATION AMONG DUE DILIGENCE TEAMS
XII. HANDLING DEFECTS
XIII. IF THERE IS FINANCING, COORDINATING DUE DILIGENCE WITH FINANCING SOURCE
XIV. PRE-CLOSING, CLOSING AND POST-CLOSING.
XV. SCHEDULING AND OTHERWISE ADDRESSING WITH SHORT TIME FRAMES
XVI. CONCLUSION
I. INTRODUCTION
A well organized and executed due diligence review is a key component to a successful acquisition of oil and gas properties, particularly producing oil and gas properties. It will determine whether there are any factors, such as loss of title, litigation, environmental problems, obligations and liabilities which would have a material adverse impact on the assets that a Buyer, investor or lender should know about. It also serves to verify the basic business, economic and operational assumptions a Buyer has made to determine the value the assets will have to the Buyer and the purchase price a Buyer is willing to pay for those assets.
The basic structure of the due diligence review will be determined by the nature of the transaction, the provisions of the Purchase Agreement, if there is one, and the issues that arise as the due diligence process progresses. Due diligence is an organic process and its course and scope can change as more information about the properties under review becomes available. These factors will play a role in how smoothly the process will go, how long it will take, and how much it will cost.
An effective due diligence review cannot be accomplished by simply pulling out copies of old due diligence checklists and forms and distributing them to the due diligence team. Although that may be a good place to start, an effective due diligence review will include custom made, continually changing checklists designed specifically for the transaction. They will address the relevant issues unique to that transaction. A successful due diligence review must also include the right people, the right goals and objectives, and the right processes to achieve those goals and objectives. These elements require a sophisticated knowledge of the principals and fundamentals of due diligence.
Conducting the due diligence review is usually a daunting task and there must be a well thought out plan in order to assemble, report and evaluate all of the issues that are significant for a successful transaction. This article will outline and discuss the general parameters of a due diligence review in the context of the acquisition of upstream oil and gas properties from the Buyer's perspective. It also covers the general elements of an acquisition due diligence review and will cover among other things, how the nature of the transaction and the contract language affects the review, what has to be reviewed, handling defects, due diligence team responsibilities, and scheduling and otherwise dealing with short time frames.
There is never enough time or enough people to accomplish a "perfect" due diligence review. Success is measured by how well the due diligence plan and the teams adapt to changing requirements and how well resources are allocated to accomplish as many of the goals and objectives as possible, within the time allotted.
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II. THE BASIC PARAMETERS OF THE DUE DILIGENCE REVIEW
Before we can begin designing and planning the due diligence review, we need to know some basic information about the transaction. The following information will constitute the basic parameters of the transaction and will constitute a good first list of questions to ask. This information should be continually developed throughout the review process.
A. Name of the Seller
B. The nature of the transaction (asset or stock transaction)
C. List of properties and their allocated values
D. Seller's relationship to the properties (e.g. Operator, Non-Operator, Owner, Agent)
E. The nature of the specific properties (what kind of properties are they and where are they located?)
F. Buyer's relationship to the properties. (will Buyer take over operations, own a working interest or a royalty interest or a fee interest?)
G. Anticipated Closing date
H. Deadline when title and environmental defects must be asserted
I. Other critical dates in the Purchase Agreement
J. Contact list of seller's key personnel in each area of review.
III. PRINCIPALS THAT WILL MAKE THE PROCESS MORE EFFECTIVE AND EFFICIENT
The following are principals that when applied will make the due diligence review process more effective and efficient.
A. There should be a clear allocation of responsibilities among the participants. This allocation should be in writing. This written allocation of responsibilities will help reduce duplicative efforts.
B. Review procedures and responsibilities regularly and modify as appropriate. The due diligence process is not static and success will go to those who are able to adapt to changing circumstances most efficiently.
C. Establish written procedures for sharing information. It will not happen automatically.
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D. Gather information on the results of due diligence in a uniform format, which is easy to read and understand.
E. Team leaders must work closely together at all stages. Relevant issues must be shared. Oftentimes issues material to one team are discovered by the inquiries by the other teams.
F. Communicate significant issues immediately as they may have an impact on the negotiations and may cause the transaction to be restructured, or terminated.
G. Follow good due diligence etiquette with seller's personnel. You will gain more information and quicker access to information if you are friendly and cooperative. Due diligence personnel are charged to gather information and should not usually be adversarial.
IV. HOW THE NATURE OF THE TRANSACTION AFFECTS THE DUE DILIGENCE REVIEW
The nature of the transaction, the nature of the properties, the nature of Buyer's relationship to the Seller and the nature of Buyer's relationship to the properties has a direct affect on the due diligence review.
A. Asset transaction versus stock transaction
Generally, an asset purchase will provide for adjustments to the purchase price for individual title defects where a stock purchase will only provide for adjustments for matters that have a "material adverse effect" on the total value of the assets or the company. Also, liabilities in an asset acquisition can be allocated in varying ways between the Buyer and the Seller, while generally all liabilities are assumed by the Buyer in a stock transaction. Although the general nature of the review is very similar, the scope, depth and limitations of the due diligence review can be quite different.
B. Nature of the Properties
Each type of property, by its nature and...
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