JurisdictionUnited States
Due Diligence in Oil & Gas and Mining Transactions
(Sept 2018)


Christopher S.C. Heasley
Kirkland & Ellis LLP
Houston, TX
David M. Wildes
Newfield Exploration
The Woodlands, TX

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CHRIS HEASLEY is a senior associate with Kirkland & Ellis LLP in the oil and gas asset acquisition and divestiture practice, in Houston, TX. Chris's practice focuses on acquisitions, divestitures, and formation of joint ventures involving energy assets, with a particular emphasis on oil and gas deep-water and unconventional resources. Chris's transactional experience also includes advising clients in connection with the formation of joint ventures and complex joint development projects, farm-out and participation agreements to develop oil and gas properties, oil and gas transportation and gathering agreements, natural gas processing and fractionation agreements, and other commercial transactions.

DAVID M. WILDES is Managing Counsel at Newfield Exploration Company in The Woodlands, Texas, where his primary focus is on acquisitions, divestitures and other oil and gas asset transactions. Previously, Mr. Wildes supported the company's land, operations, marketing, contracts, land administration and seismic teams on various E&P transactions, contracts, matters and disputes. Prior to joining Newfield, David was in-house counsel at Linn Energy, LLC, where he supported the business development group on acquisitions and divestitures and was the lead operations, land and E&P transactions attorney for the Rockies Division, as well as the California, Hugoton, East Texas and Michigan assets. In private practice, Mr. Wildes advised clients on onshore and offshore acquisitions, divestitures and other oil and gas asset transactions, as well as title and diligence matters, at Baker & McKenzie LLP, Thompson & Knight LLP, Wilson & Johnson LLP, and George C. Hippard & Associates, PC. He is Board Certified in Oil, Gas and Mineral Law by the Texas Board of Legal Specialization and is also licensed in Pennsylvania and West Virginia.

I. Introduction

In the negotiation of a typical upstream oil and gas purchase and sale agreement ("PSA"), the title defect mechanics are among the most intensely negotiated provisions since the value being transferred is derived from the value of the oil and gas reserves and the reserves yet to be produced. While the variations of a title defect mechanic are virtually unlimited and such provisions must take into account the negotiating posture, size and complexity of the deal, upstream counterparties have developed a "market" for title defects that takes into account the seller's desire to complete the deal with minimal on-going title liability and the purchaser's desire to have meaningful rights in the event that a title issue is identified and quantified.

Within a PSA, title matters are likely to be addressed in several different sections, including the representations and warranties, conditions to closing, indemnification and title defect mechanics. While "title defects" may provide remedies in a number of different areas within a PSA, this paper will focus on the provisions that commonly appear in the title defect mechanics of a PSA during the "interim period" between the execution date and closing date, along with briefly touching upon the pre-execution diligence and post-closing special warranty protection.

A seller typically provides limited title documentation before the signing of the PSA. It is customary for most title diligence to be conducted during the interim period; however, once the parties have moved into the interim period, the seller will be required to provide copies of all title documentation in its possession, including any previously commissioned title opinions and landmen run sheets. Although records that are covered by attorney-client privilege are carved out from what a seller must provide to a purchaser

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for the overall asset-wide diligence, title opinions are an exception to the carve-out. The purchaser's protection for title issues (other than a special warranty of title included in the assignment or deed) is typically limited to a defect process with notice provided to seller a certain number of days prior to closing. Under this construct, the purchaser has the ability to access and verify title to the assets during the period between signing and closing of the PSA. Subject to agreed limitations, including specified thresholds and deductibles, the purchaser is entitled to a downward purchase price adjustment for identified title defects affecting the assets. Once the defect claim period expires, the seller typically provides no on-going warranties related to title issues (other than the special warranty of title).

II. Representations, Warranties and Indemnification

Although a seller will push for all title issues to be handled in the title defect process, if the purchaser will not be entitled to a downward purchase price adjustment on account of particular title issues discovered during the interim period or known pre-signing, then indemnity protection may be sought. Typically, a PSA provides for indemnity for both "Retained Obligations" and breaches of the seller's representations and warranties. While both may provide post-closing protection for the purchaser because of title issues,2 the seller's indemnity obligations for breach of non-fundamental reps and warranties are customarily subject to thresholds, deductibles and caps along with specified survival periods.3 "Retained Obligations", on the other hand, typically provide dollar one

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indemnity protection for the purchaser. Thus, the purchaser will commonly seek to classify known or threatened liabilities (such as existing litigation related to title issues) as "Retained Obligations". However, to the extent a liability is unknown or the seller will not agree to retain a specified category of liabilities, then the purchaser should consider including a responsive representation in the agreement.4

The representations and warranties can also facilitate and focus further title due diligence efforts and help the purchaser manage its risk exposure in relation to the acquisition. For example, when a seller rejects certain representations in totality or proposes a carve out that makes the representation no longer meaningful for the purchaser, the purchaser may reasonably interpret those revisions as a signal about specific areas to focus its diligence efforts between signing and closing (or prior to executing the acquisition agreement, if possible). One area where this can be particularly troubling is in connection with the typical representation that seller holds title to its surface rights or right of way sufficient to operate the system. Given the typical volume, surface rights are often impractical (or impossible) for a purchaser to diligence the risk prior to closing and, therefore, any carve outs should be limited in nature.

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In addition to indemnity protection and the potential signaling function, the accuracy of the representations and warranties also play a role in determining whether the purchaser is required to close the transaction. As a condition to the purchaser closing the acquisition agreement, it is customary for the seller to "bring down" its representations and warranties (meaning that the accuracy of the representations is confirmed as of the closing). However, this closing condition is nearly always limited by materiality, either to accuracy "in all material respects" or to a breach that causes a "material adverse effect". Following the closing, the purchaser typically has the right to bring an indemnity claim against the seller if the purchaser incurs damages that are attributable to the inaccuracy of any of the seller's representations and warranties not being true and correct as of the execution date or the closing date, irrespective of the materiality qualifiers included in the closing condition; however, in addition to the individual claim threshold and deductible, these claims may be subject to a cap equal to an agreed percentage of the purchase price.5

If title issues are particularly prevalent in a specified deal, the purchaser should be cognizant of any post-closing waivers of title issues generally, which is often pushed by sellers.6

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III. Pre-Execution Diligence

As previously discussed, prior to signing the PSA, a seller will not typically provide back-up title documentation to facilitate a pre-signing review of title in order to (i) limit the period of time during which a purchaser can find potential defects, (ii) prevent discoveries that could lead to changes to the unsigned PSA and or delay its signing and (iii) maximize confidentiality should the deal never be signed. However, this does not mean that a purchaser should not conduct pre-signing diligence to get a general level of comfort with the proposed lease and well exhibits. Depending on the purchaser's analysis as to the probability that the deal will be signed, purchaser may begin discretely reviewing record title. Further, in order to assess and allocate value, a purchaser should confirm that the proposed exhibits tie to their internal geodatabase models and projections.

In addition to reviewing the exhibits and schedules to identity any red flags or inconsistencies with the purchaser's model, a purchaser should provide a thorough due diligence checklist to the seller and confirm that all requested items are received. A sample due diligence checklist is attached hereto as Annex A. To the extent that a seller does not or cannot provide the relevant documentation, such lack of information should be taken into account in the definitive documentation.

IV. Definitive Documentation Provisions

Given that a purchaser's title protections are generally limited to the interim period and is clearly...

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