Triple Threat: Due Diligence Pitfalls for the Buyer, Seller, and Financier This webcast will begin promptly at 12:00 PM EST Follow Steptoe & Johnson on Twitter: @Steptoe_Johnson ALSO FIND US ON http://www.linkedin.com/companies/216795 http://www.facebook.com/steptoe.johnson 2016 Steptoe & Johnson PLLC. All Rights Reserved.
Today s Presenter Andrew S. Graham Member Morgantown, WV andrew.graham@steptoe johnson.com 304 598 8161
There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.
Due Diligence In due diligence, the buyer (or lender) reviews the assets and liabilities of the seller (or borrower) in an effort to determine whether the information used to make the original deal (the PSA or the financing arrangement) was accurate and whether the new information still supports going ahead with the deal
Due Diligence First questions: Who is the seller entity? You might think that this is an easy one, but sometimes it isn t Who is the buyer entity? Ditto What s being sold? Assets or the whole company How much is being sold? 100% of what s being sold, or something less?
Due Diligence The type of due diligence used depends upon the nature of the transaction Asset purchase Stock purchase or merger Distressed company or assets Often has shorter time frame; may require third party or court approval Secured loan Equity financing
Due Diligence Due diligence can include a wide variety of inquiries: Legal Accounting/Financial Environmental Engineering Geological Marketing
Due Diligence Title For those of us who work primarily in land, due diligence means reviewing the title to the assets We start with the seller s schedule of wells/leases Summaries of WI/NRI The major focus of oil and gas due diligence is verifying that the seller s assertions regarding WI and NRI are correct Many buyers (or lenders) will want to review the title to the assets that account for 80% of the value in the deal Oftentimes, the 80/20 rule comes into play 80% of the value comes from 20% of the assets Only once have I worked on a deal where the buyer/lender in a large transaction asked for a review of every single lease in the deal
Title Opinions Title Scope Leasehold title only? Minerals too? HBP properties? Leases still within their primary term? What do you really want to know about? Once upon a time, folks wanted to know everything about the free gas obligations in the leases. Nowadays, not so much. In the past, folks didn t pay much attention to pooling clauses in PA and WV leases because no one pooled leases for vertical wells. But today, understanding pooling rights is critical.
Title Opinions Title Sellers often have previous title opinions for assets But, do you want to rely on them? How reliable is the examiner? How thorough is the opinion?» You re buying Utica Shale leasehold rights, but the seller s prior opinions are limited to the Clinton Formation And are certified through 9/12/1978 Of course, some sellers have no title opinions These sellers will have the most attractive acreage
Title Opinions Title Prioritizing the work By value? By acreage? Alphabetical by last name? First name? Detail Do you want a title opinion or just a report? Is a general description of defect sufficient or do you need to give the seller as much detail as possible to aid in curative efforts?
Title Opinions Title The search will be like any other title examination Includes a search for Deeds Mortgages/deeds of trust Lis pendens Fixture filings Leases Tax liens Court records the pending litigation search Mechanics liens
Title Opinions Title Non record title matters Farmouts Non consents JOAs Production payments Production calls Balancing agreements Drilling obligations
Material Agreements Material agreements Especially important in asset purchases Generally, unrecorded JOA pref rights Master services Broker s and finder s fee arrangements Agency Vendor Contracts with insiders (sweetheart deals)
Production and Payment Production and payment information Are the leases HBP or just HHBP? The extra H is for hopefully If continuous production is lacking, are there shut in payments? Have the royalty owners been paid? If not, why not? Are the royalty owners unhappy with the way the royalties are calculated? Are you buying your way into the next Tawney or Heritage case?
Environmental Risks Environmental It has been my experience that environmental risks (including the environmental regulatory environment) quash deals more often than title busts The price of a lease is almost always negotiable, but the price of some environmental or regulatory risk is higher than some buyers want to pay
Location of Assets Something that gets overlooked in some deals is the importance of understanding the location of assets in order to conduct due diligence Maps of well locations and lease boundaries are almost always helpful to the due diligence team Often requested, not always received For producing assets, access rights (easements, licenses, etc.) might be just as important as lease terms and title examinations
Review Records Review corporate records Are the parties in good standing? Has the seller kept up with the corporate formalities? This is sometimes an issue with privately held companies Are there consents that must be obtained? Supermajority votes that must be taken?
Other Concerns In the merger/stock purchase setting, some other factors need attention: HR concerns Number of employees; integrating them with new ownership; managing new employees going forward Benefits issues Tax concerns Anti trust (Hart Scott Rodino) Securities laws
Most Important Questions Frequently, the most important questions in due diligence relate to time: When does due diligence begin? When the Letter of Intent is signed? When the PSA is signed? How long does the buyer (or lender) have to conduct due diligence? What s so magical about 60 days? Can we get extra time?
Risk or Defects How do you know if your due diligence has revealed a problem (or risk or defect)? PSA should have defined: Defensible Title Usually defined as threshold amount of WI, NRI, and/or net acreage Permitted Encumbrance Would ordinarily be a problem, but we already know about it and how we re going to resolve it» i.e., mortgages that will be satisfied at closing Material Defect Can you know one when you see one?
How to Deal with Risks or Defects What do you do with the problems (or defects or risks) identified in due diligence? Purchase price adjustment No matter what folks are talking about, they re usually talking about money Can seller (or borrower) fix the problem? How long does seller have to cure? Indemnification Escrow Dispute resolution Arbitration of title defect claims
Advice for Sellers Some advice for sellers Due diligence is not the time to learn about the weaknesses in your assets Valuing your assets for sale means understanding their strengths and weaknesses Be ready to address: Assignment restrictions Notice requirements, pre closing and post closing Make sure the assets have already been moved into the correct seller entity
Advice for Sellers Some advice for sellers Preparing transfer documents Be ready to tackle the ever growing problem of tax ID numbers Buyers and lenders: this goes for you too Recorders and clerks always seem to want this information as part of recordation, but collecting it is often overlooked until the last minute» Some are mineral specific; some are limited to surface It s a buyer s market: don t think you can put lipstick on a pig and get anything other than a pig
QUESTIONS?
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May 2016 Energy Webcast Life Estates in Texas Presented by Zach Gaver May 19, 2016 Invitations will be sent in the coming weeks!
Thank You! Andrew S. Graham Member Morgantown, WV andrew.graham@steptoe johnson.com 304 598 8161
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