Comprehensive Guide to Due Diligence Review and Letter of Intent
This comprehensive guide delves into the due diligence review process and the intricacies of crafting a letter of intent in the context of oil and gas property acquisitions. It covers the basic framework, goals, what is not covered, a roadmap of the presentation, available forms, the acquisition and divestment overview, principal instruments like letter of intent, and more.
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DUE DILIGENCE REVIEW: LETTER OF INTENT AND BEYOND
GOALS FOR PRESENTATION A. Basic framework of acquisition and divestment of oil and gas properties B. Letter of Intent and Purchase and Sale Agreement C. Due Diligence Review D. Mechanics and strategy for a successful review
WHAT IS NOT COVERED (AMONG OTHER ISSUES) 1. Tax issues 2. Environmental pitfalls 3. Geological or engineering conclusions 4. Discussion of state specific laws
ROADMAP OF PRESENTATION 1. 1. Overview of Acquisition and Divestment of oil and gas properties Overview of Acquisition and Divestment of oil and gas properties for foundational for foundational purposes purposes 1.Letter of Intent 2.Purchase and Sale Agreement 2. 2. Intro to Due Diligence Intro to Due Diligence 3. 3. Due Diligence Due Diligence clause of Purchase and Sale Agreement clause of Purchase and Sale Agreement 4. 4. Review of records Review of records 5. 5. Compilation of necessary Compilation of necessary reports reports 6. 6. Strategy of review Strategy of review
FORMS AVAILABLE 1) 1) Sample Letter of Intent Sample Letter of Intent 2) 2) Sample Acquisition Title Opinion Sample Acquisition Title Opinion 3) 3) Truncated Purchase and Sale Agreement Truncated Purchase and Sale Agreement
OVERVIEW OF ACQUISITION AND DIVESTMENT A) A) Seller s preparation for sale Seller s preparation for sale 1) Assets 2) Internal valuation of Assets 3) Market the Assets a) Not discussing auctions/bid packages/stock purchases B) B) Buyer s preparation for purchase Buyer s preparation for purchase 1) Decision to acquire oil and gas properties 2) Type of interest, location of properties, specific play 3) Identify marketed Assets fulfilling criteria above 4) External valuation of Assets/Budget
PRINCIPAL INSTRUMENTS 1) 1) Letter of Intent Letter of Intent 2) 2) Purchase and Sale Agreement Purchase and Sale Agreement
LETTER OF INTENT Outlines basic principles of the forthcoming Purchase and Sale Outlines basic principles of the forthcoming Purchase and Sale Agreement Agreement Bare bones of the pending agreement Bare bones of the pending agreement Simply an agreement to negotiate Simply an agreement to negotiate Not terribly exciting Not terribly exciting
LETTER OF INTENT (CONT.) 1. 1. Anticipated Purchase Price Anticipated Purchase Price 2. 2. Basic terms Basic terms A) Percentage of interest conveyed, reservations, etc. 3. 3. In some instances it may allow for review of Seller s documents before In some instances it may allow for review of Seller s documents before finalization of Purchase and Sale Agreement finalization of Purchase and Sale Agreement A) Not routine
LETTER OF INTENT (CONT.) PRACTICE POINT: Use of non PRACTICE POINT: Use of non- -binding language binding language It is understood by the parties that this letter constitutes only a letter of intent and that with the exception of the confidentiality and exclusivity provision set forth in paragraph 14 above, neither neither Seller Seller nor nor Buyer Buyer will will have have any any obligation transaction transaction described described in in this this letter letter until until such such time authorized authorized representatives representatives of of both both parties parties. However, acceptance by the Seller will immediately obligate the parties to act in good faith and with due diligence to negotiate a PSA containing, among others, the terms and provisions set forth above which, when executed by the parties, will constitute the binding agreement by and between the parties. In the event the PSA is is not not executed executed by by both both parties parties on party party may may terminate terminate this this letter letter of of intent, intent, and and neither liability liability to to the the other other party party for for such such termination termination. obligation or or liability time as as the the PSA liability in in connection connection with PSA has has been been executed with the by the the the executed by on or or before before January neither party party will January 31 will have have any 31, , 2016 2016, , either any obligation obligation or or either
LETTER OF INTENT (CONT.) BUYER BEWARE: Do not create a binding agreement BUYER BEWARE: Do not create a binding agreement Do not include all terms that normally appear in a Purchase and Sale Agreement. The closer to a contract, the more likely it will construed as one.
LETTER OF INTENT (CONT.) The buyer should be very careful to recite in the bid that he is making an offer to enter into negotiations leading to a definitive purchase and sale agreement and that the bid is not an offer to purchase the properties. The unsolicited buyer may be forced to make a preliminary offer based on a very limited amount of data. Therefore, he he should should couch couch the the preliminary preliminary offer offer in in very very broad it it is is not not an an offer offer to to purchase purchase but but merely merely an an inquiry to to enter enter into into negotiations negotiations for for a a sale sale. . Therefore, very clear clear that the seller seller would would like broad terms inquiry as terms and as to to whether whether the and make make it it very that like - - Bryant III, Ira H. Stormy , Due Diligence for Oil and Gas Properties: A Home Study Course for Continuing Professional Development, 1994, AAPL
PURCHASE AND SALE AGREEMENT The actual agreement The actual agreement Identify all parties and the properties to be sold Choice of law Indemnification/Representations Allowable encumbrances Valuation of properties (Title defects, allowable in some instances) Upward/Downward adjustments Ongoing operations Effect of Default Closing, Transfer, Form of Conveyance (State and Fed), Post-closing adjustments Due Diligence clause
PURCHASE AND SALE AGREEMENT (CONT.) Must Must be specifically tailored be specifically tailored Purchase Price Cash, Stock, or combination Closing versus Effective date Survival of obligations/warranties after Closing Leasehold only, Wellbore only Ongoing litigation/disputes Litigation versus Arbitration
TOOLS FOR NEGOTIATION 1. Typically start with a form agreement 2. Back and forth of negotiation 3. Redline in Microsoft Word 4. Merge function in Microsoft Word 5. Trust but verify
INTRO TO DUE DILIGENCE 1. Actions a reasonable person/entity would conduct prior to entering into an obligation. 2. A purchaser s comprehensive evaluation in order to establish the value of the assets.
PRACTICAL REALITY 1. 1. Confirm Confirm Seller s Seller s ownership ownership 2. 2. Determine Determine quality quality of of Seller s Seller s Assets Assets 3. 3. Kick Kick the the tires tires 4. 4. Avoid Avoid future i. Avoid buying a lawsuit ii. Knowledge of future curative future costs costs 5. 5. Adjust Adjust Purchase Purchase Price Price
DUE DILIGENCE REVIEW 1) 1) Buyer s review of assets to be acquired Buyer s review of assets to be acquired A) Public Records B) Seller s internal records 2) 2) Dependent on language of Purchase and Sale Agreement Dependent on language of Purchase and Sale Agreement A) Buyer typically charged with knowledge of defects that are normally discovered during due diligence review 3 3. .3 3 Disclaimer Disclaimer. . Seller makes no representation of any kind as to the Records or any information contained therein. Buyer agrees that any conclusions drawn from the Records shall be the result of its own independent review and judgment.
SCOPE OF REVIEW Must rely on the language contained in the executed Purchase and Sale Agreement Must rely on the language contained in the executed Purchase and Sale Agreement Not a one-size fits all proposition Each project is different Oil Patch title is never perfect Oil Patch title is never perfect Acceptable defects versus Major Title Defects Business decisions
SCOPE OF REVIEW (CONT.) Examples Examples of Due Diligence Clauses: of Due Diligence Clauses: Buyer's Buyer's Due review of the Assets (the Due Diligence Period ) for as long as Buyer deems necessary in order to ensure Seller has marketable title to the Assets. Due Diligence Diligence Activities Activities. . Buyer shall be entitled to conduct a due diligence Due Due Diligence Diligence Procedure of twenty (20) business days thereafter (the Due Diligence Period ), Buyer shall have the right to conduct a due diligence examination of the public records and the records of Seller that pertain to the Leases, Wells and Other Assets. Procedure (a) Upon execution of this Agreement, and for a period
SCOPE OF REVIEW (CONT.) Examples of Due Diligence Clauses Examples of Due Diligence Clauses: : 3 3. .1 1. . Buyer's Buyer's Due the execution of this Agreement, Buyer shall be entitled to conduct a due diligence review of the Assets (the Due Diligence Period ). The permissible scope of Buyer s due diligence review shall include, without limitation, confirming (i) the quantum of the net mineral acres, net revenue interest and working interest owned by Seller in the Leases and Wells, (ii) the ownership, title, acreage, and term of the Assets; and (iii) the environmental condition of the Assets. Due Diligence Diligence Activities Activities. . For a period of forty-five (45) days following Purchaser s Purchaser s Due be entitled to conduct a due diligence review of Public Records and Seller s Records for a period not to exceed five (5) business days. Due Diligence Diligence Upon execution of this Agreement, Purchaser shall
SCOPE OF REVIEW (CONT.) We ve got a long way to go and a short time to get there. We ve got a long way to go and a short time to get there. - Jerry Reed, Eastbound and Down
SCOPE OF REVIEW (CONT.) Other important clauses to review Other important clauses to review 1. Permitted Encumbrances 2. Acceptable defects 3. Defects which lead to upward/downward adjustment to Purchase Price 4. Definition of Assets
PERMITTED ENCUMBRANCES Acceptable Acceptable claims claims against against the the Assets Assets Burdens that nonetheless leave the Assets marketable Normal Course of Dealing Easily resolved Don t materially interfere with operation or exploration See also ARTICLE 4 of Truncated Purchase and Sale Agreement for example of Permitted Encumbrances
ACCEPTABLE TITLE DEFECTS Defensible Defensible Title Effective Date and the Closing Date, title to each Asset that is: (i) free of material liens or encumbrances (including, without limitation, mortgages, deed of trusts, security interests, lis pendens and judgment liens), is not subject to a Title Defect as defined in Section 4.1D, below, is deducible from the applicable county records and Seller s business files and, as shown in the aforementioned records and files, is such that a a prudent prudent person person engaged engaged in in the development development and and operation operation of of oil oil and knowledge knowledge of of all all the the facts facts and and their their legal legal significance accept accept the the same same; and (ii) entitles Buyer to no less than a 78.5% Net Revenue Interest ( NRI ) inclusive of Existing Burdens and the Additional ORI reserved by the Seller. Title. . The term "Defensible Title" shall mean, as of the the business business of of the and gas gas properties significance would the ownership, ownership, properties who would be be willing who has willing to to has
TITLE DEFECTS Title Title Defect Defect. . The term "Title Defect" means any lien, encumbrance, claim, and defect in or objection to an Asset, excluding Permitted Encumbrances and the non-defects described in Subsections (1) through (7) of this Section 4.1.D below, that alone or in combination with other defects renders Seller's title to the Asset (i) less less than than Defensible Defensible Title Title, and (ii) reduces reduces the the value value of of the the Asset Asset. See also ARTICLE 4 of Truncated Purchase and Sale Agreement for examples of Adjustments to Purchase Price
ASSETS DEFINED Definition Definition of of Assets Assets will will direct direct scope scope of of review review Leasehold only Wellbore only Blanket conveyance ORI, Net Profits
FORMAT OF REVIEW 1. 1. Formal Acquisition Title Opinion Formal Acquisition Title Opinion 2. 2. Title Memorandum/Title Reports Title Memorandum/Title Reports 3. 3. Informal ownership letter Informal ownership letter ***Regardless of format, ongoing communication is key. ***Regardless of format, ongoing communication is key.
RECORDS FOR REVIEW Seller s Records 1.Prior Opinions 2.Lease and Well files 3.Material Agreements Public Records 1. Office of the County Clerk and Recorder 2. BLM and/or State lease files 3. UCC records, Secretary of State records, County and District Court records, Commission records
SELLERS RECORDS 1.Prior Opinions/Reports 2.Lease and Well files A) Copies of the leases B) Could include curative documents and correspondence C) Division Orders, Revenue Decks, Authorization for Expenditure (AFE), Joint billing, Gas purchase contracts 3.Material Agreements A) Joint Operating Agreements, Exploration, Areas of Mutual Interest, Farmouts, Communitization Agreements, Federal Exploratory Units How good are they? Do they provide enough information? How good are they? Do they provide enough information?
SELLERS RECORDS Always review if available: Always review if available: Exhibit A of Joint Operating Agreement Lands, Division of Working Interest, Parties subject to agreement Area of Mutual Interest Westland Oil Development Corp. v. Gulf Oil Corp., 637 S.W.2d 903 (Tex. 1982). Mountain West Mines, Inc., v. Cleveland-Cliffs Iron Co., 376 F. Supp. 2d 1298 (D. Wyo. 2005), aff d 470 F. 3d 947 (10th Cir. 2006).
SELLERS RECORDS Always review if available: Always review if available: Preferential Right of Purchase Federal Exploratory Unit Agreements Suspense accounts Farmout Agreements
PUBLIC RECORDS 1. Office of the County Clerk and Recorder i. Time to acquire records ii. Update of prior title, or from inception 2. BLM and/or State lease files 3. UCC records, Secretary of State records, County and District Court records, Commission records
PROJECT MANAGEMENT 1. 1. Priorities Priorities 2. 2. Supervision of team Supervision of team 3. 3. Flexibility/Balance Flexibility/Balance 4. 4. Ongoing communication Ongoing communication
PRIORITY LIST Time to complete is usually short Time to complete is usually short Leads Leads to priority list to priority list Some Assets will be more valuable than others Large acquisition concentrated ownership in certain areas/spacing units Focus on what matters Focus on what matters
TEAM MANAGEMENT Prioritize Prioritize your personnel your personnel Areas of expertise Areas of expertise Experienced members reviewing challenging issues Asset priority Asset priority Best team members on high value Assets
FLEXIBILITY/BALANCE Remain adaptable Remain adaptable Every overturned rock will reveal something new Priorities change Finding the appropriate balance Finding the appropriate balance No one wants to be responsible for killing a deal But cannot put your head in the sand Knowledge of Purchase and Sale Agreement
ONGOING COMMUNICATION Major defects/issues Major defects/issues Seller s incentive to resolve defect Purchase Price adjustments Missing documents Missing documents Know where to look Know who to contact Realize what omission could mean
CHECKLIST Creation of a checklist Creation of a checklist Unique each time highlight what is most pressing Due diligence is not a one-size-fits all proposition Avoids duplicative work Accountability/Flexibility
FORMS AVAILABLE 1) 1) Sample Letter of Intent Sample Letter of Intent 2) 2) Sample Acquisition Title Opinion Sample Acquisition Title Opinion 3) 3) Truncated Purchase and Sale Agreement Truncated Purchase and Sale Agreement
OF NOTE Pennaco Energy, Inc. v. KD Company LLC, 2015 WY 152 (Wyo. 2015). Pennaco Energy, Inc. v. KD Company LLC, 2015 WY 152 (Wyo. 2015).
REFERENCES AND QUESTIONS - - Bryant III, Ira H. Stormy , Due Diligence for Oil and Gas Properties: A Home Study Course for Continuing Professional Development, 1994, AAPL Contact Info: Contact Info: Eric Thompson Eric Thompson ethompson@akers ethompson@akers- -lawfirm.com lawfirm.com akers akers- -lawfirm.com lawfirm.com (720) 488 (720) 488- -0835 0835
