The Best Practices of Leading Energy Lawyers

I N S I D E T H E M I N D S

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Energy Acquisitions and Joint Ventures

Robert A. James Co-Chair, Energy Industry Team Pillsbury Winthrop Shaw Pittman LLP

Energy Acquisitions and Joint Ventures – By Robert A. James

Developing and Transferring Energy Projects and Energy Business Lines

I am a commercial lawyer in a large law firm who advises operating companies as well as investors of all sizes in the energy industry. In this role, my work is divided between the two relatively different functions of counseling on fairly specialized subjects on the one hand, and providing broad-based leadership and support of major transactions on the other.

My transactional practice falls into two general categories. The first is “energy project development,” which is the process of creating new or expanded infrastructure. Working with the client’s personnel and my colleagues in regulatory, tax, and other disciplines, I help establish relationships with host governments, holders of subsoil and surface rights, joint venture participants, engineers, contractors, suppliers, and purchasers of goods and services. Unlike many lawyers working in this industry, I am in the fortunate circumstance of having partners who handle the finance and securities aspects of development, leaving me free to advise on spending money rather than raising it—or worse, having to repay it.

For me, the types of projects under development have historically included oil and gas exploration and production assets, liquefied natural gas terminals, pipelines, refineries, conventional power plants, and transmission facilities. Additionally, my practice includes geothermal and other resource extraction projects and renewable power generation. Recently, I have also been working on a variety of projects using conventional fuels in unconventional, “carbon-conscious” ways—including gasification, coal-to- liquids, gas-to-liquids, and even proposals for carbon capture and storage (geological carbon dioxide sequestration for enhanced oil recovery).

The second general category of my transactional practice, and the substantive subject of this chapter, consists of “energy acquisitions and joint ventures.” These are portfolio movements, from one set of owners to another, for energy industry assets, plants, subsidiaries, divisions, and other business lines.

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“Movements” can include corporate mergers and acquisitions, asset and equity divestitures, and joint ventures and strategic alliances establishing a new entity. Yet this field also covers arrangements that do not require the transfer of legal title to the facilities in question, such as contract joint ventures, operating agreements, processing agreements, and tolling agreements. These often complex transactions shift some or all of the economic risks and rewards to a counter-party while leaving behind certain legal or economic attributes.

Adding Value from the Outside

The energy industry is blessed with highly capable company law departments and savvy entrepreneurs. As outside counsel, I continuously strive to find ways to add value for my clients and to the industry on a number of dimensions.

The first step towards providing that value is to summon the collective experience of my colleagues and myself in a large law firm with in-depth exposure to a wide variety of transactions across energy and other industry sectors, project types, and clients. For example, my handling of construction projects in non-energy fields (e.g., public civil works), and my representation of contractors and investors as well as owners, help me anticipate the counter-parties’ motivations and provide fruitful analogies for me and my energy industry clients.

Second, in many cases I have more service years with the client than anyone else on the current project team. I can therefore help to anticipate the risk tolerance of that particular company’s management team or board of directors. A lawyer’s knowledge that the client’s own chief executive officer in prior purchases flatly rejected offering the seller an environmental indemnity for pre-closing matters will be highly valuable and relevant information for the project team.

Third, I seek to bring to the table knowledge of current market conditions, trends, and expectations of the diverse participants and of the governmental and private third parties whose cooperation or acquiescence is essential. A

Energy Acquisitions and Joint Ventures – By Robert A. James law firm involved in a number of contemporaneous negotiations can advise, for example, what percentage termination or “break-up” fees are now expected, whether an agency will regard change in control of an entity holding a critical permit or license to be an “assignment” requiring consent, or whether a seller in an auction environment is likely to accept a bidder’s deletion of a knowledge limitation in the representations and warranties.

Fourth, the value I can provide comes not only from my individual services, but from my firm’s reputation and networking resources, which we bring to bear for our clients—particularly entrepreneurial ones or those new to a product line or geographical market. Given our reputation and capabilities, the knowledge that we are serving as a company’s counsel helps assure others that any transactions will be conducted in accordance with high standards of quality and integrity. Our experience with other industry participants, and our track record appearing before relevant government agencies, can enhance the profile of a client that has not dealt with such entities in the past. In many cases, we introduce one client to other clients with complementary financing, supply, consulting, or partnering interests, even if we receive no (immediate) monetary benefit from doing so.

Fifth, while most companies are not staffed for the peak intensity required for transactions outside the ordinary course, a law firm is able to bring intense focus, additional lawyers or legal assistants, and efficiently coordinated specialists in a variety of geographic locations.

Only sixth do I come to the value one normally expects of a commercial lawyer, whether outside or inside—that is, the ability to gather and digest the advice of specialists in many complex fields of law, business, and public policy, and then to compile and translate that advice into a compelling description of practical options fully intelligible to project executives. In this manner, the business team can make informed decisions on what risks should be assumed in exchange for which rewards. As decisions are made, commercial law counsel implements them through structuring, drafting, and negotiating the project documents. Rewards naturally need to be secured in a clear and enforceable manner. Risks need to be assumed for consideration, transferred to the other party for a price, transferred to a

Inside the Minds – Published by Aspatore Books third party (e.g., through insurance), or mitigated by one or more parties to reduce the risks of their occurrence in the first place.

Finally, but most importantly, there is the ineffable quality of judgment. Most people associated with a complex transaction will remember the point in time when a critical evaluation or effective argument—or, perhaps, simply the patience to remain silent—has enhanced or protected a company’s position, well over and above any amount of technical knowledge, documentary craftsmanship, and project management skill. Every transactional lawyer strives to make that contribution at that moment.

Energy Sectors and Energy Transactions

There are many methods of breaking down energy transactions, but one useful way is to analyze the distinctive economic and legal aspects of deals within each industry sector. The sectors associated with petroleum—crude oil, natural gas, and products refined or processed from those hydrocarbons—are conventionally divided among upstream (exploration and production), midstream (field processing, pipeline transportation, and marine transportation), and downstream (refining, marketing, and trading). All of these sectors share the characteristic that the end product ultimately is a fungible, storable commodity traded or priced on a market that is global or is constrained by global factors.

The upstream sector is characterized by extensive regulation of operations in the United States, and even more so in countries where the public sector controls resources beneath private property. While there is extensive regulation of production, and complex taxation and cost and revenue allocation issues and structures abound, there is otherwise a considerable degree of competition and contractual freedom among private participants. This sector features large investments that must be borne out over an extremely long period of time. It is associated with a high degree of political risk, not only in the developing world from expropriation, but also in advanced economies through increasing levels of regulation and taxation with potentially enormous impacts on project economics.

Energy Acquisitions and Joint Ventures – By Robert A. James

The midstream sector, compared to the upstream sector, features increasing amounts of commercial regulation and smaller numbers of players in each field. Rates of return are more constrained for existing pipelines, while returns from processing and from construction of new or interconnecting facilities can vary widely depending on bottlenecks, barriers to entry, and the cyclical or volatile demand for midstream products.

The downstream sector resembles the non-energy manufacturing, petrochemical, and distribution industries more closely than do the other energy segments. While safety and environmental factors are important in all segments, they assume considerable economic importance in the design , operation and transfer of oil refinery and marketing facilities. This sector also features its own distinctive regulations dealing with gasoline distribution and the trading of commodities.

Standing alongside the petroleum segments are the electric power generating, transmission, and distribution segments. These segments produce and deliver a commodity that is intensely local rather than global, for which storage is impractical, and the transmission of which can be severely limited by barriers and capacity limits. Traditional investor-owned utilities develop their projects in the heavy shadow of state public utilities regulation. The relatively low rates of return generally encountered in transmission and local distribution favor projects with stable cash flow over a long time horizon. On the other hand, projects developed by independent power producers are heavily driven by the financial expectations, time horizons, and risk aversion of financing parties.

Energy Transactions Are Political Acts

The most common mistake I observe clients making with respect to energy law is failing to consider fully the potential public policy aspects of a transaction, particularly over the life of the investment as economic conditions change. One look at today’s newspaper should be sufficient to convince an investor that actions in the energy industry are also acts in the political arena. Too frequently, public policy and public relations risks are not thoroughly evaluated ahead of time in the investment stage, and are not

Inside the Minds – Published by Aspatore Books transferred or mitigated to the same extent as other project risks. People sometimes analyze the economics of transactions with or depending on the government as if those terms will remain constant in the full range of economic and political scenarios. Clients need to take into account the prospect of political risk—not only in emerging economies, but in the developed world as well.

Keeping Current in Energy and in Energy Law

It is clichéd but critical for transactional lawyers to stay on top of emerging knowledge in the field. As a history buff, I still spend a great deal of time catching up on the fundamentals and history of both the energy industry and the commercial and corporate law disciplines in which I practice.

When I do turn my attention to the cutting edge, I focus both on data and on personal relations. On the business side, I regularly consult industry publications such as Petroleum Economist, Platt’s Oilgram Daily, and Platt’s Global Power Report, among others, and a wide variety of general business publications and Web sites. I also have too many Google and Yahoo! search alerts pushing Internet content to my e-mail inbox. On the legal side, I regularly review California, Texas, and general U.S. court decisions and legislation and keep abreast of regulations and law review articles in my areas of particular focus.

But by itself, knowledge of industrial and legal facts, occurrences, and trends will not deliver projects to the lawyer’s doorstep. “Book learning” is only the price of admission for representation of sophisticated clients. The distinctive keys to success are found in personal networks. First and foremost, each lawyer should be very conversant with the skills, experience, and contacts of his or her law firm or law department colleagues. Next, professional associations, such as the Association of International Petroleum Negotiators and the International Bar Association’s section on energy, environmental, resources, and infrastructure law, also provide incremental contacts and speaking and writing opportunities. I find the optimal setting for presentations and articles is one in which inside counsel, outside counsel, and business decision-makers all can interact. To that end,

Energy Acquisitions and Joint Ventures – By Robert A. James my law firm hosts an annual energy conference encouraging just that type of cross-pollination.

Most enjoyably, conversations with clients, prospects, and other friends help identify practical opportunities and limitations associated with trends spotted in my reading, writing, and networking. Only through such friendships can one assess whether an intriguing economic or legal development has sufficiently complex or important consequences that outside counsel will play a major role in dealing with it.

Energy Acquisitions and Joint Ventures

I turn now to the process of developing legal strategies for success in the acquisition, divestiture, or joint venture of interests in energy industry infrastructure projects and business lines.

I would note first that the internal and external legal resources required for operation of an energy company are not necessarily those needed for a portfolio decision. It is one thing to run a business and another thing entirely to structure, offer, and sell it, preserving and increasing value at each stage.

Even more than for purchases and sales, a joint venture requires a considerable amount of trust, faith and circumspection on the part of every entity involved in the venture—restraints that they would not need to exercise with respect to a wholly-owned venture. A joint venture cannot function at its best if each parent is so suspicious of the other parent and the venture that every operational decision must be weighed and negotiated by all participants.

At the outset of any project, the company should assemble a team possessing the essential technical tools and craftsmanship to handle the sale documents. But the team also needs members who are endowed with the market knowledge and broad-based experience needed to form sound judgments. Neither the technical skill nor the market sophistication is sufficient by itself.

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The Most Important Question

After asking whether clients would like to have a seat and a cup of coffee, I move on to business and pose my most important question, upon which all strategy and tactics going forward will be based: “What do you believe to be the highest-valued use of the business in question, and why?”

This question can be raised in the form of a series of narrower questions, each with the same end in mind. One can ask what kind of firm will be best able to achieve the highest returns by virtue of being the owner of the business, rather than being its customer, supplier, or customer. Or one can press further and ask why that same value cannot be achieved by another owner, through contractual entitlements to outputs or similar arrangements.

The client may not have a ready response to this question. In fact, one purpose of the early sale process may well be to seek out offers that will help to answer it. But the process of matching the assets’ attributes to particular uses can enable the team to decide how to structure the deal, who should be invited to bid, when to make the offer, or whether the client itself is already the best available owner of the business.

For example, a corporate group may decide that a particular business line is “non-core” to its strategic vision, but it does not follow that this subsidiary should, must, or can be sold. It may be that no one will offer a greater value, or that any such over-valuing party is constrained by competition law from bidding for the asset. On the other hand, the particular weaknesses or vulnerabilities of one company or type of company may make a business line particularly profitable, beyond the business line’s own cash flow.

Keeping the Goal in Mind

The goal of the valuation process is to gauge whether the effort to define and prepare for sale a business is likely to attract offers demonstrating that the business is worth more to another party, after deduction of transaction costs, than it is to the current ownership. (As noted above, that value to another may be either an affirmative contribution of cash flow to that

Energy Acquisitions and Joint Ventures – By Robert A. James owner, or a “negative” deprivation of the cash flow, proprietary technology, logistical position, or other features to a competitor.)

Armed with even an initial analysis of comparative value, the commercial lawyer can begin to identify potential counterparties, structure transactions, and devise offer processes that collectively can move the business to its most highly valued use. But the client’s idiosyncratic goals can also affect the type of strategy the attorney employs. Any given client will face or impose constraints that can dramatically affect the ostensible goal of obtaining full value for the business. Cash flow limitations, short time horizons, intense competition, regulatory barriers, and predictions of market movements all may impair the top theoretical deal from being done. Understanding all of those constraints, without being overly judgmental about them, will help the lawyer and client sort through the available transfers and achieve the best practical valuation and ownership of the asset.

Representing a Corporate Group

Often in a sale process, potential mismatches will reveal themselves between objectives of a corporate group on the one hand, and an operating company or subdivision on the other hand. For example, a corporation’s headquarters finance department may strongly prefer not to offer any parent guarantees or credit support. But the affected operating company will often see such credit support either as essential to remaining in business or as an opportunity for obtaining new markets.

The energy lawyer’s role is to elevate such conflicts to the right level within the organization and lay out with considerable sensitivity the issues they raise. Sometimes an adviser plays a more useful role as a neutral in resolving such disputes than would an internal party who may be perceived as a partisan combatant. One of the most important attributes of inside or outside counsel is to be candid and loyal to the corporate group, and its board of directors, taken as a whole.

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Strategic Steps for Acquisitions

Seen from the business line owner’s standpoint, the typical pattern in the energy industry is a large-scale public acquisition followed by a series of divestitures or complementary small-scale acquisitions of smaller business lines. For buyers, the processes are much the same. The primary difference is that the buyer’s focus is on the selection of target business lines rather than the identification of potential counterparties.

The strategic steps for an acquisition from the seller’s standpoint include the following:

1. Defining the business line. Sometimes the division or subsidiary offered for sale depends implicitly on other corporate assets. Other times, the business line includes legacy liabilities that will detract from its valuation. To sell the business, it may be necessary to transfer title to key property or to create arms’-length contracts for products, services or technology.

2. Conducting seller-side due diligence reviews. Even an owner of a business may not fully appreciate what it owns and what specific components of assets, contracts, human resources, and know-how are essential to its success. At this stage, the owner may want to solidify its relationship with key employees through formal employment agreements or informal discussions of their future prospects, either within the corporate group or with the business being sold. Engagement agreements with investment banks, valuation advisers, and other consultants are often struck at this point.

3. Identifying prospective buyers. None of the other strategies will be very effective if the client does not invite the right companies to participate, or if it invites so many parties to participate that the best buyer decides to stay away from an overheated sale process.

Energy Acquisitions and Joint Ventures – By Robert A. James

4. Visualizing key third-party conditions. As early as possible, the team should brainstorm which governmental and private parties will need to consent to, or at least acquiesce in, the proposed sale. These conditions can affect everything from the form of the confidentiality agreement, to the structure of the deal, to the timetable for keeping the deal together between signing and closing.

5. Structuring the transaction. Appendix A consists of excerpts from my firm’s Outline of Legal Aspects of Mergers and Acquisitions in the United States, describing in detail the issues to be considered at the structuring stage.

6. Facilitating bidder due diligence reviews. Confidentiality agreements are required by this stage, potentially including “standstill” clauses prohibiting the bidders from pursuing hostile approaches to the seller’s stockholders. If the objective is to provide very limited representations, warranties, and indemnities in the sale agreement, the best path to that end is to provide as full and open a due diligence review process as possible under the circumstances. The seller will want to prepare its personnel thoroughly for bidder visits and communications, in particular by ensuring that the bidders are provided factual information rather than assumptions, conclusions, or value judgments. (From the buyer’s standpoint, Appendix B contains a sample due diligence review checklist for a U.S. business line.)

7. Managing internal and external publicity. Public, governmental, customer, supplier, and employee relations during an acquisition process need to be conducted on the basis that the sale may or may not occur. The seller should not find itself in a worse position, or with a materially impaired business line, should the sale not take place.

8. Drafting the purchase and sale agreement. Appendix C contains a sample table of contents for a robust purchase and sale agreement. The

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principal negotiations occur with respect to the scope of the representations, warranties, and indemnities, the handling of third- party claims and conditions precedent, and the termination options and remedies for default.

9. Bidding and negotiating. The seller’s project team establishes and administers rules for the sale process. I would urge caution before infusing a private divestiture with too many rules having contractual effect, since timetables and market developments can make a process undesirable or obsolete.

10. Signing. Unlike many commercial transactions, the signing of an acquisition agreement is only the start of a complex, expensive, and highly uncertain process aimed at closing.

11. Satisfying, or securing waiver of, the conditions precedent to closing. Once the seller and buyer are linked by an enforceable purchase agreement, negotiations take place on an intense basis with the governmental, financing, or other third parties referenced in the closing conditions. Key counterparties include parent companies (including key finance, tax, and compliance departments), rating agencies and securities analysts, banks and other investors, host governments, joint venture parties, contractors, regulators, royalty holders, technology licensors, suppliers, distributors, and customers. The purchase agreement can try to anticipate third-party responses and even propose alternative deal structures should a third party prove to be hostile.

12. Closing. The closing, rather than the signing, is the true opportunity for a client team to declare an acquisition or divestiture to be a success. It is often possible to establish an “economic closing” date either before or after the date on which the funds, documents and asset title transfer, so that the economic risks and rewards of the business pass from seller to buyer at a convenient time (e.g., as of the beginning of a calendar quarter).

Energy Acquisitions and Joint Ventures – By Robert A. James

13. Handling post-closing matters. Transactions involving working capital adjustments, or purchase prices with “earn-out” compensation based on the business’s profits or revenues after the effective date of sale, will feature intense post-closing activity. In many other cases, the prospect of claims by third parties may need to be tendered under the indemnity clauses, or the parties themselves may claim breaches of representations, warranties, or covenants.

Of all of these, the most important steps in a business sale process are the identification of potential buyers and a cold-eyed evaluation of the competitive circumstances in which each player—including the client— finds itself. The reason these steps are so essential is that the results of these actions will largely determine the degree to which the client controls the process or has to adhere to market expectations.

Artificially cutting off the invitation list, or unnecessarily tying up the asset through exclusivity, option, or refusal right arrangements, can exclude the bidders who are most likely to attach the highest value to the business. But in some cases, reaching a preliminary agreement with a preferred bidder may be essential to making the sale occur. As with other aspects of the acquisition game, these are judgment calls where experience and market awareness are required and valued.

Strategic Steps for Joint Ventures

Appendix D, my memorandum entitled “Joint Venture Agreements: Major Issues and Common Provisions,” expands upon the strategic aspects of joint venture transactions. Many of these steps are similar to those described above for acquisitions and divestitures, since each joint venture is to some extent both a purchase and a sale. Joint ventures also raise considerable issues of governance, exit and termination scenarios, and relations with the parents’ independent businesses.

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Factors Impacting Strategies

One factor that will influence the selection of acquisition or joint venture strategy is the jurisdiction or type of jurisdiction in which the business line operates and in which the transaction parties reside. Useful distinctions can be drawn among transactions in developing economies, centrally planned economies, and developed economies. In particular, transactions in developing and centrally planned countries regularly must take into account the lack of assured infrastructure, markets, and legal systems. Developed countries often bring their own peculiar risks in the form of complex regulations and third-party rights.

Another feature that will impact strategy is the competitive position of the companies standing in the position of seller or buyer. An auction setting will expose multiple potential motivated buyers to the greatest vulnerability and drive them to assume risks, rather than signal that they will be difficult parties with whom to negotiate. Auctions drive bidders to choose their opportunities carefully and to consider escrows, hold-backs, and insurance to cover risks that sellers are otherwise unwilling even to consider bearing out of their own pockets.

Other variables include the degree to which the assets are defined, the business has a good track record, and data are available for due diligence review. Both the seller and bidders will enjoy smoother sailing with such businesses, compared to those that have no record of success or poor documentation and can be measured only by their aspirations.

Yet another constraint is the sheer patience and tolerance for ambiguity demonstrated by the client. Mergers and acquisitions are poker games requiring equal helpings of aggressiveness and restraint, depending on the always imperfect state of information and the parties’ respective pressures for actions and results.

Energy Acquisitions and Joint Ventures – By Robert A. James

Lessons Learned

I strongly encourage client teams upon a deal’s conclusion to discuss and articulate what lessons can be learned and applied to future projects. These discussions can be facilitated by someone not involved in the transaction at hand, and the results can be conveyed in generic terms throughout a corporate group without tainting the participants for their candor.

I would also like to register a pet peeve. Part of the reason negotiated acquisition and joint venture agreements are so difficult to read and interpret is that, in the course of the negotiation of exceptions to the other side’s standard documentation, the parties graft on a bewildering number of “provisos” and “notwithstanding” clauses.

Each side wants to be constructive and accept the slightly overbroad language requested by the other side. Instead of recasting an objectionable clause, it will suggest accepting the language but inserting a proviso taking away the clause in certain situations. Or a party may insert a paragraph, but rather than review whether it is in conflict with other parts of the agreement, simply declare that the new clause applies “notwithstanding anything herein to the contrary.”

My experience with contracts (and, sadly, with disputes) is that in many situations, it is better practice to revise complex clauses as if the risk allocation were being drafted from the outset. While that entails extra effort and negotiation up front, it is preferable to relying on later readers (e.g., senior executives, arbitrators, or judges) to navigate through a minefield of terminology such as “notwithstanding,” “subject to,” and my all-time favorite, “without prejudice.”

Legal and Business Trends

In the energy industry context, the most important laws regarding acquisitions and joint ventures have long related to the long-term environmental obligations that may be imposed on a party far back or far ahead in the chain of title of ownership. Reclamation and clean-up

Inside the Minds – Published by Aspatore Books obligations can entail huge sums of money, and even a slight difference in restoration standards can change the timeline and adjust the price tag considerably.

In recent years, I have observed greater variation in the indemnification and other risk allocation provisions that are acceptable to sellers and bidders. I would not regard any standard provision on the handling of pre-closing liabilities to be non-negotiable. Many energy business lines, particularly on the power side, now depend greatly on the valuation of intangible assets like key transmission agreements and intellectual property rights. There have been more and more auctions by sellers and their representatives, such as receivers and bankruptcy trustees, resulting in buyers bidding without total reliance on sale agreement markups.

Acquisition practices must also keep up with developments in technology and international investment. Over the next few years, I believe there will be an increased focus in sales and joint ventures on the state of the parties’ electronics records and the treatment of confidential information provided by the parties and by third parties. Acquisitions of energy businesses by foreign owners will receive greater scrutiny as the national security consequences of energy asset ownership become more politicized.

More prosaically, I also believe the future will bring the fall of what can be called the “last refuge of inaccessibility.” E-mail and cell phone communication will be standard for airplane passengers (despite a recent FAA decision). The result will be ever more compressed timetables for deals of all types (and ever less pleasant air travel).

Costs and Communications

The key for a successful counsel-client relationship is identifying and discussing openly what roles inside and outside counsel should play, based on the respective value that each legal member of team can provide. Budgeting to perform the roles assigned can then be performed with more confidence. Once a budget is in place, it is essential to keep and open lines

Energy Acquisitions and Joint Ventures – By Robert A. James of communication for discussing changing facts and options as soon as the changes or alternatives present themselves.

Unfortunately for clients and their lawyers seeking to budget acquisitions and joint ventures in good faith, the costs and time required for deals vary widely and precedent results are of very limited relevance. A “divestiture” amounting to exercise of an option under a joint venture agreement may only cost $2,000 in fees and be effective within a couple of days, while a complex multinational acquisition or joint venture negotiated over a period of years may entail costs of a thousand times that figure.

But that variability does not mean that counsel and clients cannot allocate responsibility for cost-effective services. Where the scope of work is well defined or a number of similar transactions are planned, fixed compensation can be negotiated. Incentive compensation arrangements can be structured that share risk between the client and the attorney for an uncertain or potentially unsuccessful deal, and distribute rewards based on appropriate measures of success.

Parting Advice

Years ago, my firm was involved in a sensitive negotiation for the purchase of a strategically critical energy infrastructure business. The client’s chief executive officer conveyed his enthusiasm for the business and its managers, described the collateral benefits a purchase would bring to the corporate group, and otherwise made clear he was keen to land such a transaction. But what were his last words to his lead negotiator? “Don’t be afraid to come home without a deal.”

In other words, every project team must be given or develop, and must adhere to, a set of walk-away conditions from the very initiation of a project, before the first day of discussions with the other side. The negotiators must apply those conditions consistently, not just on occasion. In every way, the client, working hand in hand with its counsel, must convince the other side that it can and will terminate discussions rather than enter into the wrong contract.

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Robert A. James is co-chair of Pillsbury’s global energy industry team. Resident in both the San Francisco and Houston offices of his firm, he has been recognized by clients and peers for the quality of his energy counsel, as reported in Chambers Global, Chambers USA, World’s Leading Energy and Natural Resource Lawyers, Who’s Who Legal, and other rankings.

His transactional practice focuses on oil, gas, power, and infrastructure project development (including liquefied natural gas projects in the United States and Asia); acquisitions and divestitures of business lines and formation of joint ventures in the energy, manufacturing, extractive, research, and marketing fields; engineering, procurement, and construction projects across the private and public sectors; and supply, distribution, processing, tolling, and co-location agreements. His corporate counseling practice features records retention compliance programs, international investment protection, fine art acquisitions, and counsel to trade associations.

Mr. James has spoken and written on a variety of corporate, commercial, and construction law topics. He was chairman of the board of the Easter Seal Society of the San Francisco Bay Area, and he serves in other community and professional organizations. He is a graduate of Yale Law School (J.D., 1983) and Stanford University (A.B., 1980).

He can be contacted by e-mail at [email protected].

Acknowledgment: The author thanks his colleagues Jerry Peppers and Amy Smolen for helpful comments.

Dedication: This chapter is dedicated to Caroline and Stewart, who know Daddy’s real job is “helping people make promises and keep promises—complicated, expensive promises with lots of exceptions.”

Energy Acquisitions and Joint Ventures – By Robert A. James

APPENDIX A

EXCERPTS FROM PILLSBURY WINTHROP SHAW PITTMAN LLP, OUTLINE OF LEGAL ASPECTS OF MERGERS AND ACQUISITIONS IN THE UNITED STATES (FIFTEENTH EDITION, SEPTEMBER 2003)

Introduction

This Outline summarizes important aspects of United States law as it relates to mergers and acquisitions. It identifies many significant issues relating to structuring an acquisition including tax, accounting, corporate, securities, antitrust, trade regulation, environmental, intellectual property, insolvency, labor and employee benefits laws. Any acquisition can also be expected to have unique legal concerns relating to the particular businesses in which the subject companies are engaged. In commencing work on any proposed acquisition, it is vital to involve counsel at an early stage to assist in identifying potential legal issues at a time when they are best resolved as well as in structuring and negotiating the transaction.

As acquisitions become increasingly transnational because of the relaxation of trade barriers, the growth in the number of companies seeking a worldwide market and the geographic diversity of acquisition targets, the need to address cross-border issues in even seemingly uncomplicated acquisitions continues to expand. This Outline, now in its fifteenth edition, has grown accordingly so that its contents include the United States aspects of joint ventures, purchasing the business and/or assets of financially troubled companies and the regulation of foreign investment or ownership, and its distribution includes citizens of countries around the world. We welcome inquiries from the numerous individuals and organizations making use of this Outline as to substantive matters and as to comments on how future editions can be made more useful to you. Please address any comments or suggestions regarding the Outline to Stephen R. Rusmisel (212) 858-1442 or Jerry P. Peppers (212) 858-1205.

While this Outline describes many issues common to acquisitions, it is not intended to be a treatise or to constitute legal advice on any of these subjects. The Outline summarizes matters as of September, 2003 and will therefore not reflect changes and developments which occur thereafter.

I. OVERVIEW OF LEGAL, STRUCTURAL, FINANCING AND OTHER CONSIDERATIONS.

A. Legal and Structural Considerations. A number of factors must be considered before deciding upon even the most fundamental aspects of a

Inside the Minds – Published by Aspatore Books transaction. For example, the tax advantages to an acquiror of a particular structure may be outweighed by the possibility that the acquiror may assume significant contingent liabilities arising by reason of the structure, such as product liability or pension or environmental liabilities.

B. Financing Considerations. In addition, the financing of a merger or acquisition can take a variety of forms, each with a number of differing legal consequences. The completion of financing arrangements and agreements regarding purchase price depends in part on the results of both business and legal due diligence. Because such due diligence review may not commence or be complete until after initial financing decisions and purchase price agreements have been made, early consideration of alternative financing options and related legal consequences can provide the flexibility that is often necessary later for final negotiations of the purchase price and for satisfying the business and legal concerns of sellers, purchasers, lenders and investors.

C. Other Considerations. From a legal standpoint, the most cost-effective and otherwise successful mergers and acquisitions result when parties involved in such transactions have some familiarity, before planning and negotiating a transaction, with the many legal considerations relating to mergers and acquisitions. Inefficiency and significant costs can be avoided by reviewing and discussing these considerations with counsel at an early stage. Our experience has shown that such timely review and discussion helps to (i) clarify and prioritize the objectives of a transaction; (ii) consummate a transaction in a timely manner; (iii) facilitate an efficient post-closing transition; and (iv) avoid disappointing and costly surprises about the value of acquired assets or stock or unknown liabilities (either those assumed by an acquiror or retained by a seller).

II. BASIC FORMS FOR STRUCTURING ACQUISITIONS.

There are four basic forms for structuring acquisitions: (A) Merger or Consolidation; (B) Asset Purchase; (C) Stock Purchase; and (D) Joint Venture. These forms are summarized below, along with some observations regarding their relative advantages and disadvantages. Also included is a brief summary of privatization as a form of cross-border acquisition. In addition to corporate considerations, tax and accounting consequences may also be critical in determining the structure of a transaction. (See III and IV below.)

A. Statutory Merger or Consolidation. The terms “merger” and “consolidation” refer to the combination of two or more corporations, limited liability companies, limited partnerships or partnerships upon the affirmative vote of the requisite stockholders, members, limited partners or partners, as

Energy Acquisitions and Joint Ventures – By Robert A. James applicable, of the constituent entities, and the filing of a certificate in the jurisdiction(s) of incorporation, formation or organization, as the case may be. Some states also permit the merger or consolidation of one or more corporations with one or more limited liability companies, limited partnerships or partnerships. In a merger, the constituent entities are merged into one of the constituent entities, which is deemed to be the surviving entity of the merger. In a consolidation, the entities are consolidated to form a new entity. The stock, membership interests, limited partnership interests or partnership interests, as the case may be, of the non-surviving entity’s(ies’) stockholders, members, limited partners or partners, as applicable, is converted into stock, membership interests, limited partnership interests, partnership interests of the surviving or resulting entity, cash or some other form of consideration set forth in such certificate as a matter of law. Upon completion, the surviving or resulting entity carries on the combined business and the other(s) cease(s) to exist in separate form. (See III.A.2 and III.B.1 for a summary of the tax considerations involved in mergers and consolidations.) Following are some structural variations of statutory mergers of corporations:

1. Direct Statutory Merger. Target is merged into acquiror and target’s stockholders receive stock, cash, debt, property, or a combination thereof, of acquiror.

(a) State corporation laws generally do not permit a direct merger of a United States (“U.S.”) target into a foreign acquiror. Hence, most acquisitions using a foreign parent’s stock are effected through a “triangular” merger with a U.S. subsidiary of the foreign parent as the acquiror. (b) Target is merged out of existence, which may be undesirable depending on the target’s industry or the extent to which the target holds real property, nonassignable assets (including special franchises, licenses, permits, and local qualifications to do business) or contracts which require the consent of third parties to any assignment. This constraint also applies to consolidations and to “forward triangular mergers” described below. 2. Forward Triangular Merger. Target is merged into subsidiary (generally newly formed) of acquiror and target’s stockholders receive stock, cash, debt, property, or a combination thereof, of acquiror (subsidiary’s parent).

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(a) Results in the transfer of target’s business (both assets and liabilities) to a wholly-owned subsidiary of acquiror. (b) Permits control over jurisdiction of incorporation, and maximum flexibility in terms of certificate of incorporation and by-laws. (c) Target is merged out of existence with the consequences described in 1(b) above. 3. Reverse Triangular Merger. Subsidiary of acquiror (generally newly formed) is merged into target, target’s stockholders receive stock, cash, debt, property, or a combination thereof, of acquiror (subsidiary’s parent) and shares of acquisition subsidiary are converted into shares of target.

(a) Target becomes wholly-owned subsidiary of acquiror. (b) Target’s corporate identity is preserved, mitigating the consequences described in 1(b) above (but not effective to prevent contractual or other consequences triggered by a “change of control”). 4. Advantages. Advantages of all three forms of merger and of consolidation:

(a) Total acquisition, and no minority stockholders remain after the merger; (b) Generally, no sales tax or bulk sales problems arise although there may be sales tax problems in some states with direct statutory mergers or forward triangular mergers; and (c) Relatively simple documentation. 5. Disadvantages. Disadvantages of all three forms of merger and of consolidation:

(a) Acquiror must assume all liabilities of target (fixed and contingent, disclosed and undisclosed), but direct exposure of acquiror is limited in a triangular merger because such liabilities are of its subsidiaries;

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(b) Warranties will not normally survive the merger (although stockholder commitments may be obtained where target is closely held or where a discrete number of stockholders own a major block, or part of the consideration may be held back either in the form of escrow or a contingent payment for several years); (c) Stockholders of non-surviving corporations may have dissenters’ appraisal rights permitting them to receive cash for their stock in an amount equal to an appraised market value set by a court; and (d) Mergers or consolidations of different types of entities may be complicated by or prohibited under the laws of some states. B. Asset Purchase. An acquiror may also purchase either substantially all, or only a part, of the assets of a corporate target in return for stock, cash, debt, property or a combination thereof. Advantages and disadvantages comparable to those described below generally also apply to a sale of assets by a limited liability company (“LLC”), limited partnership or partnership.

1. Advantages. In addition to the tax advantages noted in III below, there are the following advantages to a purchase and sale of assets: (a) Can acquire all or only selected assets and all or only selected liabilities, whether contingent or otherwise (although, if substantially all assets are purchased, exclusion of liabilities may not be effective, especially where the seller no longer has economic substance); (b) Can avoid dealing with minority stockholders in many circumstances; (c) Unless purchasing substantially all of the assets, no stockholder vote of target is required; and (d) Typically no appraisal rights for dissenting stockholders. 2. Disadvantages. In addition to the tax disadvantages noted in III below, there are the following disadvantages to a purchase and sale of assets:

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(a) Corporate identity of target is not preserved for acquiror; (b) More complex documentation requiring assignment and conveyance instruments (causing, in many instances, otherwise undisclosed problems to surface); (c) May require numerous consents to assignment of contractual rights, potentially causing delay and giving rise to additional costs; (d) May trigger acceleration of certain obligations and require prepayment of target’s indebtedness; (e) If significant amount of real estate is involved, transfer taxes, recording fees, etc. may be substantial; (f) If intellectual property is registered in many jurisdictions, many assignments need to be filed; (g) Possible sales tax and bulk sales problems; and (h) If assets purchased and sold constitute “substantially all” of the assets of target, a stockholder vote of target is usually required. C. Stock Purchase. An acquiror may gain control over a target by purchasing stock from the target’s stockholders, rather than merging with the target or purchasing its assets. The acquiring corporation may negotiate with individual stockholders or, if the target is a public company, it may make a tender offer. Advantages and disadvantages comparable to those described below generally also apply in the context of a purchase and sale of membership interests in a LLC, limited partnership interests or partnership interests.

1. Advantages. A stock purchase provides the following advantages:

(a) Target’s corporate identity is preserved together with special franchises, licenses, permits and local qualifications to do business (other than those that may be affected by a change in control); (b) Generally, no sales tax or bulk sales problems;

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(c) Target’s contract rights will not be impaired (unless specific contractual provisions require consent to changes in control); (d) Relatively simple transaction when the target is closely held; (e) Can be implemented through an exchange offer if management opposes the transaction; (f) Where target is closely held, may implement hold back or escrow protection and can also provide for “earn out” component of purchase price; (g) Even if acquiror is party to security documentation with an after-acquired property clause, target’s assets may remain free from such a lien; (h) It may be possible to avoid the need for the approval of the target’s board of directors; and (i) Simpler documentation because there is no need to transfer individual assets, rights and liabilities. 2. Disadvantages. In addition to the tax disadvantages noted in III below, this structure has the following disadvantages:

(a) May result in less than total acquisition with resulting minority stockholders, giving rise to possible future questions of fiduciary obligations to such stockholders; and (b) Target is acquired subject to all its liabilities, including any undisclosed liabilities. D. Joint Venture. Joint ventures are a common vehicle for combining business efforts, especially between entities from different countries. Joint ventures can provide a relatively low-cost means by which co-venturers can share benefits from particular assets or advantages, such as technology, expertise, name recognition, governmental contacts or financial clout. Joint ventures involve many issues, including antitrust concerns, which affect business combination activity generally. Joint ventures can be mere contractual arrangements or can be structured as jointly owned entities such as corporations, partnerships (either general or limited) or limited liability companies. Often the most complicated issues that arise out of entering into a joint venture are how to allocate and distribute the economic benefits of the joint venture and how to address the eventual end of the joint venture. Co-

Inside the Minds – Published by Aspatore Books venturers will generally want their arrangement to be clear with respect to their respective rights as to allocation and distribution of the economic benefits of the joint venture, under what circumstances the joint venture may be terminated and the consequences of termination to each co-venturer.

1. Corporation. Co-venturers may set up a corporation in which they are the shareholders. Typically, the certificate of incorporation, by-laws and shareholders agreement will include provisions regarding management and control of the corporation, matters requiring supermajority approval, restricted transferability of interests, obligations to capitalize the corporation initially and on an ongoing basis, allocation and distribution of economic benefits of the joint venture, dispute resolution between the co-venturers and termination of the venture (such as buy-out provisions). The major advantage of a corporate structure is that the co-venturers’ liabilities generally are limited to their equity in the corporation.

The major disadvantages of a corporate structure are that:

(a) The corporation will be a separate taxable entity, unless one of the co-venturers holds a significant enough share to allow consolidation, resulting in double taxation (mitigated for domestic co-venturers by the dividends received deduction) and the inability of either co-venturer to directly utilize losses; (b) The corporate structure may be more restrictive with respect to allocation and redistribution of income and allocation and distribution of capital on dissolution; and (c) Dissolution is a taxable event at both the corporate and co-venturer levels. 2. Partnership. Co-venturers may enter into a partnership agreement which governs their relationship with each other. Typically, the provisions in the partnership agreement cover those matters described above as included in corporate organizational documents, but with the addition of provisions covering issues such as management (usually by the general partner(s)), maintenance of capital accounts, allocations of gains and losses and administration of taxes. In order to limit a co-venturer’s liability in the venture, general partnerships are usually structured with each co-venturer creating a corporate or limited liability company subsidiary to be a general

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partner in the partnership. Sometimes a limited partnership structure is utilized, with the co-venturers investing as limited partners as well as the shareholders of the corporate general partner. Almost all states and the District of Columbia now recognize limited liability partnerships which generally limit a general partner’s liability to that partner’s own negligent acts or the negligence of employees under his (or its) direction.

The major advantages of a partnership structure are:

(a) The flexibility in structuring all aspects of the relationship between the partners, including contributions of capital and allocations of income, loss and distributions; (b) The ability to pass income and losses directly through to the partners; and (c) The ability to effect a dissolution with little or no tax cost. The major disadvantages are:

(a) The partnership structure may not satisfy legal, political, marketing or convenience requirements; (b) If not structured and administered carefully, management of the partnership may be awkward and limitation of liability jeopardized; and (c) Partners may recognize gain from the partnership for income tax purposes without receiving any distribution from the partnership. 3. Limited Liability Company. Limited liability companies are recognized and permitted by statute in every state and the District of Columbia. The co-venturers, as members of a LLC, enter into an operating agreement which governs their relationship with each other. Typically, the provisions in the operating agreement cover those matters described above as included in a partnership agreement.

The major advantages of the LLC structure are:

(a) As in a partnership, the ability to pass through income and losses directly to the members;

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(b) As in a partnership, the ability to dissolve the joint venture with little or no tax cost; (c) As in a corporation, generally a co-venturers’ liabilities are limited to its capital contribution obligations; and (d) The ability to manage the company without jeopardizing the limited liability afforded its members. The major disadvantages of the LLC structure are:

(a) The LLC structure may not satisfy legal, political, marketing or convenience requirements; (b) Merger of a LLC with entities organized in or formed under the laws of jurisdictions other than the state in which the LLC is formed may be complicated by or prohibited under state law; and (c) Members of a LLC may recognize gain from the LLC for income tax purposes without receiving any distribution from the LLC. 4. Other Joint Ventures. Sometimes co-venturers will combine their efforts through contractual arrangements, such as service agreements, consulting agreements, licenses, marketing alliances and other agreements by which respective contributions of assets and distribution of labor may be agreed. It is not unusual for a joint venture arrangement to be structured with a contractual component and also a combination of LLC, partnership and corporate entities interlocked to maximize the advantages and minimize disadvantages of such entities.

It is not unusual in complex joint venture arrangements to have combinations of partnership and corporate structures interlocked to maximize the advantages and minimize disadvantages of the various structures.

E. Privatization. The concept of “privatization” generally refers to any strategy or process that results in the transfer to a non-government entity of an asset or enterprise, in whole or in part, which is owned or controlled by a government. More precisely, privatization has been defined to mean “a strategy to shift the production of goods and services from the Government to the

Energy Acquisitions and Joint Ventures – By Robert A. James private sector in order to reduce Government expenditure and to take advantage of the efficiencies that normally result when services are provided through the competitive market place.”

Like the concept itself, the various policies and programs that have been described as privatization have a considerable history. Policies designed to facilitate the substitution of the private sector for the public sector are not new. But the wide range of public sector activities that are now being considered for privatization and the unusual scope of the methods being suggested to achieve this objective distinguish privatization efforts today from those of the past.

Privatization, at least if defined broadly, is far more widely accepted than is generally acknowledged. The number of privatization transactions has increased in the last fifteen years. While in the past much international attention has been focused on the transfer of major national enterprises such as British Telecom and certain French banks from public to private ownership, scores of less-dramatic, smaller-scale cases of privatization exist at the state and local level in the United States, France, England, Germany, Spain and Japan, as well as in a number of developing countries in Latin America, Asia, and the former Eastern bloc countries of Europe.

1. Goals and Advantages. Among the goals and advantages of privatization are the following:

(a) Privatization is seen as a means to reduce or eliminate the effects of politics on the operation of privatized businesses; (b) By eliminating bureaucratic interference, privatized companies can significantly improve operational efficiencies; and (c) Privatization can also encourage the development of domestic capital markets (by giving workers and citizens a direct stake in the value of the privatized company) and possibly lead to a reduction in public sector budget deficits (through cash receipts and future tax revenues), especially if the government involved can dispose of loss generating businesses. 2. Disadvantages. Counter-arguments against privatization include:

(a) In numerous developing countries, publicly-owned production is the only business approach practicable. The

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economic return on investment is not seen as being sufficiently attractive to motivate potential private investors; (b) Employment opportunities are sometimes thought to be more stable under government ownership. With privatization might come significant layoffs of workers so as to reduce business costs; and (c) In some countries, government ownership of certain industrial or service sectors has been seen as a way of preventing potential domination of these industries by certain ethnic groups. 3. Methods of Privatization. The various types of privatization that are being used by both developed and developing countries, depending on their respective political and economic climates, are:

(a) Contracting out by governments for provision of services (as is now sometimes done in the United States); (b) Building and operating public sector infrastructure by private sector parties (as in Argentina); (c) Management by the public sector but in a private sector mode (as in Spain and Italy); (d) Public distribution of shares to the citizens through vouchers that can be exchanged for stock in a bidding process (as in Russia and the Czech and Slovak Republics); (e) Sale of a public sector enterprise to outside investors (whether foreign or domestic); (f) Management or employee buyouts; (g) Sale of assets (rather than stock); and (h) Global public offering of shares. F. The Acquisition Agreement. The acquisition agreement is the basic document with respect to an acquisition. Since the buyer can never be fully familiar with the assets, business relationships, personnel, contingent liabilities and other facets of the business to be acquired, it will seek to negotiate an acquisition agreement in which the seller provides detailed information in these and other areas. Consequently, the largest part of the agreement will typically deal with seller’s representations and warranties about the nature and condition of the business and assets being sold. Since the buyer often has the prerogative

Energy Acquisitions and Joint Ventures – By Robert A. James of preparing the first draft of the agreement, such representations and warranties are usually extensive and may be more or less tailored to the seller’s business depending on the buyer’s familiarity with it. The representations and warranties are then customized through negotiations between buyer and seller and continuing due diligence efforts by the parties and their representatives. The representations and warranties usually contemplate that the seller will prepare disclosure schedules that provide detailed information about the business, and seller typically indemnifies buyer against any damages resulting from the failure of the representations and warranties to be true. A buyer may seek further comfort by proposing to retain or hold back some portion of the purchase price against any indemnification that may become due to it for breaches of the seller’s representations and warranties.

From a seller’s standpoint, an acquisition agreement would ideally be very simple, selling the assets or corporate shares with few or no representations as to the condition or quality of what is being sold in return for immediately available funds representing the entire purchase price.

The acquisition agreement generally contains:

1. a description of the assets or shares to be sold; 2. a description of the purchase price to be paid, including any provisions for any post-acquisition adjustment to the purchase price (typically based on changes in working capital or net assets of the target from a reference date to the closing date) and earn-out provisions; 3. provisions for the mechanism of the closing, such as when and where the closing will be held, how the purchase price shall be paid and what deliveries shall be made at closing; 4. provisions for termination of the agreement and any break-up fees; 5. representations and warranties of both the buyer and the seller (the seller’s representations would normally be quite detailed with respect to the operation of its business while the buyer’s representations are generally limited to matters bearing on its ability to perform the transaction, except that buyer’s representations may be more extensive if equity of the buyer is a significant component of the purchase price);

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6. provisions regarding the conduct of the target business and any further actions that may be required between the agreement and closing dates; 7. covenants effective during the post-acquisition period relating to such matters as buyer and seller may agree, which often include restrictions on competition by the seller, rights and duties with respect to taxes related to the sold business and the maintenance of benefits for transferred employees; 8. conditions precedent to the obligation of each party to close, including the continued accuracy of representations and warranties as of the closing date and the receipt of necessary approvals of third parties; 9. provisions regarding the length of time that the representations, warranties and covenants will survive; 10. indemnification provisions often specifying thresholds and/or ceilings of liability with respect to indemnification obligations, procedures for resolving disputes (particularly breaches of the seller’s representations and warranties) and any holdback or escrow of a portion of the purchase price against such indemnification obligations; and 11. provisions covering the termination of the agreement (prior to closing); 12. provisions covering miscellaneous matters such as transaction expenses and conventional “boilerplate” provisions dealing with choice of law, jurisdiction, notices, severability, assignment, counterparts and other matters. G. The Merger Agreement. An agreement and plan of merger is the principal document typically used in a merger. A merger, which requires the approval of the holders of at least a majority of the outstanding voting stock, is often used to effect the equivalent of a stock purchase without the need for the approval of all shareholders, some of whom may be unable or unwilling to give such approval. The contents and structure of an agreement and plan of merger in a private transaction generally parallel those of the acquisition agreement used in an asset or stock purchase, except that an agreement and plan of merger contains those provisions necessary to carry out a merger, including provisions for making necessary state filings and for converting the capital stock of the merging corporations. For the same reasons that a merger may be chosen for the structure of a transaction (e.g. a large number of unrelated

Energy Acquisitions and Joint Ventures – By Robert A. James stockholders from which consent may be difficult to obtain; as is always the case with a company that has publicly traded stock and as may also be the case with relatively widely-held private companies), often the consideration in a merger is widely distributed. In transactions where a public company is acquired (and occasionally where a widely-held private company is acquired) the representations and warranties do not survive the closing and indemnification provisions are omitted. In such circumstances, the primary significance of representations and warranties is with respect to the conditions to closing. Even in the case of widely-held companies, it is possible to structure indemnification, typically by escrowing or holding back a portion of the purchase price.

III. TAX CONSIDERATIONS.

A. Tax Free Reorganizations.

Certain transactions can be structured so that target stockholders and security holders will recognize no gain or loss except to the extent that the gain or loss realized is attributable to the receipt of “boot” (i.e., generally, any consideration other than stock, securities or warrants of the acquiror or, in limited circumstances, its parent).

1. Permissible Consideration.

(a) Stock. Subject to an exception for “nonqualified preferred stock” (discussed below), target shareholders that participate in a tax-free reorganization generally will not be taxed to the extent they receive acquiror stock (or, in certain circumstances, stock of the acquiror’s parent). (b) Securities. Target security holders that participate in a tax-free reorganization will not be taxed to the extent they receive securities of the acquiror (or, in certain circumstances, securities of the acquiror’s parent) with a principal amount that does not exceed the principal amount of the target securities exchanged. (c) Warrants. Target shareholders and security holders that participate in a tax-free reorganization will also not be taxed to the extent they receive warrants of the acquiror (or, in certain circumstances, warrants of the acquiror’s parent). However, note the warning in III.A.3(a) below.

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(d) Nonqualified Preferred Stock. “Nonqualified preferred stock” received by a target shareholder in an otherwise tax free reorganization will be treated as taxable “boot.” Nonqualified preferred stock is stock that is limited and preferred as to dividends and does not participate in corporate growth to any significant extent. Note that a conversion privilege by itself will not necessarily cause preferred stock to participate. In addition, subject to certain special exceptions, the stock must (i) be putable or mandatorily redeemable, or (ii) be subject to an issuer call that, as of the issue date, is more likely than not to be exercised, or (iii) bear a dividend rate that varies in whole or in part with reference to interest rates, commodity prices or other similar indices. In the case of clauses (i) and (ii), the right or obligation must be exercisable prior to the twentieth anniversary of the issue date and must not be subject to a contingency that makes exercise remote. 2. Transaction Structures.

(a) Statutory Merger or Consolidation (“A” Reorganization). (See II above for a summary of the corporate considerations and the advantages and disadvantages of the forms of mergers set forth below.) (i) Direct Statutory Merger. In a direct statutory merger, the target is merged into the acquiror under applicable state law and the acquiror survives. The target’s shareholders generally receive shares of stock of the acquiror. (This type of transaction can also be done as a “consolidation” of two corporations into a third.) A direct merger affords an acquiror a good deal of flexibility in choosing the type of consideration offered to the target shareholders and in disposing of unwanted target assets. A. Under a “safe harbor” contained in the Internal Revenue Service (“IRS”) ruling guidelines, a merger will still be tax-free where up to 50% of the stock of the target is acquired for cash in anticipation of or pursuant to the merger, provided the

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remaining target shareholders receive either voting or nonvoting common or preferred stock (other than nonqualified preferred stock) of the acquiror in the merger. (See III.A.3(a) below.) B. Unlike the “C” reorganization and triangular-merger reorganizations discussed below, there is no requirement that “substantially all” of target’s assets be acquired or retained by the acquiror. C. In a variation, the target is permitted to merge into a LLC that is wholly owned by the acquiror and therefore treated as a “disregarded entity” under the so-called “check-the-box” entity classification rules. (ii) Forward Triangular Merger. In a forward triangular merger, the target is merged into a subsidiary (usually newly formed) of the acquiror and the subsidiary survives. The target’s shareholders receive shares of stock of the acquiror (the subsidiary’s parent).

A. As with a direct statutory merger (see III.A.2(a)(i) above), there is flexibility as to the forms of consideration that may be used. B. The subsidiary must acquire and retain “substantially all” of the target’s assets (generally, 90% of net assets and 70% of gross assets under the IRS guidelines). This requirement limits pre- and post- merger dispositions of unwanted target assets. C. Stock of the subsidiary may not be used as consideration. (iii) Reverse Triangular Merger. In a reverse triangular merger, a subsidiary of the acquiror

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(usually newly formed) is merged into the target and the target survives. The target’s shareholders receive shares of stock of the acquiror (the subsidiary’s parent) and shares of the subsidiary’s stock are converted into shares of stock of the target. A. In a reverse triangular merger, there is less flexibility as to permissible forms of consideration than with either the direct merger or the forward triangular merger. The target’s shareholders must exchange an amount of target stock that constitutes “control” of the target (defined as 80% of voting power and 80% of each class of non-voting stock) for voting stock (common or preferred) of the acquiror. Thus, the acquiror cannot acquire more than 20% of any class of target stock for “boot” as part of the merger or in any transaction outside the merger. In the absence of contrary guidance from the IRS, voting nonqualified preferred stock should count in determining control. On the other hand, warrants do not count in determining control even though they can be received tax-free in the merger. B. As in a forward triangular merger, the target must acquire and hold “substantially all” of its (and the subsidiary’s) assets immediately after the merger. C. In certain circumstances, a reverse subsidiary merger followed by an upstream merger of the target into the acquiror can also qualify as a tax-free reorganization. (b) Stock-for-Stock Acquisition (“B” Reorganization). In a “B” reorganization, the target’s stock is acquired solely for voting stock (common or preferred) of the acquiror or the acquiror’s parent. This type of transaction is relatively uncommon and a reverse triangular merger is generally the

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preferred structure. (See II above for a summary of the corporate considerations and the advantages and disadvantages of stock purchases.) (i) The acquiror (or its parent) must issue solely voting stock in exchange for the target stock. Absolutely no “boot” is permitted (i.e., the acquiror cannot, as part of the same plan, acquire any target stock for consideration other than acquiror voting stock, ruling out acquiror warrants). In the absence of contrary guidance from the IRS, target shareholders’ receipt of voting nonqualified preferred stock should not poison a “B” reorganization. (ii) The acquiror must own target stock constituting “control” of the target after the transaction. (See III.A.2(a)(iii)(A) above for the definition of “control.”) (c) Stock-for-Assets Acquisition (“C” Reorganization). In a “C” reorganization, assets of the target are acquired for voting stock of the acquiror or the acquiror’s parent. This transaction is relatively uncommon and the direct statutory merger or the forward triangular merger is generally the preferred structure. (See II above for a summary of the corporate considerations and the advantages and disadvantages of asset purchases.) (i) As in a forward or reverse triangular merger, the acquiror must acquire “substantially all” of the target’s assets. (ii) With one exception, consideration is limited to voting stock (common or preferred) of the acquiror or the acquiror’s parent. (In the absence of contrary guidance from the IRS, voting nonqualified preferred stock should be permitted.) The exception is that “boot” may constitute up to 20% of the consideration, but only if the target’s liabilities (which would otherwise be ignored) are also counted as “boot.” Because an operating business typically has significant fixed and contingent liabilities “boot” is not typically used.

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(d) Acquisition of Bankrupt Company (“G” Reorganization). In a “G” reorganization pursuant to a plan of reorganization approved by a bankruptcy court or by a court in receivership, foreclosure or other similar proceedings, substantially all the assets of the target are acquired for common or preferred stock (in addition to debt securities, typically) of the acquiror or its parent. (i) Consideration need not be limited to voting stock. (ii) Target shareholders need not maintain a proprietary interest in the acquiror. Creditors that receive stock in satisfaction of their claims are generally treated as shareholders for purposes of determining whether the “continuity of interest” requirement is satisfied. (See III.A.3(a) below.) (iii) Sales of target assets, effected prior to the acquisition for the purpose of satisfying the claims of creditors, generally will not result in a failure to satisfy the “substantially all” requirement. (See III.A.2(a)(ii)(B) above.) 3. General Requirements.

(a) Continuity of Shareholder Interest. All tax-free reorganizations must preserve the target shareholders’ “proprietary interest” in the acquiror. Although there is no hard and fast rule as to what amount of stock the target shareholders must receive to preserve continuity of interest, the IRS ruling guidelines will be satisfied if the target shareholders receive an amount of stock of the acquiror (or its parent, if permissible) equal in value to at least 50% of the formerly outstanding target stock. In the absence of contrary guidance from the IRS, nonqualified preferred stock should count toward preserving continuity of interest even though receipt of nonqualified preferred stock is taxable. Warrants, however, will not count in preserving continuity of interest. Finally, former target shareholders may sell their interests immediately before or after the acquisition without threatening continuity of interest as long as they sell to parties unrelated to the acquiror.

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(b) Continuity of Business Enterprise. It is a further requirement of all tax-free reorganizations that the acquiror either continue a line of the target’s historic business or use a significant portion of the target’s historic assets in a business. This requirement is generally satisfied if the target’s assets are redeployed within the acquiring corporation’s “qualified group” (defined as a group of corporations in which 80% of the vote and value of at least one member of the group is owned by the acquiror, and each other member of which is similarly owned by another member). (c) Step-Transaction Doctrine. If the overall acquisition plan involves not only a tax-free reorganization described above but also another transaction, under the “substance over form” or “step-transaction” doctrine, the related transactions may be viewed together in determining their effect. This may result in a recharacterization of the putative reorganization, which may change its tax consequences. For this reason, it is important to consider the potential effect of any related transaction. 4. Acquisition of Domestic Target by Foreign Acquiror. If a transaction involves the acquisition of a domestic target corporation by a foreign acquiror, the following additional conditions generally must be satisfied for the transaction to be tax-free to the domestic target shareholders: (a) In the transaction, domestic target shareholders must receive, in the aggregate, 50% or less (by vote and value) of the foreign acquiror’s stock outstanding immediately after the transfer. (b) After the transaction, domestic insiders of the domestic target corporation (i.e., directors, officers or 5% shareholders) must own, in the aggregate, 50% or less (by vote and value) of the foreign acquiror’s stock (whether or not the stock was acquired in the transaction). (c) The foreign acquiring corporation (or certain qualified subsidiaries or partnerships) must have an “active trade or business” outside the United States for the preceding three years and there can be no intention on the part of the foreign acquiror or the transferring shareholders to dispose of or discontinue that trade or business.

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(d) The fair market value of the foreign acquiror must be at least equal to the fair market value of the domestic target at the time of the transaction. (e) If, after the transaction, a domestic target shareholder owns 5% or more (by vote or value) of the foreign acquiror’s stock (whether or not the stock was acquired in the transaction), the shareholder must sign a “gain recognition agreement.” The agreement generally requires that the shareholder recognize any gain inherent in the domestic target stock at the time of the transaction if the shareholder disposes of the foreign acquiror’s stock within five years or certain other events occur. (f) The domestic target must file a detailed information statement. 5. Acquisition Involving a CFC Target. If the target is a “controlled foreign corporation” (a “CFC”), then a domestic 10% target shareholder may be required to recognize deemed dividend income if, after the transaction, either the foreign acquiror is not a CFC or the domestic 10% target shareholder holds less than 10% of the foreign acquiror’s voting stock. For this purpose, a foreign corporation is a CFC if 50% of its stock is held by domestic shareholders, each of which holds at least 10% of its voting stock. 6. Additional Considerations.

(a) A tax-free reorganization defers recognition of gain for the target and the target’s shareholders, and the acquiror inherits the tax basis of each of the target’s assets as well as the target’s other tax attributes. (b) A tax-free reorganization requires the issuance of stock of the acquiror or its parent. (i) Registration under applicable securities laws is required unless an exemption is available. (ii) A tender offer may require enhanced financial disclosure. (iii) Section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), as amended, and Rule

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10B-5, promulgated thereunder, are applicable to the disclosure. (iv) State “blue sky” qualification may be required. (v) If the stock is not registered, it may be necessary for the acquiror to grant registration rights (either demand rights or “piggy-back” rights) to the target stockholders. (vi) Under certain circumstances, large stockholders or other central persons to the target may be restricted from selling the consideration stock for some period. B. Taxable Transactions.

1. Merger for Cash and/or Notes. Any of the forms of tax-free merger discussed above may be utilized in a taxable merger, in which case the target’s shareholders will typically receive cash or notes or a combination of the two. (a) The corporate advantages and disadvantages are generally the same as for a tax-free statutory merger or consolidation. (See II above.) (b) If the target merges into the acquiror or a subsidiary of the acquiror (i.e., a “forward merger”) in a taxable merger, the transaction is treated as a taxable sale by the target of its assets, followed by a liquidation of the target. Gain is taxable to both the target and the target shareholders, and the acquiror’s tax basis in each target asset is “stepped up” to fair market value. (c) If a subsidiary of the acquiror is merged into the target (i.e., a “reverse merger”) in a taxable merger, the transaction is treated as a purchase by the acquiror of the target stock. Gain is taxable only to the target shareholders, and the acquiror receives a tax basis in the target stock equal to its cost (while the target retains its pre-acquisition tax basis in its assets). 2. Purchase of Stock for Cash and/or Notes. (a) The corporate advantages and disadvantages are generally the same as for a tax-free stock-for-stock acquisition. (See II above.)

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(b) The target stockholders are taxed on their gain, and the acquiror receives a tax basis in the target stock equal to its cost (while the target retains its pre-acquisition tax basis in its assets). (c) If the target is a member of an affiliated group of corporations filing consolidated Federal income tax returns, an affiliated group filing separate returns, or an S corporation, the acquiror may, with the cooperation of the seller or sellers, elect to treat a purchase of at least 80% of the target stock as though the target had, in effect, sold its assets to a newly organized corporation and then liquidated. The consequences of such a “section 338(h)(10) election” are as follows: (i) The acquiror will receive the benefit of a “stepped-up” depreciable and amortizable tax basis in the assets of the target. (ii) Any gain realized by the target as a result of the deemed sale of its assets may be sheltered by its own net operating losses and tax credits, as well as any net operating losses and tax credits of its selling consolidated group. (iii) Gain is taxable to the target, but generally not to the target shareholders. (d) A stock acquisition by tender offer typically involves a taxable purchase of most of the target’s stock by a subsidiary of the acquiror, followed by a “reverse merger” of the subsidiary into the target (see III.A.2.(a)(iii) above) to eliminate minority shareholders. The entire transaction is effectively treated as a taxable purchase of target stock by the acquiror.

3. Purchase of Assets for Cash and/or Notes.

(a) The corporate advantages and disadvantages are generally the same as for a tax-free stock-for-assets acquisition. (See II above.) In addition, in a taxable asset purchase, the acquiror may selectively acquire only certain assets and assume only certain liabilities.

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(b) The target is taxed on the assets that it sells even if it follows the sale with a complete liquidation. Upon any such liquidation, the target shareholders are generally also taxed on the gain realized on their target stock (unless the target is an S corporation or has an 80% or greater domestic corporate shareholder). (c) The acquiror receives a tax basis in each asset equal to the amount of the purchase price allocable to it. 4. Installment Sale. If the acquiror purchases stock or assets and the parties agree that payment will be made, in whole or in part, after the close of the taxable year in which the sale occurs, the seller may be able to account for and report any gain (but not loss) under the installment method (i.e., gain will be taxed only as actual payments are received). (a) The acquiror can defer payment of all or a part of the purchase price with seller financing, often at a favorable interest rate. Special rules apply to notes or deferred payments that bear below-market interest rates or that include contingent payments of interest or principal. (b) The target or selling shareholders can defer recognition of gain for tax purposes, but the tax benefit for the target or selling shareholder is substantially reduced to the extent proceeds, to any seller, exceed $5,000,000. (c) Installment-method reporting is available for most deferred-payment sales, but is not available for the sale of publicly traded securities. (d) A deferred payment that is supported by a third- party guarantee or stand-by letter of credit does not constitute a payment in the year of sale. However, a purchaser’s note that is payable on demand or readily tradable (as well as the note of a third party) will be treated as a payment in the year of sale. Furthermore, the purchaser’s notes may be subject to pledge restrictions. C. Hybrids and Variations on Basic Forms.

1. Holding Company Formation. Certain target shareholders may “roll over” their target stock into stock of a holding company formed (and primarily owned) by the acquiror (or a subsidiary of the

Inside the Minds – Published by Aspatore Books acquiror). This technique is typically used when minority shareholders of a publicly traded target wish to avoid a taxable sale or exchange, but the acquiror wishes to purchase a majority of the shares of target stock for cash and/or notes. (a) The “rollover” target shareholders can receive stock of the holding company (preferred or common, voting or non-voting), other than nonqualified preferred stock, tax-free, while the other target shareholders can receive cash or notes in a taxable transaction. (b) There is no minimum amount of holding company stock that must be issued to the “rollover” shareholders. (c) Variations include interposing a holding company above both the target and the acquiror. 2. Contingent Stock or Stock Earn-Out Arrangements and Stock Escrow Arrangements. Such arrangements are generally permitted in tax-free reorganizations. (a) IRS guidelines for contingent stock or stock earn-out arrangements require, among other things: (i) the issuance of all such stock within five years; (ii) a valid business reason for the arrangement; (iii) a stated maximum number of issuable shares, 50% of which must be issued in the initial distribution; (iv) non-assignability of the right to receive the stock; and (v) the use of only acquiror stock. (b) IRS guidelines for a stock escrow arrangement require, among other things: (i) the release of all stock (which must be validly issued and outstanding) within five years; (ii) a valid business reason for the arrangement; (iii) current distribution of all dividends to the target shareholders; and (iv) voting rights exercisable by the target shareholders. 3. Net Operating Loss Carryforwards. The acquisition of a corporation with net operating losses (“NOLs”), investment credits or other tax attributes presents special problems. (a) Use of a corporation’s NOLs and certain other of its tax attributes is substantially limited if the stock ownership (by value) of the corporation changes by 50% over a three- year period. If a triggering ownership change occurs, the use of pre-change NOLs and other tax attributes against the

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corporation’s post-change profits is subject to an annual limitation equal to the product of (i) an amount equal to the fair market value of the equity of the corporation before the ownership change and (ii) a prescribed interest rate. (b) Very generally, carryovers will be lost if the principal purpose of the acquisition (or the principal motivation behind a particular structure) is to secure their benefit. 4. Joint Ventures and Pass-Through Entities. Pass-through entities are commonly used to structure asset acquisitions and joint ventures. The three entities discussed below generally incur no Federal income tax liability at the entity level; rather, they pass items of income and loss through to their equity participants. (See also II.D.) (a) Partnership. A partnership can take the form of a general partnership (in which all partners share in the liabilities of the partnership) or a limited partnership (in which one or more general partners are joined by limited partners, who may not participate in the management of the partnership business and who have limited liability). A partnership is a pass-through entity for Federal income tax purposes and allows for extremely flexible allocations of taxable income and loss. (See also II.D.2.) (b) Limited Liability Company. A LLC with two or more members can elect to be treated as a partnership or a corporation for Federal income tax purposes. Consequently, an LLC can obtain pass-through treatment for Federal income tax purposes in the same way as a partnership, but will confer the benefit of limited liability on all of its members. A single-member LLC can elect to be treated as a corporation or disregarded as an entity separate from its owner. An LLC need not satisfy the strict eligibility requirements pertaining to an S corporation and it offers the same allocation flexibility as a partnership. Although the law and practice of LLCs are still relatively new, they are increasingly seen as an alternative to partnerships (general and limited) and S corporations. (c) S Corporation. An “S corporation” is a corporation that elects to be taxed generally in a manner similar to a partnership (i.e., on a pass-through basis). Under current law, the shareholders of an S corporation may not exceed 75 in

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number, and they must all be individuals who are United States citizens or residents (or certain trusts or estates). In addition, a wholly-owned S corporation subsidiary can elect to be disregarded as a separate entity from its parent. However, S corporations generally lack the allocation flexibility of partnerships and LLCs.

IV. ACCOUNTING FOR BUSINESS COMBINATIONS.

During 2001 the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets (together, the “Statements”). The Statements prohibit the use of the pooling-of-interests method for business combinations and require that acquisitions initiated after June 30, 2001 be accounted for as purchases. A purchase is accounted for as the acquisition of assets and assumption of liabilities at fair value (i.e., the purchase cost) by an acquiror. Goodwill will be recorded if the purchase price exceeds the fair value of the net assets acquired. The results of the target are reflected from the purchase date; the prior results of the acquiror are not restated.

Negative goodwill is recognized immediately in income as an extraordinary gain. Negative goodwill (under present rules which are being revised) is the amount that results after all nonmonetary, noncurrent assets have been reduced to zero.

A. Goodwill. Under the Statements, goodwill should be initially recognized as an asset in the financial statements. Goodwill is measured as the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired (including identifiable intangibles) and liabilities assumed. Goodwill, including goodwill that exists at the effective date of the Statements, must be allocated to the acquiring company’s “reporting units,” as defined under the Statements. Goodwill should not be amortized but should be tested for impairment at the reporting unit level. A “reporting unit” will be an operating segment or smaller sub-set of a company. B. Goodwill Impairment Testing. Goodwill must be tested for impairment within six months of adoption of the Statements (which are now effective for virtually all companies) by comparing the fair value of the reporting unit to its carrying value. If the carrying value exceeds the fair value, additional computations are required to determine the amount of the impairment. Subsequent to the initial impairment test, an annual determination of fair value of the reporting unit is required unless certain criteria are met. In

Energy Acquisitions and Joint Ventures – By Robert A. James addition, there are indicators that would require interim goodwill impairment testing. C. Intangible Assets Other than Goodwill. A recognized intangible asset should be amortized over its useful life and reviewed for impairment. A recognized intangible asset with an indefinite useful life should not be amortized until its life is determined to be finite. The FASB agreed that the useful life of an intangible is indefinite when the life extends beyond the foreseeable horizon. The Statements also clarify that indefinite does not mean infinite and that the useful life of an “intangible” asset should not be considered indefinite because a precise finite life is not known. The Securities and Exchange Commission (“SEC”) is expected to closely scrutinize the allocation of purchase price between non-amortizable intangible assets, goodwill and amortizable intangible assets. D. Acquisitions of Less Than All of a Business.

1. If the acquisition results in the acquiror obtaining control of the target (generally involving an acquisition of more than 50% of the voting stock), the acquisition will be included in the acquiror’s consolidated financial statements. All assets and liabilities will be recorded at fair value to the extent of the change in control and the minority interest will be shown between liabilities and equity in the acquiror’s balance sheet. For accounting purposes, the acquiror is generally the entity whose shareholders and management emerge in control, not necessarily the legal survivor. 2. If significant influence over a target has been obtained, but not control (generally involving between 20% and 50% of the voting stock), the equity method of accounting will be used. The investment will be shown as one line on the balance sheet and the acquiror will reflect in its income statement its share of the results of the target, as adjusted, for amortization of the excess purchase price, including identifiable intangibles, on one line. Goodwill and indefinite lived intangibles will not be amortized. However, the entire investment will be subject to an impairment review. 3. If significant influence over an investment has not been obtained (generally less than 20% of the voting stock), an investment in a private company will be accounted for at the lower of cost or market, and generally only dividends received will be included in the income of the acquiror. If the investment is in a public company, the investment will be carried at market with changes in market value

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being included in income or comprehensive income based on the designation (trading vs. available for sale) given to the investment. 4. When a holding company with no substantive operations acquires only a portion of an operating company in a leveraged buyout (“LBO”) transaction, complicated issues arise regarding what basis of accounting should be utilized by the holding company in valuing its interest in the operating company. This issue, discussed at length in the FASB’s Emerging Issues Task Force Issue No. 88-16, is complex and requires consultation with accounting professionals because of the potentially significant impact on the financial statements of the companies. 5. When less than all of a business is acquired, the separate financial statements of the acquired entity may reflect the acquisition as a capital transaction (“recap”) in lieu of a purchase business combination. The criteria impacting this determination are not easily identified in accounting literature and are subject to interpretation. Therefore, consultation with accounting professionals is required.

V. FINANCING CONSIDERATIONS. A. Sources of Capital for Payment of Purchase Price.

1. Self-generated by acquiror (includes cash from operations, lines of credit, commercial paper).

2. Proceeds of acquisition financing:

(a) Senior Debt. (i) May include term loans (usually secured by real estate and other property, plants and equipment) and revolving credit lines for working capital purposes (usually secured by inventory and receivables). (ii) Acquired company’s assets may be pledged as collateral (LBO). (iii) Loans may be made by a single bank or group of banks, depending upon size of transaction. (iv) Recently, insurance companies, mutual funds, hedge funds, finance companies and other

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non-bank financial institutions have been participating in this market. (v) Senior debt can also be used to enable an employee stock ownership plan (“ESOP”) to acquire target stock. (b) Mezzanine Securities. (i) Debt securities junior to senior debt sold to finance acquisitions are widely known as “mezzanine” debt and include so-called “high-yield” or “junk” bonds. (ii) Mezzanine debt may be sold in private transactions or through registered transactions depending upon the size and nature of the mezzanine portion. (iii) Purchasers include banks, insurance companies, pension and mezzanine investment funds, other institutional investors and wealthy individual investors. (iv) Generally subordinated to the senior debt and usually unsecured. It is not unusual for two or more layers of mezzanine indebtedness, each subordinate to the next more senior layer, to be issued in order to achieve optimum capitalization; sometimes, the senior debt will require the mezzanine debt to be held at the holding company level in order to structurally subordinate such debt to the senior debt of the operating company and to keep the balance sheet of the target operating company more attractive for fraudulent conveyance purposes. (v) Some mezzanine securities have been structured to defer cash interest payments, such as “zero-coupon” bonds, and others may pay interest currently, but in additional securities rather than cash (“pay-in-kind” securities). (vi) Often have equity “kicker” in form of convertible feature or separate warrants.

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(c) Equity Securities. (i) Include both preferred and common stock. (See VI below for a description of American Depositary Receipts (“ADRs”).) (ii) Have traditionally been sold to financial institutions interested in an equity level participation in leveraged acquisitions and also to LBO funds and other institutional investors, pension funds (subject to complex rules under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”)) and management groups. (iii) Generally raised in private transactions not involving registration under the securities laws. (iv) Pay-in-kind feature has also been used extensively, in lieu of cash dividends, in preferred stock issued to institutions in leveraged acquisitions. (d) Bridge Financing. (i) Investment banks and other sources may provide short term so-called “bridge” financing to bridge the gap between such immediately available sources of financing and longer term financing or asset sales. (ii) Generally intended to be repaid promptly after the completion of the acquisition through sales of assets or securities or other refinancing. (e) Rights Offerings. (i) Background. Rights offerings are commonly utilized by many non-United States companies, often because of legally mandated preemptive rights. In the United States, rights offerings are being considered with greater frequency as a means of raising capital. In a rights offering, an issuer makes an offer to existing shareholders, usually on a pro rata basis and for a specified exercise period, to sell securities for a cash price which is typically less than the pre-offering market price of such securities. Rights offerings are generally underwritten or are

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structured as placements with “clawback” rights on the part of shareholders. Historically many issuers have excluded or cashed out United States shareholders from rights offerings because of United States regulatory constraints. A. Underwritten Rights Offerings. Under this form of offering, underwriters commit to purchase the securities on a standby basis, i.e., to the extent that existing shareholders do not take up their rights. Issuers may distribute “provisional allotment letters,” which evidence the issuance of the securities in “nil-paid” form. The rights to purchase the securities may themselves be transferable, in which case a trading market for the rights themselves arises during the subscription period, with shareholders who do not wish to purchase the underlying securities selling the rights into the market. Upon receipt by the issuer of the subscription price and an executed provisional allotment letter, the subject securities become fully paid and non-assessable.

B. Clawback Offerings. In clawback offerings, underwriters or institutional investors are allotted securities, subject to the right of shareholders to “claw back” their rights of subscription. In clawback offerings no separate market for the rights themselves develops. Clawback offerings are often utilized when the subject securities are in bearer form and communication with shareholders is effected through newspaper publication. (ii) SEC Proposals Relating to Rights Offerings by Non-United States Companies. The SEC has issued a proposal to facilitate the extension of rights offerings made by “foreign private issuers” to United States shareholders. A “foreign private issuer” is

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defined as any foreign issuer other than a foreign government except an issuer meeting the following conditions: (1) more than 50% of the outstanding voting securities of such issuer are held of record by residents of the United States; and (2) any of the following: (x) the majority of the executive officers or directors of the issuer are United States citizens or residents, (y) more than 50% of the assets of the issuer are located in the United States or (z) the business of the issuer is administered principally in the United States. The proposal encompasses a small issue exemption from the registration provisions of the Securities Act of 1933 (“1933 Act”) pursuant to a new Rule 801 and a new Form F-11 registration statement for offerings exceeding the small issue exemption threshold which will allow the use of documents prepared pursuant to the issuer’s home jurisdiction disclosure requirements. It must be kept in mind that unless and until the proposal is adopted pursuant to final rule-making of the SEC, the proposal will not have the force of law. There has been no action on the proposal as of this printing. (iii) Effect on Other Laws. The above proposals will have no impact on the anti-fraud or civil liability provisions of the Federal securities laws. Exemptions from state blue sky laws for rights offerings may be available under a number of possible bases. Offerings will have to be examined on a case-by-case basis to determine whether such exemptions are available. 3. Assumption or retention of the acquired company’s indebtedness.

4. Retention by seller of liquid or other assets to reduce purchase price; this retention includes (subject to complex Federal rules) the possibility of using surplus assets from overfunded employee benefit plans of the target.

5. Post-closing sales of assets by acquiror to reduce acquisition indebtedness.

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6. Seller financing. (a) Deferred payment provisions and installment sale transactions. (b) Rollover of existing stock ownership for stock of the acquisition company. B. Earn-Outs.

1. Contingent purchase price determination based on future performance. (a) Formula used to define future performance that gives rise to contingent price. (b) May be coupled with an escrow of cash or shares. (c) May be used to defer payment of purchase price. (d) Rule 144 holding period generally not extended by virtue of contingency. (e) May enable seller and buyer to reach agreement on a price where there is disagreement on target’s potential. 2. Problems.

(a) Development of a formula and the choice and definition of a standard (net worth, net income, gross income, net sales, gross sales), as well as accounting principles and other procedures for computing and verifying performance. (b) May prevent acquiror from integrating target during earn-out period. (c) Extent to which acquiror may employ or change: (i) charges against income, including intercorporate transactions and allocations; (ii) reserves; (iii) sales techniques; (iv) recognition of income; (v) commitment and cost of capital; (vi) tax elections; and

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(vii) general and administrative expense. (d) When maximum not earned, disputes may result. (e) Difficulty when a related business is acquired or when a portion of the target is divested during earn-out period. (f) Conflict of interest where seller stays on to run business during earn-out period. (g) Kick-out clauses: (i) right to abandon business; (ii) right to terminate target’s management; and (iii) a cap on the earn-out permits the acquiror to buy its way out of disputes. (h) IRS may impute interest (recharacterizing a portion of the purchase price as such) at a variable statutory rate unless interest is provided for on deferred purchase price at least at such rate. C. Regulatory Restrictions.

1. Regulation T. Pursuant to Regulation T of the Board of Governors of the Federal Reserve System (the “Board”), (a) Extending Credit. A broker or dealer may not extend credit if such credit is for the purpose of purchasing, carrying or trading in securities—a “purpose credit”; (i) is not secured by securities which are either: A. margin securities, including: 1. securities registered on a national securities exchange, and 2. securities on a list of widely traded stocks prepared by the Board; or B. exempt securities pursuant to the 1934 Act;

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(ii) is so secured, but is in an amount in excess of a specified percentage (currently 50%) of the loan value of the margin securities or the good faith loan value of exempt securities. (b) Arranging Credit.

(i) A broker or dealer may not arrange for the extension of credit except: A. on such terms as it could extend the credit itself; B. on terms which do not violate Regulations U (see V.C.2 below) or G and the arranging results solely from investment banking services being rendered by such broker or dealer or the sale of non-margin securities if the sale is exempt from the registration requirements of the 1933 Act by reason of Sections 4(2) or 4(6) therein; C. where the credit is extended by a foreign person to purchase foreign securities; or D. a subsequent loan or advance or a face-amount certificate as permitted under 15 U.S.C. Section 80A-28(d). (ii) A broker or dealer may underwrite a public offering of securities (other than certain equity securities with installment or other deferred-payment provisions) without being deemed to have “arranged” an extension of credit thereby. 2. Regulation U.

(a) Regulation U of the Board generally prohibits a bank from extending any credit secured directly or indirectly by any margin stock for the purpose of purchasing or carrying any margin stock (or refunding or refinancing any indebtedness originally incurred for such purpose) in an amount exceeding the maximum loan value prescribed from time to time for collateral securing the credit. Margin stock currently has a

Inside the Minds – Published by Aspatore Books maximum loan value of 50% of its current market value. Other collateral has a loan value as determined by the bank in good faith. (b) “Margin stock” is defined in Regulation U to include any equity security (or debt security convertible into equity) listed on a national securities exchange or included in the Board’s list of over-the-counter stocks, which includes stocks traded in the OTC market which have the requisite high level of distribution and investor interest. (c) The Board has interpreted the provisions of Regulation U dealing with indirect security for a purpose loan to include arrangements such as a negative pledge clause. However, a negative pledge clause covering all of a borrower’s assets will not trigger Regulation U’s loan value requirements unless more than 25% of such assets consist of margin stock. (d) Unlike Regulation T, which contains a maintenance requirement for collateralization of loans subject to its provisions, Regulation U only prohibits the substitution and withdrawal of collateral for a purpose loan if the loan would not be properly collateralized after the substitution or withdrawal. (e) Like Regulation T, Regulation U prohibits a bank from “arranging” any credit which could not be extended by the bank itself under the provisions of Regulation U. (f) Regulation U regulates only loans for the purpose of purchasing or carrying margin stock, as defined (or refundings or refinancings of such loans), and then only if the loans (or such refundings or refinancings) are secured directly or indirectly by margin stock. If the loan would not meet the margin requirements, banks may consider deferring taking a pledge of target stock until the acquisition is consummated and the stock is delisted, i.e., is no longer margin stock. Additionally, if at the time of a refunding or refinancing the stock being purchased or carried has ceased to be margin stock, the refunding or refinancing would no longer be subject to Regulation U.

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(g) A bank would not be prohibited under Regulation U from extending unsecured credit (or credit secured solely by non-margin stock collateral) for the purpose of purchasing or carrying margin stock, nor would a bank be prohibited from extending a loan secured by margin stock for the purpose of purchasing or carrying a speculative stock which did not constitute margin stock.

VI. AMERICAN DEPOSITARY RECEIPTS.

A. Attributes. An ADR is a certificate, or receipt, which represents a specified number of the underlying securities of a foreign issuer. ADRs are issued by a United States bank (a “depositary”) with whom the underlying securities are deposited. The depositary appoints a custodian (located in the foreign issuer’s country of incorporation) to hold the deposited securities. ADR prices are quoted in U.S. dollars, and dividends and interest on the underlying securities are converted by the depositary and are paid out in U.S. dollars. ADRs may be issued in connection with a new issue of the underlying security in public offerings (including exchange offers) or in private placements. ADRs can also be established to facilitate secondary market trading without any concurrent issuance of the underlying security. ADRs may be listed with the New York Stock Exchange (the “NYSE”) or the American Stock Exchange (“AMEX”), quoted by the Nasdaq Stock Market (“Nasdaq”), or traded on the Nasdaq OTC Bulletin Board system or as “pink sheet” securities. As global offerings have become more common, it has become customary to establish tranches of shares taking the form of ADRs for an offering in the United States and Global Depositary Receipts (“GDRs”) or International Depositary Receipts (“IDRs”) for offerings in other countries outside the home jurisdiction of the issuer.

B. Types of ADR Facilities.

1. Unsponsored ADR Facilities. Unsponsored ADR facilities are established unilaterally by a depositary, usually in response to investor or broker interest. In some cases, duplicative unsponsored ADR facilities with respect to the same securities of a foreign issuer may exist. Although as a technical matter a depositary may unilaterally establish an unsponsored ADR facility, practically speaking it must have the cooperation of the issuer of the underlying securities, as the ability of the depositary to register ADRs on a Form F-6 registration statement is predicated on the issuer either being subject to the reporting provisions of the 1934 Act, or exempt pursuant to Rule

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12g3-2(b) thereof. It is typical for holders of unsponsored ADRs to bear the costs of unsponsored ADR facilities.

2. Sponsored ADR Facilities. Sponsored ADR facilities are created jointly by a foreign issuer and a depositary. Upon the establishment of a sponsored ADR facility, unsponsored facilities with respect to the same securities will need to be terminated. The SEC staff has taken the position that an unsponsored program may not co- exist with a sponsored program for the same securities. The existence of an unsponsored ADR program may therefore be an obstacle to an issuer who would like to establish a sponsored ADR program. This will often require the negotiation of cancellation fees with the depositaries of the unsponsored programs. Depending upon the number of ADRs outstanding, the cancellation fees can be substantial and are typically borne by the issuer, or by the depositary of the sponsored program. The foreign issuer and the depositary enter into a deposit agreement which governs their rights and responsibilities and those of the holders of ADRs. Typically, the foreign issuer will bear some or most of the costs of a sponsored facility, depending on the “level” of the program being implemented (see below). Sponsored ADR facilities are often referred to as being one of three “levels,” which correspond to the degree of foreign issuer involvement, amount of public information made available and whether new capital is being raised by the issuer:

(a) Level 1. Level 1 ADRs trade only on the over-the- counter market (i.e., “pink sheets”) and are not listed with NYSE or AMEX or quoted on Nasdaq. The foreign issuer will seek an exemption from the reporting requirements of the 1934 Act pursuant to Rule 12g3-2(b) thereof (see VI.D.1.b.ii below); (b) Level 2. Level 2 ADRs are listed with NYSE or AMEX or are quoted on Nasdaq but do not involve a public offering of the underlying securities (i.e., when new capital is not being raised). Periodic disclosure obligations under the 1934 Act will also arise for issuers on the establishment of Level 2 ADR facilities; and (c) Level 3. Level 3 ADRs are listed with NYSE or AMEX or are quoted on Nasdaq and involve a public offering of the underlying securities (i.e., new capital is being

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raised). Periodic disclosure obligations under the 1934 Act will also arise for issuers upon the establishment of Level 3 ADR facilities. C. Advantages. The establishment of an ADR facility may be advantageous to a foreign issuer for a number of reasons:

1. Because United States investors often favor ADRs over securities of a foreign company, ADRs can prove useful in the context of an exchange offer when a foreign acquiror intends to use its own stock as consideration for the acquisition of a United States public company. 2. An ADR facility can prove an attractive vehicle for stock ownership in a foreign company in cases in which a foreign acquiror wishes to incentivize the employees of a company on a post- acquisition basis through the use of stock option and other employee benefit plans. 3. A foreign acquiror may wish to utilize the ADR vehicle as a means of raising capital in the United States to fund a United States acquisition or for other corporate purposes. 4. ADRs provide a mechanism for investors to receive dividends in U.S. dollars. 5. Issuers may benefit from the enhanced liquidity that a listing in the U.S. (such as the NYSE or Nasdaq) may bring. 6. Some U.S. investors may only be permitted to invest in U.S. dollar denominated securities under the terms of their organizational documents. D. Legal requirements.

1. Use of ADRs in an Exchange Offer or Other Public Offering. (a) 1933 Act Requirements. ADRs and the underlying securities with respect thereto are considered separate securities for Federal securities law purposes and both must be registered under the 1933 Act. (i) ADRs are registered by the filing and effectiveness of a Form F-6 registration statement. The Form F-6 consists largely of the ADR certificate

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and the deposit agreement among the foreign issuer, the depositary, and the holders from time to time of the ADRs, which governs the rights and obligations of the parties with respect to the ADRs (e.g., the payment of dividends). (ii) The underlying securities are registered by the filing and effectiveness of, in the case of an exchange offer, a Form F-4, and, in the case of a public offering for cash, either a Form F-1, F-2 or F- 3 registration statement. These forms require information on the issuer and the underlying securities, including a description of the business of the issuer (including a requirement to reconcile certain figures with United States generally accepted accounting principles (“GAAP”)) and other requirements as to financial statements, and a discussion and analysis of the company’s operating and financial review and prospects (commonly referred to as the “MD&A”). (In the case of the establishment of an employee benefit plan, a short Form S-8 registration statement would be utilized.) (b) 1934 Act Requirements.

(i) Forms 20-F and 6-K. The listing of ADRs on an exchange or Nasdaq (i.e., a Level 2 ADR program) will require the filing of an initial registration statement on Form 20-F and thereafter annual reports on Form 20-F. Form 20-F calls for information similar to that required by a registration statement on Form F-1 (see above). Unlike a domestic issuer, a foreign issuer is not required to file quarterly reports. However, the issuer is required to furnish reports on a Form 6-K containing material information which it makes public in its home country or files with the stock exchange on which its securities are traded, or otherwise distributes to its securityholders. (ii) Rule 12g3-2(b) Exemption. If ADRs are not to be offered publicly and will not be listed or quoted (i.e., Level 1 ADR program), a foreign issuer

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must apply for an exemption from the reporting requirements of the 1934 Act. If the exemption is granted, the foreign issuer must furnish to the SEC copies of all material information that the issuer makes public in accordance with the laws of its home country, files with a stock exchange on which its securities are traded, or otherwise distributes to its securityholders. 2. Use of ADRs in a Private Offering. A foreign issuer may wish to raise capital from institutional investors by effecting a private placement by using one of a number of exemptions, including Rule 144A under the 1933 Act. However, Rule 144A may not be utilized for securities which are listed on NYSE or AMEX or quoted on Nasdaq. An exemption from registration for securities issued pursuant to employee benefit plans may be available pursuant to Rule 701 under the 1933 Act.

VII. DUE DILIGENCE—IDENTIFICATION OF EXISTING AND CONTINGENT LIABILITIES.

A. Purpose. An acquiror often considers it commercially prudent as well as consistent with its board of directors’ fiduciary obligations to undertake a “due diligence” investigation of the target’s books and records and to evaluate its affairs, as promptly as possible, in connection with a proposed acquisition. B. Participants. It is important to coordinate an investigation to be undertaken by the acquiror’s business and financial personnel, independent accountants, counsel, and other appropriate specialists (e.g., actuaries, intellectual property counsel, title companies, engineers, information systems technicians, environmental engineers, appraisers and insurance brokers). Written reports from each such specialist, including a summary of legal and business issues, may be advisable, depending on the complexity of the transaction, prior to finalizing the transaction’s structure. C. Objectives. 1. To evaluate target’s business and financial strengths and weaknesses. 2. To enable drafting and negotiation of appropriate representations, warranties and indemnification to deal with areas of special concern.

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3. To evaluate exposure to existing and contingent liabilities (including environmental and product liabilities). 4. To evaluate accounting systems and controls and consistency of target’s application of GAAP with that of acquiror. 5. To evaluate products, proprietary rights, and research and development. 6. To identify and evaluate legal and contractual impediments to completion of the proposed acquisition, including required authorizations, consents and approvals. 7. To determine whether the information contained in the acquisition agreement and related documentation is consistent with the corporate records and other documents of the target and to confirm that such records and documents do not indicate that information important to an informed acquisition decision has been omitted from the acquisition agreement and related documentation. D. Timing.

1. It is strongly recommended that the investigation be undertaken before the structuring of a transaction and the signing of a definitive agreement. 2. Where the investigation is undertaken after signing and before closing, a specific condition to such closing should be negotiated to permit termination or revision of the agreement in the event the investigation reveals significant adverse conditions. 3. Where secrecy is desirable, the execution of a confidentiality agreement may be advisable prior to conducting the investigation. Sometimes it is appropriate to structure a limited investigation to be conducted off the target’s premises. Where a bidding or auction process is in effect, the management and counsel of the target should conduct the auction or bid with procedures designed to ensure fairness to all potential acquirors, granting equal time and access for due diligence examination of records and interviews with management and other employees. In the event that the management of the target is itself participating in one of the bidding groups, it may be necessary for other bidders to insist upon formal procedures to ensure the opportunity for a meaningful due diligence investigation.

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E. Review by Counsel. Legal counsel should review the entire legal and corporate structure of the target as well as the corporate law of the state of incorporation of the target in an effort to identify any significant “downside” risks. Set forth below is a list of some of the significant categories to consider. This list, however, is intended to be a guide rather than a comprehensive list. Every due diligence investigation should be a complete and exhaustive examination of the target, specifically tailored to the target under consideration.

1. Basic corporate documents:

(a) charter documents and all amendments thereto; (b) by-laws and all amendments thereto; (c) stock books, stock transfer ledgers and stockholder agreements; (d) minute books for meetings of stockholders, board of directors and important committees (e.g., executive and audit committees); (e) good standing certificates from state of incorporation and from states of foreign qualification; and (f) partnership or joint venture documents. 2. Material contracts, agreements, commitments and leases should be reviewed for:

(a) assignability; (b) validity; (c) representations, warranties and covenants; (d) onerous or unusual provisions, including liability/indemnity provisions; (e) breaches or defaults; (f) redetermination or escalation clauses; and (g) term and termination. 3. Complete list of any existing, threatened or potential actions, suits and governmental or regulatory proceedings and pending or threatened proceedings or investigations, and all documentation and correspondence relating thereto.

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4. Employment policies and personnel, including review of all employee benefit plans, policies, contracts with employees, labor history, the Occupational Safety Health Act of 1970, as amended (“OSHA”) and worker’s compensation history and discrimination claims. 5. Compliance with appropriate statutes and agency guidelines, including: (a) OSHA and all regulations promulgated thereunder; (b) Environmental Protection Act and state and local regulations; (c) ERISA; (d) Equal Employment Opportunity Act of 1972; (e) labor practices; (f) special requirements for regulated industries; (g) The Age Discrimination in Employment Act of 1967, as amended; and (h) Title VII of the Civil Rights Act of 1964, as amended. 6. Permits, licenses, regulations and other governmental authorizations. 7. Federal, state, local and foreign tax returns.

8. Antitrust considerations: (a) pending or threatened private and governmental actions; (b) agreements with or requests by the Federal Trade Commission (the “FTC”) concerning the target or its assets; and (c) consents, decrees or existing orders with respect to pricing, policy disposition or requisitions. 9. Patents, trademarks, copyrights, trade secrets and other proprietary information held or used by the company.

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10. Real property (owned and leased), valuation and marketability of title. 11. All insurance policies, outstanding claims and agreements relating to indemnification. 12. Environmental: (a) all environmental permits, licenses, registrations and other authorizations and all applications thereof; (b) all environmental studies and reports within the last five years; (c) all reports, manifests, regulatory filings and other documents relating to hazardous waste or management over the last five years; (d) all documents relating to contamination, clean-up or remediation on-site or off-site, or spills or releases; (e) all documents relating to PCB equipment and asbestos existence or exposure; and (f) all correspondence with and notices to and from any regulatory authorities. 13. Financial statements and reports. 14. Appraisals and other reports prepared by management. 15. Prospectuses, offering circulars and SEC reports or filings. 16. Security interests (such as those evidenced by Uniform Commercial Code (“UCC”) financing statements) on any real, personal or intangible property. 17. All evidence of indebtedness for borrowed money or indebtedness created by guaranties of contract performance. 18. Interested party transactions, including all payments made to or from affiliates, directors and officers. 19. All marketing or business plans.

Energy Acquisitions and Joint Ventures – By Robert A. James

APPENDIX B

SAMPLE BUYER’S DUE DILIGENCE CHECKLIST

[This sample is for reference purposes only, and is not intended as an actual checklist for a particular transaction. It does not constitute a legal opinion and it is not a substitute for legal advice and attorney-client communications.]

Copies provided 1. LEGAL: 1.1 BASIC COMPANY DOCUMENTS 1.1.1 Diagram of the organizational structure, including company whose business line is to be acquired (“Company”), including a list of all entities, foreign and domestic, and dates and jurisdictions of incorporation or formation. 1.1.2 All formation documents, including articles, bylaws, certificates of incorporation, or equivalent organization documents. 1.1.3 List of directors and officers. 1.1.4 Minute books of the organization. 1.1.5 List of jurisdictions in which qualified to do business, operations are conducted or property is owned or leased. 1.1.6 Good standing and tax certificates. 1.1.7 Agreements concerning members’ rights and voting agreements.

1.2 MARKET CHARACTERISTICS 1.2.1 Description of current market environment. 1.2.2 Historical and projected market developments.

1.3 OPERATIONS 1.3.1 Maintenance history.

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Copies provided 1.3.2 Production history. 1.3.3 Summary of expansion opportunities. 1.3.4 Description of each facility including: list of machinery and equipment, describing appraised value and whether such equipment is leased or owned; existing warranties or guarantees; summary of recent capital investment undertakings and proposals. 1.4 MATERIAL CONTRACTS, AGREEMENTS AND OTHER INFORMATION AND DOCUMENTS (INCLUDING MATERIAL CONTRACTS AND AGREEMENTS FILED WITH THE SEC) 1.4.1 Major supply, services, and transmission counterparties and material contracts with same. 1.4.2 Major customers and material contracts with same. 1.4.3 All partnership, strategic alliance, joint venture or joint development agreements. 1.4.4 All consulting agreements. 1.4.5 Loan and guarantee agreements (including those with officers, directors or employees), revolving credit agreements, financing leases, etc. 1.4.6 Asset purchase, merger or other acquisition agreements. 1.4.7 Inventorship agreements. 1.4.8 Summary of real property lease commitments with leases attached. 1.4.9 Summary of equipment leases with leases attached, and any UCC financing statements. 1.4.10 Non-competition agreements. 1.4.11 Confidentiality and standstill agreements.

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Copies provided 1.4.12 Surety or performance bonds. 1.4.13 Mortgages, indentures, security agreements and guarantees and any other contracts or agreements creating encumbrances, options, restrictions and claims affecting any property. 1.4.14 Installment and other types of sales agreements creating encumbrances, options, restrictions and claims affecting any property. 1.4.15 Standard forms (i.e., invoices, purchase orders, etc.). 1.4.16 Product warranty agreements. 1.4.17 A list of associations and organizations to which the Company belongs. 1.4.18 Any material contract or agreement not otherwise within the foregoing categories.

1.5 INTELLECTUAL PROPERTY 1.5.1 Schedule listing and describing patents, trademarks or trade names, copyrights or other similar intangible assets held by the Company or used by it in the conduct of its business, and patent and trademark registrations and applications. 1.5.2 Copies of all patents, trademarks/service marks or copyright registrations or pending applications (both domestic and foreign). 1.5.3 Schedule of domain names and registrations, if any, thereof. 1.5.4 Description of proprietary and other software programs used in the Company’s business. 1.5.5 Licensing agreements, merchandising agreements (naming the Company as licensee or licensor) or assignments relating to patents, technology, trademarks or trade names, copyrights, or other

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Copies provided similar intangible assets, including software and systems. 1.5.6 All licensing or technology agreements with a governmental entity. 1.5.7 Binding and non-binding letters of intent and memorandums of understanding relating to licensing and technology. 1.5.8 Manuals or other written documents detailing the procedures for maintaining the secrecy of trade secrets. 1.5.9 Communications to or from third parties relating to the validity or infringement of the Company’s patents, trademarks, trade names, copyrights and other intangible assets, including software and systems. 1.5.10 Communications from third parties demanding or requesting the licensing or purchase of third party patents, copyrights or trade secrets due to Company’s actual or intended business. 1.5.11 Studies or reports relating to the validity or value of the Company’s patents, technology, trademarks or trade names, copyrights, or other similar intangible assets, and the licensing or merchandising thereof.

1.6 INFORMATION SYSTEMS (“IS”) AND SERVICES 1.6.1 Description of each of the Company’s information systems. 1.6.2 IS function organization. 1.6.3 IS budget. 1.6.4 Other IS projects ongoing or planned. 1.6.5 Current licensed applications (Internet, server, desktop).

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Copies provided 1.6.6 Third party tool dependencies and cost; open source utilized and associated documentation. 1.7 LICENSES AND PERMITS 1.7.1 Any licenses, permits and registrations issued by U.S. federal, state or local authorities and any foreign counterparts thereto. 1.7.2 Documents relating to compliance with, and filings and orders under, various U.S. federal and state acts and regulations and municipal ordinances applicable to the Company, and any foreign counterparts of the foregoing, including: (i) The Occupational Safety and Health Act and all regulations promulgated thereunder; (ii) The Employee Retirement Income Security Act of 1974, as amended; (iii) Equal Employment Opportunities Act; (iv) Labor practices regulation; (v) The Age Discrimination in Employment Act of 1967, as amended; (vi) Title VII of the Civil Rights Act of 1964, as amended; and, (vii) Protection of the environment.

1.8 INSURANCE 1.8.1 Schedule of all insurance policies currently in effect, indicating (i) provider(s), (ii) risk exposure covered, (iii) coverage limits and (iv) deductibles. 1.8.2 Copies of all insurance policies covering the Company or its employees. 1.8.3 List of all outstanding insurance claims and of all claims made in the past five years.

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Copies provided

1.9 LITIGATION 1.9.1 List and summary of pending or threatened legal proceedings or investigations, including administrative proceedings, governmental investigations, tax proceedings and arbitrations and correspondence and pleadings relating thereto. 1.9.2 Correspondence, memoranda or notes concerning any dispute with any employees, suppliers, competitors, or customers regarding any claim for an amount in excess of $25,000. 1.9.3 List and summary of all litigation (real and threatened) since inception, including the resolution thereof. 1.9.4 Correspondence with auditors regarding threatened or pending litigation, assessments or claims. 1.9.5 Consent decrees, injunctions, settlements, judgments and orders. 1.9.6 Reports, notices, correspondence or complaints relating to any violation or infringement by the Company of governmental regulations, including, but not limited to, the areas of securities regulation, equal employment opportunity, occupational safety and health and environmental protection, and antitrust, and copies of any other material correspondence with federal or state regulatory agencies.

1.10 ENERGY REGULATION 1.10.1 Confirmation of exemption from state and local siting agency approval. 1.10.2 Confirmation that the Company qualifies as an exempt wholesale generator (EWG).

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Copies provided 1.10.3 Confirmation that the Company has market-based rate-setting (MBR) authority. 1.10.4 Any other information related to energy regulatory status. 2. FINANCIAL: 2.1 BUSINESS PLAN, FORECASTS AND BUDGETS 2.1.1 Consolidated and consolidating financial statements for each of the preceding five fiscal years and interim periods of the current fiscal year, together with the related audit reports. 2.1.2 Accountants’ management report letters and management responses for each of the preceding five fiscal years. 2.1.3 Appraisals and other reports prepared by management or independent consultants within the last three years relating to the assets, business, operations, products or strategic direction of the Company or any of its subsidiaries. 2.1.4 Financial forecasts and strategic plans for subsequent year(s) including basis for assumptions used (i.e. percentage growth, market trends, etc). 2.1.5 Forecasts for the current year. 2.1.6 Detailed budget for current year and analysis of actual versus budget.

2.2 GENERAL 2.2.1 Monthly internal financial statements and management reports for trailing 12 months. 2.2.2 Trend and ratio analysis as regularly used by the Company for last 8 quarters. 2.2.3 Summary of all accounting policies and procedures.

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Copies provided 2.2.4 List of all bank accounts, brokerage accounts and other banks or lenders with whom the Company has a relationship (describe nature of relationship). 2.3 Sales / Accounts Receivable / Backlog 2.3.1 Description of revenue recognition policy. 2.3.2 Summary of sales by product and customer. 2.3.3 Summary of bad debts over last three years. 2.3.4 Accounts receivable summary detailing account balances and reserves. 2.3.5 Accounts receivable aging.

2.4 PROPERTY 2.4.1 Schedule of all owned and leased real property, together with any available title insurance policies, title searches, sureties and environmental assessments. 2.4.2 List of any easements or rights-of-way. 2.4.3 Schedule of material fixed assets. 2.4.4 List of office furnishings and equipment. 2.4.5 List of any spare parts or other inventory. 2.4.6 Any other material personal property.

2.5 NON CURRENT ASSETS 2.5.1 Describe policy regarding lives and capitalization limits. 2.5.2 Detailed listing of assets, including asset description, category, date acquired, cost, accumulated book depreciation, accumulated tax depreciation, state where located.

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Copies provided 2.5.3 Capital leases outstanding and summary of penalties for prepayment. 2.5.4 Summary of marketable securities 2.5.5 Summary of equity investments, including analysis of cost of investments, date of investment and any write-downs in valuation. 2.5.6 Summary of goodwill, including details of compliance with FAS standards, detailing name of acquisition, date of acquisition, accumulated amortization, analysis of any impairment issues, and anticipated write-offs. 2.5.7 Summary and analysis of intangible assets, including details of amortization.

2.6 OTHER FINANCIAL INFORMATION 2.6.1 Detail of prepaid expenses. 2.6.2 Aged accounts payable listing. 2.6.3 Breakdown of expenses, including R&D, sales and marketing and G&A. 2.6.4 Purchase commitments. 2.6.5 Open purchase orders. 2.6.6 Other contingent liabilities.

2.7 SHARES (OR PARTNERSHIP OR LLC MEMBERSHIP INTERESTS) 2.7.1 All agreements under which any person has any rights regarding interests in the Company. 2.7.2 Permits and consents to the transfer of any interest in the Company and all notices or other correspondence with governmental entities relating to any such transfer.

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Copies provided 2.7.3 Detail of any planned equity transactions for the foreseeable future.

2.8 TAX 2.8.1 Federal, FSC, international, state and local income and franchise tax returns and related workpapers, including review checklists filed by the Company and all affiliated companies for the last three years. 2.8.2 Any requests to change accounting methods and periods. 2.8.3 Any tax notices or other correspondence related to Company. 2.8.4 Any waivers of statute of limitations for any jurisdiction of the Company. 2.8.5 Revenue agents reports, tax protests, other notices of potential tax adjustments, closing agreements, or documents filed or prepared in conjunction with any tax controversy in any Federal, foreign, state, or local jurisdiction of the Company. 2.8.6 Current status of any tax audits and relevant correspondence. 2.8.7 Assessment and reserve for potential tax controversies. 2.8.8 Tax account analysis of current, deferred, payable & cushion for last 3 years and related accountants’ workpapers. 2.8.9 Effective tax rate calculation for last three years. 2.8.10 Inter-company agreements and loans; transfer pricing studies. 2.8.11 Agreements among members and/or affiliated companies on sharing of revenue and expenses, and taxes.

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Copies provided 2.8.12 List of locations from which it accepts orders or does business, and copies of tax returns filed with respect to those locations. List of locations where the Company has employees located and a description of the functions of the employees located at those locations. List of jurisdictions where the Company or any of its affiliated companies is subject to tax or where a taxing authority has claimed that such company is subject to tax. 2.8.13 Payroll returns and any information relating to the status of independent contractors. 2.8.14 Estimate of tax services incurred which have not billed or paid. 2.8.15 All tax elections or consents (including foreign, federal, state or local) filed with respect to the Company and each of its affiliated companies. 2.8.16 Any agreement, contract, arrangement or plan of the Company or any of its affiliated companies that has resulted or would result in the payment of (I) any “excess parachute payment” or (II) any amount that will not be fully deductible under any provision of federal, state, local or foreign law. 2.8.17 List whether the Company or any of its affiliated companies is a United States real property holding corporation. 2.8.18 The amount of any deferred intercompany gain or loss allocable to the Company and each of its affiliated companies. 2.8.19 The tax basis of the assets of the Company and of each of its affiliated companies. 2.8.20 The loss or credit carryovers, if any, allocable to the Company and each of its affiliated companies.

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Copies provided 2.8.21 The earnings and profits of the Company and each of its affiliated companies. 2.8.22 Current property tax. 2.8.23 Calculation of the impact of transfer of equity on property valuation. 2.8.24 Estimate of transfer tax.

2.9 AUDIT DOCUMENTATION 2.9.1 Management letters from accountants concerning internal accounting controls in connection with all audits for the last three years and management responses. 2.9.2 All letters which have been sent to the company in connection with all audits in the last three years. 3. HUMAN RESOURCES: 3.1 PERSONNEL 3.1.1 Key employee listing with salary, title and function.

3.1.2 Organization chart by location, function, grade and compensation. 3.1.3 List of consultants and independent contractors and dates and status of engagement. 3.1.4 Indemnification agreements. 3.1.5 Employment contracts and severance agreements for officers and other key employees. 3.1.6 Any collective bargaining agreements. 3.1.7 Any information regarding labor relations and union organization efforts.

3.2 BENEFITS AND GUIDELINES 3.2.1 Employment handbook, policies and procedures.

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Copies provided 3.2.2 Vacation plans. 3.2.3 Schedule of bonus payments and payment dates. 3.2.4 Summaries of all other fringe benefits. 3.2.5 Documents relating to employee benefit plans, pension and profit sharing plans, deferred compensation, etc., covering any employee of the Company, including plan documents and summary plan descriptions. 3.2.6 Employee offer letters and forms of non-officer employment contracts or offer letters. 3.2.7 Forms of employment/service contracts used by each foreign subsidiary with its employees. 3.2.8 Contracts with consultants and independent contractors that have not been terminated by written notice. 3.2.9 Summary and copies of all commission, bonus and other incentive compensation plans. 3.2.10 Expense and accrual for commission, vacation expense, and incentive and/or bonus plans. 3.2.11 List of recently terminated employees and his/her severance agreement. 3.2.12 Standard employee and consultant confidentiality, non-competition or inventions agreements. Please provide a list of those subject to such agreements as well as those who fit this category, but have not signed such an agreement. 3.2.13 Special or nonstandard confidentiality, non- competition or inventions agreements (and a list of employees/consultants subject thereto). 3.2.14 Summary of liability for termination payments to directors, officers and employees.

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Copies provided 3.2.15 If Company has made any special bonus commitments to employees, list the name(s) of such employee(s) and the bonus terms.

3.3 EMPLOYEE BENEFITS AND PENSIONS 3.3.1 Employee pension and/or retirement plan documents (including all amendments to the plans, correspondence concerning plan registration and summary plan descriptions). 3.3.2 Employee welfare benefit plan documents (including health, long-term and short-term disability and life insurance plans) and summary plan descriptions. 3.3.3 Regulatory filings for each pension or retirement plan, last two years. 3.3.4 Verification as to whether the health plan is insured or self-funded. 3.3.5 Verification as to whether the employer maintains retiree health benefits. 3.3.6 Form 5500 for the last three years for each ERISA Plan. 3.3.7 Pension and/or retirement plan IRS favorable determination letter and IRS Opinion Letter. 3.3.8 Evidence relating to discrimination test for the past two years for the pension and/or retirement plan. 3.3.9 Contract with third party administrator for the pension and/or retirement plan and welfare plans. 3.3.10 Forms for distributions and plan loans for the pension and/or retirement plan. 3.3.11 Plan trust statements. 3.3.12 Prior year’s ending payroll register.

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Copies provided 3.3.13 COBRA notices and election forms, including a list of individuals currently receiving COBRA benefits. 3.3.14 Contract between third party administrator for the pension and/or retirement plan and welfare plans. 3.3.15 Forms for distributions and plan loans for the pension and/or retirement plan. 3.3.16 Plan trust statements. 3.3.17 Prior year’s ending payroll register. 3.4 Workers’ Compensation 3.4.1 Insured or self-insured. 3.4.2 Loss experience. 3.4.3 Potential material claims. 3.5 Compliance 3.5.1 Copies of EEO-1 reports for the past 5 years. 3.5.2 Copies of VETS 100 reports for the past 5 years. 3.5.3 Copies of affirmative action plan. 3.5.4 OSHA 200 reports for the past 5 years. 4. ENVIRONMENTAL: 4.1 All current environmental permits, licenses and other authorizations, and all applications therefor, which are required under federal, state, local and foreign law. 4.2 All environmental studies, memoranda, audits and reports made in the last five years, including audit or inspection reports, whether performed by or on behalf of the Company, a governmental agency or others. 4.3 All correspondence with environmental regulatory authorities and all notices to and from

Energy Acquisitions and Joint Ventures – By Robert A. James

Copies provided environmental regulatory authorities including notices of violation, and notices of deficiency over the past five years. 4.4 All documents relating to civil, criminal or administrative actions, suits, demands, citizen suit notices, claims, hearings or investigations concerning environmental issues. 5. MISCELLANEOUS: 5.1 Any documents or information which are significant to any portion of the business of the Company, or which should be considered and reviewed in light of other disclosures made regarding the business and financial condition of the Company.

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APPENDIX C

PILLSBURY WINTHROP SHAW PITTMAN LLP SAMPLE BUYER’S FORM OF ASSET PURCHASE AGREEMENT

ASSET PURCHASE AGREEMENT

dated as of [______], 20[__]

by and between

[______]

and

[______]

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TABLE OF CONTENTS

Page

ARTICLE 1

PURCHASE AND SALE

1.1 Assets and Liabilities; Assignments. X 1.2 Consideration. X 1.3 Payment of Closing Payment and Escrow Amount. X 1.4 Allocation of Purchase Price. X 1.5 Post-Closing Purchase Price Adjustment. X

ARTICLE 2

CLOSING

2.1 Closing. X 2.2 Closing Deliverables. X

ARTICLE 3

REPRESENTATIONS AND WARRANTIES OF SELLER

3.1 Organization, Standing and Power. X 3.2 Authorization, Execution, Delivery, Binding Nature and Enforceability. X 3.3 Subsidiaries and Equity Investments. X 3.4 No Violation. X 3.5 Litigation. X 3.6 Financial Statements. X 3.7 Books and Records. X 3.8 Absence of Undisclosed Liabilities. X 3.9 Absence of Certain Changes or Events. X 3.10 Compliance With Law; Governmental Authorizations. X 3.11 Environmental Matters. X 3.12 Sufficiency of Assets. X 3.13 Personal Property. X 3.14 Real Property. X 3.15 Tax Matters. X 3.16 Employee Matters. X

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3.17 Intellectual Property. X 3.18 Contracts and Commitments. X 3.19 Insurance. X 3.20 Accounts Receivable. X 3.21 Accounts Payable. X 3.22 Inventory. X 3.23 Products. X 3.24 Product Formulation. X 3.25 Affiliate Interests. X 3.26 No Material Change. X 3.27 Customers. X 3.28 Suppliers. X 3.29 Distributors. X 3.30 Brokers. X 3.31 Effect of Transaction. X 3.32 Bonds. X 3.33 Investments. X 3.34 Bank Accounts. X 3.35 Unlawful Payments. X 3.36 Solvency. X 3.37 Disclosure. X

ARTICLE 4

REPRESENTATIONS AND WARRANTIES OF BUYER

4.1 Organization, Standing and Power. X 4.2 Authorization, Execution, Delivery, Binding Nature and Enforceability. X 4.3 No Violation. X 4.4 Brokers. X 4.5 No Other Representations or Warranties. X

ARTICLE 5

COVENANTS AND AGREEMENTS

5.1 Conduct of Business Prior to the Closing. X 5.2 Further Assurances. X 5.3 Access to Information. X 5.4 Confidentiality. X

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5.5 Commercially Reasonable Efforts. X 5.6 Tax Matters. X 5.7 Expenses. X 5.8 Transfer Taxes. X 5.9 No Competition, Negotiation or Solicitation. X 5.10 Press Releases. X 5.11 Intellectual Property. X 5.12 Bulk Sales Requirements. X 5.13 No Dissolution or Distributions. X 5.14 Removal of Excluded Assets. X 5.15 Collection of Receivables. X 5.16 Employee Matters. X 5.17 No Encumbrances. X 5.18 Labor Matters. X 5.19 Supplemental Disclosure. X 5.20 FIRPTA Affidavit. X 5.21 Products. X 5.22 Payment of Indebtedness of Related Persons. X 5.23 Other Actions. X

ARTICLE 6

CONDITIONS PRECEDENT

6.1 Conditions Precedent of Buyer. X 6.2 Conditions Precedent of Seller. X

ARTICLE 7

TERMINATION

7.1 Termination. X 7.2 Notice of Termination. X 7.3 Effect of Termination. X 7.4 Extension and Waiver. X

ARTICLE 8

INDEMNIFICATION

8.1 Indemnification by Seller. X 8.2 Indemnification by Buyer. X

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8.3 Indemnification Procedures. X 8.4 INDEMNIFICATION IN CASE OF STRICT LIABILITY OR INDEMNITEE NEGLIGENCE. X 8.5 Certain Limitations. X

ARTICLE 9

SURVIVAL

9.1 Survival. X

ARTICLE 10

DEFINITIONS AND USAGE

10.1 Definitions. X 10.2 Usage. X

ARTICLE 11

MISCELLANEOUS

11.1 Waiver. X 11.2 Notices. X 11.3 Mail Received After Closing. X 11.4 Governing Law and Consent to Jurisdiction. X 11.5 Counterparts. X 11.6 Headings. X 11.7 Entire Agreement. X 11.8 Amendment and Modification. X 11.9 Schedules. X 11.10 Binding Effect; Benefits. X 11.11 Assignability. X 11.12 Severability. X 11.13 Time of Essence. X 11.14 Payments. X 11.15 Limitation on Damages. X

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EXHIBITS

Exhibit A Form of Opinion of Counsel for Seller Exhibit B Form of Opinion of Special Counsel for Buyer Exhibit C Form of Opinion of General Counsel for Buyer Exhibit D Form of Assignment of Intellectual Property Exhibit E Form of Bill of Sale Exhibit F Form of Deeds Exhibit G Form of Employment Agreements Exhibit H Form of Escrow Agreement Exhibit I Form of FIRPTA Affidavit Exhibit J Form of Real Property Assignments Exhibit K Form of Undertaking

SCHEDULES

Schedule 1.1 Equipment Schedule 2.2 Employment Agreement Signatories Schedule 3.6 Financial Statements Schedule 3.10 Governmental Authorizations Schedule 3.13 Personal Property Schedule 3.14(a) Real Property Schedule 3.14(h) Real Property Leases Schedule 3.16(a) Employee Matters Schedule 3.16(c) Terminated Employees Schedule 3.16(f) Funded Status of Defined Benefit Plans Schedule 3.17(a) Intellectual Property Schedule 3.17(b) Intellectual Property Infringement Schedule 3.18(a) Material Contracts Schedule 3.18(c) Consents Schedule 3.19(a) Insurance Policies Schedule 3.19(b) Self Insured Risks Schedule 3.20 Receivables Schedule 3.21 Accounts Payable Schedule 3.23(a) Standard Terms and Conditions and Warranty Forms Schedule 3.23(d) Personal Injury Claims Schedule 3.25(a) Affiliate Amounts Schedule 3.25(b) Affiliate Agreements Schedule 3.27 Material Customers Schedule 3.28 Material Suppliers Schedule 3.29 Distributors

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Schedule 3.32 Bonds Schedule 3.33 Investments Schedule 3.34 Bank Accounts Schedule 5.1 Increased Compensation Schedule 5.5 Governmental Filings Schedule 5.16 Employees Schedule 10.1 Assumed Contracts

Energy Acquisitions and Joint Ventures – By Robert A. James

APPENDIX D

JOINT VENTURE AGREEMENTS: MAJOR ISSUES AND COMMON PROVISIONS

Robert A. James

This memorandum provides a checklist of the most important aspects of arrangements for joint ventures involving the U.S. or at least one U.S. party for industrial manufacturing, resource extraction, transportation, marketing and research. These aspects include major legal and business issues to be considered in structuring such a relationship (Part I), as well as a variety of provisions commonly found in the detailed agreements documenting the transaction (Part II). The checklist is not exhaustive, and many ventures will not address all or most of the listed items. The author nonetheless hopes that this overview of important questions and clauses will be useful to parties considering joint venture opportunities.

I. MAJOR ISSUES √

A. Strategic Issues

1. Compare Joint Venture with Alternatives. A joint venture is most likely to succeed where:

• the parties’ respective objectives are complementary;

• the parties’ timetables for achieving goals are consistent;

• the parties’ respective resources are both adequate to the task and not disproportionate; and

• each party is willing and able to commit sufficient resources to the joint venture. Mismatched objectives can make a joint venture less favorable than alternatives such as acquisitions, divestitures, or supply, distribution or licensing transactions. Insufficient manpower to monitor the joint venture can give rise to control disputes, for example. A lack of financial resources can create tension over future expansion and new opportunities, and will generate pressure for early payouts. An otherwise self-sufficient prospective partner eyeing an alliance solely for purposes of gaining a foothold in a new market may lose interest in the venture as soon as it is formed.

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I. MAJOR ISSUES √

2. Assess and Compare Parties’ Goals and Resources. Before entering into a joint venture, each party should:

• define its objectives;

• assess its resources; and

• seek to understand the objectives and resources of the other potential investors.

Typical business objectives for entering into a joint venture include gaining immediate access to a market; reducing the commitment of funds and manpower necessary to enter that market; minimizing the risks associated with market entry; and acquiring new capital and technology.

3. Consider Limited Pre-Venture Undertakings.

• Prepare feasibility study justifying the joint venture and its scope.

• Develop initial preliminary work product, with limited commitments and relatively easy exit provisions.

• Execute letter of intent or memorandum of understanding—maintaining confidentiality at each stage—to preserve the participants’ expectations on key subjects before concluding a joint venture agreement.

B. Tax Issues.

1. Identify Tax-Optimal Joint Venture Structure. Tax and legal advisors typically consider:

• whether the joint venture should be a limited liability company (LLC), general or limited partnership or corporation;

• under which jurisdiction it should be organized;

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I. MAJOR ISSUES √

• whether the each parties’ participant in the joint venture should be a branch of a domestic subsidiary or a foreign subsidiary;

• whether each participant should have a permanent establishment in the joint venture’s jurisdiction;

• the extent to which the participants’ financial contributions to the venture should take the form or debt or equity;

• the location which title should pass to property that the participants transfer to the venture;

• where and how the participants should provide technical services to the venture;

• whether the participants should transfer rather than license technology to the venture; and

• how and when distributions by the joint venture should be made.

2. Address Other Tax Issues. The joint venture’s structure will also have implications under the tax, currency and other laws of the local jurisdiction that deserve separate consideration. The structure of the joint venture has significant implications under U.S. and local tax law, and tax issues usually are the most important factors in deciding which structure to use. The U.S. investor generally desires first to maximize its ability to use foreign tax credits to reduce its U.S. income tax, and second to minimize the foreign taxes paid by the joint venture itself.

C. Antitrust and Competition Law Issues.

1. Assess Legality of Core Arrangements. Each party should consider the consequences for the proposed joint venture posed by U.S. and local antitrust law. Even a joint venture wholly outside the U.S. may violate U.S. antitrust law through the activity of the joint venture itself or through ancillary agreements between the

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I. MAJOR ISSUES √

participants. The current position of the U.S. enforcement agencies is generally that a joint venture outside the U.S. should be challenged only if the adverse effect on U.S. commerce is substantial and foreseeable.

The U.S. Supreme Court has stated that the legality of a joint venture under antitrust laws depends on a number of factors, including

• market power of the participants; • the joint venture’s market and its relationship to the markets of its parents; • the potential power of the joint venture in the relevant market; and • an appraisal of what the competition in the relevant market would have been if one or all of the participants had entered it alone instead of through the joint venture. 2. Assess Legality of Collateral Restraints. Often the joint venture itself is found to be legal but ancillary agreements among the participants are prohibited if they limit competition between the participants more broadly than necessary to make the joint venture work. Be wary of “gun-jumping” activities undertaken before the joint venture has become effective or approved.

3. Assess Local Competition Law. The Antitrust Enforcement Guidelines for International Operations, published in 1995 by the U.S. Department of Justice and Federal Trade Commission, are useful guides to the application of U.S. antitrust laws to international cooperative activity. The European Union and many countries similarly prohibit restrictive business practices. For example, Japan’s Antimonopoly Act (Act Concerning Prohibition of Private Monopoly and Maintenance of Fair Trade, Act No. 54, April 14, 1947, as amended) declares that “[n]o entrepreneur shall effect private monopolization or any unreasonable restraint of trade,” and prohibits “unfair business practices.” Such local laws can be used to scrutinize the anti-competitive effects of joint ventures.

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I. MAJOR ISSUES √

4. Assess Notification or Approval Requirements. The competition laws of many countries feature pre-combination notification or approval requirements for consummation of transactions including some types of joint ventures. Such laws include the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, in the United States. Even a modest amount of activity in a given country may trigger the application of such requirements.

D. Local Law Issues.

The joint venture will of course be subject to extensive regulation by local authorities, including through foreign investment laws and statutes governing joint ventures in particular, as well as through corporate law, commercial codes and rules concerning agency and distribution arrangements. Local law issues may include:

• exclusion of certain sectors of the economy from foreign investment; • requirements as to the relative proportions of equity interest that local and foreign participants may hold; • governmental and central bank approvals for transactions; • restrictions on offshore bank accounts, transactions in foreign currency or repatriation of foreign currency; • currency exchange controls, import controls, price controls, and anti-dumping restrictions; and • worker participation or other labor requirements. E. Local Incentives.

On the other hand, local legal and commercial programs may also provide incentives for foreign investors. In Japan, for example, joint venture corporations with a foreign capital ratio of 50 percent or more may qualify for special low-interest loans from the Japan Development Bank. Export credit may be available for equipment to be used by the joint venture.

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II. COMMON PROVISIONS √

A. Participants. Each party must determine through what entity it will participate in the joint venture. Examples:

• a branch of an existing offshore company; or • a special purpose company. B. Scope. It is crucial to delineate at the outset the purpose of the joint venture, both as to present activity and future opportunities. If the participants define the scope of the joint venture with precision, they can avoid costly disputes over what activities are or are not within that scope.

The participants should decide, for example,

• whether the joint venture will have the right of first refusal as to any future opportunities identified or acquired by the joint venture or any participant; • whether the participants can individually take advantage of new technology or products developed by the joint venture; • whether the joint venture or its participants will be empowered to veto activity of its participants that is competitive with the joint venture; • how the joint venture will handle new opportunities. For example, a participant may be permitted to require the joint venture to embark on a new extraction project on a sole-risk basis, or to opt out of a project pursued by the others. In either case, the dissenters may gain the benefit of the new project only after the venturers have received a defined multiple of their incremental investment. C. Duration. The agreement should state whether the joint venture will continue for a fixed term with options for extension, or will continue on an “evergreen” basis. The participants should also agree on the conditions and procedures for terminating the joint venture and the procedures to be used for valuing the participant interests upon termination. The joint venture agreement could provide for termination of the joint venture upon

• expiration of the agreement,

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II. COMMON PROVISIONS √

• the agreement of the participants, • an uncured default by a participant (if there are only two participants), • an unresolvable deadlock, and • a significant and detrimental change in relevant local law. The stipulated valuation procedures could vary with the circumstances of termination. For example, the joint venture agreement could mandate the use of the lower of book value or fair market value for elimination of a defaulting participant’s interest and liquidation value in other circumstances. There are many possible variations. Where there are only two participants, for example, a “shotgun” clause could provide that one participant may announce a price per share in the joint venture, and the other may then elect either to buy that participant’s interest, or sell its own, at the announced price.

D. Legal Form of Venture. A joint venture may take the form of a limited liability entity (an LLC, a corporation or limited partnership) or a general partnership under local law. But before evaluating various entities, consideration should be given to a simpler structure: a bare contractual agreement to share costs and benefits (in which case no new entity is created).

Each arrangement entails consequences as to control and tax treatment. Local corporate law often provides greater protections for investors than are afforded non-corporate entities, such as

• protections for minority shareholders,

• supermajority requirements for shareholder votes on certain actions, and

• fiduciary obligations of directors and officers that may be difficult to disclaim.

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II. COMMON PROVISIONS √

E. Initial Contributions. The participants should determine the kinds of initial contributions the participants are to make to the joint venture, their timing and their amounts. Contributions can take the form of debt or subordinated debt incurred by the joint venture or equity issued by the joint venture. The transfers can take the form of cash, other tangible property or intangible property rights (although the value of services may not qualify as contributions in all cases). The participants should investigate the legal and tax aspects of these contributions, such as whether assignability of intangibles is restricted, and whether transfer tax and transaction costs can be minimized.

F. Allocation of Liabilities. The participants should decide if any liabilities will be assumed relating to past operations of the participants or assets contributed to the joint venture. Indemnities among the participants, and with the joint venture itself, can allocate responsibility for claims arising from ongoing operations of the participants and of the joint venture. The participants should not forget the impact of liability and property insurance policies carried by the participants, or by third party contractors.

G. Future Contributions. The participants should consider whether the joint venture can require the participants’ parents to fund the joint venture at some future time. If future costs can be mandated, the agreement can specify in what manner (e.g., by direct loans, contributions to capital, or guarantees of loans from third parties) and in what amounts.

H. Dividends and Distributions. The participants should consider the basis for allocating costs and distributing profits. If the joint venture is a partnership, the participants must establish a contribution system of capital accounts that is effective under partnership and tax law, and should agree as to the methods for recording accruals and deductions. The local jurisdiction may impose withholding taxes on repatriated dividends or distributions, or on payments of interest on loans made by participants.

Energy Acquisitions and Joint Ventures – By Robert A. James

II. COMMON PROVISIONS √

I. Management of Venture. The participants should consider defining and allocating functions and responsibilities of the joint venture’s management. Management issues include:

• whether one participant or a third party will act as an operator of the venture;

• the respective rights of the participants to appoint the board of directors and officers of the joint venture;

• the scope of these individuals’ duties;

• selection and replacement of other key joint venture personnel;

• whether employees of the joint venture should be loaned or “seconded” from the participants or directly employed by the joint venture, and the impact of this arrangement on WC and employee benefit plans;

• the dissemination of information to the participants.

J. Participant Control of Fundamental Decisions. The participants should also consider what kinds of decisions will require a vote by the board or the participants, and the quorum, pass mark and procedures for such decisions. Participants typically consider retaining control with respect to such major issues as:

• liquidation or dissolution of the joint venture;

• sale or disposition of the assets;

• merger or acquisition of new business;

• expansion of the scope of the joint venture;

• issuance of new stock;

• change in the composition of the board of directors;

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• increase in required contributions;

• approval of the annual budget;

• major financing arrangements; and

• other major operational decisions (such as contracts outside of the ordinary course; long-term business plans; dismissal of officers; and contracts with participants for supplies or services).

K. Deadlocks and Disputes. The participants should agree on the procedures to be followed in the event of a deadlock by the board or other dispute. For example, the participants may agree first to refer the matter to the participants’ respective CEOs and then to other forms of alternative dispute resolution. The joint venture agreement should also state the governing law and the jurisdiction in which disputes are to be litigated.

L. Transfers, Admissions, Withdrawals and Removals. The participants should consider the terms and conditions governing transfers of interests, the admission of new participants into the joint venture and the voluntary withdrawal and involuntary removal of participants.

As to exit, the joint venture agreement may restrict the assignability of participant interests by requiring the prior consent of the other participants to any transfer, or by granting rights of first refusal to the joint venture or other participants, or their nominees, to acquire the interest. (However, such provisions may be prohibited or restricted under local law, particularly if ownership by foreign entities would be increased.)

As to entry, the joint venture agreement may require the prior, unanimous approval of all or a supermajority of participants before new participants may be admitted.

The joint venture agreement may require prior approval of all or a certain number of remaining participants for the voluntary withdrawal or involuntary removal of a participant. The joint

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venture agreement should set out the circumstances justifying such actions (e.g., removal based on default, insolvency of the participant or acquisition of the participant by a defined class of third party). Consider impact of mergers and stock sale on your clauses.

M. Consequences of Termination or Exit. As is the case for termination of the joint venture, the joint venture agreement may stipulate the procedures to be used in each circumstance for valuing the participant interests in question. The participants should also consider

• whether a participant that withdraws will be prohibited from competing with the joint venture for a certain period of time;

• whether a transfer or withdrawal will be deemed a termination of the joint venture for tax or other purposes; and

• the extent to which the transferring or withdrawing party should indemnify the others for the effects of such a termination.

N. Confidentiality and Ownership of Proprietary Information. The joint venture agreement may provide for the confidential treatment by the participants of the proprietary information of the participants and of the joint venture. Rules should be considered regulating the ownership and use of information developed for and by the joint venture, including licenses from the joint venture to the participants and vice versa.

O. Compliance with Laws. The joint venture agreement may bind the participants and the joint venture to comply with applicable laws. A U.S. party should inform itself about the Foreign Corrupt Practices Act, which prohibits any U.S. person or firm from knowingly making payments directly or indirectly to officials of foreign government or instrumentalities to obtain or retain business. The Act imposes criminal penalties for violation and as a

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practical matter may impose on a U.S. business operating in a foreign country the duty to inquire in certain circumstances as to the ultimate designee of payments made to local persons. A U.S. party should also be aware of the Export Administration Regulations and ITS regulations that prohibit U.S. persons from agreeing to take certain actions furthering international boycotts and other laws applicable to specific businesses and locales.

P. Miscellaneous. A joint venture agreement typically contains other common provisions of general application. Examples include:

• representations and warranties as to each participant’s authority to enter into the venture, and as to assets, businesses or liabilities to be contributed to the venture; and

• events of default and their consequences (e.g., when default is deemed to have occurred, notice requirements and the time allowed to cure).

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About Pillsbury

Pillsbury Winthrop Shaw Pittman LLP is a dynamic full-service law firm with market-leading strengths in the energy, financial services, real estate and technology sectors. Our lawyers serve clients throughout the U.S. and internationally, including from key global financial centers such as New York, London, Tokyo and Shanghai. Industry-driven client teams and a multidisciplinary approach to crucial business issues of the day also ensure our clients receive thorough counsel on all aspects of a matter.

The 2007 Corporate Counsel survey of Fortune 500 companies named Pillsbury a "Go-To Firm" in five practice areas—corporate transactions, litigation, IP litigation, IP patent counseling, and labor and employment. Pillsbury placed among the nation's top 20 law firms in number of minority partners according to the Minority Law Journal 2007 Diversity Scorecard and was also named as one of Working Mother magazine's 100 Best Companies in 2006.

Geographic reach. We are one of the few law firms with nearly equal numbers of attorneys on the East and West Coasts of the United States – in California, New York, Washington, DC and Virginia – and the balance in Houston, London, Shanghai, and Tokyo.

Excellence in Client Service. Our first principle is superior client service – we work at it, and we think the results speak for themselves. For every client matter, regardless of size, we assess and align our resources to deliver optimal results for the client. Chambers USA ranked 92 Pillsbury attorneys at the top of their fields in 2007. Thirteen of these lawyers were ranked in two or three different categories.

Client Teams. Our practice is organized around our clients, with the client teams at the center. Client teams have regular, nonbillable meetings to share information about the client and industry and to brainstorm ways to help our clients succeed. Each client team has designated facilitators and a page on our intranet to share information about client needs and expectations.

Industry Focus and Teams. Our work for clients is focused in the following eight industry sectors: Technology, Communications, Consumer

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& Retail, Aviation, Financial Services, Global Energy, Life Sciences, and Real Estate. This concentration ensures that the firm’s attorneys offer our clients a depth of knowledge and experience about their industries. The firm also has industry teams for Education, Health Care, Industrials & Materials, Media & Entertainment and Nanotechnology, as well as Restaurant, Food & Beverage and Travel, Leisure & Hospitality.

Shared Experience. Clients benefit from our collective knowledge – about their business, industry, and legal issues. We call this client service model our “matrix” – a network of professionals organized in client teams, industry teams, and practice teams – linked by technology, organization, and an overriding commitment to excellence.

More than 60 of our partners and counsel have served in roles with government agencies, from the Department of the Treasury and the Federal Reserve to the SEC and EPA, and can therefore provide clients an insider’s knowledge of matters like regulatory investigations and settlement negotiations.

Diversity. Diversity of race, culture, gender, and ideology makes us a stronger firm and helps us better serve clients competing in a global economy. Many Pillsbury offices, committees, and practices are led by women, minorities, and openly gay attorneys. We actively seek attorneys who speak foreign languages and at present have attorneys on loan to clients in Japan and France. We regularly sponsor a two-day program for all of the firm’s African American attorneys; a number of the firm’s clients also attend.

Pro Bono and Community. Pillsbury provides legal services to individuals and organizations in need throughout the United States. In 2006, half of our attorneys performed pro bono work. We have been honored with a Pro Bono Lifetime Achievement Award from the hunger relief organization “Share Our Strength.”

Our attorneys and staff are also encouraged to contribute their time and support to community organizations, including Habitat for Humanity and local chapters of the United Way.

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Our Practice Areas

Aviation Global Sourcing

Climate Change & Sustainability Government Contracts & Disputes Communications Health Care Corporate & Securities Indian Law Employment & Labor Insolvency & Restructuring Energy Intellectual Property Environment, Land Use & Natural Resources International

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Our Global Energy Industry Team

In the complex practice energy industry, Pillsbury is recognized as one of the few international law firms whose experience ranges through the entire value chain. Our clients include: - oil and gas and petrochemical producers, transporters, distributors and managers; - electric and gas utilities and their holding companies and affiliates; - independent power producers (IPPs) and independent transmission companies; - owners and operators of nuclear power plants and nuclear waste facilities - uranium mining and milling companies; - engineering, procurement and construction (EPC) contractors, suppliers and service providers; and - underwriters, lenders and investors.

Over 100 energy industry lawyers are located throughout our offices with significant depth in New York, San Francisco, Houston, and Washington, DC. Our Houston office was opened in 2003 and now includes 30 lawyers whose practice includes complex litigation, transactional and regulatory law. Our Washington office includes 14 energy specialists representing clients across all sections of the nuclear industry in private transactions and on matters before federal regulatory and licensing agencies, the Departments of Energy, Labor, State and Commerce, state public service commissions, federal and state courts, and international arbitration panels.

We have acted as counsel in connection with all facets of the energy business – upstream and downstream – including oil and gas exploration and development, terminals, pipelines, refineries and receiving facilities, liquefaction and regas facilities, petrochemical plants, power generation, transmission and distribution, cogeneration and distributed generation, nuclear power, renewables, and new energy technologies. The major legal disciplines employed in our practice are outlined below.

Antitrust & Competition Our lawyers have extensive antitrust experience in transactional work, criminal and civil litigation and antitrust counseling for the electricity, natural gas and other energy and utility sectors.

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Corporate, Securities & Corporate Finance We handle dozens of utility and energy company financings every year, covering the entire gamut of financing structures, from straight senior or subordinated bonds through complex structures such as hybrid securities, project-backed securities and stranded cost securitizations. We have often designed innovative financing structures to meet a client’s special needs.

Environmental, Land Use & Natural Resources We cover the full range of environmental and land use issues, including permitting and compliance, multi-agency enforcement, compliance programs, addressing regulatory obstacles and integrating environmental considerations into business and development plans.

Litigation & Alternative Dispute Resolution Our litigation lawyers are experienced in representing utilities, IPPs, major oil industry participants, nuclear power plant owners and operators and other energy industry players, and our practice in this area covers regulatory matters, project and venture disputes, white collar criminal matters and alternate dispute mechanisms.

Mergers & Acquisitions We have handled acquisitions, dispositions, restructurings and all types of reorganizations across all sectors of the energy industry.

Project Development & Finance Practical and business oriented, our project finance lawyers bring exceptional knowledge and skill to all phases of project development, construction and financing. We have distinctive strengths in the liquefied natural gas (LNG) and renewable energy sectors.

Regulatory Compliance With our long history representing regulated public utilities and other regulated companies, we can help a company structure its business and relationships to avoid regulatory and legal problems.

Renewable Energy Pillsbury attorneys advise parties involved in renewable energy projects both in the US and worldwide. We represent both developers and financial institutions in this fast-growing sector.

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Nuclear Energy We have had a premier nuclear energy law practice for over 50 years and represent a large number of clients in all aspects of the nuclear industry. We assist clients in every phase of the regulation of a nuclear facility’s lifecycle -- from initial licensing to decommissioning and waste disposal -- and with respect to regulatory compliance issues such as government investigations, employee concerns, safety-conscious work environment, and whistleblower litigation. The firm represents clients in complex nuclear energy litigation before state and federal courts, arbitration tribunals, and administrative agencies. We also represent our clients in the sale and purchase of nuclear generating plants, procurement of services and equipment, fuel procurement, contracting with government agencies, and a variety of other commercial transactions.

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Energy Acquisitions and Joint Ventures – By Robert A. James

Offices

United States San Diego Shanghai 501 West Broadway 47F, Hong Kong New Houston Suite 1100 World Tower 2 Houston Center San Diego, CA 92101- 300 Huai Hai Zhong Road 909 Fannin Street, Suite 3575 Shanghai 200021 2000 619.234.5000 People's Republic of China Houston, TX 77010-1018 +86.21.5116.2940 713.276.7600 San Diego—North County Tokyo Los Angeles 12255 El Camino Real, 5F, Fuerte Kojimachi 725 South Figueroa Street Suite 300 Building Suite 2800 San Diego, CA 92130- 7-25, Kojimachi 1-chome Los Angeles, CA 90017- 2006 Tokyo 102-0083 5406 619.234.5000 Japan 213.488.7100 +81.3.5226.7260 San Francisco New York 50 Fremont Street 1540 Broadway San Francisco, CA 94105- New York, NY 10036- 2228 4039 415.983.1000 212.858.1000 Silicon Valley Northern Virginia 2475 Hanover Street 1650 Tysons Boulevard Palo Alto, CA 94304-1114 McLean, VA 22102-4859 650.233.4500 703.770.7900 Washington, DC Orange County 2300 N Street, NW 650 Town Center Drive Washington, DC 20037- 7th Floor 1128 Costa Mesa, CA 92626- 202.663.8000 7122 714.436.6800 International Sacramento 400 Capitol Mall, Suite London 1700 Tower 42, Level 23 Sacramento, CA 95814- 25 Old Broad Street 4419 London, EC2N 1HQ 916.329.4700 United Kingdom +44.207.847.9500

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