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DUE DILIGENCE IN A MIDSTREAM ACQUISITION
“KNOWLEDGE IS POWER”
by
Christopher S. Collins
Vinson & Elkins LLP
November 2013
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TABLE OF CONTENTS
I. WHAT IS THE MIDSTREAM SEGMENT?.................................................................... 1
II. DUE DILIGENCE PROCESS – REDUCING OR MINIMIZING RISK.......................... 3
A. What is Due Diligence? .................................................................................................. 3
B. Why is it Important for the Acquirer to do Legal Due Diligence? .................................. 4
C. Interrelationship Between the Due Diligence Process and the DefinitiveAcquisition Agreement ................................................................................................... 8
D. Establishing a Spirit of Cooperation between the Parties; ConfidentialityAgreements ..................................................................................................................... 8
E. How to Conduct Diligence – The Process..................................................................... 10
III. AREAS OF PARTICULAR CONCERN FOR A DUE DILIGENCE TEAM IN AMIDSTREAM ACQUISITION....................................................................................... 14
A. Identification of the Purchased Assets .......................................................................... 15
B. Real Estate Diligence.................................................................................................... 16
C. Environmental Diligence .............................................................................................. 19
D. Regulatory Diligence .................................................................................................... 23
E. Contracts Diligence....................................................................................................... 24
IV. THE USE OF REPRESENTATIONS, WARRANTIES AND INDEMNITIES TOREDUCE OR MINIMIZE RISK ..................................................................................... 24
A. Purpose for Representations, Warranties and Indemnities. ........................................... 25
B. Factors Affecting the Breadth of Representations and Warranties................................ 26
C. Negotiated Limitations on Representations and Warranties. ........................................ 26
D. Negotiated Limitations on Indemnification. ................................................................. 27
V. CONCLUSION................................................................................................................ 31
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DUE DILIGENCE IN A MIDSTREAM ACQUISITION
“KNOWLEDGE IS POWER”
By Christopher S. CollinsVinson & Elkins LLP
November 2013
This paper has been prepared to provide a high-level overview and insight into (i) how to
conduct a due diligence review in a midstream merger and acquisition transaction, whether
structured as a stock purchase, asset purchase, merger or other business combination (a
“Midstream Acquisition”), (ii) the purposes for, and value of, conducting diligence of a
Midstream Acquisition target, (iii) certain areas of particular focus in a Midstream Acquisition
diligence effort, and (iv) the interplay between the due diligence process and the definitive
acquisition agreement to be negotiated between the acquirer and seller in a Midstream
Acquisition. Although the due diligence process can impact both parties in a Midstream
Acquisition, the focus of this paper is the activities by the potential acquirer of a Midstream
Acquisition target. This paper is intended to provide a practical guide and some tips to
performing legal due diligence and should not be construed as providing legal advice.
I. WHAT IS THE MIDSTREAM SEGMENT?
The term “Midstream” is often broadly and sometimes inconsistently used in the oil and
gas industry. Most oil and gas industry participants would readily agree that the oil and gas
industry is comprised of three major segments: Upstream, Midstream and Downstream. The
Upstream segment is more commonly referred to as exploration and production (E&P) and
includes activities centered on searching for potential subsurface hydrocarbon fields and the
recovery and production of such hydrocarbons (including crude oil and raw natural gas). The
Midstream and Downstream segments are not as easily defined and often have overlapping
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facilities and services. For our purposes, we will consider the Downstream segment to consist of
the refining and processing of hydrocarbons into consumer products (gasoline, jet fuel and
diesel) and the Midstream segment to consist of the diverse transportation, storage and marketing
assets and services that link the energy supply side (Upstream segment) with the demand side for
energy commodities including delivery of hydrocarbons to the Downstream segment for
conversion into consumable products.
Conducting effective due diligence in the context of a Midstream Acquisition can be a
daunting task, in that a Midstream Acquisition target may own and operate varying types of
facilities and provide a broad array of activities and services, including the following:
Crude and Natural Gas Gathering
Crude and Natural Gas Transportation Pipelines
Rail and Marine Transportation
Processing, Treating and Fractionation
Hydrocarbon and Hydrocarbon Product Storage
Product Terminalling and Transloading
The midstream industry in the United States has seen significant changes over the past
twenty years, and is currently experiencing rapid growth and consolidation opportunities. In the
1980s, midstream activities were primarily conducted by the majors who constructed, owned and
operated midstream assets in support of their exploration and production properties and refining
and petrochemical facilities, whereas today independent midstream companies dominate the
midstream value chain. For midstream companies, the demand for oil and gas infrastructure is
one of the major drivers for growth. In 2013, the United States became the world’s largest
producer of hydrocarbons, in large part due to the increased drilling activities in various shale
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plays (including the Marcellus, Haynesville, Barnett, Eagle Ford and Bakken shales) and
productive hydrocarbon basins (such as the Permian Basin) which have prompted a demand for
significant midstream infrastructure. Natural gas gathering networks, gas processing facilities,
fractionation plants and transportation pipelines for natural gas and natural gas liquids have been,
and continue to be, in high demand due to the development of these shale plays. The ownership
and operation of midstream infrastructure assets is today a thriving business which has resulted
in the development of many public and private companies with a focus on midstream activities
(including: Enterprise Products Partners, Kinder Morgan, Plains All American, Spectra Energy,
Williams Companies, Energy Transfer Partners, ONEOK Partners, Enbridge Energy Partners
and Targa Resources Partners), as well as venture capital firms and strategic investors which
specialize in or have a strong focus on the development of midstream infrastructure. In light of
the prevailing attractive returns on investment for greenfield midstream projects, many of these
venture capital sponsors have adopted a “build and sale” business plan relating to midstream
infrastructure projects.
In 2012, midstream M&A transactions in excess of $44 billion in value were conducted
in the United States and in the first half of 2013, over $16 billion of midstream M&A
transactions have been announced (PWC’s Oil & Gas M&A Analysis). In these domestic M&A
transactions, there were varying levels of due diligence completed in connection with the
acquisition and disposition of the subject midstream companies, divisions and assets.
II. DUE DILIGENCE PROCESS – REDUCING OR MINIMIZING RISK
A. What is Due Diligence?
Due diligence in the context of a Midstream Acquisition is simply stated, the process by
which a potential acquirer of a midstream business or division or group of midstream assets
obtains and reviews information about the Midstream Acquisition target to reach an informed
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decision or confirm its decision to acquire the target business. There are various kinds of due
diligence conducted in a Midstream Acquisition, including:
1) Financial Due Diligence – Where the acquirer, along with its accounting firm oraccounting or financial advisors, analyze the financial status and historical andprojected financial performance of the target business.
2) Operating Due Diligence – Where the acquirer, along with its engineering andoperations consultants (and often investment banking firms), analyze theoperations and operational performance of the target business.
3) Strategic Due Diligence – Where the acquirer focuses on the ability of thebusiness combination to achieve the strategical and value-added benefitsperceived in the acquisition (including customer and competitor responses andtechnology uplifts) and addresses integration and culture challenges.
4) Legal Due Diligence. Where the acquirer, along with its in-house and outsidelegal counsel and other advisors, analyze the target business to determinecompliance with laws and regulations, legal title to assets, required consents toconsummate the transaction and compliance with other legal requirements(including contract terms).
Although Financial Due Diligence, Operating Due Diligence, Strategic Due Diligence
and Legal Due Diligence often overlap and require interaction among the various specialists
involved in the due diligence effort, this paper will focus on the requirements of Legal Due
Diligence.
B. Why is it Important for the Acquirer to do Legal Due Diligence?
Many people seem to view legal due diligence as essentially playing a shell game –trying
to find the hidden pea (liability) while the barker (the seller) tries to mislead, distract and
misdirect the acquirer. A due diligence process does lend itself to a “detective’s mentality” as
you sort through information disclosed by the seller, but the objectives of a due diligence
investigation are much broader than simply trying to find the hidden problem or undisclosed
liability.
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A properly conducted legal due diligence process undertaken at the front end of a
Midstream Acquisition can provide the potential acquirer invaluable insight into the target and
allow the acquirer to avert a poor business decision or to proceed with a higher degree of comfort
that following closing the acquirer will receive the benefit of its commercial bargain.
The legal due diligence process serves many diverse purposes, some of which are
intuitive and some of which are not as evident, including the following:
1) Information Gathering and Validation of Value. Accumulating detailedinformation about the operations of the target business, so to enable the acquirerto confirm and validate the proposed value attributable to the target business (andresulting purchase price consideration) and to provide support to the board ofdirectors or other governing party of the acquirer that the transaction is likely toenhance value.
2) Validation and Confirmation of Assumptions. Confirmation of various businessor operating assumptions regarding the rights held by the target business on whichthe value of the acquisition or the future plans for the target business werepremised.
3) Identification of Obstacles to Closing and Transition Issues. Identification ofissues that should be taken into consideration in order to establish an orderlyclosing of the acquisition and transition of the acquired business, including (i)required consents and approvals under material contractual arrangements, (ii)replacement of facilities or services which will not transfer with the business,such as accounting, financial, marketing or monitoring functions, and (iii)permitting requirements, including unique aspects of the acquired business whichrequire additional permits beyond those already maintained by the acquirer orassignable from the target company.
4) Identification of Liabilities and Obligations. Identification of current andpotential liabilities and obligations of the target business that would need to betaken into consideration in determining the valuation of the target business or theallocation of risks between the acquirer and the seller;
5) Identification of Title and Operating Deficiencies. Identification of titledeficiencies or instances of noncompliance with contract terms or laws whichmight require remediation prior to the acquirer being able to proceed withconsummation of the transaction; and
6) Identification of Termination Rights, Purchase Rights and Other ContractProvisions Which Could Impact the Ownership of the Assets or Conduct of theBusiness. Identification of: termination rights pursuant to which material
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contracts may be terminated (and the resulting loss of benefits by the acquirer) asa result of consummation of the transaction; rights of first refusal or otherpreferential rights triggered by the transaction which could impact the acquirer’sability to acquire and maintain all rights in and to the target company’s assets orbusiness post-closing; and contractual restrictions on the conduct of businesswhich could limit the acquirer’s ability to expand the target business post-closing.
The above-stated objectives of a due diligence investigation make it apparent that due
diligence is an essential and invaluable tool for the acquirer in a Midstream Acquisition which,
when used properly, can help to (i) minimize the risk of the acquisition (ii) allocate identified
and often unidentifiable risks between the transaction parties and (iii) maximize value to the
acquirer’s equityholders.
Persons who have not consummated or been involved in many M&A acquisitions
sometimes inquire as to what minimal level of due diligence is legally required in an acquisition.
Except in securities transactions (where stock or other equity securities are being issued), I am
unaware of any federal or state statute which mandates that a potential acquirer conduct any
particular level of diligence with respect to a target company or undertake any diligence efforts
at all. However, since directors of an acquiring company have a fiduciary duty of care to such
company’s equityholders, it seems clear (and is supported by various court decisions) that the
governing body of the acquirer should require that some minimal level of due diligence be
performed on a target business prior to consummating an acquisition.
I have also had posed the question of why an extensive due diligence examination (which
can be time consuming and expensive) should be conducted in the scenario where the potential
acquirer has significant transaction leverage and is able to extract broad representations and
warranties and indemnification protection from the seller in the definitive acquisition agreement.
Extensive indemnification coverage from a seller is not always a substitute for a carefully
conducted due diligence process. An acquirer which relies exclusively on the indemnification
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provisions in the definitive acquisition agreement may find that being indemnified for the direct
and actual damages resulting from a breach of a representation by the seller does not fully
compensate the acquirer for the indirect costs and time associated with dealing with problems
inherited from the acquisition. If a thorough due diligence investigation had been conducted, the
acquirer might have elected not to proceed with the transaction until the identified problems had
been remedied, or might have elected to shift all responsibility to seller to address and remedy
such problems. Also, in some situations, damages from collection under an indemnification
claim cannot fully compensate the seller for the loss such as the scenario where strategic assets
or material rights are lost as a result of a failure of title or termination of a valuable contract
right. It is also worth noting, that definitive acquisition agreements often include a waiver by the
acquirer of the right to collect consequential damages (including loss profits) resulting from the
breach of a representation. Additionally, post-closing indemnification claims can sometimes
turn contentious and result in litigation proceedings being initiated by the acquirer in order to
recover. Clearly, having knowledge of a problem prior to execution of a purchase agreement or
prior to closing is a better position for an acquirer than determining how to proceed with and
collect an indemnification claim post-closing.
At the heart of the decision of whether to conduct a due diligence review or how
extensive a due diligence review to conduct is the concept of “Caveat Emptor”. Caveat emptor –
“Let the Buyer Beware” – is a warning which reminds a potential acquirer that the seller of the
target business has as his goal maximizing value to the seller and accordingly, the seller is not
likely to volunteer disclosures which could result in a purchase price reduction or in the seller
having to retain liabilities following the closing. The acquirer, in order to have a full and
complete picture of the risks and liabilities being assumed in a Midstream Acquisition, should
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use all tools available to it to flush out issues and identify liabilities – including due diligence
and a comprehensive definitive acquisition agreement.
C. Interrelationship Between the Due Diligence Process and the Definitive AcquisitionAgreement
It is a self-evident truth that the more knowledge that a potential acquirer gathers about a
target business (i.e., through due diligence), the better positioned the acquirer will be to structure
responsive, effective and tailored representations and warranties in the definitive acquisition
agreement and protect its investment. In certain cases, the results of a proper due diligence
investigation prior to signing of the definitive purchase agreement may result in the acquirer
changing the structure of the acquisition to address concerns which are discovered in the
diligence process. This could be an extreme case where the acquirer converts the transaction
from a stock transaction to an asset purchase in light of excessive liabilities or risks at the entity
level which the acquirer is unwilling to assume or, in the less extreme case, where identified
risks are simply required by the acquirer to be recharacterized as “retained liabilities” which are
retained and handled by the seller following the closing. Also, due diligence after the signing of
an acquisition agreement may lead to the discovery of breaches of representations or warranties
which are so material as to justify terminating the acquisition agreement or renegotiating the
terms of the transaction.
D. Establishing a Spirit of Cooperation between the Parties; Confidentiality Agreements
A key to proper due diligence in any Midstream Acquisition is to commence the
diligence process at the earliest opportunity. Good preparation (including educating oneself
about the target company and its business) is the first step toward effective execution of a due
diligence process. Due diligence can be a time consuming and frustrating experience for each
transaction party; however, the due diligence process can be an efficient and manageable process
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if the acquirer at the outset creates a focused diligence plan and coordinates with the seller
regarding timing and expectations. One of the most frustrating problems experienced by a seller
in an M&A transaction is having to divert its employees from running the business to the task of
providing duplicative diligence materials to representatives of the acquirer, when the materials
could have been provided only once had the acquirer been more focused and had a more
streamlined and coordinated diligence process.
At the end of the day, due diligence is not a negotiation and should not be treated like the
shell game where the seller continues to try to mislead the acquirer but rather is a dynamic, fact
finding exercise which requires a cooperative effort of all parties. The initial goal of a due
diligence process is to gather as much information about the target business as possible. In order
to encourage the seller to be forthcoming with information (including proprietary and
confidential information), it is typical for the seller and potential acquirer to enter into a
confidentiality or nondisclosure agreement. This agreement will:
1) Contain restrictions upon the potential acquirer’s use and subsequent disclosure ofthe target company’s disclosed information;
2) Contain provisions which address the ongoing obligations of the parties if thetransaction is not consummated, including the destruction or retention ofconfidential information by the potential acquirer; and
3) Often establish the procedures for the seller to provide disclosures to the potentialacquirer.
Many sellers will request or require that other protective provisions also be included in
the nondisclosure agreement, such as a nonsolicitation provision which restricts the potential
acquirer from soliciting employees of the target company or seller during negotiations and for a
specified period following closing or abandonment of the transaction. In the case of a seller with
publicly traded equity, a standstill provision may be requested which restricts the acquirer from
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acquiring equity in the seller or target company during negotiations and for a designated period
following closing or abandonment of the transaction.
Note that, in some instances where the seller and acquirer are significant competitors, the
parties may need to be sensitive to antitrust law concerns and exercise stricter caution when
delivering and receiving information (such as customer, pricing and market information) which
might be commercially sensitive. In such case, it is not unusual for the parties to specify a small
subset of personnel within each organization which will be the only parties allowed to access and
review the sensitive information.
E. How to Conduct Diligence – The Process
There is no single matrix, model or guide to apply when a potential acquirer prepares and
conducts legal due diligence in a Midstream Acquisition. For the due diligence effort to be
successful and effective, it needs to be customized and tailored to the target company’s business.
Accordingly, the attorneys should initially try to gain a good and detailed understanding of the
acquirer’s purchase and integration plan and of the target company’s business. The desired
scope of the due diligence effort should be taken into consideration early in the process,
including:
1) determining specific identified or anticipated risks (i.e., known environmental orregulatory problems) to be diligenced and scrutinized;
2) establishing materiality thresholds for contracts, and perhaps litigationproceedings, to be reviewed; and
3) deciding on the form, content and timing of reporting findings.
When deciding the scope of a due diligence exercise, an acquirer may jump to the
conclusion that if the transaction is an asset purchase (as opposed to a stock sale where the
acquirer, by operation of law, takes on all of the liabilities of the business enterprise) then due
diligence may not be necessary or as critical. Potential acquirers should be aware that certain
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jurisdictions will impose successor liability upon the acquirer notwithstanding that the
transaction is structured as an asset sale under a de facto merger doctrine or specifically by
statute in areas such as tax and employee benefits. Accordingly, understanding the skeletons in
the seller’s closet, of the type discoverable in a well-run diligence process, may be invaluable in
transactions structured as asset purchases. If an issue arises post-closing as to liability affecting
the acquired business, the one question you don’t want to be asked by the chief executive officer
of the acquirer is, “Why didn’t we pick this up in our diligence?” Unless the diligence team can
respond with an answer which demonstrates how the scope of the transaction diligence was
reasonably determined, the persons coordinating the diligence effort might find themselves in the
hot seat as they search for a response to the question.
Once the non-disclosure agreement has been entered into and the scope of the diligence
exercise determined, it is important for the acquirer to assemble a due diligence team and make
sure that all members of the team understand the scope of the due diligence exercise and their
respective responsibilities. A due diligence investigation is the poster child for the expression “it
takes a team effort.” A successful due diligence program (which is one which gathers the
targeted information in an efficient manner and communicates the gathered information and data
in a timely and useful manner to the acquirer) is a collaborative effort which requires a careful
coordination between the acquirer’s in-house team members and the outside professionals and
advisors (including financial, investment banking and legal advisors). A clear allocation of
duties and responsibilities can streamline the diligence process with (i) designated management
members reviewing and addressing operations and business information, (ii) accountants and
investment bankers reviewing financial statements, projections and other financial information
and determining working capital requirements and the proper procedures and methodologies for
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calculating working capital and (iii) attorneys and legal advisors focusing on legal matters (title,
compliance with law, etc.) and related key liability issues. Once the acquirer’s diligence team is
formed, it is often a good idea to have a kickoff meeting with principals of the seller to
communicate the goals of the diligence effort and the anticipated process and procedures.
After the due diligence team is assembled, the next step is to prepare and deliver to the
seller a due diligence request list. The due diligence request list should be comprehensive but
not so overly broad or burdensome as to overwhelm the seller and its management team.
Specialists in relevant areas (such as antitrust, environmental, employee benefits, regulatory,
intellectual property, real estate, tax, etc.) should be consulted during and have an integral role in
creating the due diligence request list. The due diligence request list will serve as the guide for
identifying and cataloging the information received from the seller.
It is often helpful early in the due diligence process to determine how the disclosing party
will disseminate or make available materials to the acquirer in response to the diligence request.
There are several ways this can be done:
1) assembly of hard copies of requested documentation at the seller’s offices withthe acquirer’s diligence team being provided on-site access for review;
2) delivery of requested documentation from seller to the acquirer via a delivery ofhard copies of the various documents;
3) delivery of requested documentation from seller to the acquirer electronically viaa disc of all response documents; or
4) the establishment by seller of an electronic, virtual, and interactive data roomwhere the response documents will be deposited and designated members of theacquirer’s diligence team will be provided password protected access.
The foregoing methods of document assembly are listed in the order of efficiency of the
process with the electronic data room being the most efficient. The norm for larger M&A
transactions is the online data room which decreases the cost of the diligence process and allows
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a broader and more efficient dissemination of data. Also, the online data room approach can be
particularly useful to sellers in an auction process where multiple bidders may be conducting
diligence at the same time. There are a number of professional printers and other service
companies which will establish, monitor and maintain the electronic data room, on behalf of the
seller, for a fee.
The documents produced in response to a due diligence request can reveal crucial
information about the disclosing party and target business and help identify issues; however,
written responses from the seller indicating that particular information requests are not applicable
to the target business can sometimes be equally valuable in that it helps to narrow the diligence
efforts and the focus of the diligence team. Also be sensitive to the fact that the diligence
process is an evolutionary process involving building blocks of information which are likely to
result in the need for supplemental diligence requests to gain a full understanding of the target
business and the underlying risks.
The due diligence process is an interactive process between the seller, the acquirer and
their respective representatives. Experience has proven that designating a contact person at each
party who is responsible for fielding and responding to diligence requests will facilitate a more
efficient and effective process and result in less anxiety and better efficiency.
In today’s digital environment, which increasingly ignores the time constraints resulting
from human involvement in M&A transactions, an acquirer is likely to encounter due diligence
time frames which are exceedingly short in time, unscheduled and unpredictable. In these
contexts, it is invaluable to have an experienced diligence team which can assemble quickly,
streamline the process and maximize the diligence benefits which can be gained in the short time
period.
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As discussed earlier, the acquirer and its attorneys should establish the preferred method
by which the acquirer desires to receive the results of the diligence review. This can range from
periodic conferences or conference calls, at which results are revealed, to the preparation of a
detailed, written due diligence memorandum which summarizes all of the findings. Gathering
and memorializing information about a target company has little value unless the information is
timely communicated to the decision makers for the acquirer who can apply and benefit from the
information in their negotiations with the seller. It is accordingly important that the results of the
diligence be timely communicated in a useful manner since the results of the due diligence
review can drive changes to the business and economic terms for the transaction and influence
risk allocation in the definitive acquisition agreement.
III. AREAS OF PARTICULAR CONCERN FOR A DUE DILIGENCE TEAM IN AMIDSTREAM ACQUISITION
As merger and acquisition activities continue to increase in the midstream segment,
acquirers are finding that due diligence is of supreme importance in helping them to assess the
risks and liabilities inherent in Midstream Acquisitions. Due to the unique nature of midstream
assets and operations, traditional due diligence approaches which have been applied in other
energy transactions may not be practical and it will be important that the persons designing the
scope of the diligence review for the midstream target have a good comprehension of the
midstream industry and the critical elements and risks arising therefrom to achieve a successful
due diligence effort.
In almost all M&A transactions (whether or not in the energy sector or the midstream
segment) there will be a number of fundamental areas for diligence including the following:
general corporate matters (including governing documents, qualifications to dobusiness, capitalization, and organizational structure);
compliance with laws;
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pending and threatened litigation, proceedings, consent decrees andinvestigations;
financial and accounting matters;
personnel/employee benefits/labor matters;
environmental matters;
governmental regulation (including governmental permits, licenses, approval andconsents);
intellectual property (including patents, licenses, trademarks, tradenames andother intellectual property);
tax exposures and compliance;
indebtedness;
compliance with material contracts;
ownership and condition of real property interests; and
ownership and condition of personal property.
In this section of the paper, I will focus on a few specific areas where heightened
sensitivity may be needed to perform a successful and effective due diligence effort for a
Midstream Acquisition. These areas include:
A. Identification of the Purchased Assets
A critical aspect of midstream due diligence is obtaining and verifying a full and accurate
description of the current and past assets of the target company including not only a physical
listing of the assets but also a historical profile reflecting (ownership, age, use and operational
specifications). In this context, apply an inquisitive “who, when and where” approach to
understanding the assets and you will gain a better assessment of potential risks associated with
future ownership and operation of the assets. The acquirer will want to know current and past
owners and operators, operational history and threatened or pending complaints, investigations
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or proceedings affecting the assets. Often by reviewing the detailed asset list, the diligence team
may also discover that the seller has included a few “stray cats and dogs” which are not useful to
or required by the acquirer for its ongoing operations and which could possibly subject the
acquirer to exposure, or require it to incur additional costs in the future. If the due diligence
effort discovers these potentially risky but unneeded assets prior to execution of the definitive
purchase agreement, then the acquirer will have the opportunity to either (i) reject the assets and
require that they be excluded from the transaction and become the responsibility of the seller or
(ii) accept the troublesome assets but quantify the risks associated with them and exact a
corresponding reduction in the purchase price.
B. Real Estate Diligence
In Midstream Acquisitions (which often can involve hundreds or thousands of miles of
pipeline facilities, compressor pads, storage caverns and storage wells), the real estate diligence
effort can be very extensive and time consuming. The expense and time required to complete
real estate diligence in a Midstream Acquisition can be heavily influenced by the quality of the
seller’s real estate records and right of way files.
1) There are several types of real estate interests which an acquirer is likely to
encounter in a typical Midstream Acquisition including:
a. Fee Simple Ownership of Tracts: What one commonly thinks of as directownership of the asset. Often, the real estate underlying major plantfacilities will be owned in fee.
b. Leasehold Estate: Where the facilities (i.e., compressors, processingplants, etc.) are owned by the target company but the rights in theunderlying real property on which the facilities are located are owned by athird party and leased to the target company.
c. Easement or Right-of-Way: These terms are used interchangeably andgenerally refer to contractual rights to use segments of land owned by athird party for a limited purpose, such as an easement to run a pipeline
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across the property of a third party. These are the most common types ofreal property interest for pipelines and gathering lines.
d. License: Often similar to a lease, but the term is used to cover a variety ofdifferent types of contractual arrangements involving uses of real property.
e. Permit: Not really a traditional real property interest. These rights areoften granted by governmental entities for pipeline crossings and similarlimited use rights.
2) Real estate-related diligence in a Midstream Acquisition due diligence effort
should include a verification that:
a. the applicable entity (which may be the seller or a direct or indirectsubsidiary of the seller) actually does own the real property interestsnecessary to operate the target business;
b. there are no liens against the real property interests for amounts owed(whether voluntary liens for financings or involuntary liens, such asmechanics liens) which could interfere with acquirer’s ownership or use ofsuch assets or detract from the value of such assets;
c. there are no restrictions or other encumbrances that can interfere with thecurrent and intended use of the real property interests;
d. there are no restrictions on transferability, change of control provisions,purchase options or preferential purchase rights (such as rights of firstrefusal) which will be triggered as a result of the consummation of thesubject transaction; and
e. each site has the necessary off-site easements and other rights necessary tooperate the site (such as utilities, railroad spurs and pipelines for rawmaterials supply and finished product off-take). This can be particularlydifficult to diligence in the absence of good real estate records.
3) Important Tools that a potential acquirer can use to conduct or enhance the Real
Estate Due Diligence include:
a. For fee simple tracts and ground lease tracts, the acquirer may seek toobtain:
i. a commitment for title insurance and title exception documentsfrom a reputable title company; and
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ii. a metes and bounds or “as built” survey of the material tractswhich should reveal any significant encroachments on or againstthe tracts.
b. For leasehold estate tracts, the acquirer may:
i. obtain and review a true and current copy of each lease coveringreal estate;
ii. obtain a copy of any recorded memorandum of lease filed of publicrecord as well as copies of existing subordination, non-disturbance/attornment agreements with the seller’s lenders; and
iii. as part of the definitive acquisition agreement, require that theseller, prior to closing, deliver to the potential acquirer estoppelagreements where the third party lessor acknowledges nooutstanding breaches or issues under the lease.
c. For pipeline easements, the potential acquirer may request copies from
seller of the following:
i. Alignment maps showing each segment of the pipeline from oneend to the other, identifying each segment separately.
ii. For each segment, a file containing (A) the original or a copy ofthe recorded easement document, (B) an abstractor’s certificate orother external evidence that, at the time the easement was granted,the grantor of the easement owned good title to the tract in whichthe easement is located, free and clear of any liens (or if there is alien, a subordination agreement by the grantor’s lender), and (C)copies of each transfer of the easement document from the originalgrantee to the current owner of the easement estate. If the ownerof the easement estate is the subject of a statutory merger,conversion or name change, the file should include copies of thecertificate of merger, conversion or name change, which should berecorded in the real property records of the county where theeasement tract is located.
iii. For each segment crossing a street, road, river, lake or the like, apermit or similar document from the applicable governmentalauthority.
iv. For each segment crossing a railroad track, the document is likelyto be a license or permit, rather than an easement.
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4) Pipeline Easements: Often the diligence review respecting the continuity of
pipeline easements along extensive segments of pipeline assets can offer many
challenges including:
a. Except in the case of relatively new or greenfield midstream facilities, it israre to have complete (100%) documentation for all pipeline segments,and it is not uncommon to have entire segments for which there is nodocumentation of an easement, license or permit.
b. Records for gathering lines are sometimes skeletal at best. The producermay have rights under its oil, gas and mineral lease to install gatheringlines within the leased tract, but those rights may not expressly run to thebenefit of the seller if it is not the producer.
c. If the seller has the power of eminent domain with respect to thepipeline/gathering line, a number of title deficiencies can be solved, albeitat some potential cost.
5) 80/20 Rule: Diligence teams conducting real estate diligence in the midstream
sector often apply the 80/20 Rule as the standard which guides their diligence
efforts in the real estate context. Such rule, loosely interpreted, provides:
a. Don’t spend 80% of the due diligence time dealing with assets comprising20% of the value. More specifically, where the real estate review of allassets will be a formidable task, the diligence team might need to focus onthe real estate assets which attribute the greatest value to the targetcompany.
b. Try to get from the seller the relative valuation of assets/segments basedon their contribution to EBITDA or cash flow, not necessarily on theircost or replacement cost. Focus on and check a higher percentage of thehigher value properties/segments and a lower percentage of the lowervalue properties/segments.
c. Particularly for pipeline and gathering lines, the diligence team may electto spot check the files as opposed to reviewing every file. It may not bepractical as a matter of time or expense to review every minor easement.
C. Environmental Diligence
Midstream Acquisitions, due to the diverse nature of the facilities that comprise
midstream assets, require an extensive analysis of the target business’ compliance with
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applicable environmental standards which impose various requirements relating to spills and
releases, waste transport and disposal activities, wastewater and stormwater discharges and air
emissions. The clear trend in environmental regulation of midstream activities is to place more
restrictions and limitations on activities that may affect the environment, requiring owners and
operators to incur potentially significant operating costs and capital expenditures to attain and
maintain compliance. Any failure to comply with these more stringent requirements can result in
the assessment of administration, civil and criminal penalties, the imposition of investigatory,
monitoring and remedial obligations and possibly the issuance of injunctions which may limit or
prohibit some or all of the activities of the target business. Accordingly, environmental diligence
in a midstream acquisition is a primary component of the overall diligence review process and a
valuable tool for limiting or entirely avoiding risk, whether by contractual modification, asset
corrective action (prior to acquisition) or elimination of the asset from the asset package.
Over the last couple of years, the Environmental Protection Agency (“EPA”) and various
state regulatory agencies have adopted more stringent regulations relating to midstream oil and
gas activities. For example, on August 16, 2012, the EPA published final rules under the federal
Clean Air Act that subject oil and natural gas production, processing, transmission and storage
operations to regulation under the New Source Performance Standards (NSPS) and National
Emission Standards for Hazardous Air Pollutants (NESHAP) programs. With regard to
midstream assets, this new rule establishes NSPS requirements applicable to processes and
equipment at gathering and boosting stations, natural gas compressor stations, and natural gas
processing plants, including new and modified compressors, new and modified pneumatic
controllers and storage vessels, as well as NESHAP requirements applicable to glycol
dehydrators. The new rule also strengthens the leak detection and repair requirements that apply
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to existing natural gas processing plants. In light of this changing and evolving regulatory
environment, it is crucial that the acquirer have outside environmental advisors and consultants
on its diligence team which are well versed in the new and emerging regulatory changes
affecting midstream operations.
The primary environmental regulatory issues relating to soil, water, waste and air
compliance issues for typical midstream assets includes compliance with the following statutes:
Clean Air Act (including air emissions permitting, NSPS and NESHAP programcompliance, and greenhouse gas monitoring and reporting activities)
Clean Water Act (including wastewater and stormwater permitting and dischargesthereunder as well as jurisdictional wetlands in the event of pipeline expansion)
Resource Conservation and Recovery Act (including management, transport anddisposal of wastes)
Comprehensive Environmental Response, Compensation and Liability Act(including management, disposal and any releases of hazardous substances)
Endangered Species Act (including surveys and mitigation strategies to the extentthat any expansion of pipelines or facilities is being considered)
State Department of Environmental Quality Requirements (including past spillincidents and other releases that may have impacted soils, groundwater and/orsurface water, resulting in possible obligations to investigate and remediate)
In addition to the foregoing, some states (such as Texas) have an additional oil and gas
regulatory commission or agency that can be responsible for monitoring and regulating various
components of midstream operations.
Midstream operations can involve various waste streams which can be generated by
gathering pipelines, compression stations and processing treatment and fractionation plants and
have to be taken into consideration in the environmental due diligence process. The key
environmental laws governing pollution liability associated with a midstream business are:
Comprehensive Environmental Response, Compensation and Liability Act
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All Appropriate Inquiry (AAI) rule (the current standard for satisfying the AAIrule is performance of an ASTM E1527-05 Phase I environmental site assessment(ESA) but the EPA has proposed rulemaking to use a new standard, ASTME1527-13, in addition to the current 2005 standard).
It is common for the potential acquirer to negotiate the right to access and perform site
visits at the real properties and cause a Phase I ESA assessment with respect to the facilities and
activities of the target business to be conducted by an environmental consulting firm. The
Phase I assessment is a limited investigation (which normally includes a site visit and records
review but doesn’t include any invasive sampling at the various sites). The Phase I assessment is
designed to determine whether there is a recognized environmental condition (REC), typically
relating to observed or suspected environmental conditions that have resulted in, or threaten to
result in, contamination to surface or subsurface conditions, and thus requires further analysis.
The Phase I assessment typically will involve a review of environmental permitting and
assessment of operating conditions to determine the extent to which deficiencies and/or alleged
violations of environmental laws may exist. Oftentimes, the seller will require that the Phase I
assessment be limited to whether a REC exists with a REC being defined in ASTM Standard
1527-05 as:
“the presence or likely presence of any hazardous substances or petroleumproducts on a property under conditions that indicate an existing release, a pastrelease or a material threat of a release of any hazardous substances or petroleumproducts into structures on the property or into the ground, groundwater or surfacewater of the property.”
Acquirers will typically try to expand the scope of the Phase I to also include any other
instances of non-compliance with applicable environmental laws and matters which could
reasonably be expected to require remediation under applicable environmental laws.
It is possible that the Phase I assessment will reveal areas of concern which warrant
additional testing (including invasive investigation and sampling – Phase II testing) for the
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acquirer to be able to properly assess the magnitude of the risk. Oftentimes, the Phase I study or
Phase II testing reveals environmental issues which can result in a negotiation between the
potential acquirer and seller as to who has the risk with respect to such matters including the
responsibility for supervising and/or conducting required remediation efforts. As a result of the
negotiations, there may be a purchase price reduction (in acknowledgment of the costs that the
potential acquirer will incur to address a deficiency), an agreement that the seller will cure the
deficiency (either pre- or post-closing) at its own cost or, perhaps, removal of the asset with the
deficiencies from the asset package.
D. Regulatory Diligence
Most midstream operations and activities are not regulated by the Federal Energy
Regulatory Commission (“FERC”), including with respect to rates and tariffs, and the primary
regulatory body is an agency of the state in which the midstream assets are located. To the
extent, however, that an intrastate pipeline system delivers hydrocarbons into interstate
commerce, FERC may have jurisdiction over the pipeline, although it could be limited
jurisdiction. As a result, regulatory counsel for the acquirer should review the jurisdictional
status of the midstream assets as part of the due diligence effort to determine the likelihood that
FERC would determine the facilities to be jurisdictional and thereby subject the operations to
federal regulation. Regulatory counsel should also coordinate the diligence effort to confirm that
the operations of the target business are in compliance with state regulatory requirements and
applicable federal requirements, if any. Failure to comply with federal and state regulations
(including regulations relating to transportation of hydrocarbons and construction, abandonment
and interconnection of physical facilities) can result in the imposition of administrative, civil and
criminal penalties.
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E. Contracts Diligence
It is possible that an acquirer may be particularly concerned about certain contractual
obligations which may be present in the target company’s contracts, such as (i) “take or pay”
provisions, (ii) obligations to construct infrastructure for the benefit of producers or other third
parties, or (iii) exclusivity arrangements. The diligence effort will need to be tailored to focus on
such matters.
Also, in the current midstream environment, master limited partnerships (“MLPs”)
constitute a significant portion of the midstream companies active in the United States and due to
their unique “pass through” tax structure, MLPs are often able to pay higher multiples for
midstream businesses than other potential acquirers with more conventional structures. Where
the acquirer is a MLP (or an entity which has plans to become a MLP through an initial public
offering), it is likely that an additional component of the due diligence effort will be for the
diligence team to review the operations and material commercial contracts of the target company
to confirm that the income generated by the target company is “qualifying income” for tax
purposes. Generally speaking, a MLP must generate at least 90% of its income from “qualifying
income” or it can become taxable as a corporation. Accordingly, the “qualifying income”
diligence in a Midstream Acquisition is of particular significance to the MLP acquirer.
IV. THE USE OF REPRESENTATIONS, WARRANTIES AND INDEMNITIES TOREDUCE OR MINIMIZE RISK
In the preceding sections, this paper has focused on how the due diligence process can be
a useful tool for the acquirer to identify and allocate risks in a Midstream Acquisition. Another
mechanism or tool available to an acquirer to allocate deal risk, which is closely connected to the
due diligence process, is the inclusion of representations, warranties and indemnities in the
definitive acquisition agreement. One judge in a Delaware Court of Chancery ruling validated
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the practice of allocating risks through representations and warranties when he observed that
“Due diligence is expensive and parties to contracts in the merger and acquisition areas often
negotiate for contractual representations that minimize a buyer’s need to verify every minute
aspect of a seller’s business”. Cobalt Operating LLC v. James Crystal Enters., LLC, No. Civ. A.
714-VCS, 2007 WL 2142926 at *28 (Del. Ch. August 20, 2007.)
The extent and scope of representations and warranties in the acquisition agreement are
generally the most heavily negotiated areas in the selling or buying of a midstream business.
Sellers naturally and invariably will attempt to limit the scope of representations, asserting
throughout the negotiations, that the due diligence materials should be sufficient for the acquirer
to understand the risks associated with the business. Acquirers, on the other hand, will want to
have broad and comprehensive and unqualified representations and warranties so to shift risk to
the seller and preserve the value and benefit of the acquirer’s bargain.
A. Purpose for Representations, Warranties and Indemnities.
The sellers’ representations and warranties can serve many of the same purposes and
provide comparable benefits to the acquirer as the due diligence process, including:
1) eliciting and providing due diligence information about the target company and itsbusiness and assets;
2) providing helpful information to the acquirer respecting required approvals,consents and filings required to accomplish the transaction;
3) identifying known risks and providing the basis for allocation of such known risksas well as unknown risks between the seller and acquirer; and
4) providing the framework for the acquirer’s remedies for a breach of therepresentation or warranty (i.e., discovery of a liability which was not disclosed)which remedy can be termination of the acquisition agreement if the breach isdiscovered prior to closing or indemnification from the seller if the breach isdiscovered post-closing.
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Representations and warranties are basically statements of fact and assurances by the
seller which provide an acquirer with sufficient comfort to proceed with the transaction. The
definitive purchase agreement generally expressly provides for indemnification of the acquirer
for breaches of representations and warranties by the seller and includes the procedures and
mechanics for acquirer to make an indemnification claim. The indemnification protection is very
flexible and can be tailored to further allocate transaction risk. Through the use of broad
representations and warranties backed by the indemnification covenant, a potential acquirer is
able to minimize some of the risks associated with acquiring the target business.
B. Factors Affecting the Breadth of Representations and Warranties.
The breadth of the representations and warranties which a potential acquirer may exact
from a seller often depends upon the circumstances surrounding the transaction:
1) If the acquirer is paying a premium value for the target business and there are fewor no competitors in the sale process, then the acquirer would have a betteropportunity and leverage to insist upon broad and comprehensive representationsand warranties with few qualifiers and which allocate as much risk as possible tothe seller.
2) If the acquirer is competing in a competitive bid process for the target business,the acquirer may be more willing to accept and the seller may have more leverageto insist upon narrower and less comprehensive representations and warrantiesand thus greater risk upon the acquirer.
C. Negotiated Limitations on Representations and Warranties.
It is likely that the seller will seek to limit its representations and warranties (and
therefore shift transaction risk to acquirer) in the following ways:
1) Materiality: The seller may attempt to qualify representations and warranties bywhat is material (which may be a specified monetary amount) or by what mightcause a material adverse effect on the target business taken as a whole.
2) Knowledge: The seller may seek to qualify certain or all of its representationsand warranties by the actual knowledge of an identified group of officers of seller.For the acquirer to recover for a breach of such representation, it must show not
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only that there was a breach, but also that the members of the designatedknowledge group had knowledge of the breach.
3) Scope: The seller may request that certain representations and warranties belimited to certain designated disclosure materials. For example, the seller mayrequest that the breach of contracts representation be limited only to thosecontracts listed as material contracts in the schedules to the acquisition agreementor may seek to limit its representation that the business has required permits tothose permits the failure of which to have would not have a material and adverseimpact on the business.
4) Timing: The seller may attempt to limit specific representations and warranties toapply only as of a specified date or particular time period.
D. Negotiated Limitations on Indemnification.
It is also common in Midstream Acquisitions for the seller to seek to limit the scope of its
indemnification obligations in the following ways:
1) Limited Survival. The seller may request short survival periods during which anindemnification claim can be made for a breach of representations and warranties.Additionally, the seller may attempt to have some representations and warrantiesnot survive closing.
2) Limitation on the Types of Recoverable Losses. The seller may seek to limit thetypes of damages which can be recovered under the indemnification provisions inthe definitive acquisition agreement. Typically, sellers will request that“consequential, indirect and punitive” damages not be recoverable by theacquirer.
3) Thresholds and Deductibles. The seller may seek to have its indemnificationobligation be subject to threshold baskets or deductibles that are designed toprovide the seller assurance that, even in the event of a breach of a representationor warranty, the seller will only have responsibility for material claims. Thethreshold basket concept provides that when the acquirer’s indemnifiable lossesexceed an agreed-upon basket amount, the seller is liable for the total amount ofall losses, including the amount required to fill the basket. The deductibleconcept provides that when the acquirer’s indemnifiable losses exceed the agreed-upon deductible amount, the seller is liable only for the excess amount of lossesabove the deductible.
4) Liability Caps/Ceilings. The seller may seek an absolute cap on the amount ofindemnifiable losses payable to acquirer in the event of a breach of arepresentation or warranty. This varies from transaction to transaction but it is notuncommon in Midstream Acquisitions to have liability caps of 10 to 25% of thetotal purchase price. When liability caps are agreed by the acquirer, certain
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fundamental representations and warranties (which often include title) are carvedout as an exception to the liability cap.
The primary takeaway here is that no matter how thorough the due diligence effort is,
certain unknown liabilities may escape the due diligence review. Additionally, it is possible that
the seller (either intentionally or inadvertently) may fail to disclose various liabilities or matters,
which can have adverse consequences to the acquirer following closing. Accordingly, the
representations and warranties of the seller to be included in the acquisition agreement should be
carefully crafted and the indemnification from the seller must be carefully negotiated so that the
acquirer will have recourse against the seller if certain risks or liabilities arise prior to or after the
closing. Also, don’t lose sight of the fact that an indemnification covenant is only as good as the
ability and wherewithal of the seller to pay. Accordingly, it may be necessary for the acquirer to
request a parent guarantee, a purchase price hold back or an escrow to provide a viable source of
recovery in the event of a breach and resulting indemnification claim. Terms for the payment of
the holdback or release of the escrow can be tailored to be consistent with the risk allocation
agreed between the parties.
There are certain particular representations and warranties which an acquirer in a
Midstream Acquisition may try to obtain from a seller as follows:
1) Inventories. A midstream business may hold inventories of hydrocarbons for itsown account and the representations and warranties should cover the volumes ofand validate the target business’ rights in and to such inventories. For example, ifthe midstream business includes gas storage facilities, the representations andwarranties may address volumes of base or pad gas owned, base gas parked bythird parties and third party gas injected and stored in the facility.
2) Imbalances. Natural gas gathering, processing and treating activities can result inimbalance obligations which can impose a significant liability of the targetbusiness. Accordingly, seller’s representations and warranties should specify thatno gas imbalances exist other than those disclosed by seller in its disclosureschedules and other than normal and customary gathering imbalances occurringafter execution of the definitive acquisition agreement.
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3) Capital Commitments and Producer Obligations. Since midstream companies areoften in a constant state of growth (i.e. development of gathering systems andlaterals to capture E&P growth), it may be important for the acquirer to include arepresentation and warranty in the acquisition agreement which discloses thescheduled and committed capital expenditure obligations of the target business,and the commitments made by the target business to producers to installmidstream infrastructure facilities in favor of producers’ E&P assets. A carefuldiligence of these obligations to producers sometimes reveals that the targetcompany may have promised more than what a reasonable owner/operator canactually provide. In this case, negotiations for amendments with the producersmay be necessary.
4) Regulatory Matters. In addition to the typical “compliance with applicable laws”representation, it is prudent to include in the midstream acquisition agreement arepresentation and warranty respecting the governmental bodies which govern theactivities of the target business. For example, a specific representation that thepipelines included in the target business are not subject to the jurisdiction of theFERC with respect to rates and tariffs might be appropriate. The diligence teamshould also determine whether there are regulatory authorities other than federaland state agencies which govern the midstream activities of the target company.For example, midstream companies in certain of the shale plays may have assetsor facilities which are located on or cross Indian reservations. In this situation, itwill be necessary for the diligence team to understand the scope of regulation bythe applicable tribal authorities, the authorizations granted by the tribal authoritiesand the various contractual arrangements between the tribal authorities and thetarget company.
5) Condition of the Assets; Sufficiency of the Assets. The inclusion ofrepresentations and warranties regarding the condition of the assets and thesufficiency of the assets to allow acquirer to continue the business are oftenheavily negotiated in Midstream Acquisitions. These representations andwarranties are truly risk allocation devices. The seller is likely to press theacquirer to conduct a physical inspection of the material assets and rely on suchdiligence as opposed to including such representations and warranties. Theacquirer, on the other hand, will seek more comfort in knowing that if materialdeficiencies in the condition or scope of the assets exist, which were notuncovered by the physical inspection, it can seek recourse against seller pursuantto the representations and warranties.
6) Rights of Way/Easements. Sellers and acquirers often have differing views as tothe scope of representations for inclusion in the acquisition agreement withrespect to pipeline rights of way and easements. The acquirer may press for arepresentation that seller has good and valid title or good and indefensible title toall rights of way and easements and that the pipeline rights of way have no gaps(or no material gaps) which could interfere with the target business’ operations.The seller, on the other hand, may negotiate for a lower title standard (i.e.,
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defensible title) and for a knowledge or materiality qualifier with respect to gapsin the pipeline right of way.
In addition to the foregoing specific representations and warranties which address
specific midstream matters, the acquirer may seek to include broad representations and
warranties in the definitive acquisition agreement to shift the risk of certain unknown liabilities
to the seller. This is particularly the case where the potential acquirer has not had the
opportunity to complete a thorough due diligence investigation prior to execution of the
acquisition agreement. These broad representations are generally heavily negotiated and include:
1) No Undisclosed Liabilities Representation. This representation is designed toprotect the acquirer against any unknown liabilities which have not otherwisebeen addressed in specific representations. The acquirer will want the seller torepresent and warrant that there are no target business liabilities (includingcontingent and unknown liabilities) other than those specifically reflected infinancial statements or seller’s disclosure schedules delivered with the acquisitionagreement or those incurred in the ordinary course of business since the date ofthe most recent balance sheet. The seller will likely attempt to narrow the scopeof such representation to address only liabilities of a nature or type required to bedisclosed as a liability on a balance sheet prepared in accordance with GAAP.This latter seller-favorable framework can have the effect of excluding from thescope of the representation certain contingent liabilities since GAAP requires acertain level of probability before a liability needs to be booked.
2) Full Disclosure (10b-5) Representation. This representation basically requires theseller to represent that seller has not made any untrue statement of a material factor omitted to state a material fact necessary in order to make the statements made,in light of the circumstances under which they were made, not misleading.Although 10b-5 representations are common in issuances of public securities,they are the exception, rather than the rule in Midstream Acquisitions.
Another way that the due diligence process complements the acquisition agreement
negotiations is that specific liabilities or risks which were discovered in the due diligence process
may become designated as “retained liabilities” under the definitive acquisition agreement
pursuant to which the seller agrees to retain such liabilities and to indemnify the acquirer from
liabilities resulting from such matters without regard to baskets, deductibles or caps.
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V. CONCLUSION
Due diligence reviews and the inclusion of representations, warranties and indemnities in
the definitive acquisition agreement are two tools which are invaluable to a potential acquirer in
a Midstream Acquisition and are designed to help the acquirer gain knowledge, minimize deal
risk, allocate unwanted risk to the seller and maximize value to the acquirer’s equityholders. In
negotiating a Midstream Acquisition, knowledge in the hands of the acquirer means power, and
due diligence and representations and warranties are the two primary means of gaining better
insight into and knowledge of the target company’s business. An effective due diligence process
and properly crafted representations, warranties and indemnities will allow the acquirer to
properly assess and allocate the transaction and business risks associated with the Midstream
Acquisition and increase the likelihood that (i) the acquirer, upon closing, preserves the value of
its investment, (ii) receives the full benefit of its bargain, and (iii) has an efficient transition of
the acquired business.
US 2139768v.1