title due diligence - steptoe-johnson.com...conducting due diligence - defects • sample net acre...

Title Due Diligence

Presented by:Don Hueske

&

Blake Jones

Texas and Oklahoma Series

These materials are public information and have beenprepared solely for educational purposes. These materialsreflect only the personal views of the authors and are notindividualized legal advice. It is understood that each caseis fact-specific, and that the appropriate solution in anycase will vary. Therefore, these materials may or may notbe relevant to any particular situation. Thus, the authorsand Steptoe & Johnson PLLC cannot be bound eitherphilosophically or as representatives of their variouspresent and future clients to the comments expressed inthese materials. The presentation of these materials doesnot establish any form of attorney-client relationship withthe authors or Steptoe & Johnson PLLC. While everyattempt was made to ensure that these materials areaccurate, errors or omissions may be contained therein,for which any liability is disclaimed.

Road Map

I. PSA – NEGOTIATION, KEY TERMS

II. SCOPE OF EXAMINATION

III. REPORTING/COMMUNICATION

IV. CONDUCTING DUE DILIGENCE

PSA – Negotiation

• Involve Due Diligence Attorneys in Negotiation of:

– Title Defect Definition

– Permitted Encumbrances

– Method of Calculating Defects

PSA – Type of Transaction

• Asset Purchase

– Defect Adjustment to Purchase Price

• Stock Purchase

– Defect has a material adverse effect on the total value of the company or assets Adjustment to Purchase Price

PSA – Seller Definition

• Subsidiaries

• Mergers/Acquisitions

PSA – Type of Properties• Lease Based Units

• Multi-Tract/Multi-Lease Units

• Seller Operated Assets

• PDP/PUD

• Depth Limitations

• Oil and/or Gas

• Fee Properties

• Surface Rights

PSA – Schedule of Assets/Allocated Values

• Leases

• Wells

• Units

• Surface Rights/ROWs

• Excluded Assets

PSA - Deadlines

• Title Defect Deadline

– Set Internal Deadlines

– Interim Defect Reporting?

• Closing Date

PSA – Purchase Price & Defect

Thresholds

• Purchase Price

• Individual Defect Deductible

• Aggregate Defect Threshold

• Defect Cap

– Property

– Purchase Price

PSA – Title Defect Definition

• Example: Any lien, charge, contract, agreement, obligation, encumbrance, or matter affecting the Assets that would not give Buyer Defensible Title.

PSA – Defensible Title Definition

• NRI not less than NRI on asset list

• WI not greater than WI on asset list without proportionate increase in NRI

• Net acres not less than NMA on asset list

• No encumbrances

– Subject to permitted encumbrances

PSA – Permitted Encumbrances• Governmental regulation of assets

– Spacing rules, allowables

• Rights of Way/Easements

• Permitted consents, Pref. Rights

• Royalties, ORRIs

• Title irregularities unless another person has a superior claim of title

• Liens that are not delinquent

• Subordinated mortgages by lessor

• Unrecorded documents not executed by seller

• Threatened litigation

PSA – Other Exhibits

• Material Contracts

• Preferential Rights

• Pending Litigation

• Liens/Encumbrances

Scope of Examination

• Amount to be Reviewed:

– Percentage of Allocated Value

– Percentage of Properties/Leases

– Review Properties with AV below Defect deductible?

– Lender Requirements

– Core Acreage


• What is being Reviewed:

– Full title

– Full record room search

– Relying on online indices?

– Relying on prior title opinions?

– Relying on ownership reports?


• Adjusting the Scope of Examination:

– Adding Properties with Common Title

– Adding Additional Properties

– Swapping Properties

• Low Hanging Fruit

• Greater Allocated Value can be reviewed in shorter period of time

• Core Acreage

Reporting/Communication

• Determine Client Expectations

• Staffing Due Diligence Team

• Set Internal Deadlines

• Regularly Scheduled Calls:

– Client

– Seller

– Due Diligence team members

• Track Progress in Real Time

Reporting/Communication

• Management Spreadsheets: Progress Reports, Budget Reports

• Asset Spreadsheets

• Checklists

• Acquisition Title Opinions

• Defect Notices

• Lien and Litigation Report

• Executive Summary

Conducting Due Diligence - Process

• Review PSA

• Review maps and plats

• Review Virtual Data Room (“VDR”) or physical land files

– Evaluate organization and number of files

– Set scope with client/ID target properties

– Identify properties without title opinions

– Identify properties with common title


• Identify missing files

– Notify seller as soon as possible

• Assign files that need to be run in county to landmen

• Run post-certification date title on properties with title opinions

• Assign files to review attorneys


• Review Land Files:

– Title Opinions

– Leases

– Wells

– Production

– Division Orders

– Contracts


• Review Lease Files:– Depth Restrictions

– Pugh Clauses

– Pooling/Unitization Limitations

– Continuous Development Clauses/Drilling Obligations

– Consents to Assign

– Ratifications/Amendments

– Pref. Rights/ROFR

– Surface Restrictions

– Marketing Deductions


• Review Well Files:

– Maps/DPUs

– Production

– Railroad Commission (“RRC”)/Oklahoma Corporate Commission (“OCC”) Filings:

• Permits

• Amendments to units

• Well Status

• Plugging liability

Conducting Due Diligence - Title

• NRI Not less than NRI on PSA Exhibit

• WI Not greater than WI on PSA Exhibit without a proportionate increase in NRI

• Net Acres Not less than on PSA Exhibit

• Depths/Formations Title to all depths with AV on PSA Exhibit

• Defensible Title No Defects


• Material Contracts:

– JOAs

– AMIs

– Farmouts

– Restrictions on Transfer/Assignment

– Marketing/Midstream Contracts

– Preferential Rights


• Litigation:

– Active/Pending, threatened

• Lien Search

– Permitted encumbrance?

– Condition to closing or addressed post-closing?

• Subordinations, Releases


• Property Descriptions:

– Check Exhibits/Assignments for accuracy

– Satisfy Statute of Frauds?

• Payment of Royalties/Shut-Ins

– Require check copies?

Conducting Due Diligence - Defects

• Defect Notices – Forms:

– Spreadsheet for all defects

• “Non-Assertable” and below deductible defects

– Word Document for individual property defects

– Don’t rely on a form from a prior deal


• Does the Defect meet the definition set forth in the PSA?

– Not an Excluded Encumbrance

– Above Defect Deductible

• Note all “below deductible” defects for Buyer’s records

– All defects below the Defect Cap


• Common Defects:

– Interest owned by a third party

– Lease Expiration/Acreage Loss/Loss of Depths

– Gap in Production

– Liens

– Competing Chain of Title

– Target Depths owned by a third party


• Defect Notice Contents:

– Description of the Defect

– Defect value and supporting calculation

– Supporting Documentation

• Required to provide documents in Seller files?

• Electronic delivery permitted?

– Materials Examined


• Sample Net Acre Defect:– Defect Description: Seller is asserting 200 acres for the

Subject Lease; however, only 160 acres have been assigned to a unit, and the primary term has expired, resulting in a defect of 40 net acres due to Pugh Clause/CDC.

– Defect Value: $2,000,000

– Supporting Calculation:• AV x (Net Acre Decrease/Asserted Net Acres)

• $10,000,000 x (40 acres/200 acres) = $2,000,000

– Supporting documentation: Lease (highlight Pugh clause,

CDC), RRC/OCC filings and plats, title opinion.


• Sample NRI Defect:– Defect Description: Seller is asserting an 80% NRI for

the Subject Lease; however, Seller assigned an ORRI of 5%, resulting in an NRI of 75%

– Defect Value: $625,000

– Supporting Calculation: • AV x (Decrease in NRI/Asserted NRI) = Defect Value

• $10,000,000 x (.05/.80) = $625,000

– Supporting documentation: Title Opinion, Lease, Assignment of ORRI.


• Sample WI Defect:– Defect Description: Seller has asserted a WI of 90% and an

NRI of 75% in the Subject Lease; however, record title reflects that Seller has a 100% WI and 75% NRI.

– Defect Value: • $100,000.

– Supporting Calculation:• Estimate of projected increase in costs and expenses

attributed to increase in WI.

• Estimated Lease Costs: $1,000,000 x 10% WI Increase = $100,000

– Supporting documentation: Title Opinion, Lease, DOI,

Royalty Payment information, lease maintenance expenses.


• Defect Strategy:

– Assert all good faith Defects

– Close to Defect Threshold Select strongest defects

– Can Seller pull individual properties?

• Buyer may elect to not assert


• Seller Response:

– Accepts Defect and Defect Value

– Accepts Defect, not Defect Value

– Will Cure Defect

– Disputes Defect

• Not properly asserted under terms of PSA

• Does not meet definition of Defect


• Negotiating Defect Values:

– Bargaining power

– Strength of Defects

– “Contractual Title”

– Potential for cure

– Future relationship between Buyer/Seller

– Indemnification

– Arbitration

Questions?

[email protected]

281-203-5755

[email protected]

281-203-5730

mailto:[email protected]

mailto:[email protected]

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