DUE DILIGENCE FROM A BUYERS PERSPECTIVE:

An Overview of the Due Diligence Process

Dallas Parker
713.238.2700 dparker@mayerbrown.com

September 2010

William S. Moss III

713.238.2649

bmoss@mayerbrown.com
Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; Mayer Brown JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

Review of M&A Basics: Due Diligence Objectives

Due Diligence is:

Investigation of the target business or assets Evaluation of factors that may have a future impact on the business or assets Confirmation of information provided by the seller and its advisors

Objective is to identify:
Factors that affect acquisition decision and/or valuation
Risks associated with ownership of the Target/target assets Obstacles to effecting the transaction or realizing the investment objectives
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Identify Risks and Confirm Assumptions

The due diligence process should:

Confirm the Seller/Target has title/rights to key assets Identify potential liabilities and risks

Determine or confirm valuation

Identify any obstacles to effecting the transaction (third party consents, regulatory approvals, etc.) Identify issues that will affect the reps and warranties

Identify steps necessary to integrate the business/assets into the Buyers operations
Confirm that the acquisition will meet the Buyers investment objective
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Impact on Transaction
Viability
Structure, scope and timing Transaction details
Valuation Purchase agreement
Structure and timing of payments Representations and warranties Pre-closing covenants

Closing conditions
Indemnification

Deal terms (including representations and warranties and indemnification provisions) and purchase price can be materially affected by issues identified during due diligence review
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Importance of Effective Due Diligence

Reduces Risk (and Related Costs) of a Failed Deal

Contractual Protections May Be Insufficient
The Seller may not be willing (or able) to provide sufficient post-closing indemnification to cover all losses Certain issues cannot be cured with dollars Acquisition agreement may limit recovery
Survival of representations and warranties Caps, baskets and deductibles Limits on consequential damages/lost profits Time, expense and risk of litigation

Sellers Due Diligence Responsibilities

Data Room Preparation

Gather, organize and index documents obtained from appropriate business units and specialty teams

May be necessary to redact documents due to contractual confidentiality restrictions, political implications of disclosure or sensitive terms (e.g., customers, pricing, margins)
May be appropriate to withhold certain documents until later in the process

Prepare Management Presentation

Sellers Due Diligence Responsibilities

Preparation of Disclosure Schedules

Seller will prepare schedules to the definitive agreement based on its own due diligence review

Some of the schedules will be based on information contained in the data room. Other schedules will be based on information obtained from inquiries of the relevant individuals who are responsible for the business being sold

If Seller is receiving stock as consideration, the Seller will need to conduct a more thorough due diligence investigation not materially different that Buyers due diligence investigation.
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Buyers Due Diligence Responsibilities

Prepare due diligence checklist General legal contract review
Assignment/change of control provisions that might be triggered as a result of contemplated transaction

Exclusivity, non-compete, most favored nation provisions

Parties ability to terminate contract before end of term

Prepare summary of key commercial terms of contracts, if requested Review of financial information and other corporate-type documents (e.g., correspondence with government agencies, letters from outside legal counsel to auditors, correspondence with outside legal counsel to auditors, correspondence with auditors regarding issues or disputes)
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Buyers Due Diligence Responsibilities

Specialists should review tax, environmental, IP and benefits related documents
Attend management presentation; ask follow-up questions as appropriate

Due diligence report may be prepared

Summarize documents reviewed and discussions with Seller and its representatives Identify and quantify any problems or opportunities and propose solutions/alternatives

Identify areas where further due diligence may be warranted or desirable

Confirm information contained in disclosure schedules

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Key Sources of Information

External helps corroborate information received from the Target

Public documents Lien searches Litigation searches

Seller/Target
Data room materials Management presentations and site tours Offering memoranda and other marketing materials Press releases and other information from the Targets website

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Organizing the Due Diligence Process Goals

Defining Goals and Setting Expectations

Deliverables Key Considerations

Process
Timing Budget

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Organizing the Due Diligence Process Scope

Factors affecting the appropriate scope of review include:
Deal structure and size what is material to the deal? Industry of the Target business/assets Location of operations

Value drivers
Cost and time constraints Identity of the Target Competition Financing

Generally want to be covered either by due diligence review or reps and warranties. Extensive reps and warranties may reduce scope of due diligence review.
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Managing the Due Diligence Process

The Due Diligence Team

Legal Business/Subject matter experts
Tax, litigation, employment, labor, IP, environmental, etc.

Financial Regulatory

Insurance/Risk management
Foreign counsel

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Managing the Due Diligence Process

Organization
Team Leader/Point Person Allocation of responsibilities

Distribution and Tracking Plan Communication Plan

Extremely important aspect of due diligence process Confidentiality requirements

Process and Timing

Up the chain Between due diligence team and drafting team Between the Buyer and the Seller/Target

Often different teams handling due diligence and negotiations

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Special Issues Competitors

Legal Restrictions
Antitrust laws may prohibit competitors from exchanging certain information prior to consummation of the transaction (e.g., pricing)

Seller/Target Imposed Limits Solutions

Redact (pricing, customer information, etc.) Clean Team

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Due Diligence - Upstream

Proven Developed Reserves (PDPs) only? Other proven categories? Any value given to Probables / Possibles?
Comparison to independent engineering report

As of date?
File review only vs. updated records checks by landmen / title counsel Is check stub title good enough? What does the lender require? How good is Exhibit A the list of material O&G properties?
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Due Diligence Midstream/Pipeline

A good system map?

Schedules of easements / rights of way Compressor / pump station / terminal sites What sort of real property title diligence currently exists & can be built upon? How extensive should additional real property title diligence be?

How to conduct a practical environmental assessment project?

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Due Diligence Power

Title insurance on plant sites

Easements / Rights of way for
General / Vehicular Access

Fuel (gas) pipelines - inputs

Transmission lines - outputs Water supply lines / storage

Stations / substations
Interconnection facilities Any shared facilities?

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DUE DILIGENCE FROM A BUYERS PERSPECTIVE:

FCPA Due Diligence

Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; Mayer Brown JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

FCPA Overview
US law passed in 1977 to prohibit bribery of foreign officials/ first aggressive anti-bribery statute among developed nations Two main components:
Anti-Bribery Provisions Prohibits bribes (or offers to bribe) made to foreign officials, political parties, candidate for public office whether made directly or through a third party for the purpose of obtaining or retaining business Accounting Provisions Requires companies to maintain accurate books and records and adequate accounting and financial controls. No allegations of bribery are required Joint Jurisdiction US Department of Justice (bribery & corruption-criminal) and US Securities & Exchange Commission (books and records-civil) Violations Include both criminal and civil penalties, including imprisonment, fines, loss of export licenses and suspension from competing on government contracts

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Who is liable under the FCPA?

Domestic
All US issuers and private companies (domestic concerns) using instrumentalities of interstate commerce Any US corporation or national engaging in any foreign bribery-related conduct US citizens or foreign nationals operating in the US or using instrumentalities

Foreign
Foreign corporations subject to SEC regulation (e.g., via ADRs) and using instrumentalities All foreign corporations when in US territory, whether or not they use instrumentalities of interstate commerce

Includes directors, officers, employees, and agents of entities subject to the statute
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FCPA Penalties: Criminal and Civil

Corporate Sanctions
Fines of up to $2 million for each violation of the anti-bribery prohibition Fines of up to $25 million for violation of accounting provision Record $800 million in monetary sanctions in Siemens Disgorgement of proceeds associated with improper payments Injunction to prevent future violations Suspension and debarment Compliance Monitor
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FCPA Penalties: Criminal and Civil

Individual Sanctions
Up to $250,000 per criminal violation
Government prohibits indemnification for fines

Up to 5 years imprisonment
Recent sentences: 36 months, 18 months, 6 months

Equitable Remedies: Injunction, bar from serving as director or officer

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FCPA and M&A Transactions

Deloitte Survey on International Business Transactions
87% always or frequently conduct background checks before international M&A activity; 67% always do so

67% always or frequently conduct background check before international joint venture activity; 49% always do so
57% have restructured or renegotiated potential deal based on information uncovered during background checks; 70% have pulled out of a deal
Source: Look Before You Leap: Investigative Due Diligence in International Business Relationships. (available at http://www.deloitte.com/dtt/whitepaper/0,1017,sid%253D2007%2526cid%253D150086,00.html)

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Potential FCPA Exposures in M&A Transactions

Acquisition involving government owned or controlled entity or where the government has an ownership interest
Need for government authorization of private entity acquisition Inherit liability for past FCPA violations when acquiring private entity (successor liability)

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FCPA in the M&A Context Enforcement Actions

Lockheed/Titan (2005) While conducting pre-acquisition due diligence of Titan, Lockheed discovered payments to obtain telephone contract in Republic of Benin. Deal failed to close because of FCPA problems. Titan prosecuted
GE/InVision (2005) While conducting pre-acquisition due diligence of InVision, GE discovered FCPA concerns. The Target had enlisted consultants to obtain contracts for equipment in China, Thailand and Philippines. Deal closed, the Buyer forced the Target to make a voluntary disclosure Latin Node (2009) First FCPA action filed based entirely on pre-acquisition conduct unknown to the Buyer when the transaction closed
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FCPA in the M&A Context: DOJ Opinion Procedure Release No. 08-02
Halliburton sought advice from the DOJ concerning its potential FCPA liability in connection with a proposed acquisition of a UK oil field services company
UK law prevented access to the information necessary to complete appropriate FCPA due diligence prior to closing Halliburton informed the DOJ it would impose an FCPA policy on the UK company and implement a post-closing FCPA due diligence work plan on third parties, joint ventures, customs, etc.

Halliburton would report the results of any risks found to DOJ

DOJ recognized the insufficient time and inadequate access to complete the pre-acquisition FCPA due diligence DOJ determined not to take any enforcement action against Halliburton
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Factors to Consider in Designing Pre-Merger Due Diligence Process

Education of diligence team on FCPA issues

Factor in necessary time for FCPA review Follow up on identified Red Flags and risk areas Document, document, document due diligence steps

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DOJ View on Due Diligence Questions

Alice Fisher, Former Assistant Attorney General, identified five questions Buyers should ask Targets during due diligence
Interaction with foreign governments as customers Interaction with foreign governments as JV partners

Government licenses and approvals required to operate abroad

Requirements relating to customs in foreign countries Relationship with 3rd-party representatives, including how those representatives vetted The Department has seen each of these areas as fraught with challenging FCPA issues, and, if possible, an acquiring company should be comfortable that it has assessed those risks before closing a deal.
(Alice Fisher, November 2007)

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Protection Through FCPA Reps and Warranties

Overview of typical FCPA representation and warranty

No corrupt payments were made by the Target to foreign officials, either directly or indirectly, for the purpose of obtaining or retaining business, or to otherwise securing an improper advantage Absence of government officials as owners or in other relevant provisions

Books and records are accurate and complete

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FCPA Due Diligence

Assess the existence and awareness of systems and controls over the following areas:
Expense claims, payments and petty cash disbursements Use of agents and outside consultants

Entertainment and gifts provided to third parties

Contracting with government bodies Fraud response mechanisms Identification and monitoring of relationship development and maintenance with state-owned enterprises and their employees Accurate recording of transactions within the targets books and records Record keeping protocols in respect of transactions recorded in the books and records

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FCPA in the M&A Context

Buyer Due Diligence Checklist
Assess corruption levels of the Targets country and industry (Transparency International Index) Evaluate the Targets compliance program
Clear policies and procedures, senior management oversight, third-party processes, training, hot line reporting

Request information on prior FCPA problems Analyze existing internal controls and perform financial audits on the Targets books and records Include in the acquisition agreement FCPA compliance and resolution of FCPA issues as a condition of closing Voluntarily disclose to DOJ and SEC past unlawful activity before closing

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Q&A

Thank you
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