1. DUE DILIGENCE FROM A BUYER’S PERSPECTIVE:
An Overview of the Due Diligence Process
Dallas Parker
William S. Moss III
September 2010

2. 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

3. 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 Buyer’s operations
Confirm that the acquisition will meet the Buyer’s investment objective

4. 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

5. 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

6. Seller’s 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

7. Seller’s 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 Buyer’s due diligence investigation.

8. Buyer’s 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)

9. Buyer’s 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

10. 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 Target’s website

11. Organizing the Due Diligence Process – Goals
Defining Goals and Setting Expectations
Deliverables
Key Considerations
Process
Timing
Budget

12. 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.

13. 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

14. 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

15. 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

16. 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?

17. 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?

18. Title insurance on plant sites Easements / Rights of way for –
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?

19. DUE DILIGENCE FROM A BUYER’S PERSPECTIVE:
FCPA Due Diligence

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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”)

26. 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

27. 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

28. 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

29. 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)

30. 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

31. 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 target’s books and records
Record keeping protocols in respect of transactions recorded in the books and records

32. FCPA in the M&A Context Buyer Due Diligence Checklist
Assess corruption levels of the Target’s country and industry (Transparency International Index)
Evaluate the Target’s 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 Target’s 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

33. Q & A
Thank you