<PAGE>
As filed with the Securities and Exchange Commission on November 10, 1997
Registration No. 33-95156
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
AMENDMENT NO. 1
to
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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WOLVERINE ENERGY 1997-1998
DEVELOPMENT PROGRAM
Wolverine Energy 97-98(A) Development Company, L.L.C.,
Wolverine Energy 97-98(B) Development Company, L.L.C.,
Wolverine Energy 97-98(C) Development Company, L.L.C.,
Wolverine Energy 97-98(D) Development Company, L.L.C.,
Wolverine Energy 97-98(E) Development Company, L.L.C.,
Wolverine Energy 97-98(F) Development Company, L.L.C.,
Wolverine Energy 97-98(G) Development Company, L.L.C.,
Wolverine Energy 97-98(H) Development Company, L.L.C.,
Wolverine Energy 97-98(I) Development Company, L.L.C.,
and Wolverine Energy 97-98(J) Development Company, L.L.C.
(Exact name of registrants as specified in their Articles of Agreement)
Michigan 1311 To be applied for
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of Classification Code Number) Identification Nos.)
incorporation or
organization)
4660 South Hagadorn Road, Suite 230
East Lansing, Michigan 48823
(517) 351-4444
(Address, including zip code, and telephone number,
including area code, of registrants' principal executive offices)
Michael D. Ewing, Esq.
Three First National Plaza, Suite 3750
Chicago, Illinois 60602
(312) 558-5165
(Address, including zip code, and telephone number,
including area code, of agent for service)
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE
PUBLIC: As soon as practicable after the effective date of this Registration
Statement.
If any of the securities being registered on this Form are
to be offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box: X
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CALCULATION OF REGISTRATION FEE
-------------
<TABLE>
<CAPTION>
Proposed Proposed
Amount maximum maximum Amount of
Title of Securities to be offering price aggregate registration
to be registered registered (1) per unit (2) offering price (1) fee (3)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Membership Interests 15,000 $1,000 $15,000,000 $5,172.41
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) This Registration Statement covers all Limited Liability Company Membership
Interests that may be acquired by investors, whether as limited liability
Interests or as general liability Interests.
(2) Subscriptions will be accepted in the minimum amount of five Interests
($5,000), subject to certain lower requirements for investments by IRAs and
Keogh Plans and certain state law requirements.
(3) Of this amount, $3,448.28 was paid at the time of the initial filing of
this Registration Statement; the balance is included herewith.
THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
<PAGE>
WOLVERINE ENERGY 1997-1998
DEVELOPMENT PROGRAM
CROSS-REFERENCE SHEET
Cross Reference Sheet Furnished Pursuant to Item 501 of Regulation S-K
ITEM NUMBER AND CAPTION HEADING IN PROSPECTUS
1. Forepart of Registration Statement Outside front cover page of Prospectus
and Outside Front Cover Page of
Prospectus
2. Inside Front and Outside Back Inside front cover page and outside
Cover Pages of Prospectus back cover page of Prospectus
3. Summary Information, Risk Factors "Summary of Program," Summary of Tax
and Ratio of Earnings to Fixed Considerations," and "Risk Factors"
Charges
4. Use of Proceeds "Application of Proceeds"
5. Determination of Offering Price "Terms of Offering"
6. Dilution Not applicable
7. Selling Security Holders Not applicable
8. Plan of Distribution "Plan of Distribution" and "Terms of
Offering"
9. Description of Securities to be "Summary of Program," "Investor
Registered Interestholder Limited Liability and
Potential Liabilities of Participating
Investor Interestholders,"
"Participation in Costs and Revenues"
and "Summary of Company Operating
Agreement"
10. Interests of Named Experts and "Legal Opinions" and "Experts"
Counsel
11. Information With Respect to the
Registrants:
(a) Description of Business "Summary of Program," "Proposed
Activities and Policies" and
"Application of Proceeds"
(b) Description of Property "Proposed Activities and Policies"
(c) Legal Proceedings Not applicable
(d) Market Price of and Dividends Not applicable
on the Registrants' Common
Equity and Related
Stockholder Matters
(e) Financial Statements Not applicable
(f) Selected Financial Data Not applicable
(g) Supplementary Financial Not applicable
Information
(h) Management's Discussion and Not applicable
Analysis of Financial
Condition and Results of
Operations
ii
<PAGE>
(i) Changes in and Disagree- Not applicable
ments with Accountants on
Accounting and Financial
Disclosure
(j) Directors and Executive "Management"
Officers
(k) Executive Compensation "Management"
(l) Security Ownership of Certain "Management"
Beneficial Owners and
Management
(m) Certain Relationships and "Proposed Activities and Policies,"
Related Transactions "Application of Proceeds,"
"Participation in Costs and Revenues,"
"Compensation and Reimbursement,"
"Conflicts of Interest" and
"Management"
12. Disclosure of Commission Position "Management - Fiduciary Obligations
on Indemnification for Securities and Indemnification" and "Summary of
Act Liabilities Company Operating Agreement"
iii
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED , 1997
PROSPECTUS
$15,000,000
WOLVERINE ENERGY 1997-1998
DEVELOPMENT PROGRAM
Membership Interests
Minimum Offering: $300,000
Wolverine Energy, L.L.C. (the "Manager"), is offering 15,000 ($15,000,000)
membership interests ("Interests") in a series of up to ten Michigan limited
liability companies (the "Companies") of which the Manager will be the managing
Interestholder (collectively, the "Program"). Investors whose subscriptions are
accepted will be admitted as Investor Interestholders in the Company which is
next formed following their subscription. This Prospectus relates solely to the
Company identified on the cover page of the Prospectus Supplement attached
hereto.
The Manager will (i) contribute cash (the "Manager's Contribution") in an
amount equal to 5.0% of aggregate Investor Interestholders' capital
contributions, and (ii) be solely responsible for the acquisition of working
interests in natural gas development projects, the supervision of activities by
the respective Operators of such projects and all other Company activities. The
Manager will receive an interest in the capital and profits of the Company (the
"Manager's Investment Interest") on the same terms as the Investor
Interestholders which is equal to its proportionate share of the aggregate
capital contributions of the Manager and the Investor Interestholders (the
Investor Interestholders and the Manager, in respect of its Manager's Investment
Interest only, are herein collectively referred to as the "Investors"). The
Manager will also receive (i) certain fees, and (ii) an interest in the capital
and profits of the Company with respect to which it will not be required to make
a capital contribution (the "Manager's Promoted Interest" and, with the
Manager's Investment Interest, the "Manager's Interests"). The Manager's
Promoted Interest will be equal to 5.24% until the Investors (including the
Manager with respect to the Manager's Investment Interest) have received a
return of their capital contributions and, thereafter, a 30.24% interest. The
Manager has a minimal and substantially illiquid net worth and no material
amount of tangible assets; it will depend upon the availability of cash from
profits from the Management Fee and the Turnkey Agreement, if any, to make the
Manager's Contribution. See "Plan of Distribution" and "Compensation and
Reimbursement." After payment of initial fees and expenses, approximately 90%
of Investor Interestholders' capital contributions will be available for Company
activities and operations. The Company will participate (i) in the
establishment of natural gas reserves by acquiring leaseholds and/or working
interests in natural gas projects and participating in the drilling of
development wells thereon, and (ii) thereafter, in the ownership of such
reserves and in the sale of production from such wells and provide regular cash
distributions to Investor Interestholders. See "Proposed Activities and
Policies."
ANY INVESTMENT, INCLUDING AN INVESTMENT IN INTERESTS, INVOLVES CERTAIN
RISKS. INVESTOR INTERESTHOLDERS SHOULD CONSIDER AND ACCEPT CERTAIN RISKS OF
THEIR INVESTMENT IN INTERESTS, INCLUDING, WITHOUT LIMITATION, THE FOLLOWING:
- THE COMPANY MAY BE FORMED AFTER THE SALE OF $300,000 OF INTERESTS,
WHICH COULD RESULT IN A LIMITED DEGREE OF INVESTMENT DIVERSIFICATION
IN THE COMPANY'S ASSETS
- THE COMPANY OPERATING AGREEMENT CONTAINS PROVISIONS WHICH LIMIT OR
ELIMINATE CERTAIN FIDUCIARY OBLIGATIONS OF THE MANAGER AND WHICH MAY
WAIVE RIGHTS OF INVESTOR INTERESTHOLDERS REGARDING CONFLICTS OF
INTEREST, SUBSTANTIALLY RESTRICT THE INVESTOR INTERESTHOLDERS' RIGHT
TO RESELL OR DISPOSE OF INTERESTS AND LIMIT THE RIGHTS OF INVESTOR
INTERESTHOLDERS TO VOTE ON ISSUES AFFECTING THE BUSINESS OF THE
COMPANY
- THE MANAGER HAS NOT OBTAINED A RULING OF THE INTERNAL REVENUE SERVICE
WITH RESPECT TO THE FEDERAL INCOME TAX TREATMENT OF AN INVESTMENT IN
INTERESTS; SPECIAL TAX COUNSEL HAS NOT OPINED UPON CERTAIN MATERIAL
TAX ISSUES WHICH REQUIRE A FACTUAL DETERMINATION REGARDING AN
INVESTMENT IN INTERESTS
- SUBSCRIBERS FOR INTERESTS WHO ELECT NOT TO BECOME PARTICIPATING
INVESTOR INTERESTHOLDERS WILL NOT BE PERMITTED TO DEDUCT CERTAIN
INTANGIBLE DRILLING AND DEVELOPMENT COSTS INCURRED AND PAID BY THE
COMPANY AGAINST THEIR TAXABLE INCOME FROM SOURCES OTHER THAN THE
COMPANY
<PAGE>
- SUBSCRIBERS FOR INTERESTS WHO DO ELECT TO BECOME PARTICIPATING
INVESTOR INTERESTHOLDERS WILL BE SUBJECT TO UNLIMITED LIABILITY FOR
THE COMPANY'S OBLIGATIONS UNTIL THEY BECOME NON-PARTICIPATING INVESTOR
INTERESTHOLDERS AT WHICH TIME THEY WILL BE LIABLE ONLY FOR OBLIGATIONS
WHICH AROSE PRIOR TO BECOMING NON-PARTICIPATING INVESTORS
- THE LAW CONCERNING THE DUTIES OWED BY MANAGERS OF A LIMITED
LIABILITY COMPANY TO ITS MEMBERS IS RELATIVELY UNDEVELOPED; THE
MANAGER MAY NOT BE REQUIRED TO OBSERVE THE SAME FIDUCIARY
OBLIGATIONS TO THE COMPANY AND ITS INTERESTHOLDERS AS WOULD A
DIRECTOR OF A CORPORATION TO ITS SHAREHOLDERS OR A GENERAL
PARTNER OF A LIMITED PARTNERSHIP TO ITS LIMITED PARTNERS
- THE INTERESTHOLDERS WILL BE TOTALLY DEPENDENT UPON THE MANAGER TO
ACQUIRE WORKING INTERESTS IN APPROPRIATE PROJECTS AND PROPERLY
SUPERVISE THEIR DEVELOPMENT AND OPERATION AND THE ADMINISTRATION
OF THE COMPANY
- THE COMPANY WILL BE SUBJECT TO THE RISKS INHERENT IN ACQUIRING
NATURAL GAS PROPERTIES, CONDUCTING DEVELOPMENT DRILLING AND
COMPLETION OPERATIONS AND MARKETING PRODUCTION
SEE "RISK FACTORS" AT PAGE 19 HEREIN FOR A MORE COMPLETE DISCUSSION OF THESE AND
OTHER RISK FACTORS AND THEIR EFFECT ON THE COMPANY AND/OR INVESTOR
INTERESTHOLDERS.
Securities broker-dealers (the "Soliciting Dealers") which are registered
in each state in which they conduct securities-related business and which are
members of the National Association of Securities Dealers, Inc. ("NASD"), will
solicit subscriptions for Interests. Sales commissions of 8.0% of the purchase
price of the Interests will be paid to Soliciting Dealers at the time that each
subscription for Interests procured by such Soliciting Dealers is accepted by
the Manager. Due diligence fees of up to 1.0% of the purchase price of the
Interests may be paid to the Soliciting Dealers. Sales commissions and due
diligence fees may be waived for sales of Interests to certain persons.
Additional sales commissions of up to 4.5% of Residual Operating Cash Flow (as
defined), may be paid to the Soliciting Dealers as a reduction of the Manager's
share of distributions of Net Cash Flow in subsequent years if the Company
generates sufficient cash flow from operations to make such payments. The
minimum subscription is five Interests, or $5,000, except that a minimum
subscription of two-and-one-half Interests, or $2,500, will be accepted from
tax-exempt investors. Residents of certain states may be required to make a
greater minimum subscription. See "Terms of the Offering - Suitability" and
"Plan of Distribution."
If, after 60 months following the first distribution of Net Cash Flow from
Operations, the Investor Interestholders have not received distributions of Net
Cash Flow from Operations which are equal to 100% of their subscriptions
("Payout"), the Manager will subordinate (i) 100% of Net Cash Flow from
Operations attributable to the Manager's Promoted Interest, plus (ii) UP TO 100%
of Net Cash Flow from Operations attributable to the Manager's Investment
Interest, to the extent necessary to cause the Investor Interestholders to reach
Payout. See "Plan of Distribution - The Manager's Contribution and the
Manager's Interests," "Proposed Activities and Policies - Cash Distributions -
Subordination of Cash Distributions to Manager," "Participation in Costs and
Revenues - Allocation of Tax Items" and "Compensation and Reimbursement -
Interest in Projects - Manager."
Interests are not subject to assessment. The resale or redistribution of
Interests (other than the Manager's Interests) will be subject to certain
restrictions in the Company Operating Agreement permitting the Manager to refuse
to permit such transfers if, in its sole discretion, such transfers would be
inadvisable for the Company to permit (generally in the case of transfers which
could adversely affect the Company's tax treatment). However, the Manager will
offer to repurchase up to 10% of the outstanding Interests on each of five
anniversary dates of the commencement of distributions by the Company (subject
to its financial ability to do so at the time), beginning on the third such
anniversary date, at a price per Interest equal to 36 times the PRO RATA average
monthly net operating income of the Company for the twelve months preceding such
offer to repurchase. See "Terms of Offering - Repurchase of Interests."
Interests will be sold in the Companies serially. The subscription period
for Interests of the Company will commence on the date of the Supplement to this
Prospectus prepared and distributed with this Prospectus with respect to the
Company and following the formation and funding of the preceding Company, if
any, and terminate at any time after subscriptions for $300,000 (the "Minimum
Amount") are received and accepted, in the sole discretion of the Manager. THE
SUBSCRIPTION PERIOD FOR INTERESTS IN THE LAST COMPANY WILL EXPIRE ON DECEMBER
31, 1998, UNLESS EARLIER TERMINATED BY THE MANAGER. See "Plan of Distribution."
Subscriptions will be irrevocable following delivery to the Manager and
funds in payment thereof will be
2
<PAGE>
deposited in an interest-bearing escrow account at Paragon Bank & Trust,
Holland, Michigan (the "Escrow Agent"), pending formation of the Company.
The Company will not be formed unless subscription funds of at least the
Minimum Amount have been received and accepted by the Manager with respect to
the Company, and the Manager determines to form the Company. If, 90 days
following the subscription period, subscription funds of less than the
Minimum Amount have been received, all such subscription funds, with interest
earned thereon, will be returned to subscribers by the Escrow Agent within 14
days. A subscriber whose funds are deposited in the escrow account no fewer
than five business days prior to the termination of the subscription period
for Interests in any Company will receive, within 60 days following the
formation and funding of that Company, interest earned on those funds to the
date of funding of that Company. If a subscriber has not been admitted to
the Company within 15 days after subscription, the subscription and payment,
together with any interest earned thereon, will be returned to such
subscriber by the Escrow Agent. All subscription funds, together with any
interest earned thereon, will be returned to each subscriber whose
subscription is not accepted within 30 days. The Company will furnish to its
Investor Interestholders an annual report containing audited financial
statements. The Company also intends to furnish tax information by March 15
of each year. See "Additional Information."
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR THE SECURITIES REGULATORY AUTHORITY OF ANY STATE NOR HAS
THE COMMISSION OR ANY SUCH AUTHORITY PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND ANY SUPPLEMENTS THERETO IN CONNECTION WITH THIS OFFERING AND, IF
GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY WOLVERINE ENERGY, L.L.C., ANY OF ITS AFFILIATES OR
ANY OTHER PERSON.
NEITHER THE DELIVERY OF THIS PROSPECTUS, TOGETHER WITH ANY SUPPLEMENTS
THERETO, NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCE CREATE AN
IMPLICATION THAT THE INFORMATION HEREIN OR THEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO ITS DATE. THIS PROSPECTUS, TOGETHER WITH ANY SUPPLEMENTS THERETO,
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF
THE SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY STATE OR OTHER JURISDICTION
WHERE IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
TABLE OF CONTENTS
PAGE
Summary of Program 4
The Company 4
Risk Factors 4
Proposed Activities 6
Election to Become Participating Investor Interestholder; Automatic
Conversion to Non-Participating Investor Interestholder Status 8
Terms of the Offering 8
Plan of Distribution 9
Suitability Requirements 9
Cash Distributions 10
Financing 10
Application of Proceeds 10
Participation in Costs and Revenues 11
Compensation and Reimbursement 14
Voting and Other Rights of Investor Interestholders 16
Fiduciary Obligation and Indemnification of Manager 16
Conflicts of Interest with Manager or Affiliates 17
Reports to Investor Interestholders 17
Principal Executive Offices 17
Summary of Tax Considerations 18
Company Status and Allocable Interests 18
Company Income, Gains and Losses 18
Company Deductions 19
Liquidation and Termination of the Company 19
Redemption or Sale of Interests 19
Alternative Minimum Tax 19
Considerations for Tax-Exempt Investors 19
3
<PAGE>
State and Local Income Taxes 20
Risk Factors 20
Particular Risks of This Offering 20
Risks Related to Gas Investments 26
Tax-Related Risks 27
Investor Interestholder Limited Liability and
Potential Liabilities of Participating
Investor Interestholders 29
Summary 28
Limited Liability 29
Potential Personal Liability For Special Obligations 29
Investor Protection 30
Terms of the Offering 31
General 30
Subscription Period 31
Suitability Standards 31
Subscription Procedures and Payments 34
No additional Assessments 35
Transfers of Interests 35
Interest Repurchase Program 35
Plan of Distribution 37
Early Subscription Incentive 38
Indemnification 38
Sales Material 38
The Manager's Interests 39
Proposed Activities and Policies 39
Summary 39
Acquisition of Projects 40
Operating Policies 42
Turnkey Agreement 44
Prototype Operating Agreement 45
Insurance 47
Uncommitted Capital Funds of Other Entities 47
Ownership and Management of Projects 47
Sale of Production 48
Reinvestment of Revenues and Proceeds 48
Cash Distributions 48
Liquidation Policy 49
Financing 51
Application of Proceeds 52
Participation in Costs and Revenues 53
Description of Company Allocations 54
Allocations Among Investors Interestholders 56
Compensation and Reimbursement 57
Summary 57
Interest in Projects 58
Organization and Offering Costs 58
Administrative Cost Allowance 58
Asset Disposition Fee 59
Direct Costs and Costs of Operation 59
Possible Turnkey Profit 60
Management Fee 60
Other Benefits 60
Conflicts of Interest 60
Activities of the Manager and its Affiliates 60
Management of Other Entities 62
Property Acquisitions and Dispositions 62
Management 64
Wolverine Energy, L.L.C. 64
The Prior Manager 64
Affiliated Companies 65
Executive Officers and Directors 65
Executive Compensation 66
Fiduciary Obligations and Indemnification 66
4
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Prior Activities 67
Identification and Initial Capitalization of
Prior Antrim Programs 68
Administrative Costs Incurred and
As a Percentage of Gross Subscriptions 68
Direct Costs Incurred and
As a Percentage of Gross Subscriptions 69
Prior Manager Operating Results in Prior Programs Through 12/31/96
and Investor Operating Results in Prior Programs Through 12/31/96 69
Tax Aspects 78
Limitations 79
Classification as a Partnership 80
Company Taxation 81
Leasehold Acquisition Costs 82
Deduction of Intangible Drilling and Development Costs 82
Depletion 84
Depreciation 86
Farmout Agreement 86
Allocations 86
Organization, Start-Up and Syndication Expenses 89
Distributions 89
Trade or Business Requirements 90
Alternative Minimum Tax 90
Termination of the Company 92
Activities Engaged In for Profit 93
Material Distortion of Income 93
Company Borrowings 94
Registration of Tax Shelters 94
Audits, Interest and Penalties 95
Sales of Company Property 96
Redemption or Sale of Interests 96
Company Elections 97
Basis and At Risk Rules:
Limitation of Deduction of Losses 97
Passive Activities 98
Automatic Conversion of Interests 101
Foreign Investor Interestholders 102
Possible Changes in Tax Laws 103
State and Local Taxes, including Michigan 103
Need for Independent Advice 103
Conclusion 103
Investment by Pension and
Other Retirements Plans 104
Competition, Markets and Regulation 106
Summary 106
Competition and Markets 107
Regulation 107
Summary of Company Operating Agreement 110
Accounting 110
Governing law 110
Control of Company Operations 110
Indemnification 110
Temporary Investments 111
Amendments and Voting Rights 111
Automatic Conversion of
Participating Investor Interestholder 112
Removal of the Manager 112
Dissolution of Company 112
Transferability of Interests 113
The Manager's Capital Account 113
Legal Opinions 113
Reports and Accounting 114
Additional Information 114
General 114
Registration Statement 114
Litigation 114
Availability of Documents 115
Glossary of Terms 115
Financial Statements of Manager F-1
5
<PAGE>
SUMMARY OF PROGRAM
THIS SUMMARY OF PROGRAM IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION APPEARING THROUGHOUT THIS PROSPECTUS AND THE APPLICABLE SUPPLEMENT.
FOR AN EXPLANATION OF CERTAIN TERMS USED IN THIS PROSPECTUS, PLEASE REFER TO THE
GLOSSARY OF TERMS HEREIN. FOR A DISCUSSION OF RISKS THAT SHOULD BE CONSIDERED
IN EVALUATING AN INVESTMENT IN INTERESTS, REFER TO "RISK FACTORS" IN THIS
PROSPECTUS AND IN THE APPLICABLE SUPPLEMENT. WHENEVER THE CONTEXT HEREIN SO
REQUIRES, THE MASCULINE SHALL INCLUDE THE FEMININE AND NEUTER, AND THE SINGULAR
SHALL INCLUDE THE PLURAL, AND CONVERSELY.
THE COMPANY
This Prospectus and each Supplement thereto relates to the offering to
qualified investors of up to 15,000 ($15,000,000) membership interests
("Interests") in a series of up to ten (10) limited liability companies (the
"Companies") to be formed by Wolverine Energy, L.L.C. (the "Manager"). The
Companies will each be activated following the completion of the offering of
Interests of such Company and will thereafter acquire assets solely from the net
proceeds of such offering and commence operations. This Prospectus relates
solely to the Company identified on the cover page of the Prospectus Supplement
attached hereto. Investor Interestholders will not be liable for the debts or
obligations of the Company in excess of the amount of capital he/she has
contributed to the Company in the form of the purchase price for his/her
Interests, OTHER THAN, AT SUCH INVESTOR INTERESTHOLDER'S ELECTION, IN CERTAIN
LIMITED CIRCUMSTANCES, WITH RESPECT TO SPECIAL OBLIGATIONS WHILE SUCH PERSON IS
A PARTICIPATING INVESTOR INTERESTHOLDER. See "Risk Factors - Participating
Investor Interestholders" and "Investor Interestholder Limited Liability and
Potential Liabilities of Participating Investor Interestholders."
The offering period for Interests in the Company will commence on the date
of the Supplement to this Prospectus prepared with respect to the Company and
attached to this Prospectus and will terminate at any time after subscriptions
for $300,000 of Interests have been received and accepted, in the sole
discretion of the Manager, but in no event later than December 31, 1998.
RISK FACTORS
An investment in Interests is subject to certain risks, some of which may
be beyond the ability of the Manager to affect or control. Prospective Investor
Interestholders should consider various possible risks of their investment in
Interests, including, without limitation, the following:
- - SPECULATIVE NATURE OF GAS INVESTMENTS - there can be no assurance that the
wells in which the Company acquires a working interest will produce natural
gas in quantities which are sufficient to make such well commercially
viable; the risks which could affect the commercial success of a well
include, without limitation, the failure to find gas reserves which are
sufficient to warrant development, prohibitively high costs of discovery,
development or production of such gas, depressed market prices for natural
gas, unpredictable public demand for natural gas, interruptions in or the
unavailability of suitable means to transport gas to end users and the
inability to foresee or forestall certain events, such as well blowouts or
cave-ins, which could interrupt or terminate production from a well
- - COMPETITION - the competition for attractive development projects and for
lucrative gas supply contracts is fierce and attracts competitors with far
greater resources and market power than the Manager or the Operators
- - OPERATING AND ENVIRONMENTAL HAZARDS - the operations of the Company will be
subject to risks of loss from operating incidents and environmental
protection measures which may curtail or prohibit the Company's planned
activities and result in substantial economic loss
- - LIMITED DIVERSIFICATION - the Company may be formed after the sale of as
few as $300,000 of Interests, which could result in a limited degree of
investment diversification in the Company's assets
- - UNSPECIFIED PROJECTS; DEPENDANCE UPON MANAGEMENT - the Interestholders will
be totally dependent upon the
6
<PAGE>
Manager to acquire working interests in appropriate projects and properly
supervise their development and operation and the administration of the
Company
- - LACK OF LIQUIDITY - there will be substantial limitations imposed by the
federal and applicable state securities laws on the resale of Interests
and, in all likelihood, no public market for such resale will develop
- - LIMITATIONS ON LIABILITY OF AND INDEMNIFICATION OF MANAGER AND AFFILIATES -
the Company Operating Agreement contains provisions which limit or
eliminate certain fiduciary obligations of the Manager and which may waive
rights of Investor Interestholders regarding conflicts of interest and
reduce the Manager's fiduciary duties, substantially restrict the Investor
Interestholders' right to resell or dispose of Interests and limit the
rights of Investor Interestholders to vote on issues affecting the business
of the Company
- - CONFLICTS OF INTERESTS - the Manager and its affiliates will be subject to
substantial conflicts of interest between their interests in and
obligations to the Company and its other activities
- - UNCOMMITTED CAPITAL FUNDS OF OTHER ENTITIES - the Manager and its
affiliates may also participate in other natural gas investment entities
with respect to which it has managerial and/or fiduciary responsibilities;
in certain circumstances, the Company will be required to compete with such
other entities for (i) the managerial time and resources of the Manager,
and (ii) appropriate investment opportunities
- - POTENTIAL UNLIMITED LIABILITY - subscribers for Interests who do elect to
become Participating Investor Interestholders will be subject to unlimited
liability for the obligations of the Company until they become
Non-Participating Investor Interestholders at which time they will be
liable only for obligations which arose prior to their becoming
Non-Participating Investors
- - UNCERTAINTY OF GOVERNING LAW - the law concerning the duties owed by
managers of a limited liability company to its members is relatively
undeveloped; the Manager may not be required to observe the same fiduciary
obligations to the Company and its Interestholders as would a director of a
corporation to its shareholders or a general partner of a limited
partnership to its limited partners
- - PASSIVE INVESTOR IN PROJECTS - the Manager will work closely with the
Operators in connection with all important decisions affecting the projects
in which the Company invests, and the Manager or its affiliate may be a
co-operator of certain projects in which the Company acquires a working
interest. However, in cases where neither the Manager nor its affiliates
is a co-operator of a project in which the Company invests, such project
will be operated by Operators which (i) control the conduct and management
of all development, drilling and operating activities of each well in the
project, and (ii) over which the Manager exercises no control
- - PRIOR PERFORMANCE NO GUARANTEE - the previous success of the Manager and
its affiliates in sponsoring and managing natural gas projects is not a
guarantee, and may not be indicative, of the success of the Company
- - POSSIBLE JOINT LIABILITY - as owners of working interests in gas wells, the
Company and the Investor Interestholders may become subject to additional
liabilities attributable to the working interests of their joint working
interest owners
- - BORROWINGS - Participating Investor Interestholders may be personally
liable for the repayment of any monies borrowed by the Company which it is
unable to repay from its assets and cash flow
- - REMOVAL OF MANAGER; DISSOLUTION AND TERMINATION OF COMPANY - the removal
for cause of the Manager as managing Interestholder in the Company or the
involuntary dissolution and termination of the Company is possible only
with the agreement of the holders of a majority of the Interests; such
removal, however, will subject the Company and the Interestholders to
additional risks related to the subsequent income tax effects on the
Company and the need to secure substitute management, among others
7
<PAGE>
- - GOVERNMENT REGULATION - various governmental bodies regulate the natural
gas development and production industry and their actions could result in
the imposition of higher costs on the Company to pursue its investment
program or prohibit it from developing a prospect to which it has committed
resources
- - TAX-RELATED RISKS - the federal income tax treatment of an investment in
Interests is subject to uncertainty in some respects, particularly the
deductibility of intangible drilling and development expenses by
Interestholders (Participating and Non-Participating), the substantial
economic effect of the allocations of tax items in the Company Operating
Agreement, the treatment of unrelated business taxable income to tax-exempt
Investor Interestholders, the possibility of audit and disallowance of
certain tax reporting positions taken by the Company and the possibility of
an audit of the Company and the resulting adjustments in the Investor
Interestholders' personal income tax returns, including for items not
related to the Company
- - UNCERTAINTY OF FEDERAL INCOME TAX TREATMENT - the Manager has not obtained
a ruling of the Internal Revenue Service with respect to the federal income
tax treatment of an investment in Interests. Further, Special Tax Counsel
has not opined upon certain material tax issues which require a factual
determination regarding an investment in Interests
- - TAXABLE INCOME WITHOUT CASH - circumstances may result in Investor
Interestholders being allocated taxable income from the Company which
results in an income tax liability which exceeds, perhaps greatly, the cash
distributions to them from the Company for the same period
- - LIMITATIONS ON DEDUCTIBILITY - subscribers for Interests who elect not to
become Participating Investor Interestholders will not be permitted to
deduct certain intangible drilling and development costs incurred and paid
by the Company against their personal taxable income, but may be permitted
to offset such costs against other passive income that they report in the
same of subsequent tax years
- - TAX LAW CHANGES - Congress frequently examines substantial revisions to the
Internal Revenue Code of 1986 and, not infrequently, amends the Code in
ways which could adversely affect certain Investor Interestholders,
sometimes retroactively.
See "Risk Factors" at page 19 herein for a more complete discussion of these and
other risk factors and their effect on the Company and/or Investor
Interestholders.
PROPOSED ACTIVITIES
The Company will acquire working interests in natural gas development
projects in the Primary Area, including the Antrim shale formation in northern
lower Michigan and other Devonian shale formations in southwestern lower
Michigan, northeastern Indiana and northwestern Ohio. The Company will engage
chiefly in developmental drilling on projects intended to reach and exploit gas
reserves in the Antrim shale formation in the Primary Area. The Company may
also invest up to 35% of its net investable assets to acquire working interests
in natural gas development projects in other areas of the continental United
States if, in the opinion of the Manager, such investment(s) would further the
Company's investment goals, including the diversification of its assets and the
earlier realization of revenues from production of gas.
The Antrim formation is a Devonian shale located throughout Alcona, Antrim,
Charlevoix, Crawford, Kalkaska, Montmorency, Otsego and Oscoda Counties,
Michigan, in which owners and Operators of natural gas wells have historically
enjoyed high rates of success in developing commercially viable natural gas
reserves. Affiliates of the Manager and its sole owner have made investments in
Antrim shale development wells since 1987; a more extensive discussion of such
affiliates' investment record in natural gas exploration and development is
contained under "Prior Activities" herein.
The Company will make investments in natural gas development projects
through the acquisition of undivided
8
<PAGE>
working interests in projects controlled by Operators which are not
affiliates of the Manager (although affiliates of the Manager may have
acquired working interests in other natural gas projects operated by such
Operators), although the Manager will work closely with the Operators in
connection with all important decisions affecting the projects in which the
Company invests. The Manager has not specifically identified projects in
which any Company will acquire a working interest. The Manager is, however,
continually investigating and evaluating projects in which it may be suitable
for the Company to acquire a working interest.
The Company will invest its capital in such projects for the purpose of
acquiring title to working interests therein, providing capital to conduct
drilling and completion activities thereon and participate in the
installation of production, collection and distribution facilities with
respect to such wells in order to generate net revenues from sales of gas for
regular cash distributions to Investor Interestholders. The Company may
participate, through the retention of otherwise distributable proceeds from
the sale of gas or borrowings, in (i) the performance of remedial work
intended to improve well operations, (ii) the utilization of enhanced or
secondary recovery methods, and (iii) the conduct of limited additional
development drilling and completion operations, with respect to any projects.
If, in the sole opinion of the Manager, circumstances warrant and the
interests of the Company would be favorably affected thereby, the Company may
participate in the acquisition of gas gathering systems, plants and other
facilities downstream from the wellhead which provide distribution of gas
from wells in which the Company has acquired a working interest.
The Manager will be solely responsible for the selection and acquisition
of the working interests acquired by the Company and for the supervision of
the Operators of such working interests during all phases of drilling,
completion and installation of production, collection and distribution
facilities thereon, the operation of the wells, drilling of development
wells, if any, completion, re-working, recompletion, deepening or
sidetracking of existing wells and installation of any enhanced or secondary
recovery methods (if applicable), and decision-making with respect to future
alterations in the operation or completion of the wells. The Manager will
also be solely responsible for the supervision of the sale of Interests and
the administration and management of the Company.
The Company will acquire working interests in projects through the
Manager, which will have acquired such working interests from one or more of
a number of Operators and other sources in contemplation of conveying such
working interest to the Company. The Company will pay a fixed price (the
"Turnkey Cost") to the Manager to (i) pre-pay its share of the intangible
costs of development, drilling and completion of that number of net wells on
such property which the Company acquires, (ii) pre-pay its share of the
post-Completion costs of such wells for items identified in the applicable
AFE, and (iii) guarantee that the Company will not be responsible for any
cost overruns with respect to such activities. The Turnkey Cost with respect
to each working interest in a project acquired by the Company will be fixed
prior to such acquisition. The Manager estimates that the Turnkey Cost of
each project in which the Company acquires a working interest will be based
upon the Manager's actual cost to acquire such working interest from a
non-affiliated party, if any, and the anticipated cost to develop such
project as estimated by the Operator, and will reflect market prices for
turnkey development, drilling, completion and Facilities installation
commitments prevailing in the market among non-affiliated parties. See,
however, "Conflicts of Interest - Property Acquisitions and Dispositions."
The Company will only acquire working interests in projects having an
Operator which is not affiliated with the Manager. The Manager may serve as
co-operator of a project with an unaffiliated Operator in a project in which
the Company holds a working interest, but will not serve as the sole
Operator. Under extraordinary circumstances involving the failure of the
primary Operator to properly discharge its obligations to the Company, the
Manager will seek a substitute Operator or contract on behalf of the Operator
with an unaffiliated party to monitor and operate the wells in the project
and otherwise discharge the Operator's duties.
The Company will acquire working interests in projects located primarily
in the same general location (i.e., the Antrim shale formation in the Primary
Area) and will seek to develop and own natural gas reserves in the same
geological formation. This concentration of investment will be mitigated
somewhat by an attempt to diversify the Company's investments among several
projects. The ability of the Manager to diversify the Company's investments
will be, to a substantial degree, a function of the amount of capital
available to the Company and the Company will be able to commence operations
with $300,000 of subscriptions.
9
<PAGE>
The Manager will generally seek to acquire working interests in projects
for the Company with the intent of recovering its investment over the long term
through the sale of gas (subject to the Company' intention to liquidate its
assets, distribute the proceeds to Investor Interestholders and dissolve within
10 years), but may sell such working interests sooner if circumstances,
including the price at which such working interests can be sold and the
Manager's opinion regarding future gas prices, warrant. Further, the Manager
intends to cause the Company to acquire a portfolio of projects that balances
high current production rates with likely long-term production rate stability.
ELECTION TO BECOME PARTICIPATING INVESTOR INTERESTHOLDER; AUTOMATIC
CONVERSION TO NON-PARTICIPATING INVESTOR INTERESTHOLDER STATUS
Investor Interestholders may elect to become Participating Investor
Interestholders by agreeing to assume joint and several liability for the
Company's Special Obligations. Special Obligations consist generally of the
Company's obligations and liabilities of whatever type or description arising
solely out of or in connection with its ownership of working interests in
each of the wells in which it owns a working interest, including but not
limited to the obligation to pay drilling and completion costs and the cost
of Facilities, tort liabilities for personal injury or environmental damage
and repayment obligations with respect to any indebtedness of the Company,
including indebtedness that is validly incurred by the Company, though it may
exceed the amounts or percentages described in the Prospectus with respect to
the Company's policies regarding maximum levels of indebtedness to be
incurred. THE LIABILITY OF PARTICIPATING INVESTOR INTERESTHOLDERS FOR
SPECIAL OBLIGATIONS OF THE COMPANY WILL EQUAL THE AMOUNT BY WHICH SUCH
SPECIAL OBLIGATIONS EXCEED THE SUM OF (I) THE PROCEEDS FROM INSURANCE PAYABLE
TO THE COMPANY ON ACCOUNT OF SUCH SPECIAL OBLIGATIONS, PLUS (II) THE VALUE OF
THE ASSETS OF THE COMPANY AVAILABLE TO PAY SUCH LIABILITIES, AND WILL NOT BE
LIMITED TO THE AMOUNT OF SUCH PARTICIPATING INVESTOR INTERESTHOLDERS'
INVESTMENT IN THE COMPANY. Only Participating Investor Interestholders will
be entitled to the working interest exception to the passive activity rules
under the Code with respect to the wells for which they have assumed personal
liability for Special Obligations. Participating Investor Interestholders
will be automatically converted to Nonparticipating Investor Interestholders
upon the earlier to occur of (i) one year following the completion of the
offering, or (ii) the Facilities Completion Date of the last well to be
Completed in which the Company holds a working interest. Such
Nonparticipating Investor Shareholders will generally not be liable for
Special Obligations with respect to such wells which arise after such
conversion, but will remain liable for Special Obligations incurred by the
Company with respect to such wells arose while they were Participating
Investor Interestholders, i.e., prior to such conversion. The Manager will
provide written notice to each Investor Interestholder of the Facilities
Completion Date. See "Risk Factors," "Liability of Participating Investor
Interestholders" and "Proposed Activities and Policies - Operating Agreements
- - Insurance," "Tax Aspects - Passive Activities - Conversion of Interests"
and "Summary of Company Operating Agreement."
TERMS OF THE OFFERING
A Company will be activated and commence investment when subscriptions
for at least the Minimum Amount of Interests for that Company is received and
accepted. All subscribers for Interests will be accepted or rejected by the
Manager within 15 days of receipt of their subscriptions. Until the Minimum
Amount of subscriptions is received with respect to any Company, all
subscription funds will be held in an interest-bearing escrow account.
Subscriptions to the same Company thereafter received will be held in escrow
until the subscriber has been accepted by the Manager and admitted to the
Company. All subscription funds will be credited with interest actually
earned while (i) on deposit in the escrow account, and (ii) held by the
Manager in temporary investments pending the final closing of the offering of
Interests of the Company (the "Final Closing"). All persons admitted to the
Company will receive, within 60 days following the Final Closing, interest
earned on their subscription funds during the Temporary Investment Period.
If a subscriber has not been admitted to the Company within 15 days of
receipt of his/her subscription, his/her subscription shall be deemed
rejected and returned to him. All subscribers whose subscriptions are
rejected or deemed rejected shall receive the return of their subscription
payment, with all interest actually earned thereon, within 30 days. The
offering of Interests will conclude not later than December 31, 1998.
The minimum subscription for Interests is $5,000, except that for an
Individual Retirement Account (IRA) or Keogh Plan investor, the minimum
subscription is $2,500. The offering period for the Company may close at any
time after
10
subscriptions for the Minimum Amount of Interests has been received. The
Manager or its affiliates may purchase up to 5% of the Minimum Amount of
Interests for any Company in order for the Company to obtain subscriptions
for the Minimum Amount. All Interests acquired by the Manager or its
affiliates (other than the Manager's Interests) will be purchased for
investment purposes only and may not be resold or otherwise redistributed
unless such Interests are registered for sale in a public offering or exempt
from such registration under the Securities Act and the securities regulatory
statutes and regulations applicable to such resale. The Company's offering
period will close prior to the acquisition of working interests in specific
gas projects by that Company. After the Company's offering period closes the
offering of Interests in the next Company in the Program will commence.
INTEREST REPURCHASE PROGRAM. Investor Interestholders (whether
Participating Interestholders or non-Participating Interestholders) may tender
Interests to the Manager for repurchase on the terms described herein on each of
five anniversaries of the date of the first cash distribution by the Company,
commencing with the third such anniversary. Repurchase of Interests by the
Manager is subject to certain conditions, including the receipt by the Manager
of certain opinions of counsel and the determination of the Manager that it has
the financial ability to make such repurchase at the time. Subject to such
conditions, the Manager will offer annually to repurchase for cash a maximum of
10% of the Interests originally subscribed to in the Company. Subject to such
conditions, the Manager is obligated to purchase all Interests presented to it
by Investor Interestholders, up to the 10% ceiling referred to above. The
repurchase price will be based upon a minimum of 36 times the PRO RATA monthly
net operating income during the twelve months preceding receipt of the request
for repurchase or some greater amount which is solely in the discretion of the
Manager. Such repurchase price may not approximate the fair market value of the
Interests. See "Terms of the Offering - Repurchase Program" and "Tax Aspects -
Classification of the Company" and "- Sale or Redemption of Interests."
PLAN OF DISTRIBUTION
The Interests will be offered by Soliciting Dealers with which the Manager
contracts on behalf of the Company. Sales commissions and due diligence fees
will be paid to the Soliciting Dealers after the Minimum Amount of subscriptions
for the Company ($300,000) is received. Each Soliciting Dealer will receive
aggregate sales commissions of up to 8.0% and due diligence fees of up to 1.0%
of the sales price of Interests sold by them at the time subscriptions for such
Interests are received and accepted. Additional sales commissions of up to 4.5%
of Residual Operating Cash Flow may be paid to the Soliciting Dealers from the
Manager's share of distributions of Net Cash Flow in subsequent years if the
Company generates sufficient cash flow from operations to make such payments.
No sales commissions or due diligence fees will be charged with respect to
purchases of Interests by the Manager or any of its affiliates. Individuals who
are affiliates of the Manager may also sell Interests directly to Investor
Interestholders that are not affiliates of the Manager; sales commissions or due
diligence fees may be paid to such affiliates with respect to such purchases of
Interests.
SUITABILITY REQUIREMENTS
Investment in the Company involves financial risk and is suitable only for
persons of substantial means who have no need for liquidity in their investment
and can afford to lose all or substantially all of their investment. The
following suitability requirements represent the minimum suitability
requirements for investors in the Company, and the satisfaction of such
requirements by a prospective investor does not necessarily mean that an
investment in the Company is a suitable investment for that investor.
Each subscriber for Interests must represent that he/she has (a) individual
or joint net worth with his/her spouse of $225,000 or more (exclusive of home,
home furnishings and automobiles), or (b) individual or joint net worth with
his/her spouse of $60,000 or more (exclusive of home, home furnishings and
automobiles) and had during his/her last tax year, or estimates that he/she will
have during the current tax year, individual or joint "taxable income," as such
term is defined in Section 63 of the Code, of $60,000 or more, without regard to
his/her investment in Interests. Additional representations and warranties
required of Investor Interestholders are set forth in the Company Operating
Agreement. Investors who are residents of certain states may be subject to
higher suitability requirements. Investors may include IRAs, Keogh Plans,
Qualified Plans and other tax-exempt entities. These investors should, however,
carefully review
11
<PAGE>
with their tax advisors the discussion under "Investment by Pension and Other
Retirement Plans" for specific considerations applicable to their investment
in Interests. See "Terms of Offering - Suitability."
CASH DISTRIBUTIONS
The Company will distribute to Investor Interestholders such cash funds as
the Manager deems unnecessary to retain in the Company to pay Company costs and
expenses and/or to service Company debt, if any. Distributions to Investor
Interestholders are anticipated to begin at the end of the first calendar
quarter following the completion of drilling, completion and installation of
production, collection and distribution equipment on the wells and the
commencement of commercially viable gas production therefrom, a process that is
anticipated to take approximately 6-12 months. Distributions will be made
monthly for the first six (6) months and quarterly thereafter. If the Company
elects to re-work wells, install enhanced recovery equipment or engage in
development drilling, distributions may be suspended and not begin again until
such activities have been completed and the development well(s), if any, have
been connected to a gathering network and production has begun, a process that
is anticipated to take approximately 6-12 months from commencement of drilling.
The Manager has agreed to subordinate the distribution to it of (i) 100% of the
Net Cash Flow from Operations attributable to the Manager's Promoted Interest
plus, (ii) UP TO 100% of the Net Cash Flow from Operations attributable to the
Manager's Investment Interest to the extent necessary to cause the Investor
Interestholders to reach Payout if, after 60 months following the first
distribution of Net Cash Flow from Operations, the Investors, including the
Manager with respect to the Manager's Investment Interest, have not received
distributions of Net Cash Flow from Operations which, in the aggregate, are
equal to 100% of the Investor Interestholders' subscriptions (i.e., Payout).
Any such deferral of distributions of cash to the Manager will be recovered by
the Manager from first available Net Cash Flow from Operations after the
Investor Interestholders have reached Payout until such deferrals have been
recovered. See "Proposed Activities and Policies - Cash Distributions -
Subordination of Cash Distributions to Manager," "Participation in Costs and
Revenues - Allocation of Tax Items" and "Compensation and Reimbursement -
Interest in Projects - Manager."
FINANCING
The Company will not borrow money to acquire working interests in projects
or pay its share of the anticipated costs of drilling, completion and
installation of production, collection and distribution equipment on the wells.
Nevertheless, the Manager reserves the right to cause the Company to borrow up
to 15% of the total subscriptions of their respective Investor Interestholders
for use in re-working wells, installing enhanced recovery equipment or engaging
in development drilling. The Manager expects that the Company will borrow less
than these limits. All borrowing entails certain risks. See "Financing" and
"Risk Factors - Risks of Financing."
APPLICATION OF PROCEEDS
The Company will have approximately 90% of total investor subscriptions
available to acquire working interests in projects, pay its share of the costs
of drilling, completion installation of production, collection and distribution
12
<PAGE>
equipment on the wells and fund working capital reserves, if required, as
described below. For further information, see "Application of Proceeds."
<TABLE>
<CAPTION>
Percentage Percentage
Minimum Per $5,000 of investor sub- of all sub-
Amount subscription scriptions scriptions
------ ------------ ---------- ----------
<S> <C> <C> <C> <C>
Gross investor subscriptions $300,000 $5,000 100.0% 95.24%
Manager's Contribution 15,000 250 5.0% 4.76%
------- ------- ------ ---------
Total contributions $315,000 $5,250 105.0% 100.00%
Less: Broker commissions (1) (24,000) (400) (8.0%) 7.62%
Due diligence fees (2) (3,000) (50) (1.0%) 0.95%
Organization and offering costs allowance (3) (7,500) (125) (2.5%) 2.38%
-------- ------ ------ --------
Net investor subscriptions 280,500 4,675 93.5% 89.05%
Less: Management fee (4) (10,500) (175) (3.5%) 3.33%
-------- ------- ------ -------
Investor subscriptions available
for investment 270,000 4,500 90.0% 85.71%
Total capital available to pay
Turnkey Cost $270,000 $4,500 90.0% 85.71%
========= ======== ====== =======
- ---------------------------------------------
</TABLE>
(1) Securities sales commissions of up to 8% of the purchase price of the
Interests will be paid to broker/dealers which are members of the National
Association of Securities Dealers, Inc. (NASD), with respect to Interests
which are placed by them at the time that each subscription for Interests
procured by such Soliciting Dealers is accepted by the Manager. Additional
sales commissions of up to 4.5% of Residual Operating Cash Flow may be paid
to the Soliciting Dealers as a reduction of the Manager's share of
distributions of Net Cash Flow in subsequent years if the Company generates
sufficient cash flow from operations to make such payments. Sales
commissions and due diligence fees may be waived for sales of Interests to
certain persons.
(2) The Company may pay a due diligence expense reimbursement fee of up to 1%
of the gross proceeds of Investor Interestholder subscriptions to
participating broker/dealers which sell Interests.
(3) The costs of organizing the Company and conducting the offering of
Interests will be paid by the Manager. The Company will pay the Manager an
allowance equal to 2.5% of Investor Interestholders' capital contributions
in exchange for the Manager's agreement to pay such costs; any amounts
which exceed such allowance will be paid by the Manager and the Company
will not be liable therefor.
(4) The Company will pay the Manager a one-time Management Fee equal to 3.5% of
aggregate Interestholders' capital contributions, payable in the year of
subscription, for its services in managing the Company in such year.
Payable from Investor Interestholder subscriptions only.
PARTICIPATION IN COSTS AND REVENUES
Sales commissions, organization and offering costs, the Management Fee,
revenues from temporary investments, INTANGIBLE development, drilling,
completion, production and transportation Facilities and other costs and
proceeds from the sale of properties to the extent they do not exceed the book
value of the properties sold, will generally be allocated 100% to the Investor
Interestholders and 0% to the Manager.
Undeveloped leasehold costs, development costs and costs associated with
the acquisition of Company properties, including the Acquisition Fee, will be
allocated 100% to the Investors (including 4.76% to the Manager with respect to
the Manager's Investment Interest) and 0% to the Manager with respect to the
Manager's Promoted Interest.
TANGIBLE development, drilling, completion, production and transportation
Facilities and other costs will be allocated in the proportion required to
result in the total of all development, drilling, completion, production and
transportation Facilities and other costs being allocated 94.76% to the
Investors, including the Manager with respect to the Manager's Investment
Interest, and 5.24% to the Manager with respect to the Manager's Promoted
Interest. The Manager will be allocated revenue in respect of the sale of
tangible equipment with respect to the Manager's Promoted Interest to the extent
that the cost thereof was allocated to it.
13
<PAGE>
Revenues from the sales of production, less the administrative cost
allowance, direct costs, operating costs, and all other costs and expenses, and
the net proceeds to the Company from the sale of its assets (after payment of
the asset disposition fee, noted below) will generally be distributed 94.76% to
the Investors (including the Manager with respect to its Investment Interest)
and 5.24% to the Manager with respect to the Manager's Promoted Interests, until
the Investors (including the Manager with respect to its Investment Interest)
have received aggregate distributions equal to Payout (see "Glossary of Terms").
Thereafter, such amounts will be distributed 69.76% to the Investors (including
the Manager with respect to its Investment Interest) and 30.24% to the Manager
with respect to the Promoted Manager's Interest (in addition to any revenues
allocated to the Manager or its affiliates as Investor Interestholders with
respect to Interests owned by them). The Manager has agreed to subordinate the
distribution to it of (i) 100% of the Net Cash Flow from Operations attributable
to the Manager's Promoted Interest, plus (ii) UP TO 100% of the Net Cash Flow
from Operations attributable to the Manager's Investment Interest if, after 60
months from the date of the first distribution of cash to Investors, the
Investors, including the Manager with respect to the Manager's Investment
Interest, have not received distributions of Net Cash Flow from Operations
which, in the aggregate, are equal to 100% of their aggregate capital
contributions. Any such deferral of distributions of cash to the Manager will
be recovered by the Manager from first available Net Cash Flow from Operations
after, and for so long as, the Investors have received distributions of Net Cash
Flow from Operations which, in the aggregate, are equal to 100% of the
Investors' subscriptions, until such deferrals have been recovered. See
"Proposed Activities and Policies - Cash Distributions - Subordination of Cash
Distributions to Manager," "Participation in Costs and Revenues - Allocation of
Tax Items" and "Compensation and Reimbursement - Interest in Projects -
Manager."
The gain from the sale of the Company property will generally be allocated
in accordance with the distribution of net proceeds from such sale, subject to
the priority payment to the Investor Interestholders of proceeds from such sale
sufficient to recoup the amount by which aggregate distributions, if any, in
prior years, to the Manager with respect to the Manager's Promoted Interests
exceed 5.24% or 30.24% of Adjusted Capital, as appropriate. See "Glossary of
Terms." Losses incurred by the Company in connection with such sales will
generally be allocated among the Investor Interestholders and to the Manager in
proportion to their respective contributions of capital to the Company, i.e.,
100% to the Investors, including the Manager with respect to the Manager's
Investment Interest, and the Manager or its affiliates with respect to any
Interests they own in such capacity, and 0% to the Manager with respect to the
Manager's Promoted Interest. If there is a loss on a sale or insufficient gain
from a sale to permit 5.24% or 30.24%, as appropriate, of the aggregate amount
of net proceeds of the sale to be allocated to the Manager, the Manager will be
specially allocated additional gain from subsequent sales of Company property,
if any, to make up the difference. See "Proposed Activities and Policies - Cash
Distributions - Subordination of Cash Distributions to Manager," "Participation
in Costs and Revenues - Allocation of Tax Items" and "Compensation and
Reimbursement - Interest in Projects - Manager."
The following table summarizes the allocation of costs and revenues of the
Company between the Manager and the Investor Interestholders.
<TABLE>
<CAPTION>
Manager's Manager's
Promoted Investment Investor
Description Interest Interest Interestholders Investors (1)
----------- -------- -------- --------------- -------------
<S> <C> <C> <C> <C>
COSTS
* Selling expenses (2) 0.00% 0.00% 100.00% 100.00%
* Organization and offering costs allowance (3) 0.00% 0.00% 100.00% 100.00%
* Management fee (3) 0.00% 0.00% 100.00% 100.00%
* Acquisition costs and expenses (4)(7)(8) 0.00% 0.00% 100.00% 100.00%
* Intangible drilling and
development costs (5)(6) 0.00% 0.00% 100.00% 100.00%
* Tangible drilling and
development costs (5)(12) (13) (13) (13) (13)
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
* Administrative cost allowance (3) 5.24% 4.76% 90.00% 94.76%
* Direct costs and operating costs (4)(5)(15) 5.24% 4.76% 90.00% 94.76%
* Additional development costs (5)(9)(15) 5.24% 4.76% 90.00% 94.76%
* Financing costs (5)(10)(15) 5.24% 4.76% 90.00% 94.76%
* Professional and other costs (5)(11)(15) 5.24% 4.76% 90.00% 94.76%
REVENUES
* Net revenues from temporary
investments (14) 0.00% 0.00% 100.00% 100.00%
* Revenues from sales
of production (5) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Revenues from the sale or
other disposition of Company properties (15) (15) (15) (15)
- --------------------------
</TABLE>
(1) Including the Manager with respect to the Manager's Investment
Interest; the Manager will be allocated the costs and revenues
attributable to the Manager's Investment Interest in the same manner
as for Investor Interestholders, except with respect to sales
commissions, organization costs, intangible drilling and development
costs and revenue from temporary investments.
(2) See "Plan of Distribution."
(3) See "Compensation and Reimbursement."
(4) See the complete definitions of "direct costs" and "operating costs"
in "Glossary" and Article 2 of the Company Operating Agreement.
(5) The Interestholders' shares of costs and revenues are subject to
adjustment if transferred Interests are surrendered for Company
assets. Adjustments may also be required under the "qualified income
offset" provision of the Company Operating Agreement. See "Tax
Aspects - Allocations to Interestholders."
(6) See "Tax Aspects - Deduction of Intangible Drilling and Development
Costs."
(7) Includes costs arising out of or relating to the acquisition of
gathering facilities, plants and other assets necessary to produce gas
reserves efficiently. Company borrowings, the proceeds of which are
used to pay costs and expenses arising out of or relating to the
additional development of Company properties, will be repaid out of
the Investor Interestholders' and the Manager's respective shares of
revenues in the same proportion as the costs and expenses paid with
the proceeds of such borrowings would have been charged if expended
out of the Interestholders' capital contributions.
(8) See "Tax Aspects - Leasehold Acquisition Costs."
(9) Includes leasehold acquisition costs, tangible and intangible drilling
and development costs and overhead expenses incurred in connection
with (a) drilling and completion and installation of collection,
production and distribution Facilities on additional development wells
drilled on Company properties, and (b) re-working, recompleting,
deepening or sidetracking of or installation of secondary, tertiary or
other enhanced recovery methods on, existing wells composing the
Project. See "Proposed Activities and Policies - Operating Policies -
Basic Operating Policies."
(10)Includes interest, points, financing fees and charges, professional
fees and other costs of borrowings associated with Company operations.
See "Financing."
(11)Fees and expenses of independent public accountants, outside counsel,
Independent Experts and other professionals employed by the Company
and associated costs and expenses.
(12)See "Tax Aspects - Depreciation."
(13)The respective allocations of these items to the Manager and the
Investor Interestholders will be adjusted so that the Manager is
allocated 5.24% of the total costs of drilling, completing and
equipping (or plugging and abandoning) wells with respect to the
Manager's Promoted Interest and the Investors are allocated 94.76% of
such costs (including 4.76% to the Manager with respect to the
Manager's Investment Interest). The precise allocation of tangible
costs will depend upon the percentage of the Turnkey Cost expended to
pay tangible versus intangible costs.
(14)Fees and expenses related to investing such funds in short-term,
liquid instruments, if any, will be paid out of the interest earned
prior to the allocation of the balance of such revenues among the
Interestholders.
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<PAGE>
(15) Revenues from sales of production and from the sale or other
disposition of Company properties will be distributed 94.76% to the
Investors as a group, including 4.76% to the Manager with respect to
the Manager's Investment Interest, and 5.24% to the Manager with
respect to the Manager's Promoted Interest, until the Investor
Interestholders have each received a return of its Net Capital
Contribution; thereafter, such revenues will be distributed 69.76% to
the Investors as a group, including 4.76% to the Manager with respect
to the Manager's Investment Interest, and 30.24% to the Manager with
respect to the Manager's Promoted Interest (see " - Description of
Company Allocations" below).
For a detailed explanation of the system for distribution of revenues and
payment of expenses, see "Participation in Costs and Revenues."
The Manager will receive (i) the amounts of revenues received and direct
and operating costs charged to the Manager as an Investor in the same manner
as for the Investor Interestholders with respect to the Manager's Investment
Interest, plus (ii) an amount equal to 5.24% of all Company revenues and will
be charged 5.24% of all Company direct and operating costs until the Investor
Interestholders have each received a return of its Net Capital Contribution,
and 30.24% of such amounts thereafter, all in exchange for its having
contributed an amount equal to 5.0% of aggregate Interestholders' net capital
contributions for its aggregate interest in the Company. Further, the
Manager will generally be allocated gain from the sale of the Company
property in accordance with the distribution of net proceeds from such sale.
See "Glossary of Terms." Losses, excluding specially allocated items as
described above, incurred by the Company in connection with such sales will
generally be allocated to the Investor Interestholders and to the Manager in
proportion to their respective capital contributions. If there is a loss on
a sale or insufficient gain from a sale to permit the appropriate percentage
of the aggregate amount of net proceeds of the sale to be allocated to the
Manager, the Manager will be specially allocated additional gain from
subsequent sales of Company property, if any, to make up the difference.
The Manager will retain a 2% overriding net revenue interest in each
property after it assigns the balance of its working interest to the Company,
provided that the overall working interest in such property exceeds 75% of the
net revenue interest. To the extent that the Manager obtains and does not
re-assign this retained overriding net revenue interest in a property, it will
be entitled to a 2% interest in the revenues of such property attributable to
the working interest (i.e., remaining after payment of the landowner and other
overriding royalties) after payment of all associated operating costs, without
being required to contribute a proportional amount of all capital required to
develop and operate wells on such property. The Manager anticipates that the
primary benefit to it of the retained overriding net revenue interest in
projects assigned by it to the Company will be to permit it to re-assign
portions of it as additional compensation to persons, who or which may include
affiliates of the Manager, who or which make working capital loans to the
Manager, primarily to enable it to acquire and "warehouse" additional gas
projects for future development. See "Proposed Activities and Policies."
For further information with respect to Company allocations, see
"Participation in Costs and Revenues."
COMPENSATION AND REIMBURSEMENT
The Manager will receive a one-time Management Fee equal to 3.5% of
subscriptions. See "Application of Proceeds."
Each Company will pay the Manager an amount (i.e., the Turnkey Cost) for
each property in which it acquires a working interest which is determined in
advance of such acquisition and the Manager anticipates will reflect prices for
turnkey development, drilling and completion commitments prevailing in the
market among non-affiliated parties allocable to such working interest through
Completion. With respect to all working interests in projects acquired by the
Company, to the extent that the actual amounts payable upon the completion of
the activities described in the estimate for such working interest are less than
the Turnkey Cost (which is anticipated to reflect market prices for turnkey
development, drilling and completion commitments prevailing in the market among
non-affiliated parties), the Manager will receive compensation in an amount
equal to the difference. IF THE AMOUNT ACTUALLY PAYABLE THROUGH COMPLETION AND
FOR IDENTIFIED POST-COMPLETION FACILITIES FOR ANY WELL ON A PROPERTY IN WHICH
THE COMPANY HAS
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A WORKING INTEREST EXCEEDS THE TURNKEY COST FOR SUCH PROPERTY, THE MANAGER
WILL PAY SUCH EXCESS FROM ITS OWN FUNDS AND THE COMPANY WILL NOT BE LIABLE
FOR SUCH EXCESS AMOUNTS.
The Manager will receive an annual administrative cost allowance,
commencing in the month that the Company first realizes revenue from production,
at the rate of 3.5% of aggregate Investor Interestholders' capital
contributions, net of PRO RATA returns of capital to Investor Interestholders,
in each year or partial year thereafter until the termination of the Company, in
lieu of reimbursement for the administrative costs allocable to the Company,
except those incurred when it acts as operator of Company projects. Such
amounts are payable only out of Company revenues. Upon the sale by the Company
of any of its property, including all or a portion of its working interests in
any projects, the Manager will receive an asset disposition fee equal to 3.5% of
the gross proceeds from such sale.
The sales commissions and, to the extent that the due diligence fees
described above exceed actual due diligence expenses incurred by the Soliciting
Dealers, will constitute compensation to the Soliciting Dealers. Set forth
below is a tabular summary of the items of compensation and reimbursement
payable from the Company to the Manager and its affiliates:
<TABLE>
<CAPTION>
IF MINIMUM
FORM OF AMOUNT
COMPENSATION METHOD OF COMPENSATION SOLD (1)
<S> <C> <C>
OFFERING AND ORGANIZATION STAGE
Management Fee 3.5% of aggregate Investor Interestholders' capital contributions $10,500
ACQUISITION AND OPERATING STAGE
Administrative 3.5% of aggregate Investor Interestholders' capital contributions per $10,500 per year
cost allowance annum, net of PRO RATA returns of capital to Investor Interestholders, (1)(2)
commencing in the month that the Company first realizes revenue from
production, accrued monthly in lieu of reimbursement of administrative
costs and expenditures paid by the Manager, subject to adjustment
Possible Difference, if any, between organizational and offering costs Indeterminate
organizational allowance and actual costs of the organization of the Company and
and offering offering of Interests, including accounting, filing and legal fees,
costs profit printing and other costs and marketing expenses
Possible turnkey Difference, if any, between the Turnkey Cost and actual development, Indeterminate
profit drilling, completion and identified post-Completion Facilities costs
Compensation for Fair market value, on an accountable basis, for services to the Indeterminate
services Company which do not constitute customary, routine or recurring
administrative tasks in the Company's day-to-day business
Interest in Percentage of proceeds of production equal to Manager's Promoted Indeterminate (3)
revenues Interest, after allocations of direct costs, operating costs,
administrative costs allowance and all other expenses
Overriding 2% net revenue interest in the projects on same terms as Company; Indeterminate
royalty provided, however, that the working interest, as a whole, exceeds 75%
of the entire net revenue interest of such property
LIQUIDATION STAGE
Asset disposition 3.5% of gross proceeds of sales of Company property Indeterminate (4)
fee
Interest in Percentage of proceeds of sales of Company assets in accordance with Indeterminate
proceeds of sales Manager's Promoted Interest from time to time (5.24% until Payout, (3)(5)
30.24% after Payout) after allocations of direct costs, operating
costs, administrative costs allowance and all other expenses
</TABLE>
------------------------------
(1) These payments will generally be less than the corresponding expenses paid
by the Manager in the early years of Company operations and the resulting
deficit will generally be recovered by the Manager over a five-year period.
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<PAGE>
(2) Payable from revenues from sales of production only. See the tables of
Direct and Administrative Costs Incurred As A Percentage of Gross
Subscriptions in "Prior Activities" for information about affiliated
entities.
(3) The Manager has agreed to subordinate the distribution to it of (i) 100% of
the Net Cash Flow from Operations otherwise distributable to it with
respect to the Manager's Promoted Interest, and (ii) UP TO 100% of the Net
Cash Flow from Operations otherwise distributable to it with respect to the
Manager's Investment Interest if, after 60 months following the first
distribution of Net Cash Flow from Operations, the Investor Interestholders
have not received distributions of Net Cash Flow from Operations which, in
the aggregate, are equal to 100% of the Investor Interestholders'
subscriptions to the extent necessary to cause the Investor Interestholders
to reach Payout. See "Proposed Activities and Policies - Cash
Distributions - Subordination of Cash Distributions to Manager,"
"Participation in Costs and Revenues - Allocation of Tax Items" and
"Compensation and Reimbursement - Interest in Projects - Manager."See the
tables of Investor Interestholder and Manager Operating Results in Prior
Programs in "Prior Activities" for information about affiliated limited
partnerships.
(4) The Asset Distribution Fee equals 3.5% of the gross proceeds of the sale of
Company property.
(5) Payable only out of gains realized on such sales. See "Participation in
Costs and Revenues - Company Allocations."
For further information, see "Compensation and Reimbursement."
VOTING AND OTHER RIGHTS OF INVESTOR INTERESTHOLDERS
Under applicable law and the Company Operating Agreement, the Investor
Interestholders have the right to inspect and copy all Company records required
to be maintained by law, to reasonably request information regarding the
business and financial condition of the Company, and to have dissolution by
court order if it is not reasonably practicable to carry on the business of the
Company in conformity with the Company Operating Agreement. The Company
Operating Agreement provides that, subject to specified conditions, the Investor
Interestholders may by vote of a majority in interest (i) amend the Company
Operating Agreement, (ii) dissolve the Company, (iii) approve or disapprove the
sale of all or substantially all of the assets of the Company other than in the
ordinary course of the Company's business, (iv) remove the Manager for cause and
elect a new managing Interestholder, provided that such action will not
adversely affect the tax status of the Company or any of the Investor
Interestholders, (v) cancel any contract for services (other than the Company
Operating Agreement itself) between the Company and the Manager without penalty
(but subject to possible liability for damages) upon 60 days notice, provided
such action will not violate applicable federal income tax status of the
Company, and (vi) elect a liquidator if the Company is dissolved as a result of,
among other things, the removal, withdrawal, dissolution or bankruptcy of the
Manager. By a vote of two-thirds in interest of the Investor Interestholders,
they may approve or disapprove the selection of an additional or successor
managing Interestholder. The Manager is required to call a meeting of Investor
Interestholders upon receipt of a written request from more than 10% in interest
of all the Investor Interestholders for a vote on a matter as to which Investor
Interestholders have voting rights. THE COMPANY OPERATING AGREEMENT PROVIDES
THAT INTERESTS OWNED BY THE MANAGER OR ITS AFFILIATES WILL NOT BE COUNTED IN
DETERMINING WHETHER A MAJORITY IN INTEREST HAS BEEN RECEIVED ON MATTERS
AFFECTING THE MANAGER. See "Summary of Company Operating Agreement."
FIDUCIARY OBLIGATION AND INDEMNIFICATION OF MANAGER
The Manager, as managing Investor Interestholder, is accountable to the
Company and the Investor Interestholders as a fiduciary and must handle Company
affairs in good faith, may not obtain any secret advantage or benefit from the
Company and must share with it all business opportunities clearly related to the
subject of its operations. In contrast to the relatively well-developed state
of the law concerning fiduciary duties owed by officers and directors to the
shareholders of a corporation or by the general partner to the limited partners
of a limited partnership, the law concerning the duties owed by managers of a
limited liability company to its members is relatively undeveloped. The Act
does not prohibit limited liability companies from restricting or expanding the
liabilities of managers to the company and members of such company in the
operating agreement or Articles. In order to induce the Manager to act as
trustee for and manage the business of the Company, Article 3 of the Company
Operating Agreement contains various provisions that are designed to mitigate
possible conflicts of interest (see "Conflicts of Interest") which may have the
effect of restricting the fiduciary duties that might otherwise be owed by the
Manager to the Company and the holders of Interests or which waive or consent to
conduct by the Manager that might otherwise raise issues as to compliance with
fiduciary duties. Because this is a rapidly developing and changing area of the
law and there is virtually no case law on the subject, the Manager has not
obtained an opinion of counsel covering the provisions of the Company Operating
Agreement which purport to waive or restrict fiduciary duties of the Manager.
The Company
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<PAGE>
Operating Agreement contains provisions that restrict the fiduciary duties
that might otherwise be owed by the Manager and waive or consent to conduct
by the Manager that might otherwise raise issues as to compliance with
fiduciary duties. Unlike a trustee which must act solely in the best
interests of his/her beneficiary, the Company Operating Agreement permits the
Manager to consider the interests of all parties to a conflict of interest,
including the interests of the Manager and its affiliates and other entities
to which the Manager or its affiliates owe a fiduciary duty, provided the
Manager acts in a manner that is fair and reasonable to the Company and the
Investor Interestholders. Since the Manager, not an independent third party,
will make decisions with respect to the resolution of any such conflicts,
investors must rely on the judgment of the Manager to appropriately resolve
any such conflicts. See "Summary of Company Operating Agreement."
The Act provides that a limited liability company is permitted to indemnify
a Manager against expenses incurred in the defense of an Investor Interestholder
derivative action if the Manager acted in good faith and in a manner reasonably
believed to be in or not opposed to the best interests of the Company. No
indemnification is permitted if the Manager was liable for negligence or
misconduct unless a court orders that under all the circumstances indemnity is
proper. The Company Operating Agreement makes this indemnification mandatory
and extends it to affiliates of the Manager. Because the Act authorizes but is
otherwise silent on additional indemnification rights, the Company Operating
Agreement also provides for indemnification of the Manager and its affiliates by
the Company against losses and liabilities sustained by them in connection with
the Company, provided that the same were not the result of negligence, a failure
to act in good faith or misconduct on the part of the Manager or its affiliates.
Notwithstanding the above, and subject to the provisions of the Act, the
Manager and its affiliates and any person acting as a Soliciting Dealer shall
not be indemnified for any losses, liabilities or expenses arising from or out
of an alleged violation of federal or state securities laws unless (1) there has
been a successful adjudication on the merits of each count involving alleged
securities law violations as to the particular indemnitee and the court approves
indemnification of the litigation costs, or (2) such claims have been dismissed
with prejudice on the merits by a court of competent jurisdiction as to the
particular indemnitee and the court approves indemnification of the litigation
costs, or (3) a court of competent jurisdiction approves a settlement of the
claims against a particular indemnitee and the court finds that indemnification
of the settlement and related costs should be made. Moreover, in any claim for
indemnification for federal or state securities law violations, the party
seeking indemnification shall place before the court the position of the U.S.
Securities and Exchange Commission, the Massachusetts Securities Division and
any other applicable regulatory authority (including, in the case when an
Investor Interestholder has filed the claim as plaintiff, the state in which
such Investor Interestholder was offered or sold Interests) with respect to the
issue of indemnification for securities law violations. It is the position of
the U.S. Securities and Exchange Commission that, to the extent that
indemnification provisions purport to include indemnification for liabilities
arising under the Securities Act of 1933, as amended, such indemnification is
contrary to public policy and, therefore, unenforceable.
CONFLICTS OF INTEREST WITH MANAGER OR AFFILIATES
The Manager and its affiliates are free to engage in gas exploration and
development for their own accounts and may sponsor programs for the formation of
additional entities to engage in activities similar to those of the Company.
The Company may also participate in joint acquisitions with affiliated entities
that will acquire non-operating interests from, or in the same projects in which
working interests are acquired by, the Company. While the Company Operating
Agreement contains prohibitions and restrictions in several areas, possible
conflicts of interest between the Company and the Manager or such other entities
may nevertheless result. For example, because the Manager's share of revenues
from the sale of gas produced from Company projects is larger than its share of
Company capital and may be larger than its share of proceeds from sales of
Company projects, it will be in its interest for the Manager to cause the
Company to acquire projects as quickly as possible and may be in its interest
for the Manager to cause the Company to hold rather than to sell a property.
See "Proposed Activities" and "Conflicts of Interest."
REPORTS TO INVESTOR INTERESTHOLDERS
Each Investor Interestholder will receive a written report within 150 days
after the close of the Company's fiscal
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<PAGE>
year containing audited financial statements and information regarding
operations.
PRINCIPAL EXECUTIVE OFFICES
The principal executive office of the Company and the Manager is 4660 South
Hagadorn Road, Suite 230, East Lansing, Michigan 48826; telephone (800)
800-9949.
SUMMARY OF TAX CONSIDERATIONS
The following is a summary of the tax aspects considered to be of material
interest to a typical prospective purchaser of Interests and is based upon an
opinion of Patzik, Frank & Samotny Ltd., Special Tax Counsel to the Company.
This summary is not intended to be a substitute for careful tax planning and no
person or entity should invest in the Company without first consulting a
qualified tax advisor about the federal, state and local income and other tax
consequences to such investor of an investment in Interests and reviewing, in
detail, the discussion of such matters in "Tax Aspects" herein. For a more
detailed discussion of these and other tax aspects, and the qualifications to
this summary, see "Tax Aspects" and "Risk Factors - Tax-Related Risks."
The Company will be formed for the purpose of acquiring and developing
working interests in natural gas projects and generating income through the
operation of such projects. It is not expected that the Company will generate
significant federal income tax benefits other than intangible drilling and
development cost deductions and percentage depletion allowances. Consequently,
potential investors should recognize that the Company is not organized primarily
to provide tax benefits and an investment in the Company is not a suitable
investment for those investors seeking the benefits of a "tax shelter."
COMPANY STATUS AND ALLOCABLE INTERESTS
In the opinion of Special Tax Counsel, the Company, if organized in
accordance with the provisions described herein, will more likely than not be
classified as a partnership for federal income tax purposes, and not as an
association taxable as a corporation. As such, the Company is not required to
pay federal income tax but is required to file a federal income tax information
return each year. Each Investor Interestholder is then required to take into
account in computing his/her own federal income tax liability his/her allocable
share of Company income, gain, loss, deduction and credit, regardless of any
actual cash distributions made to such Investor Interestholder during his/her
taxable year. Each Investor Interestholder's allocable share of such items will
be determined in accordance with allocations set forth in the Company Operating
Agreement, provided such allocations are recognized for federal income tax
purposes.
COMPANY INCOME, GAINS AND LOSSES
Each Company's income from the sale of gas will be taxable to the Investor
Interestholders as ordinary income subject to depletion. Gains and losses from
sales of gas projects (and/or any equipment) held for more than one year and not
held primarily for sale to customers generally will be gains and losses
described in Section 1231 of the Code. Other gains and losses on sales of gas
projects will result in ordinary income and losses. Any of such income or loss
should be characterized as income or loss other than from a passive activity to
the extent that Investor Interestholders elect to assume liability for
obligations of the Company and thereby become Participating Investor
Interestholders. Participating Investor Interestholders should generally be
able to offset such income or loss against losses or income from other sources.
Investor Interestholders who elect to retain their limited liability will have
income or loss allocable to them from the Company considered "passive income"
which generally may only be utilized to offset losses or income from the
Investor Interestholders' other passive activities. However, for Investor
Interestholders who initially elect to become Participating Investor
Interestholders and who are allocated losses from the Company which are
considered to other than from a passive activity, the income allocable to them
from the Company in taxable years following their automatic conversion to
Nonparticipating Investor Interestholders, will also be considered income other
than from a
20
<PAGE>
passive activity, notwithstanding their status as Nonparticipating
Investor Interestholders following such conversion. AN INVESTMENT AS A
PARTICIPATING INVESTOR INTERESTHOLDER MAY NOT BE ADVISABLE FOR A PERSON WHOSE
TAXABLE INCOME FROM ALL SOURCES IS NOT RECURRING OR IS NOT NORMALLY SUBJECT TO
HIGHER MARGINAL FEDERAL INCOME TAX RATES. See "Tax Aspects - Passive
Activities."
COMPANY DEDUCTIONS
Expenses incurred to acquire mineral interests in gas projects and to drill
or produce gas will be treated in one of the following manners for federal
income tax purposes: (a) intangible drilling and development costs may be
deducted when accrued or capitalized at the Company's election; (b) ordinary and
necessary business expenses may be deducted when accrued; (c) in the case of a
dry hole or other worthless property, an ordinary loss deduction may be claimed;
and (d) all other expenditures made by the Company with respect to the
acquisition, development or operation of their projects which do not qualify
under (a), (b) or (c) above must be capitalized and recovered, if at all,
through depletion or depreciation. Such expenses will generally be allowable as
deductions to the Investor Interestholders against their Company income and
gains described above or, to the extent an Investor Interestholder elects to be
a Participating Investor Interestholder, against income from other sources. Any
of such expenses should be characterized as arising other than from a passive
activity to the extent that Investor Interestholders elect to assume liability
for obligations of the Company and thereby become Participating Investor
Interestholders with respect to all wells (i) upon subscription, and (ii) after
the Facilities Completion Date, and such Investor Interestholders should
generally be able to offset such expenses against income from other sources.
Investor Interestholders who elect to retain their limited liability will have
any such expenses allocable to them from the Company considered as expenses
arising from a "passive activity" which generally may only be utilized to offset
income from the Investor Interestholders' other passive activities, including
income from the Company. See "Tax Aspects - Passive Activities."
LIQUIDATION AND TERMINATION OF THE COMPANY
Upon liquidation of the Company, all of its assets will be sold and the
cash proceeds distributed to the Investor Interestholders. A sale of any
Company property by the Company will have the tax consequences described under
"Tax Aspects - Sales of Company Property" and, with respect to recapture, under
"- Termination of Company." The distribution of the cash proceeds from such
sale will result in taxable income to an Investor Interestholder only to the
extent the amount distributed exceeds his/her adjusted basis in his/her
Interests. An Investor Interestholder will recognize loss to the extent that
the cash received is less than his/her adjusted basis in his/her Interests. The
character of such gain or loss is discussed below under "Tax Aspects - Sales of
Company Property."
REDEMPTION OR SALE OF INTERESTS
Generally, gain or loss realized upon the redemption or sale of Interests
held for more than eighteen months will be taxed as long-term capital gain or
loss. That portion of realized gain allocable to "unrealized receivables,"
including accelerated depreciation subject to recapture and depletion deductions
(to the extent such deductions reduced the basis of gas projects) and
"substantially appreciated inventory", will be taxed as ordinary income.
Furthermore, the amount realized upon such a sale will include the amount of
liabilities to which such Interests are subject. See "Tax Aspects - Redemption
or Sale of Interests."
ALTERNATIVE MINIMUM TAX
For all taxpayers other than Subchapter C corporations, the alternative
minimum tax is equal to 26% of the excess of the "alternative minimum taxable
income" over an exemption amount, up to $175,000 and 28% of the excess of the
"alternative minimum taxable income" over an exemption amount over $175,000,
reduced generally by the regular tax paid by the taxpayer for the taxable year.
The effect of the alternative minimum tax on an Investor Interestholder may
depend upon a number of factors peculiar to such Investor Interestholder. See
"Tax Aspects - Alternative Minimum Tax."
<PAGE>
CONSIDERATIONS FOR TAX-EXEMPT INVESTORS
Prospective Investor Interestholders that are tax-exempt entities,
including charitable corporations, pension, profit-sharing or stock bonus
plans, Keogh Plans, IRAs and certain other employee benefit plans, should
note that net income derived from the conduct of a trade or business
regularly carried on by them or by an entity taxable as a partnership in
which they are a partner may constitute "unrelated business taxable income"
upon which a tax is imposed. Income derived from ownership of a working
interest in gas projects has been held to constitute unrelated business
taxable income, even though ownership is in the form of a limited partnership
interest (which, for federal income tax purposes, may be substantially the
same as ownership of interests in a limited liability company). For that
reason, substantially all of a tax-exempt Investor Interestholder's share of
Company income in excess of such tax-exempt Investor Interestholder's $1,000
annual exemption amount may constitute unrelated business taxable income.
See "Investment by Pension and Other Retirement Plans."
STATE AND LOCAL INCOME TAXES
An investment in the Company may subject an Investor Interestholder to
income taxes imposed by the states and localities in which the Company
operates as well as any other jurisdictions in which an Investor
Interestholder resides or does business and, accordingly, may require an
Investor Interestholder to file one or more state or local income tax returns
reflecting such income from Company operations. The Company may also be
subject to state or local taxes in states and localities in which it operates.
RISK FACTORS
Prospective investors should recognize that the gas development and
production business is a high risk venture. Investment in Interests is
recommended only to persons who are prepared to assume the substantial risks
discussed below and elsewhere in this Prospectus. The nature of such risks
requires persons who purchase Interests to be in a position to (a) hold such
investment for a substantial number of years, and (b) absorb the possible
loss of such investment. The risks listed under the heading "Particular
Risks of This Offering" are those specifically applicable to this offering
and the risks listed under the heading "Risks Related to Gas Investments" are
those generally associated with and inherent in gas programs conducted
through entities such as limited liability companies. Tax risks are listed
separately under the heading "Tax-Related Risks."
PARTICULAR RISKS OF THIS OFFERING
UNSPECIFIED PROJECTS; DEPENDENCE UPON MANAGER. The Manager will select
all projects in which working interests will be acquired by the Company.
However, the identity of such projects will not be specified at the time that
the Supplement to this Prospectus with respect to such Company is prepared
and, hence, will not be disclosed to prospective subscribers for Interests
prior to such subscription. Therefore, prospective investors will not have
an opportunity to review those projects before investing in the Company or to
participate in the selection of projects after acquiring Interests. The
Manager may, therefore, during the course of the offering of Interests in the
Company select projects in which such Company will acquire a working interest
and persons subscribing for Interests will not be permitted to withdraw their
subscriptions as a result of the selection of any such projects and may not
receive notification of the selection of any such property prior to funding
of such Company. See "Proposed Activities and Policies - Acquisition
Policies" and the applicable Supplement attached to this Prospectus with
respect to the Company.
CONFLICTS OF INTEREST; UNCOMMITTED CAPITAL FUNDS OF OTHER COMPANIES. The
Program will consist of a series of Companies activated serially, as often as
every other month, each of which will be newly formed and have no history of
operations or earnings. Consequently, two or more Companies in the Program,
as well as other entities formed by the Manager or its affiliates under other
similar programs may have uncommitted capital funds available at the same
time. The fact that existing Companies are and other entities may be in a
position to purchase additional interests in projects may delay purchasing
activities by other or later Companies and create the risk of conflicts of
interest with other
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or later Companies. In addition, because the Manager (i) has agreed to the
imposition of certain restrictions if specified percentages of the Company's
net subscriptions have not been invested or committed for investment within
two years after commencement of its operations, and (ii) will receive an
Acquisition Fee with respect to each acquisition of a working interest in a
property, the Manager's determination as to whether a working interest in a
particular property is suitable for purchase made at a time immediately prior
to the expiration of either of such periods may be subject to a conflict of
interest. The Manager has a fiduciary obligation to act in the best interests
of the Company. See "Conflicts of Interest - Management of Other Entities."
NON-OPERATOR OF PROJECTS. The prototype Operating Agreement confers
contractual authority with respect to all such matters on the operator solely
or on the co-operators jointly and requires it or them to take action with
respect to such matters. In addition, the sole operator or co-operators will
hire and supervise the contractors engaged to conduct drilling and completion
activities and install production, collection and distribution Facilities and
operate the wells. The Manager will work closely with the Operators in
connection with all important decisions affecting the projects in which the
Company invests, and may be a co-operator of some of such projects. However,
with respect to any specific project in which the Company invests, neither
the Manager nor any of its affiliates will be the sole Operator nor may the
Manager of any of its affiliates be a co-operator. In such cases, the
Manager will not be able to exercise ultimate control over the activities
conducted upon the property, such as the drilling and completion of wells,
installation of production, collection and distribution Facilities,
additional development drilling, recompletion, re-working, deepening or
sidetracking existing wells, installing enhanced recovery methods or altering
operating technologies or methods, and may not share such control. Further,
a sole Operator of such a well will have complete control of the marketing of
the property's gas production and may commit the production of the property
to long-term purchase contracts with such purchasers and on such terms as it
chooses. Any or all of the choices actually made by a sole Operator of a
property with respect to the drilling, completion, production and management
of the wells could vary greatly from the anticipated choices upon which the
Manager based its determination to have the Company acquire a working
interest in such property. Such determinations will be made by such sole
Operators, in consultation with the Manager, based upon their expertise and
experience and in the exercise of its judgment as to the choices which will
generate the most economically favorable results from each well. As a
result, the Company's share of the costs of completing any well and placing
it in production may exceed the amounts budgeted by the Operator to pay such
costs. With respect to Completion activities and post-Completion Facilities
identified in the applicable AFE, such increased costs will be the
responsibility of the Manager to pay on behalf of the Company pursuant to the
Turnkey Agreement and the Company will be subject to such overruns only to
the extent that the Manager is unable to pay such costs and the Company is
required to determine whether to pay such costs itself in order to protect
its investment in such project. However, with respect to post-Completion
activities which are not identified in the applicable AFE, such increased
costs would be the direct responsibility of the Company. In such event, the
Manager may seek to cause the Company to borrow such amounts or make
arrangements for the making of payments by the Company in lieu of such
amounts through leasing Facilities, transportation or processing fees or by
other means. ANY SUCH AMOUNTS WILL, HOWEVER, CONSTITUTE SPECIAL OBLIGATIONS
WITH RESPECT TO SUCH WELL.
The Company will, therefore, be largely dependent upon the competence and
probity of the Operators for the success of its investments in projects,
despite the Manager's investigations and analysis of the property prior to
investment. The Company will, however, retain certain rights in the operating
agreement to approve certain fundamental actions by the Operator and to
remove the Operator for cause under certain circumstances. See "Proposed
Activities and Policies -Operators; Operating Agreements."
CONCENTRATION OF INVESTMENT/POSSIBLE LACK OF PROPERTY DIVERSIFICATION.
If only the Minimum Amount of subscriptions for any Company are received, the
number of projects in which working interests may be acquired by such Company
may be reduced, and the Company's ability to diversify risk may be
diminished. In some cases, interests in assets other than projects (e.g.,
processing and gathering facilities) may be acquired. In all cases, however,
the Investor Interestholders of the Company must rely upon the Manager to
diversify the activities of the Company. Investors should be aware that the
lesser the amount raised by any Company in this offering, the greater the
risk from lack of diversification for such Company. The Company will not
acquire any working interest in the projects in which interests are held by
the partnerships identified in "Prior Activities" and will not enter into any
revenue-sharing arrangements
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with such partnerships or other entities in order to diversify its risk. See
"Proposed Activities and Policies." Note: The amounts shown in the table
appearing under the caption "Application of Proceeds" do not reflect any
borrowings by the Company. See "Financing."
FACTORS SPECIFIC TO ANTRIM SHALE FORMATION IN THE PRIMARY AREA. The rate
of development, drilling and completion of natural gas wells in the Antrim
shale formation has grown substantially over the immediate past and may be
expected to continue to do so for the foreseeable future. This rapid growth
has taxed and will in the future tax the gas distribution infrastructure
(i.e., gas gathering and transportation pipelines, CO2 removal and other gas
conditioning facilities and systems and compression and pumping stations),
resulting in increased pipeline pressures, unbalanced volumes of gas and
other factors which limit the amount of gas that any well or project may
place into the system for transportation and sale. As a result, the
limitations of the gas distribution infrastructure and other related factors
have, on occasion, caused production at individual wells or projects
(including wells and projects in which affiliates of the Manager hold or have
held working interests) to be curtailed for varying lengths of time, and may
be expected to occur from time to time in the future. As more Antrim wells
are completed and come on line, the capacity of the existing distribution
system to accept and transport gas more nearly approaches capacity and the
necessity of reducing production from or shutting in altogether wells becomes
more likely. There is no reasonably reliable means with which to anticipate
how and where in the Antrim shale these capacity limitations may occur, nor
how the managers of such systems will opt to cope with them. Therefore, there
can be no assurance that production from wells in which the Company holds a
working interest will not be curtailed for varying lengths of time, and no
reasonable means by which the Manager or its affiliates can provide any
assurance that they will be successful in minimizing such production cutbacks
if and when they occur. Further, the measures which the Michigan Department
of Natural Resources, the owner/managers of the various gas distribution and
treatment facilities and others may take to alleviate the effects of capacity
limitations on the overall gas delivery system, such as requiring gas
balancing, unitization of fields, reduction in production pressures and
capacity rationing may result in limiting the volume production that may be
obtained from wells and projects in which the Company holds a working
interest.
INVESTOR PERFORMANCE DATA AND EXPERIENCE. The sole owner, director and
executive officer of the Manager has acted as a manager of prior gas
development programs (including acting as a principal of the general partner
of programs organized as partnerships and of the managing trustee/shareholder
of programs organized as Delaware business trusts), and the investment
performance of those programs is described in "Prior Activities." The
performance of such programs, however, is no guarantee and may not be
indicative of the results that will be experienced by the Company. The
Company will not acquire any working interest in the projects in which
interests are held by the partnerships identified in "Prior Activities" and
will not enter into any revenue-sharing arrangements with such partnerships
or other entities in order to diversify its risk. The Companies, moreover,
will collectively be substantially larger than the Prior Programs and none of
the Prior Programs were engaged in raising capital for investment prior to
identifying the projects in which it would invest; consequently, the Manager
may be said to not have previously sponsored programs similar to the Company.
DISTRIBUTIONS. The Manager intends to cause the Company to maintain a
regular, reasonably predictable pattern of distributions once such
distributions have commenced. However, cash distributions will be dependent
primarily upon the Company's cash flow from the sale of gas and may be
deferred to the extent revenues are applied to repay Company debts and
liabilities, perform remedial or additional work to improve a well's
producing capability or drill additional development wells. Company taxable
income will be reportable by Investor Interestholders in the year earned,
even if cash is retained for Company purposes rather than distributed to
Investor Interestholders, possibly causing Investor Interestholders to incur
a tax liability without receiving cash distributions from the Company. See
"Tax Aspects - Company Taxation" and "-Distributions."
JOINT WORKING INTERESTS; POSSIBLE LIABILITY FOR OBLIGATIONS OF JOINT
WORKING INTEREST OWNERS. It is anticipated that the Company will hold
interests in projects primarily as joint working interest owners with other
parties, including the Operators and, possibly, other entities which are
affiliated with the Manager. As such, although the Manager expects to work
closely with the Operators in connection with all important decisions
affecting the projects in which the Company invests, the management and
control of such working interest will be exercised by a party other than the
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Manager, resulting in decisions affecting the Company's investment in the
working interest being controlled by a third party. Further, under certain
circumstances, it could be determined that the Company and such other parties
have joint and several liability with respect to obligations relating to the
working interest. In such event, or if the Manager determined that it was in
the best interest of the Company to discharge such obligations in order to
complete work on or maintain its ownership of the working interest
notwithstanding the default in payment by such other parties, the Company
could be or become responsible for the obligations of such other parties
relating to the entire working interest. See "Proposed Activities and
Policies - Acquisition Policies."
BORROWINGS AND OTHER FINANCING. The Manager anticipates that the net
proceeds from the sale of Interests in the Company will be sufficient to pay
such Company's share of the costs of the acquisition and anticipated
operation of its share of the working interest in the projects in which it
invests (i.e., the Manager does not intend to "leverage" the Company's
initial investment in any property). The Manager has, however, reserved the
right to cause the Company to borrow up to 15% of the Company's gross
proceeds from the sale of Interests and may cause the Company to engage in
such borrowings to either (i) improve the productivity of the projects in
which it holds a working interest through re-working existing wells,
installing enhanced recovery equipment or drilling developmental wells on
such property, or (ii) respond to the need for additional funds due to
unforeseen circumstances. In addition, the Company may utilize other
financing methods (e.g., reinvestment of Net Revenues, farm-outs or sales of
net profits interests in projects) to obtain such funds. Any borrowings will
be so-called "non-recourse" borrowings in which the lender's recourse for
repayment of the borrowings will be limited to the assets of the Company and
none of the Investor Interestholders will be personally liable for such
obligation. The effect of borrowings or other financings could be to
increase the profitability of the Company, but could also be to reduce cash
available for distribution to the extent that cash is utilized to service or
repay borrowings or to reduce the Company reserves in the case of farm-outs
or sales of net profits interests. There can be no assurance that any such
financing can be arranged and the limitation on the personal liability of the
Investor Interestholders may make borrowings particularly difficult or
impossible to arrange.
LACK OF LIQUIDITY; INABILITY TO RESELL OR DISPOSE OF INTERESTS. Though
the Interests are registered under the Securities Act, they are not intended
to be publicly-traded securities; there is no public or other liquid market
for Interests nor is one expected to develop. Federal tax laws and
regulations also impose significant limitations upon the ability of an
Investor Interestholder to sell or otherwise dispose of his/her Interests.
Furthermore, the Company Operating Agreement contains provisions which
severely limit the transferability, under any circumstances, of Interests.
See "Summary of Company Operating Agreement" and "Tax Aspects."
Furthermore, the Manager may refuse to recognize any transfer of Interests
that may have occurred on a "secondary market or the substantial equivalent
thereof", within the meaning of applicable provisions of the Code, in order
to preserve the status of the Company as partnerships for tax purposes.
There can be no assurance that the market conditions and the value of the
projects in which any Company owns working interests will enable the Manager
to successfully implement such Company's policy to liquidate its assets and
distribute the proceeds thereof to the Investor Interestholders after the
seventh and before the end of the tenth year of such Company's operations.
The obligation of the Manager to acquire up to 10% of the outstanding
Interests annually for five years beginning in the third year following the
Company's initial distribution to Investor Interestholders (subject to its
financial ability to do so at the time) is limited in amount of Interests
which must be purchased and fixes the price of such mandatory offer to
repurchases at an amount which may be significantly below the fair market
value of such Interests. In addition, such Interests will not be acquired if
the acquisition would either result in the termination of the Company for
federal income tax purposes or cause the Company to be treated as a publicly
traded partnership under the Code. THEREFORE, AN INVESTOR CANNOT EXPECT TO
BE ABLE TO READILY LIQUIDATE HIS/HER INVESTMENT IN INTERESTS AT ANY TIME. IN
ADDITION, INVESTOR INTERESTHOLDERS WILL NOT HAVE THE RIGHT TO WITHDRAW ANY
CAPITAL FROM THE COMPANY OR TO RECEIVE THE RETURN OF ALL OR ANY PORTION OF
THEIR CAPITAL CONTRIBUTIONS EXCEPT OUT OF DISTRIBUTIONS OF NET REVENUES OR
UPON THE SALE OF OTHER DISPOSITION OF THE COMPANY'S PROPERTY OR THE
DISSOLUTION AND LIQUIDATION OF THE COMPANY. ACCORDINGLY, AN INVESTOR IN
INTERESTS MUST BE PREPARED TO BEAR THE RISKS INHERENT IN AN INVESTMENT IN
INTERESTS FOR AN INDEFINITE PERIOD OF TIME. SEE "SUMMARY OF COMPANY
OPERATING AGREEMENT."
INVESTOR VOTING RIGHTS; ABSENCE OF DISSENTER'S RIGHTS. The right of
Investor Interestholders to vote is limited to specified matters, and
Investor Interestholders may, in certain instances, be bound by decisions
made by only a
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majority vote of other Investor Interestholders or made solely by the
Manager. Affiliates of the Manager may acquire a limited number of Interests
(up to 5%) and may exercise their right to vote such Interests on matters, if
any, submitted to the Interestholders for a vote. In addition, Investor
Interestholders will not be entitled to exercise dissenters' appraisal
rights. Therefore, Investor Interestholders may be required to maintain their
investments even after a substantial amendment of the Company Operating
Agreement or a sale of substantially all of the assets of the Company in
exchange for securities of another company or in the event of a substantial
change in the business or objectives of the Company. See "Summary of Company
Operating Agreement."
CONFLICTS OF INTEREST. In order to eliminate the possibility of the
necessity for provision for assessments of Investor Interestholders (which
would be required if the Company acquired its working interest in a property
directly from its Operator and took upon itself the risk of cost overruns in
the drilling and completion of the wells corresponding to its working
interest therein), the Company will acquire its working interests in such
wells and pay its PRO RATA share of the costs of development, drilling and
Completion and post-Completion Facilities identified in the applicable AFE of
such wells through the Turnkey Agreement with the Manager. The Company will
acquire its working interest in its projects and fund its share of the costs
of Completion and identified post-Completion Facilities of the wells thereon
through the Manager at a price per net well, i.e., the Turnkey Cost, which
will exceed the Operators' PROJECTED (though not guaranteed) price of such
working interests and costs of Completion and such post-Completion
Facilities. The amount by which the Turnkey Cost exceeds the costs which are
anticipated to be payable by the Manager to the Operator is intended to
compensate the Manager for the risk that the cost of developing, drilling and
completing the wells on the property and installing the post-Completion
Facilities identified in the applicable AFE will exceed the Operators'
estimates of such amounts and, indeed, the Turnkey Cost. The Turnkey Cost
will not be determined at arm's length and will not be subject to review by
an independent expert on behalf of the Investor Interestholders.
The Program consists of up to ten Companies, any or all of which could
acquire projects from the Manager or its affiliates. The Investor
Interestholders will not be involved in the day-to-day operations of the
Company, including the acquisition and supervision of the operation of the
projects. Accordingly, the Investor Interestholders must rely on the
Manager's judgment in such matters. The Manager and its affiliates are free
to engage in gas exploration and development for their own accounts and may
sponsor programs for the formation of additional entities to engage in
activities similar to those of the Company. The Companies may also
participate in joint acquisitions with affiliated entities that will acquire
non-operating interests from, or in the same projects in which working
interests are acquired by, the Company. Subject to certain limitations, the
Manager is free to fix the terms of net profits, royalties and other
non-operating interests as they relate to the working interests held by the
Company. As a consequence, conflicts of interest between the Company and the
Manager as managing Investor Interestholder of such other entities may arise.
While certain transactions between the Manager or its affiliates and the
Company may occur on terms no less favorable than those which could be
obtained from independent third parties, possible conflicts of interest may
nevertheless result. See "Proposed Activities" and "Conflicts of Interest."
LIMITATIONS ON LIABILITY OF AND INDEMNIFICATION OF MANAGER AND
AFFILIATES. In order to induce the Manager to manage the business of the
Company, Article 3 of the Company Operating Agreement contains various
provisions that are designed to mitigate possible conflicts of interest (see
"Conflicts of Interest") which may have the effect of restricting the
fiduciary duties that might otherwise be owed by the Manager to the Company
and the holders of Interests or which waive or consent to conduct by the
Manager that might otherwise raise issues as to compliance with fiduciary
duties.
The Act provides that a limited liability company is permitted to
indemnify a Manager against expenses incurred in the defense of an Investor
Interestholder derivative action if the Manager acted in good faith and in a
manner reasonably believed to be in or not opposed to the best interests of
the Company. No indemnification is permitted if the Manager was liable for
negligence or misconduct unless a court orders that under all the
circumstances indemnity is proper. The Company Operating Agreement makes
this indemnification mandatory and extends it to affiliates of the Manager.
Because the Act authorizes but is otherwise silent on additional
indemnification rights, the Company Operating Agreement also provides for
indemnification of the Manager and its affiliates by the Company against
losses and liabilities sustained by them in connection with the Company,
provided that the same were not the result of negligence, a failure to act in
good faith or misconduct on the part of the Manager or its affiliates.
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Notwithstanding the above, and subject to the provisions of the Act, the
Manager and its affiliates and any person acting as a Soliciting Dealer shall
not be indemnified for any losses, liabilities or expenses arising from or
out of an alleged violation of federal or state securities laws unless (1)
there has been a successful adjudication on the merits of each count
involving alleged securities law violations as to the particular indemnitee
and the court approves indemnification of the litigation costs, or (2) such
claims have been dismissed with prejudice on the merits by a court of
competent jurisdiction as to the particular indemnitee and the court approves
indemnification of the litigation costs, or (3) a court of competent
jurisdiction approves a settlement of the claims against a particular
indemnitee and the court finds that indemnification of the settlement and
related costs should be made. Moreover, in any claim for indemnification for
federal or state securities law violations, the party seeking indemnification
shall place before the court the position of the U.S. Securities and Exchange
Commission, the Massachusetts Securities Division and any other applicable
regulatory authority (including, in the case when an Investor Interestholder
has filed the claim as plaintiff, the state in which such Investor
Interestholder was offered or sold Interests) with respect to the issue of
indemnification for securities law violations. It is the position of the
U.S. Securities and Exchange Commission that, to the extent that
indemnification provisions purport to include indemnification for liabilities
arising under the Securities Act of 1933, as amended, such indemnification is
contrary to public policy and, therefore, unenforceable. See "Summary of
Company Operating Agreement."
REMOVAL/SUBSTITUTION OF MANAGER. The Manager may be removed as managing
Interestholder of the Company only for cause by a majority vote of its
Investor Interestholders. In such event, the Investor Interestholders must,
in order to continue that Company, elect a successor managing Interestholder
to prevent a dissolution of the Company. The failure to obtain a suitable
successor managing Investor Interestholder would result in the dissolution of
the Company, with possible adverse investment and tax consequences. The
Company Operating Agreement permits the Manager to transfer its interest and
substitute as Manager (a) another corporation in connection with a merger of
consolidation or a transfer of all or substantially all of the assets of the
Manager under certain circumstances, or (b) a parent or subsidiary of the
Manager. In such event, there is a risk that the substituted managing
Investor Interestholder would operate the Company differently than the
Manager.
LIMITED LIABILITY OF INVESTOR INTERESTHOLDERS. The Company Operating
Agreement and the Act generally provide that the liability of any Investor
Interestholder for the obligations of the Company is limited to (i) his/her
Capital Contributions, (ii) his/her PRO RATA share of the Company's assets,
and (iii) if he/she elects to become a Participating Investor Interestholder
and for so long as he/she remains a Participating Investor Shareholders,
his/her PRO RATA share of Special Obligations, if any. However, if an
Investor Interestholder (whether Participating or Non-Participating) has
received the return of any part of his/her Capital Contribution to such
Company, such Investor Interestholder is generally liable to such Company for
the amount of the returned contribution if he/she knew the distribution was
unlawful. See, particularly, the extensive discussion of such matters under
"Investor Interestholder Limited Liability and Potential Liabilities of
Participating Investor Interestholders."
Further, Investor Interestholders who wish to take full advantage of the
tax benefits available from an investment in the Company and who do not have
sufficient passive income from other sources to enable them to do so
otherwise, may elect to become Participating Investor Interestholders in
order to shift the characterization of their interest in such Company from a
passive to a non-passive activity and thereby eliminate substantial barriers
to the deductibility of certain items allocable to such Investor
Interestholder from such Company against non-passive income. See "Tax
Aspects - Passive Activities." Participating Investor Interestholders,
having contractually obligated themselves to joint and several liability for
the Company's Special Obligations which arise during the period that they are
Participating Investor Interestholders, may be exposed to obligations of such
Company considerably in excess of their initial investment in Interests.
There can be no assurance that (i) events giving rise to Special Obligations
in excess of the amounts anticipated by such Company will not occur, (ii) the
proceeds of insurance carried by the Operators covering such events will be
sufficient to pay such Special Obligations, and (iii) the amount of any such
Special Obligations remaining after application of insurance proceeds will
not exceed the value of the assets of such Company available to pay them.
See "Proposed Activities and Policies - Operating Agreements - Insurance" and
"Liability of Participating Investor Interestholders."
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Participating Investor Interestholders after automatic conversion to
Nonparticipating Investor Interestholder status will generally not be liable
for Special Obligations of the Company of which they are an Investor
Interestholder which arise thereafter. See "Summary of Company Operating
Agreement -Conversion of Participating Investor Interestholders."
DISSOLUTION AND TERMINATION OF COMPANY. A Company will be dissolved and
terminated upon the occurrence of certain events, including the bankruptcy,
insolvency, dissolution or withdrawal of the Manager. The Investor
Interestholders have certain rights to reconstitute the Company under such
circumstances and thereby avoid termination of the Company, although there is
no certainty that the Investor Interestholders could find a new managing
Investor Interestholder to replace the withdrawing Manager in such
circumstances. See "Summary of Company Operating Agreement."
RISKS RELATED TO GAS INVESTMENTS
SPECULATIVE NATURE OF GAS INVESTMENTS. The acquisition, development and
operation of natural gas projects is not an exact science and involves a high
degree of risk. The evaluation of any natural gas development project is
based on available geologic and engineering data with respect to the volume
and accessibility of gas reservoirs in the ground; the extent and quality of
such data may vary widely from case to case. Each acquisition decision is
also based on assumptions concerning, among other things, the price at which
gas can be sold over an extended period in the future, the amount of gas
which can be developed and/or produced and successfully marketed during any
given period, the time value of money, the costs of production and the
inflation rate, the extent of foreign imports of gas, political conditions in
the gas-producing regions of the world, particularly in the Persian Gulf
region, and the price and availability of alternative energy sources. In any
event, the estimation of the quantity of gas reserves in the ground, the cost
and risk of developing those reserves and the projection of future prices and
costs of production of natural gas is impossible to perform with certainty
and is inherently speculative in nature. For example, for a period during
the 1980's, there were surpluses in natural gas supplies which caused a
decline in gas price. Such conditions caused the exercise by some owners of
gas pipelines of "market-out" and similar contract provisions in gas purchase
contracts and the renegotiation of other existing contracts to reduce the
quantities of gas such persons were obligated to purchase and/or the price
they were required to pay.
The drilling and completion of gas wells, installation of production,
collection and distribution Facilities, re-working and operation of gas wells
involve hazards such as unusual or unexpected formations, pressures or other
conditions, blow-outs, fires, failure of equipment, downhole collapses and
operational and other hazards. Furthermore, the Company may be subject to
liability for pollution and other damages and will be subject to statutes and
regulations relating to environmental matters. Although the Operators will
be required to maintain on behalf of the Company insurance coverage as
provided in the respective Operating Agreement which the Manager believes is
normal and customary for the industry in the area and which it feels is
adequate under the circumstances, and the Manager maintains additional
umbrella coverage, the Company may suffer losses due to hazards against which
it cannot insure or against which it may elect not to insure. Any such
uninsured losses will reduce Company capital and/or cash otherwise available
for distributions. See "Proposed Activities and Policies - Insurance."
RISKS OF DRILLING. The Company will participate in the drilling of
development wells on the projects. In addition, during the productive lives
of most gas projects, the reworking of wells will be required as a matter of
normal operating practice to obtain the full potential of the wells. The
Company reserve the right to participate in drilling or reworking activities
on such projects. Drilling for gas is speculative and involves substantial
risks, including the risk of drilling unproductive wells, the risk of
equipment failures and the risk of encountering impenetrable formations,
water encroachments or unexpected pressures and other conditions which could
result in a blowout. Reworking existing wells involves the risk that
production may not be increased and that any increased production will not
compensate the Company for reworking costs. See "Proposed Activities and
Policies."
COMPETITION. Competition for attractive development projects and for
experienced and competent drilling, completion and facilities installation
contractors and other vendors whose services are essential to the success of
a
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development project among other programs having objectives similar to those
of the Company, gas production companies and end-users of gas, many of which
have greater financial and other resources than the Company, is often
intense. This may result in the Company experiencing delays in investing net
proceeds from the sale of Interests or not being able to acquire particular
projects otherwise desired for acquisition, and in Operators experiencing
delays in drilling, completion and production activities and/or not being
able to obtain the services of the contractors which they deem the best for a
particular task with respect to any well or property. See "Competition,
Markets and Regulation."
GOVERNMENTAL REGULATION. The natural gas industry is subject to
extensive regulation under which, among other things, rates of production
from Company wells and distribution of gas produced may be limited.
Governmental regulation also may limit or otherwise affect the market for the
Company's gas production and the price that may be paid for that production.
Governmental regulations relating to environmental matters could also affect
the Company's operations by increasing the costs of drilling, completion and
operations or by requiring the modification of operations in certain areas.
The nature and extent of various regulations, the nature of other political
developments, and their overall effect upon the Company are not predictable.
See "Competition, Markets and Regulation."
OPERATING AND ENVIRONMENTAL HAZARDS. Hazards incident to the operation
of gas projects, such as accidental leakage, are sometimes encountered.
Substantial liabilities to third parties or governmental entities may be
incurred, the payment of which could reduce the funds available for
distribution or result in the loss of the Company's projects. Although it is
anticipated that customary insurance will be obtained, the Company may be
subject to liability for pollution and other damages due to hazards which
cannot be insured against or have not been insured against due to prohibitive
premium costs or for other reasons. Environmental regulatory matters also
could increase the cost of doing business or require the modification of
operations in certain areas. See "Competition, Markets and Regulation."
UNCERTAINTY OF FUTURE PRICES AND DEMAND FOR GAS. Company revenues and,
in turn, cash distributions to Investor Interestholders, will be highly
dependent on the future prices of and demand for gas. Various factors beyond
the control of the Manager will affect prices of gas and natural gas liquids,
including but not limited to, the worldwide supply of gas, political
instability or armed conflict in gas-producing regions, the price of foreign
imports, the levels of consumer demand, the price and availability of
alternative fuels, the availability of and proximity to pipelines, and
changes in existing federal regulation and price controls. Prices for gas
have fluctuated greatly during the past three years and markets for gas and
natural gas liquids continue to be volatile. The currently unsettled energy
markets make it particularly difficult to estimate future prices of gas, and
any assumptions about future prices may prove incorrect. See "Competition,
Markets and Regulation."
Gas markets in the U.S. have been unsettled in recent years due to a
number of factors, including lack of market demand and substantial regulatory
uncertainties. Production from gas wells in many geographic areas of the
U.S. (generally not including the region in which the Company expects to
operate) has been curtailed for considerable periods of time due to a lack of
market demand, and such curtailments may continue in the future. In
addition, there may be an excess supply of gas in areas where wells in which
the Company may acquire working interests are located. In that event, it is
possible that such wells will be shut in or that gas in those areas will be
sold on terms less favorable than might otherwise be obtained. In addition,
under the Natural Gas Wellhead Decontrol Act of 1989, gas prices are
generally decontrolled for wells spudded after July 26, 1989. The
combination of the above and other factors makes it particularly difficult to
estimate accurately future prices of gas sold by the Company, and any
assumptions concerning future prices may prove incorrect. Any such factors,
alone or in combination, that decrease the price of gas will decrease
revenues to the Company, in turn decreasing or eliminating cash
distributions. See "Competition, Markets and Regulation."
TAX-RELATED RISKS
Selected tax-related risks of an investment in Interests are discussed
below; this, however, is not represented to be an exhaustive list of all such
risks. Prospective subscribers for Interests are directed to the more
complete discussion of federal income tax matters relating to an investment
in Interests contained in "Tax Aspects" herein.
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GENERAL. The Manager will not request a ruling from the Service
regarding the federal income taxation of the Company and its Investor
Interestholders. Based upon certain assumptions and other matters, Special
Tax Counsel has rendered its opinion that the material federal income tax
benefits of an investment in Interests, in the aggregate, more likely than
not, will be realized in substantial part by an Investor Interestholder who
is a U.S. citizen, who acquires his/her Interests for profit, and who (i) has
sufficient passive income against which he/she can deduct his/her share of
any Company deductions and losses, or (ii) elects to become (and for so long
as he/she remains) a Participating Investor Interestholder. Such opinion,
and the further opinions of Special Tax Counsel described below and in "Tax
Aspects", are not binding on the Service, however, and there is no assurance
that future legislative, judicial or administrative action will not adversely
affect such opinion. See "Tax Aspects."
PARTNERSHIP CLASSIFICATION FOR TAX PURPOSES. In order for income and
deductions to be passed through to the Investor Interestholders, the Company
must be classified as partnerships for federal income tax purposes. If the
Company were taxed as a corporation for federal income tax purposes, the tax
consequences resulting from the ownership of Interests would be adversely
affected and any anticipated federal income tax benefits would be reduced or
eliminated. Based on certain assumptions and other matters, Special Tax
Counsel is of the opinion that, at the time of its formation, if formed in
conformity with the provisions described herein, the Company will more likely
than not be treated as a partnership for federal income tax purposes and.
subject to certain conditions on redemptions described herein, it is more
likely than not that the Company will not be treated as corporations pursuant
to the "publicly traded partnership" rules of Section 7704 of the Code. See
"Tax Aspects -Classification as a Partnership."
ALLOCATIONS. The Company Operating Agreement provides for the allocation
of all items of Company income, loss, gain, deduction and credit among the
Investor Interestholders. If such allocation provisions are not recognized
for federal income tax purposes (a) a portion of the federal income tax
deductions allocated to and claimed by Investor Interestholders could be
reallocated to the Manager, notwithstanding that the Investor Interestholders
had been charged with the expenditures giving rise to such deductions, and
(b) a portion of taxable income allocated to the Manager could be taxed to
Investor Interestholders and/or the Manager, notwithstanding that the
revenues giving rise to such taxable income had been credited to the Manager.
Based on certain assumptions and other matters, Special Tax Counsel is of
the opinion that the allocation of income, loss, gain, deduction and credit
in the Company Operating Agreement will more likely than not be recognized
for federal income tax purposes. See "Tax Aspects - Allocations."
PREPARATION AND AUDIT OF TAX RETURNS. The transmission of information
concerning the Company and its operations to the Investor Interestholders may
be delayed, requiring Investor Interestholders to file requests for
extensions of time within which to file their personal income tax returns.
In addition, the federal income tax returns of the Company may be audited by
the Service, which could result in an audit of the federal income tax returns
of the Investor Interestholders. Any such audit of the Investor
Interestholders' tax returns could result in adjustments of items not related
to the Company as well as items related to the Company. Investor
Interestholders may also incur expenses in contesting adjustments to the
income tax returns of the Company. See "Tax Aspects - Audits, Interest and
Penalties."
UNRELATED BUSINESS TAXABLE INCOME TO TAX-EXEMPT INVESTORS. Most of the
income to be generated by the Company will constitute income from gas working
interests, which will be unrelated business taxable income to tax-exempt
investors. Tax-exempt investors, including individual retirement accounts
and other employee benefit plans, may become subject to federal income
taxation on their Interests of such income to the extent unrelated business
taxable income from all sources exceeds $1,000 per year. See "Investment by
Pension and Other Retirement Plans."
CHANGES IN FEDERAL INCOME TAX LAWS. There can be no assurance that the
federal income tax treatment currently applicable to gas activities conducted
in business Company form will not be modified by legislative, administrative
or judicial action that may have a retroactive effect. The recently enacted
Taxpayer Relief Act of 1997 ("1997 Act") contains provisions relating to
publicly traded and other large partnerships, such which may have
applicability to the Company. The 1997 Act provides, among other things,
that the depletion deduction be computed and deducted at the partnership
level, rather than passed through to the partner (s.) See "Possible Changes
in Tax Laws."
TAXABLE INCOME WITHOUT CASH. The Company has no obligation to assure
that the Investor Interestholders
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received cash distributions from the Company which equal or exceed the
federal income tax liability which would result from an allocation of taxable
net income and other items of the Company to such Investor Interestholders.
There are any number of foreseeable circumstances which could result in the
Company having taxable income in any year without free cash flow from which
to make distributions to Investor Interestholders. In such event, the
allocations of items of Company income, loss, gain, deduction and credit to
any Investor Interestholder in such year could exceed the amount of cash
distributed by the Company to such Investor Interestholder in such year,
which could require such Investor Interestholder to pay the resulting federal
income tax liability from other assets. There can be no assurance that
circumstances will not occur which may result in Investor Interestholders
being allocated taxable income from the Company which results in an income
tax liability which exceeds, perhaps greatly, the cash distributions to them
from the Company for the same period.
INVESTOR INTERESTHOLDER LIMITED
LIABILITY AND POTENTIAL LIABILITIES OF
PARTICIPATING INVESTOR INTERESTHOLDERS
SUMMARY
Generally, equity participants in a limited liability company such as the
Company enjoy limited liability with respect to the obligations of the
company, i.e., they will not be held personally liable for the obligations of
the company, so long as it is organized and its business is conducted in
accordance with the statutes under which it was formed and the organizational
documents pursuant to which it was created. In such event, participants may
lose all of the assets which they contributed to the company in consideration
of their equity interest, but would not be subject to any further liability
for the obligations of the company. However, in order to enable Investor
Interestholders to enjoy the benefits of the treatment of their investment in
Interests under certain provisions of the Code which are not generally
available to equity participants which have such limited liability, the
Company, in conformity with the Act, has provided Investor Interestholders
with the option to elect to personally assume liability for specific actual
or potential obligations of the Company incurred during the period such
election is in effect. Investor Interestholders who elect to assume such
liability may revoke such election at specified times, but will remain liable
for obligations of the Company incurred during the effectiveness of such
election indefinitely. Simultaneously, however, the Company will enjoy the
benefits of insurance protection provided by (i) the Operators of the
projects in which the Company acquires a working interest, pursuant to
provisions in the operating agreement with respect to such project that will
be required before the Company will acquire such working interest, and (ii)
an affiliate of the Manager, which has acquired and will maintain throughout
the life of the Company, certain policies of insurance covering liability
with respect to any project in which the Manager or its affiliates, including
the Company, has an interest, directly or indirectly. See "Proposed
Activities and Policies - Operating Agreements -Insurance" and "Proposed
Activities and Policies - Insurance."
LIMITED LIABILITY
Assuming compliance with the form of Company Operating Agreement and
applicable formative and qualifying requirements in Michigan and any other
jurisdiction in which the Company conducts its business, an Investor
Interestholder will not be personally liable under Michigan law for any
obligations of such Company, except, with respect to Participating Investor
Interestholders, for Special Obligations, except to the extent of any unpaid
Capital Contributions that he/she agrees to contribute to such Company and
except for indemnification liabilities arising from any misrepresentation
made by an Investor Interestholder. SEE, HOWEVER, "LIABILITIES OF
PARTICIPATING INVESTOR INTERESTHOLDERS."
The liability of an Investor Interestholder for the Company's obligations
is generally expected to be controlled by Michigan law, which is the law
under which the Company will be organized. The Company may not be recognized
as a separate entity under the law of the state of residence of an Investor
Interestholder and the limitations on liability provided for by the form of
Company Operating Agreement and Michigan law might not be recognized under
the law
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of such state. Therefore, it is possible that Investor Interestholders would
not be entitled to any limitation on liability for the Company's obligations
in an action governed by the law of such state.
The Act does not contain any provision imposing liability on an Investor
Interestholder for participation in the control of the Company, although no
Investor Interestholder has any rights to do so except through the rights to
propose and vote on matters described above. The Act does not require an
Investor Interestholder who receives distributions that are made when the
Company is or would be rendered insolvent to return those contributions and
the form of Company Operating Agreement does not so require. It is uncertain
under applicable case law whether an Investor Interestholder would be
required to return such contributions under equitable principles enforced by
courts.
The form of Company Operating Agreement will have been signed by the
Manager prior to the date of admission of any Investor Interestholders and
the Manager will be the initial participant. BY SIGNING THE OMNIBUS
SIGNATURE PAGE AND, THEREBY, THE SUBSCRIPTION AGREEMENT AND THE COMPANY
OPERATING AGREEMENT, AND ENGAGING TO PAY THE PRICE OF INTERESTS, THE INVESTOR
INTERESTHOLDERS BECOME BOUND BY THE PROVISIONS OF THE COMPANY OPERATING
AGREEMENT AT THE TIMES THEIR SUBSCRIPTIONS ARE ACCEPTED BY A COMPANY, EVEN
THOUGH THEY DO NOT SIGN THE COMPANY OPERATING AGREEMENT.
POTENTIAL PERSONAL LIABILITY FOR SPECIAL OBLIGATIONS.
Pursuant to provisions of the Company Operating Agreement and the Act, a
Participating Investor Interestholder will be jointly and severally liable
for the Special Obligations of the Company to which he/she subscribes with
respect to wells for which he/she has assumed liability for Special
Obligations and which arise while he/she is a Participating Investor
Interestholder with respect to such well (i.e., until he/she is automatically
converted from a generally-liable Participating Investor Interestholder to a
Nonparticipating Investor Interestholder with limited liability with respect
to such well); provided, however, that even after a Participating Investor
Interestholder is automatically converted to a Nonparticipating Investor
Interestholder, such former Participating Investor Interestholder may remain
liable for Special Obligations with respect to a well which arose while
he/she was a Participating Investor Interestholder but which are asserted by
third parties after he/she has ceased to be a Participating Investor
Interestholder. Thus, each Participating Investor Interestholder's potential
liability with respect to his/her Interests is not limited to his/her
subscription, but may include the amount, if any, by which the amount of
Special Obligations which arise while he/she is a Participating Investor
Interestholder exceed the assets of the Company available to pay such amount.
Prior to the earlier to occur of (i) one year following completion of the
offering, or (ii) the Facilities Completion Date, Participating Investor
Interestholders will be personally liable for Special Obligations with
respect to all wells in which his/her Company holds a working interest; after
such date, Participating Investor Interestholders will be automatically
converted to Nonparticipating Investor Interestholder status.
INVESTOR PROTECTION.
The Company has taken certain steps to reduce the above-described risks
to the Participating Investor Interestholders, including the following:
INSURANCE - the Operators will be required to maintain insurance
coverage with respect to the wells on the projects in which the Company
holds a working interest with specified coverages and liability limits (see
"Proposed Activities and Policies - Form of Operating Agreements -
Insurance") which will be available to defray such Company's liability for
certain Special Obligations. In addition, the Company will share coverage
under a broad form comprehensive liability insurance policy with other
entities which are affiliated with the Manager. See "Proposed Activities
and Policies - Insurance."
AUTOMATIC CONVERSION TO NONPARTICIPATING INVESTOR INTERESTHOLDER -
each Participating Investor Interestholder will be automatically converted
to Nonparticipating Investor Interestholder status upon the earlier to
occur of (i) one year following the completion of the offering, or (ii) the
Facilities Completion Date
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and generally shall not be liable for Special Obligations of the Company
which arise thereafter (though even after such conversion, such former
Participating Investor Interestholder may remain liable for Special
Obligations which arose while he/she was a Participating Investor
Interestholder but which are asserted by third parties after such person
has converted to Nonparticipating Investor Interestholder status).
These measures may, in specific instances, be effective in reducing the amount
of or even eliminating a Participating Investor Interestholder's personal
liability for Special Obligations. However, there can be no assurance that,
such measures notwithstanding, (i) a Participating Investor Interestholder will
not be held liable for and be required to pay all or some portion of the Special
Obligations of the Company incurred while he/she is a Participating Investor
Interestholder, and (ii) such personal liability will not be significant in
amount.
TERMS OF THE OFFERING
GENERAL
Wolverine Energy, L.L.C., as Manager, is offering to qualified investors
during 1997 and 1998 an aggregate of up to $15,000,000 membership interests
(Interests) in a series of up to ten limited liability companies (the
"Companies") to be formed under the Act, of which the Manager will be the
managing Interestholder, whose subscriptions are accepted will be admitted as
Investor Interestholders in the Company. The Company has not been formed or
commenced operations, has no assets or liabilities and has not been
capitalized. The Company will engage in a program the primary objectives of
which will be to (i) establish gas reserves by participating in the
development, drilling, completion and installation of production, collection
and distribution equipment on development natural gas wells, (ii) make cash
distributions from revenue generated by marketing and sales of gas production
from such wells and sales of such wells.
The minimum subscription for Interests is $5,000, except that for
Individual Retirement Accounts ("IRAs") and Keogh Plans the minimum subscription
is $2,500. For purposes of satisfying the minimum subscription, a "spousal" IRA
and the IRA of the working spouse will be considered a single investor provided
that at least $250 of the combined subscriptions is contributed by the smaller
account. All IRA and employee benefit plan fiduciaries are urged to review
"Investment by Pension and Other Retirement Plans" before investing in the
Company. The Manager, its employees and affiliates, may purchase any number of
Interests, including Interests sufficient to reach the minimum aggregate
subscription for any Company, on the same terms and conditions as other Investor
Interestholders, except that no sales commissions or due diligence fees will be
charged for such purchases. Any Interests purchased by the Manager or its
affiliates will be purchased for investment and not for resale.
SUBSCRIPTION PERIOD
Subscriptions to purchase Interests will only be solicited with respect to
one Company at a time; this Prospectus will be supplemented prior to the
commencement of sales of Interests in the Company. If, at the end of the
subscription period for the Company, subscription funds for less than the
Minimum Amount ($300,000) have been received, such funds, with any interest
earned, will be returned to subscribers within 30 days. In addition, if within
24 months after the admission of the Investor Interestholders to the Company,
that Company has not expended or committed for expenditure an amount equal to
100% of that Company's Investor Interestholders' capital contributions (after
payment of the management fee), the Manager shall distribute, as a return of
capital, to the Investor Interestholders' on a PRO RATA basis the amount of such
unexpended and uncommitted Company funds (together with a proportionate amount
of the management fee), after deducting therefrom an amount that the Manager
reasonably determines will be equal to the Company's necessary operating capital
that will not be provided by anticipated revenues from Company operations. The
phrase "committed for use" shall mean contracted for, actually earmarked for or
allocated by the Manager to property acquisitions. The phrase "necessary
operating capital" shall mean those funds which, in the opinion of the Manager,
should remain available to assure the continuing operations of the Company.
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An investor will become an Investor Interestholder of the Company in
which Interests are being offered at the time his/her subscription is
received and accepted by the Manager. THE MANAGER RESERVES THE ABSOLUTE
RIGHT TO REJECT TENDERED SUBSCRIPTIONS IN WHOLE OR IN PART AT ANY TIME FOR
ANY REASON. Properly completed subscriptions not rejected within 30 days of
receipt will ordinarily be deemed accepted. Sales of Interests in any
Company may be closed at any time if at least the Minimum Amount of
subscriptions have been received and accepted. The minimum and maximum
duration of the offering period and the maximum amount of Interests which may
be sold with respect to any Company will be identified in a Supplement to
this Prospectus prior to the commencement of the offering of Interests in
such Company. The subscription period for Interests in the last Company will
expire no later than on December 31, 1998.
Immediately following the admission of Investor Interestholders to the
Company, the Manager will prepare a Supplement to this Prospectus to reflect the
Investor Interestholder capital contributions to that Company, the maximum
number of Interests available to be offered in the next succeeding Company, if
any, and the final offering termination date for such Company. After the
Company has been activated and funded, no additional Interests in that Company
will be sold. The Manager will furnish to each Investor Interestholder a notice
of admission and a report of the results of the offering of Interests in such
Company within 30 days following the activation of such Company.
SUITABILITY STANDARDS
GENERAL. An investment in Interests involves a high degree of financial
risk and is suitable only for persons of substantial means who have no need for
liquidity in their investment and who can afford to lose all or substantially
all of their investment. The net worth- and income-based standards expressed
herein represent minimum requirements for investors to invest in Interests; THE
MERE SATISFACTION OF SUCH REQUIREMENTS BY A PROSPECTIVE INVESTOR DOES NOT, IN
AND OF ITSELF, MEAN THAT AN INVESTMENT IN INTERESTS IS SUITABLE FOR SUCH
INVESTOR AND DOES NOT MODIFY THE MANAGER'S ABSOLUTE RIGHT TO REJECT
SUBSCRIPTIONS FOR INTERESTS FROM ANY PERSON WITHOUT THE NEED TO PROVIDE ANY
REASON OR JUSTIFICATION THEREFOR. IT IS THE OBLIGATION OF THE SOLICITING
DEALERS TO MAKE EVERY REASONABLE EFFORT TO ASSURE THAT THE INTERESTS ARE
SUITABLE FOR INVESTORS, BASED ON THE INVESTOR'S INVESTMENT OBJECTIVES AND
FINANCIAL SITUATION, REGARDLESS OF THE INVESTOR'S INCOME OR NET WORTH.
MINIMUM SUITABILITY STANDARDS. Generally, each subscriber for Interests
must represent that: (a) he/she has a net worth of $225,000 or more (exclusive
of home, home furnishings and automobiles); or (b) he/she has a net worth of
$60,000 or more (exclusive of home, home furnishings and automobiles) and an
annual "taxable income" as defined in Section 63 of the Code of $60,000 or more;
or (c) he/she is purchasing Interests in a fiduciary capacity for a person or
entity meeting either of the standards in (a) or (b) above; or (d) it is an IRA
or self-directed Keogh Plan, the individual who established the same or the plan
beneficiaries of which, as the case may be, meet(s) the standards in (a) or (b)
above. The net worth standards will be applied to the combined net worth of a
husband and wife purchasing Interests jointly and the income standards will be
applied to their joint or individual tax returns, as the case may be. Other
persons purchasing Interests jointly must make the minimum $5,000 investment
multiplied by the number of joint purchasers and each of such persons must meet
the applicable net worth and income standards without regard to the other joint
purchaser(s). Further, Interests will only be sold to persons who represent in
writing that he/she is the sole and true party in interest and that he/she is
not purchasing for the benefit of any other person (or that he/she is purchasing
for another person who meets all of the conditions set forth herein).
ADDITIONAL REQUIREMENTS. Set forth below are additional requirements that
investors from particular states must also satisfy. In addition, by making an
investment in Interests, an Investor Interestholder represents and warrants that
he/she will not take any action or fail to take any action that would cause any
of their statements, promises or agreements to be false if they were made at a
later time.
California residents generally may not transfer Interests without the
consent of the California Commissioner of Corporations.
Michigan residents are not permitted to make an investment if the dollar
amount of the investment is equal to more that 10% of their net worth.
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The Commissioner of Securities of Missouri classifies the Interests as
being ineligible for any transactional exemption under the Missouri Uniform
Securities Act (Section 409.402(b), RSMo. 1969). Therefore, unless the
Interests are again registered, the offer for sale or resale of Interests by an
Investor Interestholder in Missouri may be subject to the sanctions of such act.
ALL INVESTOR INTERESTHOLDERS. A resident of California who subscribes for
Interests must (i) have a net worth of not less than $250,000 (exclusive of
home, furnishings, and automobiles) and expect to have gross income in the year
of purchase of such Interests of $65,000 or more, or (ii) have net worth of not
less than $500,000 (exclusive of home, furnishings, and automobiles), or (iii)
have net worth of not less than $1,000,000, or (iv) expect to have gross income
in the year of purchase of such Interests of not less than $200,000.
A resident of New Hampshire who subscribes for Interests must have either:
(i) a net worth of not less than $250,000 (exclusive of home, furnishings, and
automobiles), or (ii) have net worth of not less than $125,000 (exclusive of
home, furnishings, and automobiles) and $50,000 of taxable income.
A resident of Michigan or North Carolina who subscribes for Interests must
(i) have a net worth of not less than $225,000 (exclusive of home, furnishings,
and automobiles) or (ii) have a net worth of not less than $60,000 (exclusive of
home, furnishings, and automobiles), and estimated taxable income (as defined in
Section 63 of the Code) in the year of purchase of such Interests of not less
than $60,000 without regard to an investment in the Company.
A resident of Pennsylvania who subscribes for Interests must either (i)
have a net worth of not less than $225,000 (exclusive of home, furnishings, and
automobiles), or (ii) have a net worth of not less than $60,000 (exclusive of
home, furnishings, and automobiles) and taxable income in the year next
preceding the year of purchase of such Interests or expect to have gross income
in the year of purchase of such Interests of not less than $60,000, or (iii) be
purchasing in a fiduciary capacity for a person or entity having such net worth
and/or such taxable income.
INTERESTHOLDERS WHO ELECT TO BECOME PARTICIPATING INTERESTHOLDERS. A
resident of Alabama, Arizona, Arkansas, Indiana, Iowa, Kansas, Kentucky, Maine,
Minnesota, Mississippi, Missouri, North Carolina, Ohio, Oklahoma, Oregon,
Pennsylvania, South Dakota, Texas, Vermont or Wisconsin who subscribes for
Interests and elects to become Participating Investor Interestholders must
represent that he/she: (i) has an individual or joint minimum net worth
(exclusive of home, home furnishings and automobiles) with his/her or her spouse
of $225,000 or more, without regard to the investment in the Company and a
combined minimum gross income of $100,000 ($125,000 for Arizona residents) or
more for the year of purchase of such Interests and for the previous two years;
or (ii) has an individual or joint minimum net worth with his/her or her spouse
in excess of $1,000,000, inclusive of home, home furnishings and automobiles; or
(iii) has an individual or joint minimum net worth with his/her or her spouse in
excess of $500,000 (exclusive of home, furnishings and automobiles); or (iv) has
a combined minimum gross income in excess of $200,000 in the current year and
the two previous years.
A resident of California who subscribes for Interests and elects to become
a Participating Investor Interestholder must (i) have a net worth of not less
than $250,000 (exclusive of home, home furnishings and automobiles) and expect
to have gross income in the year of purchase of such Interests of $120,000 or
more, or (ii) have a net worth of not less than $500,000 (exclusive of home,
home furnishings and automobiles), or (iii) have a net worth of not less than
$1,000,000, or (iv) expect to have gross income in the year of purchase of such
Interests of $200,000 or more.
A resident of Massachusetts who subscribes for Interests and elects to
become a Participating Investor Interestholder must represent that he/she (i)
has a net worth of not less than $225,000 (exclusive of home, home furnishings
and automobiles), and (ii) expect to have in the year of purchase of such
Interests and had for the two preceding years gross income of $120,000 or more.
A resident of Michigan who subscribes for Interests and elects to become a
Participating Investor Interestholder must represent that he/she has a net worth
of not less than $225,000 (exclusive of home, home furnishings and
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automobiles), and had in each of the last two years and expect to have in the
year of purchase of such Interests, "taxable income" as defined in Code
Section 63 of $100,000 or more, without regard to an investment in the
Company.
A resident of New Mexico who subscribes for Interests and elects to become
a Participating Investor Interestholder must represent (i) that the purchase
price of such Interests does not exceed 10% of his/her net worth (exclusive of
home, home furnishings and automobiles), and (ii) had in each of the last two
years and expect to have in the year of purchase of such Interests, gross income
of $120,000 or more.
A resident of Tennessee who subscribes for Interests and elects to become a
Participating Investor Interestholder must represent that he/she(i) has a net
worth of at least $225,000 (exclusive of home, home furnishings and
automobiles), and (ii) had in each of the last two years and expect to have in
the year of purchase of such Interests, taxable income of $100,000 or more.
A resident of Washington who subscribes for Interests and elects to become
a Participating Investor Interestholder must (i) have a net worth, or joint net
worth with that persons spouse, of not less than $1,000,000 at the time of
purchase, or (ii) have an individual income in excess of $200,000, or joint
income with that person's spouse in excess of $500,000, in each of the two years
preceding the year of purchase of such Interests and a reasonable expectation of
reaching the same income level in the current year.
TRANSFEREES. Transferees of Interests seeking to become substituted
Investor Interestholders must also meet the suitability requirements discussed
above, provided that the requirements with respect to net worth and taxable
income may be waived at the Manager's discretion under certain limited
circumstances, including transfers of Interests by an Investor Interestholder to
a dependent or to the Company for the benefit of a dependent or transfers by
will, gift, or by the laws of descent and distribution.
FALSE STATEMENTS BY INVESTORS. If at any time the Manager determines that
any statement, promise or agreement made by an investor to the Manager was false
when made, has been violated, or would be false if made at a later time, or that
an investor is otherwise not qualified to hold interests in federal gas leases,
or otherwise jeopardizes the Company's tax status or the limited liability of
the Investor Interestholders, then the Manager will have the right, but not the
obligation, to purchase the Interests of such investor at a price equal to the
most recent valuation of the Interests determined pursuant to the formula
described in the Company Operating Agreement or, if there has been no
determination under the formula, then at a price equal to 85% of the investor's
net subscription.
SUBSCRIPTION PROCEDURES AND PAYMENTS
Persons desiring to subscribe for Interests should execute and send the
following documents to his/her Soliciting Dealer for transmission to the
Manager:
(a) an executed copy of the Omnibus Signature Page; and
(b) a check payable to "Paragon Bank & Trust, Escrow Agent -
Wolverine 1997-1998" in an amount equal to the purchase price for the
number of Interests to be purchased by that investor.
Pending receipt of subscriptions for the Minimum Amount of Interests in the
Company, all funds collected from investors will be deposited in an
interest-bearing escrow account with Paragon Bank & Trust, Holland, Michigan,
and will be held in escrow by such bank. After subscriptions for at least the
Minimum Amount of Interests have been received and accepted by the Manager, the
Company will be "activated" and the Investor Interestholders' share of
commissions and due diligence fees will be paid from such funds. Commencement
of the Company's operations shall be the time when all of the Company's
investors have been admitted as Investor Interestholders and all subscriptions
(less commissions and due diligence fees) have been transferred from the escrow
account to the Company operating account (i.e., following the Final Closing
date). While on deposit in the escrow account or held by the Company in
temporary investments pending the Final Closing and acquisition of working
interests in projects (i.e., during the
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Temporary Investment Period), all subscription funds will be invested in bank
time deposits, short-term bank certificates of deposit, short-term
governmental obligations, U.S. Treasury bills or bank money market accounts
and similar investments. Any such temporary investment revenues earned on
Investor Interestholders' capital contributions will be allocated solely to
the Investor Interestholders, PRO RATA based upon the period commencing with
the date each investor's subscription and check are received in proper form,
collected and the proceeds invested, and ending with the Final Closing date,
and will be distributed to the Investor Interestholders within 60 days
following the Final Closing date. This investment activity may cease if the
Manager determines that the Company may be deemed to be an investment company
under the Investment Company Act of 1940. Subscription funds received with
respect to any Company will not be commingled with any other funds.
Fully paid subscriptions in proper form will be deemed accepted, subject to
reduction in accordance with the Subscription Agreement, if not rejected within
30 days of receipt by the Manager. If not rejected by the Manager, each
subscriber will become an Investor Interestholder in the Company in which
Interests were being offered at the time he/she subscribed. If a subscription
is rejected, the Subscription Agreement and subscription funds tendered
therewith will be returned to the appropriate subscriber without interest or
deduction for expenses. If subscribers are not admitted to the Company to which
they subscribed before the expiration of the subscription period for Interests
in such Company, all subscription funds will be returned in full, together with
any interest thereon, to such subscribers within 30 days. If, 90 days following
the subscription period, subscription funds of less than the Minimum Amount have
been received, all such subscription funds, with interest earned thereon, will
be returned to subscribers by the Escrow Agent within 14 days.
NO ADDITIONAL ASSESSMENTS
No calls or assessments for funds in addition to an Investor
Interestholder's subscription amount will be made, except with respect to the
liability of Participating Investor Interestholders with respect to Special
Obligations.
TRANSFERS OF INTERESTS
Investor Interests may only be transferred in full accordance with the
terms of the Company Operating Agreement and applicable federal and state
securities laws. Except for gifts and transfers by operation of law, no
transfer of Investor Interests may be made unless (i) the Manager, in its sole
and absolute discretion, consents thereto, (ii) the transferor assigns all of
his/her Interests, or (iii) both the transferor and the transferee will own at
least $5,000 of Interests ($2,500 for IRAs and Keogh Plans) after such transfer,
and (iv) the transferor and/or the transferee reimburse the Company for filing
fees and other expenses of the substitution or addition. The Manager shall
recognize an assignment of Investor Interests as of the first day of the
calendar month following the month in which receipt of notice of such assignment
and any required documentation, including documents providing information
required under the Code such as the name, address and taxpayer identification
number of the transferor, the amount of Investor Interests acquired by the
transferee, the date on which the Investor Interests were acquired and the
transferee's name. The Manager anticipates that it will decline to consent to
any such transfer which would have the effect of causing an involuntary
termination of the Company for federal income tax purposes or could otherwise
adversely affect the status of the Company as a partnership for federal income
tax purposes. In addition, the Manager has the right to refuse to recognize any
transfer of Investor Interests if it believes that such transfer occurred on a
secondary market or the substantial equivalent thereof. See Article 13 of the
Company Operating Agreement.
The transferee of Investor Interests may become a substituted or additional
Investor Interestholder with the consent of the Manager which may be withheld in
its sole discretion, but must reimburse the Company for filing fees and other
expenses of the substitution or addition. While the Manager may withhold such
consent in certain circumstances (e.g., if the Company's tax status as a
partnership for federal income tax purposes would be jeopardized), the economic
benefits of ownership of an Investor Interest may, in general, be transferred or
assigned without regard to whether the Manager has consented unless a transfer
occurred on a secondary market or the substantial equivalent thereof. (See
Article 13 of the Company Operating Agreement).
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THE FOREGOING LIMITATIONS ON THE TRANSFER OF INVESTOR INTERESTS DO NOT
APPLY TO THE MANAGER'S INTERESTS. SUBJECT TO THE REQUIREMENT THAT NO
TRANSFER OF A MANAGER'S INTEREST MAY TAKE PLACE IF TO DO SO WOULD HAVE
THE EFFECT OF CAUSING AN INVOLUNTARY TERMINATION OF THE COMPANY AS A
PARTNERSHIP OR OTHERWISE ADVERSELY AFFECT THE STATUS OF THE COMPANY AS
A PARTNERSHIP FOR FEDERAL INCOME TAX PURPOSES, THE MANAGER MAY WITHOUT
APPROVAL FROM THE INVESTOR INTERESTHOLDERS OR ANY OTHER PERSON SELL,
TRANSFER, PLEDGE OR OTHERWISE ENCUMBER ITS MANAGER'S INTERESTS.
INTEREST REPURCHASE PROGRAM
- Interestholders may tender Interests for repurchase by the Manager on
each of five anniversary dates of the first cash distribution of the
Company beginning with the third such anniversary date (the
"Repurchase Dates")
- Interestholders may, at their election, sell Interests to the Manager
for not less than 36 times the PRO RATA average monthly net operating
income of such Company for the 12 months preceding such purchase
- The Manager is obligated to purchase on each Repurchase Date such
Interests which aggregate up to 10% of the initial subscriptions of
the Company, subject to the compliance of such offer to repurchases
with certain provisions of the Code and interpretations thereof by the
Service, the receipt of opinions of counsel to such effect AND THE
DETERMINATION BY THE MANAGER THAT IT HAS THE FINANCIAL ABILITY TO
EFFECT SUCH REPURCHASES AT THE TIME
Investor Interestholders are required to provide the Manager with written
notification of their intention to avail themselves of the repurchase program.
Subject to the receipt of the opinions of counsel and other conditions described
below, the Manager will offer to repurchase for cash a maximum of 10% of the
Interests originally subscribed for on each Repurchase Date. The Manager's
offers to purchase Interests will, however, be conditioned on the receipt of an
opinion of its counsel that the consummation of such offer will not cause the
Company to be treated as a "publicly traded partnership" for purposes of Code
Sections 469 and 7704 and on its determination that the repurchases of a
particular Investor Interestholder's Interests will not result in the
termination of the Company for federal income tax purposes. Further, the
obligation of the Manager to offer to repurchase Interests on the terms
described herein is also conditioned on the determination of the Manager that it
has such assets, net worth and liquidity to repurchase such Interests at the
time that they are tendered to it without materially adversely affecting its
financial condition, in its sole opinion.
The Manager will not favor one of the Companies over the others in the
offer to repurchase Interests. Such offer will be extended equally to all
Interestholders participating in each of the Companies. Notwithstanding the
foregoing, if more than 10% of the Interests in the Company or more Interests
than the Manager is able to purchase are tendered on any Repurchase Date,
Interests will be purchased on a "first-come, first-served" basis on such
Repurchase Date determined according to the date of receipt by the Manager of a
letter of acceptance of the repurchase offer from the Investor Interestholder.
The Manager may be unable to repurchase all Interests tendered, due to
limitations imposed by the Code or loan or banking agreement(s) to which the
Manager may be a party or because such offer to repurchase would cause the
Manager to have acquired more than 10% of the Interests in the Company on a
Repurchase Date, or because it has determined that its financial condition at
the time that such Interests are tendered for repurchase would preclude such
repurchases.
The process leading to the purchase by the Manager of an Investor
Interestholder's Interests will be initiated by the provision by such Investor
Interestholder to the Manager of written notice of his/her intention to have
his/her interests purchased by the Manager. The Manager will determine a
purchase price for Investor Interestholder Interests with respect to each
Repurchase Date. The Manager will provide each electing Investor Interestholder
a written offer of the established price for purchase of the specific Interests
within 30 days of the Manager's receipt of the written notification. The
Manager will keep such offer open for 30 days after the mailing of such offer to
the Investor Interestholder. Upon notification of the repurchase price
established by the Manager, the Investor Interestholder, if
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he/she elects to accept such repurchase price, must notify the Manager in
writing that such price is acceptable. The Manager will promptly mail the
Investor Interestholder a check for the proceeds of the purchase.
The minimum offer which the Manager may make, if it determines that its
financial condition is adequate to allow it to purchase any Interests tendered
for repurchase, will be a cash amount equal to not less than 36 times the PRO
RATA average monthly production sales of the Company for the 12 months ending on
the Repurchase Date in respect of which the Manager has received the written
notification referred to above. The Manager may, in it's sole and absolute
discretion, increase the offer for Interests tendered for sale.
The price for repurchase of Interests established by the Manager may not
represent the fair market value of such Interests. In setting the offering
price, the Manager will consider its desire to acquire production as represented
by the Interests and will take into account what it perceives to be its own best
interests and the interests of its equity owners. Nevertheless, each Investor
Interestholder is free to accept or not to accept any offering price from the
Manager; no Investor Interestholder is in any way obligated to accept the
Manager's offer. The Manager will also provide each Interestholder with a
calculation of the valuation of his/her Interests, based on the most recent
reserve evaluation prepared by an independent expert in accordance with SEC
Regulation S-X, Article 4, Rule 4-10. This calculation will take into account
the Manager's best estimate of anticipated production declines or increases,
known price increases or decreases, operating, recompletion and plugging costs,
and other relevant factors. Further, the Manager undertakes to comply in all
respects with Rule 14e-1 of the Commission in respect of all purchases of
Interests by it in respect of the Interest Repurchase Program.
PLAN OF DISTRIBUTION
SELLING ARRANGEMENTS; COMMISSIONS; DUE DILIGENCE FEES
TYPE OF DISTRIBUTION; CURRENT COMPENSATION. Subscriptions for Interests
will be solicited on a "best efforts" basis by Soliciting Dealers that are
members in good standing of the National Association of Securities Dealers,
Inc. (NASD), and the offering will be conducted in compliance with the Rules
of Fair Practice adopted by the NASD. Each Soliciting Dealer will receive
sales commissions from the Manager equal to (i) 8.0% of the purchase price
for Interests sold by that Soliciting Dealer at the time that the
subscription for such Interests is received and accepted by the Company
("Current Compensation"), plus (ii) the right to receive additional
contingent compensation, described below. Current Compensation of less than
8.0% of the purchase price for Interests may, in the discretion of the
Manager, be paid on large subscriptions by a single investor. No commissions
or due diligence fees will be paid on purchases (i) by the Manager or its
affiliates, or (ii) effected through the Manager or its affiliates and not
involving any Soliciting Dealer. In addition, Soliciting Dealers will be
entitled to due diligence fees payable by the Manager of up to 1.0% of the
purchase price of such Interests.
CONTINGENT COMPENSATION. Additional sales commissions of up to 4.5% of
Residual Operating Cash Flow ("Contingent Compensation"), may be paid to the
Soliciting Dealers as a reduction of the Manager's share of distributions of
Net Cash Flow in subsequent years if the Company generates sufficient cash
flow from operations to make such payments, as described below. However, the
payment of Contingent Compensation is subject to the limitations described
under "Limitations on Payment of Contingent Compensation" below.
Soliciting Dealers may receive Contingent Compensation in the form of
payments of a portion of Company profits, computed as a percentage of
Residual Operating Cash Flow. As a condition to the payment of such
Contingent Compensation, (i) the Interestholders must have received cash
distributions from the Company equal, in the aggregate, to 100% of their
initial subscription amount plus a 6% cumulative annual preferred return on
such initial subscription amount, and (ii) the amount of Contingent
Compensation cannot in any event exceed 12% in the aggregate of each
distribution. Soliciting Dealers can earn the right to receive Contingent
Compensation through the sales of specified
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minimum numbers of Interests in the Company pursuant to the schedule provided
below:
Amount of Interests Sold Contingent Compensation
In excess of $75,000, 1.5%
but less than $150,000
In excess of $150,000, 3.0%
but less than $225,000
In excess of $225,000 4.5%
LIMITATIONS ON PAYMENT OF CONTINGENT COMPENSATION. Contingent
Compensation may be paid, subject to the limitations described above, only
from Residual Operating Cash Flow for the period concerned. Residual
Operating Cash Flow shall consist of revenues from sales of production
reduced by operating expenses charged by the Operator to the Company's
working interest, the Administrative Cost Allowance for such period and the
establishment or increase of such cash reserves as the Manager shall deem
prudent for the Company to maintain under the circumstances.
ADDITIONAL CONDITIONS OF SUBSCRIPTIONS. All subscriptions solicited from
either (i) a husband and wife purchasing Interests for their own accounts, or
(ii) more than one plan, Company, fund or foundation established by a given
corporation or other entity, or (iii) clients of a single fiduciary or other
organization that serves clients on the basis of scheduled fees for
investment advice (such as a registered investment advisor with respect to
his/her clients or a bank or trust company with respect to funds maintained,
managed or advised by it) who purchase Interests upon the recommendation of
such fiduciary or other organization, shall be deemed to be a single
subscription for the purpose of determining eligibility for reduced
commissions, provided the aggregate amount of Interests in a single Company
so purchased exceeds $500,000. A corporation, partnership or other entity
shall also be counted singly unless such entity was organized for the
specific purpose of acquiring Interests, in which event each beneficial owner
of interests in the entity shall be counted as a subscriber.
The Company will be charged with the sales commissions paid by it to a
Soliciting Dealer with respect to Interests subscribed for by Investor
Interestholders and will reallocate the amount of the sales commissions to
the Investor Interestholder in respect of which such sales commission was
paid. Therefore, Investor Interestholders that are charged reduced
commissions or due diligence fees will be credited with proportionately
larger net subscriptions and will have relatively greater interests in the
capital and revenues of the Company than Investor Interestholders who pay
commissions and due diligence fees at a higher rate.
Commissions and due diligence fees will be paid by the Company following
the activation/admission of investors. However, after the minimum
subscription amount has been raised through BONA FIDE transactions with
respect to the Company and prior to the activation of the Company, the
Manager or an affiliate thereof may advance funds on a bi-monthly basis to
pay commissions and due diligence fees to Soliciting Dealers. Such advances,
if any, in excess of the commissions payable by the Company will be
reimbursed from the proceeds of the Investor Interestholders' capital
contributions upon the Company's activation. The total of all current
compensation paid to Soliciting Dealers in connection with the distribution
of Interests by the Company will not exceed, in the aggregate, 10% of
subscriptions (i.e., aggregate offering proceeds) in accordance with Appendix
F to the Rules of Fair Practice of the NASD.
EARLY SUBSCRIPTION INCENTIVE
Investors who subscribe for the first 300 Interests ($300,000) of any
Company (unless increased by the Manager in its sole discretion) and whose
subscriptions are received and accepted by the Manager within 90 days of the
commencement of the offering of Interests by the Company, shall qualify to
receive the Early Subscription Incentive. The Early Subscription Incentive
will consist of the rebate to such investors of an amount equal to 5.0% of
the amount of their subscription for Interests without reducing the number of
Interests acquired by them through their subscription.
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The Early Subscription Incentive will be paid by the Company to such
investors within 90 days of the completion of the offering of Interests by
the Company. The Early Subscription Incentive will be paid for by the Company
with funds obtained from reductions in the amount of the Turnkey Price paid
by the Company to the Manager.
INDEMNIFICATION
Each Soliciting Dealer may be deemed to be an "underwriter" within the
meaning of Section 2(11) of the Securities Act of 1933, as amended (the
"Securities Act"). The Manager and the Company will indemnify each
Soliciting Dealer, under certain circumstances, against certain civil
liabilities, including liabilities arising under the Securities Act.
SALES MATERIAL
The Soliciting Dealers may utilize sales material in addition to this
Prospectus, as Supplemented from time to time, in connection with the
offering of Interests. This sales material may consist of a sales brochure,
corporate reports and copies of published articles about the Manager or its
affiliates or excerpts therefrom, literature relating to the gas industry
generally, summary descriptions of other gas programs of which the Manager or
its affiliates is the sponsor or manager and information on distributions
from affiliated limited partnerships, slide, audio/videotape, computer
diskette and flipchart presentations, copies of published articles,
information regarding investments by IRAs and other general information. The
Manager has not authorized the use of other sales material, and the offering
of Interests is made only by means of this Prospectus, as Supplemented from
time to time. When used, sales material must be preceded or accompanied by
this Prospectus, as Supplemented from time to time. Although the information
contained in the sales material does not conflict with any of the information
set forth herein, such material does not purport to be complete. Sales
material should not be considered a part of or incorporated in this
Prospectus or the Registration Statement of which this Prospectus is a part
even though it has been submitted to the U.S. Securities and Exchange
Commission.
THE MANAGER'S INTERESTS
The Manager's Interests consist of the number of Interests which
corresponds to the Manager's share of revenues, expenses and Net Cash Flow
from Operations of the Company, i.e., that number of Interests which
corresponds to the sum of the Manager's Promoted Interest and the Manager's
Investment Interest. The Manager has agreed to subordinate the distribution
of (i) 100% of the Net Cash Flow from Operations otherwise distributable to
it with respect to the Manager's Promoted Interest, and (ii) UP TO 100% of
the Net Cash Flow from Operations otherwise distributable to it with respect
to the Manager's Investment Interest to the extent necessary to cause the
Investors, including the Manger with respect to the Manager's Investment
Interest, to reach Payout if, after 60 months following the first
distribution of Net Cash Flow from Operations, the Investor Interestholders
have not received distributions of Net Cash Flow from Operations which, in
the aggregate, are equal to 100% of the Investor Interestholders'
subscriptions. Any such deferral of cash distributions to the Manager will
be recovered by the Manager from first available Net Cash Flow from
Operations after the Investor Interestholders have received distributions of
Net Cash Flow from Operations which, in the aggregate, are equal to 100% of
the Investor Interestholders' subscriptions, until such deferrals have been
recovered. See "Proposed Activities and Policies - Cash Distributions -
Subordination of Cash Distributions to Manager," "Participation in Costs and
Revenues - Allocation of Tax Items" and "Compensation and Reimbursement -
Interest in Projects - Manager."
PROPOSED ACTIVITIES AND POLICIES
SUMMARY
The Company will be formed to acquire working interests in natural gas well
development projects in the Primary Area and, possibly, other areas of the
continental United States. The projects in which such Company will
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invest will not be identified at the time that a prospective investor
subscribes for Interests. Net funds available to the Company will be used to
acquire working interests in projects which (i) meet the criteria for
acquisition which have been established by the Manager, and (ii) the Manager
identifies subsequent to the commencement of the offering of Interests in
such Company.
The Company will acquire working interests in individual gas projects to
be drilled. Projects will be evaluated by the Manager on behalf of the
Company on the basis of its estimated long-term (e.g., 20 year) production
potential, with the intent that a purchaser in the position of the Company
could recover its investment and earn a reasonable profit from the sale of
natural gas alone over such term. This policy is intended to assure that the
projects in which the Company hold working interests will (i) provide a
predictable and sustainable revenue stream to the Company from sales of gas
produced during the Company' expected lives, and (ii) have substantial and
ascertainable values, based upon the remaining expected productive life of
such projects, when the Company seeks to liquidate its working interests in
such projects in order to comply with the Company' finite-life investment
policy. The Company will seek to liquidate its assets and distribute the
proceeds thereof to the Investor Interestholders beginning after the seventh
full year following the first distribution of Net Cash Flow from Operations
and to complete such liquidation prior to the end of the tenth full year
following the first distribution of Net Cash Flow from Operations. See
"Liquidation Policy" below. The Company may sell or exchange its working
interests in projects earlier or later than its initial investment policy
envisions, however, if price or other circumstances so warrant.
The Company will acquire percentage working interests in natural gas
projects (incorporating multiple wells) to be developed by the Operators on
development prospects. Through its ownership of a portion of the working
interest such projects and thereby indirectly in the individual wells which
comprise such projects, the Company will participate in the development,
drilling and completion of such wells and in the construction and
installation of production, collection, distribution and other necessary
support Facilities which will link wells in which it has such an interest to
a natural gas pipeline which will transport the gas produced from such wells
to commercial customers.
The Company will acquire working interests in natural gas development
projects from the Manager, which will have acquired such working interests
from one or more unaffiliated owners, usually in contemplation of conveying
such working interests to such Company. The Company will pay a fixed
"turnkey" price to the Manager to pre-pay its PRO RATA share of the costs of
(i) development, drilling and completion of the net wells in such projects
acquired by the Company through Completion, and (ii) the post-Completion
Facilities with respect to such net wells which are identified in the
applicable AFE with respect to such wells. Generally, the Turnkey Cost will
reflect market prices for turnkey development, drilling, completion and
post-Completion Facilities commitments prevailing in the market among
non-affiliated parties and will be based upon the PRO RATA portion of the
estimated total for development, drilling, completion and post-Completion
Facilities costs as determined by the Operator of such property attributable
to the net wells acquired by the Company. The Turnkey Cost for each project
will be established by the Manager at the time it determines that the Company
will acquire a working interest in such project and will be established in
accordance with the general rule described above. See, however, "Conflicts
of Interest - Management of Other Entities."
The Manager cannot identify any projects in which working interests will
be acquired by the Company because (i) the Company will not be formed or
acquire working interests in any projects until after the offering of
Interests has been completed, and (ii) the amount of capital that will be
raised by the Company cannot be predicted. Decisions as to the projects in
which working interests will be acquired by the Company and the time, manner
and terms upon which they will be disposed of will be made by the Manager in
the best interests of the Company.
ACQUISITION OF PROJECTS
GENERAL POLICIES. At the time that a prospective investor subscribes for
interests in the Company the Manager will not have identified any projects in
which working interests will be acquired by such Company. However, the
Manager is continuously conducting and/or commissioning studies and
investigations of available natural gas development projects and the
respective Operators of such projects, working interests in some or all of
which may be acquired by the Company or by other programs sponsored by
affiliates of the Manager. In determining whether a
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working interest in any particular property is to be acquired, and the price
to be paid, the Manager will consider such criteria as estimated reserves,
estimated cash flow from the sale of production, present and estimated future
prices of gas, the availability of markets for the gas that may be produced
and the identity and experience of the Operator of such projects. The Manager
will also consider the likely costs and risks inherent in drilling wells on
such projects as evidenced by the historical experience of Operators of wells
on adjacent parcels, and the availability and cost of the equipment, labor
and services which must be paid for to drill, complete and install
production, collection and distribution facilities at the wells and connect
the wells to a gathering system. The Manager may also consider the potential
for increased production from a property under consideration through the
application of leading-edge recovery methods (e.g., horizontal drilling or
the application of progressive cavity pumps to increase the recovery of
reserves) and the intent and plans of the Operator to employ such
technologies. In all cases, the Manager will evaluate the record of the
Operator of the property and of the drilling, completion and any other
contractors whose services will be engaged to conduct activities thereon.
The Manager may also utilize evaluations by affiliates of the Manager and/or
independent geologists and engineers of estimated reserves and projected
rates of production attributable to such property.
Projections of net revenues obtainable from estimated reserves and the
present value of such projected net revenues, which will influence the
maximum price which the Manager will decide to pay for a working interest in
a property, will be based on such assumptions as to natural gas prices and
such discount factors as the Manager deems appropriate from time to time in
light of the current economic circumstances, conditions and trends within the
natural gas industry and the varying degrees of risk of non-recovery
attendant to various categories of natural gas reserves. Interests in
projects will be acquired from third parties and, subject to the restrictions
set forth in the Company Operating Agreement, from the Manager or affiliates
thereof.
OVERRIDING ROYALTY TO THE MANAGER. The Manager will retain a 2%
overriding royalty interest in each property from the working interest in
such property which it assigns to the Company; provided, however, that the
working interest, as a whole, in such property exceeds 75% of the entire net
revenue interest of such property. To the extent that the Manager retains
and does not re-assign this retained overriding royalty interest in a
property, it will be entitled to a 2% share in the revenues of such property
attributable to the entire leasehold interest (i.e., prior to payment of the
landowner and other overriding royalties) in such project, including the
portion of the working interest not held by the Company, without being
required to contribute a proportional amount of all capital required to
develop and operate wells on such property. The Manager anticipates that the
primary benefit to it of the retained overriding royalty interest in projects
assigned by it to the Company will be to permit it to re-assign portions of
the working interest as additional compensation to persons, who or which may
include affiliates of the Manager, who or which provide services or expertise
or make working capital loans to the Manager, primarily to enable it to
acquire leasehold and other assets for future development. See "Compensation
and Reimbursement."
ACQUISITIONS FROM AFFILIATES OF MANAGER. All acquisitions of Projects by
the Company in the Program will be made from the Manager or an affiliate of
the Manager. Such projects will have been acquired by the Manager primarily
for subsequent transfer to the Company and will be acquired at a price and on
terms which are consistent with those described in "Proposed Activities -
Acquisition of Projects" and " -Turnkey Agreement" herein. The Manager will
not realize a profit on the sale of working interests in projects to the
Company except to the extent that the Turnkey Cost exceeds the actual costs
to develop, drill and complete and install identified post-Completion
Facilities on the wells on such Project in which the Company acquires a
working interest. See " Compensation and Reimbursement - Potential Profit
on Turnkey Agreement."
OPERATORS; OPERATING AGREEMENTS. All projects in which the Company
acquire working interests will have at least one operator who or which is not
affiliated with the Manager. In no event will the Manager or any of its
affiliates organize gas development projects of which it is the sole operator
in which the Company will acquire a working interest. The Manager may,
however, participate in individual projects as a co-operator with an
unaffiliated Operator, and the Company may acquire working interests in net
wells in such projects. The Manager will utilize its experience and stature
in the natural gas development community to obtain working interests in
projects with which it is already familiar and/or about which it is able to
gather significant information from sources other than the Operator of the
property or seller of the working interest, obtain independent verification
and/or analysis of such property from experts in
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engineering and geology and, if necessary or advisable, make on-site visits
to such property and to the offices of the Operator. The Company will only
acquire working interests in projects with respect to which the Operator is
of demonstrably high expertise and repute. The Manager will examine the
operating agreements with respect to such projects closely and will not cause
the Company to acquire a working interest in such a property unless it
provides, among other things, that no additional development drilling,
re-working, recompleting, deepening or sidetracking of existing wells or
installation of any secondary, tertiary or other enhanced recovery methods on
the property may be undertaken without the approval of a majority in interest
of the owners of the working interest of the property.
DIVERSIFICATION. The Manager will generally try to diversify the
Company's investments by investing in projects consisting of more than one
lease and more than one field in an attempt to balance investments between
those deemed more likely to have high rates of production, albeit at a higher
cost to drill and complete the wells on such project, and those likely to
have lower though more constant, rates of production, and lower drilling and
development costs. The Manager may, however, elect to invest all or a major
portion of the Company's capital in a single acquisition if it believes it to
be in the best interests of the Company to do so. Such an acquisition would,
nevertheless, be required to include a diversified group of individual
projects. The Manager's ability to diversify Company acquisitions depends,
to a large extent, on the amount of capital the Company has available.
Efforts will be made to complete acquisitions as soon after commencement of
Company operations as sound business practice permits. While the Manager
expects that from 3 to 9 months may be required for this purpose,
difficulties may be encountered in identifying, selecting and acquiring
working interests in projects, necessitating a longer period.
TYPES OF INTERESTS TO BE ACQUIRED. The Company will only acquire working
interests in the projects in which it invests. The Company may not purchase
any other type of interest in a project, including a non-operating interest
such as a royalty interest, overriding royalty interest or production
payment. The drilling, completion and other contractors, if any, with
respect to the projects will, in all events, not be an affiliate of the
Manager, although the terms on which the Company acquires its working
interest in a property may provide that the Manager, as managing
Interestholder of the Company, may, under specified circumstances, discharge
the existing Operator and take over operation of the property in order to
preserve the value of the Company's investment therein until a substitute
Operator can be obtained. A Company may not purchase equity securities of
any kind, including equity securities of issuers which hold interests in
projects which would otherwise be suitable for investment by the Company.
PRIMARY AREA. The Company will acquire working interests in projects
located primarily within the known or highly-likely extent of the Devonian
shale of the Michigan Central Basin. The portion of this formation located
in northern lower Michigan is commonly referred to as the Antrim shale
because it outcrops in western Antrim County and extends through all or
portions of Alcona, Antrim, Charlevoix, Crawford, Kalkaska, Montmorency,
Otsego and Oscoda Counties in Michigan. Another portion of this Devonian
shale formation is under development as well in southwestern lower Michigan,
northeastern Indiana and northwestern Ohio. The Manager has participated in
the development of gas wells in the Antrim shale formation in the Primary
Area and believes that it will be able to obtain for the Company working
interests in projects in the Antrim formation and elsewhere in the Primary
Area which have a high potential to produce gas in commercial quantities.
However, the Manager may, if circumstances warrant, acquire working interests
in natural gas development projects which are not within the Primary Area,
but which provide a reasonable basis for developing natural gas reserves
which is comparable with or favorable when compared to the available
opportunities to acquire like working interests within the Primary Area and
which have other likely advantages, e.g., earlier revenues from production of
gas. The Company will acquire working interests in areas other than the
Primary Area only if, in the opinion of the Manager, it would be in the best
interests of the Company to do so. Information with respect to the
experience of affiliates of the Managers is provided under the captions
"Management" and "Prior Activities" herein.
OPERATING POLICIES
BASIC OPERATING POLICIES. The Company will acquire working interests in
projects as non-operating working interest holders and, except under
extraordinary circumstances, will not engage in significant activities in
connection with drilling, completion, installation of production, collection
or distribution Facilities on or the day-to-day operations
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of wells thereon. The Manager or its affiliates will, however, on behalf of
the Company and in co-operation with the Operators of each property, devise a
development program with respect to such property which will determine the
number of wells to be drilled, the techniques to be used in drilling,
completing and installing collection, production and distribution Facilities
and equipment on such wells. Additional drilling activities may be conducted
by the Operators of such projects, however, as an incidental part of the
management of such projects after they have been placed in production or with
a view toward enhancing the value of the property. For example, some
projects in which a working interest is acquired by the Company may, after
they have been in production for a period of time, require or could benefit
from additional development or remedial work, such as the drilling of
additional development wells or the re-working, recompleting, deepening or
sidetracking of existing wells or the installation of one of several
secondary, tertiary or other enhanced recovery methods. The intended effect
of such efforts would be to increase production volume from a property,
either from the existing or new wells or both, at a cost in capital
investment and production downtime that was justified in light of the
increased revenues from the greater levels of production and produced an
acceptable rate of return on the capital and lost revenues so invested. The
Manager reserves the right to approve the conduct of such operations by the
Operator of a property in which the Company holds a working interest on
behalf of the Company. However, the Company's share of any such operations
will be paid from funds borrowed in accordance with the Program's borrowing
policies as described in "Financing" herein, and the Company will not make
calls for additional capital contributions from Investor Interestholders in
order to participate in such activities.
Decisions as to the management of the Company and its assets and the
time, manner and terms upon which it will dispose of its working interest in
any property, will be made by the Manager based upon its judgment at the time
and in the best interests of the respective Company, subject to the primacy
of the Operator with respect to the operation of any property and the sale of
production therefrom.
FACILITIES DEVELOPMENT. After the Completion of each well, the
respective Operator will determine which Facilities should be constructed on
the well or for its benefit to enable the gas produced therefrom to be
transmitted to a commercial purchaser. Unlike decisions with respect to the
drilling and completion of a well, which are made well in advance of the
purchase of a working interest in such well by the Company and which are
usually not subject to substantial changes or exercises of discretion by the
Operator after drilling has begun, decisions with respect to the type of
Facilities to equip a well with and whether to purchase or lease such
Facilities, alone or with others, are driven by economic (especially
including gas prices and equipment costs) and technological factors which
change rapidly and dynamically with respect to each other. The Operator has
the authority and responsibility to determine what Facilities should be
employed and whether such Facilities should be constructed or acquired
directly by the owners of the working interest in the well (including the
Operator and the Company) either alone or in conjunction with the working
interest owners of adjacent wells for their mutual benefit, or leased from
other owners of working interests in adjacent wells (including the Operator),
or if the use of such Facilities should be contracted for on a
fee-for-service basis from the owners of working interests in adjacent wells
(including the Operator). The prototype Operating Agreement confers
contractual authority with respect to all such matters on the Operator and
requires it to take action with respect to such matters. In addition, the
Operator will hire and supervise the contractors engaged to conduct drilling
and completion activities and install production, collection and distribution
Facilities and operate the wells. All decisions regarding the appropriate
arrangements to make with respect to Facilities for each well will be made in
the best interests of the working interest owners of the well, including the
respective Operator and the respective Company, based upon the production
potential of the well, the costs of various alternative Facilities and the
likely effect of the choice of each on the level of production from the well,
the availability of Facilities owned by other working interest owners that
could be utilized at such well and the terms of any lease of fee-for-service
(e.g., transportation, compression, CO2 removal) arrangements available from
such other owners, including the Operator.
The respective Operator of any property will retain the discretion to
cause the working interest owners of such property to install whatever
Facilities it deems in the best interests of the owners of the working
interest in such property. Furthermore, such decisions may include borrowing
funds and pledging such property as collateral therefor to acquire and
install such Facilities. THE OPERATORS, WHICH MAY IN CERTAIN INSTANCES
INCLUDE THE MANAGER OR AN AFFILIATE OF THE MANAGER AS A CO-OPERATOR, WILL
HAVE AUTHORITY TO MAKE ALL SUCH DECISIONS WITH RESPECT TO THE CHOICE OF
FACILITIES WITH RESPECT TO THE WELLS IN WHICH THE COMPANY OWN A WORKING
INTEREST AND THE MEANS OF PAYMENT
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THEREFOR OR FOR THE USE THEREOF. THE PROTOTYPE OPERATING AGREEMENT CONFERS
CONTRACTUAL AUTHORITY WITH RESPECT TO ALL SUCH MATTERS ON THE OPERATOR AND
REQUIRES IT TO TAKE ACTION WITH RESPECT TO SUCH MATTERS. ALL SUCH
EXPENDITURES, WHETHER FOR ACQUISITION OR CONSTRUCTION OR LEASE OF FACILITIES
OR FEES FOR THE USE OF FACILITIES, AND REGARDLESS OF WHETHER SUCH AMOUNTS
REQUIRE THE RESPECTIVE COMPANY TO BORROW FUNDS THEREFOR, WILL CONSTITUTE
SPECIAL OBLIGATIONS FOR WHICH PARTICIPATING INVESTOR INTERESTHOLDERS WILL BE
PERSONALLY LIABLE.
ADDITIONAL DEVELOPMENT. Undeveloped acreage or additional wells on the
projects in which the Company owns a working interest may become drillable
because of changes in legal restrictions relating to the spacing of wells and
may be sold or otherwise disposed of or drilled by the respective Operator,
or, in certain limited instances, farmed out, subject to the restrictions
described below. Therefore, the Manager reserves the right, on behalf of the
Company, to approve the development of these undeveloped leasehold interests
and horizons if geological information and the anticipated costs of such
development makes the drilling of a development well advisable, and to borrow
funds and/or reinvest Company capital otherwise available for distribution to
Investor Interestholders to fund the Company's participation in such
activities. Alternatively, undeveloped acreage or additional wells which may
be drilled because of changes in legal restrictions relating to the spacing
of wells may be sold or otherwise disposed of, or farmed out. A Company will
not acquire a working interest in a property for the sole purpose of its
subsequent sale or farmout.
The Operator of a property may determine that the optimal operation of
one or more of the wells which constitute such project indicates that
attempts to increase the gas production of the property through horizontal
drilling, additional development or remedial work, such as the drilling of
additional development wells, re-working, recompletion, deepening or
sidetracking of existing wells or the installation of one of several
secondary, tertiary or other enhanced recovery methods should be undertaken.
The intended effect of such efforts would be to increase production volume
from a property in which such Company owns a working interest, either from
the existing or new wells or both, at a cost in capital investment and
production curtailment that was justified in light of the increased revenues
from the greater levels of production and produced an acceptable rate of
return on the capital and lost revenues so invested. The Manager reserves
the right to approve the conduct of such operations by the Operators on
behalf of Company.
ASSOCIATED ASSETS. In connection with its acquisition of working
interests in projects, the Company may also participate, as a holder of a
working interest in a property, in the acquisition of well machinery and
equipment, gathering and/or storage facilities, processing, refining or other
plants and other assets downstream from the wellhead related to such property
or the processing, refining or marketing of gas products. This will be done
only if, in the Manager's judgment, the economic effect of any such
acquisition can reasonably be expected to be substantially the same as the
acquisition of working interests in the projects or products themselves or if
the acquisition increases the value of its working interests in any
associated projects or products. A Company may participate in a transaction
of the sort described in this paragraph even if different risks from those
customarily associated with the purchase and operation of working interests
in producing projects are presented.
FARMOUTS. A Company will not participate in the farming out of a
property unless the Manager, exercising the standard of a prudent Operator,
determines that (i) the Company, in conjunction with the owners of the
balance of the working interest in such property, lacks sufficient funds to
drill a well or wells on a property and cannot obtain suitable alternative
financing for such purposes, or (ii) the property has been downgraded by
events occurring after the acquisition by the Company of a working interest
in such property, (iii) drilling activities on the property would result in
an excessive concentration of Company funds and would create undue risks to
the Company, or (iv) the best interests of the Company would be served by the
farmout. The Manager will approve a farm out of a property only if it and
the other working interest holders will retain such economic interests and
concessions as a reasonably prudent Operator could obtain under the
circumstances.
TURNKEY AGREEMENT
The Company will acquire working interests in individual wells on
development projects from the Manager, which will have previously acquired
working interests in such wells directly from a Beneficial Owner (which may
be an affiliate of the Manager) pursuant to an Operating Agreement. The
terms of the arrangement pursuant to which the
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Company will acquire working interests in projects from the Manager are
incorporated into an agreement (the "Turnkey Agreement") having the following
terms and considerations, among others:
(i) the Company will have the right to acquire working interests in
individual wells from the Manager, which will have acquired such working
interests from one or more Beneficial Holders, which may include affiliates
of the Manager, usually in contemplation of conveying such working interest
to such Company, in increments corresponding to the number of Interests
which such Company has received and accepted subscriptions for during the
Offering Term;
(ii) The Manager will retain a 2% overriding royalty interest in all
net wells acquired by the Company pursuant to the Turnkey Agreement,
provided that the working interest in such net wells exceeds 75% of the net
revenue interest in such wells, which overriding royalty it may retain or
assign to other persons, including affiliates of the Manager, as additional
consideration for the making of working capital loans by such persons to
the Manager or for other purposes;
(iii) The Manager will pay the actual cost of all development,
drilling and completion activities through Completion and the costs of all
post-Completion Facilities identified on the AFE with respect to each well
acquired by the Company, regardless of whether such costs exceed (A) the
amounts estimated therefor by the respective Operator in the cost estimate
with respect to such well, or (B) the Turnkey Cost;
(iv) the Company will pay the Manager a fixed amount (i.e., the
Turnkey Cost) per net well acquired by such Company for its working
interest in such well and to pre-pay its share of (A) all development,
drilling and completion activities on such wells through Completion and the
costs of all post-Completion Facilities identified on the AFE with respect
to each well acquired by the Company, and (B) all post-Completion
Facilities identified in the applicable AFE with respect to such wells;
(v) the Turnkey Cost to be paid by any Company for its working
interest in all Projects will be determined by the Manager after the
commencement of the offering of Interests by such Company and will reflect
market prices for turnkey development, drilling and completion and
post-Completion Facilities commitments prevailing in the market among
non-affiliated parties and will generally be based upon the PRO RATA
portion of the total development, drilling, completion and post-Completion
Facilities expenses estimated by the Operator of such property attributable
to the net wells acquired by the Company; and
(VI) THE MANAGER WILL ENSURE THAT ALL AMOUNTS CHARGED BY THE
RESPECTIVE OPERATOR TO THE COMPANY'S WORKING INTERESTS FOR DEVELOPMENT,
DRILLING AND COMPLETION ACTIVITIES AND INSTALLATION COSTS FOR
POST-COMPLETION FACILITIES IDENTIFIED IN THE RESPECTIVE AFE OR FOR OTHER
PURPOSES WHICH ARE PROPERLY CHARGEABLE TO THE WORKING INTEREST IN NET WELLS
ACQUIRED BY THE COMPANY IN THE PROJECT WILL BE PAID BY THE MANAGER AS AND
WHEN DUE, REGARDLESS OF WHETHER SUCH AMOUNTS EXCEED THE TURNKEY COSTS FOR
SUCH WELLS.
THE TURNKEY AGREEMENT DOES NOT ENCOMPASS ANY ACTIVITIES ATTRIBUTABLE TO A
WORKING INTEREST IN ANY WELL OWNED BY THE COMPANY AFTER COMPLETION OTHER THAN
FACILITIES SPECIFICALLY IDENTIFIED IN THE AFE PREPARED BY THE OPERATOR WITH
RESPECT TO EACH WELL IN WHICH THE COMPANY ACQUIRES A WORKING INTEREST..
EXPENDITURES FOR THE POST-COMPLETION ACQUISITION OR CONSTRUCTION OF FACILITIES
ON THE PROJECTS OTHER THAN THOSE SO IDENTIFIED BY THE RESPECTIVE OPERATOR ARE
NOT SUBJECT TO THE MANAGER'S OBLIGATIONS UNDER THE TURNKEY AGREEMENT. LIKEWISE,
NO EXPENDITURES WITH RESPECT TO THE WELLS OF ANY DESCRIPTION AFTER THE
FACILITIES COMPLETION DATE ARE COVERED BY THE TURNKEY AGREEMENT.
The terms upon which the Company will acquire its working interests in
wells and the services of the Operators to conduct development of wells are
incorporated into the Turnkey Agreement to be executed between the Company
and the Manager upon the first closing of the sale of Interests. The terms
of the Turnkey Agreement , specifically including the amount of the Turnkey
Cost and the services to be obtained in exchange therefore, were determined
by the Manager and its affiliates and have not been reviewed by an
independent expert. A copy of the proposed form of
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Turnkey Agreement is available for inspection at the offices of the Manager.
PROTOTYPE OPERATING AGREEMENT
The Manager will cause the Company to acquire working interests in
projects by becoming a non-operating party to operating agreements (the
"Operating Agreements") between the Operators of the Projects and the
non-operating working interest holders which provide for the conduct of the
development, drilling, completion and operation of wells on such property.
The Manager anticipates that each Operating Agreement will have certain terms
which are usual and customary terms and others upon which it anticipates that
it will condition the participation of the Company as a working interest
owner of such property, which prototype terms are described below. Although
the Manager reserves the right to cause the Company to become a party to an
Operating Agreement which materially deviates from the prototype form, such
participations will be disfavored and such deviations must be balanced by
other favorable terms for such Company.
The Manager will work closely with the Operators of projects in which the
Company participate throughout the development of each such property. The
Manager will continue to have a significant voice in the decisions of each
Operator with respect to the drilling and completion of and installation of
production, collection and distribution Facilities on wells on each such
property, the management and supervision of production activities, the
marketing and sale of gas production, all decisions with respect to the
re-working, recompleting, deepening or sidetracking of wells, horizontal
drilling activities or installation of any secondary, tertiary or other
enhanced recovery methods and the sale or abandonment of such wells.
However, the prototype form of Operating Agreement confers and the Manager
anticipates that each executed Operating Agreement will confer contractual
authority with respect to all such matters on the Operator and requires it to
take actions with respect to such matters. In addition, the Operator will
hire and supervise the contractors engaged to conduct drilling and completion
activities and install production, collection and distribution Facilities and
operate the wells.
The Manager and the respective Operators generally will have agreed on
the development program to be conducted on the subject property prior to the
Company becoming a working interest owner therein. However, the Operating
Agreement will, in most cases, provide that in the event of a disagreement
over whether to drill any additional wells on any property, the working
interest owners and other interested parties wishing to drill such wells may
do so and bear the cost thereof proportionately among them, while the working
interest owners which elect not to participate in such additional drilling
activity can decline to contribute capital to bear any portion of the cost of
such additional drilling. In the event that such well(s) produce gas in
commercial quantities, the Operating Agreement will usually provide that the
parties which bore the cost of such wells by contributing additional capital
to allow them to be developed will be entitled to receive all revenues from
sales of gas from such well until they have recovered (i) all of their costs
for above-the-wellhead equipment and operating expenses, and (ii) 300% of all
drilling and completion costs, including all in-well equipment costs. The
working interest owners who elected not to participate in such additional
development activity by not contributing additional capital in proportion to
their prior working interest in such project will only receive a portion of
the revenues from such additional wells thereafter. The form of Operating
Agreement further provides, among other things, that no additional
development drilling, re-working, recompleting, deepening or sidetracking of
existing wells or installation of any secondary, tertiary or other enhanced
recovery methods on the wells may be undertaken without the approval of the
Manager and that no long-term sales contract may be entered into with respect
to the production from the property without the consent of the Manager.
AUTHORITY FOR EXPENDITURE; COSTS. Each Operator will provide the Manager
with a written representative estimate of costs with respect to the wells to
be drilled on the affected property. Such estimate will represent its best
estimate of the aggregate costs of development, drilling and completing the
wells which it proposes to drill on such property, installation of the
Facilities thereon that the Operator anticipates will be required and
reimbursement of the Operator's allocable PRO RATA overhead charges on an
accountable basis. The sample estimate will not include (i) the Company's
PRO RATA share of the costs of Facilities which are installed after the
Facilities Completion Date or for the benefit of more than a single well,
including facilities partially owned with third parties which service such
Company's wells in addition to wells in which such Company does not own a
working interest, and (ii) costs of extraordinary events.
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The Manager will review and approve the estimate for each well in which
the Company acquires a working interest before the later to occur of the
acquisition of such working interest or the commencement of drilling. The
estimate will only represent the Operator's best estimate of the costs of
Completion of the well and the acquisition of the anticipated Facilities
required. The non-operating working interest owners are responsible for
their share of all such expenses, regardless of amount.
REMOVAL OF THE OPERATOR. The prototype form of Operating Agreement
provides that the Operator may be removed by the Company as Operator if it
fails or refuses to carry out its duties under the Operating Agreement or
becomes insolvent or bankrupt or is placed in receivership upon 90 days
written notice, after which a successor Operator must be selected from among
the non-Operator holders of working interests; the Manager, as a non-Operator
party to the Operating Agreement, may be required to act as Operator of a
property in such event or obtain another Operator to act on its behalf.
INSURANCE. The prototype form of Operating Agreement provides that the
Operator must carry insurance and require all contractors and sub-contractors
which provide goods or services in connection with the drilling, completion
or operation of wells in which the Company has a working interest to carry
insurance which complies with the following requirements:
(i) workmen's compensation coverage meeting the requirements of
Michigan;
(ii) general public liability coverage with limits of $1,000,000
per occurrence and $2,000,000 in the aggregate; and
(iii) automobile public liability coverage with limits of
$500,000 combined single limit for bodily injury and/or property
damage.
All such insurance shall name the applicable Company as a loss payee and the
cost of such coverage shall be borne in the same proportions as the working
interests in the wells on the property are owned, subject to certain provisions
regarding automobile coverage.
This description of the prototype form of Operating Agreement contains a
summary of each material term of such Agreement. This description, however, is
a summary only; the full text of the prototype form of Operating Agreement is
available for inspection at the offices of the Manager.
INSURANCE
An affiliate of the Manager has obtained a broad form comprehensive
liability insurance policy with respect to its natural gas drilling,
development and operating activities and those of each of its affiliates,
including the Company. This policy will provide insurance coverage IN
ADDITION to that provided by the Operators. The Manager and the Company will
pay their respective proportionate share of the premium per month for this
coverage, which will be treated as an operating expense of the Company. The
overall aggregate premium for this coverage is approximately $15,000 to
$25,000 per year, which will be apportioned PRO RATA among all of the
entities that are within its coverage. This policy will insure against
losses which the Company (and the Participating Investor Interestholders)
and/or any other covered affiliate of the Manager become legally obligated to
pay for bodily injury and/or property damage arising from sudden
contamination or pollution. This policy does NOT provide coverage for
gradual contamination or pollution. The policy contains a per occurrence
limit of $5,000,000 and an annual aggregate limit of $10,000,000. This policy
is underwritten by Lloyd's of London and a certificate of insurance with
respect thereto is available at the offices of the Manager. See, however,
"Risk Factors - Insurance."
UNCOMMITTED CAPITAL FUNDS OF OTHER ENTITIES
The Companies will commence operations from time to time, although it may
take a year or more to invest the
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entire capital of the Company. Consequently, a number of Companies, as well
as the Company and other entities or programs sponsored by the Manager or its
affiliates, may have uncommitted funds available at the same time and may
join together in acquiring working interests in projects. The Company's
share of any such acquisition will be based, among other things, on the date
operations were commenced, the amount of its available funds, the type of
projects in which working interests have already been acquired and the
desired degree of diversification of property interest holdings. Subject to
diversification considerations, prior Companies with available capital shall
participate in all property interest purchases available to subsequent
Companies, which may delay purchases by subsequent Companies, including the
Company. Sales and purchases of working interests in projects between
Companies formed in this Program will not be made for the purpose of
diversifying or balancing the interests of such Companies in such projects,
but working interests in projects may be sold to other programs sponsored by
the Manager or its affiliates, subject to certain limitations designed to
reduce potential conflicts of interest. See "Conflicts of Interest -
Management of Other Entities."
OWNERSHIP AND MANAGEMENT OF PROJECTS
Title to Company projects generally will be recorded in the name of the
Company, and not in the name of the Manager as nominee of the Investor
Interestholders, nor in the name of a special nominee entity organized for
the sole purpose of holding record title.
Operations on projects in which the Company holds a working interest will
be conducted by unaffiliated Operators retained by the holders of a majority
of the working interests in each of the wells on such projects who or which
will already be in place when the Company acquires a working interest in such
property. The Manager will have principal direct responsibility for the
acquisition and management of the Company' assets and the administration of
its investment activities. In addition to the principals and employees of
the Manager and its affiliates, where necessary or advisable the Company will
ordinarily utilize the services of firms having applicable specific expertise
under the supervision of the Manager's staff.
The Manager will not make any advances to the Company nor will the
Company borrow any funds for the purpose of sustaining a regular pattern of
distributions even though loan payment requirements, unusual operating costs
or other expenses or temporary reductions in Company revenues may reduce
funds available for distribution. In order to avoid potential conflicts of
interest and to assure that transactions, if any, between the Manager or its
affiliates and the Company are fair and reasonable, the Manager must observe
certain guidelines in connection with such transactions. See "Conflicts of
Interest -Transactions Between the Company and the Manager."
The Manager may retain persons who are affiliates to provide certain
on-site and other supervisory services with respect to the projects and the
Company's relationship with the Operators which do not constitute customary,
routine and/or recurring tasks in connection with the administration of the
day-to-day business of the Company. To the extent that such persons render
services specifically to the Company in connection with its ownership and
operation of the Projects, the Manager may agree that such person will bill
the Company for the value of such services on the basis of time actually
spent and accountable expenses incurred (or such other method to which the
Manager may reasonably agree) in connection with his/her activities on behalf
of the Company. The Company will pay such amounts from revenues from sales
of production only and treat them as direct expenses.
SALE OF PRODUCTION
The Operators of the projects in which any Company holds a working
interest will be collectively responsible for the marketing of such Company's
gas production. A Company may acquire a working interest in a property with
respect to which the Operator has entered into contracts for the marketing or
sale of gas or other hydrocarbons, or other marketing arrangements. In
evaluating the current and anticipated future marketing of the Company's gas,
the Manager will attempt to assure that the Operators have obtained the
highest possible price but will consider, among other things, the rate at
which the purchasers can take deliveries, the availability of commitments to
build required pipeline connections and the ability and willingness of
purchasers and pipelines to purchase and transport gas from additional
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wells in the field. It is anticipated that all sales of gas production will
be to parties which are not affiliated with the Manager. No Company will
have any contracts for the sale of any gas at the time of its formation. A
Company may, however, acquire working interests in projects from which the
natural gas production is already dedicated to a specific purchaser pursuant
to a gas sales contract between the Operator of such project and a purchaser
which was entered into prior to the acquisition of a working interest in such
Project by the Company.
REINVESTMENT OF REVENUES AND PROCEEDS
A Company will purchase working interests in additional projects after
its acquisition period solely from capital and borrowings and only if a
working interest in such additional property is necessary to protect the
Company's investment in working interests in projects it already owns.
Accordingly, the Company will not reinvest revenues and will ordinarily not
reinvest proceeds from the sale or disposition of working interests in
projects or associated assets except as necessary to pay debts or
expenditures for other Company operations.
CASH DISTRIBUTIONS
GENERAL POLICIES. The Manager's policy is to distribute substantially
all Company net revenues to the Investors. Until the Company is fully
invested in working interests in projects, such cash funds will come from
interest earned in short term investments and will be distributed solely to
the Investor Interestholders. The Manager will review the Company accounts
not less often than quarterly, and will distribute such cash funds as the
Manager deems unnecessary to retain in the Company. The Manager will retain
the right to defer (or waive) its right to receive (i) reimbursement of
direct operating costs, and/or (ii) the annual Administrative Fee, in whole
or in part, in order to permit a greater percentage of Company revenues to be
distributed to Investors. In such event, such deferred amounts will bear
interest at the prime lending rate of the Escrow Agent and will be adjusted
annually on January 1. Any such deferral or waiver will be disclosed to
Investor Interestholders in the affected Company and in the Supplements to
this Prospectus for any Company which subsequently offers Interests for sale
to the public. Any such loan will also conform to all provisions relating to
loans from the Manager or its affiliates to the Company. See "Financing."
The Manager's objective in acquiring working interests in and
participating in the development of projects will be to acquire working
interests in projects from which the projected income will provide sufficient
cash flow to provide a regular, reasonably predictable pattern of
distributions for the Company, subject to change if net revenues are greater
than anticipated. The Manager will ordinarily seek to acquire working
interests in projects having an anticipated production life of 20 years or
more, in order that it may (i) produce a reasonable return on the capital
invested by the Company over its anticipated lifespan of 7 to 10 years, and
(ii) provide a reasonable basis for establishing a substantial value which
the Company may realize upon sale to an unaffiliated party in an arm's-length
transaction. See "Liquidation Policy" below.
REINVESTMENT OF CASH. In the case that the Company participates in the
drilling of additional development wells or the re-working, recompletion,
deepening or sidetracking of existing wells, on projects in which it holds a
working interest, until such wells have been drilled, completed and brought
into production, or such re-working, recompletion, deepening or sidetracking
has been completed and such wells returned to production, the cash funds
available for distribution will diminish, possibly to zero, as capital funds
of the Company and other working interest owners are invested in the
property, until production on such wells has commenced or resumed, as the
case may be. Once the Company completes its acquisition activities and, in
the case that the Company participates in (i) the drilling of additional
development wells, or (ii) the re-working, recompletion, deepening or
sidetracking of existing wells, on projects in which it holds a working
interest, such wells have been drilled and completed and brought into
production, or such re-working, recompletion, deepening or sidetracking has
been completed and such wells returned to production, the cash funds to
distribute will be generated primarily by its working interests in the
projects (i.e., revenues from the production and sale of gas less operating
costs). Such distributions will be net of Company costs allocated to the
account of each Investor Interestholder. Once the Company has begun
distributing cash generated from sales of gas produced from projects in which
it owns a working interest, the Manager intends to make distributions of
available Company cash at a rate which will be sustainable over a period of
five or more years.
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SUBORDINATION OF CASH DISTRIBUTIONS TO MANAGER. The Manager has agreed
to subordinate the distribution to it of (i) 100% of the Net Cash Flow from
Operations otherwise distributable to it with respect to the Manager's
Promoted Interest, and (ii) UP TO 100% of the Net Cash Flow from Operations
otherwise distributable to it with respect to the Manager's Investment
Interest to the extent necessary to cause the Investors to reach Payout only
if, after 60 months following the first distribution of Net Cash Flow from
Operations, the Investor Interestholders have not received distributions of
Net Cash Flow from Operations which, in the aggregate, are equal to 100% of
the Investor Interestholders' subscriptions. Any such deferral of
distributions of cash to the Manager will be recovered by the Manager from
first available Net Cash Flow from Operations after, and for so long as, the
Investor Interestholders have received distributions of Net Cash Flow from
Operations which, in the aggregate, are equal to 100% of the Investor
Interestholders' subscriptions, until such deferrals have been recovered.
See "Participation in Costs and Revenues -Allocation of Tax Items" and
"Compensation and Reimbursement - Interest in Projects - Manager."
LIQUIDATION POLICY
In order to provide additional information upon which a prospective
investor in Interests may evaluate the appropriateness of such investment
against his/her investment parameters, the Manager has established as an
investment objective that the Company observe the following policies:
(i) after the seventh full year of Company operations, seek
opportunities to sell or otherwise liquidate its working interests in
projects on the most advantageous terms available;
(ii) distribute all proceeds of the liquidation of Company assets
after the seventh year following the first distribution of Net Cash
Flow from Operations to the Investor Interestholders in accordance
with allocation of revenues described herein promptly without
reinvestment in working interests in projects;
(iii) seek to liquidate all Company assets before the completion of
the tenth year of Company operations; and
(iv) dissolve the Company immediately following the distribution of
the proceeds of the sale of the last Company asset.
The intended effect of these policies is to make the Company finite life
entities with respect to which a reasonable analysis can be made of the
risk-and liquidity-adjusted rate of return of investment of capital invested
therein. There can be no assurance that the projects in which the Company
invest will perform as expected or that the market for such projects will,
after the seventh year of Company operations, be favorable for disposition of
the Company' assets and, therefore, that the Company will be able to
liquidate prior to the end of the tenth year of Company operations on terms
which are favorable to the Investor Interestholders or at all. In any event,
the Manager retains the right and the obligation to manage the Company in the
best interests of the Investor Interestholders and to fail to observe the
foregoing policies if necessary to do so. Therefore, there can be no
assurance that the Company will not continue to hold working interests in
projects beyond the tenth year of Company operations, though it is the
Manager's intent that they shall not.
In order to (i) induce the Manager to incur the capital and operating
costs to provide administrative services to the Company during the first
seven years of Company operations and thereafter until they cease operation,
(ii) charge the Company for such services at rates which permit cost recovery
by the Manager only over the full anticipated term of the Company' operation
lives and which, therefore, may produce a loss and/or negative cash flow to
the Manager in the early years of Company operations, and (iii) ameliorate
the conflict of interest inherent in the consideration by the Manager of
opportunities for the Company to sell its working interests in some or all of
its projects prior to the end of the seventh year of Company operations
(e.g., because of favorable market or other conditions) and thereby reduce
the aggregate amount of the administrative costs allowance payable to it by
the Company (see "Conflicts of Interest -Property Acquisitions and
Dispositions"), the Company will agree to a "make whole" provision with
respect to the
52
<PAGE>
administrative costs allowance payable by the Company to the Manager. This
provision calls for the making of a payment to the Manager, determined in
accordance with a formula (described below), upon and from the proceed of the
sale of any substantial Company asset prior to the end of the seventh year of
Company operations as a preferred payment prior to the distribution of such
proceeds to Investor Interestholders. The amount of such payment would be
the PRO RATA portion (based upon the ratio which the net investable capital
of the Company originally invested in such working interest bore, at the time
of investment, to the total net investable capital of the Company) of the
remaining administrative costs allowance attributable to such asset which
would have been paid after such sale and prior to the end of the seventh year
of Company operations but for the liquidation of such asset, multiplied by a
profit factor and discounted to the date of payment.
POSSIBLE IN-KIND DISTRIBUTION. The Manager will attempt to provide the
opportunity to receive an in-kind distribution of their PRO RATA interest in
the Company's working interests in projects rather than the proceeds of the
liquidation of the Company's assets to those Investor Interestholders who
wish to continue to hold working interests in producing gas wells rather than
cash. There can be no assurance that the Manager will be able to present such
an opportunity to Investor Interestholders with respect to all of the
projects or any portion of them or at all. In considering such an action,
the Manager will be required to take into account the possible adverse
federal income tax consequences to the non-electing Investor Interestholders
and the effects of selling less than all of the Company's assets on the
liquidation value of the working interests that are sold. In addition, the
option to take an assignment of working interests may require that the
Investor Interestholder who makes such election also incur expenses for
additional legal, appraisal, recording and administrative fees and agree to
pay additional administrative expanses in the future, some of which may be
payable to affiliates of the Manager. The Manager is unable to determine
whether such an option will be made available and, if one is, the terms of
such option and the costs that would be incurred by an electing Investor
Interestholder.
FINANCING
THE COMPANY WILL NOT BORROW MONEY TO ACQUIRE PROJECTS OR PAY FOR ITS PRO
RATA SHARE OF THE COSTS OF DRILLING, COMPLETION OR THE INSTALLATION OF
PRODUCTION, COLLECTION OR DISTRIBUTION FACILITIES, OR THE COSTS OF ANY OTHER
FACILITIES ACQUIRED OR INSTALLED PRIOR TO THE FACILITIES COMPLETION DATE. A
Company may, however, borrow to meet working capital needs or for other
purposes such as drilling, completing and installing collection, production
and distribution Facilities on additional development wells or re-working,
recompleting, deepening or sidetracking existing wells after the Facilities
Completion Date. In all cases, however, the Manager expects that the Company
will borrow less than the maximum amount of its borrowing capacity. The
Company will not borrow (or obtain advances) for the purpose of funding
distributions. Borrowing capacity in an amount equal to 15% of the aggregate
subscriptions of the Investor Interestholders may be reserved for use when
the Manager determines that such activities are warranted.
Third party borrowing, if any, will be sought primarily from commercial
banks, although advances from gas pipeline companies or through the creation
of production payments may be utilized. The Manager has not sought or
obtained any lines of credit for this or any other purpose, and there can be
no assurance that such borrowings could be made. Such borrowings would
ordinarily be secured by borrowing against the Company's assets. Except
under the limited circumstances described under "Proposed Activities -
Reinvestment of Revenues and Proceeds," the Company will not borrow funds for
additional property purchases after its initial acquisition period has ended.
Investor Interestholders will not be individually liable for the
repayment of any Company indebtedness, except as provided specifically with
respect to Participating Investor Interestholders. The repayment of the
principal amount of such borrowings will be allocated to the Manager and the
Investor Interestholders in the same manner as the cost of the working
interest in the wells on such property. All interest charges and similar
costs and expenses of Company borrowings associated with Company assets are
allocated in the same manner as operating costs. There can be no assurance
that the Company will be able to borrow against property upon satisfactory
terms. Moreover, during the term of such borrowings, the Investor
Interestholders' Interest of the taxable income of the Company may be greater
than the net cash available for distribution to them. Notwithstanding the
foregoing, the maintenance of a continuous flow of cash
53
<PAGE>
distributions, once begun, to the Investor Interestholders is one of the
principal objectives of the Company.
If sufficient financing is unavailable on favorable terms, it may be
desirable to use Company revenues otherwise distributable to Investors for
development purposes. The use of Company cash to pay such costs or to
amortize indebtedness would defer distributions of cash to the Investor
Interestholders. The extent of such deferral will depend upon the terms of
any loans actually obtained.
Any loans made to the Company by the Manager or its affiliates will bear
interest at the lesser of (i) the Manager's interest cost from time to time
during the terms of such loans, (ii) the rate which would be charged to the
Company on comparable loans for the same purpose (without reference to the
Manager's financial abilities or guarantees) by unrelated banks, or (iii) the
maximum lawful rate. The Manager and its affiliates will not receive points
or other financing charges or fees, regardless of amount, on any loans made
to the Company. The Company will not lend money to the Manager or its
affiliates.
When two or more Company participate in the same transaction (which will
occur frequently) and financing is obtained for the benefit of all of the
participating Company, the Company will become liable to pay only its PRO
RATA share of the loan. Its share in the purchased projects will be
mortgaged only to the extent required to secure its proportionate share of
the loan.
The Manager may advance and disburse funds for the payment of bills and
invoices for direct costs of the Company's operations, and, in such event,
will reimburse itself for such expenditures from first available funds in the
Company account.
54
<PAGE>
APPLICATION OF PROCEEDS
Approximately 90 percent of Investor Interestholder subscriptions will be
used to purchase working interests in natural gas development projects and
pay the respective Company's share of the costs of drilling, completing and
installing production, collection and distribution Facilities thereon. The
following table summarizes the application of proceeds of the offering,
assuming the minimum amount has been subscribed for by Investor
Interestholders.
<TABLE>
<CAPTION>
Percentage Percentage
Minimum Per $5,000 of investor sub- of all sub-
Amount subscription scriptions scriptions
------ ------------ ---------- ----------
<S> <C> <C> <C> <C>
Gross investor subscriptions $300,000 $5,000 100.0% 95.24%
Manager's Contribution 15,000 250 5.0% 4.76%
------ --- ---- -----
Total contributions $315,000 $5,250 105.0% 100.00%
Less: Broker commissions (1) (24,000) (400) (8.0%) 7.62%
Due diligence fees (2) (3,000) (50) (1.0%) 0.95%
Organization and offering costs allowance (3) (7,500) (125) (2.5%) 2.38%
------- ----- ----- -----
Net investor subscriptions 280,500 4,675 93.5% 89.05%
Less: Management fee (4) (10,500) (175) (3.5%) 3.33%
-------- ----- ------ -----
Investor subscriptions available
for investment 270,000 4,500 90.0% 85.71%
Total capital available to pay
Turnkey Cost $270,000 $4,500 90.0% 85.71%
======== ====== ===== ======
</TABLE>
- -------------------------
(1) Securities sales commissions of up to 8% of the purchase price of the
Interests will be paid to broker/dealers which are members of the National
Association of Securities Dealers, Inc. (NASD), with respect to Interests
which are placed by them at the time that each subscription for Interests
procured by such Soliciting Dealers is accepted by the Manager. Additional
sales commissions of up to 4.5% of Residual Operating Cash Flow may be paid
to the Soliciting Dealers as a reduction of the Manager's share of
distributions of Net Cash Flow in subsequent years if the Company generates
sufficient cash flow from operations to make such payments. Sales
commissions and due diligence fees may be waived for sales of Interests to
certain persons.
(2) The Company may pay a due diligence expense reimbursement fee of up to 1%
of the gross proceeds of Investor Interestholder subscriptions to
participating broker/dealers which sell Interests.
(3) The costs of organizing the Company and conducting the offering of
Interests will be paid by the Manager. The Company will pay the Manager an
allowance equal to 2.5% of Investor Interestholders' capital contributions
in exchange for the Manager's agreement to pay such costs; any amounts
which exceed such allowance will be paid by the Manager and the Company
will not be liable therefor.
(4) The Company will pay the Manager a one-time Management Fee equal to 3.5% of
aggregate Interestholders' capital contributions, payable in the year of
subscription, for its services in managing the Company in such year.
Payable from Investor Interestholder subscriptions only.
55
<PAGE>
PARTICIPATION IN COSTS AND REVENUES
TABULAR SUMMARY OF ALLOCATIONS
The following table summarizes the allocation of costs and revenues of the
Company between the Manager and the Investor Interestholders.
<TABLE>
<CAPTION>
Manager's Manager's
Promoted Investment Investor
Description Interest Interest Interestholders Investors(1)
- ---------------------------------------- --------- ---------- --------------- ------------
<S> <C> <C> <C> <C>
COSTS
* Selling expenses (2) 0.00% 0.00% 100.00% 100.00%
* Organization and offering costs allowance (3) 0.00% 0.00% 100.00% 100.00%
* Management fee (3) 0.00% 0.00% 100.00% 100.00%
* Acquisition costs and expenses (4)(7)(8) 0.00% 0.00% 100.00% 100.00%
* Intangible drilling and
development costs (5)(6) 0.00% 0.00% 100.00% 100.00%
* Tangible drilling and
development costs (5)(12) (13) (13) (13) (13)
* Administrative cost allowance (3) 5.24% 4.76% 90.00% 94.76%
* Direct costs and operating costs (4)(5)(15) 5.24% 4.76% 90.00% 94.76%
* Additional development costs (5)(9)(15) 5.24% 4.76% 90.00% 94.76%
* Financing costs (5)(10)(15) 5.24% 4.76% 90.00% 94.76%
* Professional and other costs (5)(11)(15) 5.24% 4.76% 90.00% 94.76%
REVENUES
* Net revenues from temporary
investments (14) 0.00% 0.00% 100.00% 100.00%
* Revenues from sales
of production (5) 5.24%(15) 4.76%(15) 90.00%(15) 94.76%(15)
* Revenues from the sale or
other disposition of Company properties (15) (15) (15) (15)
</TABLE>
- ----------------------------
(1) Including the Manager with respect to the Manager's Investment
Interest; the Manager will be allocated the costs and revenues
attributable to the Manager's Investment Interest in the same manner
as for Investor Interestholders, except with respect to sales
commissions, organization costs, intangible drilling and development
costs and revenue from temporary investments.
(2) See "Plan of Distribution."
(3) See "Compensation and Reimbursement."
(4) See the complete definitions of "direct costs" and "operating costs"
in "Glossary" and Article 2 of the Company Operating Agreement.
(5) The Interestholders' shares of costs and revenues are subject to
adjustment if transferred Interests are surrendered for Company
assets. Adjustments may also be required under the "qualified income
offset" provision of the Company Operating Agreement. See "Tax
Aspects - Allocations to Interestholders."
(6) See "Tax Aspects - Deduction of Intangible Drilling and Development
Costs."
(7) Includes costs arising out of or relating to the acquisition of
gathering facilities, plants and other assets necessary to produce gas
reserves efficiently. Company borrowings, the proceeds of which are
used to pay costs and expenses arising out of or relating to the
additional development of Company properties, will be repaid out of
the Investor Interestholders' and the Manager's respective shares of
revenues in the same proportion as the costs and expenses paid with
the proceeds of such borrowings would have been charged if expended
out of the Interestholders' capital contributions.
56
<PAGE>
(8) See "Tax Aspects - Leasehold Acquisition Costs."
(9) Includes leasehold acquisition costs, tangible and intangible drilling
and development costs and overhead expenses incurred in connection
with (a) drilling and completion and installation of collection,
production and distribution Facilities on additional development wells
drilled on Company properties, and (b) re-working, recompleting,
deepening or sidetracking of or installation of secondary, tertiary or
other enhanced recovery methods on, existing wells composing the
Project. See "Proposed Activities and Policies - Operating Policies -
Basic Operating Policies."
(10)Includes interest, points, financing fees and charges, professional
fees and other costs of borrowings associated with Company operations.
See "Financing."
(11)Fees and expenses of independent public accountants, outside counsel,
Independent Experts and other professionals employed by the Company
and associated costs and expenses.
(12)See "Tax Aspects - Depreciation."
(13)The respective allocations of these items to the Manager and the
Investor Interestholders will be adjusted so that the Manager is
allocated 5.24% of the total costs of drilling, completing and
equipping (or plugging and abandoning) wells with respect to the
Manager's Promoted Interest and the Investors are allocated 94.76% of
such costs (including 4.76% to the Manager with respect to the
Manager's Investment Interest). The precise allocation of tangible
costs will depend upon the percentage of the Turnkey Cost expended to
pay tangible versus intangible costs.
(14)Fees and expenses related to investing such funds in short-term,
liquid instruments, if any, will be paid out of the interest earned
prior to the allocation of the balance of such revenues among the
Interestholders.
(15)Revenues from sales of production and from the sale or other
disposition of Company properties will be distributed 94.76% to the
Investors as a group, including 4.76% to the Manager with respect to
the Manager's Investment Interest, and 5.24% to the Manager with
respect to the Manager's Promoted Interest, until the Investor
Interestholders have each received a return of its Net Capital
Contribution; thereafter, such revenues will be distributed 69.76% to
the Investors as a group, including 4.76% to the Manager with respect
to the Manager's Investment Interest, and 30.24% to the Manager with
respect to the Manager's Promoted Interest (see " - Description of
Company Allocations" below).
DESCRIPTION OF COMPANY ALLOCATIONS
There shall be no distinction between Participating and Nonparticipating
Investor Interestholders or the Interests owned by each with respect to
allocations of items of taxable income, loss, gain, deduction or credit by
the Company.
The Investor Interestholders, as a group, will be charged 100% of the
sales commissions and other selling costs of the Interests. 100% of net
revenues from the temporary investment of Company capital and the costs and
expenses arising out of or related to such temporary investments will also be
allocated to the Investor Interestholders, as a group. Net subscriptions
(the Interestholders' capital contributions to the Company, plus the
Manager's Contribution, after payment of selling, organizational and offering
expenses), will be principally used to pay the Management Fee and the Turnkey
Cost (which will, in turn be applied by the Manager to pay the Company's PRO
RATA share of the costs of drilling, completing and installing production,
collection and distribution Facilities identified in the applicable AFE on
the wells attributable to the Company's working interest). Costs and
expenses arising out of or related to the acquisition of its interest in the
Project shall be allocated 100% to the Investor Interestholders, as a group,
and 0% to the Manager.
The Company will pay the Manager an organizational and offering costs
allowance equal to 2.5% of Investor Interestholder subscriptions. The
Manager will pay all direct expenses of the organization of the Company and
the offering of Interests, including accounting, filing and legal fees,
printing and other costs and marketing expenses. The Manager and not the
Company will be liable for all such expenses, including any such expenses
which exceed 2.5% of subscriptions. The organizational and offering costs
allowance will be allocated 100% to the Investor Interestholders, as a group,
and 0% to the Manager.
57
<PAGE>
Upon the commencement of Company operations, the Manager will receive a
Management Fee in an amount equal to 3.5% of aggregate Interestholders'
capital contributions, payable upon receipt of investor's subscriptions by
the Company from the escrow account established for the benefit of investors,
in consideration of its services as manager of the Company during the ramp-up
period of the Company's administrative activities in the year of formation.
Such expense shall be allocated 100% to the Investor Interestholders, as a
group, and 0% to the Manager.
Revenues from sales of production of gas from wells in which the Company
holds an interest, direct costs (generally, those costs incurred for goods
and services provided by third parties, including interest, commitment fees
and other charges in connection with borrowings by the Company and
professional fees and expenses) and operating costs (expenditures and costs
incurred in producing and marketing gas from producing wells) to the extent
paid by the Company or on its behalf (and deducted from the Company's share
of Project revenues before payment to the Company) and other expenses
incurred in connection with Company business and revenues (other than
proceeds of sales of properties) will be allocated to the Manager according
to the Manager's Promoted Interest and the balance to the Investors, as a
group, including the Manager with respect to the Manager's Investment
Interest.
Ongoing administrative costs (customary and routine overhead expenses)
will be performed or paid for by the Manager, which will receive, in lieu of
reimbursement therefor, an annual administrative cost allowance equal to 3.5%
of aggregate Interestholders' capital contributions to the Company,
commencing in the month that the Company first realizes revenue from
production, in each year or partial year thereafter (subject to reduction,
PRO RATA, as Company assets are liquidated and the proceeds thereof are
distributed to Interestholders) until the termination of the Company, payable
monthly, PRO RATA, which will be allocated to the Manager according to the
Manager's Promoted Interest and the balance to the Investors, as a group
(including the Manager with respect to the Manager's Investment Interest).
The amount of the administrative cost allowance shall be adjusted annually to
reflect increases or decreases in the costs of administration in accordance
with the procedures and index published annually by the Council of Petroleum
Accountants Societies (COPAS) and shall be payable only out of Company
revenues. The Manager may subcontract with other persons, including
affiliates of the Manager, to perform such services for the Company or on its
behalf and may compensate such person from its assets and sources of
liquidity available to it. Such costs will also be allocated in accordance
with the amount of the Manager's Promoted Interest to the Manager and the
balance to the Investors, including the Manager with respect to the Manager's
Investment Interest.
The Manager has agreed to subordinate the distribution to it of (i) 100%
of the Net Cash Flow from Operations attributable to the Manager's Promoted
Interest, plus (ii) UP TO 100% of the Net Cash Flow from Operations
attributable to the Manager's Investment Interest if, after 60 months from
the date of the first distribution of cash to Investors, the Investors, as a
group (including the Manager with respect to the Manager's Investment
Interest), have not received distributions of Net Cash Flow from Operations
which, in the aggregate, are equal to 100% of the Investors' subscriptions.
Any such deferral of distributions of cash to the Manager will be recovered
by the Manager from first available Net Cash Flow from Operations after, and
for so long as, the Investors have received distributions of Net Cash Flow
from Operations which, in the aggregate, are equal to 100% of the Investors'
subscriptions, until such deferrals have been recovered. See "Proposed
Activities and Policies - Cash Distributions - Subordination of Cash
Distributions to Manager" and "Compensation and Reimbursement - Interest in
Projects - Manager."
The portion of the Turnkey Cost not allocated to the acquisition of the
Company's working interest in the wells comprising the Project will be
considered development, drilling, completion and post-Completion Facilities
costs. The portion of the Turnkey Cost allocated to development, drilling,
completion and post-Completion Facilities costs will be further allocated
between intangible and tangible costs in the manner deemed appropriate by the
Manager and will be intended to maximize the amount of such costs which are
allocated to intangible development, drilling and completion costs.
Intangible development, drilling and completion costs will be allocated
100% to the Investor Interestholders, as a group, and 0% to the Manager.
Tangible development, drilling, completion and Facilities costs will be
allocated between the Manager and the Investor Interestholders so that an
amount corresponding to the Manager's Promoted Interest of the combined total
of all tangible and intangible development, drilling and equipping (or
plugging and
58
<PAGE>
abandoning) wells will be allocated to the Manager, and the balance is
allocated to the Investors, including the Manager with respect to the
Manager's Investment Interest. The allocation of tangible development,
drilling, completion and Facilities expenses between the Manager and the
Investor Interestholders, therefore, will depend upon the relative
proportions of tangible and intangible development, drilling and completion
costs incurred.
All tangible and intangible development, drilling and completion expenses
incurred in connection with the drilling and completion of additional
development wells, if any, recompletion, re-working, deepening or
sidetracking of existing wells and installation of any enhanced, tertiary or
secondary recovery methods (if applicable) will be allocated to the Manager
in accordance with the Promoted Manager's Interest and the balance to the
Investors including the Manager with respect to the Manager's Investment
Interest.
The proceeds from the sale or other disposition of the Company property
will generally be allocated so that the net proceeds of the sale are
allocated to the Manager in accordance with the Manager's Promoted Interest
from time to time (5.24% prior to Payout and 30.24% after Payout) and the
balance to the Investors, including the Manager with respect to the Manager's
Investment Interest, subject to the PRO RATA payment of the asset disposition
fee. The Manager will receive, from the proceeds of the sale of any Company
assets and before the allocation or distribution of the proceeds thereof
among the Interestholders (including the Manager), an asset disposition fee
equal to 3.5% of the gross proceeds from such sale. Gain for tax purposes
will be allocated to the Investors and the Manager, PRO RATA, until the
Capital Account of the Manager is equal to its Net Capital Contribution and,
thereafter, to the Investors and the Manager in proportion to their
respective distributions of Net Cash Flow. Losses incurred by the Company in
connection with sales of Company property will be allocated to the Investors
and to the Manager in proportion to their respective interests in the book
value of the property sold (i.e., generally in proportion to capital
contributions). See Articles 7 and 8 of the Company Operating Agreement.
The Manager will be allocated the costs and revenues attributable to the
Interests that it owns, determined in the same manner as for Investor
Interestholders. All allocations described above are subject to adjustment
(i) upon the withdrawal of assets by the new owner of a selling Investor
Interestholder's Interests (see Article 13 of the Company Operating
Agreement), and (ii) pursuant to the "qualified income offset" provision of
the Company Operating Agreement described in "Tax Aspects - Allocations to
Investor Interestholders."
ALLOCATIONS AMONG INVESTOR INTERESTHOLDERS
The Investor Interestholders' collective share (and, with respect to the
Interests purchased by the Manager, its respective share) of revenues, gains,
costs, expenses, losses and other charges and liabilities will be credited
and allocated among the Investor Interestholders PRO RATA according to their
relative net subscriptions to the Company. Investor Interestholders, as
among themselves, share Company revenues and distributions on the basis of
net subscriptions. Therefore, since Investor Interestholders may be charged
unequal percentage amounts of their subscription for selling commissions paid
with respect to the sale of Interests to them, Investor Interestholders whose
sales commissions are reduced or eliminated may receive a return of their
subscriptions before other Investor Interestholders.
59
<PAGE>
COMPENSATION AND REIMBURSEMENT
The Manager or its affiliates will receive the following compensation
and/or reimbursement from the Company.
SUMMARY
<TABLE>
<CAPTION>
IF MINIMUM
FORM OF AMOUNT
COMPENSATION METHOD OF COMPENSATION SOLD (1)
- ------------- ---------------------- -------------
<S> <C> <C>
OFFERING AND ORGANIZATION STAGE
Management Fee 3.5% of aggregate Investor Interestholders' capital contributions $10,500
ACQUISITION AND OPERATING STAGE
Administrative 3.5% of aggregate Investor Interestholders' capital contributions per $10,500 per year
cost allowance annum, net of PRO RATA returns of capital to Investor Interestholders, (1)(2)
commencing in the month that the Company first realizes revenue from
production, accrued monthly in lieu of reimbursement of administrative
costs and expenditures paid by the Manager, subject to adjustment
Possible Difference, if any, between organizational and offering costs Indeterminate
organizational allowance and actual costs of the organization of the Company and
and offering offering of Interests, including accounting, filing and legal fees,
costs profit printing and other costs and marketing expenses
Possible turnkey Difference, if any, between the Turnkey Cost and actual development, Indeterminate
profit drilling, completion and identified post-Completion Facilities costs
Compensation for Fair market value, on an accountable basis, for services to the Indeterminate
services Company which do not constitute customary, routine or recurring
administrative tasks in the Company's day-to-day business
Interest in Percentage of proceeds of production equal to Manager's Promoted Indeterminate (3)
revenues Interest, after allocations of direct costs, operating costs,
administrative costs allowance and all other expenses
Overriding 2% net revenue interest in the projects on same terms as Company; Indeterminate
royalty provided, however, that the working interest, as a whole, exceeds 75%
of the entire net revenue interest of such property
LIQUIDATION STAGE
Asset disposition 3.5% of gross proceeds of sales of Company property Indeterminate (4)
fee
Interest in Percentage of proceeds of sales of Company assets in accordance with Indeterminate
proceeds of sales Manager's Promoted Interest from time to time (5.24% until Payout, (3)(5)
30.24% after Payout) after allocations of direct costs, operating
costs, administrative costs allowance and all other expenses
</TABLE>
------------------------------
(1) These payments will generally be less than the corresponding expenses paid
by the Manager in the early years of Company operations and the resulting
deficit will generally be recovered by the Manager over a five-year period.
(2) Payable from revenues from sales of production only. See the tables of
Direct and Administrative Costs Incurred As A Percentage of Gross
Subscriptions in "Prior Activities" for information about affiliated
entities.
(3) The Manager has agreed to subordinate the distribution to it of (i) 100% of
the Net Cash Flow from Operations otherwise distributable to it with
respect to the Manager's Promoted Interest, and (ii) UP TO 100% of the Net
Cash Flow from Operations otherwise distributable to it with respect to the
Manager's Investment Interest if, after 60 months following the first
distribution of Net Cash Flow from Operations, the Investor Interestholders
have not received distributions of Net Cash Flow from Operations which, in
the aggregate, are equal to 100% of the Investor Interestholders'
subscriptions to the extent necessary to cause the Investor Interestholders
to reach Payout. See "Proposed Activities and Policies - Cash
Distributions - Subordination of Cash Distributions to Manager,"
"Participation in Costs and Revenues - Allocation of Tax Items" and
"Compensation and Reimbursement - Interest in Projects - Manager."See the
tables of Investor Interestholder and Manager Operating Results in Prior
Programs in "Prior Activities" for information about affiliated limited
partnerships.
(4) The Asset Distribution Fee equals 3.5% of the gross proceeds of the sale of
Company property.
(5) Payable only out of gains realized on such sales. See "Participation in
Costs and Revenues - Company Allocations."
60
<PAGE>
INTEREST IN PROJECTS
THE MANAGER'S PROMOTED INTEREST. The Manager will generally receive it's
a percentage of (i) revenues derived from the sale of gas from Company wells,
and (ii) proceeds from the sale of Company property, depending upon the
selling price of the property and its book value at the time of sale, in
accordance with the Manager's Promoted Interest from time to time (5.24%
until Payout, 30.24% after Payout), including any development wells drilled
on projects in which the Company owns a working interest, and will be
allocated a like percentage of direct and operating costs, selling or
liquidation costs, the administrative cost allowance, all other costs
associated with wells on projects in which the Company has purchased a
working interest or on which development wells are drilled and associated
interest expenses; the balance of such items will be allocated to the
Investors, including the Manager with respect to the Manager's Investment
Interest. The Manager has agreed to subordinate the distribution to it of
(i) 100% of the Net Cash Flow from Operations otherwise distributable to it
with respect to the Manager's Promoted Interest, and (ii) UP TO 100% of the
Net Cash Flow from Operations otherwise distributable to it with respect to
the Manager's Investment Interest to the extent necessary to cause the
Investor Interestholders to reach Payout if, after 60 months following the
first distribution of Net Cash Flow from Operations, the Investor
Interestholders have not received distributions of Net Cash Flow from
Operations which, in the aggregate, are equal to 100% of the Investor
Interestholders' subscriptions. Any such deferral of distributions of cash to
the Manager will be recovered by the Manager from first available Net Cash
Flow from Operations after the Investor Interestholders have received
distributions of Net Cash Flow from Operations which, in the aggregate, are
equal to 100% of the Investor Interestholders' subscriptions, until such
deferrals have been recovered. See "Proposed Activities and Policies - Cash
Distributions - Subordination of Cash Distributions to Manager" and
"Participation in Costs and Revenues - Allocation of Tax Items."
To the extent that (i) the Manager's share of revenues and proceeds of
sale exceeds its capital contributions, and (ii) the administrative cost
allowance exceeds such Company's administrative costs, the Manager will have
received compensation.
THE MANAGER'S OVERRIDING NET REVENUE INTEREST. The Manager will retain a
2% overriding net revenue interest in each property after it assigns the
balance of its working interest to the Company, provided that the overall
working interest in such property exceeds 75% of the net revenue interest.
To the extent that the Manager obtains and does not re-assign this retained
overriding net revenue interest in a property, it will be entitled to a 2%
interest in the revenues of such property attributable to the working
interest (i.e., remaining after payment of the landowner and other overriding
royalties) after payment of all associated operating costs, without being
required to contribute a proportional amount of all capital required to
develop and operate wells on such property. The Manager anticipates that the
primary benefit to it of the retained overriding net revenue interest in
projects assigned by it to the Company will be to permit it to re-assign
portions of it as additional compensation to persons, who or which may
include affiliates of the Manager, who or which make working capital loans to
the Manager, primarily to enable it to acquire and "warehouse" additional gas
projects for future development. See "Proposed Activities and Policies."
ORGANIZATION AND OFFERING COSTS
The Company will pay the Manager an organizational and offering costs
allowance equal to 2.5% of Investor Interestholder subscriptions. The
Manager will pay all direct expenses of the organization of the Company and
the offering of Interests, including accounting, filing and legal fees,
printing and other costs and marketing expenses. The Manager and not the
Company will be liable for all such expenses, including any such expenses
which exceed 2.5% of subscriptions.
ADMINISTRATIVE COST ALLOWANCE
The Manager will receive the annual administrative cost allowance at the
rate of 3.5% of aggregate Investor Interestholders' capital, net of PRO RATA
returns of capital to Investor Interestholders, in each year or partial year
thereafter until the termination of the Company, commencing in the month that
the Company first realizes revenue from production, in lieu of reimbursement
for administrative costs incurred on behalf of such Company. The Manager may
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waive or defer payment of the Administrative Cost Allowance in any month
without prejudice to its right to receive such amount in any subsequent
month. The amount of the administrative costs allowance shall be adjusted
annually to reflect increases or decreases in the costs of administration in
accordance with the procedures and index published annually by the Council of
Petroleum Accountants Societies (COPAS) and shall be payable only out of
Company revenues. The administrative cost allowance will be accrued monthly
in advance to the extent not waived in advance by the Manager and be payable
out of Company revenues only. To the extent that the administrative cost
allowance for any period exceeds actual administrative costs during such
period, the Manager will receive compensation. Administrative costs incurred
during the early years of Company operations generally will exceed the
administrative cost allowance. Such unreimbursed administrative costs
incurred by the Company during such period generally will be recovered by the
Manager over a period of not more than five years after such Company is
activated. Thus, funds that might otherwise have been used by such Company
to defray its administrative costs may be used for distributions during the
this period and, conversely, after such period, some revenues will be used to
pay the administrative cost allowance which might otherwise be available for
distributions.
The administrative cost allowance received by the Manager in lieu of
reimbursement of costs incurred by the Manager to provide administrative
services to the Company will be used to defray a portion of the salaries of
its officers and employees. Salaries of "controlling persons" of the Manager
(directors, executive officers and 5% Investor Interestholders), including
Mr. Arbaugh, will not be reimbursed from the proceeds of the administrative
cost allowance. Administrative costs shall not include any item of expense
incurred by the Manager acting as Operator of Company projects. See "Direct
Costs and Costs of Operations" below.
ASSET DISPOSITION FEE
The Company will pay an asset disposition fee to the Manager equal to
3.5% of the proceeds of the sale of Company assets, upon each sale of Company
assets, prior to the distribution of the proceeds of such sale. See
"Proposed Activities and Policies - Liquidation Policies" for a more complete
description of this provision.
In the event that the Manager is removed as managing Interestholder of
the Company by vote of the Investor Interestholders other than for cause,
such Company shall be required to pay an amount to the Manager equivalent to
the asset disposition fee which would have been payable to the Manager if
such Company had sold all of its assets on the day of such removal for an
amount equal to sixty times the average monthly gross revenues of the Company
for the immediately preceding 12 months.
DIRECT COSTS AND COSTS OF OPERATION
Each Company shall pay all direct costs and costs of operation of such
Company directly from Company assets (or, in the case of operating costs,
such costs may be deducted from such Company's share of revenues from the
sale of production prior to the distribution of such amounts to such Company
by the Operators). To the extent that "controlling persons" of the Manager
(directors, executive officers and 5% Investor Interestholders) provide
actual professional services to the Company (i.e., property selection or
management, preparation of reserve or financial information, etc.) directly
related to Company operations, salaries of such persons may be reimbursed as
a direct cost; provided, however, that the total annual reimbursement for all
such persons' salaries shall not exceed an amount equal to .4% of
subscriptions. The Manager may cause the Company to retain and compensate
the Manager and/or its affiliates, on an accountable time-and-charges or
other basis, for services provided directly to the Company in connection with
the monitoring of such Company's assets and the operation thereof by the
Operators and in supervising the activities of the Operators specifically
with respect to such Company's projects which do not constitute customary,
routine or recurring administrative tasks in connection with the
administration of such Company's day-to-day business.
The reimbursement described above is without regard to the profitability
of the Company, and, to the extent that it includes a portion of such
salaries, may be deemed compensation to the Manager. When acting as the
Operator of projects in which the Company holds an interest, the Manager will
not receive any compensation but will be reimbursed for actual costs and
expenses incurred in providing such operating services, including a charge
for allocable
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administrative costs. In circumstances where the Manager does not act as
Operator for the Company property, the Manager will not charge such Company
any direct fees for monitoring well operations and/or Operators, but will be
entitled to reimbursement only for those related expenses, including direct
costs payable to affiliates, actually incurred by it.
In many instances, the Manager will advance and disburse monies for the
payment of direct costs incurred in connection with Company operations, and
will be reimbursed by such Company for such expenditures. Such procedures
are consistent with standard gas industry practice and will be reviewed by a
firm of independent public accountants in connection with their examination
of the financial statements of the Company.
POSSIBLE TURNKEY PROFIT
Each Company will pay the Turnkey Cost to the Manager in exchange for the
services described under "Proposed Activities and Policies - Turnkey
Agreement." To the extent, if any, that the amount payable to the Operators
by the Manager for such services is less than the Turnkey Cost, the Manager
will receive compensation.
MANAGEMENT FEE
The Manager will receive a Management Fee equal to 3.5% of subscriptions,
payable in the year such subscriptions are received by the Company, for its
services in administering the activities of such Company in the year of such
payment.
OTHER BENEFITS
To the extent that the Manager incurs expenses for which it is reimbursed
by the Company, it may be deemed to have received a benefit. Any interest
charged on loans to the Company by the Manager may be considered additional
compensation.
CONFLICTS OF INTEREST
Transactions between the Company and the Manager or its affiliates
(including individual Companies in the Program) will involve various
conflicts of interest. With respect to these and all other areas of
conflict, the Manager will exercise its fiduciary duties toward the Company.
Prospective purchasers should consider the disclosures set forth elsewhere in
this Prospectus, as well as the following matters.
ACTIVITIES OF THE MANAGER AND ITS AFFILIATES
The Manager will be free to engage independently of the Company in all
aspects of the gas business for its own account and for the accounts of
others, subject to certain express limitations contained in the Company
Operating Agreement prohibiting it from conducting certain operations or
obtaining services or facilities for the Company or for affiliated entities
that may own non-operating interests in projects in which the Company own
working interests in a manner or in areas where such operations, services or
facilities might benefit the Manager or its affiliates. The Manager does not
intend to conduct any operations or obtain any services or facilities in a
manner designed to benefit it or its affiliates at the expense of the Company.
The Manager's Articles of Organization provide that no contracts or other
transactions between it and any of its directors or other entities in which
the directors are financially or otherwise interested shall be automatically
invalidated by the fact that one or more of the Manager's directors or
officers is interested in or is a director or officer of such other entity,
or by the fact that any director or officer of the Manager, individually or
jointly with others, may be a party to or may be interested in any such
contract or transaction. The Articles relieve these persons from any
liability that might automatically arise by reason of contracts with the
Manager for their benefit or the benefit of any other firm in which
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they have an interest. The Articles do not prevent such contracts from being
invalidated if entered into or preceded by a breach of fiduciary duty to the
Manager by any officer or director, nor do they relieve any officer or
director from liability for breach of fiduciary duty. Such liability may be
enforced only by the Manager, however, or by an Investor Interestholder on
behalf of the Manager, in accordance with Michigan law.
As a consequence of the foregoing, the officers and directors of the
Manager generally are not limited from competing with the Manager of the
Company in the gas business, but must exercise their business judgment
consistent with their fiduciary responsibilities to those entities. These
arrangements may give rise to conflicts of interest with the Manager and the
Company. The Manager will have a majority of the non-interested members of
its board of directors evaluate and authorize any transactions in which any
other officer or director has a direct or material indirect interest.
It is the Manager's policy that neither the Manager nor its affiliates
will acquire projects, other than those necessary to protect adjacent
property already acquired by the Manager in anticipation of transfer to
future income programs, until substantially all of the aggregate net
subscriptions budgeted for the purchase of Company projects have been
expended or committed for expenditure. The Manager and its affiliates may
acquire working interests in gas projects which will not be offered to the
Company, and as to such projects the foregoing restrictions will not apply.
No restrictions are imposed on directors or shareholders of the Manager or
its affiliates who are not also officers.
Under certain extraordinary circumstances, the Manager or its affiliates
may act as sole Operator of some or all of the Company' projects and in such
case, will be reimbursed for its costs, including allocable Direct Costs paid
on behalf of the Company and Administrative Costs in accordance with
customary industry practice. The Manager will also provide management
supervision, geological and related services for the Company, but will be
entitled to reimbursement only for expenses, including Direct Costs and
Administrative Costs, actually incurred by it in connection with such
activities. See "Compensation." As Operator of Company projects, the
Manager would have the exclusive right to sell Company production and would
endeavor to obtain the highest competitive price. The Manager is not
prevented from engaging in other business transactions with purchasers of gas
production. Such transactions may be facilitated by the sale of Company
production.
All operating and other agreements entered into on behalf of the Company
with the Manager or its affiliates shall be in writing, shall precisely
describe the services to be rendered and all compensation to be paid and,
excluding the Company Operating Agreement itself and agreements with
entities, shall be subject to cancellation by the Manager or its affiliates
without penalty on 60 days prior written notice and, if permitted by law, by
a majority in interest of the Investor Interestholders, without penalty, on
60 days prior written notice, subject to the conditions of the Company
Operating Agreement and provided such action will not cause the Investor
Interestholders to lose their limited liability or adversely affect the
federal income tax status of the Company. See "Summary of the Company
Operating Agreement - Voting and Other Rights of Limited Investor
Interestholders" and "Tax Aspects - Partnership Status."
Neither the Manager nor any affiliate (except other entities sponsored by
affiliates of the Manager) shall enter into any agreement with the Company
where an interest in production is payable to the Manager or an affiliate in
consideration for services to be rendered. However, the Manager will receive
a 2% overriding royalty interest in each interest in a project acquired by
the Company (provided, however, that the working interest in such project
must exceed 75% of the net revenue interest in the project) which will
entitle it to receive and amount equal to 2% of the grass amount of revenue
from sale of production without deduction for operating costs attributable to
such production.
No loans or advance payments will be made by the Company to the Manager
or any of its affiliates. All benefits derived from marketing or other
relationships affecting property of the Company and the Manager and its
affiliates shall be fairly and equitably apportioned according to the
respective interests of each. The Manager will not take any action with
respect to the assets or property of the Company which does not primarily
benefit the Company as a whole, including the utilization of Company funds as
compensating balances for its own benefit and future commitments of
production.
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MANAGEMENT OF OTHER ENTITIES
Affiliates of the Manager are currently the managers of natural gas
investment programs which have already commenced operations and of others
which it is anticipated will commence operations shortly, and the Manager and
its affiliates expect in the future that they will serve as general partner
or managing interestholder of other gas programs. The Manager or its
affiliates may also act as a partner with other gas companies, institutions
or private investors in other entities formed to search for gas or to acquire
non-operating interests in producing gas projects. Programs similar to this
Program may also be formed by the Manager or its affiliates in the future.
Companies (including the Company and other Companies formed in this Program)
and other entities managed, directed or controlled by the Manager may, in
fact, be viewed as competing with one another for available property
acquisitions. Although the Manager may determine the extent and nature of
each party's participation in a property acquisition, the determination of
the Manager will be based, in large part, on the amount of unexpended funds
of each party, the respective periods of time any such parties are in
existence, the desire to insure broad participation in all available property
acquisitions and the type of investment which each party is entitled to
make. See "Proposed Activities - Uncommitted Capital Funds of Other
Companies." However, subject to diversification considerations, to the
extent that several Companies have uncommitted net subscriptions available
for property purchases, the Manager intends to cause prior Companies to
participate in all property purchases available to subsequent Companies.
The Company may also participate in joint acquisitions or joint ventures
with the Manager or its affiliates. Although the Manager will be in a
position to determine the terms of any such joint acquisitions or joint
ventures, it has a fiduciary duty to act fairly with respect to the Investor
Interestholders.
In addition, because the Manager has agreed to return to the Investor
Interestholders any portion of the Company's net subscriptions that has not
been used or committed within the first two years after commencement of its
operations (see "Proposed Activities - Uncommitted Capital Funds of Other
Companies"), the Manager's determination as to whether a particular property
is suitable for purchase made at a time immediately prior to the expiration
of such period may be subject to a conflict of interest. The Manager has a
fiduciary obligation to act in the best interests of the Company and does not
believe that such potential conflict has adversely affected any such past
determination.
The Manager will make all decisions regarding the allocation of property
purchases and costs between and among its affiliates, including the Company
and other Companies formed in this Program, including decisions affecting
matters such as the consideration to be paid in transactions between such
parties. See, however, " - Property Acquisitions and Dispositions" below.
PROPERTY ACQUISITIONS AND DISPOSITIONS
The Manager will pay only the portion of the costs of acquiring producing
projects as is attributable to the Manager's Investment Interest, but will
generally receive a portion of all revenues from the sale of gas produced
from Company projects in addition to the portion attributable to the
Manager's Investment Interest plus the Manager's Promoted Interest. Since
the Manager is entitled to receive a share of the Company's net revenues, it
will be in the Manager's interest to cause the Company to acquire projects as
quickly as possible so that revenues will become available for distribution.
Depending upon whether or not there is sufficient gain on the sale of the
Company property, the Manager may receive up to 30.24% of the proceeds of a
sale of a producing property in addition to the cash attributable to the
Interests it owns, if any, unless the property is earmarked for sale at the
time of acquisition or the proceeds of such a sale are intended to provide
funds to acquire other projects. In either of such cases, the Manager will
be allocated only such proceeds as are attributable to the Manager's
Investment Interest, but will be allocated an amount equal to the Manager's
Investment Interest plus the Manager's Promoted Interest of any loss. See
"Participation in Costs and Revenues." The difference between the Manager's
share of Company net revenues which are derived from sale of gas production
and its share of the proceeds from sales of Company projects may create a
conflict of interest in the Manager's decision whether to sell property.
Except to the extent described in the preceding paragraph, the Company will
not acquire any projects with a view
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to their subsequent sale, and projects will be sold only if events subsequent
to their acquisition cause the Manager to believe their sale is in the best
interests of the Investor Interestholders. The decision to farmout and the
terms of any farmout agreement may also present a conflict of interest for
the Manager insofar as the Manager may benefit from cost savings and a
reduction of risk, and in the event of a farmout to an affiliated limited
partnership or Company, the Manager will represent both entities.
The Manager has agreed to prohibitions and restrictions in several areas
of possible conflict involving the interests of a manager and its affiliates
and the interests of the entities it manages and their partners or Investor
Interestholders. Included are (i) prohibitions or restrictions relating to
sales of property to the Company by the Manager or its affiliates, or
purchases of property from the Company by them; (ii) formulas for determining
the cost of property either sold to the Company or purchased from it by the
Manager or its affiliates; (iii) conditions regarding the sale of the
Company's undeveloped leasehold interests to the Manager or its affiliates,
including the method of allocating the purchase price between producing
projects and undeveloped leasehold interests under circumstances where an
affiliated drilling program has joined with a production purchase program in
acquiring property; (iv) restrictions on the Company's ability to purchase
projects from affiliated entities, or to sell its projects to other entities;
and (v) limitations on farmouts of Company property.
The Manager or its affiliates may in the future administer other property
acquisition programs in which the Manager or another of the Manager's
affiliates may have greater compensation or a greater share of revenues than
is provided in this Program. Thus, since the Manager or its affiliates will
be in a position to determine the terms of any sharing arrangements among
entities controlled by it, it may be advantageous to it to favor one entity
over another since the income participation of the Manager or its affiliates
may vary among entities. Also, because the Company may acquire and own the
underlying working interest in projects in which other affiliates will
acquire and own non-operating interests, various specific conflicts of
interest will be inherent in connection with the acquisition, ownership and
management of such interests. Because the Manager has a fiduciary duty to
act fairly with respect to the partners and Investor Interestholders in each
entity, the Manager has established certain guidelines to mitigate such
conflicts.
If, at any time, two or more affiliates or other entities managed,
directed or controlled by the Manager are engaged in purchasing interests in
producing projects, the Manager, in its discretion, may cause such affiliates
to participate with the Company on such basis as the Manager determines. In
cases involving net profits royalties, the primary factor in determining the
sharing of net profits between the working interest acquired or owned by the
Company and the net profits royalty acquired by an affiliated entity will be
the amount of money contributed to the acquisition by each purchaser. In
fixing such sharing percentages, the Manager does not expect to give special
consideration to risks associated with the ownership of the working interest
or to costs of equipment which will be owned by the Company as working
interest owner in arriving at the amount of net profits from which the net
profits royalty holder's share of production is determined. If the
non-operating interest acquired by an affiliated entity is a landowner's
royalty, overriding royalty or production payment in a producing property in
which a working interest is acquired or owned by the Company, the
determination of the prices to be paid for the working and non-operating
interests, respectively, will be substantially more complex.
In such circumstances, if each participant in a transaction acquires a
different type of interest in the same property, as will typically be the
case when affiliated entities acquire non-operating interests (other than net
profits royalties) that are carved out of working interests acquired or owned
by the Company, then provided that the Manager's revenue interest in the
affiliated entity is substantially similar to or less than its revenue
interest in the Company, each participant's portion of the purchase price
will be determined on the basis of an appraisal of the fair market values of
the respective interests in the property being acquired (taking into account
the tax consequences applicable to the several participants) by petroleum
reservoir engineers retained by the Manager. If the Manager or an affiliate
other than an affiliated entity acquires or owns an interest in any such
property acquisitions, such appraisal will be performed by an Independent
Expert. If the revenue interest of the Manager and its affiliates in any
affiliated entity participant in such a property acquisition is greater than
their revenue interest in the participating Companies, then with respect to
the property interests so acquired the greater revenue interest shall be
reduced so as not to exceed the lesser revenue interest. Investors should
note that appraisals, even by Independent Experts, are only estimates of
value and may not represent
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measures of the realizable value.
Interests in producing projects may be transferred among affiliates with
a view toward achieving the investment objectives of the various participants
so long as no profit accrues to the Manager or its affiliates at the expense
of any other affiliate, including the Company. The conflicts which exist
among Companies formed pursuant to this offering would also exist among the
Company on the one hand and other affiliates formed to acquire non-operating
or other interests in producing projects on the other hand. Such conflicts
include, in addition to those described above, determinations of what type of
non-operating interest to create and the risks relating thereto.
MANAGEMENT
The Manager, Wolverine Energy, L.L.C., was formed in 1995 to act as
managing equity owner of investment entities in natural gas development
projects. The Manager generally has no significant assets or liabilities
other than its fees and expenses receivable from various affiliated
investment entities of which it is the managing equity owner. The principal
executive offices of the Manager and of all of the affiliated corporations
and other entities described below is at 4660 South Hagadorn Road, Suite 230,
East Lansing, Michigan 48823; telephone (800) 800-9949. At December 31,
1996, the Manager and its subsidiaries and affiliates, had seven full-time
equivalent employees.
WOLVERINE ENERGY, L.L.C.
Wolverine Energy, L.L.C., (i.e.., the Manager) is a Michigan limited
liability company which was organized to continue the business of a group of
affiliated entities of which Mr. Arbaugh was a 50% equity owner
(collectively, the "Prior Manager") and through which Mr. Arbaugh had
previously conducted his/her natural gas investment business. The Manager
was formed by Mr. Arbaugh after the reorganization of the business of the
Prior Manager and the termination of the activities of the Prior Manager as
an organizer of new natural gas development projects. All of the outstanding
capital stock of the Manager is owned by Mr. Arbaugh, who is its sole
executive officer and director.
The principal business of the Manager is the design, organization and
management of oil and gas investment programs. Since its formation in
November 1995, the Manager has served as sole managing trustee and
shareholder of one natural gas development investment program organized as a
Delaware business trust, and is currently serving as managing interestholder
of natural gas well development programs organized as Michigan limited
liability companies (including each prior Company). More recent information
with respect to the activities of the Manager in the design, organization and
management of such programs can be found in the applicable Supplement to this
Prospectus.
The Manager organizes and manages gas well exploration, development or
production programs. The Manager does not act as driller or primary Operator
of such programs. The Manager's investment philosophy is to align itself, as
investor and investment manager, with gas Operators with demonstrable track
records of drilling, completing and operating commercially successful natural
gas wells. Through the personal affiliations of Mr. Arbaugh in the oil and
gas industry in the geographical areas in which it operates, active
membership in the Michigan Oil and Gas Association and the Independent
Petroleum Association of America, Mr. Arbaugh as principal of the Manager has
been able to establish relationships with consistently successful Operators
and has an ongoing opportunity to participate in promising and/or
commercially successful prospects and producing projects.
THE PRIOR MANAGER
The Prior Manager was formed to continue the natural gas investment
business of Messrs. Arbaugh and others which was begun in 1978. The Prior
Manager reorganized its business and affairs in 1995, at which time it ceased
to be engaged in the organization of new natural gas development programs.
From 1983 until its aforementioned reorganization in 1995, the principal
business of the Prior Manager was the design, organization and management of
oil and gas investment programs. The Prior Manager also participated in
and/or managed "wildcat" drilling investment programs during that period.
The Prior Manager has served as sole managing general partner of 23 Antrim
shale
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formation natural gas drilling investment programs. Financial information
with respect to 20 of these Antrim partnerships is provided herein under the
caption "Prior Activities." No information is provided herein with respect
to the remaining 3 Antrim partnerships because they were privately negotiated
transactions involving a single large investor and differ substantially in
structure from the partnerships with respect to which information is provided
herein and with the Company. The Prior Manager has also participated in
drilling projects and in partnership with gas industry institutional partners
in the exploration for natural gas on prospects located in Colorado,
Oklahoma, Utah, California, Ohio and Michigan. The Prior Manager's
non-Antrim experience includes two gas projects in Colorado, several oil
wells in a single project in Oklahoma and several Niagaran oil and gas
projects in Michigan.
AFFILIATED COMPANIES
Mr. Arbaugh is an owner of 50% of the equity securities of Wolverine
Multi-Vest, a real estate investment company, the principal activity of which
is the design, organization and management of real estate investment
programs, including "tax shelters;" its principal executive office is at 1111
Michigan Avenue, Suite 301, East Lansing, Michigan 48823; telephone (517)
351-3333.
Mr. Arbaugh is also an equity investor, though not individually or with any
affiliate with a controlling interest, in the following companies:
MOBILE INFORMATION SERVICES, INC. - pager interface trust company
operating in Chicago, Illinois
WOLVERINE TOWERS, INC. - owner of radio and television transmission
tower in Lansing, Michigan
SUPERBROKERS, INC. - yacht brokerage located in Traverse City,
Michigan
Mr. Arbaugh is a principal shareholder and Chairman of:
BAYSIDE BEVERAGE CORPORATION - distributor of Miller Brewing Co.
products in and around Petoskey, Michigan
EXECUTIVE OFFICERS AND DIRECTORS
The sole shareholder, executive officer and director of the Manager is:
GEORGE H. ARBAUGH, JR., age 57, President and Director. Mr. Arbaugh
is and has been for more than the past five years President and a Director
of the Manager and the Prior Manager and their respective affiliates. Mr.
Arbaugh was awarded a bachelors degree in Economics from Michigan State
University in 1963. He was sole proprietor of a chain of sporting goods
stores in Michigan from 1969 until he sold that business in 1977. From
1977 until 1979, Mr. Arbaugh acted as an independent consultant and sales
representative for a major sporting goods manufacturer. Mr. Arbaugh
acquired his interest in the Prior Manager in 1979 and was actively engaged
in its activities full time from that time until its reorganization in
November 1995; Mr. Arbaugh remains actively engaged in the business of the
Prior Manager on a less than full-time basis. Mr. Arbaugh has been active
in the oil and gas investment business since 1979 for his own account and
through investment entities. Mr. Arbaugh formed the Manager in November
1995 and has been actively engaged in its activities full time since that
time.
GARY L. FOLTZ, AGE 56, Executive Vice President and Chief Operating
Officer. Mr. Foltz has been Executive Vice President and Chief Operating
Officer of the Manager since May 1, 1997. Mr. Foltz's main responsibility
is to oversee and manage the operations of the Manager. Mr. Foltz was
awarded a bachelors degree in Business Administration and a Juris Doctorate
Degree in 1968 from the University of Kentucky. Mr. Foltz was employed for
two years by the State of Kentucky and for three years by First Kentucky
Trust Company, Louisville, Kentucky, as a specialist in personal estate and
tax planning. In 1973, Mr. Foltz joined Dooley's, Inc., a developer and
operator of restaurants and night clubs in university communities. He was
personally involved in the planning and development of four Dooley's units,
representing an investment exceeding five million dollars ($5,000,000), and
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the employment of over three hundred (300) employees. In addition to his
restaurant experience, Mr. Foltz has served as general partner and manager
of various business developments outside the oil and gas industry. Mr.
Foltz is also a major stockholder and director of Crystal Computer
Corporation in San Jose, California. He is the 100% owner of a hospitality
industry consulting company, and investor/developer of several real estate
projects.
CHARLES B. TEOPFER, AGE 56, Senior Vice President, Sales and
Marketing. Mr. Toepfer has been Senior Vice President, Sales and Marketing
since January 1, 1997. Mr. Toepfer's main responsibility is to expand and
support the selling group members. From 1985 until 1990, Mr. Toepfer was
Senior Vice President of ATEL Securities Corporation. Mr. Toepfer was also
employed by Ridgewood Energy Corporation and City Equity Group. Mr. Teopfer
held NASD Series 24, 7 and 63 licenses from 1972-1994.
EXECUTIVE COMPENSATION
The Company will reimburse the Manager for direct costs incurred by or on
behalf of the Company and will pay the Manager the administrative cost
allowance, subject in each case to the limitations and conditions set forth
under the heading "Compensation and Reimbursement - Direct Costs and Costs of
Operation" and " - Administrative Cost Allowance." These payments to the
Manager will not include compensation and expenses attributable, on the basis
of time spent and logged, to services provided by affiliates of the Manager
directly to the Company for services which are not related to customary,
routine and recurring activities in connection with the administration of the
Company's day-to-day business.
FIDUCIARY OBLIGATIONS AND INDEMNIFICATION OF MANAGER
A manager is accountable to a limited liability company as a fiduciary
and consequently must handle company affairs with trust, confidence and good
faith, may not obtain any secret advantage or benefit from the Company and
must share with it all business opportunities clearly related to the subject
of its operations. In contrast to the relatively well-developed state of the
law concerning fiduciary duties owed by officers and directors to the
shareholders of a corporation or by the general partner to the limited
partners of a limited partnership, the law concerning the duties owed by
managers of a limited liability company to its members is relatively
undeveloped. The Act does not prohibit limited liability companies from
restricting or expanding the liabilities of managers to the company and
members of such company in the operating agreement or Articles. In order to
induce the Manager to act as trustee for and manage the business of the
Company, Article 3 of the Company Operating Agreement contains various
provisions that are designed to mitigate possible conflicts of interest (see
"Conflicts of Interest") which may have the effect of restricting the
fiduciary duties that might otherwise be owed by the Manager to the Company
and the holders of Interests or which waive or consent to conduct by the
Manager that might otherwise raise issues as to compliance with fiduciary
duties. Because this is a rapidly developing and changing area of the law
and there is virtually no case law on the subject, the Manager has not
obtained an opinion of counsel covering the provisions of the Company
Operating Agreement which purport to waive or restrict fiduciary duties of
the Manager. Investor Interestholders who have questions concerning the
duties of the Manager should consult their counsel.
Because the Manager will make all decisions relating to the Company and
the Company will not have any employees, the officers and directors of the
Manager will make such decisions. The directors and officers of the Manager
have fiduciary duties to manage the Manager, including its investments in its
affiliates, in a manner beneficial to the shareholders of the Manager.
Because the Manager has a fiduciary duty to manage the Company in a manner
beneficial to the Investor Interestholders and owes a similar duty to the
Investor Interestholders of every Company it manages, certain conflicts of
interest could arise. Article 12 of the Company Operating Agreement contains
many provisions that restrict the Manager's freedom of action in order to
mitigate possible conflicts of interest. Not every possible conflict can be
foreseen, however. Therefore, the Company Operating Agreement provides that
whenever a conflict of interest arises between the Manager or its affiliates,
on the one hand, and the Company or any Investor Interestholder(s), on the
other hand, for which no express standard is contained in the Company
Operating Agreement, the Manager will, in resolving such conflict or
determining such action, consider the relative interests of the parties
involved in such conflict or affected by such action, any customary or
accepted industry practices, and, if applicable,
69
<PAGE>
generally accepted accounting practices or principles. Thus, unlike the
strict duty of a trustee who must act solely in the best interests of his/her
beneficiaries, the Company Operating Agreement permits the Manager to
consider the interests of all parties to a conflict of interest, including
the interest of the Manager and its affiliates and other entities to which
the Manager or its affiliates owe a fiduciary duty, provided the Manager acts
in a manner that is fair and reasonable to the Company or the Investor
Interestholders.
The Act provides that an Investor Interestholder (whether Participating
or Non-Participating) may institute legal action on behalf of the limited
liability company (an Investor Interestholder's derivative action) to recover
damages from the Manager or from a third party where the Manager has refused
to institute the action or where an effort to cause the Manager to do so is
not likely to succeed. In addition, the statutory or case law of certain
jurisdictions may permit an Investor Interestholder to institute legal action
on behalf of all other similarly situated Investor Interestholders (a class
action) to recover damages from the Manager for violations of its fiduciary
duties to the Investor Interestholders.
The Act provides that a limited liability company is permitted to
indemnify a Manager against expenses incurred in the defense of an Investor
Interestholder derivative action if the Manager acted in good faith and in a
manner reasonably believed to be in or not opposed to the best interests of
the Company. No indemnification is permitted if the Manager was liable for
negligence or misconduct unless a court orders that under all the
circumstances indemnity is proper. The Company Operating Agreement makes
this indemnification mandatory and extends it to affiliates of the Manager.
Because the Act authorizes but is otherwise silent on additional
indemnification rights, the Company Operating Agreement also provides for
indemnification of the Manager and its affiliates by the Company against
losses and liabilities sustained by them in connection with the Company,
provided that the same were not the result of negligence, a failure to act in
good faith or misconduct on the part of the Manager or its affiliates.
Notwithstanding the above, and subject to the provisions of the Act, the
Manager and its affiliates and any person acting as a Soliciting Dealer shall
not be indemnified for any losses, liabilities or expenses arising from or
out of an alleged violation of federal or state securities laws unless (1)
there has been a successful adjudication on the merits of each count
involving alleged securities law violations as to the particular indemnitee
and the court approves indemnification of the litigation costs, or (2) such
claims have been dismissed with prejudice on the merits by a court of
competent jurisdiction as to the particular indemnitee and the court approves
indemnification of the litigation costs, or (3) a court of competent
jurisdiction approves a settlement of the claims against a particular
indemnitee and the court finds that indemnification of the settlement and
related costs should be made. Moreover, in any claim for indemnification for
federal or state securities law violations, the party seeking indemnification
shall place before the court the position of the U.S. Securities and Exchange
Commission, the Massachusetts Securities Division and any other applicable
regulatory authority (including, in the case when an Investor Interestholder
has filed the claim as plaintiff, the state in which such Investor
Interestholder was offered or sold Interests) with respect to the issue of
indemnification for securities law violations. It is the position of the
U.S. Securities and Exchange Commission that, to the extent that
indemnification provisions purport to include indemnification for liabilities
arising under the Securities Act of 1933, as amended, such indemnification is
contrary to public policy and, therefore, unenforceable.
See Article 3 of the Company Operating Agreement for further information
regarding indemnification of the Manager and its affiliates.
PRIOR ACTIVITIES
The Prior Manager, of which Mr. Arbaugh is a 50% equity owner and
President, and of which Mr. Arbaugh shares management responsibilities, has
participated in the sponsorship, organization and management of 28 limited
and/or general partnerships and Delaware business trusts (collectively, the
"Prior Antrim Programs") since 1988 which have acquired interests in Antrim
shale formation development projects, participated in the drilling and
completion of development wells on such projects and shared in the proceeds
of the sale of gas from such projects after they were put into production.
The Manager has participated in the sponsorship, organization and management
of a single Delaware business trust in 1995 which was organized and raised
funds to acquire interests in Antrim shale formation natural gas
70
<PAGE>
development projects and is engaged in the acquisition of such interests
currently, as of the date of this Prospectus.
Set forth below are summaries of historical results of the Prior Antrim
Programs which, it should be noted, engaged in activities similar to those in
which the Company will engage. Such summaries of the results of the Prior
Antrim Programs may not be relied upon as indicative of the results that can
be anticipated by the Company because (i) variations in industry
circumstances, income tax effects, economic conditions and location from time
to time can and often do have a material effect on the performance of any
investment in an entity organized to develop and realize production from gas
reserves, and (ii) no assurance can be given that any Company will achieve
results comparable to any other entity sponsored or managed by the Prior
Manager, the Manager or their affiliates. The following tables summarize, as
of December 31, 1996, the capital contributions and cash distributions to the
Prior Manager, as managing general partner or managing trustee and
shareholder and investor general and limited partner unit holders of the
Prior Antrim Programs, as well as general and administrative expense
reimbursement, revenues, operating expenses and direct costs of such programs.
IDENTIFICATION AND INITIAL CAPITALIZATION OF PRIOR ANTRIM PROGRAMS
This schedule provides a brief summary of the initial capitalization and
dates of commencement of operations (NOT of the offering of interests to
investors) of each of the Prior Antrim Programs. Prospective investors in
Interests should note that the information pertaining to the first year of
operations of each Prior Antrim Program contained in the succeeding schedules
has not been annualized and that, therefore, the amounts, and particularly
the percentages, of the administrative costs and direct costs incurred in the
first year of operations may not be directly comparable from partnership to
partnership and should be read in conjunction with the information on this
schedule setting forth the date of commencement of operations. However, as
with each of the Prior Antrim Programs, these programs were organized and
capitalized with the intent to acquire working interests in specific Antrim
shale development projects which were identified to the investors in such
Prior Antrim Programs at the time that their investment was solicited and
obtained. In any event, the capital of such Prior Antrim Programs has been
fully invested only in the projects which were identified to their investor
partners at the time of subscription and all operations with respect to such
projects will be conducted by such Operators, thereby precluding any conflict
of interest on the part of the Prior Manager, the Manager or their affiliates
between such Prior Antrim Programs and the Company in either (i) the
selection of projects in which any Company will invest, or (ii) the
operations of any Company.
ADMINISTRATIVE COSTS INCURRED AND AS A PERCENTAGE OF GROSS SUBSCRIPTIONS
This schedule provides information with respect to the amounts paid by
each Prior Antrim Program to the Prior Manager or its affiliates as its
portion of the administrative costs incurred by the Prior Manager an behalf
of all affiliated programs in the years identified. Such expenses were
allocated to the specific Prior Antrim Program on a cost basis in accordance
with generally accepted accounting principles or standard industry practices
which may have been in effect by allocating the time spent by the Prior
Manager's personnel among all projects conducted by the Prior Manager for its
own account, joint ventures or other affiliated programs and by allocating
rent and other overhead on the basis of relative direct time charges. That
percentage of such costs attributable to a specific Prior Antrim Program's
activities generally has been similarly allocated to specific Prior Antrim
Programs, except that the costs of acquiring projects will not be taken into
account for this purpose. Administrative costs are allocated on a PRO RATA
basis determined according to the number of net wells in production twelve
months following closing. It should be noted, however, that the amount of
administrative costs incurred by each Prior Antrim Program IN ITS FIRST
TWELVE MONTHS OF OPERATIONS reflects (i) the greater level of administrative
involvement by the Prior Manager during the "start up" phase of the
partnership's operations, and (ii) the portion of the year during which such
partnership is in operations. These two factors tend to have opposite
effects on the level of administrative costs incurred in the first year of
operations and render information with respect to such costs less indicative
of the operating efficiencies (or inefficiencies) of the Prior Manager and
its affiliates than information with respect to later years when operations
have assumed greater regularity and economies of scale in operations can be
realized.
71
<PAGE>
DIRECT COSTS INCURRED AND AS A PERCENTAGE OF GROSS SUBSCRIPTIONS
This schedule provides information with respect to the amounts paid by
each Prior Antrim Program directly to unaffiliated vendors for services
rendered to such partnership in the years identified; the types of services
provided in connection with these payments are described in "Compensation and
Reimbursement - Direct Costs and Costs of Operation." It should be noted,
however, that the amount of direct costs incurred by each Prior Antrim
Program IN ITS FIRST YEAR OF OPERATIONS reflects (i) non-recurring costs
incurred in connection with the organization of the program and the offering
of interests therein to investors, including, but not limited to, legal,
accounting and engineering fees, printing costs, registration and similar
fees and reimbursements for travel, entertainment and other costs incurred in
connection with the review of projects in which such program acquired a
working interest and the negotiation and execution of such acquisition, and
(ii) the portion of the year remaining following the commencement of
operations by such programs. These two factors tend to have opposite effects
on the level of direct costs incurred in the first year of operations and
render information with respect to such costs less indicative of the
operating costs of the programs than information with respect to later years
when such services are not typically required, other than with respect to
annual audit and tax return preparation services.
PRIOR MANAGER OPERATING RESULTS IN PRIOR PROGRAMS THROUGH 12/31/96 AND
INVESTOR OPERATING RESULTS IN PRIOR PROGRAMS THROUGH 12/31/96
These schedules provide actual operating financial information with
respect to each of the Prior Antrim Programs since their respective
commencements of operations. No attempt has been made to provide annualized
information with respect to revenues, operating, administrative or direct
costs, allocable profits (losses) from operations or cash distributions to
investor partners, primarily because of the differences in tax circumstances
of each investor partner and the relatively short investment history of the
Prior Antrim Programs. Investors who wish to analyze the data contained in
this schedule to compute annualized results are cautioned to take into
account (i) the time during the initial year of operation when each Prior
Antrim Program commenced operations, and (ii) the fact that each of the Prior
Antrim Programs is still in the early stages of its anticipated productive
life. Therefore, the revenue and cost data reflect the ramp-up in revenues
and high early-stage costs typical of development gas projects and do not
reflect the anticipated greater profitability of each well that will be
experienced when (i) production and, therefore, revenues have reached their
peak and leveled off, (ii) the high initial expenses of drilling, completing
and equipping a well for production have been realized, and (iii) the
relatively lower expenses of ongoing production are the only operating costs
of the wells.
The constituent agreements of the Prior Antrim Programs provide that all
of the deductible administrative and direct costs of the programs are
allocated 100% to the investors and the Prior Manager-affiliate manager
participates only in revenues and operating costs on the terms specific to
each entity, and the schedules appropriately reflect that. Investors who
wish to analyze the Prior Antrim Programs in terms of their respective
overall performance must aggregate the revenues and costs data from the two
schedules to compute total revenues and costs for each program.
A description of the information provided under each of the descriptive
column headings is provided below:
CUMULATIVE REVENUES THROUGH 12/31/96 - the allocable portion of
the program's cumulative revenues from sales of gas from commencement
of operations through December 31, 1996, inclusive, allocated as
provided in the respective program's equityholders' agreement.
CUMULATIVE OPERATING COSTS THROUGH 12/31/96 - the allocable
portion of the program's share (as a working interest holder in one or
more projects) of cumulative operating costs of the projects from
commencement of operations through December 31, 1996, inclusive, as
determined by the Operator of the projects (not an affiliate of the
Prior Manager) in accordance with the respective operating agreements
with respect to each property and the program's corresponding working
interest therein, allocated as provided in the respective program's
equityholders' agreement.
72
<PAGE>
CUMULATIVE ADMINISTRATIVE COSTS THROUGH 12/31/96 - the program's
share of cumulative administrative costs of all programs administered
by the Prior Manager from commencement of operations of the respective
program through December 31, 1996, inclusive, as determined by the
Prior Manager or its affiliates in accordance with the procedure
described above in " - Administrative Costs Incurred and As a
Percentage of Gross Subscriptions", allocated 100% to the investor
partners as provided in the respective program's equityholders'
agreement.
CUMULATIVE DIRECT COSTS THROUGH 12/31/96 - the program's direct
costs from commencement of operations of the respective program
through December 31, 1996, inclusive, as determined by the Prior
Manager or its affiliates in accordance with the procedure described
above in " - Administrative Costs Incurred and As a Percentage of
Gross Subscriptions", allocated 100% to the investor partners as
provided in the respective program's equityholders' agreement.
CUMULATIVE CASH FLOW FROM OPERATIONS THROUGH 12/31/96 - the
program's net operating cash flow from commencement of operations
through December 31, 1996, inclusive, prior to reductions to reflect
the program's direct costs or allocable share of administrative costs,
allocated as provided in the respective program's equityholders'
agreement (reflects difference between "Cumulative Revenues Through
12/31/96" and "Cumulative Operating Costs Through 12/31/96").
CUMULATIVE CASH FLOW THROUGH 12/31/96 - the program's net cash
flow from all sources from commencement of operations through December
31, 1996, inclusive, allocated as provided in the respective program's
equityholders' agreement (reflects difference between "Cumulative Cash
Flow From Operations Through 12/31/96" and "Cumulative Administrative
Costs Through 12/31/96" plus "Cumulative Direct Costs Through
12/31/96").
CUMULATIVE REVENUES DISTRIBUTED THROUGH 12/31/96 - the program's
actual cash distributions to partners, regardless of source, from
commencement of operations through December 31, 1996, inclusive,
allocated as provided in the respective program's equityholders'
agreement.
CUMULATIVE SECTION 29 CREDIT THROUGH 12/31/96 - the allocable
portion of the program's share (as a working interest holder in one or
more projects) of cumulative federal income tax credits under Section
29 of the Code with respect to sales of gas from the projects as
determined by the Operator of the projects (not an affiliate of the
Prior Manager) in accordance with the respective operating agreements
with respect to each property and the program's corresponding working
interest therein, from commencement of operations through December 31,
1996, inclusive, allocated as provided in the respective program's
equityholders' agreement.
REVENUES DISTRIBUTED FOR THE THREE MONTHS ENDED 12/31/96 - the
program's actual cash distributions to partners, regardless of source,
for the THREE MONTH PERIOD FROM SEPTEMBER 1, 1996, THROUGH DECEMBER
31, 1996, inclusive, allocated as provided in the respective program's
equityholders' agreement (Note: there can be no assurance that the
distributions made during this period are indicative of the
distributions that may be expected to be made by such program in
subsequent periods or by the Company in any period).
No information is provided with respect to interest expense inasmuch as
the Prior Antrim Programs have not leveraged their investments in working
interests in projects through long-term borrowings and the operating costs of
the projects have not exceeded revenues from sales of gas plus operating
capital needs, which would necessitate borrowings for working capital
purposes. Entries designated with a "*" indicate either that the information
requested is not applicable to the program or that the amount is 0.
73
<PAGE>
<TABLE>
<CAPTION>
Investor
Partners' Number of
Name of Commencement Initial Investor
Program of Operations Subscriptions Partners
----------- ------------- ------------- -----------
<S> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 March, 1989 $ 847,154 22
Wolverine Chester North
Antrim Drilling Program #2 March, 1990 827,500 21
Wolverine Chester North
Antrim Drilling Program #3 June, 1991 362,700 13
Wolverine Chester North
Antrim Drilling Program #4 March, 1991 410,250 15
Wolverine Otsego County
Antrim Development Program #5 June, 1991 1,117,984 29
Wolverine Charlton North
Antrim Development Program #6 October, 1991 586,496 11
Wolverine Antrim Development
Program #7 March, 1991 447,188 11
Wolverine Otsego County
Antrim Development Program #8 October, 1991 827,566 30
Wolverine Antrim Development
Program #9 January, 1992 175,000 5
Wolverine Antrim Development
Program #10 January, 1992 175,000 4
Wolverine Antrim Development
Program #11 December, 1991 493,099 21
Wolverine Antrim Development
Program #14 December, 1992 1,059,250 23
Wolverine Antrim Development
Program #15-1991 May, 1992 267,000 12
Wolverine Antrim Development
Program #15-1992 December, 1992 1,568,500 49
Wolverine Antrim Development
Program #16 December, 1992 1,200,000 3
Wolverine Antrim Development
Program #17 December, 1992 550,000 9
</TABLE>
74
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Summary of investor tax benefits and cash distribution returns
As of Deember 31, 1996
<TABLE>
<CAPTION>
TOTAL
CUMULATIVE CUMULATIVE CUMULATIVE
INVESTOR FIRST-YEAR FIRST-YEAR CUMULATIVE SECTION 29 OTHER TAX DEDUCTIBLE
PROGRAM CONTRIBUTIONS DEDUCTIONS IDC DEPLETION CREDITS DEDUCTIONS TAX ITEMS
<S> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $847,154 $62,406 $397,539 $240,772 $625,487 $1,454,217 $2,092,528
Wolverine Chester North
Antrim Drilling Program #2 827,500 413,206 334,679 160,309 517,794 1,842,386 2,337,374
Wolverine Chester North
Antrim Drilling Program #3 362,700 29,439 187,899 38,155 184,039 544,099 770,153
Wolverine Chester North
Antrim Drilling Program #4 410,250 9,564 242,121 93,150 274,958 630,378 965,649
Wolverine Otsego County
Antrim Development Program #5 1,117,984 51,895 659,423 242,200 770,623 1,626,628 2,528,251
Wolverine Charlton North
Antrim Development Program #6 586,496 2,315 338,419 125,066 342,479 680,937 1,144,422
Wolverine Antrim Development
Program #7 447,188 1,613 245,899 86,466 310,429 613,628 945,993
Wolverine Otsego County
Antrim Development Program #8 827,566 4,604 483,575 125,322 432,438 923,317 1,532,214
Wolverine Antrim Development
Program #11 493,099 759 120,373 52,803 235,109 573,178 746,354
Wolverine Antrim Development
Program #14 1,059,250 11,097 541,250 598 205,507 710,825 1,252,673
Wolverine Antrim Development
Program #15/1991 267,000 2,697 133,687 5,157 58,608 186,599 325,443
Wolverine Antrim Development
Program #15/1992 1,568,500 36,672 703,053 80,674 415,664 1,179,855 1,963,582
Wolverine Antrim Development
Program #16 1,200,000 470 328,790 46,110 358,454 965,196 1,340,096
Wolverine Antrim Development
Program #17 1,270,000 0 262,500 32,926 0 410,596 706,022
Wolverine Antrim Development
Trust #18 2,172,132 54,545 1,142,011 32,433 0 890,914 2,065,358
Wolverine Antrim Development
Trust #19 1,910,383 49,035 1,312,776 59,536 0 814,599 2,186,911
Wolverine Antrim Development
Trust #20 2,500,000 59,904 1,692,643 90,349 0 912,351 2,695,343
Wolverine Antrim Development
Trust #21 1,109,290 28,171 726,124 34,753 0 400,163 1,161,040
Wolverine Antrim Development
Trust #22 1,700,000 102,804 1,109,000 58,927 0 461,101 1,629,028
Wolverine Antrim Development
Trust 1995 2,475,410 50,000 2,000,000 328 0 239,541 2,239,869
Wolverine Antrim Development
1996-1, L.L.C. 1,154,000 82,257 791,782 778 0 85,257 877,817
Wolverine Antrim Development
1996-2, L.L.C. 3,567,450 106,890 2,634,365 255 0 106,890 2,741,510
</TABLE>
<TABLE>
<CAPTION>
Cumulative
Cumulative Cumulative Tax Savings/
Cumulative Tax Savings Cash Distri- Cash Distri-
Assumed Cumulative Cash and Cash tions as % of tions as % of
Program Tax Rate Tax Savings Distribution Distributions Contributions Contributions
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 33.0% $1,316,021 $953,958 $2,269,979 112.6% 268.0%
Wolverine Chester North
Antrium Drilling Program #2 33.0% 1,289,127 706,721 1,995,848 85.4% 241.2%
Wolverine Chester North
Antrim Drilling Program #3 33.0% 438,189 144,474 582,663 39.8% 160.6%
Wolverine Chester North
Antrim Drilling Program #4 33.0% 593,622 322,723 916,345 78.7% 223.4%
Wolverine Otsego County
Antrim Development Program #5 33.0% 1,604,946 709,198 2,314,144 63.4% 207.0%
Wolverine Charlton North
Antrim Development Program #6 33.0% 720,138 296,348 1,016,486 50.5% 173.3%
Wolverine Antrim Development
Program #7 31.0% 603,687 272,493 876,180 60.9% 195.9%
Wolverine Otsego County
Antrim Development Program #8 31.0% 907,424 369,033 1,267,457 44.6% 154.2%
Wolverine Antrim Development
Program #11 31.0% 466,479 160,765 627,244 32.6% 127.2%
Wolverine Antrim Development
Program #14 31.0% 593,836 116,677 710,513 11.0% 67.1%
Wolverine Antrim Development
Program #15/1991 31.0% 159,495 36,765 196,260 13.8% 73.5%
Wolverine Antrim Development
Program #15/1992 31.0% 1,024,374 335,525 1,359,899 21.4% 86.7%
Wolverine Antrim Development
Program #16 31.0% 773,884 104,304 878,188 8.7% 73.2%
Wolverine Antrim Development
Program #17 39.6% 279,585 164,361 443,946 12.9% 35.0%
Wolverine Antrim Development
Trust #18 39.6% 817,882 337,800 1,155,682 15.6% 53.2%
Wolverine Antrim Development
Trust #19 39.6% 866,017 299,111 1,165,128 15.7% 61.0%
Wolverine Antrim Development
Trust #20 39.6% 1,067,356 229,836 1,297,192 9.2% 51.9%
Wolverine Antrim Development
Trust #21 39.6% 459,772 99,984 559,756 9.0% 50.5%
Wolverine Antrim Development
Trust #22 39.6% 645,095 85,480 730,575 5.0% 43.0%
Wolverine Antrim Development
Trust 1995 39.6% 886,988 2,318 889,306 0.1% 35.9%
Wolverine Antrim Development
1996-1, L.L.C. 39.6% 347,616 0 347,616 0.0% 30.1%
Wolverine Antrim Development
1996-2, L.L.C. 39.6% 1,085,638 0 1,085,638 0.0% 30.4%
</TABLE>
75
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Administrative Costs Incurred and as a Percentage of Gross Subscriptions
As of December 31, 1996
<TABLE>
<CAPTION>
1989 1990 1991 1992
------------------------- ------------------------ ------------------------ -----------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $18,000 2.1% $19,094 2.3% $20,504 2.4% $21,087 2.5%
Wolverine Chester North
Antrim Drilling Program #2 13,950 1.7% 27,900 3.4% 29,407 3.6% 30,245 3.7%
Wolverine Chester North
Antrim Drilling Program #3 6,380 1.8% 18,972 5.2% 19,513 5.4%
Wolverine Chester North
Antrim Drilling Program #4 5,984 1.5% 18,921 4.6% 19,461 4.7%
Wolverine Otsego County
Antrim Development Program #5 10,179 0.9% 34,148 3.1% 43,256 3.9%
Wolverine Charlton North
Antrim Development Program #6 0 0.0% 11,256 1.9% 22,765 3.9%
Wolverine Antrim Development
Program #7 3,153 0.7% 17,090 3.8% 18,577 4.2%
Wolverine Otsego County
Antrim Development Program #8 16,799 2.0% 33,936 4.1%
Wolverine Antrim Development
Program #11 8,938 1.8% 14,261 2.9%
Wolverine Antrim Development
Program #14
Wolverine Antrim Development
Program #15/1991
Wolverine Antrim Development
Program #15/1992
Wolverine Antrim Development
Program #16
Wolverine Antrim Development
Program #17
Wolverine Antrim Development
Trust #18
Wolverine Antrim Development
Trust #19
Wolverine Antrim Development
Trust #20
Wolverine Antrim Development
Trust #21
Wolverine Antrim Development
Trust #22
Wolverine Antrim Development
Trust 1995
Wolverine Antrim Development
1996-1, L.L.C.
Wolverine Antrim Development
1996-2, L.L.C.
</TABLE>
<TABLE>
<CAPTION>
1993 1994 1995 1996
------------------------- ------------------------ ------------------------ -----------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $21,165 2.5% $21,927 2.6% $22,913 2.7% $16,717 2.0%
Wolverine Chester North
Antrim Drilling Program #2 30,357 3.7% 31,450 3.8% 32,864 4.0% 62,853 7.6%
Wolverine Chester North
Antrim Drilling Program #3 19,585 5.4% 20,291 5.6% 21,203 5.8% 69,200 19.1%
Wolverine Chester North
Antrim Drilling Program #4 19,533 4.8% 20,236 4.9% 21,146 5.2% 43,175 10.5%
Wolverine Otsego County
Antrim Development Program #5 43,416 3.9% 44,979 4.0% 47,002 4.2% 60,538 5.4%
Wolverine Charlton North
Antrim Development Program #6 22,850 3.9% 23,672 4.0% 24,737 4.2% 27,442 4.7%
Wolverine Antrim Development
Program #7 17,643 3.9% 18,278 4.1% 19,100 4.3% 21,506 4.8%
Wolverine Otsego County
Antrim Development Program #8 34,061 4.1% 35,162 4.2% 36,874 4.5% 47,730 5.8%
Wolverine Antrim Development
Program #11 15,682 3.2% 16,246 3.3% 5,769 1.2% 24,641 5.0%
Wolverine Antrim Development
Program #14 26,157 2.5% 48,338 4.6% 16,977 1.6% 138,742 13.1%
Wolverine Antrim Development
Program #15/1991 4,738 1.8% 8,755 3.3% 53,692 20.1% 26,022 9.7%
Wolverine Antrim Development
Program #15/1992 18,038 1.1% 51,610 3.3% 9,725 0.6% 126,859 8.1%
Wolverine Antrim Development
Program #16 30,425 2.5% 39,682 3.3% 56,006 4.7% 82,861 6.9%
Wolverine Antrim Development
Program #17 15,446 1.2% 42,689 3.4% 77,913 6.1%
Wolverine Antrim Development
Trust #18 55,000 2.5% 31,911 1.5% (90,196) -4.2%
Wolverine Antrim Development
Trust #19 47,760 2.5% 55,000 2.9% 66,863 3.5%
Wolverine Antrim Development
Trust #20 66,863 2.7% 87,500 3.5%
Wolverine Antrim Development
Trust #21 87,500 7.9% 41,780 3.8%
Wolverine Antrim Development
Trust #22 40,106 2.4% 61,330 3.6%
Wolverine Antrim Development
Trust 1995 7,500 0.3% 61,885 2.5%
Wolverine Antrim Development
1996-1, L.L.C. 30,177 2.6%
Wolverine Antrim Development
1996-2, L.L.C. 95,097 2.7%
</TABLE>
76
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Direct Costs Incurred and as a Percentage of Gross Subscriptions
As of December 31, 1996
<TABLE>
<CAPTION>
1989 1990 1991 1992
------------------------- ------------------------ ------------------------ -----------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $ 1,500 0.2% $ 3,951 0.5% $11,856 1.4% $ 5,380 0.6%
Wolverine Chester North
Antrim Drilling Program #2 0 0.0% 3,957 0.5% 6,021 0.7%
Wolverine Chester North
Antrim Drilling Program #3 988 0.3% 2,462 0.7% 2,695 0.7%
Wolverine Chester North
Antrim Drilling Program #4 2,494 0.6% 2,607 0.6% 3,565 0.9%
Wolverine Otsego County
Antrim Development Program #5 1,365 0.1% 4,334 0.4% 9,035 0.8%
Wolverine Charlton North
Antrim Development Program #6 114 0.0% 2,104 0.4% 2,002 0.3%
Wolverine Antrim Development
Program #7 114 0.0% 2,351 0.5% 4,862 1.1%
Wolverine Otsego County
Antrim Development Program #8 114 0.0% 3,136 0.4% 4,795 0.6%
Wolverine Antrim Development
Program #11 600 0.1% 4,139 0.8%
Wolverine Antrim Development
Program #14 5,894 0.6%
Wolverine Antrim Development
Program #15/1991 1,450 0.5%
Wolverine Antrim Development
Program #15/1992 107 0.0%
Wolverine Antrim Development
Program #16
Wolverine Antrim Development
Program #17
Wolverine Antrim Development
Trust #18
Wolverine Antrim Development
Trust #19
Wolverine Antrim Development
Trust #20
Wolverine Antrim Development
Trust #21
Wolverine Antrim Development
Trust #22
Wolverine Antrim Development
Trust 1995
Wolverine Antrim Development
1996-1, L.L.C.
Wolverine Antrim Development
1996-2, L.L.C.
</TABLE>
<TABLE>
<CAPTION>
1993 1994 1995 1996
------------------------- ------------------------ ------------------------ -----------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $ 4,254 0.5% $ 3,729 0.4% $ 3,020 0.4% $16,717 2.0%
Wolverine Chester North
Antrim Drilling Program #2 3,954 0.5% 3,275 0.4% 2,675 0.3% 8,311 1.0%
Wolverine Chester North
Antrim Drilling Program #3 3,615 1.0% 2,100 0.6% 1,800 0.5% 7,607 2.1%
Wolverine Chester North
Antrim Drilling Program #4 2,612 0.6% 4,280 1.0% 2,650 0.6% 12,604 3.1%
Wolverine Otsego County
Antrim Development Program #5 3,686 0.3% 4,085 0.4% 7,338 0.7% 11,380 1.0%
Wolverine Charlton North
Antrim Development Program #6 2,750 0.5% 3,080 0.5% 4,578 0.8% 4,335 0.7%
Wolverine Antrim Development
Program #7 2,940 0.7% 2,600 0.6% 3,470 0.8% 4,498 1.0%
Wolverine Otsego County
Antrim Development Program #8 3,690 0.4% 2,720 0.3% 4,242 0.5% 2,929 0.4%
Wolverine Antrim Development
Program #11 2,147 0.4% 1,370 0.3% 1,973 0.4% 4,945 1.0%
Wolverine Antrim Development
Program #14 4,375 0.4% 2,540 0.2% 2,656 0.3% 15,270 1.4%
Wolverine Antrim Development
Program #15/1991 5,675 2.1% 890 0.3% 1,267 0.5% 14,462 5.4%
Wolverine Antrim Development
Program #15/1992 6,775 0.4% 3,410 0.2% 3,410 0.2% 17,337 1.1%
Wolverine Antrim Development
Program #16 5,865 0.5% 2,660 0.2% 5,666 0.5% 14,355 1.2%
Wolverine Antrim Development
Program #17 5,302 0.4% 1,790 0.1% 1,790 0.1% 10,746 0.8%
Wolverine Antrim Development
Trust #18 153 0.0% 4,030 0.2% 8,635 0.4% 30,760 1.4%
Wolverine Antrim Development
Trust #19 4,166 0.2% 8,635 0.5% 30,803 1.6%
Wolverine Antrim Development
Trust #20 8,751 0.4% 23,979 1.0%
Wolverine Antrim Development
Trust #21 8,751 0.8% 23,866 2.2%
Wolverine Antrim Development
Trust #22 1,616 0.1% 19,839 1.2%
Wolverine Antrim Development
Trust 1995 5,000 0.2% 2,056 0.1%
Wolverine Antrim Development
1996-1, L.L.C. 1,270 0.1%
Wolverine Antrim Development
1996-2, L.L.C. 68 0.0%
</TABLE>
77
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Sponsor operating results in prior programs
As of December 31, 1996
<TABLE>
<CAPTION>
CUMULATIVE CUMULATIVE
CUMULATIVE CUMULATIVE CUMULATIVE CASH FLOW NET CUMULATIVE
CUMULATIVE OPERATING ADMINISTRATIVE DIRECT FROM CUMULATIVE REVENUES SECTION 29
PROGRAM REVENUES COSTS COSTS COSTS OPERATIONS CASH FLOW DISTRIBUTED CREDIT
------- ---------- ---------- -------------- ---------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North $ 293,738 $157,536 $ 0 $ 0 $136,202 $136,202 $130,707 $ 99,032
Antrim Drilling Program #1
Wolverine Chester North $ 241,485 $132,597 $ 0 $ 0 $108,888 $108,888 $ 90,242 $ 80,825
Antrim Drilling Program #2
Wolverine Chester North $ 68,702 $ 40,052 $ 0 $ 0 $ 28,651 $ 28,651 $ 22,823 $ 28,948
Antrim Drilling Program #3
Wolverine Chester North $ 115,131 $ 70,691 $ 0 $ 0 $ 44,440 $ 44,440 $ 44,112 $ 47,113
Antrim Drilling Program #4
Wolverine Otsego County $ 316,267 $172,495 $ 0 $ 0 $143,771 $143,771 $ 95,620 $132,612
Antrim Development Program #5
Wolverine Charlton North $ 147,677 $ 65,556 $ 0 $ 0 $ 82,121 $ 82,121 $ 51,601 $ 64,570
Antrim Development Program #6
Wolverine Antrim Development $ 126,190 $ 64,978 $ 0 $ 0 $ 61,212 $ 61,212 $ 37,094 $ 53,065
Program #7
Wolverine Otsego County $ 185,029 $ 88,292 $ 0 $ 0 $ 96,737 $ 96,737 $ 59,465 $ 80,578
Antrim Development Program #8
Wolverine Antrim Development $ 104,298 $ 63,914 $ 0 $ 0 $ 40,384 $ 40,384 $ 24,415 $ 44,457
Program #11
Wolverine Antrim Development $ 75,522 $ 55,162 $ 0 $ 0 $ 20,360 $ 20,360 $ 29,415 $ 51,516
Program #14
Wolverine Antrim Development $ 34,257 $ 19,502 $ 0 $ 0 $ 14,756 $ 14,756 $ 7,879 $ 13,862
Program #15/1991
Wolverine Antrim Development $ 234,926 $139,490 $ 0 $ 0 $ 95,437 $ 95,437 $ 76,940 $ 98,374
Program #15/1992
Wolverine Antrim Development $ 205,391 $136,032 $ 0 $ 0 $ 69,359 $ 69,359 $ 25,798 $ 87,711
Program #16
Wolverine Antrim Development $ 110,740 $ 54,778 $ 0 $ 0 $ 55,962 $ 55,962 $ 42,668 $ 0
Program #17
Wolverine Antrim Development $ 167,169 $122,316 $ 0 $ 0 $ 44,853 $ 44,853 $ 87,693 $ 0
Trust #18
Wolverine Antrim Development $ 192,343 $100,037 $ 0 $ 0 $ 92,306 $ 92,306 $ 77,649 $ 0
Trust #19
Wolverine Antrim Development $ 239,090 $116,675 $ 0 $ 0 $122,414 $122,414 $ 59,665 $ 0
Trust #20
Wolverine Antrim Development $ 102,183 $ 49,323 $ 0 $ 0 $ 52,860 $ 52,860 $ 25,956 $ 0
Trust #21
Wolverine Antrim Development $ 120,864 $ 56,222 $ 0 $ 0 $ 64,643 $ 64,643 $ 22,191 $ 0
Trust #22
Wolverine Antrim Development $ 25,970 $ 14,338 $ 0 $ 0 $ 11,632 $ 11,632 $ 602 $ 0
Trust 1995
Wolverine Antrim Development $ 16,753 $ 10,645 $ 0 $ 0 $ 6,108 $ 6,108 $ 0 $ 0
1996-1, L.L.C.
Wolverine Antrim Development $ 3,596 $ 2,598 $ 0 $ 0 $ 998 $ 998 $ 0 $ 0
1996-2, L.L.C.
</TABLE>
78
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Investor operating results in prior programs
As of December 31, 1996
<TABLE>
<CAPTION>
CUMULATIVE CUMULATIVE
CUMULATIVE CUMULATIVE CUMULATIVE CASH FLOW NET CUMULATIVE
CUMULATIVE OPERATING ADMINISTRATIVE DIRECT FROM CUMULATIVE REVENUES SECTION 29
PROGRAM REVENUES COSTS COSTS COSTS OPERATIONS CASH FLOW DISTRIBUTED CREDIT
------- ---------- ---------- -------------- ---------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North $1,668,605 $744,775 $161,407 $ 81,761 $923,830 $680,661 $823,251 $526,455
Antrim Drilling Program #1
Wolverine Chester North $1,392,515 $618,546 $259,027 $ 28,192 $773,969 $486,750 $616,479 $436,969
Antrim Drilling Program #2
Wolverine Chester North $ 449,213 $247,742 $175,144 $ 21,268 $201,470 $ 5,059 $121,651 $155,091
Antrim Drilling Program #3
Wolverine Chester North $ 608,866 $285,349 $148,457 $ 30,812 $323,517 $144,247 $278,611 $227,845
Antrim Drilling Program #4
Wolverine Otsego County $1,655,782 $815,290 $283,518 $ 41,223 $840,493 $515,751 $613,578 $638,011
Antrim Development Program #5
Wolverine Charlton North $ 687,724 $290,715 $132,722 $ 18,963 $397,009 $245,323 $244,747 $277,909
Antrim Development Program #6
Wolverine Antrim Development $ 656,727 $305,574 $115,346 $ 20,836 $351,153 $214,972 $235,399 $257,364
Program #7
Wolverine Otsego County $ 875,975 $392,723 $204,543 $ 21,625 $483,252 $257,084 $309,568 $351,860
Antrim Development Program #8
Wolverine Antrim Development $ 479,371 $275,619 $ 85,537 $ 15,174 $203,752 $103,041 $136,350 $190,652
Program #11
Wolverine Antrim Development $ 437,166 $253,319 $230,213 $ 30,213 $183,847 $(77,102) $ 87,262 $153,991
Program #14
Wolverine Antrim Development $ 113,929 $ 61,886 $ 93,207 $ 23,744 $ 52,042 $(64,908) $ 28,886 $ 44,746
Program #15/1991
Wolverine Antrim Development $ 775,279 $445,212 $206,231 $ 31,039 $330,066 $ 92,796 $258,585 $317,290
Program #15/1992
Wolverine Antrim Development $ 638,308 $427,530 $208,975 $ 28,546 $210,778 $(26,743) $ 78,506 $270,743
Program #16
Wolverine Antrim Development $ 315,841 $156,233 $136,048 $ 19,628 $159,608 $ 3,932 $121,693 $ 0
Program #17
Wolverine Antrim Development $ 476,781 $348,856 $ (3,285) $ 43,578 $127,925 $ 87,632 $250,107 $ 0
Trust #18
Wolverine Antrim Development $ 548,578 $285,312 $169,623 $ 43,604 $263,266 $ 50,038 $221,462 $ 0
Trust #19
Wolverine Antrim Development $ 681,902 $332,768 $154,363 $ 32,730 $349,135 $162,041 $170,171 $ 0
Trust #20
Wolverine Antrim Development $ 291,434 $140,672 $129,280 $ 32,617 $150,762 $(11,136) $ 74,028 $ 0
Trust #21
Wolverine Antrim Development $ 344,715 $160,348 $101,436 $ 21,455 $184,366 $ 61,475 $ 63,289 $ 0
Trust #22
Wolverine Antrim Development $ 74,068 $ 40,892 $ 69,385 $ 7,056 $ 33,176 $(43,265) $ 1,716 $ 0
Trust 1995
Wolverine Antrim Development $ 64,534 $ 41,005 $ 30,177 $ 1,270 $ 23,529 $ (7,918) $ 0 $ 0
1996-1, L.L.C.
Wolverine Antrim Development $ 13,852 $ 10,009 $ 95,097 $ 68 $ 3,843 $(91,322) $ 0 $ 0
1996-2, L.L.C.
</TABLE>
79
<PAGE>
TAX ASPECTS
The following is a summary of material federal tax considerations for
persons considering an investment in the Company. The discussion, among
other things, summarizes certain provisions of the Internal Revenue Code of
1986, as amended (the "Code"), the applicable Treasury Regulations
promulgated or proposed thereunder (the "Regulations"), current published
positions of the Internal Revenue Service (the "Service") and existing
judicial decisions, all of which are subject to change at any time.
There can be no assurance that any deductions or other tax consequences
which are described herein, or which a prospective Investor Interestholder in
the Company may contemplate, will be available. In addition, no assurance
can be given that legislative or administrative changes or court decisions
may not be forthcoming which would significantly modify the statements
expressed herein. In some instances, these changes could have a substantial
effect on the tax aspects of an investment in the Company. Any future
legislative changes may or may not be retroactive with respect to
transactions prior to the effective date of such changes. Bills have been
introduced in Congress in the past and may be introduced in the future which,
if enacted, would adversely affect some of the tax consequences presently
anticipated from an investment in the Company.
Moreover, although the Company has retained professional tax advisors,
there are risks and uncertainties concerning certain of the tax aspects
associated with an investment in the Company and there can be no assurance
that some or all of the deductions claimed by the Company may not be
challenged by the Service. Disallowance of such deductions could adversely
affect the Company and the Investor Interestholders. Prospective Investor
Interestholders should also be aware that the Service is conducting an
intensified and aggressive audit program with respect to individual and
partnership returns showing particularly large tax losses or other evidence
of tax-oriented financial decisions. As a consequence, there is a greater
likelihood that the Service will audit the Company's information returns and
the Investor Interestholders' individual returns and subject those returns to
particularly close scrutiny. Such audits could result in tax adjustments,
including adjustments to items on Investor Interestholders' returns unrelated
to the Company. In the event that any of the tax returns of the Company are
audited, it is possible that substantial legal and accounting fees will be
incurred to substantiate the position of the Company. Such fees would reduce
the cash flow otherwise distributable to the Investor Interestholders. Such
an audit may result in adjustments to the Company's tax returns which would,
at a minimum, require an adjustment to the taxable income reported by each
Investor Interestholder on his/her personal tax return and could cause an
audit of unrelated items on each Investor Interestholder's tax returns which,
in turn, could result in adjustments to such items. EACH PROSPECTIVE
INVESTOR INTERESTHOLDER IS THEREFORE URGED TO CONSULT HIS/HER TAX ADVISOR
WITH RESPECT TO THE TAX CONSEQUENCES ARISING FROM AN INVESTMENT IN THE
COMPANY.
NO RULING FROM THE SERVICE REGARDING EITHER THE TAX ASPECTS
OR THE STATUS OF THE COMPANY AS A PARTNERSHIP FOR TAX
PURPOSES HAS BEEN OR WILL BE REQUESTED.
The description of the tax aspects discussed herein is supported by a tax
opinion of special tax counsel to the Company, Patzik, Frank & Samotny Ltd.,
Chicago, Illinois ("Special Tax Counsel"). A copy of the form of the tax
opinion is attached to this Memorandum as Appendix IV. The opinion of
Special Tax Counsel is, of course, not binding on the Service or the courts.
The legal discussion below is based upon (a) the facts set forth in this
Memorandum and the Exhibits hereto and (b) the following representations by
the Manager:
(i) The Manager will be solely responsible for and will direct the
business affairs of the Company and in such capacity will not
be acting as an agent for the Investor Interestholders;
(ii) The interest of the Manager in each material item of Company
income, gain, expense, loss, deduction or credit will be at
least 1% of each such item at all times during the existence
of the Company;
80
<PAGE>
(iii) The Company will make no election to be excluded from the
application of the partnership tax provisions of Subchapter K
of Chapter l of Subtitle A of the Code;
(iv) The Company Operating Agreement will be entered into by and
among the Interestholders and the Managing Interestholder, and
any amendments thereto, will be duly executed and will be made
available to any Investor Interestholder upon written request.
The Company Operating Agreement will be duly filed in all
places required under the Act for the due formation of the
Company and for the continuation thereof in accordance with
the terms of the Company Operating Agreement. The Company
will at all times be operated in accordance with the terms of
the Company Operating Agreement and Act;
(v) The Company will own operating mineral interests, as defined
in the Code and in the Regulations, and none of the Company's
revenues will be from non-working interests;
(vi) The amounts that will be paid to the Manager will be amounts
that would not exceed amounts that would be ordinarily paid
for similar transactions between persons having no affiliation
and dealing with each other at "arm's length";
(vii) The Manager will cause the Company to properly elect to deduct
currently any intangible drilling and development costs;
(viii) The Company will have a December 31 taxable year and will
report its income on the accrual basis;
(ix) The Manager believes that at least 90% of the gross income of
the Company will constitute income derived from the
exploration, development, production and/or marketing of oil
and gas. The Manager does not believe that any market will
ever exist for the sale of Interests. Further, the Interests
will not be traded on an established securities market; and
(x) The Company and each Interestholder will have the objective of
carrying on business for profit and dividing the gain
therefrom.
LIMITATIONS
The federal income tax consequences described below are, to a significant
extent, available only to taxpayers who invest in the Company with the BONA
FIDE intent of deriving an economic profit without regard to any income tax
advantages. The determination of whether an Investor Interestholder is
participating in the Company for profit is subjective and based upon the
motives of the particular Investor Interestholder. It is difficult to assess
this subjective intent or anticipate the future activities of any Investor
Interestholder, and thus it is assumed for purposes of this discussion that
the Investor Interestholders shall have the requisite profit motive. A
determination that such is not the case would have a substantially adverse
effect upon the tax consequences of an investment in the Company. No
prospective Investor Interestholder should invest in the Company unless the
prospective Investor Interestholder does so with an intent to realize an
economic profit without regard to tax consequences.
Virtually all of the income tax consequences described herein are
dependent upon the fair market value of the property to be acquired by and
the services rendered to the Company being not less than the price paid
therefor. While the Manager believes that the values of such property and
services will be not less than the prices paid, there can be no assurance
that the Service or the courts will concur with such valuations.
Oil and gas exploration offers several tax benefits under current federal
income tax laws which include the current deduction of intangible drilling
and development costs, cost recovery or depreciation deductions, and the
depletion allowance for oil and gas production. The tax benefits afforded by
oil and gas exploration are offset or diminished as a result of the recapture
of intangible drilling and development costs, cost recovery and depreciation
deductions and
81
<PAGE>
depletion deductions in the event of disposition of an
interest in the Company or an interest in the developed oil and gas
properties owned by the Company. The imposition of the minimum tax and, if
applicable, the application of the passive loss rules may further diminish
the favorable tax benefits. Although the favorable tax benefits mitigate the
economic risk of oil and gas exploration through participation in the
Company, the tax benefits do not eliminate potential losses if the oil and
gas properties of the Company are nonproductive or are marginally productive.
Each prospective investor should be aware that, unlike a ruling from the
Service, an opinion of counsel represents only such counsel's best judgment.
THERE CAN BE NO ASSURANCE THAT THE SERVICE WILL NOT SUCCESSFULLY ASSERT
POSITIONS WHICH ARE INCONSISTENT WITH THE OPINIONS SET FORTH IN THIS DISCUSSION
OR THE TAX REPORTING POSITIONS TAKEN BY THE COMPANY. EACH PROSPECTIVE INVESTOR
SHOULD CONSULT HIS/HER OWN TAX ADVISOR TO DETERMINE THE EFFECT OF THE TAX ISSUES
DISCUSSED THEREIN ON HIS/HER INDIVIDUAL TAX SITUATION.
CLASSIFICATION AS A PARTNERSHIP
CLASSIFICATION. Limited liability companies, such as the Company, are
classified for federal income tax purposes as either partnerships or
associations taxable as corporations. On December 17, 1996, the Service issued
final regulations known as "check the box" regulations. These regulations
completely changed the regime for classifying entities pursuant to Code Section
7701. These regulations are effective for entities formed on or after January
1, 1997.
Treasury Regulation Sections 301.7701-1 ET. SEQ.(hereinafter the
"Classification Regulations") provide that any entity which is not organized as
a corporation pursuant to federal or state statute shall be treated as a
partnership if such entity has two or more members. The Classification
Regulations provide that such an entity may ELECT to be treated as a corporation
for federal income tax purposes.
The Company has been organized as a limited liability company under
Michigan law. Accordingly, the Company is not a corporation as defined in
Treas. Reg. Section 301.7701-2(b). Therefore, the Company will be treated as a
partnership for federal income tax purposes unless it elects to be treated as an
association taxable as a corporation. Assuming that the Company does not make
such an election, Special Tax Counsel is of the opinion that the Company will be
classified as a partnership for federal income tax purposes.
PUBLICLY TRADED PARTNERSHIPS. Pursuant to Code Section 7704, certain
publicly traded partnerships will be treated as corporations for federal income
tax purposes. Since the Company will be treated as a partnership for federal
income tax purposes, this provision may be applicable to the Company. A
"publicly traded partnership" is defined as ". . . any partnership if . . . (1)
interests in such partnership are traded on an established securities market, or
(2) interests in such partnership are readily tradable on a secondary market (or
the substantial equivalent thereof). " The Interests do not and are not intended
to trade on an established securities market.
The Service has issued regulations to provide guidance with respect to
several issues involving the definition of a publicly traded partnership. Under
the regulations, interests will not be considered to be traded on the "secondary
market or the substantial equivalent thereof" unless the partnership is involved
in such trading and if the partnership does not recognize a transfer made on the
market by admitting the transferee as a partner. In addition, certain
transfers, including transfers upon death, transfers between family members, the
issuance of interests in return for property or services or block transfers, are
disregarded in determining whether interests are traded on the secondary market
or the substantial equivalent thereof. An additional safe harbor is available
to exempt trades that take place through a qualifying matching service which
typically involves the use of computerized or printed listing system which
attempts to match a partner's wish to dispose of their interest in a partnership
with persons who wish to buy such interest, so long as the number of matched
trades is somewhat limited.
In recent years, various systems have been established for the purchase and
sale of limited partnership interests which do not trade on an established
securities market. It is possible that one or more of these systems will become
a secondary market or the substantial equivalent thereof. The Manager has
represented, however, that no interests in
82
<PAGE>
partnerships or limited liability companies in which Wolverine has acted as
general partner or manager have ever been traded on such a system. The
Manager has also represented that it has no present intention of taking any
steps to allow the Interests to become readily tradable on such a system and
will not allow redemptions pursuant to the Redemption Plan if such
redemptions would result in the Company being treated as publicly traded.
The Company has established a plan whereby it will redeem up to 10% of
the outstanding Interests per year over a five year period. The regulations
provide that a redemption pursuant to a redemption or repurchase agreement
which constitutes a "closed end redemption plan" will be disregarded in
determining if there is a secondary market or the substantial equivalent
thereof. A closed end redemption plan is a plan in a partnership which does
not offer interests after the initial offering and no partner or related
person offers interests in substantially identical investments. Since the
Manager intends to offer a series of investments during 1997-1998, the
Company my not qualify for this exception. However, it is not anticipated
that the Interest Repurchase Program will be available until after the
offering for the related programs have closed.
The regulations contain another exception which requires that: (1) the
redemption or repurchase does not occur until at least sixty (60) days after
notice; (2) the purchase price is set at least sixty (60) days after receipt
of notification or not more than four times per year; and (3) not more than
10% of the capital and profits interest be repurchased in any taxable year.
It is anticipated that the Interest Repurchase Program will meet these
criteria. Accordingly, the Interest Repurchase Program should not cause the
Company to be considered publicly traded.
If the Interests were in the future to become readily tradable as defined
above, or in subsequent Regulations, rulings or other relevant authority, the
Company could for this reason become taxable as a corporation for federal
income tax purposes.
COMPANY TAXATION
Subject to the foregoing, Special Tax Counsel is of the opinion that the
Company will not be subject to federal income tax. The Company will,
however, be required each year to file partnership information tax returns.
The Investor Interestholders will be required to take into account, in
computing their respective federal income tax liabilities, their respective
distributive shares of all items of Company income, gain, expense, loss,
deduction, credit and tax preference for any taxable year of the Company
ending within or with the taxable year of the respective Investor
Interestholder, without regard to whether such Investor Interestholder has
received or will receive any cash distributions from the Company. An
Investor Interestholder, therefore, may be subject to tax if the Company has
income even though no cash distribution is made.
If the cash distributed by the Company for any year to an Investor
Interestholder, including his/her share of the reduction of any Company
liabilities, exceeds his/her share of the Company's undistributed taxable
income, the excess will constitute a return of capital. A return of capital
is applied first to reduce the tax basis of the Investor Interestholder's
interest in the Company, and any amounts in excess of such tax basis will
generally be treated as gain from a sale of such Investor Interestholder's
interest in the Company.
The Social Security Act and the Code exclude from the definition of "net
earnings from self-employment" a limited partner's distributive share of any
item of income or loss from a partnership other than a guaranteed payment for
personal services actually rendered. In January, 1997 the Services issued
proposed Regulations governing whether income allocated to a member of a
limited liability company will constitute self-employment income. Under the
proposed Regulations, an individual is treated as a limited partner (and
therefore not subject to self-employment tax on his/her allocable share of
limited liability company income) unless ONE OR MORE of the following
applies: the individual has personal liability for the debts of, or claims
against, the limited liability company by virtue of the individual's capacity
as an owner; the individual has authority to bind the entity under the law of
the jurisdiction in which it was formed; or the individual participants in
the entity's trade or business for more than 500 hours during the course of
the taxable year. The Participating Investor Interestholders have personal
liability for the Special Obligations and, therefore, will not likely be
treated as "limited partner equivalents" for purposes of the self-employment
tax. Therefore, it is likely
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that a Participating Investor Interestholder's share of any income or loss
from the Company will constitute "net earnings from self employment" at least
during the period that such Participating Investor Interestholder is liable
for the Special Obligations. The Non-Participating Investor Interestholders
should be treated as limited partners for self-employment tax purposes. The
1997 Act instructed the Service to withdraw these proposed Regulations for
effectiveness prior to July 1, 1998. The legislative history indicates
Congress' concern that the Service had exceeded its authority in issuing
these regulations, and that limited partners' self-employment income should
only include guaranteed payments for services.
Consequently, each such Participating Investor Interestholder should
consult with his/her own tax advisors as to whether his/her share of Company
income or loss will affect his/her self employment tax liability or his/her
social security benefits.
LEASEHOLD ACQUISITION COSTS
The cost of acquiring oil and gas leases, or other similar property
interests, is a capital expenditure and may not be deducted in the year paid
or incurred but must be recovered through depletion. If, however, a lease is
proved to be worthless by drilling or abandonment, the cost of such lease
(less any recovery thereof through the depletion deduction) constitutes a
loss to the taxpayer in the year in which the lease becomes worthless.
DEDUCTION OF INTANGIBLE DRILLING AND DEVELOPMENT COSTS
Section 263(c) authorizes an election by the Company to deduct as
expenses intangible drilling and development costs ("IDCs") incurred in
connection with oil and gas properties at the time such costs are incurred in
accordance with the Company's method of accounting, provided that the costs
are not more than would be incurred in an arms-length transaction with an
unrelated drilling contractor. In general, IDCs consist of those costs which
in and of themselves have no salvage value. Regulation Section 1.612-4(a)
provides examples of items to which the option to deduct IDC applies,
including all amounts paid for labor, fuel, repairs, hauling, and supplies,
or any of them, which are used (i) in the drilling, shooting, and cleaning of
wells, (ii) in such clearing of ground, draining, road making, surveying, and
geological works as are necessary in the preparation for the drilling of
wells, and (iii) in the constructing of such derricks, tanks, pipelines, and
other physical structures as are necessary for the drilling of wells and the
preparation of wells for the production of oil or gas. The Service, in Rev.
Rul. 70-414, 1970-2 C.B. 132, set forth further classifications of items
subject to the option and those considered capital in nature. The ruling
provides that the following items are not subject to the election of
Regulation Section 1.612-4(a): (i) oil well pumps (upon initial completion of
the well), including the necessary housing structures; (ii) oil well pumps
(after the well has flowed for a time, including the necessary housing
structures; (iii) oil well separators, including the necessary housing
structures; (iv) pipelines from the wellhead to oil storage tanks on the
producing lease; (v) oil storage tanks on the producing lease; (vi) salt
water disposal equipment, including any necessary pipelines; (vii) pipelines
from the mouth of a gas well to the first point of control, such as a common
carrier pipeline, natural gasoline plant, or carbon black plant; (viii)
recycling equipment, including any necessary pipelines; and (ix) pipelines
from oil storage tanks on the producing leasehold to a common carrier
pipeline.
A partnership's classification of a cost as IDC is not binding on the
government, which might reclassify an item labeled as IDC as a cost which
must be capitalized. In BERNUTH V. COMMISSIONER, 57 T.C. 225 (1972), AFF'D,
470 F.2d 710 (2nd Cir. 1972), the Tax Court denied taxpayers a deduction for
the portion of a turnkey drilling contract price that was in excess of a
reasonable cost for drilling the wells in question under a turnkey contract,
holding that the amount specified in the turnkey contract was not
controlling. Similarly, the Service, in Rev. Rul. 73-211, 1973-1 C.B. 303,
concluded that excessive turnkey costs are not deductible IDC.
To the extent the Company's prices meet the reasonable price standards
impose by BERNUTH, SUPRA, and Rev. Rul 73-211, SUPRA, and to the extent such
amounts are not allocable to tangible property, leasehold costs, and the
like, the amounts paid to the Manager under the Turnkey Agreement (other than
those payments allocated to acquisition of the working interests) should
qualify as IDC and should be deductible at the time described below. That
portion of the
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amount paid to the Manager that is in excess of the amount that would be
charged by an independent driller under similar conditions will not qualify
as IDC and will be required to be capitalized.
In Rev. Rul. 75-304, 1975-2 C.B. 94, the Service held that amounts paid
by holders of working interests constituted capital expenditures for the
leasehold interest and not deductible IDC where such working interest owners
were required to pay the turnkey costs only after successful completion of a
well. The Turnkey Agreement requires the Company to make the turnkey
payments whether or not the wells are successful. Accordingly, while Special
Tax Counsel is unable to determine the percentage of the turnkey costs which
will be allocated to capital expenditures versus IDC, Rev. Rul. 75-304,
SUPRA., should not require all of the expenditures under the Turnkey
Agreement to be capitalized.
Special Tax Counsel is unable to express an opinion regarding the
reasonableness or proper characterization of the payments under the Turnkey
Agreement, since the determination of whether the amounts are reasonable or
excessive is inherently factual in nature. No assurance can be given that
the Service will not characterize a portion of the amount paid to the Manager
as an excessive payment, to be capitalized as a leasehold cost, assignment
fee, syndication fee, organization fee, or other cost, and not deductible as
IDC. To the extent not deductible, such amounts will be included in the
Interestholders' bases in their Interests.
The Company may be considered to have entered into an arrangement whereby
it would purchase an interest in the Project and agree to pay a
disproportionate part of the costs of drilling any development wells thereon.
In such situations, the party who is paying more than his/her share of costs
of drilling may not deduct all of such costs as intangible drilling and
development costs unless his/her percentage of ownership of the lease is not
reduced before he/she has recovered from the first production of the well an
amount equal to the cost he/she incurred in drilling, completing, equipping
and operating the well. The Company may not have this right with respect to
the Project and the Operating Agreements. If circumstances permit, however,
the Company will adopt the position that all of the intangible drilling and
development costs incurred are deductible (even though such costs may be
disproportionate to its ownership of the lease) on the basis that the
Operating Agreements constitute partnerships for federal income tax purposes
and that the excess IDC are specifically allocable to the Company. There can
be no assurance that this position would prevail against attack by the
Service.
A portion of the IDC paid or incurred in connection with productive
development wells may constitute a tax preference item. See " - Alternative
Minimum Tax."
In the case of an Investor Interestholder which constitutes an
"integrated oil company," 30% of the amount otherwise allowable as a
deduction for IDC under Section 262(c) must be capitalized and deducted
ratably over a 60-month period beginning with the month the costs are paid or
incurred. This provision does not apply to nonproductive wells. For this
purpose, an "integrated oil company" is generally defined as an individual or
entity with retail sales of oil and gas aggregating more than $6 million and
refining of more than 50,000 barrels per day for the taxable year.
To the extent that drilling and development services are performed for
the Company in 1997, amounts incurred pursuant to BONA FIDE arm's-length
drilling contracts and constituting IDC should be deductible by the Company
in 1997. To the extent that such services are performed in 1998, however,
the Company will only be allowed to deduct in 1997 amounts which are:
(1) incurred pursuant to BONA FIDE arm's-length drilling contracts
which provide for absolute noncontingent liability for
payment, and
(2) attributable to wells spudded within 90 days after December
31, 1997. Sections 461(h)(1) and 461(i)(2) provide, in
relevant part:
". . . in determining whether an amount has been incurred
with respect to any item during any taxable year, the all
events tests shall not be treated as met any earlier than
when economic performance with respect to such item
occurs.
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* * *
. . . economic performance with respect to the act of
drilling an oil or gas well shall be treated a having
occurred within a taxable year if drilling of the well
commences before the close of the 90th day after the
close of a taxable year."
The clear implication of these provisions is that an amount incurred
during a taxable year for drilling or completion services which could
otherwise be accrued for tax purposes will not be disqualified as a deduction
merely because the services are performed during the subsequent taxable year
(provided that the services commence within the first ninety (90) days of
such subsequent year).
Consequently, in the opinion of Special Tax Counsel, IDC meeting the
above criteria should be deductible by the Company in 1997 even though a
portion of such costs are attributable to services performed during 1998.
Each Investor Interestholder, however, may deduct his/her share of
amounts paid in 1997 for services performed for the Company in 1997 only to
the extent of his/her "cash basis" in the Company as of the end of 1997. For
this purpose, a taxpayer's "cash basis" in a tax shelter which is taxable as
a partnership (such as the Company) is the taxpayer's basis in the
partnership determined without regard to any amount borrowed by the taxpayer
with respect to the partnership which (a) is arranged by the partnership or
by any person who participated in the organization, sale or management of the
partnership (or any person related to such person within the meaning of
Section 461(b)(3)(c)), or (b) is secured by any asset of the partnership.
Inasmuch as "cash basis" excludes borrowing arranged by an extremely broad
group of persons who could be "related" to a person who "participated" in the
organization, sale or management of the Company, it is not possible for
Special Tax Counsel to express an opinion as to whether each Investor
Interestholder will be allowed to deduct his/her allocable share of any
prepaid development and drilling expenses to the extent that they exceed
his/her actual cash investment in the Company. Amounts borrowed by an
Investor Interestholder from the Manager or any of its Affiliates and
borrowings arranged by such persons will not be considered part of such
Investor Interestholder's "cash basis" for these purposes.
IDC which has been deducted is subject to recapture as ordinary income
upon certain dispositions (other than by abandonment, gift, death, or
tax-free exchange) of an interest in an oil or gas property. The amount
subject to recapture is the lesser of (i) the amount of gain realized upon
the disposition of the property, or (ii) the amount of the previously
deducted IDC that are allocable to the property (directly or through the
ownership of an interest in a partnership) reduced by the amount (if any) by
which the depletion deductions would have been increased had such costs been
capitalized. Where only a portion of an oil and gas interest is disposed of,
all IDC subject to the recapture must be allocated first to the disposed of
portion. Depletion deductions, to the extent that they reduce the basis of
an oil and gas property, also are included in the amount recaptured.
DEPLETION
Subject to the limitations discussed hereafter, the Investor
Interestholders will be entitled to deduct, as allowances for depletion under
Section 611, their share of percentage or cost depletion, whichever is
greater, for each producing gas property owned by the Company.
Cost depletion is computed by dividing the basis of the property by the
estimated recoverable reserves to obtain a unit cost, then multiplying the
unit cost by the number of units sold in the current year. Cost depletion
cannot exceed the adjusted basis of the property to which it relates. Thus,
cost depletion deductions are limited to the capitalized cost of the
property, while percentage depletion may be taken as long as the property is
producing income. The depletion allowance for gas production will be computed
separately by each Investor Interestholder and not by the Company. The
Company will allocate to each Investor Interestholder his/her proportionate
share of production, and the adjusted basis
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of each Company property. Each Investor Interestholder must keep records of
his/her share of the adjusted basis and any depletion taken on the property
and use his/her adjusted basis in the computation of gain or loss on the
disposition of the property by the Company.
In determining the basis of each Interestholder in the Project for
purposes of determining depletion, Code Section 613A(c)(7)(D) requires that
the basis of oil and gas properties owned by a partnership be allocated to
the partners in accordance with their interests in the capital or income of
the partnership. Regulations issued under Code Section 613A(c)(7)(D) indicate
that such basis must be allocated in accordance with the partners' interests
in the capital of the partnership if their interests in partnership income
vary over the life of the partnership for any reason other than the admission
of a new partner. The terms "capital" and "income" are not defined in the
Code or in the Regulations under Code Section 613A. Instead, the Regulations
refer to the factors delineated in the Regulations promulgated under Code
Section 704 which determine a "partner's interest in the partnership." See
"Allocations" below.
Percentage depletion with respect to production of gas is available only
to those qualifying for the independent producer's exemption, and is limited
to an average of 6,000,000 cubic feet per day of domestic gas production.
The applicable rate of percentage depletion on production under the
independent producer exemption is 15% of gross income from oil and gas sales.
The depletion deduction under the independent producer exemption may not
exceed 65% of the taxpayer's taxable income for the year, computed without
regard to certain deductions. Any percentage depletion not allowed as a
deduction due to the 65% of adjusted taxable income limitation may be carried
over to subsequent years subject to the same annual limitation. For an
Investor Interestholder, the 65% limitation shall be computed without
deduction for distributions to beneficiaries during the taxable year.
The determination of whether an Investor Interestholder will quality for
the independent producer exemption will be made at the Investor
Interestholder level. An Investor Interestholder who qualifies for the
exemption, but whose average daily production exceeds the maximum number of
barrels on which percentage depletion can be computed for that year, will
have to allocate his/her exemption proportionately among all of the
properties in which he/she has an interest, including those owned by the
Company. In the event percentage depletion is not available, the Investor
Interestholder would be entitled to utilize cost depletion as discussed
above.
The independent producer exemption is not available to a taxpayer who
refines more than 50,000 barrels of oil on any one day in a taxable year or
who directly or through a related person sells oil or gas or any product
derived therefrom (i) through a retail outlet operated by him or a related
person, or (ii) to any person who occupies a retail outlet which is owned and
controlled by the taxpayer or a related person. In general, a related person
is defined by Section 613A of the Code as a corporation, partnership, estate,
or trust in which the taxpayer has a 5% or greater interest. For the purpose
of applying this provision: (i) bulk sales of oil or natural gas to
commercial or industrial users are excluded from the definition of retail
sales; (ii) if the taxpayer or a related person does not export any domestic
oil or natural gas production during the taxable year or the immediately
preceding year, retail sales outside the U. S. are not deemed to be
disqualifying sales; and (iii) if the taxpayers combined receipts from
disqualifying sales do not exceed $5,000,000 for the taxable year of all
retail outlets taken into account for the purpose of applying this
restriction, such taxpayer will not be deemed a "retailer."
The availability of depletion, whether cost or percentage, will be
determined separately by each Interestholder. Each Interestholder must
separately keep records of his/her share of the adjusted basis in an oil or
gas property, adjust such share of the adjusted basis for any depletion taken
on such property, and use such adjusted basis each year in the computation of
his/her cost depletion or in the computation of his/her gain or loss on the
disposition of such property. These requirements may place an administrative
burden on a Interestholder.
THE AVAILABILITY OF PERCENTAGE DEPLETION FOR AN INVESTOR INTERESTHOLDER
IS DEPENDENT UPON THE STATUS OF THE INVESTOR INTERESTHOLDER AS AN INDEPENDENT
PRODUCER. BECAUSE OF THE FOREGOING, SPECIAL TAX COUNSEL IS UNABLE TO RENDER
ANY OPINION AS TO THE AVAILABILITY OF PERCENTAGE DEPLETION. EACH PROSPECTIVE
INVESTOR IS URGED TO CONSULT WITH HIS/HER PERSONAL TAX ADVISOR TO DETERMINE
WHETHER PERCENTAGE DEPLETION WOULD BE AVAILABLE TO HIM.
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Percentage depletion in excess of the adjusted basis of a property is a
"tax preference" item, as that term is defined in Code Section 57, subject to
the alternative minimum tax imposed on such items. See " - Alternative
Minimum Tax."
The technical provisions and limitations relating to the availability of
depletion are complex and will vary among taxpayers. Many uncertainties
exist and each prospective Investor Interestholder should review his/her
individual circumstances with his/her personal tax advisor.
The 1997 Act provides that oil and gas large partnerships (i.e.
partnerships with 100 or more member) may elect a simplified reporting system
for federal tax purposes. Generally, items of taxable gain and loss are
computed at the partnership level, similar to a deduction, prior to
allocation to the partners. If the Company qualifies as an oil and gas large
partnership, it may elect to compute depletion at the Company level without
being subject to the 1,000 barrel-per-day limitation or the 65 percent of
taxable income limitation. However, a "disqualified person's" share of
income and depletion is separately determined and allowed. A "disqualified
person's" share of income and depletion is separately determined and
allocated. A "disqualified person" includes those persons not qualifying for
percentage depletion as described above.
DEPRECIATION
Costs of equipment, such as casing, tubing, tanks, pumping units,
pipelines, production platforms and other types of tangible property and
equipment generally cannot be deducted currently, but may be eligible for
accelerated cost recovery. All or part of the depreciation claimed may be
subsequently recaptured upon disposition of the property by the Company or of
Interests by any Investor Interestholder.
In addition, the Code provides for certain uniform capitalization rules
which could result in the capitalization rather than deduction of Company
overhead and administration costs.
FARMOUT AGREEMENT
The Company may enter into an agreement with an operator pursuant to
which the operator would agree to pay the expenses to drill on a drill site
location and would receive, in consideration therefor, an undivided interest
in such drill site plus an interest in other surrounding acreage. It is the
position of the Service that such a transaction results in the fair market
value of the interest in the surrounding undrilled acreage being taxed to the
operator as compensation and the transferor of the interest recognizing gain
or loss as if such property had been sold. Such position, if upheld, could
have adverse tax consequences to the Company and its Investor Interestholders
if it engages in such transactions.
ALLOCATIONS
In the opinion of Special Tax Counsel, the allocations of each Investor
Interestholder's share of income, gain, expense, loss, deduction or credit as
set forth in the Company Operating Agreement will more likely than not be
sustained for federal income tax purposes.
Under Section 704, a partner's distributive share of the income, gain,
expense, loss, deduction or credit of a partnership is determined in
accordance with the partnership agreement, unless the allocation set forth
therein is without "substantial economic effect. " An allocation will have
substantial economic effect only if it may actually affect the dollar amount
of the partners' shares of the total partnership revenue or costs
independently of tax consequences. Allocations which do not affect the
amounts to be distributed from a partnership generally do not have
substantial economic effect. It is essential that the allocations be
reflected in the partners' capital accounts and that such capital accounts be
the basis upon which distributions are made upon liquidation. Several
relevant factors that are considered in making a determination as to whether
an allocation will be recognized for federal income tax purposes are outlined
in the Regulations. These factors include, among others, (1) the presence of
a business purpose for the allocation, (2)
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whether related items of income, gain, expense, loss, deduction or credit
from the same source are subject to the same allocation, (3) whether the
allocation was made without recognition of normal business factors, (4)
whether it was made only after the amount of the specially allocated item
could reasonably be estimated, (5) the duration of the allocation, and (6)
the overall tax consequences of the allocation. These factors and perhaps
others may be relevant in determining whether an allocation has substantial
economic effect.
The Regulations relating to special allocations of partnership costs and
revenues under Section 704(b) provide that partnership allocations have
economic effect (and thus would be valid under the Code provided such effect
is substantial) only if they are consistent with the underlying economic
arrangements of the partners. Under the Regulations, an allocation of
income, gain, expense, loss, deduction or credit (or item thereof) to a
partner is considered to have economic effect if, throughout the full term of
the partnership, the partnership agreement provides:
(1) For the determination and maintenance of the partners'
capital accounts in accordance with the Regulations;
(2) Upon liquidation of the partnership (or any partner's
interest in the partnership), for liquidating distributions in
all cases to be made in accordance with the positive capital
account balances of the partners, as determined after taking
into account all capital account adjustments for the
partnership taxable year during which such liquidation occurs
(other than those made pursuant to this requirement and
requirement (3) below), by the end of such taxable year (or,
if later, within 90 days after the date of such liquidation);
and
(3) For a "qualified income offset" provision as defined in
Regulation Section 1.704-1(b)(2)(ii)(d) and a "minimum gain
chargeback" provision as defined in Regulation Section
1.704-2(b)(2).
No allocation to a partner will be given effect, however, which would cause or
increase a negative capital account balance for such partner in excess of that
partner's share of the partnership's minimum gain. In general, a partnership
has minimum gain to the extent that nonrecourse liabilities encumbering
partnership property exceed the adjusted tax basis of such property.
Under the Company Operating Agreement, a capital account is to be
maintained for each Investor Interestholder to which will be charged each item
of Company income, gain, expense, loss, deduction and credit in accordance with
the rules set forth in the Regulations. Upon dissolution of the Company, after
satisfying all Company liabilities, each Interestholder (including the Manager
with respect to both the Manager's Investment Interest and the Manager's
Promoted Interest) will receive a distribution in accordance with the
Interestholder's positive capital account balance. In addition, the Company
Operating Agreement contains a "qualified income offset" provision as defined in
Regulation Section 1.704-1(b)(2)(ii)(d) and a "minimum gain chargeback"
provision as defined in Regulation Section 1.704-2(b)(2).
The Company Operating Agreement provides that 100% of the IDC will be
allocated to Investor Interestholders EXCLUDING the Manager with respect to the
Manager's Investment Interest. Accordingly, the IDC which would have been
allocated to the Manager with respect to the Manager's Investment Interest will
be allocated to the Investor Interestholders. However, the Company Operating
Agreement also provides that Investor Interestholders will not be allocated gain
from the sale of the wells in the Project in an amount equal to the difference
between the IDC which the Investor Interestholders were allocated and the amount
the Investor Interestholders would have been allocated had all IDC been
allocated PRO RATA among all Interestholders, including the Manager with respect
to the Manager's Investment Interest. Accordingly, the Investor Interestholders
capital accounts will be less than the Manger's Capital account, on a pro rata
basis, which will decrease the proceeds the Investor Interestholders would
receive on liquidation of the Company.
Regulation Section 1.704-1(b)(2)(iii)(a) provides that the economic effect
of an allocation is not substantial if, at the time the allocation becomes part
of the partnership agreement, (1) the after-tax economic consequences of at
least one partner may, in present value terms, be enhanced compared to such
consequences if the allocation were not
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contained in the partnership agreement, and (2) there is a strong likelihood
that the after-tax economic consequences of no partner will, in present value
terms, be substantially diminished compared to such consequences if the
allocation were not contained in the partnership agreement. In determining
the after-tax economic benefit or detriment to a partner, tax consequences
that result from the interaction of the allocation with such partner's tax
attributes that are unrelated to the partnership will be taken into account.
In applying the substantiality test, the Regulations assume that the fair
market value of partnership property is equal to its adjusted tax basis and
any adjustments to the basis of property are presumed to be matched by a
corresponding change to the property's fair market value. Accordingly, there
cannot be a strong likelihood that the economic effect of an allocation will
be largely offset by an allocation of gain or loss from the disposition of
partnership property since the value of the property is assumed to decline by
adjustments such as depletion. Secondly, the Regulations assume that an
offsetting allocation will not render an original allocation invalid if there
is not a strong likelihood, when the original allocation is made, that the
offsetting allocation will not, in large part, occur within five years after
the original allocation has been made. Finally, even though the allocations
of IDC are disproportionate to the Interestholders' interest in the Company
(since the Manager is not allocated any IDC with respect to the Manager's
Investment Interest), such allocation will actually affect the economic
outcome to Investor Interestholders. Accordingly, such allocations should be
considered substantial under the Regulations.
Since the allocations of losses to the Interestholders are presumed to
decrease the basis of the Company's properties and the amount of income from
a gas well is speculative, at best, there can be no "strong likelihood" that
the loss allocations to the Interestholders will be offset by income
allocations within five years. Accordingly, the allocations should meet the
requirements for "substantiality" imposed by the Regulations.
Pursuant to the Company Operating Agreement, (i) allocations will be made
as mandated by the Regulations, (ii) liquidating distributions will be made
in accordance with positive capital account balances, and (iii) a "qualified
income offset" provision applies. Under the Company Operating Agreement the
basis in oil and gas projects will be allocated in proportion to each
Investor Interestholder's (including the Manager with respect to the
Manager's Investment Interest) respective share of the costs which entered
into the Interestholder's adjusted basis for each depletable property. Such
allocations of basis appear reasonable and in compliance with the Regulations
under Code Section 704. Nevertheless, the Service may contend that the
allocation to the Investors (excluding the Manager with respect to the
Manager's Investment Interest) of IDC (100%) in conjunction with the
allocation to the Manager of other tax items is invalid and may reallocate
such excess IDC or other items. Any such reallocation could increase an
Interestholder's tax liability. In view of the absence of judicial authority
interpreting Code Section 613A(c)(7)(D) and in light of the lack of specific
guidance in the Regulations, however, no assurance can be given that the
Service will not seek to reallocate the IDC. The Company Operating Agreement
has been drafted in an effort to satisfy the requirements of the economic
effect and substantiality tests. All allocations of profit and loss and
items of deduction or gain will result in adjustments to the Investor
Interestholders' (including the Manager with respect to the Manager's
Investment Interest) capital accounts which will be maintained in accordance
with the Regulations. Additionally, the Company Operating Agreement contains
a qualified income offset provision, a provision limiting the allocation of
losses to Investor Interestholders (including the Manager with respect to the
Manager's Investment Interest) if such allocation would cause a negative
balance in their capital accounts and a provision stating that liquidation
proceeds will be distributed in accordance with capital account balances. As
described above, the disproportionate allocation of IDC to the Investor
Interestholders permanently lowers capital accounts, such allocations
actually will impact the amount of proceeds such Investor Interestholders
receive in liquidation of the Company. Additionally, as stated above, it is
likely that the allocations of profit, loss, deduction and gain will meet the
requirements of the Regulations for substantiality. Based on the foregoing,
it is opinion of Special Tax Counsel that the allocations set forth in the
Company Operating Agreement will more likely than not have substantial
economic effect and/or will more likely than not be in accordance with the
interests of the Investors (including the Manager with respect to the
Manager's Investment Interest) in the Company and that, while the outcome of
litigation cannot be predicted with certainty, it is more likely than not, if
the issue were litigated, a court would so hold.
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If the allocations are not recognized, Section 704(b) requires that each
Investor's (including the Manager with respect to the Manager's Investment
Interest) distributive share be determined in accordance with his/her
interest in the Company, as determined from all the facts and circumstances.
Section 706 and the Regulations thereunder provide generally that a
partner may be allocated items of partnership income and deductions only for
that portion of the partnership's taxable year that the partner is a partner.
Accordingly, the Company shall allocate such items only to those Investor
Interestholders who are already admitted to the Company at the time such
expenses were incurred.
ORGANIZATION, START-UP AND SYNDICATION EXPENSES
Section 709(a) prohibits any Investor Interestholder from deducting any
amounts paid or incurred to organize the Company or to promote the sale of
(or to sell) an interest in the Company. Amounts paid to organize a Company,
however, may, at the election of the Company, be treated as deferred expenses
and deducted ratably over a period of not less than sixty (60) months
selected by the Company. Organization expenditures that may be amortized are
those (i) incurred incident to the creation of the Company, (ii) chargeable
to the capital account, and (iii) of a character which, if expended incident
to the creation of a partnership having an ascertainable life, would be
amortized over such life. The Manager presently intends to cause the Company
to amortize qualifying organization expenditures over a 60-month period.
Expenses connected with the promotion or sale of interests in the
Company, known as syndication expenses, are not deductible by the Company or
the Investor Interestholders and are not eligible for the 60-month
amortization as is the case for organizational expenses. Syndication
expenses include such expenditures connected with the issuing and marketing
of interests in a partnership such as sales commissions, certain professional
fees, selling expenses and printing costs. Regulation Sections 1.709-1 and
1.709-2 make it clear that the definition of syndication costs includes
counsel fees related to securities law advice, certain accountants fees,
brokerage fees and registration fees. The allocation of certain expenses
between organization costs and syndication costs is a question of fact and
the Manager will use reasonable judgment in claiming amortization deductions
for a portion of the organizational offering expenses and other expenses.
The Service may on audit contest such deductions.
Section 195 provides that no deduction is allowed for "start-up
expenditures. " However, taxpayers may elect under that Section to amortize
"start-up expenditures" over a period of not less than sixty (60) months.
"Start-up expenditures" include amounts paid or incurred in connection with
investigating the creation or acquisition of an active trade or business or
paid or incurred in connection with any activity engaged in for profit and
for the production of income prior to the day on which the active trade or
business begins, in anticipation of the activity becoming an active business.
A significant portion of a Company's expenses may be characterized as
"start-up expenditures" for federal income tax purposes. Consequently, the
Manager intends to cause the Company to elect to amortize such expenses over
a 60-month period.
While the Manager will use its best judgment in the allocation of
expenses among startup, organization, syndication and other costs, no
assurance can be given that such allocation will not be challenged by the
Service. In particular, the Service may claim that various fees paid to the
Manager constitute syndication expenses.
DISTRIBUTIONS
Cash distributions by the Company to an Investor Interestholder will not
result in taxable gain to such Investor Interestholder unless such cash
distributions exceed the Investor Interestholder's adjusted basis in his/her
Interests, in which case the Investor Interestholder will recognize gain in
the amount of such excess. Non-liquidating distributions of property other
than cash to an Investor Interestholder will reduce the Investor
Interestholder's basis in the Company by an amount equal to the Company's
basis in such property; provided, however, that the adjusted basis of the
Investor Interestholder may not be reduced below zero. An Investor
Interestholder's tax basis in any property distributed to the Investor
Interestholder will be an amount equal to the amount of reduction in the
Investor Interestholder's basis in the
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Investor Interestholder's Interests, occurring by reason of such
distribution, regardless of the value of the property distributed. A
reduction in an Investor Interestholder's share of Company indebtedness will
be treated as a cash distribution to the Investor Interestholder to the
extent of such reduction. Under some circumstances, distributions from the
Company to an Investor Interestholder may cause the amount the Investor
Interestholder has at risk with respect to the Company activity to fall below
zero, which could result in recapture of previously deducted losses. See " -
At Risk Rules - Limitation on Deduction of Losses."
TRADE OR BUSINESS REQUIREMENTS
The Service may seek to disallow certain deductions claimed by the
Company on the ground that these expenditures are not expenditures incurred
in carrying on a trade or business because the Company will not have
established and commenced its business at the time the expenditures are made.
Neither the Code nor the Regulations provide any explicit definitions of
"carrying on a trade or business." Although various subjective criteria have
been recommended for consideration in this regard, no single factor has been
found to be controlling. Further, determining the point in time when a
particular venture begins carrying on a trade or business is essentially a
question of fact, the resolution of which is not to be determined solely from
the intention of the taxpayer. The Service might contend that the Company is
not engaged in carrying on any trade or business within the meaning of
Section 162(a) until such time as the business has begun to function as a
going concern, performs those activities for which it was organized and
starts to generate receipts. In addition, the Service may contend that
certain expenses are in the nature of "start-up" expenses rather than
currently deductible trade or business expenses. See " - Organization,
Start-up and Syndication Expenses."
In the event that the Service were to disallow Company expenses based
upon the failure of the Company to have been carrying on a trade or business,
the Manager expects to cause the Company to take the position that its
expenses may be deducted in any case under Section 212 which provides for
deductions for amounts incurred for the production of income, for the
management, conservation, or maintenance of property held for the production
of income and in connection with the determination, collection or refund of
any tax.
Under Code Section 67, however, expenses of an individual taxpayer which
are otherwise deductible under Section 212 are disallowed to the extent that
they, when combined with the taxpayer's other miscellaneous deductions, do
not exceed 2% of his/her adjusted gross income. If, for any period, the
Company is found not to be engaged in a trade or business, the Service could
thus disallow an Investor Interestholder's share of various expenses of the
Company to the extent that such share, when combined with the Investor
Interestholder's otherwise allowable miscellaneous deductions, does not
exceed such 2% threshold.
ALTERNATIVE MINIMUM TAX
The Code imposes an alternative minimum tax ("AMT") in order to assure
that taxpayers may not reduce their tax below a minimum level through certain
"tax preference items. " In general, the alternative minimum tax liability of
a noncorporate taxpayer is calculated by determining AMT income ("AMTI"),
which is arrived at by (1) adding together the taxpayer's adjusted gross
income and the taxpayer's tax preference items, (2) adding and subtracting
certain other specified items, and (3) then subtracting the applicable
exemption of $30,000 for single taxpayers or $40,000 for married taxpayers
filing joint returns or $20,000 for estates, trusts, and married taxpayers
filing separate returns. The alternative minimum tax is 26% of AMTI up to
$175,000 and 28% of AMTI over $175,000. The taxpayer must then pay the
greater of the alternative minimum tax or the regular income tax. Generally,
tax credits are not allowable against the alternative minimum tax, except the
foreign tax credit. Under the Code, the $40,000 exemption ($30,000 for
single persons and $20,000 for estates, trusts and married persons filing
separately) is phased out where alternative minimum taxable income exceeds
$150,000 ($112,500 for single persons and $75,000 for estates, trusts and
married persons filing separately).
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Among the tax preference adjustment items that could result from
investing in the Company and which would be included in determining the
alternative minimum taxable income are as follows:
(a) The amount of the allowable deduction for percentage depletion for
a taxable year in excess of the adjusted basis for the property at the
end of such taxable year (determined without regard to the depletion
deduction for such year) only to the extent that this preference
results in a reduction of AMTI by more than 30%.
(b) The excess IDC arising in the taxable year, reduced by 65 percent
of the taxpayer's net income from oil and gas properties only to the
extent that the excess IDC preference results in reduction of AMTI by
more than 30%. For this purpose, the excess IDCs are, in essence, the
amount of intangible drilling and development costs of productive
wells allowable as a deduction for the taxable year over the amount
which would have been allowable as a deduction for the taxable year if
the taxpayer elected to capitalize such costs and deduct them ratably
over ten years under Section 57(6) or in accordance with cost
depletion.
(c) An adjustment that may increase or decrease alternative minimum
taxable income is depreciation attributable to personal property that
differs from the amount available under the 150 percent declining
balance method.
Generally, tax credits other than the foreign tax credit are not allowable
against the alternative minimum tax. Thus, the Section 29 Credit for production
of fuel from a non-conventional source is allowed only to the extent that the
taxpayer's regular income tax exceeds his/her alternative minimum tax. Any
Section 29 Credit which is disallowed as a result of this limitation, however,
may be carried forward as a credit in future years against the excess of the
regular tax over the alterative minimum tax.
A taxpayer other than an integrated oil company is allowed a special energy
deduction for purposes of computing his/her alternative minimum taxable income.
The deduction is based on a specified portion of certain energy related tax
preference items. The special energy deduction for alternative minimum tax
purposes is limited, however, to 40% of the taxpayer's alternative minimum
taxable income (computed without regard to either the special energy deduction
or the alternative minimum tax net operating loss. ) Generally, the special
energy deduction is subject to reduction for any taxable year if the average
price of crude oil for the immediately preceding taxable year exceeds $28 per
barrel (subject to an inflation adjustment) and is completely eliminated if the
average price of crude oil for the immediately preceding taxable year exceeds
such amount by $6 or more. Although the calculation of the special energy
deduction is complex, its general effect is to reduce the alternative minimum
tax of taxpayers who participate in the drilling of exploratory wells and in the
production of marginally productive or heavy oil wells. It should be further
noted that:
(a) the special energy deduction will be phased out in taxable years
that follow calendar years in which the price of crude oil
exceeds a specified level. The amount of the special energy
deduction (determined without regard to the phase out) is to be
reduced for any taxable year that immediately follows a calendar
year during which the average price of crude oil exceeds $28.00
per barrel (adjusted for inflation using the GNP implicit price
deflator) and will be completely phased out if the average price
of oil exceeds such inflation adjusted amount by $6.00 or more in
such year;
(b) Section 56(h)(8) of the Code provides that the Secretary of the
Treasury may, by regulation, provide for appropriate adjustments
in computing AMTI or adjusted current earnings for any taxable
year following a taxable year for which a special energy
deduction for minimum tax was allowed to ensure that no double
benefit is allowed; and
(c) certain new definitions apply in computing the special energy
deduction for minimum tax:
(1) INTANGIBLE DRILLING COST PREFERENCE - this is the amount by
which AMTI would be reduced if it were computed without
regard to IDC as defined in Sections 57(a)(2) and
56(g)(4)(D)(i) of the Code;
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(2) PORTION ATTRIBUTABLE TO QUALIFIED EXPLORATORY COSTS - for
purposes of Intangible Drilling Costs Preference, this is an
amount which bears the same ratio to the Intangible Drilling
Cost Preference as:
(i) the qualified exploratory costs of the taxpayer for
the taxable year bear to
(ii) the total intangible drilling and development costs
with respect to which the taxpayer may make an
election under Section 263(c) of the Code for the
taxable year.
(3) QUALIFIED EXPLORATORY COSTS - generally, IDC costs of a
taxpayer, other than an integrated oil company, which the
taxpayer may elect to deduct under Section 263(c) of the
Code and which are paid or incurred in connection with
drilling of an exploratory well located in the United States
within the meaning of Section 638(1) of the Code.
(4) EXPLORATORY WELL - as defined in Section 56(h)(6)(B) of the
Code, includes, among other wells, an oil or gas well which
is completed (or if not completed, with respect to which
drilling operations cease) before the completion of another
well which:
(i) is located within 1.25 miles from the well, and is
capable of production in commercial quantities
(distance test);
(ii) an oil or gas well which is not described
immediately above, but which is drilled to a total
depth of at least 800 feet below the deepest
completion depth of any well within 1.25 miles and
which is capable of production in commercial
quantities, is also defined as an Exploratory Well
(depth test); and
(iii) this also includes an oil or gas well (which does
not meet the distance or depth test) which is
capable of production in commercial quantities but
which is drilled into a new reservoir, except that
this does not include a gas well if the gas is
produced from Devonian shale, coal seams or a tight
formation (determined in a manner similar to the
manner under Section 29(c)(2) of the Code).
(5) MARGINAL PRODUCTION DEPLETION PREFERENCE - for purposes of
the special energy deduction for minimum tax, this is the
amount by which AMTI would be reduced if it were computed as
if the excess depletion deduction determined as per Sections
57(a)(1) and 56(g)(4)(G) of the Code did not apply to any
allowance for depletion determined in Section 613A(c)(6) of
the Code (referring to oil and natural gas resulting from
secondary or tertiary processes).
The applicability of the alternative minimum tax must be determined by each
individual Investor Interestholder based upon the operations of the Company and
his/her personal tax situation. Due to the inherently factual nature of the
application of the AMT to an Investor Interestholder, Special Tax Counsel is
unable to express an opinion with respect to such issues. In many
circumstances, the federal (and state) minimum tax provisions will substantially
eliminate the value of intangible drilling deductions and Section 29 tax credits
for individual taxpayers. Accordingly, any potential investor in the Company
should consult his/her own tax advisor to determine the tax consequences to him
personally of the alternative minimum tax.
TERMINATION OF THE COMPANY
The actual or constructive termination of the Company may have important
tax consequences to the Investor Interestholders. All Investor Interestholders
would recognize their distributive shares of Company income, gain, expense,
loss, deduction or credit accrued during the Company's taxable year up until the
date of termination whether
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or not any such items are distributed. Similarly, the Investor
Interestholders must account for their distributive shares of gains or losses
realized from the sale or other disposition of Company assets in liquidation
of the Company. The Code provides that if 50% or more of the capital and
profit interests in a partnership are sold or exchanged within a single
twelve-month period, the partnership will terminate for tax purposes. If
such a termination occurs, the assets of the Company will be deemed
constructively contributed to a new (for tax purposes) Company, and the
Interest in such "new" Company will be deemed distributed PRO RATA to the
Investors, including the Manager.
Upon the distribution of Company assets incident to the termination of
the Company (other than a deemed termination), an Investor Interestholder
will recognize gain to the extent that money distributed to the Investor
Interestholder plus the PRO RATA amount, if any, of liabilities discharged
exceeds the adjusted basis of his/her Interests immediately before the
distribution. Assuming that an Investor Interestholder's interest in the
Company is a capital asset, such gain will be capital gain unless Code
Section 751 applies. Code Section 751 provides generally that a partner's
gain on liquidation of a partnership will be treated as ordinary income to
the extent that the partner receives or is deemed to receive less than the
partner's PRO RATA share of certain ordinary income assets, including
unrealized receivables and potential recapture of depreciation. No loss will
be recognized by an Investor Interestholder on the distribution to the
Investor Interestholder of Company property upon the termination of the
Company.
ACTIVITIES ENGAGED IN FOR PROFIT
Section 183 provides limitations for deductions attributable to an ". . .
activity not engaged in for profit." The term ". . . activity not engaged in
for profit . . ." means an activity other than one which constitutes a trade
or business, or one that is engaged in for the production or collection of
income or for the management, conservation or maintenance of property held
for the production of income. The determination of whether an activity is
not engaged in for profit is based on all the facts and circumstances and no
one factor is determinative.
Section 183 creates a presumption that an activity is engaged in for
profit if in any three years out of five consecutive taxable years the gross
income derived from the activity exceeds the deductions attributable thereto.
Thus, if the Company fails to produce a profit in at least three of five
consecutive years, the presumption will not be available and the possibility
of successful challenge by the Service substantially increases. If Section
183 is successfully asserted by the Service, no deductions will be allowed in
excess of income.
Since the test of whether an activity is deemed to be engaged in for
profit is based on the facts and circumstances existing from time to time, no
assurance can be given that Section 183 may not be applied in the future to
disallow deductions taken by the Investor Interestholders with respect to
their interests in the Company. It should be noted that, if the Service were
to challenge an Investor Interestholder's deduction of Company losses for
lack of profit motive, such Investor Interestholder would have the burden of
proving that the Company did in fact enter into the transaction with a
reasonable expectation of profit and that the Investor Interestholder's own
investment in the Company was made with the requisite profit motive.
MATERIAL DISTORTION OF INCOME
Section 446(a) provides that taxable income shall be computed under the
method of accounting on the basis of which the taxpayer regularity computes
the taxpayer's income in keeping the taxpayer's books. Section 446(b)
provides, however, that if the method used does not clearly reflect income,
the computation shall be made under such method as does clearly reflect
income in the opinion of the Service. If the method of accounting used by
the taxpayer does not clearly reflect income, Section 446(b) grants the
Service discretion to compute the taxpayer's taxable income "under such
method" as the Service determines does clearly reflect income. It has been
established that the Service's authority to change a method of accounting may
be used to correct not only the overall method of accounting of the taxpayer
but also the accounting treatment of any item. See, e.g., BURCK V.
COMMISSIONER, 533 F.2d 768 (2d Cir. 1976).
The Service claims a very broad authority under Section 446(b) to disallow
any deduction where the deduction results in what it determines to be ". . . a
material distortion of income . . ." An example of the Service's position is
Rev.
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Rul. 79-229 1979-2 C.B. 210, which sets forth some of the factors it can
consider in determining whether a deduction results in a material distortion
of income, such as the customary practice of the taxpayer, the amount of the
expense in relation to such expenses in the past, and the materiality of the
expenditure in relation to the taxpayer's income for the year.
The broad authority claimed by the Service in Rev. Rul. 79-229 is similar
to a position taken by it in the past. However, on at least one occasion,
the United States Supreme Court specifically rejected the reasoning that the
Service has the authority to make exceptions to the general rule of
accounting by annual periods if it determines that it would be unjust or
unfair not to isolate a particular transaction and treat it on the basis of
the long term result. Despite this authority, the Service may analyze
deductions taken by a Company and attempt to reallocate such deductions to
another taxable year to the extent the Service determines that such
deductions materially distort income. Since the material distortion of
income test is based upon the facts and circumstances of a specific
transaction, Special Tax Counsel cannot express an opinion as to the likely
outcome of an attempted reallocation of Company deductions by the Service.
COMPANY BORROWINGS
Any Company income associated with cash flow applied to the repayment of
Company borrowings will remain taxable as income to the Investor
Interestholders although no distribution is made to them. A foreclosure or
other sale of any Company property securing any such indebtedness may also
result in an Investor Interestholder's realization of income for income tax
purposes even if no proceeds are distributed to the Investor Interestholder.
In determining for federal income tax purposes the amount received on the
sale or disposition of an interest in the Company an Investor Interestholder
must take into account, among other things, the Investor Interestholder's
share of Company indebtedness. An Investor Interestholder may, therefore,
realize an amount of taxable gain in excess of the actual proceeds of a sale
or disposition of Company property or of the Investor Interestholder's
interest in the Company. While the Manager does not anticipate that the
Company will incur indebtedness, all Investor Interestholders should be aware
of the restrictions, contained in the Code, on the deductibility of interest
paid by an Investor Interestholder. See " -Limitations on Interest
Deductions."
REGISTRATION OF TAX SHELTERS
Under Section 6111, any tax shelter organizer is required to register the
shelter with the Service if it meets the following tests: (i) if a person
could infer from the offering that the tax shelter ratio may be greater than
2 to 1 at the end of any of the first five years after the offering date; and
(ii) if the investment (a) is required to be registered under any federal or
state securities law, or (b) is sold pursuant to an exception under any
federal or state securities law, or (c) is substantial. For purposes of the
foregoing tests, the tax shelter ratio is the ratio with respect to any
investor of (A) the aggregate of deductions and 350 percent of the credits
potentially allowable, to (B) the aggregate of the cash invested and the
adjusted basis of other property contributed by the investor (reduced by any
liability to which that property is subject) and an investment is considered
substantial if the total offering exceeds $250,000 and five or more investors
are expected to invest. The organizers must register the shelter not later
than the day on which the interests are offered for sale. The organizers
must complete a registration form which contains information identifying and
describing the tax shelter, its benefits, and any other information required
by the Service. If the organizers fail to timely register a tax shelter or
file false or incomplete information with respect to registration, they may
be subject to a penalty equal to the greater of (a) $500 or (b) 1% of the
amount invested in the shelter. The organizers must supply purchasers with
the entity's tax shelter identification number. Failure to do so will result
in a penalty of $100 for each failure. Any person claiming any deduction,
credit or other tax benefit by reason of a tax shelter must include the
entity's tax shelter identification number on the tax return on which such
deduction, credit or other benefit is claimed. Failure to include such
number will result in a penalty of $250 for each such failure.
The Manager intends to comply with the registration requirements of
Section 6111 and, if the Company is required to so register, will provide all
of the investors with the tax shelter identification number of the Company
within a reasonable time after such number has been assigned to the Company.
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AUDITS, INTEREST AND PENALTIES
Under the Code, the Service is permitted to audit a partnership's tax
returns instead of having to audit the individual tax returns of the
partners, so that a partner would be subject to determinations made by the
Service or the courts at the partnership level. A partner is entitled to
participate in such an audit, or in litigation resulting therefrom, only in
limited circumstances. In the event that any audit results in a change in a
Company's return and an increase in the tax liability of an Investor
Interestholder, there may also be imposed substantial amounts of
nondeductible interest and penalties.
In addition to the interest imposed on deficiencies (presently 9% per
year compounded daily), the Code now provides various penalties. Under Code
Section 6662, a taxpayer will be assessed an accuracy-related penalty equal
to twenty percent (20%) of any underpayment on his/her tax return that is
attributable to (i) negligence or disregard of rules or regulations, (ii) a
valuation misstatement, or (iii) a "substantial understatement". An
"understatement" is defined as the excess of the amount of tax required to be
shown on the return for the taxable year over the amount of the tax imposed
that is actually shown on the return, reduced by any rebate. Code Section
6662(d)(2)(A). An understatement is "substantial" if it exceeds the greater
of ten percent (10%) of the tax required to be shown on the return for the
taxable year or $5,000 ($10,000 in the case of certain corporations).
Generally, the amount of an understatement is reduced by the portion
thereof attributable to (i) the tax treatment of any item by the taxpayer if
there is or was substantial authority for such treatment, or (ii) any item
with respect to which the relevant facts affecting the item's tax treatment
are adequately disclosed in the return or in a statement attached to the
return and there is a reasonable basis for the tax treatment of such item by
the taxpayer. Code Section 6662(d)(2)(B). However, in the case of "tax
shelters" there will be a reduction of the understatement only to the extent
it is attributable to the treatment of an item by the taxpayer with respect
to which there is or was substantial authority for such treatment and only if
the taxpayer reasonably believed that the treatment of such item by the
taxpayer was the proper treatment. Code Section 6662(d)(2)(C)(i). The term
"tax shelter" is defined for purposes of Code Section 6662(d)(2)(C)(ii). It
is important to note that this definition of "tax shelter" differs from that
contained in Code Sections 461 and 6111, as discussed above. A tax shelter
item includes an item of income, gain, loss, deduction, or credit that is
directly or indirectly attributable to a partnership that is formed for the
principal purpose of avoiding or evading federal income tax. The existence
of substantial authority is determined as of the time the taxpayer's return
is filed or on the last day of the taxable year to which the return relates
and not when the investment is made. Substantial authority exists if the
weight of authorities supporting a position is substantial compared with the
weight of authorities contrary to the position. Relevant authorities include
statutes, Regulations, court cases, revenue rulings and procedures, and
Congressional intent. However, among other things, conclusions reached in
legal opinions are not considered authority under the Regulations.
Although not anticipated by the Manager, there may not be substantial
authority for one or more reporting positions that the Company may take in
its federal income tax returns. In such event, if the Company does not
disclose or if it fails to adequately disclose any such position, the penalty
will be imposed with respect to any substantial understatement determined to
have been made, unless the provisions of the Regulations pertaining to waiver
of the penalty become final and the Company is able to show reasonable cause
and good faith in making the understatement as specified in such provisions.
If the Company makes a disclosure for the purposes of avoiding the penalty,
the disclosure is likely to result in an audit of such return and a challenge
by the Service of such position taken.
If it were determined that an Investor Interestholder had underpaid tax
for any taxable year, such Investor Interestholder would have to pay the
amount of underpayment plus interest on the underpayment from the date the
tax was originally due. Additionally in the event an audit of the Company's
tax return or of an Investor Interestholder's tax return results in a
substantial underpayment of tax by such Investor Interestholder due to an
investment in the Interests, such Investor Interestholder may be required to
pay interest on such underpayment determined at a higher interest rate, if it
was determined that the underpayment was pursuant to a "tax motivated
transaction."
Because of the potentially substantial effect of all the foregoing
provisions, each prospective investor should consult with his/her tax advisor
about these provisions before acquiring Interests.
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SALES OF COMPANY PROPERTY
The sale or disposition of Company property used in the Company's
business (including property of other partnerships or similar entities in
which the Company owns an interest) will generate a gain or loss equal to the
difference between the amount realized on such sale or other disposition and
the Company's adjusted basis in the property. In general, gain realized from
the sale or disposition of such property which is depreciable property or
land and was held for more than one year should qualify as gain from the sale
of a Section 1231 asset, except to the extent that any such gain is
attributable to property subject to recapture. Each Investor Interestholder
is generally entitled to treat the Investor Interestholder's share of Section
1231 gains and losses as long-term capital gains and losses if the Investor
Interestholder's Section 1231 gains exceed the Investor Interestholder's
Section 1231 losses for the year. However, net Section 1231 gains will be
treated as ordinary income to the extent of unrecaptured net Section 1231
losses of the Investor Interestholder for the five most recent prior years.
If the Investor Interestholder's share of Section 1231 losses exceeds the
Investor Interestholder's Section 1231 gains for the taxable year, such
losses will be treated as ordinary losses.
Section 1254 provides that upon disposition of any oil and gas property
by the Company, a portion of any gain may be taxed as ordinary income from
the recapture of intangible drilling and development costs and depletion.
The amount that will be taxable as ordinary income will be equal to the
lesser of: (1) the amount of intangible drilling and development costs and
depletion previously deducted with respect to the property or interest sold
(only insofar as they reduced the adjusted basis thereof); or (2) the excess
of the amount realized on disposition of the property over the adjusted basis
of the property.
Any gain on the sale or other disposition of equipment by the Company
will be taxed as ordinary income to the extent of all depreciation deductions
previously claimed with respect to such equipment, with any excess being
treated as Section 1231 gain. Similarity, gain on the sale of any buildings
owned by a Company will be treated as ordinary income to the extent of any
depreciation taken with respect to such buildings in excess of straight-line
depreciation. If, however, such buildings have been held for one year or
less, all depreciation will be recaptured as ordinary income. In the case of
a disposition of property in an installment sale, any ordinary income under
these recapture provisions is to be recognized in the year of the disposition.
REDEMPTION OR SALE OF INTERESTS
Generally, Interests will constitute capital assets in the Investor
Interestholders' hands. As such, except as described below pursuant to Code
Section 751, the redemption or sale of Interests will result in capital gain
for the selling Investor Interestholder. Such gain will be treated as long
term capital gain subject to favorable tax rates if the Investor
Interestholder has held his/her Interests for greater than 18 months.
Interests redeemed by the Company pursuant to the Interest Repurchase Program
will result in the same treatment.
The amount of gain is the difference between the amount realized for the
Interest (including the Investor Interestholder's share of any debt of the
Company of which he/she is relieved) less the Investor Interestholder's basis
in his/her Interests.
Under Code Section 751, a recapture rule applies upon the disposition of
Interests by an Investor Interestholder such that an Investor Interestholder
will be required to treat as ordinary income the portion of any gain realized
upon the disposition of the Investor Interestholder's Interests that is
attributable to property subject to depreciation recapture or certain other
property which, if sold by the Company, would give rise to ordinary income.
There are exceptions to the recapture rules for gifts, transfers at death,
transfers in certain tax-free reorganizations, like-kind exchanges and
involuntary conversions in certain circumstances.
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COMPANY ELECTIONS
Pursuant to Sections 734, 743 and 754, a partnership may elect to have
the cost basis of its assets adjusted in the event of a sale by a partner of
another partner's interest in the partnership, the death of a partner, or the
distribution of property to a partner. The general effect of such an
election is that the transferees of an interest in the partnership are
treated as though they had acquired a direct interest in the partnership
assets and, upon certain distributions to partners, the partnership is
treated as though it has newly acquired an interest in the partnership assets
and therefore acquired a new cost basis for such assets. Any such election,
once made, is irrevocable without the consent of the Service.
As a result of the complexities and the substantial expense inherent in
making the election, the Manager does not presently intend to make such an
election on behalf of any Company. The absence of any such election and of
the power to compel the making of such an election may result in a reduction
in value of an Investor Interestholder's Interests to any potential
transferee. Thus, the absence of the power to compel the making of such an
election should be considered an additional impediment to the transferability
of Interests.
Various other elections affecting the computation of federal income tax
deductions and taxable income derived from a Company must be made by the
Company and not by the individual Investor Interestholders. For purposes of
reporting each Investor Interestholder's share of Company income, gains and
losses, the Company's elections are binding upon the Investor
Interestholders.
BASIS AND AT RISK RULES: LIMITATION ON DEDUCTION OF LOSSES
An Investor Interestholder's share of Company losses will not be allowed
as a deduction to the extent such share exceeds the amount of the Investor
Interestholder's adjusted tax basis in his/her Interests. An Investor
Interestholder's initial adjusted tax basis in his/her Interests will
generally be equal to the cash he/she has invested to purchase his/her
Interests. Such adjusted tax basis will generally be increased by (i)
additional amounts invested in the Company, including his/her share of net
income, (ii) additional capital contributions, if any, and (iii) his/her
share of Company borrowings, if any, based on the extent of his/her economic
risk of loss for such borrowings. Such adjusted tax basis will generally be
reduced, but not below zero by (i) his/her share of losses, (ii) his/her
depletion deductions on his/her share of oil and gas income (until such
deductions exhaust his/her share of the basis of property subject to
depletion), (iii) distributions of cash and property make him, and (iv)
his/her share of reduction in the amount of indebtedness previously included
in his/her basis.
Code Section 465 limits an Investor Interestholder's deduction for losses
allocated to the Investor Interestholder by a Company to the amount that
he/she has "at risk" with respect to the Company. The term "loss" is defined
as meaning the excess of the deductions allowable for the taxable year over
the income received or accrued by the taxpayer during the taxable year from
such activity.
Code Section 465 and the proposed Regulations thereunder generally
provide that an Investor Interestholder will be considered to be at risk in a
Company the sum of (i) the amount of money contributed to the Company, (ii)
the adjusted basis of other property contributed to the Company, (iii) income
generated by the Company, and (iv) amounts borrowed by the Investor
Interestholder or the Company for use in the Company's activities, where the
Investor Interestholder is personally liable for the repayment of the loan or
where the Investor Interestholder has pledged property, other than property
used in the activity, as security for the borrowed amount, but only to the
extent of the net fair market value of the Investor Interestholder's interest
in the property; provided, however, that borrowed amounts will not be
considered at risk if borrowed from any person or entity who (a) has an
interest, other than as a creditor, in the Company's activities, or (b) is
related to someone who has such an interest. See Code Section 465(b)(3)(C).
Thus, for example, an Investor Interestholder will not be considered to be at
risk for amounts borrowed from the Manager or its Affiliates. An Investor
Interestholder will not be considered at risk with respect to amounts
protected against loss through nonrecourse financing, guarantees, stop loss
agreements or other similar arrangements.
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Distributions to an Investor Interestholder will generally reduce the
amount which the Investor Interestholder has at risk in the activity. The
"at risk" rules provide that the amount of any distribution received by an
Investor Interestholder or any other reduction in the Investor
Interestholder's at risk basis, after his/her or her amount at risk is
reduced to zero, will be treated as ordinary income, but only to the extent
of losses previously claimed by the Investor Interestholder from the Company.
Thus, if the Company makes distributions to an Investor Interestholder which
do not exceed his/her adjusted basis in the Company, but do exceed the
Investor Interestholder's amount at risk, he/she will have ordinary income.
Generally, the at risk limitation applies on an activity-by-activity
basis and, in the case of oil and gas properties, each property is treated as
a separate activity so that losses or deductions arising from one property
are limited to the at risk amount for that property and not the aggregate at
risk amount for all the taxpayer's oil or gas properties. The Service has
announced that, until further guidance is issued, it will permit the
aggregation of oil or gas properties owned by a partnership in computing a
partner's at risk limitation with respect to the partnership. The Service
has also announced that any rules that would impose restrictions on the
ability of partners to aggregate will be effective only for taxable years
ending after the rules are issued. If an Investor Interestholder must
compute his/her at risk amount separately with respect to each Company
property, the consequences of the at risk limitations to him are
unpredictable, but he/she may not be allowed to utilize his/her share of
losses or deductions attributable to a particular property even though he/she
has a positive at risk amount with respect to the Company as a whole.
If in any year an Investor Interestholder has a loss from the Company,
the effect of Code Section 465(a) is to permit deduction of such loss up to
the aggregate amount at risk on the last day of the taxable year. If the
amount at risk exceeds the loss, the amount deemed at risk in subsequent
years is reduced under Code Section 465(b)(5) by the amount of losses claimed
in previous years and increased by additional at risk amounts contributed to
the activity. If the amount of loss exceeds the at risk amount, the excess
loss is held in a suspense account and treated as a deduction in the first
succeeding table year that the taxpayer is at risk. The carryover loss is
then added to the deductions allowable for such year but is limited at the
end of such year by the amount then at risk. Under proposed Regulation
Section 1.465-2(b), there is no limitation on the number of years to which
such deductions may be carried.
PASSIVE ACTIVITIES
Under the Code, deductions from passive activities, to the extent that
they exceed income from all such activities (exclusive of portfolio income),
generally will not be deductible against other income of the taxpayer.
Similarly, credits from passive activities generally are limited to the tax
allocable to the passive activities. Suspended losses and credits are
carried forward and treated as deductions and credits from passive activities
in the next taxable year. When the taxpayer disposes of his/her entire
interest in an activity in a fully taxable transaction, any remaining
suspended loss incurred in connection with that activity is allowed in full.
Passive activities are defined to include trade or business activities in
which the taxpayer does not materially participate and rental activities.
Passive activities generally do not include working interests in a gas
property in which the taxpayer's form of ownership does not limit liability
(see discussion below). Interest attributable to passive activities is not
treated as investment interest.
The passive loss provision generally applies to individuals, estates,
trusts, and personal service corporations (as defined for purposes of the
provision). Certain closely held corporations are subject to a more limited
rule under which passive losses and credits may not be applied to offset
portfolio income.
Investor Interestholders, under the Company Operating Agreement, are
entitled to limited liability with respect to the drilling and operation of
wells on the Project. Therefore, in the opinion of Special Tax Counsel,
Investor Interestholders who do not elect to become Participating Investor
Interestholders will be subject to the passive activity restrictions on
deductions authorized by the Code to the extent that such deductions are
attributable to the Company's ownership of working interests in the Project
and such Investor Interestholder's income derived from working interests in
the Project will be "passive income" under the Code.
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The Code provides an exception to the passive loss limitations by
excluding from the definition of "passive activity" any working interest in
any oil or gas property which the taxpayer holds directly or through an
entity which does not limit the liability of the taxpayer with respect to
such interests. The Code further provides that such rule applies without
regard to whether or not the taxpayer materially participates in the activity.
As noted above, the term "passive activity" does not include any working
interest in any oil or gas property which the taxpayer holds directly or
through an entity which does not limit the taxpayer's liability with respect
to such interest. Temporary Regulation Section 1.469-1T(e)(4)(v) describes
an interest in an entity that limits a taxpayer's liability with respect to
the drilling or operation of a well as (i) a limited partnership interest in
a partnership in which the taxpayer is not a general partner, (ii) stock in a
corporation, or (iii) an interest in any other entity that, under applicable
state law, limits the interest holder's potential liability. For purposes of
this provision, indemnification agreements, stop loss arrangements,
insurance, or any similar arrangements or combinations thereof are not taken
into account in determining whether a taxpayer's liability is limited.
Generally, the legislative history of Code Section 469 indicates that a
"working interest" is an interest with respect to an oil and gas property
that is burdened with the cost of development and operation of the property,
and that generally has characteristics such as responsibility for signing
authorizations for expenditures with respect to the activity, receiving
periodic drilling and completion reports and reports regarding the amount of
oil extracted, voting rights proportionate to the percentage of the working
interest possessed by the taxpayer, the right to continue activities if the
present operator decides to discontinue operations, a proportionate share of
tort liability with respect to the property and some responsibility to share
in further costs with respect to the property in the event a decision is made
to spend more than amounts already contributed. Generally, the Temporary
Regulations define a working interest as "an operating mineral interest,"
which excludes royalty interests or similar interest, such as production
payments or net profits interests.
The Manager has represented that the Company will acquire and hold only
operating mineral interests, as defined in Code Section 614(d) and the
regulations thereunder, and that none of the Company's revenues will be from
non-working interests.
The Temporary Regulations provide that the working interest exception to
the passive activity rules is applicable without regard to whether the
taxpayer materially participates in the activity if the taxpayer holds the
working interest either directly or through an entity that does not limit the
liability of the taxpayer with respect to the drilling or operation of such
well pursuant to such working interest. Further, the Temporary Regulations
provide that for purposes of the working interest exception, an entity limits
the liability of the taxpayer with respect to drilling or operation of a well
pursuant to working interest held through such entity if the taxpayer's
interest in the entity is in the form of "an interest in any entity (other
than a limited partnership or corporation) that, under applicable State law,
limits the potential liability of the holder of such an interest for all
obligations of the entity to a determinable fixed amount, (for example, the
sum of the taxpayer's capital contributions)."
Section 501(2) of the Act states that "UNLESS OTHERWISE PROVIDED BY LAW
OR IN AN OPERATING AGREEMENT, a person who is a member or manager, or both,
of a limited liability company is not liable for the acts, debts, or
obligations of the Company." (emphasis supplied).
A Participating Investor Interestholder will specifically elect, pursuant
to the operable provision of the Company Operating Agreement, to be liable
for the Special Obligations. By becoming liable for the Special Obligations,
a Participating Investor Interestholder will be liable for all obligations
(whether in tort, contract or otherwise) with respect to those working
interests held by the Company at the time of his/her election. Accordingly,
with respect to the working interests, there are no limitations on a
Participating Investor Interestholder's liability. The Act, as described
above, allows a member to assume liabilities for obligations of the limited
liability company if such assumption is provided for in the Company Operating
Agreement. Accordingly, under Code Section 469(c)(3), a Participating
Investor Interestholder will be holding an interest in an entity which does
not limit his/her liability with respect to the Company's oil and gas
activities.
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To the extent that the Participating Investor Interestholders are not
limited for the liabilities with respect to the working interests held by the
Company and such liability assumption is specified in the , for purposes of
Code Section 469, Special Tax Counsel is of the opinion that it is more
likely than not that a Participating Investor Interestholder's interest in
the Company will not be considered a passive activity within the meaning of
Code Section 469 and losses generated while such Participating Investor
Interestholder interest is held will not be limited by the passive activity
provisions.
Notwithstanding this general rule, however, for purposes of Code Section
469, the economic performance rules of Code Section 461 are applied in a
different manner from that described above in "Deduction of Intangible
Drilling and Development Costs." Economic performance under the passive loss
rules is defined in Temporary Regulations 1.469-1T(e)(4)(ii)(C)-(2)(ii) as
economic performance within the meaning of Code Section 461(h), without
regard to Code Section 461(i)(2 (which contains the spudding rule).
Accordingly, if a Participating Investor Interestholder's interest is
automatically converted to that of an Investor Interestholder after the end
of the year in which economic performance is deemed to occur (under Code
Section 461), but prior to the spudding date provided in Code Section
461(i)(2), any post-conversion losses will be passive, notwithstanding the
availability of such losses (under Code Section 461) in a year in which the
taxpayer held the interest in an entity that did not limit his/her liability.
Since the conversion to Non-participating Investor Interestholder status is
automatic, a Participating Investor Interestholder will not be able to
control whether a portion of his/her deductions or losses will be considered
passive activity losses.
Losses arising from the holding of working interests in oil and gas
properties directly or through an entity that does not limit the holder's
liability are not subject to the passive loss rules. Temporary and Proposed
Regulations provide that, if the form of ownership is converted from a type
that does not limit liability to a type that does limit liability, the
portion of any losses (including those arising from the deduction of IDC)
attributable to services or materials which have not yet been provided at the
time of such automatic conversion will constitute losses from a passive
activity. Thus, if a Participating Investor Interestholder's Interests were
automatically converted to that of a Nonparticipating Investor Interestholder
prior to the time that all of the services or materials comprising the IDC of
a well had been provided, at the time of such automatic conversion such
services and materials will constitute losses from a passive activity and be
subject to the passive loss limitations. Similarly in such a situation, a
portion of the income from the well would constitute passive income. If the
automatic conversion were to occur after the filing of the Company's
information tax return but prior to the completion of the drilling and
development of a well, an amended return might have to be filed, which might
also require the Interestholders to file amended returns. Further, the Code
provides that if a taxpayer has any loss attributable to a working interest
in any succeeding taxable year is treated as income of the taxpayer which is
not from a passive activity. Accordingly, if a Participating Investor
Interestholder's Interests are automatically converted into a
Nonparticipating Investor Interestholder's Interests, any income from that
interest with respect to which he/she claimed deductions will be treated as
nonpassive income.
Notwithstanding the above, there can be no assurance that the Service
will not contend that the Participating Investors' interests in the Company
should be regarded as interests in a passive activity from the Company's
inception due to the automatic conversion feature contained in the Company
Operating Agreement. However, due to the exposure to unlimited liability for
Company obligations incurred prior to such automatic conversion, an attack by
the Service with respect to the foregoing should not be successful.
After a Participating Investor Interestholder's Interest is automatically
converted to a Nonparticipating Investor Interestholder's Interest pursuant
to the terms of the Company Operating Agreement, the character of a
subsequently generated tax attribute will be dependent upon, INTER ALIA, the
nature of the tax attribute and whether there arose, prior to conversion,
losses to which the working interest exception applied.
Assuming the activities of a Participating Investor whose Interests are
automatically converted to Non-participating Investor Interestholder status
will not result in the Interestholder's being treated as materially
participating under Temporary Regulation Section 1.469-5T, as described
above, the Investor Interestholder's activity after such conversion should be
treated as a passive activity. Code Section 469(c)(1). Accordingly, any
loss arising therefrom should be treated as a passive activity loss or
credit, respectively, under Code Section 469(d), with the benefits thereof
limited by
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Code Section 469(a)-(1), as described above. However, Code Section
469(c)(3)(B) provides that, if a taxpayer has any loss from any taxable year
for a working interest in any oil or gas property that is treated as a
non-passive loss, then any net income from such property for any succeeding
taxable year is to be treated as income that is not from a passive activity.
Consequently, assuming that a converting Participating Investor
Interestholder has losses from working interests which are treated as
non-passive, income from the Company allocable to the Interestholder after
conversion would be treated as income that is not from a passive activity.
If an investor (other than a Participating Investor Interestholder after
his/her interest is automatically converted into that of a Nonparticipating
Investor Interestholder) invests in the Company as an Investor
Interestholder, in the opinion of Special Tax Counsel, his/her distributive
share of the Company's losses will more likely than not be treated as passive
activity losses, the availability of which will be limited to the Investor
Interestholder's passive income. If the Interestholder does not have
sufficient passive income to utilize the passive activity loss, the
disallowed passive activity loss will be suspended and may be carried forward
(but not back) to be deducted against passive income arising in future years.
Further, upon the complete disposition of the interest to an unrelated party
in a fully taxable transaction such suspended losses will be available, as
described above.
Regarding Company income, Investor Interestholders should generally be
entitled to offset their distributive shares of such income with deductions
from other passive activities, except to the extent such Company income is
portfolio income. Since gross income from interest, dividends, annuities,
and royalties not derived in the ordinary course of a trade or business is
not passive income, an Investor Interestholder's share of income from
royalties, income from the investment of the Company's working capital, and
other items of portfolio income will not be treated as passive income. In
addition, Code Section 469(1)(3) grants the Secretary of the Treasury the
authority to prescribe regulations requiring net income or gain from a
limited partnership or other passive activity to be treated as not from a
passive activity.
Notwithstanding the above, Code Section 469(k) treats net income from
publicly traded partnerships ("PTPs") as portfolio income under the passive
activity loss rules. Further, each partner in a PTP is required to treat any
losses from a PTP as separate from income and loss from any other PTP and
also as separate from any income or loss from passive activities. Losses and
credits attributable to an interest in a PTP that are not allowed under the
passive activity rules are suspended and carried forward, as described above.
Further, upon a complete taxable disposition of an interest in a PTP, any
suspended losses (but not credits) are allowed (as described above with
respect to the passive activity rules). As noted above, we have opined that
the Company will not be a PTP.
In the event the Company were treated as a PTP, any net income would be
treated as portfolio income and each Partner's loss therefrom would be
treated as separate from income and loss from any other PTP and also as
separate from any income or loss from passive activities. Since the Company
should not be treated as PTP, the provisions of Code Section 469(k), in our
opinion, will not apply to the Interestholders in the manner outlined above
prior to the time that such Company becomes a PTP. However, unlike the PTP
rules of Code Section 7704, the passive activity rules of Code Section 469 do
not provide an exception for partnerships that pass the 90% test of Code
Section 7704. Accordingly, if the Company were to be treated as a PTP under
the passive activity rules, passive losses could be used only to offset
passive income from the Company.
AUTOMATIC CONVERSION OF INTERESTS
Code Section 708 provides that a partnership will be considered as
terminated for federal income tax purposes if, INTER ALIA, there is "a sale
or exchange of 50 percent or more of the total interests in partnership
capital and profits" within a 12 month period. If an automatic conversion
of a Participating Investor Interestholder's Interest into a Nonparticipating
Investor Interestholder's Interest were treated as a "sale or exchange" for
purposes of Code Section 708, the Company would be terminated for federal
income tax purposes if 50% or more of the profits and capital interests in
the Company were sold or exchanged within a 12 month period.
In Rev. Rul. 84-52, 1984-1 C.B. 157, the Service ruled that the
conversion of a general partnership interest into a limited partnership
interest in the same partnership will not give rise to the recognition of
gain or loss under Code
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Section 741 or Section 1001. The ruling noted that, under Code Section 721,
no gain or loss is recognized by a partnership or any of its partners upon
the contribution of property to the partnership in exchange for an interest
therein. Consequently, the partnership will not be terminated under Code
Section 708 since (i) the business of the partnership will continue after the
automatic conversion and (ii) pursuant to Regulation Section
1.708-1(b)(1)(ii) a transaction governed by Code Section 721 is not treated
as a sale or exchange for purposes of Code Section 708. In the ruling, the
Service also concluded that the partners' bases in their partnership
interests would be changed to the extent of any change in their shares of the
partnership's liabilities. To the extent that a deemed distribution exceeds
a partner's adjusted basis, gain will be recognized to the extent of such
excess. See also Rev. Rul. 86-101, 1986-2 C.B. 94.
If Rev. Rul. 84-52, SUPRA, is not overruled, revoked, or modified,
Special Tax Counsel is of the opinion that, more likely than not, the Company
will be not be terminated under Code Section 708 solely as a result of the
automatic conversion of Company interests. In the event a constructive
termination does occur, however, there will be a deemed contribution of the
Company's assets to a "new" Company and a distribution of the Interests in
the "new" Company to the Interestholders. This constructive termination
could have adverse federal income tax consequences, including (i) the
reallocation of basis of the assets, (ii) the recognition of income by any
Interestholder receiving a constructive distribution (including a reduction
in his/her share of Company liabilities) that exceeds his/her basis, (iii)
the loss of percentage depletion, if any, and (iv) the loss of elections made
by the Company.
Code Section 1254(a) provides, in part, that when a property is disposed
of the taxpayer must recapture as ordinary income amounts deductible as IDC
in excess of the amount deductible without regard to Code Section 263. Code
Section 1254(b) provides that rules similar to the rules of subsections (b)
and (c) of Code Section 1245 are to be applied for purposes of Code Section
254. Consequently, the converting Participating Investor Interestholder could
recognize gain upon the occurrence of such event. Code Section 752(d) treats
any decrease in a partner's share of partnership liabilities as a
distribution of money to the partner by the partnership. If, under the
applicable regulatory or statutory provisions, a converting Participating
Investor Interestholder's share of liabilities is deemed to decrease, such
decrease will result in gain to the Interestholder to the extent it exceeds
the Interestholder's basis in his/her Company interest.
FOREIGN INVESTOR INTERESTHOLDERS
The Company will be required to withhold and pay to the Service 39.6% of
any taxable income of the Company allocable to a foreign Investor
Interestholder (35% in the case of a foreign corporate Investor
Interestholder).
In addition, Interests will constitute "United States real property
interests" for purposes of the Foreign Investment in Real Property Tax Act of
1980. The sale of all or a portion of the Project will be subject to
withholding at the rate of 35% (28% in certain cases) of the gain realized
from such disposition for individual foreign Investor Interestholders and 35%
of the gain realized from such disposition for corporate foreign Investor
Interestholders. Additionally, a purchaser of Interests from a foreign
Investor Interestholder will generally be required to withhold and pay to the
Service a portion of the purchase price.
The withholding requirements described above do not excuse a foreign
Investor Interestholder from filing a United States tax return with respect
to income attributable to his/her Interests, and any tax due in excess of the
amounts withheld must be paid by the filing deadline applicable to such
foreign Investor Interestholder. In the event of overwithholding, a foreign
Investor Interestholder must file a United States tax return or other
application in order to secure the overwithheld amount. These rules may
require the filing of United States tax returns or other documents with the
Service by foreign Investor Interestholders not otherwise subject to such
filings.
Each prospective foreign Investor Interestholder should consult his/her
personal tax advisor with respect to these and other special tax consequences
that may apply to such person with regard to his/her investment.
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POSSIBLE CHANGES IN TAX LAWS
The statutes, regulations and rules with respect to all of the foregoing
tax matters are constantly subject to change by Congress or by the Department
of the Treasury, and the interpretations of such statutes, regulations and
rules may be modified or affected by judicial decision or by the Department
of the Treasury. Significant amendments have been made to the Code in recent
years, including the 1997 Act, and few final regulations have been
promulgated pursuant to such amendments. Additionally, very few rulings have
been issued thereunder. Accordingly, due to the continual changes made by
Congress, the Department of the Treasury and the courts with respect to the
administration and interpretation of the tax laws, no assurance can be given
that the foregoing opinions and interpretations will be sustained or that tax
aspects summarized herein will prevail and be available to the Investor
Interestholders.
STATE AND LOCAL TAXES, INCLUDING MICHIGAN
In addition to the federal income tax consequences described above,
prospective Investor Interestholders should consider potential state and
local tax consequences of an investment in Interests, including the Michigan
Single Business Tax. In general, an Investor Interestholder's distributive
share of the taxable income or loss of the Company generally will be required
to be included in determining the Investor Interestholder's reportable income
for state or local tax purposes in the jurisdiction in which he/she is a
resident. In addition, some states in which the Company may do business or
own properties impose taxes on non-resident Investor Interestholders
determined with reference to their PRO RATA share of Company income derived
from such state; any tax losses derived through the Company from operations
in such state may be available to offset only income from other sources
within the same state. To the extent that a non-resident Investor
Interestholder pays tax to a state by virtue of Company operations within
that state, the Investor Interestholder may be entitled to a deduction or
credit against tax owed to his/her state of residence with respect to the
same income. In addition, estate or inheritance taxes might be payable in
such jurisdictions upon the death of an Investor Interestholder. Thus, an
Investor Interestholder might be subject to income, estate or inheritance
taxes and may be required to file tax returns in states and localities where
the Company operates, as well as in the state or locality of his/her
residence. In addition, the taxability of a business trust, such as the
Company, under many state tax statutes, including the Michigan Single
Business Tax Act, is not entirely clear. Consequently, it is possible that
the Company may incur state tax liabilities.
Investor Interestholders are urged to consult their own tax advisors in
regard to the state and local income tax consequences of an investment in
Interests.
NEED FOR INDEPENDENT ADVICE
The tax matters relating to the Company and their proposed transactions
are complex and subject to various interpretations. The foregoing analysis
is merely a summary and is not intended as a complete discussion of all tax
aspects of a Company's activities or as a substitute for careful tax
planning. Each prospective Investor Interestholder must consult with and
rely upon his/her own tax counsel with respect to the possible tax results of
his/her investment in Interests.
Neither the Manager, Special Tax Counsel nor professional advisors
engaged by or associated with any of them guarantee that the tax consequences
contemplated to be offered to the Investor Interestholders as a result of the
proposed investment will in fact be available in whole or in part. Investor
Interestholders must look solely to and rely upon their own advisors with
respect to the tax consequences of their investment.
CONCLUSION
Subject to the preceding discussion, it is Special Tax Counsel's opinion
that it is more likely than not that substantially more than half of the
material tax benefits in the aggregate anticipated from the operation of the
Company will be realized if challenged by the Service. It should be noted
that Special Tax Counsel's opinion is not binding upon the Service or the
courts.
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INVESTMENT BY PENSION AND OTHER RETIREMENT PLANS
A. IN GENERAL. The following entities are generally exempt from federal
income taxation:
(i) trusts forming part of a stock bonus, pension, or profit sharing
plan (including a Keogh plan) meeting the requirements of Section
401(a);
(ii) trusts meeting the requirements for an Individual Retirement
Account ("IRA") under Section 408(a) (referred to herein, along with
trusts described in (i), as "Qualified Plans"); and
(iii) organizations described in Sections 501(c) and 501(d)
("Charitable Organizations" and, together with Qualified Plans, "Tax
Exempt Entities").
This exemption does not apply to the extent that taxable income is derived by
the above entities from the conduct of any trade or business which is not
substantially related to the exempt function of the entity ("unrelated
business taxable income"). If an entity is subject to tax on its "unrelated
business taxable income," it may also be subject to the alternative minimum
tax on related tax preference items. In the case of a charitable remainder
trust, the receipt of any "unrelated business taxable income" during any
taxable year will cause all income of the trust for that year to be subject
to federal income tax. Therefore, an investment in the Company by a
charitable remainder trust would not ordinarily be appropriate.
"Unrelated business taxable income" is generally taxable only to the
extent that the Tax Exempt Entity's "unrelated business taxable income" from
all sources exceeds $1,000 in any year. The receipt of "unrelated business
taxable income" by a Tax Exempt Entity in an amount less than $1,000 per year
will, however, require the Tax Exempt Entity to file a federal income tax
return to claim the benefit of the $1,000 per year exemption. Fiduciaries of
Tax Exempt Entities considering investing in Interests are urged to consult
their own tax advisors concerning the rules governing "unrelated business
taxable income."
Gains or losses from the sale, exchange or other disposition of property,
interest income and royalty income are generally excluded from the
computation of "unrelated business taxable income. "Unrelated business
taxable income" includes, however, gain or loss from the sale, exchange or
other disposition of property held by a dealer and "debt-financed property. "
Although some of a Company's income may be treated as royalty income, it
is highly likely that virtually all of the Company's income will be
considered to be derived from sales in the ordinary course of business.
Thus, Tax Exempt Entities should expect a significant portion, if not all, of
the income derived from their investment in the Company to constitute
"unrelated business taxable income."
B. DEBT-FINANCED PROPERTY. Even though certain types of income, such
as interest and royalties, generally may be considered passive and excluded
from unrelated business income tax, such income when derived from an
investment in property which is "debt-financed" can still result in income
subject to taxation. "Debt-financed property" is defined in the Code as any
property which is held to produce income and with respect to which there is
"acquisition indebtedness." "Acquisition indebtedness" includes indebtedness
incurred by a Tax Exempt Entity to acquire Interests and indebtedness
incurred by the Company. Each Tax Exempt Entity should consult with its own
counsel regarding whether it may have incurred "acquisition indebtedness" to
acquire Interests.
In the event the Company invests in and owns property on which there is
"acquisition indebtedness," a portion of each Tax Exempt Entity's
distributive share of the Company's taxable income (including capital gain)
may constitute "unrelated business taxable income. " This portion would be
determined in accordance with the provisions of Section 514 and is,
generally, the portion of the Tax Exempt Entity's distributive share of
Company income which is approximately equivalent to the ratio of the
Company's debt to the basis of the Company's property. Therefore, a Tax
Exempt Entity that purchases Interests may be required to report such portion
of its PRO RATA share of the Company's
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taxable income as "unrelated business taxable income. " It should be noted
that in computing the "unrelated business taxable income" of a Tax Exempt
Entity for this purpose, the deduction for depreciation is limited to the
amount computed under the straight-line method.
The Company may incur "acquisition indebtedness" in its operations which
is allocable to any Investor Interestholder which is a Tax Exempt Entity,
thus resulting in "unrelated business taxable income" to such entity.
C. ERISA CONSIDERATIONS. In considering an investment in Interests,
fiduciaries of Qualified Plans should consider (i) whether the investment is
in accordance with the documents and instruments governing such Qualified
Plan, (ii) whether the investment satisfies the diversification requirements
of Section 404(a)(1)(C) of the Employee Retirement income Security Act of
1974 ("ERISA") if applicable; (iii) the fact that the investment may result
in "unrelated business taxable income" to the Qualified Plan (including IRAs
and Keogh plans); (iv) whether the investment provides sufficient liquidity;
(v) their need to value the assets of the Qualified Plan annually; and (vi)
whether the investment is prudent.
ERISA generally requires that the assets of employee benefit plans be
held in trust and that the trustee, or a duly authorized investment manager
(within the meaning of Section 3(38) of ERISA), have exclusive authority and
discretion to manage and control the assets of the plan. ERISA also imposes
certain duties on persons who are fiduciaries of employee benefit plans
subject to ERISA and prohibits certain transactions between an employee
benefit plan and the parties in interest with respect to such plan (including
fiduciaries). Under the Code, similar prohibitions apply to all Qualified
Plans, including IRAs and Keogh plans covering only self-employed individuals
which are not subject to ERISA. Under ERISA and the Code, any person who
exercises any authority or control respecting the management or disposition
of the assets of a Qualified Plan is considered to be a fiduciary of such
Qualified Plan.
Furthermore, ERISA and the Code prohibit "parties in interest" (including
fiduciaries) of a Qualified Plan from engaging in various acts of
self-dealing such as dealing with the assets of a Qualified Plan for his/her
own account or his/her own interest. To prevent a possible violation of
these self-dealing rules, neither the Manager nor its affiliates will
purchase Interests with assets of any Qualified Plan (including a Keogh plan
or IRA) if they (i) have investment discretion with respect to such assets,
or (ii) regularly give individualized investment advice which serves as the
primary basis for the investment decisions with respect to such assets.
If the assets of the Company were deemed to be "plan assets" under ERISA,
(i) the prudence standards and other provisions of Title 1 of ERISA
applicable to investments by Qualified Plans and their fiduciaries would
extend (as to all plan fiduciaries) to investments made by the Company, and
(ii) certain transactions that the Company might seek to enter into might
constitute "prohibited transactions" under ERISA and the Code. The
Department of Labor has published regulations concerning the definition of
what constitutes the assets of a Qualified Plan with respect to its
investment in another entity (the "ERISA Regulation"). Section
2510.3-101(a)(2) of the ERISA Regulation provides as follows:
"Generally, when a plan invests in another entity, the plan's
assets include its investment, but do not, solely by reason of
such investment, include any of the underlying assets of the
entity. However, in the case of a plan's investment in an equity
interest of an entity that is neither a publicly-offered security
nor a security issued by an investment company registered under
the Investment Company Act of 1940, its assets include both the
equity interest and an undivided interest in each of the
underlying assets of the entity unless it is established that
(i) The entity is an operating company, or
(ii) Equity participation in the entity by benefit plan investors
is not significant."
Under Section 2510.3-101(f)(1) of the ERISA Regulation, equity participation in
an entity by Qualified Plans is "significant" on any date if, immediately after
the most recent acquisition of any equity interest in an entity, 25% or more of
the value of any class of equity interests in the entity is held by Qualified
Plans.
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Unless another exemption under the ERISA Regulation is available, the
Manager will not admit any Qualified Plan as an Investor Interestholder or
consent to an assignment of Interests if such admission or assignment will
cause 25% or more of the value of all Interests to be held by Qualified
Plans. Accordingly, the assets of a Qualified Plan investing in a Company
should not, solely by reason of such investment, include any of the
underlying assets of the Company.
Another exemption under the ERISA Regulation that might become available
is the "operating company" exemption. Under the ERISA Regulation, when a
Qualified Plan invests in another entity and such entity is an operating
company, the plan's assets include its investment but do not, solely by
reason of such investment include any of the underlying assets of the entity.
Under the ERISA Regulation, an "operating company" is an entity that is
primarily engaged, directly or through a majority owned subsidiary or
subsidiaries, in the production or sale of a product or service other than
the investment of capital. The ERISA Regulations do not further define
"operating company" nor do they provide any examples of the types of
activities which would cause an entity to be treated as an "operating
company." The Company will be engaged in the business of developing natural
gas wells and selling the natural gas produced therefrom. Accordingly,
except to the extent that the Company receives royalties for the sale of
natural gas, it should be considered to be "engaged . . . in the production
or sale of a product . . . other than the investment of capital." However,
due to the absence of any authority or guidance on this matter, Special Tax
Counsel is unable to conclude that the assets of a Qualified Plan will not
include the assets of the Company.
Finally, an exemption exists if the securities being issued are
considered to be "publicly offered" under the ERISA Regulations. A publicly
offered security is a security which is widely held, freely transferable and
sold in an offering pursuant to an effective registration statement under the
Securities Act of 1933. A security is widely held if held by 100 or more
persons who are independent of the issuer and one another and where the
minimum purchase amount is $10,000 or less. A security may be freely
transferable even though transferability of such security is restricted by
the tax laws or state or federal securities laws. Accordingly, while the
Interests are registered in an offering pursuant to the Securities Act of
1933, and are likely to be considered freely transferable, it is a factual
question as to whether the Interests will be widely held. As a result,
Special Tax Counsel is unable to conclude that the Interests will be
considered publicly offered securities under the ERISA Regulations.
Each fiduciary of a Qualified Plan (and any other person subject to
ERISA) should consult his/her tax advisor and counsel regarding the effect of
the plan asset rules on an investment in Interests by a Qualified Plan.
COMPETITION, MARKETS AND REGULATION
SUMMARY
Participants in the natural gas industry must compete against major and
independent oil and gas companies and each other to acquire working
interests. The competing parties often have substantially larger exploration
budgets, financial resources and technical capabilities, which may work to
the disadvantage of the Company. The availability of a ready market for gas
produced depends upon numerous factors beyond the control of the Company,
including the extent of domestic production and imports of gas, the proximity
and capacity of natural gas pipelines and the effect of state and federal
regulation of production and federal regulation of gas sold in interstate
commerce.
There is also extensive competition in the marketing of
domestically-produced natural gas. Decreases in domestic industry production
capability and increases in energy consumption can bring about shortages in
energy supplies. This, in turn, can result in substantial competition in
markets historically served by domestic natural gas resources both with
alternate sources of energy, such as residential fuel oil, and among domestic
gas suppliers. Such competition can result in increases in gas prices,
extensive efforts by producers to increase gas production and delays in
producing and marketing gas after it is discovered. Among the effects of
this competition and the deregulation of the natural gas industry and gas
prices by the Congress and the Federal Energy Regulatory Commission (FERC) is
that gas prices tend to be determined by competitive market forces with
attendant volatility and unpredictability. Changes in government regulations
relating to the production, transportation and marketing of natural gas has,
at times, resulted in the abandonment by many pipelines of long-term
contracts for the purchase of natural gas, and may spur the development
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by gas producers of their own marketing programs to take advantage of new
regulations requiring pipelines to transport gas for regulated fees, and an
increasing tendency to rely on short-term sales contracts priced at spot
market prices. Competitors in this market include other producers, gas
pipelines and their affiliated marketing companies, independent marketers,
and providers of alternate energy supplies, such as residential fuel oil.
COMPETITION AND MARKETS
The marketing of any gas produced by the Company will be effected by a
number of factors which are beyond the Manager's control and whose exact
effect cannot be accurately predicted. These factors include crude oil
imports, the availability and cost of adequate pipeline and other
transportation facilities, the marketing of competitive fuels (such as coal
and nuclear energy), and other matters affecting the availability of a ready
market, such as fluctuating supply and demand.
Members of the Organization of Petroleum Exporting Countries establish
prices and production quotas for petroleum products from time to time with
the intent of reducing the current global oversupply and maintaining or
increasing certain price levels. Political events, especially in the Middle
East, have in the past caused sharp fluctuations in oil prices, which may or
may not continue Certain large users of fuel oil and other oil products have
or may acquire the capacity to use natural gas instead. Further, market and
governmental incentives may induce users to substitute natural gas for other
fuels. These factors may increase demand for natural gas. Because there has
been a natural gas supply surplus in recent years, because additional supply
may be available and because the substitution process may occur gradually,
any increased demand may not cause increases in gas prices similar to those
experienced in the international oil markets. Decreases in oil prices, if
they occur, may result in decreases in gas prices because of substitution
back to oil.
REGULATION
The State of Michigan controls Antrim gas production through regulations
establishing the spacing of wells, limiting the number of days in a given
month during which a well can produce and otherwise limiting the rate of
allowable production. through regulations enacted to protect against waste,
conserve natural resources and prevent pollution, local, state and Federal
environmental controls will also affect Company operations. Such regulations
could affect Company operations and could necessitate spending funds on
environmental protection measures, rather than on drilling and completion
operations. If any penalties or prohibitions were imposed on the Company for
violating such regulations, the Company's operations could be adversely
affected.
The Federal Energy Regulatory Commission (FERC) regulates certain sales
of natural gas, operating as an independent agency that combines most of the
functions of the former Federal Power Commission with the prior authority of
the Interstate Commerce Commission over interstate transportation of oil. In
particular, FERC has regulatory jurisdiction over interstate gas pipelines
that will purchase or transport gas from the projects. FERC recently adopted
a major order that significantly modifies the existing environments for
natural gas sales by producers. The new order, Order 636, will require that
all interstate gas pipelines "unbundle" their services so that each
discernible service is offered separately to customers at a specified price.
Pipelines would be free to purchase, transport and sell gas for their own
accounts, provided that similar terms for transport services were offered to
other persons. Pipelines would be granted expanded authority to terminate
service obligations to their customers consistent with their contracts.
FERC expects that Order 636 will encourage more market-based pricing of
natural gas, allow producers, pipelines and customers to respond much more
quickly to market and climate changes, encourage long-term gas supply
contracts and permit customers to deal efficiently with multiple pipelines
and suppliers. Order 636 has generated extensive comment and controversy. In
particular, certain pipelines have charged that Order 636 would favor large
customers, pipelines and suppliers and would disadvantage small producers
such as the Company (unless its production were sold in conjunction with that
of other producers) without the market power to obtain competitive terms from
pipelines and purchasers of gas. Other persons have predicted that Order 636
would discourage pipeline investment, transfer risks to local distribution
companies and impose non-recoverable transition costs on pipelines. To the
extent that Order 636
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results in increased costs for the interstate transportation of gas, it may
have the effect of benefitting producers like the Company whose gas in sold
to intrastate customers. Order 636 became effective in mid-1993. The
Company is unable at this time to determine the effect of Order 636 on the
Company, but it may be significant.
Various parts of the Antrim play are crossed by transmission pipelines
belonging to MichCon, Saginaw Bay Pipeline, Great Lakes Pipeline and American
Natural Resources. These companies each traditionally purchase substantial
portions of their supply from Michigan producers. In addition, all are
subject to regulations which require them to transport gas for other end
users under certain conditions, mandated by either the Michigan Public
Service Commission or FERC. Transportation on these systems generally
requires that gas delivered meet certain quality standards and that a tariff
be paid for quantities transported The Company expects that gas produced
from wells in which it has an interest will be sold to the aforementioned
pipeline companies, as well as to local distribution companies (LDCs) or on
the spot market via open access transportation arrangements. While in the
past these purchases were generally made on the spot market, Order No. 636
has decreased reliance on the spot market and recent FERC activities have
decreased the attractiveness of the spot market. Under FERC Order No. 636,
interstate gas pipelines must separate their merchant activities fro their
transportation activities. LDCs are required to take a much more active role
in acquiring their own gas supplies under Order No. 636. Many are buying gas
directly from gas marketers and are buying their own reserves. At the same
time, state regulatory commissions are reviewing LDC procurement practices
more carefully. These LDCs have attempted to minimize their risks by
forgoing spot purchases and entering into longer-term gas supply contracts
and by diversifying their supplies.
Moreover, FERC and the industry are encouraging pipelines to develop
electronic bulletin boards (EBBs) which can provide gas buyers and sellers
with real-time data on pipeline capacity and prices across a variety of
pipeline systems. LDCs and marketers are also working to develop companies
which can access and integrate all of the information available on all
pipelines' EBBs and arrange gas supplies and transportation on behalf of
purchasers from large regions of the country, in order to create a national
market. These systems, and the development of information service companies,
will allow rapid consummation of natural gas transactions. Gas purchased in
Michigan, could, for example, be used in Seattle. Although this system may
initially lower prices due to increased competition, it is anticipated to
increase natural gas markets and the reliability of the markets.
On September 20, 1991, FERC adopted Order 555, which is currently the
subject of a rehearing petition brought by producers and pipelines. Under
Order 555, FERC reduced the number of construction permits required for
interstate pipelines, permitted negotiated rate making between pipeline
owners and their customers for newly constructed pipelines, set new
procedures for environmental compliance and changed existing rules regarding
the recovery of construction costs from pipeline revenues. The last
requirement would assure that a newly constructed pipeline that has 10 year
contracts for carriage of gas equal to 100% of its capacity would be able to
set rates to assure that all of its construction costs would be covered by
pipeline revenues. Rates for all other pipelines would be limited so that
their construction costs would only be fully recovered if the pipeline was
used at nearly full capacity during the entire year. The cancellation of at
least one Gulf of Mexico offshore pipeline projects has been attributed to
the adoption of Order 555, and many producers of natural gas have claimed
that the order has inhibited construction of pipelines.
In September 1989, a federal court of appeals invalidated FERC's Order
451, which authorized producers of price-controlled natural gas subject to
take-or-pay contracts with interstate pipelines to negotiate new, effectively
uncontrolled prices or to require the pipelines to transport the gas to
another buyer. The decision has been stayed pending action by the United
States Supreme Court. Order 451 would not have applied to the Company, but
the effects of its invalidation upon the national market for natural gas
cannot be anticipated.
Commencing in late 1985, the FERC issued a series of orders (Order No.
436, Order No. 500 and related orders) which promulgated regulations
significantly altering the marketing and pricing of gas. Among other things,
these regulations (a) require interstate pipelines that elect to transport
gas for others under self-implementing authority to provide transportation
services to all shippers on a non-discriminatory basis, and (b) permit each
existing firm sales customer of any such pipeline to modify its existing
purchase obligations over at least a five-year period. Although the new
regulations do not directly regulate gas producers such as the Company, the
availability of non-discriminatory
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transportation services and the ability of pipeline customers to modify their
existing purchase obligations under these regulations has greatly enhanced
the ability of producers to market their gas directly to end users and local
distribution companies. In this regard, though the Manager anticipates that
most, if not all, of the Company's production will be marketed and sold
within Michigan, access to markets through interstate pipelines may be
nevertheless material to marketing of the Company's gas production.
All such regulations adopted and proposed by the FERC as well as recent
court actions regarding such regulations could have an adverse impact on gas
prices and volumes and could further encourage the purchasers of gas
production to breach take-or-pay provisions of their contracts.
A number of legislative proposals have been advanced from time to time
which, if put into effect, could significantly affect the oil and gas
industry. The various proposals have involved, among other things, revision
of leasing and operating practices relating to Outer Continental Shelf lands,
revision of the NGPA (including both proposals to remove all price and
certificate controls on natural gas and proposals to extend or impose the
NGPA price ceilings), imposition of a "windfall profit" tax on natural gas
sales and restriction of certain uses of natural gas. Other proposals would
provide purchasers with "market-out" options in existing and future gas
purchase contracts, eliminate or limit the operation of "indefinite price
escalator clauses" (e. g. , pricing provisions which allow prices to escalate
by means of reference to prices being paid by other purchasers of natural gas
or prices for competing fuels). Arguments for effecting the latter two
proposals by regulatory action have been pressed on the FERC by various
proponents at various times. It is impossible to predict what legislation or
regulatory changes may result from such proposals or the effect of such
changes on the Company.
The free trade agreement between Canada and the United States has eased
restrictions on imports of Canadian gas to the United States. Additionally,
the passage in November 1993 of the North American Free Trade Agreement
(NAFTA) will have some impact on the American gas industry, by eliminating
trade and investment barriers in the United States, Canada and Mexico. In
addition, a number of new pipeline projects have been proposed to the FERC
which could substantially increase the availability of Canadian gas to
certain U.S. markets. Such imports could have an adverse effect on both the
price and volume of gas sales from Company wells.
The accelerating deregulation of natural gas and electricity transmission
has caused, and will continue to cause, a convergence of the gas and electric
industries. Demand for natural gas by the electric power sector is expected
to increase modestly through the next decade. Increased competition in the
electric industry, coupled with the enforcement of stringent environmental
regulations, may lead to an increased reliance on natural gas by the electric
industry.
The federal government and various state governments have adopted laws
and regulations regarding the control and contamination of the environment
that may affect the operations of the Company. Moreover, in the areas where
the Company will conduct their activities, statutory provisions regulate the
production of natural gas and administrative agencies may promulgate rules in
connection with the operation, location, drilling, plugging, abandonment of
and production of gas wells, determine the reasonable market demand for gas,
and establish allowable rates for production. Such regulatory orders limit
the locations of wells or the number of wells which can be drilled on a
property or may restrict the rate at which the Company's wells, if any,
produce gas. Governments may from time to time suspend or curtail operations
when considered to be detrimental to the ecology or to jeopardize public
safety. Owners of interests in projects may be subject to federal or state
regulations which impose absolute liability for the cost of clean-up of
pollution resulting from its operations, and such owners may also be subject
to possible legal liability for pollution damages. If other participants in
a property do not bear these costs, and to the extent that insurance does not
cover those risks, the Company could be solely liable for all such costs.
Federal and state legislation affecting the gas industry is under
constant review for amendment or expansion, frequently increasing the
regulatory burden. Also, numerous departments and agencies, both federal and
state, are authorized by statute to issue and have issued rules and
regulations binding on the gas industry and its individual members,
compliance with which is often difficult and costly and some of which carry
substantial penalties for the failure to comply.
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The Occupational Safety and Health Administration ("OSHA") has proposed
new standards designed to curb occupational hazards during the drilling and
servicing of oil and gas wells. It is possible that such proposals will
substantially increase the cost of servicing the Company's wells.
During 1990, the Clean Air Act was reauthorized and amended to encourage
the use of natural gas as a less polluting fuel, especially for electricity
generation, and boiler fuel, and use of compressed natural gas as a vehicle
fuel. Although these provisions may increase demand for natural gas in the
long run, especially after 1995, there is no assurance that they will do so
or that they will have any effect on shorter-run demand for gas.
SUMMARY OF COMPANY OPERATING AGREEMENT
THE RIGHTS AND OBLIGATIONS OF THE MANAGER AND THE INVESTOR
INTERESTHOLDERS ARE GOVERNED BY THE COMPANY OPERATING AGREEMENT, A COPY OF
WHICH IS ATTACHED HERETO AS APPENDIX I. NO PROSPECTIVE INVESTOR
INTERESTHOLDER SHOULD SUBSCRIBE FOR INTERESTS WITHOUT FIRST THOROUGHLY
REVIEWING SUCH AGREEMENT. THE FOLLOWING IS ONLY A BRIEF SUMMARY OF CERTAIN
SIGNIFICANT PROVISIONS OF THE COMPANY OPERATING AGREEMENT AND SHOULD NOT BE
CONSIDERED AS A COMPLETE DISCUSSION OF ALL OF THE PROVISIONS OF THE COMPANY
OPERATING AGREEMENT.
ACCOUNTING
The accounting period of the Company will end on December 31 of each
year. The Manager will utilize the accrual method of accounting for the
Company's operations on the basis used in preparing the Company's federal
income tax returns with such adjustments as may be in the Company's best
interests.
GOVERNING LAW
All provisions of the Company Operating Agreement will be construed
according to the laws of Michigan except as may otherwise be required by law
in any other state.
CONTROL OF COMPANY OPERATIONS
The powers vested in the Manager under the Company Operating Agreement
are quite broad. The Manager will have full, exclusive and complete
discretion in the management and control of the affairs of the Company and
Investor Interestholders will have no power to take part in the management
of, or to bind, the Company. The Company will have no officers; such
functions will be performed by persons appointed by the Manager and may be
removed by it at any time. The Manager may set the number of directors at
one or more and may remove a director at any time, provided that at the time
of removal there is an incumbent director or a replacement director is
appointed. If there are multiple directors, each may act on behalf of the
Company.
INDEMNIFICATION
The Manager will be entitled to reimbursement and indemnification for all
expenditures made (including amounts paid in settlement of claims) or losses
or judgments suffered by it in the ordinary and proper course of the
Company's business, provided that the Manager has determined in good faith
that the course of conduct which caused the loss or liability was in the best
interests of the Company, that the Manager was acting on behalf of or
performing services for the Company, and that such expenditures, losses or
judgments were not the result of the negligence or misconduct of the Manager.
Section 3.6. The Manager will have no liability to the Company or to any
Interestholder for any loss suffered by the Company which arises out of any
action or inaction of the Manager if the Manager, in good faith, determined
that such course of conduct was in the best interests of the Company and such
course of conduct did not
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constitute negligence or misconduct of the Manager. The Manager will be
indemnified by the Company to the limits of the insurance proceeds and
tangible net assets of the Company against any losses, judgments,
liabilities, expenses and amounts paid in settlement of any claims sustained
by it in connection with the Company, provided that the same were not the
result of negligence or misconduct on the part of the Manager.
Notwithstanding the above, the Manager will not be indemnified for
liabilities arising under Federal and state securities laws unless (1) there
has been a successful adjudication on the merits of each count involving
securities law violations; or (2) such claims have been dismissed with
prejudice on their merits by a court of competent jurisdiction; or (3) a
court of competent jurisdiction approves a settlement of such claims against
a particular indemnitee and finds that indemnification for the settlement and
the related costs should be made, and the court considering the request for
indemnification has been advised of the position of the Securities and
Exchange Commission and of the position of any state securities regulatory
authority in which securities of the Company were offered or sold as to
indemnification for violations of securities laws; provided, however the
court need only be advised of the positions of the securities regulatory
authorities of those states (i) which are specifically set forth in the
Prospectus, and (ii) in which plaintiffs claim they were offered or sold
Interests.
In any claim for indemnification for Federal or state securities laws
violations, the party seeking indemnification must place before the court the
position of the Securities and Exchange Commission and the Massachusetts
Securities Division or other respective state securities division with
respect to the issue of indemnification for securities laws violations.
The Company will not incur the cost of the portion of any insurance which
insures any party against any liability as to which such party is herein
prohibited from being indemnified.
TEMPORARY INVESTMENTS
A Company's uncommitted funds may be held in bank accounts at commercial
banks or invested in the following:
(a) Obligations of banks or savings and loan associations that either
(i) have assets in excess of $5 billion, or (ii) are insured in their
entirety by agencies of the United States government;
(b) Obligations of or guaranteed by the United States government or
its agencies;
(c) Repurchase obligations for securities described in clauses (a) or
(b) above, if possession of the subject securities is maintained by
the Company or its agent;
(d) Any debt obligation rated at the time of purchase in the highest
three grades by a nationally recognized securities rating
organization; or
(e) Funds or financial instruments that are comprised of or backed by
substantially only those obligations described in clauses (a) through
(d) above.
AMENDMENTS AND VOTING RIGHTS
The Manager may amend the Company Operating Agreement without notice to
or approval of the Investor Interestholders for the following purposes: to
cure ambiguities or errors; to conform the Company Operating Agreement to the
description in this Prospectus; to equitably resolve issues arising under the
Company Operating Agreement so long as similarly situated Investor
Interestholders are not treated materially differently; to comply with law;
to make other changes that will not materially and adversely affect any
Investor Interestholder's interest; or to maintain the federal income tax
status of the Company, to modify the liabilities of Investor Interestholders
in order to maintain the status of Participating Investor Interestholders
under the passive activity rules of the Code (so long as no Investor
Interestholder's liability is materially increased without his/her consent)
or to make modifications to the computation of items affecting the Capital
Accounts to comply with the Code.
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Other amendments to the Company Operating Agreement may be proposed
either by the Manager or a majority in interest of the Investor
Interestholders (as determined by their Capital Contributions), either by
calling a meeting of the Investor Interestholders or by soliciting written
consents. The procedure for such meetings or solicitations is found at
Section 15.2 of the Company Operating Agreement. Such proposed amendments
require the approval of a Majority in interest of the Investor
Interestholders given at a meeting of Investor Interestholders or by written
consents. Any amendment requiring Investor Interestholder action may not
increase any Investor Interestholder's liability, change the Capital
Contributions required of him or his/her rights and share in the Company's
profits, losses, deductions, credits, revenues or distributions in more than
a DE MINIMIS matter or any voting rights without the Investor
Interestholder's consent, and changes to the Manager's management rights
require its consent.
The consent of all Investor Interestholders is required for the following
additional actions by the Company: actions contravening the Company Operating
Agreement or Certificate; actions making it impossible to carry on ordinary
business; confessing a judgment in excess of 10% of the Company's assets;
dissolving or terminating the Company, other than as provided by the Company
Operating Agreement; allowing the Manager to possess or hold Company property
for other than the Company purpose or creating a new Manager except as
described below.
AUTOMATIC CONVERSION OF PARTICIPATING INVESTOR INTERESTHOLDER
Each Investor Interestholder who elects to become a Participating
Investor Interestholder by assuming liability for the Company's Special
Obligations will, upon the earlier to occur of (i) one year following the
completion of the offering, or (ii) the Facilities Completion Date, have
his/her assumption of liability automatically rescinded and thereby convert
his/her Interests to non-participating status and himself to a
Nonparticipating Investor Interestholder with respect to all Company wells.
Generally, such conversion will cause such Investor Interestholder to have
limited liability for the obligations of the Company stemming from ownership
of the wells, particularly with respect to Special Obligations of the Company
which arise after such conversion. Such Investor Interestholder will,
however, notwithstanding such conversion, remain potentially liable for
Special Obligations of the Company with respect to such wells which arose
during the period when he/she was a Participating Investor Interestholder and
which exceed the proceeds of insurance payable to or for the benefit of the
Company on account of such Special Obligations plus the value of the assets
of the Company available to satisfy such Special Obligations.
REMOVAL OF THE MANAGER
At least 50% of the Investor Interestholders, by calling a meeting or
soliciting consents, may propose the removal of the Manager for cause, which
requires the affirmative vote of a Majority in Interest of the Investor
Interestholders of the Company. Removal of the Manager causes a dissolution
of the Company, unless as described below all Investor Interestholders elect
to continue the Company. The Investor Interestholders may replace the
removed Manager or fill a vacancy by vote of a majority in interest of the
Investor Interestholders.
If the Manager is removed other than for cause (defined as breach of
fiduciary duty, fraud or material failure to perform its duties), the Company
will be required to pay an amount to the Manager equal to the amount that
would have been payable as the asset disposition fee if the Company had sold
all of its projects on the date of such removal for an amount equal to sixty
times the Company's average monthly gross revenues from sales of production
during the immediately preceding 12 months. If the Manager is removed,
resigns or is unable to serve, its share in the capital and profits of the
Company (generally 20%) shall not be affected.
DISSOLUTION OF COMPANY
Each Company will dissolve on the earliest to occur of (a) December 31 of
the year which is forty years following the year in which such Company was
organized, (b) the sale of substantially all of the Company's property, (c)
the removal, dissolution, resignation, insolvency, bankruptcy, death or other
legal incapacity or disqualification of the
114
<PAGE>
Manager, (d) the vote of either all Investor Interestholders or the Manager
and a majority in interest of the Investor Interestholders, or (e) any other
event requiring dissolution by law. The Company will wind up its business
after dissolution unless (i) the Manager and a majority in interest of the
Investor Interestholders, or (ii) if there is no Manager, all of the
remaining Investor Interestholders, elect to continue the Company. The
Manager (or in the absence thereof, a liquidating trustee chosen by the
Investor Interestholders) shall liquidate the Company's assets if it is not
continued.
TRANSFERABILITY OF INTERESTS
No Investor Interestholder may assign or transfer all or any part of
his/her interest in the Company and no transferee will be deemed a
substituted Investor Interestholder or be entitled to exercise or receive any
of the rights, powers or benefits of an Investor Interestholder other than
the right to receive distributions attributable to the transferred interest
unless (i) such transferee has been approved and accepted by the Manager, in
its sole and absolute discretion, as a substituted Investor Interestholder,
and (ii) certain other requirements set forth in the Company Operating
Agreement have been satisfied. The transferor of Interests will remain
liable for Special Obligations incurred prior to the transfer. The
transferee will be liable for Special Obligations incurred prior to the
transfer to the extent of his/her interest in the Company. See Company
Operating Agreement - Appendix I.
THE MANAGER'S CAPITAL ACCOUNT
The Manager is obligated under the Company Operating Agreement to restore
any deficit in its capital account prior to any liquidating distribution by
the Company. The Manager reserves the right, however, to offset this
obligation by waiving all or a portion of the Manager's rights to any fees or
other compensation due to it under the Company Operating Agreement.
LEGAL OPINIONS
Certain legal matters in connection with the Interests will be passed
upon by Michael D. Ewing, Esq., Chicago, Illinois, counsel to the Manager and
to the Company, and by ,
Michigan, as to matters of Michigan law. Mr. Ewing and
have each acted as counsel to the Manager and the Prior Manager
and/or affiliates of the Manager and the Prior Manager in the past and may be
expected to do so in the future with respect to similar or other matters.
Certain federal income tax matters in connection with the public offering
of Interests will be passed upon by Patzik, Frank & Samotny Ltd., of Chicago,
Illinois, as Special Tax Counsel to the Manager and the Company. A tax
opinion of Special Tax Counsel has been provided in the form attached to this
Prospectus as Appendix IV. Special Tax Counsel has not been engaged to
otherwise assist the Manager or the Company in connection with the public
offering of Interests and, accordingly, except as set forth immediately
above, has not reviewed or passed upon the adequacy or accuracy of the
disclosure set forth in this Prospectus or any applicable Supplement.
Special Tax Counsel assumes no responsibility to update the above-described
aspects of the Prospectus as a result of changes occurring on or after the
date hereof or to monitor the activities of the Manager or the Company to
assure compliance with the assumptions underlying its opinion. Special Tax
Counsel has acted as special tax counsel to the Manager and the Prior Manager
and/or affiliates of the Manager and the Prior Manager in the past and may be
expected to do so in the future with respect to similar or other matters.
No independent counsel has acted or acts as counsel to or otherwise
represents the interests of subscribers who or which will become Investor
Interestholders of the Company or other potential investors in Interests.
Investors are encouraged to seek independent legal counsel to review all
matters discussed in this Prospectus, including, but not limited to, the
federal income tax effects as they affect their particular financial and tax
circumstances, which are relevant to their decision to become Investor
Interestholders of the Company.
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REPORTS AND ACCOUNTING
The Company is required by the Agreement to and will keep appropriate
records relating to its activities. All books, records and files of the
Company will be kept at its principal offices at 4660 South Hagadorn Road,
Suite 230, East Lansing, Michigan 48823. An independent certified public
accounting firm will prepare the Company's federal income tax return as soon
as practicable after the conclusion of each year. The Manager will use its
reasonable best efforts to obtain the information for those returns as soon
as possible and to cause the resulting accounting and tax information to be
transmitted to the Investor Interestholders as soon as possible after receipt
from the accounting firm.
Each Investor Interestholder will receive reports as to the Company's
activities on at least a quarterly basis and will receive as soon as
practicable after the end of each year the necessary federal and state income
tax information and annual financial statements for the Company that have
been audited by the Company's accounting firm. The Company will be required
to make periodic reports to the Securities and Exchange Commission and to
certain state securities regulatory authorities.
ADDITIONAL INFORMATION
GENERAL
The Manager undertakes to make available to each prospective Investor
Interestholder or his/her purchaser representative, or both, during the
course of the offer and sale of Interests and prior to the sale of Interests
to such prospective Investor Interestholder, the opportunity to ask questions
of and receive answers from the Manager or any person acting on its behalf
relating to the terms and conditions of the offering and to obtain any
additional information necessary to verify the accuracy of information made
available to such purchaser.
Prior to making an investment decision respecting the securities
described herein, a prospective Investor Interestholder should carefully
review and consider this entire Prospectus and the exhibits thereto and any
applicable Supplement thereto, including without limitation the Company
Operating Agreement. Prospective Investor Interestholders are urged to make
arrangements with the Manager to inspect any books, records, contracts, or
instruments referred to in this Prospectus and any applicable Supplement
thereto and other data relating thereto. The officers and directors of the
Manager and the Company are available to discuss with prospective Investor
Interestholders any matter set forth in this Prospectus and any applicable
Supplement thereto or any other matter relating to the securities described
herein, so that Investor Interestholders and their advisors, if any, may have
available to them all information, financial and otherwise, necessary to
formulate a well-informed investment decision.
REGISTRATION STATEMENT
A Registration Statement with respect to the Interests offered hereby has
been filed on behalf of the Company with the U.S. Securities and Exchange
Commission, 450 Fifth Street, N.W. Washington, D.C. 20549, under the
Securities Act of 1933, as amended. This Prospectus does not contain all of
the information set forth in the Registration Statement, certain parts of
which are omitted in accordance with the rules and regulations of the
Commission. For further information pertaining to the Interests, reference
is made to the Registration Statement, including the exhibits filed as a part
thereof, copies of which may be inspected at the Public Reference Room of the
Commission, Washington, D.C. 20549, and copies of which may be obtained from
the Public Reference Section at prescribed rates.
LITIGATION
The Manager and its affiliates are, from time to time, parties to
litigation in the ordinary course of its business. As of the date of this
Prospectus, neither the Manager nor any of its affiliates, including its
Investor Interestholders, officers and directors, is a party to any
litigation, the adverse resolution of which would have a material adverse
effect on its operations or financial condition.
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<PAGE>
AVAILABILITY OF DOCUMENTS
The following is a partial list of documents that are available to each
potential investor upon request, in connection with an evaluation of an
investment in the Company. Any other documents relevant to the Company or
its business that are not listed below but are obtainable by the Company
without unreasonable effort or expense are also available for examination by
potential investors at the offices of the Manager (to the extent permitted by
the Company Operating Agreement). Any of the documents identified below that
may not have been executed by the parties thereto at the time of the request
will be furnished in draft form.
1. Documents relating to the Company, including:
(a) the Articles of Association of the Company and the form of Company
Operating Agreement and all amendments thereto;
(b) the Management Services Agreement between the Company and the Manager,
covering additional duties set forth therein;
(c) the form of Turnkey Agreement; and
(d) the tax opinion of Special Tax Counsel.
2. In addition to this Prospectus, the Manager has prepared various pieces of
supplementary information, including pieces generally referred to as "sales
literature." These materials, to the extent approved by the Manager, will
be so designated. Other materials not so designated have not been reviewed
or endorsed by the Manager and, accordingly, no responsibility or liability
will be had therefor.
In the event that any additional documents are made available to any
accredited investors (see "Investor Suitability Standards"), copies thereof
will be sent to all subscribers.
GLOSSARY OF TERMS
The following glossary consists of abbreviated definitions of certain of
the terms used throughout this Prospectus. SEE ARTICLE I OF THE FORM OF
COMPANY OPERATING AGREEMENT WHICH APPEARS AS APPENDIX I TO THIS PROSPECTUS
FOR COMPLETE DEFINITIONS OF THESE AND OTHER TERMS.
Each Contributing Investor Interestholder's "ADJUSTED CAPITAL" for any
year shall be determined as of the first day of any year and shall be equal
to the amount of such Contributing Investor Interestholder's Initial Capital
Contribution, reduced by the aggregate amount of all cash distributions to
such Contributing Investor Interestholder in all prior years.
"ACQUISITION PERIOD" means the first two years after commencement of
Company operations or the period until the Company's property acquisitions
are completed, whichever is shorter.
"ACT" means the Michigan Limited Liability Company Act, as amended.
"ADMINISTRATIVE COSTS" means generally customary and routine overhead
expenses incurred by the Manager in conducting Company business.
"AGGREGATE INVESTOR INTERESTHOLDER CAPITAL CONTRIBUTIONS" means the total
of all Investor Interestholder subscriptions.
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"AGGREGATE INVESTOR INTERESTHOLDER NET CAPITAL CONTRIBUTIONS" means the
aggregate Investor Interestholders' capital contributions, reduced by all
expenses of the Company for organization and offering expenses and the
Management Fee.
"CAUSE", when used in connection with the removal of the Manager by a
Majority in interest of the Investor Interestholders, shall mean, (i) breach
of its fiduciary obligations to the Company, (ii) actual fraud upon the
Investor Interestholders, (iii) a material misrepresentation in the
Prospectus of the Company Operating Agreement, or (iv) a material and
continuing failure to perform its obligations to the Company hereunder.
"CODE" means the Internal Revenue Code of 1986, as amended from time to
time.
"COMPLETION" means the point, or the activities necessary to reach the
point, at which a well is said to have been "COMPLETED," i.e., when the
development, drilling and completion activities and all other below-ground
installations or services necessary to create and prepare such well for
production have been finished, in the discretion of the applicable Operator,
according to the development plan of such Operator and such well is ready for
the installation of Facilities thereon or connection to Facilities
appurtenant thereto and commence production.
"COST" generally includes the price paid for a property and all
reasonable, necessary and actual expenses incurred in connection with the
purchase of such property.
"DEVELOPMENT DRILLING" refers to the drilling of DEVELOPMENT WELLS. A
"DEVELOPMENT WELL" is, generally, a well drilled as an additional well to the
same gas reservoir as other producing wells or not more than one location
away from a well producing from the same reservoir.
"DIRECT COSTS" are those costs directly incurred for the benefit of the
Company and generally attributable to the goods and services provided to the
Company by parties other than the Manager or its affiliates.
"FACILITIES" encompasses all above-the-wellhead facilities installed with
respect to a well for the purpose of collecting, transporting, compressing,
dewatering or otherwise processing gas production from such well for
subsequent delivery to a commercial pipeline for sale to commercial customers.
"FACILITIES COMPLETION DATE" is the date upon which all of the wells on a
property in which the Company has acquired a working interest have been
Completed and all Facilities necessary or appropriate, in the discretion of
the Operators, pursuant to the development plan of the Operators, have been
constructed and installed upon and/or connected to such wells. The Manager
will give the Investor Interestholders written notice of the Facilities
Completion Date.
A "FARMOUT" is, generally, an agreement whereby the owner of a leasehold
or working interest agrees to assign his/her interest in specific acreage to
an assignee who agrees to drill one or more wells on the acreage, while
retaining some interest such as an overriding royalty interest.
"INDEPENDENT EXPERT" means a person or firm in the business of rendering
opinions regarding the value of gas projects with no material relationship to
the Manager or its affiliates.
Each Contributing Investor Interestholder's "INITIAL CAPITAL
CONTRIBUTION" shall be equal to such Contributing Investor Interestholder's
initial capital contribution (i.e., the subscription amount for each Investor
Interestholder).
"INTERESTS" refers to fractional undivided membership interests in the
Company, determined in accordance with the Act and the Company Operating
Agreement, acquired by Investor Interestholders in this Offering and which
entitle the holder thereof to an Interest in the capital and profits of the
Company.
"INTERESTHOLDERS" refers to the Manager and the Investor Interestholders,
collectively.
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"INVESTOR INTERESTHOLDERS" are Persons who acquire Interests in the
Offering and thereby become Investor Interestholders in the Company, in their
capacity as non-management Interestholders of the Company.
A "LANDOWNER'S ROYALTY" is the royalty interest customarily retained
under an oil and gas lease by the owner of the mineral interest.
A "LEASE" refers, generally, to any interest in a gas lease or other
right authorizing the owner of such lease or other right to explore for and
produce gas.
A "MINERAL INTEREST" refers, generally, to a landowner's interest in
subsurface gas which carries with it the right to produce the gas or to
execute gas leases and to receive landowner's royalty payments.
"NET INVESTABLE CAPITAL" means the amount of Company capital remaining,
after payment of all organizational, offering, selling and administrative
costs, the Management Fee and the Acquisition Fee, which is available to and
is invested in working interests in projects.
"NET PROCEEDS OF PRODUCTION" refers to the revenues received by the
Company from the sale of all gas, less all expenses, including Operating
Costs and taxes attributable to such sales.
A "NET PROFITS INTEREST" is an overriding royalty measured by the net
profits realized by the holder of the underlying working interest in a lease.
Company "NET REVENUES" is generally synonymous with Company net cash flow
from operations.
A "NET SUBSCRIPTION" is the subscription of an Investor Interestholder,
less his/her allocable share of selling costs and the payment to the Manager
in lieu of the reimbursement of Organization and Offering Costs that is
payable out of Company capital.
A "NET WELL" refers to an aggregate net percentage working interest in
one or more wells which totals 100 percent.
"NON-OPERATING INTERESTS" refers, in general, to royalty interests and
production payments.
"OPERATING COSTS" refers to expenditures made and costs incurred in
producing and marketing gas from completed wells, including that portion of
direct costs and administrative costs allocable to the working interest in a
gas property.
"OPERATOR" refers to the person or entity with has contracted with the
owners of the working interest in any property to conduct all operations
thereon, including, but not limited to, drilling, completion and operation of
the wells, administration and maintenance of the property, marketing and sale
of the products therefrom and monitoring of the operations and performance of
the property, in exchange for a fee which may or may not be based upon or
payable from the proceeds of the sale of production from the property and who
or which may or may not also own a portion of the working interest in such
property.
"ORGANIZATION AND OFFERING COSTS" includes legal, accounting and other
costs of offering Interests and organizing the Company.
An "OVERRIDING ROYALTY" is a royalty interest created from a lease rather
than a mineral interest.
A "PARTICIPATING INVESTOR INTERESTHOLDER" is an Investor Interestholder
who elects to assume joint and several liability for the obligations of the
Company which constitute Special Obligations until the earlier to occur of
(i) one year following the completion of the offering, or (ii) the Facilities
Completion Date, after which a Participating Investor Interestholder shall
be deemed to have disclaimed personal liability for Special Obligations and
been converted to Nonparticipating Investor Interestholder status.
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"PAYOUT" means the amount and the corresponding time when each Investor
Interestholder and the Investor Interestholders as a group have received
distributions of Net Cash Flow from the Company which are equal, in the
aggregate, to the Capital Contributions of the Investor Interestholders,
individually and collectively.
"PRIMARY AREA" means the known or reasonably anticipated extent of the
gas-bearing Devonian shale formation in Alcona, Antrim, Charlevoix, Crawford,
Kalkaska, Montmorency, Otsego and Oscoda Counties, Michigan, and similar
Devonian shale formations in southwestern lower Michigan, northeastern
Indiana and northwestern Ohio.
A "PRODUCING PROPERTY" is, generally, a property producing gas in
sufficient quantities to offset its operating costs or a property with
shut-in wells deemed capable by the Manager of producing gas in such
quantities.
A "PRODUCTION PAYMENT" is, generally, an interest which entitles the
holder to receive a specified share of gross production of gas or other
minerals, or the proceeds from the sale of such share of production free of
the costs of production.
A "PROPERTY" is, generally, the entire interest in the subsurface mineral
rights appurtenant to one or more parcels of real property and carrying with
it the right to disturb the use of the property to the extent reasonably
required to conduct drilling, completion and production activities thereon.
"RESERVES" includes "PROVED RESERVES" and "UNPROVED RESERVES." "PROVED
RESERVES" are those quantities of natural gas and natural gas liquids which
upon analysis of geologic and engineering data appear with reasonable
certainty to be recoverable in the future from known gas reservoirs under
existing economic and operating conditions utilizing conventional methods.
Proved reserves includes both PROVED DEVELOPED RESERVES, which can be
expected, with little doubt, to be recovered from existing wells using
existing equipment and operating methods and PROVED UNDEVELOPED RESERVES,
which are, generally, reserves which are expected to be recovered from new
development wells or from existing wells where a relatively major expenditure
is required for recompletion. "UNPROVED RESERVES" are those quantities of
natural gas and natural gas liquids which upon analysis of geologic and
engineering data appear to be recoverable in the future from known gas
reservoirs, but with respect to which no wells have been drilled that have
established with reasonable certainty that such reserves can be recovered.
"RESIDUAL OPERATING CASH FLOW" means Company net revenues available for
distribution to Investors in any period following the receipt by the
Investors of cash distributions which are, in the aggregate, equal to 100% of
their original capital contributions plus a 6% cumulative annual preferred
return on such capital contributions, for so long as the Investors have
received, at the end of such period, cash distributions which are, in the
aggregate, equal to 100% of their original capital contributions plus a 6%
cumulative annual preferred return on such capital contributions.
A "ROYALTY" or "ROYALTY INTEREST" is an interest entitling the holder to
receive a share of gross production of gas or other minerals, or the proceeds
from the sale of such share of production free and clear of all costs of
development, operation or maintenance, and having no control over drilling
and production activities.
"SELLING COSTS" refers, generally, to the sales commissions and due
diligence fees incurred in connection with the sale of Interests.
An Investor Interestholder's "SHARING RATIO" refers, generally, to the
ratio between one Investor Interestholder's net subscription and the
aggregate net subscriptions of all Investor Interestholders.
"SPECIAL OBLIGATIONS" refers to the Company's obligations and
liabilities of whatever type or description arising solely out of or in
connection with its ownership of working shares in any one or all of the
wells making up a property, including but not limited to the obligation to
pay the costs of acquisition of the share in the property, the drilling and
completion of wells, to pay the Company's share of the costs of Facilities,
including Facilities not currently contemplated by the Operators or the
Manager and tort liabilities for personal injury or environmental damage.
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"SUBSCRIPTION" refers to the amount that an Investor Interestholder pays
for Interests.
"SUBSCRIPTION AGREEMENT" refers to the Subscription Agreement, a form of
which is annexed to this Prospectus as Appendix III.
"COMPANY PROJECTS" includes all interests, projects and rights of any
type owned by the Company.
"UNDEVELOPED LEASEHOLD INTERESTS" refers, generally, to all interests in
gas and other mineral leases except those portions of leases included within
the governmentally designated spacing or conservation unit in which an
existing producing well is located.
A "WORKING INTEREST" is the operating interest under a gas lease or
unleased mineral interest the owner of which has the right to explore for,
develop and produce gas from and to operate the projects subject to such
interest and to receive his/her PRO RATA share of the gas and minerals
produced from such projects or the proceeds from the sale thereof, and the
obligation to pay his/her PRO RATA share of all costs, including costs of
development, operation and maintenance associated therewith.
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PLANTE & MORAN, LLP
Independent Auditor's Report
To the Members
Wolverine Energy, L.L.C.
(a Michigan limited liability corporation)
We have audited the accompanying balance sheet of Wolverine Energy, L.L.C. (a
Michigan limited liability corporation) as of December 31, 1996 and 1995, and
the related statements of income and members' equity and cash flows for the year
and the period then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wolverine Energy, L.L.C. at
December 31, 1996, and 1995, and the results of its operations and its cash
flows for the year and the period then ended, in conformity with generally
accepted accounting principles.
/s/ Plante & Moran, LLP
May 28, 1997
A member of
MOORES
ROWLAND
INTERNATIONAL
A WORLDWIDE ASSOCIATION OF INDEPENDENT ACCOUNTING FIRMS
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
BALANCE SHEET
ASSETS
DECEMBER 31
-----------------------
1996 1995
CURRENT ASSETS ---- ----
Cash $ 48,892 $ -
Accounts Receivable:
Related entities (Note 4) 374,936 1,085,826
Other 15,629 -
Current portion of member note receivable (Note 4) 100,300 -
Prepaid expenses 411,170 349,930
---------- ---------
Total current assets 950,927 1,435,756
ORGANIZATION COSTS, Net 10,521 13,266
MEMBER NOTE RECEIVABLE (Note 4) 200,595 -
INVESTMENTS IN RELATED ENTITIES (Note 2) 370,812 210,410
---------- ----------
Total assets $1,532,855 $1,659,432
========== ==========
LIABILITIES AND MEMBERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ - $753,151
Line of credit (Note 3) 249,500 -
Accounts payable:
Trade 50,769 28,268
Operators 805,079 741,618
Related party (Note 4) 72,971 124,978
Accrued expenses 14,913 -
--------- ---------
Total current liabilities 1,193,232 1,648,015
MEMBERS' EQUITY 339,623 11,417
--------- ---------
Total liabilities and members' equity $1,532,855 $1,659,432
========== ==========
See Notes to Financial Statements.
F-1
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
STATEMENT OF INCOME AND MEMBER'S EQUITY
Year Ended Period Ended
December 31, December 31,
1996 1995
------------ -------------
REVENUE
Turnkey revenue $4,280,724 $2,331,446
Management fees 250,547 123,513
Other income 9,300 -
----------- ---------
Total revenue 4,540,571 2,454,959
COST OF SALES
Drilling and other related costs 3,470,477 2,378,044
General and administrative 688,715 66,498
---------- ----------
Total operating expenses 4,159,192 2,444,542
---------- ----------
OPERATING INCOME 381,379 10,417
LOSS FROM EQUITY INVESTMENTS (53,173) -
----------- ----------
NET INCOME 328,206 10,417
MEMBERS' EQUITY - Beginning of period 11,417 -
MEMBER CONTRIBUTIONS - 1,000
---------- ---------
MEMBERS' EQUITY - End of period $339,623 $11,417
========== =========
See Notes to Financial Statements
F-2
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
STATEMENT OF CASH FLOWS
Year Ended Period Ended
December 31, December 31,
1996 1995
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers $5,235,832 $1,369,133
Cash paid to operators and suppliers (4,139,748) (1,899,151)
Cash paid for interest (29,071) -
--------- ---------
Net cash provided by (used in) operating
activities (Note 5) 1,067,013 (530,018)
CASH FLOWS FROM INVESTING ACTIVITIES
Cash paid for organizational costs - (13,723)
Loans to member (300,895)
Cash paid for investment in partnerships (213,575) (210,410)
---------- ---------
Net cash used in investing activities (514,470) (224,133)
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft (753,151) 753,151
Proceeds from line of credit, net of repayments 249,500 -
Capital contributions from members - 1,000
-------- -------
Net cash provided by (used in) financing
activities (503,651) 754,151
--------- -------
NET INCREASE IN CASH 48,892 -
CASH -- Beginning of period - -
CASH - End of period $48,892 $ -
======= =========
See Notes to Financial Statements.
F-3
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
NOTE 1 - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Wolverine Energy, L.L.C. (WELLC) was formed on November 8, 1995; the 1995
financial statements include the results of operations from inception
through December 31, 1996. WELLC acquires working interests in natural gas
prospects in Michigan, forms oil and gas entities and sells them the
interests on a turnkey basis. WELLC is responsible for managing the
operations of many of the entities.
INVESTMENTS IN RELATED ENTITIES - Investments in related entities are
accounted for under the equity method. WELLC, as the manager of the oil
and gas entities, makes initial capital contributions in accordance with
provisions in the respective placement memorandum governing the activities
of the particular entity. Income or losses are allocated to the
investments according to WELLC's ownership interest in the entities, and
distributions or withdrawals are deducted from the investments.
TURNKEY DRILLING REVENUE - WELLC enters into contracts with affiliated oil
and gas entities to drill oil and gas wells under turnkey agreements.
Under the terms of the contracts, the entities pay all drilling costs and
receive working interests in the wells. The entities advance funds to
WELLC in order to finance the drilling activity.
ORGANIZATION COSTS - Organization costs are being amortized over a
five-year period using the straight-line method.
INCOME TAXES - No provision for federal income taxes has been included in
the financial statements since the income of the Limited Liability
Corporation must be reported by the respective members on their federal
income tax returns.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and
expenses during the reported period. Actual results could differ from
those estimates.
F-4
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
NOTE 2 - AFFILIATED OIL AND GAS ENTITIES
Since 1995, WELLC has sponsored the formation of a trust and limited
liability corporations (entities) for the purpose of conducting oil and gas
exploration, development, and production activities on certain oil and gas
properties. Such entities include Wolverine Antrim Development Trust 1995,
Wolverine Antrim Development 1996-1, L.L.C. and Wolverine Antrim
Development 1996-2, L.L.C. WELLC serves as manager of these entities and,
as such, has full and exclusive discretion in the management and control.
The turnkey drilling and operating agreements that WELLC enters into with
the entities provide that the entities pay for the drilling costs of the
wells at an agreed-upon price per well. Revenue from oil and gas
properties is allocated based on the working interest ownership percentage
of the properties.
WELLC holds the following interest in the entities:
1996 1996
----------- -----------
Wolverine Antrim Development Trust 1995 8.5 % 8.5 %
Wolverine Antrim Development 1996-1, L.L.C. 15.0 % - %
Wolverine Antrim Development 1996-2, L.L.C. 15.0 % - %
Following is summary of financial position and results of operations of
entities whose investments are carried at equity:
1996 1995
----------- -----------
Current assets $577,528 $1,156,501
Other assets 6,843,265 2,136,682
---------- ----------
Total assets $7,420,793 $3,293,183
========== ==========
Current liabilities $577,134 $1,153,326
Equity 6,843,659 2,139,857
---------- ----------
Total liabilities $7,420,793 $3,293,183
========== ==========
Net loss $ (422,901) $ (67,143)
=========== ==========
F-5
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
NOTE 3 - LINE OF CREDIT
The line of credit to a bank is unsecured and due on demand. The line of
credit bears interest at 1.5 percent above the prime rate ( effective rate
of 9.75 percent at December 31, 1996).
NOTE 4 - RELATED PARTY TRANSACTIONS
During 1996 and 1995, WELLC earned turnkey revenue from related entities in
the amount of $4,280,724 and $2,331,446, respectively. The balance of
turnkey revenues owed to WELLC and included in accounts receivable as of
December 31, 1996 and 1995, is $374,936 and $1,085,826, respectively.
During 1996 and 1995, WELLC charged management fees to related entities in
the amount of $250,547 and $123,513, respectively, in accordance with
respective placement memorandums
WELLC loaned $300,895 to a member during 1996. The note bears interest at
8 percent and is payable in equal installments over the next three years.
WELLC owed a related entity for drilling costs in the amount of $72,971 and
$124,978 at December 31, 1996 and 1995, respectively.
NOTE 5 - CASH FLOWS
A reconciliation of net income to net cash flows used in operating
activities is as follows:
1996 1995
-------- --------
Net income $328,206 $10,417
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization expense 2,745 457
Loss from equity investments 53,173 -
(Increase) decrease in assets:
Accounts receivable 695,261 (1,085,826)
Prepaid expenses (61,240) (349,930)
Decrease in liabilities:
Accounts payable 33,955 894,864
F-6
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
NOTE 5 - CASH FLOWS (Continued)
Accrued expenses 14,913 -
----------- ----------
Net cash provided by (used in)
operating activities $1,067,013 $(530,018)
========== ==========
There were no significant noncash investing and financing activities during
1996 and 1995.
F-7
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
BALANCE SHEET
JUNE 30, 1997
ASSETS
CURRENT ASSETS
Cash $ 45,253
Accounts receivable
Related entities 211,682
Other 44,825
Current portion of member note receivable 100,300
Prepaid expenses 155,504
---------
Total current assets 557,564
FIXED ASSETS, NET 13,980
ORGANIZATIONAL COSTS, NET 9,147
MEMBER NOTE RECEIVABLE 513,829
INVESTMENTS IN RELATED ENTITIES 419,178
---------
Total Assets $ 1,513,698
===========
LIABILITIES AND MEMBERS' EQUITY
CURRENT LIABILITIES
Accounts payable:
Trade $ 139,184
Operators 1,072,250
Related party 77,024
---------
Total current liabilities 1,288,458
MEMBERS' EQUITY 225,240
----------
Total liabilities and members' equity $ 1,513,698
===========
F-8
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
STATEMENT OF INCOME AND MEMBERS' EQUITY
6 Months Ended
June 30, 1997
--------------
REVENUE
Turnkey Revenue $ 1,041,497
Management fees 58,806
-----------
Total Revenue 1,100,303
COST OF SALES
Drilling and other related costs 793,557
General and Administrative 412,580
----------
Total operating expense 1,206,137
OPERATING LOSS (105,834)
LOSS FROM EQUITY INVESTMENTS (8,549)
----------
NET LOSS (114,383)
MEMBERS' EQUITY - Beginning of period 339,623
-----------
MEMBERS' EQUITY - End of Period $ 225,240
============
F-9
<PAGE>
APPENDIX I
FORM OF COMPANY OPERATING AGREEMENT
COMPANY OPERATING AGREEMENT
of
WOLVERINE ENERGY 97-98( )
DEVELOPMENT COMPANY, L.L.C.
This COMPANY OPERATING AGREEMENT (the "Agreement") is made as of
, 199 , by Wolverine Energy, L.L.C., a Michigan limited
liability company, which, with its successor(s) as managing member(s) under
this Agreement, is referred as the "Manager," and those persons who are
accepted as holders of interests in the Company under this Agreement.
W I T N E S S E T H:
WHEREAS, the Manager wishes to organize WOLVERINE ENERGY 97-98( )
DEVELOPMENT COMPANY, L.L.C. (the "Company"), as a limited liability company
under the Michigan limited liability company act, Sections 451.1101 to
451.2200 of the Michigan Compiled Laws, as the same may be amended from time
to time (the "Michigan Act"), to provide for the management of the Company by
the Manager, and to provide for the sale of interests in the Company, the
operation of the Company and the rights and obligations of the Manager and
owners of interests; and
WHEREAS, Articles of Association (the "Articles") shall be filed by the
Manager on , 199 , with the Secretary of
State of Michigan in accordance with of the Michigan Act to
evidence the existence of the Company;
NOW, THEREFORE, the Manager and the Interestholders collectively declare
that the Company shall be governed in accordance with the provisions of this
Agreement, and that the rights, duties and obligations of the Manager and the
Interestholders with respect to the Company and its assets and operations and
their respective interests therein shall be defined and limited as herein
provided, subject in all respects to any provision of the Michigan Act which
may be inconsistent herewith, as follows:
ARTICLE 1
ORGANIZATION AND POWERS
1.1 COMPANY EXISTENCE; NAME. The Company, comprised of the Company
created under this Agreement and the business conducted hereunder, shall be
designated as "Wolverine Energy 97-98( ) Development Company, L.L.C.,"
which name shall refer to the Company only and which shall not refer to the
Manager or the officers, agents, interestholders or other beneficial owners
of the Manager or the Company. To the extent possible, the Manager shall
conduct all business and execute all documents relating to the Company in the
name of the Company and not in the name of the Manager. The Manager may
conduct the business of the Company or hold its property under other names as
necessary to comply with law or to further the affairs of the Company as it
deems advisable in its sole discretion. This Agreement, the Articles and any
other documents, and any amendments of any of the foregoing, required by law
or appropriate, shall be recorded in all offices or jurisdictions where the
Company shall determine such recording to be necessary or advisable for the
conduct of the business of the Company.
COA-1
<PAGE>
1.2 COMPANY PURPOSE. The primary purpose of the Company is to acquire
working interests and/or similar interests in natural gas Properties in the
Devonian shale formation in Michigan, Indiana and Ohio, particularly those
which are within the Antrim shale play in Michigan, and to participate in the
drilling, completion and operation of development natural gas wells on such
Properties and in the acquisition, construction, reconstruction, operation
and management of natural gas transmission systems, all of the foregoing in
such manner as the Manager shall designate. The general purpose of the
Company shall be to acquire interests of whatever type the Manager shall
determine in natural gas Properties located within the Continental United
States. The Company shall have the power to perform any and all acts and
activities with respect to its primary or general purpose that are customary
or incident thereto including, by way of illustration and not limitation, the
acquisition, exploration, development, management, administration and
disposition of such properties as the Company shall designate and the
production and the marketing of the products therefrom. The Company may
engage in natural gas operations with others when, in the judgment of the
Manager, it is prudent and desirable under the circumstances. In any such
operations, the Company may acquire, own, hold and develop leases, either as
principal, agent, partner, syndicate member, associate, joint venturer or
otherwise and may invest funds in any such business, and may do any and all
things necessary or incidental to the conduct of any such activities.
1.3 RELATIONSHIP AMONG INTERESTHOLDERS; NO PARTNERSHIP. As among the
Company, the Manager, the Interestholders and the officers and agents of the
Company, a Company and not a partnership is created by this Agreement
irrespective of whether any different status may be held to exist as far as
others are concerned or for tax purposes or in any other respect. The
Interestholders hold only the relationship of Company interestholders to the
Manager with only such rights as are conferred on them by the Michigan Act
and this Agreement.
1.4 ARTICLES OF ASSOCIATION. The Manager shall cause to be executed and
filed (a) the Articles, (b) such certificates as may be required by so-called
"assumed name" laws in each jurisdiction, including, but not limited to,
Michigan, in which the Company has a place of business or may be considered
to be doing business pursuant to the laws of such jurisdiction, (c) all such
other certificates, notices, statements or other instruments required by law
or appropriate for the formation and operation of a Michigan limited
liability company in all jurisdictions where the Company may elect to do
business, and (d) any amendments of any of the foregoing required by law or
appropriate.
1.5 PRINCIPAL PLACE OF BUSINESS. The office and principal place of
business of the Company shall be 4660 South Hagadorn Road, Suite 230, East
Lansing, Michigan 48823, or such other place as the Manager may from time to
time designate by notice to all Investor Interestholders. The Company may
maintain such other offices at such other places as the Company may determine
to be in the best interests of the Company.
1.6 ADMISSION OF INVESTOR INTERESTHOLDERS.
(a) The Company shall have the unrestricted right at all times
prior to the Termination Date (as defined in Article 2 hereof) to admit to
the Company such Investor Interestholders in conformity with the Prospectus
as it may deem advisable, provided the aggregate subscriptions received for
Capital Contributions of the Investor Interestholders and accepted by the
Company may not be less than $300,000.
(b) Each Investor Interestholder shall execute an Omnibus Signature
Page and thereby agree to the terms of the Subscription Agreement and make
such Capital Contributions to the Company as subscribed for by the Investor
Interestholder. Subject to the acceptance thereof by the Manager, each such
subscriber shall be admitted to the Company as an Investor Interestholder.
All funds received from such subscriptions will be deposited in the Company's
name in an interest-bearing escrow account at a commercial bank until
subscriptions in the amount of at least $300,000 have been received and
collections on instruments have been successfully completed.
(c) If, by the close of business on the Termination Date, Investor
Interestholder Interests representing Capital Contributions in the aggregate
amount of at least $300,000 have not been sold or if the Manager
COA-2
<PAGE>
withdraws the offering of Investor Interestholder Interests in accordance
with the terms of the Prospectus, the Subscription Agreement and this
Agreement, the Company shall be immediately dissolved at the expense of the
Manager and all subscription funds shall be forthwith returned to the
respective subscribers together with the net interest earned thereon.
(d) In all events, interest actually earned on subscription funds
held in escrow shall be paid to subscribers for Interests, PRO RATA,
regardless of whether their subscriptions for Interests are accepted. As
soon after the Termination Date as practicable, the Company shall advise each
Investor Interestholder of the Termination Date and the aggregate amount of
Capital Contributions made by all Investor Interestholders and pay such net
interest as has been earned on such subscriptions while held in escrow to all
subscribers for Interests.
(e) The full cash price for Interests must be paid to the Company
at the time of subscription.
1.7 TERM OF THE COMPANY. For all purposes, this Agreement shall be
effective on and after the date hereof and the Company shall continue in
existence until December 31, 2035, at which time the Company shall terminate
unless sooner terminated under any other provision of this Agreement.
1.8 POWERS OF THE COMPANY. Without limiting any powers granted to the
Company under this Agreement or applicable law, the Company shall have, in
addition to all powers necessary, implied or incident to the Company purpose
as described in Section 1.2 hereof, the following additional powers;
(a) To borrow money or to loan money and to pledge or mortgage any
and all Company Property and to execute conveyances, mortgages, security
agreements, assignments and any other contract or agreement deemed by the
Manager to be proper and in furtherance of the Company's purposes and
affecting it or any Company Property;
(b) To pay all indebtedness, taxes and assessments due or to be due
with regard to Company Property and to give or receive notices, reports or
other communications arising out of or in connection with the Company's
business or Company Property;
(c) To collect all monies due the Company;
(d) To establish, maintain and supervise the deposit of funds or
Company Property into and the withdrawals of the same from Company bank
accounts or securities accounts;
(e) To employ accountants to prepare required tax returns and
provide other professional services and to pay their fees as a Company
expense;
(f) To make any election relating to adjustments in basis on behalf
of the Company or the Interestholders which is or may be permitted under the
Code, particularly with respect to Sections 743 and 754 of the Code;
(g) To employ legal counsel for Company purposes and to pay their
fees and expenses as a Company expense;
(h) To conduct the affairs of the Company with the general
objective of achieving distributable income from the Company Property;
(i) To prepare or commission reports of the value of Company
Property or the natural gas reserves thereon and to pay the costs of such
reports as a Company expense; or
(j) To sell, relinquish, release, "farm-out," or otherwise dispose
of or deal with any producing or non-producing leases, leasehold interests,
undivided interests therein or contractual rights to acquire such interests
COA-3
<PAGE>
which in the Manager's judgment should be sold, released, "farmed-out,"
relinquished or otherwise disposed of or dealt with, for such consideration
or without consideration as the Manager deems proper.
1.9 TITLE TO COMPANY PROPERTY. Title to all of the Company Property
shall be vested in the Company until the Company and this Agreement are
terminated pursuant to Article 14 hereof; PROVIDED, HOWEVER, that if the laws
of any jurisdiction require that title to all or any portion of any Company
Property be vested in a trustee or nominee of the Company, then title to that
part of the Company Property shall be deemed to be vested in the Manager or
any co-manager, as the case may be, appointed pursuant to Section 15.7 hereof.
ARTICLE 2
DEFINITIONS
The following terms, whenever used herein, shall have the meanings
assigned to them in this Article 2 unless the context indicates otherwise.
References to sections and articles without further qualification denote
sections and articles of this Agreement. The singular shall include the
plural and the masculine gender shall include the feminine, and vice versa,
as the context requires, and the terms "person" and "he" and their
derivations whenever used herein shall include natural persons and entities,
including, without limitation, corporations, partnerships and trusts, unless
the context indicates otherwise.
"Act" - The Securities Act of 1933, as amended, and any rules and
regulations promulgated thereunder.
"Additional Development Well" - With respect to any Property in which the
Company owns a Working Interest, any well (other than an Initial Well)
drilled on such property, which well is located within the proven area of a
known oil or gas reservoir to the depth of the stratigraphic horizon known to
be productive.
"Additional Well" - Any well (other than an Initial Well) in which the
Company participates as the owner of a Working Interest.
"Adjusted Capital Account" - A Interestholder's Capital Account at any
time (determined before any allocations for the current fiscal period) (a)
increased by (i) the amount of the Interestholder's share of partnership
minimum gain (as defined in Regulation Section 1.704-2(d)) at such time, (ii)
the amount of the Interestholder's share of the minimum gain attributable to
partner non-recourse debt (as defined in Regulation Section 1.704-2(b)(4))
and (iii) the amount of the deficit balance in the Interestholder's Capital
Account which the Interestholder is obligated to restore under Regulation
Section 1.704-1(b)(2)(ii)(c), if any, and (b) decreased by reasonably
expected adjustments, allocations and distributions described in Regulation
Sections 1.704-1 (b)(2)(ii)(d)(4), (5) and (6) (taking into account the
adjustments required by Regulation Sections 1.704-2(g)(ii) and 1.704-2(i)(5)).
"Affiliate" - An "affiliate" of, or person "affiliated" with, a specified
person is a person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control
with, the person specified.
"Aggregate Capital Contributions" - The Capital Contributions of the
Investor Interestholders and the Manager pursuant to Article 5 hereof.
"Agreement" - This Company Operating Agreement of Company, as amended
from time to time.
"Articles" - The Articles of Organization of the Company, as amended from
time to time.
"Capital Account" - The amount representing an Interestholder's capital
interest in the Company, as determined under Article 6 hereof.
"Capital Contributions" - The aggregate capital contributions of the
Investor Interestholders in payment of the purchase price of one or more
whole or fractional Interests (inclusive of the amount of any fee or other
compensation waived by the Company or the Manager or the amount by which the
Soliciting Dealer Commission paid pursuant to Section 9.5 hereof to any
Soliciting Dealer is less than 8% of the Capital Contribution of the
corresponding Investor Interestholder) plus the Manager's Contribution plus
any amounts contributed by the Manager pursuant to Section 14.7 hereof.
"Cause", when used in connection with the removal of the Manager by a
Majority in interest of the Investor Interestholders, shall mean, (i) breach
of its fiduciary obligations to the Company, subject to Section 3.5(c)
hereof, (ii) actual fraud upon the Investor Interestholders, (iii) a material
misrepresentation herein or in the Prospectus, or (iv) a material and
continuing failure to perform its obligations to the Company hereunder.
"Code" - The Internal Revenue Code of 1986, as amended from time to time.
"Company" - Wolverine Energy 97-98( ) Development Company, L.L.C., a
Michigan limited liability company.
"Company Property" - All property owned or acquired by the Company as
part of the Company estate under this Agreement.
"Completion" or "Completion Attempt" - As to any wells, all of the
operations conducted after drilling, testing and establishing the well as a
producer of natural gas in commercial quantities, including casing,
cementing, full testing for production and installation of all equipment such
as meters, pumps, gauges, flowlines, tanks, separators and dehydration
facilities necessary to produce and market gas, including plugging and
abandoning if the Completion Attempt is not successful.
"Direct Costs" - The direct costs and expenses incurred by the Company in
the ordinary course of its business which are not routine or recurring
expenses or the benefits of which accrue directly to the Company and are not
shared with other entities affiliated with the Manager. Such expenses
include legal, accounting, engineering and consulting expenses and regulatory
reporting costs. Such expenses do not include the customary, routine and
necessary costs incurred by the Manager which are associated with or
attributable to administration of the business of the Company.
"Escrow Date" - The later of the date on which the Company accepts the
subscription for the three hundredth Investor Interestholder Interest sold in
the initial offering to Investor Interestholders and the date on which the
Company has deposited at least $300,000 in collected funds in escrow under
Section 1.6(b) hereof.
"Initial Well" - Any well drilled on property in which the Company
participates as the owner of a Working Interest which is acquired with the
funds received by the Company as Capital Contributions, which well is located
within the proven area of a known oil or gas reservoir to the depth of the
stratigraphic horizon known to be productive, including the completion
facilities relating to that well, such as production platforms, production
equipment, flowlines and pipelines to connect the well to an interstate sales
pipeline.
"Interest" - A beneficial interest in the Company representing an Initial
Capital Contribution of $1,000, including an Investor Interestholder Interest
or a Management Interest.
"Interestholder" - An owner of a beneficial interest in the Company,
including the Investor Interestholders with respect to Investor
Interestholder Interests and the Manager with respect to the Manager
Interests and any Investor Interestholder Interests acquired by it.
"Investors" - Each Investor Interestholder and the Manager with respect
to and to the extent of the Manager's Investment Interest, which collectively
hold an interest in the Company constituting 90.00% of the total aggregate
interest in the Company.
COA-5
<PAGE>
"Investor Interestholder" - A purchaser of Investor Interestholder
Interests (including the Manager or its affiliates solely with respect to
Interests acquired by them which are not Manager Interests) whose
subscription is accepted by the Company.
"Investor Interestholder Interest" - Beneficial interests in the Company
representing an Initial Capital Contribution of $1,000 acquired pursuant to
Section 5.1 hereof in a non-public offering conducted pursuant to and in
accordance with the terms of the Prospectus.
"Liquidation" - The earlier of (a) the date upon which the Company is
terminated under Code Section 708(b)(1), or (b) the date upon which the
Company ceases to be a going concern, or (c) as otherwise defined Section
1.704-1(g) of the Regulations.
"Losses" - Defined at "Profits or Losses."
"Majority" - When used with respect to any consent to be given or
decision to be made or action taken by the Investor Interestholders, a
majority in interest of all the then current Investor Interestholders. Such
majority, or any lesser or greater interest prescribed herein, shall be
calculated based upon the total amount of the Capital Contributions.
Investor Interestholder Interests created under Section 12.9 shall not be
included in the computation.
"Manager" - Wolverine Energy, L.L.C., a Michigan limited liability
company having its principal office at 4660 South Hagadorn Road, Suite 230,
East Lansing, Michigan 48823, which is the initial Manager, and any
substitute or different Manager as may subsequently be created under the
terms of this Agreement.
"Manager's Contribution" - The capital contribution required to be made
to the Company by the Manager as provided in Section 5.4 hereof.
"Manager's Investment Interest" - Interests in the Company that represent
the beneficial interests of the Manager with respect to the Manager's
Contribution, representing an Initial Capital Contribution in an amount equal
to 5% of the aggregate Capital Contributions of the Investor Interestholders
acquired pursuant to Section 5.4 hereof, and having the same rights and
interests of the Investor Interestholder Interests, and constituting 5.00% of
the aggregate interests in the Company held by the Investors, and 4.76% of
the total aggregate interests in the Company.
"Manager's Promoted Interest" - Interests in the Company that represent
the beneficial interests and management rights of the Manager, as described
in Section 12.9 hereof, and constituting 5.24% of the total aggregate
interests in the Company.
"Managing Person" - Any of the following: (a) an officer or agent of the
Company, the Manager and each Affiliate of the Manager, and (b) any of the
directors, officers and agents of organizations named in (a) when acting for
the Manager or its Affiliates on behalf of the Company.
"Michigan Act" - The Michigan Limited Liability Company Act, as amended
from time to time (currently codified as Sections 451.1101 to 451.2200 of the
Michigan Compiled Laws).
"Net Capital Contributions" - The Capital Contributions of the
Interestholders pursuant to Article 5 hereof, less the Investor
Interestholder's allocable portion of the expenses described in Sections 9.2,
9.4, 9.5, 9.6 and 9.7 hereof, less the sum of all distributions pursuant to
Sections 8.1(b) and 8.1(c) hereof.
"Net Cash Flow" - The total gross receipts of the Company, less
corresponding cash operating expenses, all other cash expenditures of the
Company and reasonable reserves as determined by the Manager to cover
anticipated Company expenses. For purposes of determining Net Cash Flow,
gross receipts shall mean revenues from any source whatsoever, including, but
not limited to, revenues from sales of gas produced from wells on Company
Property and any proceeds from the sale, exchange, financing or refinancing
of Company Property, but excluding any Capital Contributions of the
Interestholders.
COA-6
<PAGE>
"Participating Investor" - An Investor (including the Manager with
respect to the Manager's Investment Interest) who or which makes the election
provided in Section 11.6 and thereby elects to assume personal liability for
the Special Obligations of the Company and waive limited liability with
respect to such Special Obligations for so long as such Investor
Interestholder does not terminate or reverse such election.
"Profits or Losses" - For a given fiscal period, an amount equal to the
Company's taxable income or loss for such period, determined in accordance
with Code Section 703(a) (for this purpose, all items of income, gain,
expense, loss, deduction or credit required to be stated separately pursuant
to Code Section 703(a)(1) shall be included in taxable income or loss), with
the following adjustments:
(a) Any income of the Company that is exempt from federal income tax
and not otherwise taken into account in computing Profits or Losses
pursuant to this definition and any income and gain described in Regulation
Section 1.704-1(b)(2)(iv)(i)(1) shall be added to such taxable income or
loss;
(b) Any expenditures of the Company described in Code Section
705(a)(2)(B) or treated as Code Section 705(a)(2)(B) expenditures pursuant
to Regulation Section 1.704-1 (b)(2)(iv)(i), and not otherwise taken into
account in computing Profits or Losses pursuant to this definition shall be
subtracted from such taxable income or loss;
(c) in the event of a distribution in kind under Section 8.2, the
amount of any unrealized gain or loss deemed to have been realized on the
property distributed shall be added or subtracted from such taxable income
or loss, as the case may be; and
(d) Notwithstanding any other provision of this definition, any items
which are specially allocated pursuant to Sections 4.1, 4.5, 4.6, 4.7 and
7.4 shall not be taken into account in computing Profits or Losses.
"Prospectus" - The Prospectus dated , 199 , of the Company,
together with the Supplement thereto with respect to the Company , to which the
form of this Agreement is Appendix I.
"Regulation" - A final, temporary or proposed Treasury regulation
promulgated under the Code.
"Simulated Depletion Deductions" - The simulated or actual depletion
allowance computed by the Company with respect to its oil and gas properties
pursuant to Regulations Section 1.704-1(b)(2)(iv)(k). In computing such
amounts, the Company shall have complete and absolute discretion to make any
and all permissible elections.
"Simulated Gains" and "Simulated Losses" - Respectively, the simulated
gains or simulated losses computed by the Company with respect to its oil and
gas properties pursuant to Regulations Section 1.704-1 (b)(2)(iv)(k). In
computing such amounts, the Company shall have complete and absolute
discretion to make any and all permissible elections.
"Soliciting Dealer" - Any NASD-member securities broker/dealer which is
registered as such under Section 15 of the Securities Exchange Act of 1934,
as amended, and by the securities regulatory authority of each state in which
it conducts any securities-related business, which executes a Selling
Agreement with the Manager on behalf of the Company and participates as a
selling broker/dealer with respect to Investor Interestholder Interests.
"Special Obligations" - With respect to each Initial Well or Additional
Development Well, the obligations of the Company with respect to the
drilling, completion and operation of such Initial Well or Additional
Development Well.
COA-7
<PAGE>
"Subscription Agreement" - The form of subscription agreement (a form of
which is attached to the Prospectus as Appendix II) which each prospective
Investor Interestholder must enter into with the Company through the
execution of an Omnibus Signature Page in order to subscribe for an interest
in the Company.
"Termination Date" - 90 days following the date of the Prospectus (which
may be extended, in the sole discretion of the Manager, to not later than
, 199 ), or an earlier date determined by the Company in
its discretion as follows:
(a) The Company may designate any date between the Escrow Date and
, 199 , inclusive, as the Termination Date.
(b) If the Company elects to withdraw the offering of Interests under
this Agreement, the Termination Date is the date of that election.
"Working Interest" - A Working Interest is an interest under an oil and
natural gas lease which carries with it the obligation to pay the costs of
such operation. The holders of the entire Working Interest bear 100% of the
costs of exploring, drilling, developing and operating the lease and are
entitled to receive revenues derived from oil and natural gas production on
such lease which remain after deduction of the cost of processing,
transporting and marketing such oil and natural gas, royalty and overriding
royalty interest payments and other burdens on production.
ARTICLE 3
LIABILITIES OF MANAGER AND INTERESTHOLDERS
3.1 LIABILITY AND OBLIGATIONS OF MANAGER.
(a) To the fullest extent permitted by the Michigan Act, the
Manager shall not be personally liable to any person other than the Company
and its Interestholders for any act or omission of the Manager or any
obligation of the Company incurred by the Manager in its capacity as Manager.
The Company estate shall be directly liable for the payment or satisfaction
of all obligations and liabilities of the Company incurred by the Manager and
the officers and agents of the Company within their authority.
(b) The Manager, as Manager, may be made party to any action, suit
or proceeding to enforce an obligation, liability or right of the Company,
but it shall not solely on account thereof be liable separate from the
Company and it shall be a party in that case only insofar as may be necessary
to enable such obligation or liability to be enforced against the Company
estate.
3.2 LIABILITY OF INVESTOR INTERESTHOLDERS IN GENERAL. Except as
specifically provided in Section 3.3 hereof, no Investor Interestholder in
his capacity as an Investor Interestholder shall have any liability for the
debts and obligations of the Company in any amount beyond the unpaid amount,
if any, of the Capital Contributions subscribed for by him. Except as
specifically provided in Section 3.3 hereof, each Investor Interestholder in
his capacity as an Investor Interestholder shall have the same limitation on
his liability for the Company's debts and obligations as a stockholder of a
Michigan corporation has for debts and obligations of the corporation, as
provided in Section 3803 of the Michigan Act.
3.3 LIABILITY OF PARTICIPATING INVESTOR INTERESTHOLDERS. With respect
to any Initial Well or Additional Development Well, each Participating
Investor Interestholder, in his capacity as a Participating Investor
Interestholder and after he elects and for so long as he does not terminate
his election to assume liability for Special Obligations pursuant to and in
accordance with Section 11.6 with respect to such well, shall be jointly and
severally liable with the Manager and each other Participating Investor
Interestholders for any Special Obligation of the Company with respect to
such well incurred during such period, notwithstanding that such Special
Obligation may be asserted against the Company and/or such Investor
Interestholder at any other time. The intent of this Section 3.3 is to
qualify Participating Investor Interestholders for the exclusion contained in
Section 469(c)(3) of the Code or any successor provision from
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the passive activity rules of the Code with respect to any one or more
Initial Wells or Additional Development Wells, with respect to tax items
attributable to Company expenditures which constitute Special Obligations
derived from Initial Wells or Additional Development Wells, and this Section
3.3 shall be interpreted to achieve that result.
3.4 LIABILITY OF INVESTOR INTERESTHOLDERS TO MANAGER, COMPANY AND
INTERESTHOLDERS. Except to the extent that Participating Investor
Interestholders are liable for Special Obligations under Section 3.3, no
Investor Interestholder in his capacity as an Investor Interestholder shall
be liable, responsible or accountable in damages or otherwise to any
Interestholder, the Manager or the Company for any claim, demand, liability,
cost, damage and cause of action of any nature whatsoever that arises out of
or that is incidental to the management of the Company's affairs.
3.5 LIABILITY OF MANAGING PERSONS TO COMPANY AND INTERESTHOLDERS. (a)
The Managing Persons shall have no liability to the Company or to any other
Interestholder for any loss suffered by the Company that arises out of any
action or inaction of those Managing Persons if those Managing Persons, in
good faith, determined that such course of conduct was in the Company's best
interest and such course of conduct was within the scope of this Agreement
and did not constitute negligence or misconduct of the Managing Persons
involved.
(b) No act of the Company shall be affected or invalidated by the
fact that a Managing Person may be a party to or has an interest in any
contract or transaction of the Company if the interest of the Managing Person
has been disclosed or is known to the Interestholders.
(c) Notwithstanding any provision of this Agreement or law, the
Company shall not be liable to any Interestholder nor shall any Managing
Person be considered to have breached any fiduciary duty of loyalty to the
Company or any Interestholder as the result of any of the following:
(1) The retention of a Managing Person as a consultant, agent or
adviser to an enterprise in which the Company has an interest;
(2) The ownership by a Managing Person of debt, equity or other
interests in a venture in which the Company owns or may in the future
own an interest or the organization, operation or advising of or the
ownership of interests in any entity that may participate in such
venture, whether or not the interests of the Managing Person are on
terms more or less favorable than those afforded the Company;
(3) The participation by a Managing Person or any entity
organized or advised by it in a venture in lieu of the Company's
participation or increasing its participation in the venture, whether
or not the terms afforded to the Managing Person are more or less
favorable than those afforded the Company;
(4) Any transactions with Managing Persons or entities in which
they have an interest, whether or not the terms of those transactions
are determined by costs to the Managing Persons or entities,
independent appraisals or comparable third party transactions; or
(5) Any other conflict of interest or conflicting duty described
in the Prospectus or this Agreement.
This Section 3.5(c) does not relieve any Managing Person from any duty to
exercise appropriate business judgment or care (but which shall not be
enhanced by any duty of loyalty), which duty of judgment or care shall be
governed by the other provisions of this Agreement, but the taking of any
action described in any portion of this Section 3.5(c) shall not in and of
itself be considered failure to exercise appropriate judgment or to take the
appropriate level of care.
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3.6 INDEMNIFICATION OF MANAGING PERSONS.
(a) Each Managing Person shall be indemnified from the Company
Property against any losses, liabilities, judgments, expenses and amounts
paid in settlement of any claims sustained by him in connection with the
Company or claims by the Company, in right of the Company or by or in right
of any Interestholders, if the Managing Person would not be liable under the
standards of Section 3.5. The termination of any action, suit or proceeding
by judgment, order or settlement shall not, of itself, create a presumption
that the Managing Person charged did not act in good faith and in a manner
that he reasonably believed was in the Company's best interests. To the
extent that any Managing Person is successful on the merits or otherwise in
defense of any action, suit or proceeding or in defense of any claim, issue
or matter therein, the Company shall indemnify that Managing Person against
the expenses, including attorneys' fees, actually and reasonably incurred by
him in connection therewith.
(b) Notwithstanding the foregoing, no Managing Person nor any
broker-dealer shall be indemnified, nor shall expenses be advanced on its
behalf, for any losses, liabilities or expenses arising from or out of an
alleged violation of federal or state securities laws, unless (i) there has
been a successful adjudication on the merits of each count involving alleged
securities law violations as to the particular indemnitee, or (ii) those
claims have been dismissed with prejudice on the merits by a court of
competent jurisdiction as to the particular indemnitee, or (iii) a court of
competent jurisdiction approves a settlement of the claims against the
particular indemnitee. In any claim for federal or state securities law
violations, the party seeking indemnification shall place before the court
the positions of the Securities and Exchange Commission, the Massachusetts
Securities Division and other state securities administrators to the extent
required by them with respect to the issue of indemnification for securities
law violations.
(c) The Company shall not incur the cost of that portion of any
insurance, other than public liability insurance, that insures any person
against any liability for which indemnification hereunder is prohibited.
3.7 GENERAL PROVISIONS. The following provisions apply to all rights of
indemnification and advances of expenses under this Agreement and all
liabilities described in this Article 3:
(a) Expenses, including attorneys' fees, incurred by a Managing
Person in defending any action, suit or proceeding may be paid by the Company
in advance of the final disposition of the action, suit or proceeding upon
receipt of an undertaking by the recipient to repay such amount if it shall
ultimately be determined that it is not entitled to be indemnified by the
Company under this Agreement or otherwise.
(b) Rights to indemnification and advances of expenses under this
Agreement are not exclusive of any other rights to indemnification or
advances to which a Managing Person may be entitled, both as to action in a
representative capacity or as to action in another capacity taken while
representing another.
(c) Each Managing Person shall be entitled to rely upon the opinion
or advice of or any statement or computation by any counsel, engineer,
accountant, investment banker or other person which he believes to be within
such person's professional or expert competence. In so doing, he will be
deemed to be acting in good faith and with the requisite degree of care
unless he has actual knowledge concerning the matter in question that would
cause such reliance to be unwarranted.
3.8 DEALINGS WITH COMPANY. With regard to all rights of the Company and
all actions to be taken on its behalf, the Company and not the Manager, nor
the Company's officers and agents, nor the Investor Interestholders shall be
the principal and the Company shall be entitled as such to the extent
permitted by law to enforce the same, collect damages and take all other
action. All agreements, obligations and actions of the Company shall be
executed or taken in the name of the Company, by an appropriate nominee, or
by the Manager as Manager but not in its individual capacity and every note,
bond, contract or other undertaking shall include a recitation limiting the
obligations represented thereby to the assets of the Company. Money may be
paid and property delivered to any duly authorized officer or agent of the
Company who may receipt therefor in the name of the Company and no person
dealing in good faith thereby shall be bound to see to the application of any
moneys so paid or property so delivered. No entity whose securities are held
by the Company shall be affected by notice of such fact or be bound to see to
the execution of the Company or to ascertain whether any transfer of its
securities by or to the Company or the Manager is authorized.
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3.9 NO INDEMNIFICATION OF PARTICIPATING INVESTOR INTERESTHOLDERS. The
Company shall not indemnify Investor Interestholders who elect to become
Participating Investor Interestholders pursuant to Section 11.6 for any
liability with respect to or in connection with any Special Obligation,
notwithstanding that liability for such may be asserted against such Investor
Interestholder at a time when he is not a Participating Investor
Interestholder.
ARTICLE 4
ALLOCATION OF PROFIT AND LOSS
4.1 INITIAL ALLOCATIONS WITH RESPECT TO CAPITAL CONTRIBUTIONS. All tax
items attributable to expenditures of Capital Contributions on Properties
shall be specially allocated as provided in Section 4.4 hereof. All net
income attributable to the temporary investment of the Capital Contributions
until and through the dates on which the Capital Contributions are applied to
the Company's business shall be specially allocated 100% to the Investor
Interestholders and 0% to the Manager.
4.2 ALLOCATION OF PROFITS AND LOSSES FROM OPERATIONS.
(a) First, Profits shall be allocated, PRO RATA, to the extent of
any negative balance in the Manager's or Investors' Adjusted Capital Accounts.
(b) After giving effect to the provisions of Sections 4.1, 4.4,
4.6, 4.7 and 7.4, and subject to the provisions of Section 4.2(c), Profits
and Losses for any fiscal period shall be allocated to the Investors
(including the Manager with respect to the Manager's Investment Interest) and
the Manager, respectively, in the same proportions as Cash Flow from
Operations for the corresponding period is distributed pursuant to Section
8.1(a) hereof.
(c) The Losses allocated under Section 4.2(b) shall not exceed the
maximum amount of Losses that can be so allocated without causing any
Investor Interestholder to have a negative amount in such Investor
Interestholder's Adjusted Capital Account at the end of any fiscal period.
All Losses in excess of the limitation of this Section 4.2(c) shall be
allocated to the Manager with respect to the Manager's Promoted Interest.
4.3 GENERAL ALLOCATION PROVISIONS.
(a) Except as otherwise provided in this Agreement, all items of
Company income, gain, expense, loss, deduction and credit for a particular
fiscal period and any other allocations not otherwise provided for shall be
divided among the Investors in the same proportions as they share Profits or
Losses, as the case may be for the fiscal period.
(b) The Interestholders shall be bound by the provisions of this
Agreement in reporting their shares of Company income and loss for income tax
purposes.
(c) The Company may use any permissible method under Code Section
706(d) and the Regulations thereunder to determine Profits, Losses and other
items on a daily, monthly or other basis for any fiscal period in which there
is a change in an Interestholder's interest in the Company.
(d) The definition of "Capital Account" and certain other
provisions of this Agreement are intended to comply with Regulations Sections
1.704-1(b) and 1.704-2 and shall be interpreted and applied in a manner
consistent with such Regulations. These Regulations contain additional rules
governing maintenance of Capital Accounts that may not have been provided for
in this Agreement because, in part, these rules may relate to transactions
that are not expected to occur and in some instances are prohibited by this
Agreement. If the Company after
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consultation with its regular accountants or tax counsel determines that it
is prudent to modify the manner in which the Capital Accounts, or any debits
or credits thereto, are computed in order to comply with such Regulation, or
to avoid the effects of unanticipated events that might otherwise cause this
Agreement not to comply with Regulations Sections 1.704-1(b) and 1.704-2, the
Company shall make such modification without the need of prior notice to or
consent of any Interestholder; provided, that such modification is not likely
to have a material effect on the amounts distributable to any Interestholder.
(e) Allocations under Sections 4.2(a) and 4.7 shall be made
independently for each well or Property in which the Company has an interest.
4.4 SPECIAL ALLOCATIONS.
(a) All expenses of the sale of Interests incurred by the Company
and paid pursuant to Sections 9.5, 9.6 and 9.7 hereof shall be allocated
94.76% to the Investors (including the Manager with respect to the Manager's
Investment Interest) and 5.24% to the Manager with respect to the Manager's
Promoted Interest in the year in which such expenses are incurred.
(b) All organizational expenses of the Company paid pursuant to
Section 9.4 hereof shall be allocated 94.76% to the Investors (including the
Manager with respect to the Manager's Investment Interest) and 5.24% to the
Manager with respect to the Manager's Promoted Interest in the year in which
such expenses are incurred.
(c) The management fee expense of the Company paid pursuant to
Section 9.2 hereof shall be allocated 100% to the Investors (including the
Manager with respect to the Manager's Investment Interest) and 0% to the
Manager with respect to the Manager's Promoted Interest in the year in which
such expenses are incurred.
(d) All intangible drilling and development expenses allocated to
the Company with respect to Initial Wells shall be allocated 100% to the
Investors (excluding the Manager with respect to the Manager's Investment
Interest) and 0% to the Manager with respect to the Manager's Promoted
Interest in the year such expenses are incurred.
(e) All costs and expenses incurred by the Company in connection
with the acquisition of Working Interests in Initial Wells shall be allocated
100% to the Investor Interestholders and 0% to the Manager with respect to
the Manager's Investment Interest and the Manager's Promoted Interest in the
year in which such expenses are incurred.
(f) All tangible drilling and development expenses allocated to the
Company with respect to Initial Wells shall be allocated to the Investor
Interestholders and the Manager, respectively, in such proportion as will
result in the total of all drilling and development expenses through such
date being allocated 94.76% to the Investors (including 4.76% to the Manager
with respect to the Manager's Investment Interest) and 5.24% to the Manager
with respect to the Manager's Promoted Interest in the year such expenses are
incurred.
(g) All costs of Company borrowings to pay amounts referred to in
Sections 4.4(a) through 4.4(g) hereof shall be allocated to the Manager and
the Investor Interestholders in the same proportion as the costs paid from
amounts disbursed from the proceeds of such borrowings are allocated.
4.5 AMONG INVESTOR INTERESTHOLDERS. Each Investor Interestholder shall
be allocated that percentage part of the aggregate amounts allocated to all
Investor Interestholders or to a subgroup of investors as such Investor
Interestholder's Capital Contribution bears to the aggregate Capital
Contributions of all Investor Interestholders or such subgroup.
4.6 MINIMUM ALLOCATION. Notwithstanding anything to the contrary in
this Agreement, in no event shall the Manager's allocable shares of each
material item of Company income, gain, expense, loss, deduction or credit be
less than 1% of such items.
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4.7 TAX ALLOCATION. Notwithstanding anything to the contrary in this
Agreement, to the extent that the Manager is treated for federal income tax
purposes as having received an interest in the Company as compensation for
services constituting income to the Manager under Code Section 61, any amount
allowed as a deduction for federal income tax purposes to the Company
(whether as an ordinary and necessary business expense or as a depreciation
or amortization deduction) as a result of such characterization shall be
allocated solely for federal income tax purposes to the Manager.
4.8 ALLOCATION OF PROFITS AND LOSSES FROM DISPOSITIONS. The Profits and
Losses from any sale, transfer, injury, destruction or other disposition of
Company Property or an interest therein, other than in the ordinary course of
business (including, without limitation, proceeds from insurance, refinancing
or condemnation) shall be allocated as follows:
(a) Profits or gain shall be allocated
(i) first, PRO RATA to each Interestholder to the extent of any
negative Capital Account balance;
(ii) second, PRO RATA to those Interestholders who were allocated
intangible drilling and development expenses in an amount equal
to the intangible drilling and development expenses actually
allocated less, PRO RATA, an amount of intangible drilling and
development expenses which would have been allocated to the
Manager with respect to the Manager's Investment Interest had all
intangible drilling and development expenses been allocated pro
rata among all Interestholders; and
(iii) then, 94.76% to the Interestholders (including 4.76% to
the Manager with respect to the Manager's Investment Interest)
and 5.24% to the Manager with respect to the Manager's Promoted
Interest.
(b) Losses shall be allocated PRO RATA to the Interestholders in
proportion to the Capital Account balances of the Interestholders until each
Investor Interestholder's and the Manager's Capital Account balance equals
zero and, thereafter, in accordance with the respective percentage
distributions of Cash Flow from Dispositions.
ARTICLE 5
CAPITAL CONTRIBUTIONS OF SHAREHOLDERS
5.1 CAPITAL CONTRIBUTIONS. The Capital Contributions of the Investor
Interestholders shall aggregate not less than $300,000, and shall be made by
the Investor Interestholders in exchange for Interests represented by $1,000
each (or for a fraction of an Interest represented by a proportionate price),
payable as set forth in Section 5.2.
5.2 PAYMENT OF CAPITAL CONTRIBUTIONS. The Capital Contributions of the
Investor Interestholders, made with respect to the initial offering of
Interests, shall be payable in cash upon subscription.
5.3 ASSESSMENTS; ADDITIONAL CAPITAL CONTRIBUTIONS. The Company may not
make any assessments on Interests. Further, the Company may not require that
the Investor Interestholders make any Capital Contributions in excess of the
Capital Contributions provided for under Section 5.1 hereof, for any purpose
whatsoever.
5.4 MANAGER'S CONTRIBUTION. The Manager's Contribution shall be an
amount equal to 5% of aggregate Capital Contributions made by the Investor
Interestholders and shall be made in cash by the Manager in exchange for
Manager's Investment Interest to be issued to the Manager in the same
proportion as Interests are issued to the Investor Interestholders hereunder.
The Manager in its capacity as Manager shall also make Capital Contributions
in accordance with Section 14.7.
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ARTICLE 6
CAPITAL ACCOUNTS
6.1 CAPITAL ACCOUNTS. A Capital Account shall be established and
maintained for each Interestholder and shall be adjusted as follows:
(a) The Capital Account of each Interestholder shall be increased by:
(1) The amount of such Interestholder's Capital Contribution to
the Company;
(2) The amount of Profits allocated to such Interestholder
pursuant to Articles 4, 7 and 9;
(3) The fair market value of property contributed by the
Interestholder to the Company (net of liabilities secured by the
contributed property that the Company under Code Section 752 is
considered to assume or take subject to);
(4) Any items in the nature of income or gain that are specially
allocated to such Interestholder pursuant to Sections 4.1, 4.4, 4.6,
4.7 and 7.4; and
(5) Such Interestholder's allocable share of Simulated Gains.
(b) The Capital Account of each Interestholder shall be decreased by:
(1) The amount of Losses allocated to such Interestholder
pursuant to Articles 4, 7 and 9;
(2) All amounts of money and the fair market value of property
paid or distributed to such Interestholder pursuant to the terms
hereof (other than payments made with respect to loans made by such
Interestholder to the Company), net of liabilities secured by that
property that the Interestholder under Code Section 752 is considered
to have assumed or taken subject to;
(3) Any items in the nature of expenses or losses that are
specially allocated to such Interestholder pursuant to Sections 4.1,
4.4, 4.6, 4.7 and 7.4; and
(4) Such Interestholder's allocable share of Simulated Loses and
Simulated Depletion Deductions.
6.2 CALCULATION OF CAPITAL ACCOUNT.
(a) Whenever it is necessary to determine the Capital Account of
any Interestholder, the Capital Account of such Interestholder shall be
determined in accordance with the rules of Regulation Sections
1.704-1(b)(2)(iv) and 1.704-2 (as amended from time to time).
(b) For purposes of computing the Interestholders' Capital
Accounts, any Simulated Depletion Deductions, Simulated Gains and Simulated
Losses shall be allocated among the Interestholders in the same proportions
as they (or their predecessors in interest) were allocated the bases of
Company Properties pursuant to Code Section 613A(c)(7)(D), the Regulations
thereunder and Regulations Section 1.704-1 (b)(4)(v). Pursuant to Code
Section 613A(c)(7)(D) and the Regulations thereunder and Regulations Section
1.704-1(b)(4)(v), the adjusted bases of all such properties shall be shared
by the Interestholders in the same proportions as provided in Article 4.
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6.3 EFFECT OF LOANS. Loans by any Interestholder to the Company shall
not be considered contributions to the capital of the Company.
6.4 WITHDRAWAL OF CAPITAL. A Interestholder shall not be entitled to
withdraw any part of his Capital Account or to receive any distribution from
the Company, except as specifically provided herein.
6.5 CAPITAL ACCOUNTS OF NEW INTERESTHOLDERS. Any person who shall
acquire Interests in accordance with the terms and conditions of Article 13
of this Agreement shall have the Capital Account of his transferor after
adjustments reflecting the transfer, if any, except as specifically provided
herein.
ARTICLE 7
INTEREST OF SHAREHOLDERS IN INCOME AND LOSSES
7.1 DETERMINATION OF INCOME AND LOSS. At the end of each Company fiscal
year, and at such other times as the Company shall deem necessary or
appropriate, each item of Company income, gain, expense, loss, deduction and
credit shall be determined for the period then ending and shall be allocated
to the Capital Account of each Interestholder in accordance with the
provisions hereof. With respect to the admission of Interestholders, the
Company will use the "interim closing date" method of accounting as permitted
by Regulations.
7.2 DETERMINATION OF INCOME AND LOSS IN THE EVENT OF TRANSFER. In the
event that an Interestholder transfers his interest in the Company in
accordance with the terms of this Agreement, the determination and allocation
described in Section 7.1 shall be made as of the date of such transfer and
thereafter all such allocations shall be made to the account of the
transferee of such interest; provided, however, that the Company may agree
that such determination and allocation shall be PRO RATA to the
Interestholders based upon the actual number of days in such fiscal year that
each such Interestholder held an interest in the Company. In the event of a
PRO RATA determination and allocation, the foregoing provisions of this
Section will not be applicable to the distributive shares, with respect to
the Interests transferred, of items of Company income, gain, expense, loss,
deduction and credit arising out of:
(a) the sale or other disposition of all or substantially all
Company Property, or
(b) other extraordinary nonrecurring items, all of which will be
allocated to the holder of such Company interest on the date such items of
Company income, gain, expense, loss, deduction and credit are earned or
incurred.
7.3 ALLOCATION OF NET INCOME AND NET LOSSES. All items of income, gain,
expense, loss, deduction and credit of the Company from operations and in the
ordinary course of business shall be allocated among the Interestholders in
accordance with Article 4.
7.4 QUALIFIED INCOME OFFSET AND OTHER ALLOCATION PROVISIONS.
(a) If there is a net decrease in "partnership minimum gain"
(within the meaning of Regulation Section 1.704-2(d)) during a fiscal period,
then there shall be allocated to each Interestholder items of income and gain
for such fiscal period (and, if necessary, subsequent fiscal periods) in
proportion to, and to the extent of, an amount equal to the portion of such
Interestholder's share of the net decrease in partnership minimum gain during
such fiscal period that is allocable to the disposition of Company Property
subject to one or more nonrecourse liabilities of the Company. However, such
allocation shall be reduced to the extent the Interestholder contributes
capital to the Company that is used to repay the nonrecourse liability and
the Interestholder's share of the net decrease in partnership minimum gain
resorts from the repayment. The foregoing is intended to be a "minimum gain
chargeback" provision as described in Regulation Section 1.704-2(f), and
shall be interpreted and applied in all respects in accordance with such
Regulation. If there is a net decrease in the minimum gain attributable to a
"partner nonrecourse debt" (as defined in Regulation Section 1.704-2(b) (4))
for a fiscal period, then, in addition to the amounts, if any, allocated
pursuant to the first sentence
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of this Subsection 7.4(a), there shall be allocated to each shareholder with
a share of such minimum gain attributable to a "partner nonrecourse debt"
items of income and gain for such fiscal period (and, if necessary,
subsequent fiscal periods) in proportion to, and to the extent of, an amount
equal to the portion of such Interestholder's share of the net decrease in
the minimum gain attributable to a partner nonrecourse debt during such
fiscal period that is allocable to the disposition of Company Property
subject to one or more nonrecourse liabilities of the Company. However, such
amount shall be reduced to the extent the Interestholder contributes capital
to the Company that is used to repay the nonrecourse liability and the
Interestholder's share of the net decrease in the minimum gain attributable
to a partner nonrecourse debt results from the repayment.
(b) If during any fiscal period of the Company an Interestholder
unexpectedly receives an adjustment, allocation or distribution described in
Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5) or (6), which causes or
increases a deficit balance in the Interestholder's Adjusted Capital Account,
there shall be allocated to the Interestholder items of income and gain
(consisting of a PRO RATA portion of each item of Company income, including
gross income, and gain for such period) in an amount and manner sufficient to
eliminate such deficit balance as quickly as possible. The foregoing is
intended to be a "qualified income offset" provision as described in
Regulation Section 1.704-1(b)(2)(ii)(d), and shall be interpreted and applied
in all respects in accordance with such Regulation.
(c) Notwithstanding anything to the contrary in Article 4 or this
Article 7, any item of deduction, loss or Code Section 705(a)(2)(B)
expenditure that is attributable to "partner nonrecourse debt" shall be
allocated in accordance with the manner in which the Interestholders bear the
economic risk of loss for such debt (determined in accordance with Regulation
Section 1.704-2(i).
(d) To the extent that any item of income, gain, loss or deduction
has been specially allocated pursuant to paragraph (a), (b) or (c) of this
Section 7.4 ("Required Allocations") and such allocation is inconsistent with
how the same amount otherwise would have been allocated under Section 4.2,
subsequent allocations under Section 4.2 shall be made, to the extent
possible, in a manner consistent with paragraphs (a), (b) and (c) of this
Section 7.4 which negates as rapidly as possible the effect of all previous
Required Allocations.
(e) Solely for Federal, state and local income and franchise tax
purposes and not for book or Capital Account purposes, income, gain, loss and
deduction with respect to property carried on the Company's books at a value
other than its tax basis shall be allocated (i) in the case of property
contributed in kind, in accordance with the requirements of Code Section
704(c) and such Regulations as may be promulgated thereunder from time to
time, and (ii) in the case of other property, in accordance with the
principles of Code Section 704(c) and the Regulations thereunder, in each
case, as incorporated among the requirements of the relevant provisions of
the Regulations under Code Section 704(b).
ARTICLE 8
INTEREST OF INTERESTHOLDERS IN CASH DISTRIBUTIONS
8.1 DISTRIBUTION OF NET CASH FLOW. Subject to the terms of this
Agreement, the Company shall make distributions of Net Cash Flow out of the
Company funds, to the extent and at such times as it deems advisable, in the
following manner:
(a) NET CASH FLOW. Net Cash Flow shall be computed and distributed
annually as follows:
(1) first, PRO RATA (in accordance with the percentage of total
loans that are owing to each Interestholder) to the payment to
Interestholders of interest and principal, in that order, on loans, if
any, made to the Company by such Interestholders;
(2) second, 5.24% to the Manager with respect to the Manager's
Promoted Interest and 94.76% to the Investors (including 4.76% to the
Manager with respect to the Manager's Investment Interest) until the
Investors (including the Manager with respect to the Manager's
Investment Interest) have received the return of their Capital
Contributions; and
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(2) lastly, after the Investors (including the Manager with
respect to the Manager's Investment Interest) have received the return
of their Capital Contributions, 30.24% to the Manager with respect to
the Manager's Promoted Interest and 69.76% to the Investors (including
4.76% to the Manager with respect to the Manager's Investment
Interest).
PROVIDED, however, that the Manager shall subordinate its right to receive
distributions of Net Cash Flow of (i) 100% of the Net Cash Flow from Operations
attributable to the Manager's Promoted Interest, plus (ii) UP TO 100% of the
Net Cash Flow from Operations attributable to the Manager's Investment Interest
if, after 60 months from the date of the first distribution of cash to
Investors, the Investors have not received distributions of Net Cash Flow which,
in the aggregate, are equal to 100% of the Investors' subscriptions. Any such
deferral of distributions of cash to the Manager will be recovered by the
Manager from first available Net Cash Flow after, and for so long as, the
Investors have received distributions of Net Cash Flow which, in the aggregate,
are equal to 100% of the Investors' Capital Contributions, until such deferrals
have been recovered.
(b) LIQUIDATION PROCEEDS. Upon Liquidation of the Company pursuant
to a dissolution under Section 14.1 or otherwise, the Net Cash Flow in respect
of such Liquidation shall be applied or distributed as follows:
(1) First, to the Company's creditors other than
Interestholders, to the extent of the Company's liabilities and
obligations to such creditors, including costs and expenses of
liquidation (or provision for payment shall be made, which provision
may include a distribution of assets subject to the obligations in
question);
(2) Second, PRO RATA (in accordance with the percentage of total
loans that are owing to each Interestholder) to the payment to
Interestholders of interest and principal, in that order, on loans, if
any, made to the Company by such Interestholders; and
(3) thereafter, PRO RATA to the Interestholders in proportion to
the Capital Account balances of the Interestholders as determined
after taking into account all adjustments to Capital Accounts for all
fiscal periods through and including the fiscal period in the
Liquidation occurs.
8.2 DISTRIBUTION IN KIND. If the Company elects to make distribution in
kind of any of the assets of the Company, it shall give notice of its
election to each Interestholder, specifying the nature and value of all such
assets to be distributed in kind, the deadline for giving notice of refusal
to accept a distribution in kind and to the extent advisable, the estimated
time necessary for the Company to liquidate assets if those assets are not
distributed and other information. A Interestholder may refuse to accept a
distribution in kind by giving written notice to the Company not later than
30 days after the effective date of the Company's notice of distribution. If
an Interestholder refuses distribution in kind, the Company shall retain in
the Company's name the portion of the assets which were to be distributed in
kind and which were to be allocated to the refusing Interestholder (the
"Retained Assets") and shall liquidate the Retained Assets in accordance with
this Agreement. Upon liquidation of the Retained Assets, the sum realized
shall be distributed to the Interestholder refusing distribution in kind in
full discharge of the Company's obligation to distribute the Retained Assets.
In determining the capital accounts of the Interestholders, a distribution
of assets in kind shall be considered a sale of the property distributed so
that any unrealized gain or loss with respect to such property shall be
deemed to have been realized and allocated among the Interestholders in
accordance with Article 4.
8.3 AMOUNTS WITHHELD. All amounts withheld pursuant to the Code or any
provision of any state or local tax law with respect to any payment or
distribution to the Company or the Interestholders shall be treated as
amounts distributed to the Interestholders pursuant to this Article 8 for all
purposes under this Agreement. The Company may allocate any such amounts
among the Interestholders in any manner that is in accordance with applicable
law.
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ARTICLE 9
OPERATION OF COMPANY
9.1 ADMINISTRATIVE COST ALLOWANCE. The Manager shall administer the
day-to-day business of the Company, including maintaining financial and other
records, complying with all regulatory and contractual obligations of the
Company, including for tax and other reporting, collecting and disbursing
funds, managing Company assets on a routine basis, maintaining Investor
Interestholder communications and records and other customary, necessary,
routine and/or recurring administrative tasks. In consideration thereof, for
each 12-month period beginning on the Escrow Date and ending upon the winding
up of the business affairs of the Company, the Company shall (i) accrue, and
(ii) pay out of Company revenues from the sale of production only, to the
Manager, an administrative cost allowance, payable in advance in equal
monthly installments, in an annual amount equal to 3.5% of the aggregate
Capital Contributions. The amount of the administrative cost allowance shall
be adjusted annually to reflect increases or decreases in the costs of
administration in accordance with the procedures and index published annually
by the Council of Petroleum Accountants Societies (COPAS). Such fee shall be
in lieu of any reimbursement to the Manager for the customary, routine and
necessary costs and expenses incurred by the Manager which are associated
with or attributable to the administration of the business of the Company
including, but not limited to, an allocable portion of telephone, postage,
computer service and an allocable portion of salaries and expenses of
employees and officers (other than controlling persons) of the Manager, but
shall not be in lieu of or include the direct expenses of the Company, such
as legal, accounting, engineering and consulting expenses, regulatory
reporting costs or for any other fees or expenses expressly provided for
herein. The administrative costs allowance shall begin to accrue on the
Escrow Date as to Capital Contributions in respect of Interests purchased
through that date and on each date thereafter on which the Company receives
and collects full payment for additional accepted subscriptions for Interests
as to Capital Contributions in respect of such Interests. The Company shall
not otherwise pay or reimburse the Manager for any expenses paid or incurred
in connection with the operation of the Company, including the Company's
allocable share of the Manager's overhead.
9.2 MANAGEMENT FEE. The Company shall pay the Manager out of Company
Property a management fee in an amount equal to 3.5% of aggregate Capital
Contributions. The management fee payable by Investor Interestholders whose
subscriptions for Interests are accepted by the Manager is for its services
in managing the operations of the Company in the year of such subscription.
The management fee shall be payable on the Escrow Date as to Capital
Contributions in respect of Interests purchased through that date and on each
date thereafter on which the Company receives and collects full payment for
additional accepted subscriptions for Interests.
9.3 ASSET DISPOSITION FEE.
(a) Upon each sale of the Company's interest in an Initial Well or
Additional Well, there shall be payable to the Manager out of the net
proceeds of such sale otherwise payable to the Company an asset disposition
fee equal to 3.5% of such net proceeds.
(b) In the event that the Manager is removed pursuant to Section
12.10 hereof other than for Cause, it shall be paid an asset disposition fee,
computed in accordance with Section 9.3(a) hereto, equivalent to the amount
that it would have been paid if all of the Company's property were sold on
the effective date of such removal for an amount equal to sixty (60) times
the average monthly revenues of the Company from sales of production of gas
during the last twelve months of Company operations prior to such date.
9.4 DIRECT COSTS. The Company shall pay out of Company Property all
Direct Costs at the time such costs are incurred. The Manager may pay such
Direct Costs from its funds and cause the Company to reimburse it as a matter
of administrative convenience. The Manager shall be under no obligation to
make its funds available to enable the Company to pay any Direct Costs. The
provisions of Section 3.5 shall apply to all Direct Costs paid to affiliates
of the Manager.
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9.5 SOLICITING DEALER COMMISSIONS. The Company may pay, out of Company
Property, cash selling commissions to the Soliciting Dealer who effects the
sale of each whole or fractional Interests in an amount of up to 8% of the
Capital Contribution of each such Investor Interestholder. Sales commissions
payable to a Soliciting Dealer shall be due and payable not earlier than
promptly after the latest to occur of (i) acceptance by the Company of the
Investor Interestholder's subscription, (ii) the Escrow Date or (iii) the
receipt by the Company of the gross purchase price for the Interests, with
respect to such sale.
9.6 DUE DILIGENCE ALLOWANCE. The Company may pay, out of Company
Property, a due diligence allowance, on a non-accountable basis, to the
Soliciting Dealer who effects the sale of each whole or fractional Interests
in an amount of up to 1% of the Capital Contribution of each such Investor
Interestholder. Such due diligence allowance payable to a Soliciting Dealer
shall be due and payable not earlier than promptly after the latest to occur
of (i) acceptance by the Company of the Investor Interestholder's
subscription, (ii) the Escrow Date or (iii) the receipt by the Company of the
gross purchase price for the Interests, with respect to such sale.
9.7 ORGANIZATION, OFFERING AND OTHER SELLING AND MARKETING EXPENSES. The
Company shall pay, out of Company Property, to the Manager an amount equal to
2.5% of the Capital Contributions with respect to each sale of any whole or
fractional Interest to an Investor Interestholder. Such amount shall be paid
by the Company in accordance with the provisions of this Section 9.7 on the
Escrow Date as to Capital Contributions in respect of Interests purchased
through that date and on each date thereafter on which the Company receives
and collects full payment for additional accepted subscriptions for Interests
as to Capital Contributions in respect of such Interests. In consideration
thereof, the Manager shall pay all expenses incurred by or on behalf of the
Company in respect of the organization of the Company, the offer and sale of
Interests, other selling and marketing expenses, including fees and expenses
of independent contractors and employees who are engaged in the marketing and
sales of Interests, legal, accounting, and consulting fees and distribution
and selling costs. The Manager shall indemnify and hold harmless the Company
for the payment of all such expenses, including expenses incurred by the
Company in excess of 2.5% of the Capital Contributions with respect to each
sale of any whole or fractional Interest to an Investor Interestholder.
9.8 PAYMENT AND RECOUPMENT OF FEES. As soon as funds have been released
to the Company from the escrow account referred to in Section 1.6, they may
be used to pay the fees referred to in Sections 9.2, 9.5, 9.6 and 9.7 then
due. If the Manager withdraws the offering of Interests without admitting
Investor Interestholders, any entity that has received payments from the
proceeds of the offering shall return such payments to the Company upon
demand by the Manager.
ARTICLE 10
ACCOUNTING
10.1 ELECTIONS. The Company shall elect the calendar year as its fiscal
year. The Company shall adopt the accrual method of accounting or such other
method of accounting as the Company shall determine. The Company shall not
elect to be taxed other than as a partnership. The Company shall not be
required to make an election under Section 754 of the Code or corresponding
state taxation laws.
10.2 BOOKS AND RECORDS. The Company books and records shall be kept at
the principal place of business of the Company. The Company's books and
records shall be maintained on the basis utilized in preparing the Company's
federal income tax return with such adjustments in accounting as are required
by this Agreement or as the Company determines would be in the best interests
of the Company.
10.3 REPORTS. The Trusts will keep each Investor Interestholder and
assignees complying with Article 13.3 currently advised as to activities of
the Company by reports furnished not less than quarterly. An independent
certified public accounting firm selected by the Company will prepare the
Company's federal income tax return as soon as practicable after the
conclusion of each year and each Interestholder will be furnished, at that
time, with the necessary
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accounting information for each Interestholder to take into account and
report separately such Interestholder's distributive share of the income and
deductions of the Company. The Company will use its reasonable best efforts
to obtain the information necessary for the accounting firm as soon as
practicable and to transmit the resulting accounting and tax information to
the Interestholders as soon as possible after receipt from the accounting
firm. The Company shall furnish each Interestholder as soon as practicable
after the conclusion of each year annual financial statements of the Company
which have been audited by the Company's independent certified public
accounting firm.
10.4 BANK ACCOUNTS. The Company shall maintain separate segregated
accounts in its name at one or more commercial banks, and the cash funds of
the Company shall be kept in such of those accounts as determined by the
Manager.
10.5 INTERIM ASSETS. The Company may purchase, to the extent the
Company's funds are not otherwise committed to transactions or required for
other purposes, any or all of the following:
(a) Obligations of banks or savings and loan associations that either
(i) have assets in excess of $5 billion or (ii) are insured in their
entirety by agencies of the United States government;
(b) Obligations of or guaranteed by the United States government or
its agencies;
(c) Repurchase obligations for securities described in clauses (a) or
(b) above, If possession of the subject securities is maintained by the
Company or its agent;
(d) Any debt obligation rated at the time of purchase in the highest
three grades by a nationally recognized securities rating organization; or
(e) Funds or financial instruments that are comprised of or backed by
substantially only those obligations described in clauses (a) through (d)
above.
ARTICLE 11
RIGHTS AND OBLIGATIONS OF INVESTOR INTERESTHOLDERS
11.1 PARTICIPATION IN MANAGEMENT. No Interestholder (other than the
Manager) shall have the right, power, authority or responsibility to
participate in the ordinary and routine management of the Company's affairs
or to bind the Company in any manner.
11.2 RIGHTS TO ENGAGE IN OTHER VENTURES. No Investor Interestholder or
any officer, director, shareholder or other person holding a legal or
beneficial interest in any Investor Interestholder shall, by virtue of his
ownership of a direct or indirect interest in the Company, be in any way
prohibited from or restricted in engaging in, or possessing an interest in,
any other business venture of a like or similar nature including any venture
involving the oil and gas industry.
11.3 LIMITATIONS ON TRANSFERABILITY. The interest of an Investor
Interestholder shall not be transferable under any circumstances except in
accordance with the conditions and procedures set forth in Article 13 hereof.
11.4 INFORMATION.
(a) Each Investor Interestholder's rights to obtain information
from the Company from time to time are set forth in this Section. In
addition to information provided under Section 10.3, each Investor
Interestholder shall be provided on request with the following:
(1) True and full information regarding the status of the
Company's business and financial condition;
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(2) Promptly after becoming available, a copy of the Company's
federal, state and local income tax returns or information returns for
the preceding year and prior years to the extent reasonably available;
(3) A current list of the name and last known business,
residence or mailing address of each Interestholder (unless such
Interestholder has specified that the Company is not to disclose such
information, in which case the Company, at the requesting Investor
Interestholder's cost, shall forward communications, sealed or
unsealed, from the requesting Investor Interestholder to such
Interestholder upon assertion by the Investor Interestholder in
writing to the Company of a proper purpose for the communication);
(4) A copy of the Articles and this Agreement and all amendments
thereto;
(5) True and full information regarding the amount of cash and a
description and statement of the agreed value of any other property or
services contributed by each Interestholder and which any
Interestholder has agreed to contribute in the future, and the date on
which each current Interestholder acquired his Interests: and
(6) Such other information regarding the Company's affairs as is
just and reasonable.
(b) The Company shall establish reasonable standards governing
without limitation the information and documents to be furnished and the time
and the location, if appropriate, of furnishing that information and
documents. Costs of providing information and documents shall be borne by the
requesting Investor Interestholder except for DE MINIMIS amounts consistent
with the Company's ordinary practices. The Company shall be entitled to
reimbursement for its direct, out-of-pocket expenses incurred in declining
unreasonable requests (in whole or in part) for information.
(c) The Company may keep confidential from Investor Interestholders
for such period of time as it deems reasonable any information that it
reasonably believes to be in the nature of trade secrets or other information
that the Manager in good faith believes would not be in the best interests of
the Company to disclose or that could damage the Company or its business or
that the Company is required by law or by agreement with a third party to
keep confidential.
(d) The Company may keep its records in other than written form if
capable of conversion into written form within a reasonable time.
(e) All demands or requests for information under this Section
shall be solely for a purpose reasonably related to the Investor
Interestholder's interest in the Company. All requests or demands for
information under this Section shall be in writing and shall state the
purpose of the demand; the Company's acceptance of oral requests shall not
waive or limit the scope of this provision. Any action to enforce rights
under this Section may be brought in the Michigan Court of Chancery, subject
to Section 15.4.
11.5 RESTRICTIONS UPON DISQUALIFYING FOREIGN INVESTOR INTERESTHOLDERS. If
the Company, upon advice of counsel, determines at any time that an Investor
Interestholder, because of the Investor Interestholder's nationality or the
nationality of any of an Investor Interestholder's equity owners, may cause the
Company to be disqualified as a holder of federal offshore oil and natural gas
leases or leases located on federal or state lands, the Company shall promptly
give the Investor Interestholder notice of such determination and of the
provisions of this Section 11.5 as applicable to the Investor Interestholder.
Effective upon the giving of such notice, the Investor Interestholder shall not
be entitled to vote on any Company matter and his Interests shall be disregarded
in any calculation of votes. If, upon advice of counsel, the Company determines
that, because of an Investor Interestholder's nationality or the nationality of
any of an Investor Interestholder's equity owners, a risk exists that any
federal offshore oil and natural gas lease or lease located on federal or state
lands, in which the Company has an interest, or the Company's interest therein,
may be
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canceled or forfeited or that the Company may be barred from acquiring
interests in federal or state oil and natural gas leases, or if any federal
or state agency having jurisdiction asserts that any such consequence may
result, the Company in its discretion may additionally give notice to the
Investor Interestholder to tender his Interests to the Company at the
principal offices of the Company at a time to be designated in the notice
(but not earlier than 72 hours after delivery of the notice). At the time
designated in the notice, the Company shall pay the Investor Interestholder
in cash or by check an amount equal to the price paid by the Investor
Interestholder for the Interests to be tendered less any distributions
received by such Investor Interestholder in respect of such Interests. If
the Investor Interestholder does not tender the Interests, the Company shall
mail, in the same manner as prescribed herein for notices, a check in the
same amount to the Investor Interestholder, together with a notice that the
Investor Interestholder's Interests have been canceled, and the Company shall
forthwith cancel the Investor Interestholder's Interests on the books and
records of the Company.
11.6 ELECTIONS BY INVESTOR INTERESTHOLDERS REGARDING SPECIAL
OBLIGATIONS. Each Investor Interestholder shall, at the time that he
subscribes for Interests pursuant to and in accordance with Section 1.6,
elect to:
(a) assume liability for Special Obligations with respect to all of
the Initial Wells and thereby become a Participating Investor Interestholder
with respect to each Initial Well; or
(b) decline to assume liability for Special Obligations for any
Initial Wells and thereby become an Investor Interestholder who is not a
Participating Investor Interestholder with respect to each Initial Well.
Such election shall be indicated on the Omnibus Signature Page of such
Investor Interestholder executed and delivered to the Company in respect of
his subscription for Interests and shall be binding upon such Investor
Interestholder until the earlier to occur of (i) one year following the
completion of the offering, or (ii) the Facilities Completion Date, at which
time such Interests shall be automatically converted from Participating
Investor Interestholder Interests to Non-Participating Investor
Interestholder Interests with respect to the Initial Wells and Additional
Development Wells; provided, however, that such Non-Participating Investor
Interestholders will remain liable for Special Obligations incurred by the
Company with respect to the Initial Wells and Additional Development Wells
while they were Participating Investor Interestholders. Such notice shall be
effective only upon actual receipt thereof by the Manager. The Manager shall
give each Investor Interestholder notice of the date upon which the
production commenced with respect to the last Initial Well to be completed.
The automatic termination by a Participating Investor Interestholder of
his assumption of Special Obligations with respect to all Initial Wells and
Additional Development Wells, and conversion to an Investor Interestholder
who is not a Participating Investor Interestholder with respect to such wells
shall not bar any action by the Company, including asserting claims against
such Investor Interestholder for contribution in respect of Special
Obligations incurred with respect to any such well during the time when such
Investor Interestholder was a Participating Investor Interestholder with
respect to such well, or entitle such Investor Interestholder to
indemnification by the Company in respect of claims asserted against such
Investor Interestholder by persons who or which are not affiliated with the
Company or the Manager on account of Special Obligations with respect to such
well incurred during the time when such Investor Interestholder was a
Participating Investor Interestholder with respect to such well.
ARTICLE 12
POWERS, DUTIES, LIMITATIONS AND OBLIGATIONS OF MANAGER
12.1 MANAGEMENT OF THE COMPANY. The Manager shall have full, exclusive
and complete discretion in the management and control of the Company. The
Manager agrees to manage and control the affairs of the Company to the best
of its ability and to conduct the operations contemplated under this
Agreement in a careful and prudent manner and in accordance with good
industry practice.
12.2 ACCEPTANCE OF SUBSCRIPTIONS. The Manager shall not cause the
Company to accept any subscription for Interests except as provided in
Article 1.
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12.3 SPECIFIC LIMITATIONS.
(a) The Manager shall not take any of the following actions without
the approval of all Investor Interestholders:
(1) Any act in contravention of this Agreement or the Articles;
(2) Any act that would make it impossible to carry on the
Company's ordinary business;
(3) Effecting a confession of judgment against the Company in an
amount exceeding 10% of the aggregate Capital Contributions;
(4) Causing the dissolution or termination of the Company before
the expiration of its Term, except as provided under Article 14;
(5) Possessing Company Property or assigning rights in specific
Company Property for other than a Company purpose; or
(6) Accepting a subscription that constitutes any other person
as a Manager, except as provided in Article 14.
(b) The Manager shall not sell, exchange, lease, mortgage, pledge or
transfer all or substantially all of the Company's assets if not in the ordinary
course of its business or amend this Agreement as specified in Section 15.8(b)
without the approval of a Majority of the Investor Interestholders.
(c) The Manager, the Company or the Company's agents shall not take
any action that is prohibited to the Manager by this or any other provision of
this Agreement and shall take all actions necessary or advisable to carry out
actions authorized by this Section.
12.4 SPECIFIC POWERS. In addition to the powers and duties otherwise
provided for in this Agreement, the Manager have the following powers and
duties:
(a) To direct or supervise the Company and the Company's agents in
the exercise of any action relating to the Company's affairs, including without
limitation the powers described in Section 1.8;
(b) To take the actions specified in Section 12.3 if the approvals
specified therein are obtained;
(c) To amend this Agreement as specified in Section 15.8(a);
(d) To lend money to the Company (without being obligated to do so)
if such loan bears interest at a reasonable rate not exceeding the amount that
would be charged to the Company by an unrelated lender on a comparable loan for
the same purpose (without reference to the financial abilities or guarantees of
the Manager). The Manager may not receive points or other financing charges or
fees regardless of the amount loaned to the Company. Before making any loans to
the Company, the Manager will attempt to obtain a loan from an unrelated lender
secured, if at all, only by Company Property;
(e) To approve or disapprove, in its sole discretion, any transfer of
Investor Interestholder Interests;
(f) To terminate the offering of Interests at any time prior to the
Termination Date, regardless of the amount of subscriptions, if subscriptions
for at least an aggregate of 300 Investor Interestholder Interests have been
accepted;
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(g) To withdraw the offering of Interests at any time prior to the
Escrow Date as provided in Section 1.6; or
(h) To waive any fees or compensation payable to it and to credit
such waived amount in its discretion against its obligation to contribute
capital under Section 14.7.
12.5 LIMITATION ON DUTY. Notwithstanding anything to the contrary
contained in this Article or elsewhere in this Agreement, the Manager shall have
no duty to take any affirmative action with respect to management of the Company
business or the Company Property which might require the expenditure of monies
by the Company unless the Company is then possessed of such monies available for
the proposed expenditure. Under no circumstances shall the Interestholders be
required to expend their own funds in connection with the day to day operation
of the Company business.
12.6 OFFICERS OF COMPANY; SIGNATORIES.
(a) The Manager may appoint a President, one or more Vice Presidents
as designated by it, a Secretary and such other officers and agents of the
Company as the Manager may from time to time consider appropriate, none of whom
need be Interestholders and any of whom may be affiliates of the Manager.
Except as otherwise prescribed by the Manager or in this Agreement, each officer
shall have the powers and duties usually appertaining to a similar officer of a
Michigan corporation under the direction of the Manager and shall hold office
during the pleasure of the Manager. Any two or more offices may be held by the
same person. Any officer may resign by delivering a written resignation to the
Manager and such resignation shall take effect upon delivery or as specified
therein.
(b) All conveyances of real property or any interest therein by the
Company may be made by the Manager alone as Manager of the Company, which may
execute on behalf of the Company any instruments necessary to effect the
conveyance. A certificate of the Secretary of the Company stating compliance
with this Section 12.6(b) shall be conclusive in favor of any person relying
thereon.
(c) All other documents, agreements, instruments and certificates
that are to be made, executed or endorsed on behalf of the Company shall be
made, executed or endorsed by such officers or persons as the Manager shall from
time to time authorize and such authority may be general or confined to specific
instances. In the absence of other provisions, the President is authorized to
execute any document, to take any action on behalf of the Company within this
Section 12.6(c), and to authorize other officers to execute confirmatory
documents or certificates.
12.7 PRESUMPTION OF POWER. The execution by the Manager or the officers
on behalf of the Company of leases, assignments conveyances, contracts or
agreements of any kind whatsoever shall be sufficient to bind the Company. No
person dealing with the Manager or the officers shall be required to determine
their authority to make or execute any undertaking on behalf of the Company, nor
to determine any fact or circumstances bearing upon the existence of their
authority nor to see to the application or distribution of revenues or proceeds
derived therefrom, unless and until such person has received written notice to
the contrary.
12.8 OBLIGATIONS NOT EXCLUSIVE. The Manager shall be required to devote
only such part of its time as is reasonably needed to manage the business of the
Company, it being understood that the Manager has and shall have other business
interests and therefore shall not be required to devote their time exclusively
to the Company. The Manager shall in no way be prohibited from or restricted in
engaging in, or possessing an interest in, any other business venture of a like
or similar nature including any venture engaged in oil and natural gas or
pipeline operations. Nothing in this Section 12.8 shall relieve the Manager of
its other fiduciary obligations to the Investor Interestholders, except as
limited in Article 3.
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12.9 MANAGER'S PROMOTED INTERESTS.
(a) The Manager shall be credited with a number of Manager's
Promoted Interests equal in the aggregate to an amount of Manager's Promoted
Interests which, when added to the number of Investor Interests outstanding
at any time (excluding Investor Interestholder Interests created under
Sections 12.9(b) or 12.10) is equal to 5.24% of the aggregate of all
Manager's Promoted Interests plus all Investor Interests outstanding at such
time; less the number of Investor Interestholder Interests created under
Sections 12.9(b) and 12.10. The Manager's Promoted Interests shall have no
voting rights (other than the rights held by the Manager as such) and shall
be deemed in the aggregate to have attached to them the rights held by the
Manager as such. Unless converted under Sections 12.9(b) or 12.10, no
Manager's Promoted Interest shall be held by or transferred to a person who
is not a Manager except as provided by Section 13.1.
(b) The Manager from time to time may convert all or any portion of
its Manager's Promoted Interests into Investor Interestholder Interests and
convey those converted Interests to other persons as compensation or for
other purposes. Each Management Interest shall be convertible into one
Investor Interestholder Interest. The Investor Interestholder Interests so
created shall have the rights and obligations of all other Investor
Interestholder Interests, except that the holders of the Investor
Interestholder Interests so created shall not share with other Investor
Interestholders in allocations of Profits, Losses, tax credits and all other
Items; instead, the holders of the Investor Interestholder Interests created
under this Section 12.9(b) shall share in allocations and distributions
accruing under this Agreement to the Manager in proportion to the numbers of
Interests owned by the Manager and those holders. Further, those holders
shall be allocated initially, as the balances of their Capital Accounts,
proportionate amounts of the Capital Account of the Manager who converted the
underlying Manager's Promoted Interests. The holders of Investor
Interestholder Interests created under this Section 12.9 shall have no voting
rights.
12.10 REMOVAL OF MANAGER. If, at any time, the holders of not less than
75% in interest of the Investor Interestholders Interests determine in their
discretion that the Manager is not fully performing its powers, duties and
obligations in the best interests of the Company, or it is otherwise in the
best interests of the Company to do so, such Investor Interestholders may
remove the Manager from such office and elect by at least a Majority in
interest such successor Manager as they shall determine. In the event of any
such removal or the resignation or other incapacity of the Manager as
enumerated in Section 14.1(c), the removed or former Manager's Manager's
Promoted Interests shall be automatically converted into a number of Investor
Interestholder Interests equal to the number of its Manager Interests, less
the number of Manager's Promoted Interests that the Manager may have
converted into Investor Interestholder Interests under Section 12.9(b). The
removed or former Manager, as holder of such Investor Interestholder
Interests, shall be entitled to the same allocations of income, gain,
expense, loss, deduction and credit and the same distributions to which the
Manager would otherwise have been entitled; provided, however, that the
removed or former Manager shall not then be entitled to uncollected amounts
specified in Section 9.1 to the extent not accrued before the date of
removal, resignation or other incapacity. A removed or former Manager will
be considered to be an Investor Interestholder, except with regard to
Articles 4 and 5 and Section 14.7.
12.11 INDEMNIFICATION OF SOLICITING DEALERS.
(a) The Soliciting Dealers shall not have any duty, responsibility
or obligation to the Company, the Manager or any Interestholder as a
consequence of its right to receive any selling commissions, except to the
extent provided under the Act. The Soliciting Dealers have not assumed, and
will not assume, any responsibility with respect to the Company nor will they
be permitted by the Company to assume any duties, responsibilities or
obligations regarding the management, operations or any of the business
affairs of the Company, subsequent to any offering of Interests.
(b) The Soliciting Dealers shall be indemnified and held harmless
by the Company against any losses, damages, liabilities or costs (including
attorneys' fees) arising from any threatened, pending or completed action,
suit, claim or proceeding by any Interestholder against the Soliciting
Dealers (except as may be limited by the Act or applicable state statutes,
including, but not limited to, the Massachusetts Securities Act and the
Tennessee Securities Act),
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based upon the assertion that the Soliciting Dealers have any continuing duty
or obligation, subsequent to any offering of Interests, to the Company or
Manager or any Interestholder or otherwise to monitor Company operations or
report to Investor Interestholders concerning Company operations.
ARTICLE 13
TRANSFERS OF SHARES
13.1 TRANSFER BY MANAGER. The Manager shall not sell, assign or otherwise
transfer its Manager's Promoted Interests without first obtaining the consent of
a Majority of the Investor Interestholders, except that (i) the Manager may
pledge its Manager's Promoted Interests for a loan to the Manager or its
affiliates provided that such pledge does not reduce the cash flow of the
Company distributable to other Interestholders; (ii) the Manager may waive or
assign compensation or fees payable to it, and (iii) the Manager may convert
Manager's Promoted Interests under Section 12.9(b) and convey the resulting
Investor Interestholder Interests to any person without consent.
13.2 TRANSFERS BY INVESTOR INTERESTHOLDERS. An Investor Interestholder
may not sell, exchange or transfer his Interests except as restricted by and
upon compliance with all applicable laws and all of the following provisions of
this Section 13.2:
(a) Interests may not be transferred to any person or entity if, as
determined by the Company, such assignment would have adverse regulatory
consequences to the Company or the Properties, including but not limited to, an
involuntary termination of the Company for federal income tax purposes, causing
the Company to be treated as an association for federal income tax purposes, or
would be deemed to be a transfer on a recognized public securities exchange or
the functional equivalent thereof which would have the effect of causing the
Company to be treated as a "publicly traded partnership" for federal income tax
purposes.
(b) Within 30 days after written notice of a proposed sale or
assignment is received by the Company, the Manager may request in its sole
discretion an opinion of counsel acceptable to the Manager that the proposed
transfer would not (i) cause an involuntary termination of the Company for
federal income tax purposes, (ii) cause the Company to be treated as an
association taxable as a corporation for federal income tax purposes, or
(iii) be deemed to be a transfer on a recognized public securities exchange
or the functional equivalent thereof which would have the effect of causing
the Company to be treated as a "publicly traded partnership" for federal
income tax purposes.
(c) THE WRITTEN APPROVAL OF THE MANAGER MUST BE OBTAINED, THE
GRANTING OR DENIAL OF WHICH SHALL BE WITHIN ITS SOLE AND ABSOLUTE DISCRETION,
WHICH MAY BE UNREASONABLY WITHHELD.
(d) The transferor and transferee must deliver a dated notice in
writing signed by each, confirming that (i) the transferee accepts and agrees
to comply with all the terms of this Agreement, and (ii) the transfer was
made in compliance with this Agreement and all applicable laws and
regulations.
(e) The transferor, transferee and the Company must execute all
other certificates, instruments and documents and take all such additional
action as the Manager may deem appropriate.
(f) The Manager may require as a condition to any transfer that may
create a future interest that an opinion of counsel acceptable to the Company
be delivered to the Company confirming that the proposed transfer does not
have adverse effects on the Company under the rule against perpetuities or
similar provisions of law.
Transfers shall be effective and recognized upon fulfillment of the
requirements of clauses (a) through (f) above and the transferee shall be an
Investor Interestholder owning Investor Interestholder Interests with the
same rights as appertained to the transferor. Any purported sale or transfer
consummated without first complying with this Section 13.2 shall be void.
COA-26
<PAGE>
13.3 ASSIGNMENTS BY OPERATION OF LAW. If any Investor Interestholder
shall die, with or without leaving a will, or become NON COMPOS MENTIS,
bankrupt or insolvent, or if a corporate, partnership or Company Investor
Interestholder dissolves during the Company term or if any other involuntary
transfer of an Investor Interestholder's Interests is made, the legal
representatives, heirs and legatees (and spouse, if the Interests have been
community property of such Investor Interestholder and his or her spouse),
bankruptcy assignees, successors, assigns and corporate, partnership or
Company distributees or such other involuntary transferees shall not become
transferees but shall have (subject to the other terms and provisions hereof)
such rights as are provided with respect to such persons under the law;
provided, however, that such legal representatives, heirs and legatees,
spouse, bankruptcy assignees, successors, assigns and corporate, partnership
or Company distributees or involuntary transferees may become transferees in
accordance with the provisions of Section 13.2.
13.4 EXPENSES OF TRANSFER. In the sole discretion of the Company, the
person acquiring Interests pursuant to any of the provisions of this Article
13 may be required to bear all costs and expenses necessary to effect a
transfer of such Interests including, without limitation, reasonable
attorney's fees incurred in preparing any required amendments to this
Agreement and the Articles to reflect such transfer or acquisition and the
cost of filing such amendments with the appropriate governmental officials.
13.5 SURVIVAL OF LIABILITIES. No sale or assignment of Interests shall
release the transferor from those liabilities to the Company which survive
such assignment or sale as a matter of law or that are imposed under Sections
3.2 and 3.3. A transferee Participating Investor Interestholder shall be
liable for Special Obligations incurred by the Company prior to transfer only
to the extent of the transferee's interest in the Company.
13.6 NO ACCOUNTING. No transfer of Interests, whether voluntary,
involuntary or by operation of law, shall entitle the transferor or
transferee to demand or obtain immediate valuation, accounting or payment of
the transferred Interests.
ARTICLE 14
DISSOLUTION, TERMINATION AND LIQUIDATION
14.1 DISSOLUTION. Unless the provisions of Section 14.2 are elected,
the Company shall be dissolved and its business shall be wound up upon the
decision of the Manager to withdraw the offering of Interests described in
the Prospectus in accordance with Section 12.4(g) or on the earliest to occur
of:
(a) December 31, 2035;
(b) The sale of all or substantially all of the Company Property:
(c) The death, removal, dissolution, resignation, insolvency,
bankruptcy or other legal incapacity of any Manager or any other event which
would legally disqualify any Manager from acting hereunder;
(d) The decision of all Investor Interestholders or the Manager and
a Majority of Investor Interestholders; or
(e) The occurrence of any other event which, by law, would require
the Company to be dissolved.
14.2 CONTINUATION OF THE COMPANY. Upon the occurrence of any event of
dissolution described in Sections 14.1 (a) through (e), inclusive, the
Company shall be dissolved and wound up unless the remaining Manager and a
Majority of the Investor Interestholders elect to continue the Company or, or
if there is no remaining Manager, within 90 days after the occurrence of any
such event, if a Majority of the Investor Interestholders shall elect, in
writing, that the Company shall be continued on the terms and conditions
herein contained and shall designate one or more persons
COA-27
<PAGE>
willing to be substituted as Manager. In the event all the Investor
Interestholders elect to continue the Company, it shall be continued with the
new Manager who shall succeed to and assume all of the powers, privileges and
obligations of the previous Manager hereunder except as specified in Section
12.10. In the event of a dissolution under this Section 14.2, the former
Manager shall have the rights specified in Section 12.10.
14.3 OBLIGATIONS ON DISSOLUTION. The dissolution of the Company shall
not release any of the parties hereto from their contractual obligations
under this Agreement.
14.4 LIQUIDATION PROCEDURE.
(a) A reasonable time shall be allowed for the orderly liquidation
of the assets of the Company and the discharge of liabilities to creditors so
as to enable the Company to minimize the losses normally attendant to a
liquidation.
(b) Upon dissolution of the Company for any reason, the
Interestholders shall continue to receive Net Cash Flow, subject to the other
provisions of this Agreement and to the provisions of subsection (c) hereof,
and shall share Profits and Losses for all tax and other purposes during the
period of liquidation. Distributions in liquidation of the Company shall
conform to the provisions of Section 8.1(b) hereof.
(c) The Manager shall act as liquidating Manager (or, in its
absence, a successor Manager shall act) and shall proceed to liquidate the
Company Properties to the extent that they have not already been reduced to
cash unless the Manager elects to make distributions in kind to the extent
and in the manner herein provided and such cash, if any, and property in
kind, shall be applied and distributed in accordance with Article 8.
14.5 LIQUIDATING MANAGER.
(a) If the dissolution of the Company is caused by circumstances
under which no Manager shall be acting as a Manager or if the Manager as
liquidating Manager is unable to or refuses to act, a Majority of the
Investor Interestholders shall appoint a liquidating Manager who shall
proceed to wind up the business affairs of the Company. The liquidating
Manager shall have no liability to the Company or to any Interestholder for
any loss suffered by the Company which arises out of any action or inaction
of the liquidating Manager if the liquidating Manager, in good faith,
determined that such course of conduct was in the best interests of the
Interestholder and such course of conduct did not constitute negligence or
misconduct of the liquidating Manager. The liquidating Manager shall be
indemnified by the Company against any losses, judgments, liabilities,
expenses and amounts paid in settlement of any claims sustained by it in
connection with the Company, provided that the same were not the result of
negligence or misconduct of the liquidating Manager.
(b) Notwithstanding the above, the liquidating Manager shall not be
indemnified and no expenses shall be advanced on its behalf for any losses,
liabilities or expenses arising from or out of an alleged violation of
federal or state securities laws, unless (1) there has been a successful
adjudication on the merits of each count involving alleged securities law
violations as to the particular indemnitee, or (2) such claims have been
dismissed with prejudice on the merits by a court of competent jurisdiction
as to the particular indemnitee, or (3) a court of competent jurisdiction
approves a settlement of the claims against a particular indemnitee.
(c) In any claim for indemnification for federal or state
securities law violations, the party seeking Indemnification shall place
before the court the position of the Securities and Exchange Commission and
the Massachusetts Securities Division (if applicable), the Tennessee
Securities Division (if applicable), or other applicable securities
administrators if required, with respect to the issue of indemnification for
securities law violations.
(d) The Company shall not incur the cost of that portion of any
insurance, other than public liability insurance, which insures any party
against any liability the indemnification of which is herein prohibited.
COA-28
<PAGE>
14.6 DEATH, INSANITY, DISSOLUTION OR INSOLVENCY OF AN INVESTOR
INTERESTHOLDER OR MANAGER. The death, insanity, dissolution, winding up,
insolvency, bankruptcy, receivership or other legal termination of an
Investor Interestholder who or which is not a Manager shall have no effect on
the life of the Company and the Company shall not be dissolved thereby.
14.7 MANAGER(S)'S ADDITIONAL CAPITAL CONTRIBUTIONS. Upon or prior to
the first distribution in liquidation, the Manager and each removed or former
Manager owning an interest under Section 12.10 shall contribute to the
capital of the Company an amount equal to any deficit in the Capital Account
of such existing or removed or former Manager calculated just prior to the
date of such distribution, to the extent not previously contributed. Each
Investor Interestholder owning Investor Interestholder Interests created
under Section 12.9 shall contribute at the same time to the capital of the
Company an amount equal to any deficit in that Investor Interestholder's
Capital Account calculated just prior to the date of such distribution to the
extent not previously contributed; if those Investor Interestholders do not
do so, the Manager which created those Investor Interestholder Interests
shall be responsible to contribute any remaining deficit.
14.8 WITHDRAWAL OF OFFERING. Dissolution of the Company resulting from
withdrawal of the offering of Interests is governed by Section 1.6(c) and
Section 12.4(g).
14.9 ARTICLES OF CANCELLATION. Upon the winding up of the Company and
its termination, the Manager or liquidating Manager, as the case may be,
shall cause the Articles to be canceled by filing a certificate of
cancellation with the Secretary of State of Michigan in accordance with the
provisions of Section 3810 of the Michigan Act.
ARTICLE 15
MISCELLANEOUS
15.1 NOTICES. Notices or instruments of any kind which may be or are
required to be given hereunder by any person to another shall be in writing
and deposited in the United States Mail, certified or registered, postage
prepaid, addressed to the respective person at the address appearing in the
records of the Company. Any Investor Interestholder may change his address
by giving notice in writing, stating his new address, to the Company. Any
notice shall be deemed to have been given effective as of 72 hours, excluding
Saturdays, Sundays and holidays, after the depositing of such notice in an
official United States Mail receptacle. Notice to the Company may be
addressed to its principal office.
15.2 MEETINGS OF INTERESTHOLDERS.
(a) MEETINGS. The Manager may call meetings of the Interestholders
or the Investor Interestholders concerning any matter on which they may vote
as provided by this Agreement or by law or to receive and act upon a report
of the Manager on matters pertaining to the Company's business and
activities. A Majority of the Investor Interestholders may also call
meetings by giving notice to the Company demanding a meeting and stating the
purposes therefor. After calling a meeting or within 20 days after receipt
of a written request or requests meeting the requirements of the preceding
sentence, the Company shall mail to all Interestholders written notice of the
place and purposes of the meeting, which shall be held on a date not less
than 7 days nor more than 21 days after the Company mails the notice of
meeting to the Interestholders. Any Investor Interestholder may appear and
vote or consent at a meeting by proxy, provided that such authority is
granted by a writing signed by the Investor Interestholders and delivered to
the Company at or prior to the meeting.
(b) CONSENTS. Any consent required by this Agreement or any vote or
action by the Interestholders or the Investor Interestholders may be effected
without a meeting by a consent or consents in writing signed by the persons
required to give such consent, to vote or to take action. The Manager may
solicit consents or a Majority of the Investor Interestholders may demand a
solicitation of consents by giving notice to the Manager stating the purpose
of the consent and including a form of consent. The Manager shall effect a
solicitation of consents by
COA-29
<PAGE>
giving the Interestholders or the Investor Interestholders, as the case may
be, a notice of solicitation stating the purpose of the consent, a form of
consent and the date on which the consents are to be tabulated, which shall
be not less than 7 days nor more than 21 days after the Company transmits the
notice of solicitation for consents. If a Majority of the Investor
Interestholders demand a solicitation, the Company shall transmit the notice
of solicitation not later than 20 days after receipt of the demand.
(c) GENERAL. To the extent not inconsistent with this Agreement,
Michigan law governing shareholders' meetings, proxies and consents for
corporations shall apply as to the procedure, validity and use of meetings,
proxies and consents. Any Interestholder may waive notice of or attendance
at any meeting or notice of the solicitation of any consent, whether before
or after any action is taken. The date on which the Company transmits the
notice of meeting or notice soliciting consents shall be the record date for
determining the right to vote or consent. A list of the names, addresses and
shareholdings of all Interestholders shall be maintained as part of the
Company's books and records.
15.3 LOAN TO COMPANY BY INTERESTHOLDER. If any Investor Interestholder
shall, in addition to his Capital Contribution to the Company, lend any
monies to the Company, the amount of any such loan shall not increase his
Capital Account nor shall it entitle him to any increase in his share of the
distributions of the Company, but the amount of any such loan shall be an
obligation on the part of the Company to such Interestholder and shall be
repaid to him on the terms and at the interest rate negotiated at the time of
the loan, and the loan shall be evidenced by a promissory note executed by
the Company, except that no Investor Interestholder shall be personally
obligated to repay the loan, such loan shall not be a Special Obligation, and
such loan shall be repayable and collectible only out of the assets of the
Company.
15.4 MICHIGAN LAWS GOVERN. This Agreement shall be governed and
construed in accordance with the laws of the State of Michigan, and venue for
any litigation between or against any of the parties hereto may be maintained
in Ingham County, Michigan; however, residents of Massachusetts may, at their
option, choose to maintain any such litigation in the Commonwealth of
Massachusetts.
15.5 POWER OF ATTORNEY. Each Investor Interestholder irrevocably
constitutes and appoints the Manager as his true and lawful attorney-in-fact
and agent to effectuate and to act in his name, place and stead, in
effectuating the purposes of the Company including the execution,
verification, acknowledgment, delivery, filing and recording of this
Agreement as well as all authorized amendments thereto and hereto, all
assumed name and doing business certificates, documents, bills of sale,
assignments and other instruments of conveyances, leases, contracts, loan
documents and counterparts thereof, and all other documents which may be
required to effect a continuation of the Company and which the Manager deems
necessary or reasonably appropriate, including documents required to be
executed in order to correct typographical errors in documents previously
executed by such Investor Interestholder and all conveyances and other
instruments or other certificates necessary or appropriate to effect an
authorized dissolution and liquidation of the Company. The power of attorney
granted herein shall be deemed to be coupled with an interest, shall be
irrevocable and shall survive the death, incompetency or legal disability of
an Investor Interestholder.
15.6 DISCLAIMER. In forming this Company, all Investor Interestholders
recognize that the oil and gas business is highly speculative and that the
Company makes no guaranty or representation to any Investor Interestholder as
to the probability of gain or loss from the conduct of Company business.
15.7 MANAGER RESIGNATION AND REPLACEMENT. The Manager may increase or
decrease the number of Managers so long as there is at least one Manager who
meets the requirements of Section 3807 of the Michigan Act. A Manager other
than the Manager may resign by delivering a written resignation to the
Manager not less than 60 days prior to the effective date of the resignation.
The Manager may remove a Manager at any time, provided that if there is no
incumbent, at least one new Manager is concurrently appointed. In the event
of the absence, death, resignation, removal, dissolution, insolvency,
bankruptcy or legal incapacity of a Manager other than the Manager or if an
additional Manager is to be appointed, the Manager shall appoint the Manager
in writing and shall subsequently give notice to the Investor
Interestholders, although such notice is not necessary to the validity of the
appointment. A Manager so appointed shall
COA-30
<PAGE>
qualify by filing his written acceptance at the Company's principal place of
business. If there are multiple Managers, each is vested with an undivided
interest in the Company estate and may exercise all powers vested in the
Manager as directed by the Manager. Upon the change of identity of any of
the Managers whose identity is required to be disclosed under Section 3810 of
the Michigan Act, as provided for in this Section 15.7, the Manager shall
cause an amendment to the Articles of Company to be filed with the Secretary
of State of Michigan in accordance with the provisions of Section 3810 of the
Michigan Act, indicating the change with respect to such Manager's identity.
15.8 AMENDMENT AND CONSTRUCTION OF AGREEMENT.
(a) This Agreement may be amended by the Manager, without notice to
or the approval of the Investor Interestholders, from time to time for the
following purposes: (1) to cure any ambiguity, formal defect or omission or
to correct or supplement any provision herein that may be inconsistent with
any other provision contained herein or in the Prospectus; (2) to make such
other changes or provisions in regard to matters or questions arising under
this Agreement that will not materially and adversely affect the interest of
any Investor Interestholder; (3) to otherwise equitably resolve issues
arising under the Prospectus or this Agreement so long as similarly situated
investors are not treated materially differently; (4) to maintain the federal
tax status of the Company and any of its Interestholders or to make changes
to Article 3 to maintain the status of each class of Interestholder with
regard to the passive activity rules of the Code (so long as no Investor
Interestholder's liability is materially increased without his consent) or as
provided in Section 4.3(d): and (5) to comply with law.
(b) Other amendments to this Agreement may be proposed by either
the Manager or a Majority in interest of the Investor Interestholders (as
determined by their Capital Contributions), in each case by calling a meeting
of Investor Interestholders or requesting consents under Section 15.2 and
specifying the text of the amendment and the reasons therefor. Such proposed
amendments shall be implemented only if approved by (i) the Manager and a
Majority in interest of the Investor Interestholders, or (ii) the holders of
75% of the Investor Interestholder Interests. No amendment under this
Section 15.8(b) that increases any Interestholder's liability, changes the
Capital Contributions required of him or his rights and interest in the
profits, losses, deductions, credits, revenues or distributions of the
Company in more than a DE MINIMIS manner, his rights on dissolution, or any
voting or management rights set forth in this Agreement shall become
effective as to that Interestholder without his written approval thereof.
(c) The Manager have power to construe this Agreement and to act
upon any such construction. Its construction of the same and any action
taken pursuant thereto by the Company or a Managing Person in good faith
shall be final and conclusive.
15.9 BONDS AND ACCOUNTING. The Managers and the Managing Persons shall
not be required to give bond or otherwise post security for the performance
of their duties and the Company waives all provisions of law requiring or
permitting the same. No person shall be entitled at any time to require the
Manager, the Company or any Interestholder to submit to a judicial or other
accounting or otherwise elect any judicial, administrative or executive
supervisory proceeding applicable to non-business Companies.
15.10 BINDING EFFECT. This Agreement shall be binding upon and shall
inure to the benefit of the Interestholders (and their spouses if the
Interests of such Interestholders shall be community property) as well as
their respective heirs, legal representatives, successors and assigns. This
Agreement constitutes the entire agreement among the Company, the Manager and
the Interestholders with respect to the formation and operation of the
Company, other than the Subscription Agreement entered into between the
Company and each Investor Interestholder.
15.11 HEADINGS. Headings of Articles and Sections used herein are for
descriptive purposes only and shall not control or alter the meaning of this
Agreement as set forth in the text.
15.12 TAX MATTERS PARTNER. The Manager or its designee shall be
designated the tax matters partner of the Company pursuant to Code Section
6221.
COA-31
<PAGE>
15.13 TITLE TO COMPANY PROPERTY. Title to all of the Company's property
shall be vested in the Company until this Agreement terminates pursuant to
Article 14 hereof, provided, that is the laws of any jurisdiction require
that title to any part of such property be vested in a Manager of the
Company, then title to that part of the Company's property shall be vested in
the Manager.
IN WITNESS WHEREOF, the undersigned have signed this Agreement as of the
date first above written.
WOLVERINE ENERGY, L.L.C.,
MANAGER
By:__________________________________
George H. Arbaugh, Jr., President
WOLVERINE ENERGY, L.L.C.
AS ATTORNEY-IN-FACT FOR THE
INVESTOR INTERESTHOLDERS
By:__________________________________
George H. Arbaugh, Jr., President
COA-32
<PAGE>
EXHIBIT A
INVESTOR INTERESTHOLDERS
Name
Address
Number of Interests
COA-33
<PAGE>
WOLVERINE ENERGY
1997-1998
DEVELOPMENT PROGRAM
PROSPECTUS
==============================================================================
TABLE OF CONTENTS
PAGE
Summary of Program 4
Summary of Tax Considerations 18
Risk Factors 20
Investor Interestholder Limited Liability and
Potential Liabilities of Participating
Investor Interestholders 29
Terms of the Offering 31
Plan of Distribution 37
Proposed Activities and Policies 39
Financing 51
Application of Proceeds 52
Participation in Costs and Revenues 53
Compensation and Reimbursement 57
Conflicts of Interest 60
Management 64
Prior Activities 67
Tax Aspects 78
Investment by Pension and
Other Retirements Plans 104
Competition, Markets and Regulation 106
Summary of Company Operating Agreement 110
Legal Opinions 113
Reports and Accounting 114
Additional Information 114
Availability of Documents 115
Glossary of Terms 115
Financial Statements of Manager F-1
Form of Company Operating Agreement COA-1
==============================================================================
UNTIL 90 DAYS FOLLOWING THE LATER OF (I) THE DATE OF THIS PROSPECTUS, OR (II)
THE DATE OF ANY APPLICABLE SUPPLEMENT THERETO, ALL DEALERS EFFECTING
TRANSACTION IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS, TOGETHER WITH THE
LATEST APPLICABLE SUPPLEMENT. THIS IS IN ADDITION TO THE OBLIGATION OF
DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT
TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
==============================================================================
<PAGE>
SUPPLEMENT NO. 1 TO THE PROSPECTUS OF THE
WOLVERINE ENERGY 1997-1998 DEVELOPMENT PROGRAM
DATED , 1997
WOLVERINE ENERGY 97-98 (A)
DEVELOPMENT COMPANY, L.L.C.
Wolverine Energy 97-98 (A) Development Company, L.L.C. (the "Company") is
hereby commencing the offer and sale of membership interests ("Interests") in
the Company pursuant to the terms and conditions described in the Prospectus
of the Wolverine Energy 1997-1998 Development Program (the "Program") dated
as of , 1997 (the "Prospectus"), as amended by this
Supplement No. 1 dated , 1997 ("Supplement No. 1"). All
capitalized terms used but not defined herein shall have the meanings
ascribed to such terms in the Prospectus and all of the material terms of the
offer and sale of Interests in the Company, the business in which it will
engage and the conditions under which it will operate are restated as of the
date of this Supplement as if the Company was the Company generically
described in the Prospectus, unless modified or otherwise provided or
described herein.
THE COMPANY
The Company will be formed upon the first closing of the sale of Interests
pursuant to this Supplement and the Prospectus pursuant to the terms
described in the Prospectus under the caption "Terms of the Offering." The
Company will not have significant assets or have engaged in any operations as
of that date. Upon the closing of the sale of Interests and the activation of
the Company, substantially all of its net proceeds remaining from the sale of
Interests after payment of organizational and offering costs, including the
Management Fee to the Manager, shall be used to acquire working interests in
the Properties described below and to pay certain fees and expenses to the
Manager and its affiliates, among others. See "Compensation and
Reimbursement" in the Prospectus for more information with respect to the
application of the proceeds of the sales of Interests by the Company.
TERMS OF OFFERING OF INTERESTS
The Interests will be offered and sold commencing on the date of this
Supplement pursuant to the terms of the offering of Interests by the Program
described under the caption "Terms of Offering" and "Plan of Distribution" in
the Prospectus.
PRIOR COMPANIES' OFFERING HISTORY
The Company is the first Company in the Program to offer and sell
Interests and, therefore, no information is available with respect to the
offer and sale of Interests in prior Companies in the Program.
PRIOR COMPANIES' OPERATING HISTORY
The Company is the first Company in the Program to offer and sell
Interests and, therefore, no information is available with respect to the
acquisition of Properties or operations of prior Companies in the Program.
PRIOR ACTIVITIES OF THE MANAGER AND AFFILIATES
No information with respect to the activities of the prior Antrim
Partnerships subsequent to that which is contained in the Prospectus is
available.
<PAGE>
TERMS OF THE OFFERING
The offering of Interests of the Company commenced on the date of this
Supplement No. 1. If at least $300,000 of Interests have been sold, the
Manager may, in its discretion, terminate this offering at any time
thereafter; provided, however, that not more than 15,000 Interests, in the
aggregate, may be sold in this offering pursuant to this Supplement No. 1.
If fewer than $300,000 of Interests have been sold, this offering shall
terminate 90 days following the date of this Supplement No. 1. In all
events, this offering shall terminate not later than December 31, 1998.
A-2
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13.
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
SEC registration fee . . . . . . . . . . . . . . . . . . . . . $ 5,172.41
NASD filing fee. . . . . . . . . . . . . . . . . . . . . . . . - 0 -
Accounting fees. . . . . . . . . . . . . . . . . . . . . . . . 15,000.00
Costs of printing and engraving. . . . . . . . . . . . . . . . 50,000.00
Resident agent's fees and expenses . . . . . . . . . . . . . . - 0 -
Engineering fees . . . . . . . . . . . . . . . . . . . . . . . - 0 -
Legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . 55,000.00
Registration fees. . . . . . . . . . . . . . . . . . . . . . . - 0 -
Taxes and fees, federal. . . . . . . . . . . . . . . . . . . . - 0 -
Taxes and fees, state. . . . . . . . . . . . . . . . . . . . . - 0 -
Transfer agent's fees. . . . . . . . . . . . . . . . . . . . . - 0 -
Miscellaneous. . . . . . . . . . . . . . . . . . . . . . . . . - 0 -
-----------
Total $125,172.41
===========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Sections 407 and 408 of the Michigan Limited Liability Company Act provides
that a Michigan limited liability company may indemnify and hold harmless any
person associated with the company and/or purchase and maintain insurance for
the same purpose subject to the restrictions contained therein.
Sections 3.5 through 3.7 of the Company Operating Agreement provide as
follows:
3.5 LIABILITY OF MANAGING PERSONS TO COMPANY AND
INTERESTHOLDERS. (a) THE MANAGING PERSONS SHALL HAVE NO LIABILITY TO
THE COMPANY OR TO ANY OTHER INTERESTHOLDER FOR ANY LOSS SUFFERED BY
THE COMPANY THAT ARISES OUT OF ANY ACTION OR INACTION OF THOSE
MANAGING PERSONS IF THOSE MANAGING PERSONS, IN GOOD FAITH, DETERMINED
THAT SUCH COURSE OF CONDUCT WAS IN THE COMPANY'S BEST INTEREST AND
SUCH COURSE OF CONDUCT WAS WITHIN THE SCOPE OF THIS AGREEMENT AND DID
NOT CONSTITUTE NEGLIGENCE OR MISCONDUCT OF THE MANAGING PERSONS
INVOLVED.
(b) NO ACT OF THE COMPANY SHALL BE AFFECTED OR INVALIDATED
BY THE FACT THAT A MANAGING PERSON MAY BE A PARTY TO OR HAS AN
INTEREST IN ANY CONTRACT OR TRANSACTION OF THE COMPANY IF THE INTEREST
OF THE MANAGING PERSON HAS BEEN DISCLOSED OR IS KNOWN TO THE
INTERESTHOLDERS.
(c) TO THE FULLEST EXTENT PERMITTED BY LAW AND
NOTWITHSTANDING ANY PROVISION OF THIS AGREEMENT, THE COMPANY SHALL NOT
BE LIABLE TO ANY INTERESTHOLDER NOR SHALL ANY MANAGING PERSON BE
CONSIDERED TO HAVE BREACHED ANY FIDUCIARY DUTY OF LOYALTY TO THE
COMPANY OR ANY INTERESTHOLDER AS THE RESULT OF ANY OF THE FOLLOWING:
(1) THE RETENTION OF A MANAGING PERSON AS A CONSULTANT,
AGENT OR ADVISER TO AN ENTERPRISE IN WHICH THE COMPANY HAS
AN INTEREST;
(2) THE OWNERSHIP BY A MANAGING PERSON OF DEBT, EQUITY
OR OTHER INTERESTS IN A VENTURE IN WHICH THE COMPANY OWNS OR
MAY IN THE FUTURE OWN AN INTEREST OR THE ORGANIZATION,
OPERATION OR ADVISING OF OR THE OWNERSHIP OF INTERESTS IN
ANY ENTITY THAT MAY PARTICIPATE IN SUCH VENTURE, WHETHER OR
NOT THE INTERESTS OF THE MANAGING PERSON ARE ON TERMS MORE
OR LESS FAVORABLE THAN THOSE AFFORDED THE COMPANY;
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(3) THE PARTICIPATION BY A MANAGING PERSON OR ANY
ENTITY ORGANIZED OR ADVISED BY IT IN A VENTURE IN LIEU OF
THE COMPANY'S PARTICIPATION OR INCREASING ITS PARTICIPATION
IN THE VENTURE, WHETHER OR NOT THE TERMS AFFORDED TO THE
MANAGING PERSON ARE MORE OR LESS FAVORABLE THAN THOSE
AFFORDED THE COMPANY;
(4) ANY TRANSACTIONS WITH MANAGING PERSONS OR ENTITIES
IN WHICH THEY HAVE AN INTEREST, WHETHER OR NOT THE TERMS OF
THOSE TRANSACTIONS ARE DETERMINED BY COSTS TO THE MANAGING
PERSONS OR ENTITIES, INDEPENDENT APPRAISALS OR COMPARABLE
THIRD PARTY TRANSACTIONS; OR
(5) ANY OTHER CONFLICT OF INTEREST OR CONFLICTING DUTY
DESCRIBED IN THE PROSPECTUS OR THIS AGREEMENT.
THIS SECTION 3.5(c) DOES NOT RELIEVE ANY MANAGING PERSON FROM ANY DUTY
TO EXERCISE APPROPRIATE BUSINESS JUDGMENT OR CARE (BUT WHICH SHALL NOT
BE ENHANCED BY ANY DUTY OF LOYALTY), WHICH DUTY OF JUDGMENT OR CARE
SHALL BE GOVERNED BY THE OTHER PROVISIONS OF THIS AGREEMENT, BUT THE
TAKING OF ANY ACTION DESCRIBED IN ANY PORTION OF THIS SECTION 3.5(c)
SHALL NOT IN AND OF ITSELF BE CONSIDERED FAILURE TO EXERCISE
APPROPRIATE JUDGMENT OR TO TAKE THE APPROPRIATE LEVEL OF CARE.
3.6 INDEMNIFICATION OF MANAGING PERSONS.
(a) EACH MANAGING PERSON SHALL BE INDEMNIFIED FROM THE
COMPANY PROPERTY AGAINST ANY LOSSES, LIABILITIES, JUDGMENTS, EXPENSES
AND AMOUNTS PAID IN SETTLEMENT OF ANY CLAIMS SUSTAINED BY HIM IN
CONNECTION WITH THE COMPANY OR CLAIMS BY THE COMPANY, IN RIGHT OF THE
COMPANY OR BY OR IN RIGHT OF ANY INTERESTHOLDERS, IF THE MANAGING
PERSON WOULD NOT BE LIABLE UNDER THE STANDARDS OF SECTION 3.5. THE
TERMINATION OF ANY ACTION, SUIT OR PROCEEDING BY JUDGMENT, ORDER OR
SETTLEMENT SHALL NOT, OF ITSELF, CREATE A PRESUMPTION THAT THE
MANAGING PERSON CHARGED DID NOT ACT IN GOOD FAITH AND IN A MANNER THAT
HE REASONABLY BELIEVED WAS IN THE COMPANY'S BEST INTERESTS. TO THE
EXTENT THAT ANY MANAGING PERSON IS SUCCESSFUL ON THE MERITS OR
OTHERWISE IN DEFENSE OF ANY ACTION, SUIT OR PROCEEDING OR IN DEFENSE
OF ANY CLAIM, ISSUE OR MATTER THEREIN, THE COMPANY SHALL INDEMNIFY
THAT MANAGING PERSON AGAINST THE EXPENSES, INCLUDING ATTORNEYS' FEES,
ACTUALLY AND REASONABLY INCURRED BY HIM IN CONNECTION THEREWITH.
(b) NOTWITHSTANDING THE FOREGOING, NO MANAGING PERSON NOR
ANY BROKER-DEALER SHALL BE INDEMNIFIED, NOR SHALL EXPENSES BE ADVANCED
ON ITS BEHALF, FOR ANY LOSSES, LIABILITIES OR EXPENSES ARISING FROM OR
OUT OF AN ALLEGED VIOLATION OF FEDERAL OR STATE SECURITIES LAWS,
UNLESS (i) THERE HAS BEEN A SUCCESSFUL ADJUDICATION ON THE MERITS OF
EACH COUNT INVOLVING ALLEGED SECURITIES LAW VIOLATIONS AS TO THE
PARTICULAR INDEMNITEE, OR (ii) THOSE CLAIMS HAVE BEEN DISMISSED WITH
PREJUDICE ON THE MERITS BY A COURT OF COMPETENT JURISDICTION AS TO THE
PARTICULAR INDEMNITEE, OR (iii) A COURT OF COMPETENT JURISDICTION
APPROVES A SETTLEMENT OF THE CLAIMS AGAINST THE PARTICULAR INDEMNITEE.
IN ANY CLAIM FOR FEDERAL OR STATE SECURITIES LAW VIOLATIONS, THE PARTY
SEEKING INDEMNIFICATION SHALL PLACE BEFORE THE COURT THE POSITIONS OF
THE SECURITIES AND EXCHANGE COMMISSION, THE MASSACHUSETTS SECURITIES
DIVISION AND OTHER STATE SECURITIES ADMINISTRATORS TO THE EXTENT
REQUIRED BY THEM WITH RESPECT TO THE ISSUE OF INDEMNIFICATION FOR
SECURITIES LAW VIOLATIONS.
(c) THE COMPANY SHALL NOT INCUR THE COST OF THAT PORTION OF
ANY INSURANCE, OTHER THAN PUBLIC LIABILITY INSURANCE, THAT INSURES ANY
PERSON AGAINST ANY LIABILITY FOR WHICH INDEMNIFICATION HEREUNDER IS
PROHIBITED.
3.7 GENERAL PROVISIONS. THE FOLLOWING PROVISIONS APPLY TO ALL
RIGHTS OF INDEMNIFICATION AND ADVANCES OF EXPENSES UNDER THIS
AGREEMENT AND ALL LIABILITIES DESCRIBED IN THIS ARTICLE 3:
(a) EXPENSES, INCLUDING ATTORNEYS' FEES, INCURRED BY A
MANAGING PERSON IN DEFENDING ANY ACTION, SUIT OR PROCEEDING MAY BE
PAID BY THE COMPANY IN ADVANCE OF THE FINAL DISPOSITION OF THE ACTION,
SUIT OR PROCEEDING UPON RECEIPT OF AN UNDERTAKING BY THE RECIPIENT TO
REPAY SUCH AMOUNT IF IT SHALL ULTIMATELY BE DETERMINED THAT IT IS NOT
ENTITLED TO BE INDEMNIFIED BY THE COMPANY UNDER THIS AGREEMENT OR
OTHERWISE.
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(b) RIGHTS TO INDEMNIFICATION AND ADVANCES OF EXPENSES
UNDER THIS AGREEMENT ARE NOT EXCLUSIVE OF ANY OTHER RIGHTS TO
INDEMNIFICATION OR ADVANCES TO WHICH A MANAGING PERSON MAY BE
ENTITLED, BOTH AS TO ACTION IN A REPRESENTATIVE CAPACITY OR AS TO
ACTION IN ANOTHER CAPACITY TAKEN WHILE REPRESENTING ANOTHER.
(c) EACH MANAGING PERSON SHALL BE ENTITLED TO RELY UPON THE
OPINION OR ADVICE OF OR ANY STATEMENT OR COMPUTATION BY ANY COUNSEL,
ENGINEER, ACCOUNTANT, INVESTMENT BANKER OR OTHER PERSON WHICH HE
BELIEVES TO BE WITHIN SUCH PERSON'S PROFESSIONAL OR EXPERT COMPETENCE.
IN SO DOING, HE WILL BE DEEMED TO BE ACTING IN GOOD FAITH AND WITH THE
REQUISITE DEGREE OF CARE UNLESS HE HAS ACTUAL KNOWLEDGE CONCERNING THE
MATTER IN QUESTION THAT WOULD CAUSE SUCH RELIANCE TO BE UNWARRANTED.
Notwithstanding the above, there is no indemnification for losses or
expenses arising out of an alleged violation of federal or state securities
laws unless there has been a dismissal with prejudice on the merits or a
successful adjudication on the merits of each count involving such a
violation and the court approves indemnification of litigation costs, or a
court approves a settlement and finds that indemnification of the settlement
and related costs should be made.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
None.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
1.1 Form of Soliciting Dealers Agreement*
3.1 Articles of Association of Wolverine Energy, L.L.C.++
3.2 By-Laws of Wolverine Energy, L.L.C.++
4.1 Form of Company Operating Agreement+++
5.1 Form of opinion of Michael D. Ewing, Esq.*
8.1 Form of opinion of Patzik, Frank & Samotny Ltd.*
10.1 Form of Escrow Deposit Agreement*
24.2 Consent of Michael D. Ewing, Esq.+
24.4 Consent of Patzik, Frank and Samotny Ltd*
25.1 Power of attorney of George H. Arbaugh, Jr (++, if necessary)
* Previously filed
+ Included in respective opinion
++ To be filed by amendment
+++ Included in Prospectus
(b) Financial statements:
None
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
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(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial BONA
FIDE offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
Subject to the terms and conditions of Section 15(d) of the Securities
Exchange Act of 1934, as amended, the undersigned registrant hereby
undertakes to file with the Commission such supplementary and periodic
information, documents and reports as may be prescribed by any rule or
regulation of the Commission heretofore or hereafter duly adopted pursuant to
the authority conferred in that Section.
The registrant undertakes to file an annual report of Form 10-K at the
conclusion of the fiscal year in which this registration statement is
declared effective.
The registrant undertakes to file a final Form SR indicating the actual
application of the proceeds from this offering.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, (the "Act"), may be permitted to directors, officers
and controlling persons of Wolverine Energy, L.L.C. (the "Manager"), pursuant
to the provisions described hereunder, or otherwise, the Manager has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other that the payment by the Manager of expenses
incurred or paid by a director, officer or controlling person of the Manager
in the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the Manager will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification
by it is against public policy as expressed in the Act and will be governed
by the final adjudication of such issue.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the registrant has duly caused this Amendment No. 1 to its Registration
Statement No. 33-95156 on Form SB-2 to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of East Lansing, State of
Michigan, on the 7th day of November, 1997.
WOLVERINE ENERGY 1997-1998 DEVELOPMENT PROGRAM
By: Wolverine Energy, L.L.C.
--------------------------
Manager
By: /s/ George H. Arbaugh, Jr.
--------------------------------------------
George H. Arbaugh, Jr., President and Chief
Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Signature Title Date
By: /s/ George H. Arbaugh, Jr. President, Chief Executive November 10, 1997
-------------------------- Officer, Chief Accounting
George H. Arbaugh, Jr. Officer and sole Director
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