<PAGE>
As filed with the Securities and Exchange Commission on September 3, 1998
Registration No. 33-95156
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------------------------
AMENDMENT NO. 5
to
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
------------------------------------------------
WOLVERINE ENERGY 1998-1999
DEVELOPMENT PROGRAM
<TABLE>
<S><C>
Wolverine Energy 1998-1999(A) Development Company, L.L.C., Wolverine Energy 1998-1999(B) Development Company, L.L.C.,
Wolverine Energy 1998-1999(C) Development Company, L.L.C., Wolverine Energy 1998-1999(D) Development Company, L.L.C.,
Wolverine Energy 1998-1999(E) Development Company, L.L.C., Wolverine Energy 1998-1999(F) Development Company, L.L.C.,
Wolverine Energy 1998-1999(G) Development Company, L.L.C., Wolverine Energy 1998-1999(H) Development Company, L.L.C.,
Wolverine Energy 1998-1999(I) Development Company, L.L.C., and Wolverine Energy 1998-1999(J) Development Company, L.L.C.
(Exact name of registrants as specified in their Articles of Organization)
Michigan 1311 To be applied for
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification Nos.)
incorporation or organization) Classification Code Number)
</TABLE>
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
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
CALCULATION OF REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
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) Previously paid.
------------------------------------
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 1998-1999
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 Outside front cover page of Prospectus
Statement 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 "Summary of Program," Summary of Tax
Factors and Ratio of Earnings Considerations," and "Risk Factors"
to Fixed 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 Not applicable
Dividends 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 Not applicable
and Analysis of Financial
Condition and Results of
Operations
ii
<PAGE>
(i) Changes in and Not applicable
Disagreements with
Accountants on Accounting
and Financial Disclosure
(j) Directors and Executive "Management"
Officers
(k) Executive Compensation "Management"
(l) Security Ownership of "Management"
Certain 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 "Management - Fiduciary Obligations and
Position on Indemnification for Indemnification" and "Summary of
Securities Act Liabilities Company Operating Agreement"
iii
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED AUGUST 13, 1998
PROSPECTUS
$15,000,000
WOLVERINE ENERGY 1998-1999
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 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 (i) the periodic Management
Fee payable by the Company to the Manager in consideration of the Manager's
activities in managing the day-to-day activities of the Company, and (ii)
payments from the Company to the Manager for working interests in natural gas
development projects and turnkey drilling and completion services pursuant to
the Turnkey Agreement, if any, to make the Manager's Contribution. After
payment of initial fees and expenses, approximately 91% 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
<PAGE>
- 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
- 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 by the Company and cause a corresponding reduction in 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
certain 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 (unless
the Manager determines, in its sole discretion, that it is unable from a
financial point of view 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 cash distributions of the Company for the twelve months preceding such
offer to repurchase. See "Terms of Offering - Repurchase of Interests."
2
<PAGE>
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, 1999, 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 deposited in an interest-bearing escrow account
at Franklin Bank, Southfield, 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 promptly. 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
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary of Program 9
The Company 9
Risk Factors 9
Proposed Activities 11
Election to Become Participating Investor Interestholder; Automatic
conversion to Non-Participating Investor Interestholder Status 13
Terms of the Offering 13
Plan of Distribution 14
Suitability Requirements 14
Cash Distributions 15
Financing 15
Application of Proceeds 15
Participation in Costs and Revenues 16
3
<PAGE>
Compensation and Reimbursement 20
Voting and Other Rights of Investor Interestholders 21
Fiduciary Obligation and Indemnification of Manager 22
Conflicts of Interest with Manager or Affiliates 23
Reports to Investor Interestholders 23
Principal Executive Offices 23
Summary of Tax Considerations 23
Company Status and Allocable Interests 24
Company Income, Gaines and Losses 24
Company Deductions 24
Liquidation and Termination of the Company 25
Redemption or Sale of Interests 25
Alternative Minimum Tax 25
Considerations for Tax-Exempt Investors 25
State and Local Income Taxes
Management's Discussion and Analysis of Financial Condition
and Results of Operations; Plan of Operations 26
Year Ended December 31, 1997 26
Results of Operations 26
Liquidity and Capital Resources 26
Working Interests Held for Sale and Capital expenditures 27
Environmental protection and remediation costs 27
Six months ended June 30, 1998 27
Results of operations 27
Liquidity and capital resources 27
Working interests held for
Sale and capital expenditures 27
Plan of Operations 27
Forward-looking Statements 28
Risk Factors 28
Particular Risks of This Offering 28
Risks Related to Gas Investments 34
Tax-Related Risks 36
Investor Interestholder Limited Liability and
Potential Liabilities of Participating
Investor Interestholders 37
Summary 37
Limited Liability 38
Potential Personal Liability For Special Obligations 38
Investor Protection 39
Terms of the Offering 39
General 39
Subscription Period 40
Suitability Standards 40
Subscription Procedures and Payments 43
No additional Assessments 44
Transfers of Interests 44
4
<PAGE>
Interest Repurchase Program 44
Plan of Distribution 46
Selling Arrangements; Commissions; Due diligence fees 46
Early Subscription Incentive 48
Indemnification 48
Sales Material 48
The Manager's Interests 49
Proposed Activities and Policies 49
Summary 49
Acquisition of Projects 50
Operating Policies 52
Turnkey Agreement 54
Prototype Operating Agreement 55
Insurance 57
Uncommitted Capital Funds of Other Entities 57
Ownership and Management of Projects 58
Sale of Production 58
Reinvestment of Revenues and Proceeds 59
Cash Distributions 59
Liquidation Policy 60
Financing 61
Application of Proceeds 63
Participation in Costs and Revenues 64
Description of Company Allocations 65
Allocations Among Investors Interestholders 67
Compensation and Reimbursement 69
Summary 69
Interest in Projects 70
5
<PAGE>
Organization and Offering Costs 70
Administrative Cost Allowance 71
Asset Disposition Fee 71
Direct Costs and Costs of Operation 71
Possible Turnkey Profit 72
Management Fee 72
Other Benefits 72
Conflicts of Interest 72
Activities of the Manager and its Affiliates 72
Management of Other Entities 74
Property Acquisitions and Dispositions 74
Management 76
Wolverine Energy, L.L.C. 76
The Prior Manager 77
Affiliated Companies 77
Executive Officers and Directors 77
Executive Compensation 78
Fiduciary Obligations and Indemnification 78
Prior Activities 80
Identification and Initial Capitalization of Prior Antrim Programs 80
Summary of Investor Tax Benefits and Cash Distribution Returns 80
Administrative Costs Incurred and As a Percentage of Gross Subscriptions 81
Direct Costs Incurred and As a Percentage of Gross Subscriptions 81
Sponsor Operating Results in Prior Programs Through 12/31/97 and
Investor Operating Results in Prior Programs Through 12/31/97 81
Policies of Manager and Prior Manager regarding cash distributions 83
Tax Aspects 85
Limitations 86
Classification as a Partnership 87
Company Taxation 88
Leasehold Acquisition Costs 89
Deduction of Intangible Drilling and Development Costs 89
Depletion 92
Depreciation 93
Farmout Agreement 93
Allocations 94
6
<PAGE>
Organization, Start-Up and Syndication Expenses 96
Distributions 97
Trade or Business Requirements 97
Alternative Minimum Tax 98
Termination of the Company 100
Activities Engaged In for Profit 100
Material Distortion of Income 101
Company Borrowings 101
Registration of Tax Shelters 102
Audits, Interest and Penalties 102
Sales of Company Property 103
Redemption or Sale of Interests 104
Company Elections 104
Basis and At Risk Rules:
Limitation of Deduction of Losses 104
7
<PAGE>
Passive Activities 106
Automatic Conversion of Interests 109
Foreign Investor Interestholders 110
Possible Changes in Tax Laws 110
State and Local Taxes, including Michigan 110
Need for Independent Advice 111
Conclusion 111
Investment by Pension and
Other Retirements Plans 111
Competition, Markets and Regulation 114
Summary 114
Competition and Markets 114
Regulation 115
Summary of Company Operating Agreement 117
Accounting 117
Governing law 118
Control of Company Operations 118
Indemnification 118
Temporary Investments 119
Amendments and Voting Rights 119
Automatic Conversion of
Participating Investor Interestholder 119
Removal of the Manager 120
Dissolution of Company 120
Transferability of Interests 120
The Manager's Capital Account 120
Legal Opinions 121
Reports and Accounting 121
Additional Information 121
General 121
Registration Statement 122
Litigation 122
Availability of Documents 122
Glossary of Terms 123
Financial Statements of Manager F-1
December 31, 1997 F-1
June 30, 1998 F-13
Form of Company Operating Agreement COA-1
</TABLE>
8
<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
persons who are qualified investors pursuant to federal and state securities
laws and the net worth and investment sophistication requirements of the Manager
described herein under "Terms of the Offering - Suitability Standards" 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, 1999.
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, i.e., that a well will be a dry hole,
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
9
<PAGE>
- - UNSPECIFIED PROJECTS; DEPENDANCE UPON MANAGEMENT - 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
- - 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 control the conduct and management of
all development, drilling and operating activities of each well in the
project
- - 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
10
<PAGE>
secure substitute management, among others
- - 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 substantially,
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 Prior Antrim Area, in other portions of the Antrim shale
formation in northern lower Michigan, southeastern lower Michigan, northeastern
Indiana and northwestern Ohio, and in other Devonian shale or similar
formations elsewhere in the continental United States. The Company will engage
chiefly in developmental drilling on projects intended to reach and exploit gas
reserves in Devonian shale formations. The Company will invest its net
investable assets to acquire working interests in natural gas development
projects in the Prior Antrim Area, other portions of the Antrim shale formation
and in other Devonian shale or similar formations in the continental United
States based upon the opinion of the Manager that 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
11
<PAGE>
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 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 may seek to acquire working interests in projects located
primarily in the same general location (e.g., the Prior Antrim Area) or in
multiple locations and will seek to develop and own
12
<PAGE>
natural gas reserves in the same type of geological formation. The Company will
seek to mitigate any concentration of investment in a particular location which
may result through diversification of 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.
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
The Company will be activated and commence investment when subscriptions
for at least the Minimum Amount of Interests for the 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 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 (which investments may include loans to an affiliate of the Manager)
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
13
<PAGE>
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, promptly. The offering of Interests will conclude not
later than December 31, 1999.
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 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 the 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, in its sole
discretion, 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 cash distributions of the Company 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, for a description of
the terms of such repurchase program and, particularly, a description of the
conditions to the obligation of the Manager to make such repurchases, "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 by the
Company and cause a corresponding reduction in 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.
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.
14
<PAGE>
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 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 91% 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
15
<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) (7,500) (125) (2.5%) 2.38%
----- --- ---- -----
Investor subscriptions available
for investment 273,000 4,550 91.0% 86.67%
Total capital available to pay
Turnkey Cost $273,000 $4,550 91.0% 86.67%
-------- ------ ----- ------
-------- ------ ----- ------
</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 by the Company and cause a corresponding
reduction in 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 2.5% 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
16
<PAGE>
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.
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 or,
if necessary, from net proceeds from the sale of Company property 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 Company property will be allocated as follows:
first, PRO RATA to the extent of any negative balance in the Manager's or
Investor Interestholders' Capital Accounts; second, 5.24% to the Manager with
respect to its Promoted Interest and 94.76% to the Investor Interestholders
(including the Manager with respect to the Manager's Investment Interest)
until each such Investor Interestholder's Capital Account equals his
unreturned Capital Contributions; third, to the Manager to the extent of any
deferred Net Cash Flow not distributed to the Manager, to the extent such
deferred amounts have not been recovered; fourth, to the Manager with respect
to its Promoted Interest, an amount equal to the difference between (A) the
quotient determined by dividing the excess of (x) the Capital Accounts of the
Interestholders (including the Manager's Capital Account computed only with
respect to its Investment Interest) over (y) the Net Capital Contributions
(such difference between (x) and (y) being the "Computed Capital Account") by
.6976 and (B) the Computed Capital Account; and then, 30.24% to the Manager
with respect to its Promoted Interest and 69.76%, PRO RATA, to the Investor
Interestholders (including the Manager with respect to the Manager's
Investment Interest). 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
Capital Account balances until each such Capital Account balance equals zero
and, thereafter, 69.76% to the Investor Interestholders (including 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 "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% N/A
* Organization and offering costs allowance (3) 0.00% 0.00% 100.00% N/A
* Management fee (3) 0.00% 0.00% 100.00% N/A
* Acquisition costs and expenses (4)(7)(8) 0.00% 0.00% 100.00% N/A
* Intangible drilling and
17
<PAGE>
development costs (5)(6) 0.00% 0.00% 100.00% N/A
* 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) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Additional development costs (5)(9) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Financing costs (5)(10) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Professional and other costs (5)(11) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Contingent compensation (16) 0.00% 0.00% 0.00%
REVENUES
* Net revenues from temporary
investments (14) 0.00% 0.00% 100.00% N/A
* 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
18
<PAGE>
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).
(16) Contingent compensation of up to 4.5% of Residual Operating Cash Flow
may be paid to Soliciting Dealers by the Company under specified
conditions; the amount shall be paid by the Company, but shall reduce
the amounts otherwise distributable to the Manager with respect to the
Manager's Promoted Interest. See "Plan of Distribution - Selling
Arrangements; Commissions; Due Diligence Fees - Contingent
Compensation."
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 royalty 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. This overriding royalty interest will entitle the Manager to
receive 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) prior to payment of all associated operating costs,
without being required to contribute capital to develop and operate wells on
such property. See "Proposed Activities and Policies" and "Compensation and
Reimbursement."
For further information with respect to Company allocations, see
"Participation in Costs and Revenues."
19
<PAGE>
COMPENSATION AND REIMBURSEMENT
The Manager will receive a one-time Management Fee equal to 2.5% 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 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 2.5% of aggregate Investor Interestholders' capital
contributions, net of PRO RATA returns of capital to Investor Interestholders
from sales of the Company's interests in projects determined according to the
proportion of the aggregate Investor Interestholders' capital contributions
invested in such projects, 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 2.5% of aggregate Investor Interestholders' capital contributions $7,500
ACQUISITION AND OPERATING STAGE
Administrative 2.5% of aggregate Investor Interestholders' capital contributions $7,500 per year
cost allowance per annum, net of PRO RATA returns of capital to Investor (1)(2)
Interestholders from sales of Company properties, 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
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
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
costs profit fees, printing and other costs and marketing expenses
Possible Difference, if any, between the Turnkey Cost and actual Indeterminate
turnkey profit development, drilling, completion and identified post-Completion
Facilities costs
Compensation Fair market value, on an accountable basis, for services to the Indeterminate
for 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
revenues Interest, after allocations of direct costs, operating costs, (3)
administrative costs allowance and all other expenses
Overriding 2% overriding royalty interest in the projects, provided, Indeterminate
royalty however, that the working interest, as a whole, exceeds 75% of
the entire net revenue interest of such property
LIQUIDATION STAGE
Asset 3.5% of gross proceeds of sales of Company property Indeterminate
disposition fee (4)
Interest in Percentage of proceeds of sales of Company assets in accordance Indeterminate
proceeds of with Manager's Promoted Interest from time to time (5.24% until (3)(5)
sales Payout, 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 and defer 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
21
<PAGE>
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 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
22
<PAGE>
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 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."
23
<PAGE>
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 be 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 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, to the extent allocated to
the Investor Interestholder, 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."
24
<PAGE>
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 at the lowest
long-term capital gain rates. Losses from the sale or redemption of Interests
will be subject to certain limitations in offsetting ordinary income. 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."
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.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS; PLAN OF OPERATIONS
This discussion should be read in conjunction with the financial
statements, accompanying notes and supplemental information.
YEAR ENDED DECEMBER 31, 1997
RESULTS OF OPERATIONS
Net income for 1997 was $452,656, compared with $328,206 in 1996. The
primary factor affecting the year-to-year 37.9% increase in net income was the
increase in turnkey revenue from $4,280,724 to $6,333,944, an increase of
$2,053,220, or 48.0%, which resulted in an increase in turnkey gross profits of
from $810,247 in 1996 to $1,151,339 in 1997, a difference of $341,092 or 42.1%.
Also contributing was the $112,285, or 44.8% increase in management fee revenue
from $250,547 to $362,832 and the increase in other income from $9,300 to
$149,124, a $139,824 increase.
The increased earnings of 1997 were primarily driven by the ability of
affiliated natural gas investment vehicles to raise more capital from investors
than in 1996. This increased fund-raising capability was, in turn, partially a
product of higher natural gas prices and an increase in worldwide natural gas
production. These strong results, as well as continuing efficiency improvements
throughout the organization, produced increased operating profits from turnkey
drilling contracts and management fees in 1997 over 1996.
Total capital raised by affiliated natural gas investment entities
increased from $4,935,487 in 1996 to $6,789,374 in 1997, an increase of
$1,853,887 or 37.6 percent. The natural gas investment programs organized by
The Manager have not begun to generate sufficient gas production to result in
meaningful levels of distributions of operating profits to have been made to the
Manager. Therefore, the Manager has not recognized a meaningful level of
operating profits from its interests in such programs, despite the higher level
of prices for natural gas which have prevailed over the last two years compared
with the prior years.
Total turnkey expenses and related costs increased 49.3 percent from
1996, while corresponding turnkey revenues increased 48.0 percent, causing a
decrease in turnkey profit margin from 18.9 percent to 18.2 percent. General
and administrative expenses for 1997 increased by 72.9 percent, reflecting
the higher level of capital raising activity at the affiliated natural gas
investment programs in 1997 over 1996 and the cumulative effect on the level
administrative expenses of the addition of new capital in 1997 to the capital
already under management at the end of 1996 without reduction for return of
capital to investors. Depreciation and amortization expense increased from
$2,745 to $22,061 compared with 1996. Interest expense increased $48,830 in
1997, from $29,071 to $77,901 (of which $18,645 was paid and $59,256 was
accrued for later payment), reflecting lower average borrowings outstanding
during 1996.
LIQUIDITY AND CAPITAL RESOURCES
In 1997, cash flow from operating activities amounted to $1,332,275,
compared with $1,067,013 in 1996. Total short- and long-term debt, including
amounts outstanding under the Manager's line of credit, trade payables, amounts
due to operators and related parties and other accounts payable, was $2,862,545
at year end 1997, compared with $1,178,319 at year-end 1996. Debt as a percent
of debt-plus-equity was 89.6 percent at December 31, 1997, up from 76.9 percent
at year-end 1996.
Working capital was $(1,049,598) at year-end 1997, compared with
$(242,305) at year-end 1996. At year-end 1997, the Managers's current ratio
was .64 to 1. Distributions paid in 1997 totaled $483,954, compared to
$0 in 1996. At December 31, 1997, bank lines of credit available were
$325,000, all of which were supported by commitment fees.
The Manager has a line of credit with Franklin Bank, Southfield, Michigan
in the current amount of $325,000.
26
<PAGE>
Further, a revolving credit line is being pursued with banking firms to provide
up to $2,500,000 in operating capital. The Manager has recently converted
approximately $375,000 in current obligations to five-year term debt, thereby
decreasing cash flow demands on the company.
WORKING INTERESTS HELD FOR SALE AND CAPITAL EXPENDITURES.
Inasmuch as the Manager engages in the raising of capital for investment
in natural gas development, it has not engaged directly in capital investment
in natural gas development or production activities, except with respect to
the portion of the capital invested in such activities which the Manager
provides from its own capital and for its own account. Insofar as the
Manager incurs contingent liability for turnkey development of natural gas
development projects if development costs exceed budgeted costs by more than
the anticipated turnkey profit to the Manager, it may be required to make a
capital investment in such project(s) in the amount of such excess, though
such investment is not anticipated. As such, the Manager has not made a
capital investment in any natural gas development project in excess of its
capital contribution as Manager of the affiliated investment vehicle, which
amount totaled $610,662 in 1997 and an aggregate of $1,035,109 as of the end
of 1997. The Manager has received distributions and accrued unrealized
losses with respect to these interests in the total amount of $90,699,
leaving a net recorded capital contribution of $944,410. The Manager
anticipates that it will make similar investments in affiliated natural gas
investment vehicles in 1998 and does not anticipate, nor has it provided for,
making any investment as a result of actual development expenses of such a
project exceeding budgeted costs by more than the anticipated turnkey profit
to the Manager.
The Manager does, however, utilize its capital to acquire working interests
for subsequent resale to affiliated investment vehicles. The amount of working
interests held for sale was $411,170 at December 31, 1996, and $1,458,167 at
December 31, 1997. These amounts consist of actual land costs and estimated
development, drilling and completion expenses for working interests in wells
held by the Manager and anticipated to be sold to one or more affiliated
investment vehicles pursuant to a turnkey drilling contract. The increase in
these amounts from 1996 to 1997 reflects increases in the Manager's level of
business activity and differences related to the timing of the sale of such
interests to affiliated investment vehicles. None of the working interests held
for sale by the Manager at December 31, 1997, will be available for purchase by
the Company.
It is anticipated that the Manager's 1998 internal capital expenditures
budget will be financed primarily by funds generated internally and through
borrowings under the Manager's line of credit. Amounts payable by the Manager
to make its scheduled capital contribution to affiliated natural gas investment
programs will likewise be financed internally by the Manager. The Manager
anticipates that it will make payments for natural gas project development costs
from turnkey payments from the affected affiliated natural gas investment
program. To the extent that such payments exceed anticipated amounts, the
Manager may finance them from internally generated capital or from borrowings
under its lines of credit. The planned expenditure level is subject to
adjustment as dictated by changing economic conditions and the success of the
affiliated natural gas investment vehicles in raising capital in 1998. The
Manager does not anticipate raising additional capital for its own account for
the next twelve months or for the foreseeable future beyond that time frame.
ENVIRONMENTAL PROTECTION AND REMEDIATION COSTS.
The Manager maintains insurance coverage for environmental pollution
resulting from the sudden or accidental release of pollutants. Various
deductibles per occurrence could apply, depending on the type of incident
involved. Coverage for other types of environmental obligations is not
generally provided, except when required by regulation or contract. The
financial statements do not reflect any significant recovery from claims under
prior or current insurance coverage. The Manager has not provided in its
accounts for any future costs of environmental pollution or environmental
remediation obligations. Such costs, if any, in excess of applicable insurance
coverage cannot be reasonable estimated at this time due to uncertainty of
timing, the magnitude of contamination, future technology for prevention and
remediation, regulatory changes and other factors. Although such future costs
could be significant, they are not expected to be material in relation to the
Manager's liquidity or financial position.
SIX MONTHS ENDED JUNE 30, 1998
RESULTS OF OPERATIONS
Net income for the first six months of 1998 was ($286,480), compared
with ($109,373) in the comparable period of 1997. These losses reflect the
seasonality of the Manager's business which sees a majority of profits earned
in the second half of the year, as investors' year-end tax motivated
investing occurs and turnkey drilling activity increases. The primary factor
affecting the year-to-year 161.9% increase in net loss for the comparable
six-month periods was the increase in turnkey costs from $793,558 to
$945,179, an increase of $151,621, or 19.1%, which resulted in a decrease in
turnkey gross profits from $247,939 in 1997 to $153,810 in 1998, a difference
of $94,129 or 38.0%. Also having an impact on profitability was the $164,519
or 39.9% increase in general and administrative expense from $412,580 to
$577,099 and the increase in other income from $0 to $73,783 for the
corresponding periods.
Management anticipates that its earnings for the full year 1998 will be
primarily driven by the ability of affiliated natural gas investment vehicles
to raise capital from investors. This activity is highly seasonal and,
therefore, as has customarily been the case, the overwhelming majority of
capital raised by such entities is likely to be realized in the second half
of 1998. The fund-raising capability of the Manager, in turn, will depend in
part upon the level of natural gas prices and production globally. Thus,
management does not believe that the level of earnings of the Manager through
the first six months of 1998 is indicative of the likely level of earnings
for the entire year. The natural gas investment programs organized by the
Manager have not begun to generate sufficient gas production to result in
meaningful levels of distributions of operating profits to have been made to
the Manager. Therefore, the Manager has not recognized a meaningful level of
operating profits from its interests in such programs which would contribute
to a more stable and predictable level of earnings.
Total turnkey expenses and related costs increased 19.1 percent for the
first half of 1998 as compared with the corresponding period in 1997, while
corresponding turnkey revenues increased 5.5 percent, causing a decrease in
turnkey profit margin from 23.8 percent to 2.2 percent. General and
administrative expenses for the six months ended June 30, 1998, increased by
39.9 percent, reflecting the higher level of expenses related to preparation
of a public offering by an affiliated natural gas investment program in the
first half of 1998 over the corresponding period in 1997 and the cumulative
effect on the level of administrative expenses of the addition of new capital
in 1998 to the capital already under management at the end of 1997 without
reduction for return of capital to investors.
LIQUIDITY AND CAPITAL RESOURCES
In the first half of 1998, cash flow from operating activities amounted
to $48,448, compared with $631,089 for the equivalent period in 1997. Total
short-and long-term debt, including amounts outstanding under the Manager's
line of credit, trade payables, amount due to operators and related parties
and other accounts payable, was $2,901,285 at June 30, 1998, compared with
$1,283,393 at June 30, 1998. Debt as a percent of debt-plus-equity was 79.9
percent at June 30, 1998, down from 84.5 percent at year-end 1996.
Working capital was $(950,367) at June 30, 1998, compared with
$(730,893) at the corresponding point in 1997. At June 30, 1998, the
Managers's current ratio was .67 to 1. At June 30, 1998, the Manager had
long-term debt, including the current portion, of $746,924, of which $53,251
was due within one year, compared with no long-term debt at June 30, 1997.
The Manager has a line of credit with Franklin Bank, Southfield,
Michigan in the current amount of $325,000; at June 30, 1998, that line of
credit was fully drawn and no further borrowings were available to the
Manager thereunder. Currently, a revolving credit line is being pursued with
banking firms to provide up to $2,500,000 in operating capital.
WORKING INTERESTS HELD FOR SALE AND CAPITAL EXPENDITURES
Inasmuch as the Manager engages in the raising of capital for investment
in natural gas development, it has not engaged directly in capital investment
in natural gas development or production activities, except with respect to
the portion of the capital invested in such activities which the Manager
provides from its own capital and for its own account. Insofar as the
Manager incurs contingent liability for turnkey development of natural gas
development projects if development costs exceed budgeted costs by more than
the anticipated turnkey profit to the Manager, it may be required to make a
capital investment in such project(s) in the amount of such excess, though
such investment is not anticipated. As such, the Manager has not made a
capital investment in any natural gas development project in excess of its
capital contribution as Manager of the affiliated investment vehicle, which
amount totaled $61,225 in the first half of 1998 and an aggregate of
$1,096,334 as of June 30, 1998. The Manager has received distributions and
accrued unrealized losses with respect to these interests in the total amount
of $90,699, leaving a net recorded capital contribution of $1,005,635. The
Manager anticipates that it will make similar investments in affiliated
natural gas investment vehicles in 1998 as it did in 1997 and does not
anticipate, nor has it provided for, making any investment as a result of
actual development expenses of such a project exceeding budgeted costs by
more than the anticipated turnkey profit to the Manager.
The Manager does, however, utilize its capital to acquire working
interests for subsequent resale to affiliated investment vehicles. The
amount of working interests held for sale was $998,697 at June 30, 1998, and
$76,000 at June 30, 1997. These amounts consist of actual land costs and
estimated development, drilling and completion expenses for working interests
in wells held by the Manager and anticipated to be sold to one or more
affiliated investment vehicles pursuant to a turnkey drilling contract. The
increase in these amounts from June 30, 1997, to June 30, 1998, reflects
increases in the Manager's level of business activity and differences related
to the timing of the sale of such interests to affiliated investment
vehicles. The Manager does not anticipate that any of the working interests
held for sale by the Manager at June 30, 1998, 1997, will be available for
purchase by the Company.
It is anticipated that the balance of the Manager's 1998 internal
capital expenditures budget will be financed primarily by funds generated
internally and through borrowings under the Manager's line of credit.
Amounts payable by the Manager to make its scheduled capital contribution to
affiliated natural gas investment programs will likewise be financed
internally by the Manager. The Manager anticipates that it will make
payments for natural gas project development costs from turnkey payments from
the affected affiliated natural gas investment program. To the extent that
such payments exceed anticipated amounts, the Manager may finance them from
internally generated capital or from borrowings under its line of credit.
The planned expenditure level is subject to adjustment as dictated by
changing economic conditions and the success of the affiliated natural gas
investment vehicles in raising capital in the second half of 1998. The
Manager does not anticipate raising additional capital for its own account
for the next twelve months or for the foreseeable future beyond that time
frame.
PLAN OF OPERATIONS
The plan of operations of the Manager for calendar year 1998 provides for
an increase in revenue and profitability of the Manager over prior years. The
following is a summary of that plan of operations.
The Manager anticipates that it will raise a minimum of $10,000,000 and
most likely not more than $15,000,000 of investor capital in 1998. Management
believes that it should finish 1998 at the upper end of this projected range.
The Manager expects to continue to operate as it has to date with respect to the
non-public natural gas development programs it has sponsored, i. e., by applying
capital raised by a program to the purchase of working
27
<PAGE>
interests from the Manager on a turnkey basis. Such activities will generate
turnkey revenue and administration fees which, when combined with revenue from
prior programs, should allow the Manager to operate profitably without raising
additional capital. It is management's plan to use a portion of the Manager's
profits to reduce its obligations.
The Manager holds mineral leases in the Antrim shale in Michigan which
entitle it to develop and drill natural gas wells, which the Manager has
developed with internally generated funds to prepare it for drilling. Such
acreage is not currently available for development, pending additional
development activities and the commencement of negotiations with drillers and
operators to develop, drill and operate wells on such property. The Manager's
business plan includes the following options for the acreage:
1. Develop the acreage with internally generated capital and sell the
wells to Manager-sponsored natural gas development programs, which may
in the future include the Program.
2. Co-develop the acreage with a third party.
Management is currently exploring each of these options and anticipates
exercising one of them in 1998. Each of these options, if chosen and
successfully executed, will provide operating capital to the Manager in 1998.
The Manager has purchased investment interests of between 5% and 12 1/2% of
the programs which it has sponsored. Over the past three years, the Manager has
purchased interest in five (5) programs totaling $1,035,109. Management
anticipates that it will receive cash distributions from these investments in
1998. Distributions will increase in future years as the wells are completed
for the 1997 programs, and those programs start distributing cash.
FORWARD-LOOKING STATEMENTS
Statements in this prospectus that are not historical facts, including
statements in Management's Discussion and Analysis under the heading "Plan of
Operations" and other statements about industry and company growth, estimates of
expenditures and savings, and other trend projections are forward looking
statements. These statements are based on current expectations and involve risk
and uncertainties. Actual future results or trends may differ materially
depending on a variety of factors. These include specific factors identified in
the discussion accompanying such forward looking statements, industry product
supply and pricing, political stability and economic growth in relevant areas of
the world, the Manager's successful execution of its internal performance plans,
successful partnering, actions of competitors, natural disasters, and other
changes to business conditions.
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
28
<PAGE>
acquiring Interests. The Manager will, therefore, select projects in which the
Company will acquire a working interest only following the completion of the
offering of Interests in the Company and persons subscribing for Interests will
not be permitted to withdraw their subscriptions as a result of the selection of
any such projects and will not receive information respecting the identity of
any such project prior to the completion of the offering of Interests in the
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
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.
29
<PAGE>
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 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 PRIOR ANTRIM 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
caused the cost of acquiring drilling and development rights to projects in the
Prior Antrim Area to increase and may be expected to continue to do so in the
future. Further, the dramatic increase in gas production volumes in the Prior
Antrim Area 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." These prior
programs have realized annual after-tax returns on investment for investors
ranging from 8.6% to 35.5%. 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
30
<PAGE>
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 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 prevent the Company from being treated as "publicly traded" 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
31
<PAGE>
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 (unless
the Manager determines, in its sole discretion, that it is unable from a
financial point of view 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 "TERMS OF THE OFFERING - REPURCHASE PROGRAM" AND "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
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
32
<PAGE>
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.
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 Interestholder, his/her PRO
RATA share of Special Obligations, if any (and, thereafter for any Special
Obligations incurred when he/she was a Participating Investor Interestholder).
However, if an Investor Interestholder (whether Participating or Non-
33
<PAGE>
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."
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. However, despite the
careful and thorough examination of all available data prior to the
commencement of drilling activities, there remains a not insubstantial risk
that any well will not produce commercial quantities of natural gas or
natural gas liquids (i.e., that it will be a "dry hole"), that the operator
(with or without the consent of the Manager) will elect not to conduct
completion activities on such well or otherwise seek to bring it into
production and that the investment by the Company in a working interest such
well will, therefore, be lost.
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
34
<PAGE>
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
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."
35
<PAGE>
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 expect 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.
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. The Manager has advised Special Tax Counsel that none of the Prior
Programs have been audited by the Service and that, therefore, none of the
possible adverse tax consequences described below or elsewhere herein have
befallen any of the Prior Programs. 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. Special Tax Counsel cannot
opine as to factual matters which determine the deductibility of individual
intangible drilling and development costs, but will opine that such expenses, if
as a matter of fact they are deductible items, will more likely than not be
deductible by the Investor Interestholders, and that the allocation of such
items in the Company Operating Agreement will more likely than not be respected
by the Service. Based on certain assumptions and other matters, Special Tax
Counsel is of the opinion that the allocation of income,
36
<PAGE>
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 partnership 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, 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 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 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
37
<PAGE>
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 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 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
38
<PAGE>
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 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 1998 and 1999 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.
39
<PAGE>
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 promptly. 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.
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 primary object of the Manager in limiting the
duration of the offering period and the number of Interests sold will be to
minimize the period during which subscription payments are held in cash prior to
investment in working interests. Therefore, the Manager anticipates that the
maximum offering period will be 180 days and the maximum number of Interests
sold will be $5,000,000. The subscription period for Interests in the last
Company will expire no later than on December 31, 1999.
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
40
<PAGE>
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.
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.
41
<PAGE>
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 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
42
<PAGE>
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 Signature Page; and
(b) a check payable to "Franklin Bank, Escrow Agent - Wolverine
1998-1999" 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 Franklin Bank, Southfield, 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 and such funds
will be transferred from the escrow account to the Company's operating account.
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 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, or may be advanced
to a single-purpose finance affiliate of the Manager (a "Finance Subsidiary")
which will utilize such funds solely to fund acquisitions of rights to acquire
working interests in natural gas development projects, some or all of which may
be subsequently acquired by the Company. Any funds so advanced to a Finance
Subsidiary will (i) bear interest at a rate equivalent to that which would
obtain between arm's length parties under similar circumstances, and (ii) be
fully secured by first liens on rights to acquire working interests in natural
gas development projects. 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 the
Company will not be commingled with any other funds, including other funds
invested in a Finance Subsidiary.
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
43
<PAGE>
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 promptly.
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).
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")
44
<PAGE>
- Interestholders may, at their election, sell Interests to the Manager
for not less than 36 times the PRO RATA average monthly cash
distributions of the Company for the 12 months preceding such purchase
- The Manager is obligated (unless the Manager determines, in its sole
discretion, that it is unable from a financial point of view to do so
at the time) 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
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, in its
sole discretion, that it has such assets, net worth and liquidity, or is able to
borrow funds for such purpose on terms that it deems reasonable, to repurchase
such Interests at the time that they are tendered to it without materially
adversely affecting its financial condition, in its sole opinion.
In the event that the Manager determines that it is unable to repurchase
Interests, such repurchase obligations will be waived and will not be
exercisable in any subsequent year.
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, in its sole discretion, that its
financial condition at the time that such Interests are tendered for repurchase
renders it unable to effect such repurchases at the time.
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 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
45
<PAGE>
RATA average monthly cash distributions 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. The Manager intends to
enter into Soliciting Dealer Agreements with selected Soliciting Dealers in
order to effect the distribution of Interests. The Manager expects to enter
into substantially identical Soliciting Dealer Agreements (a form of which is
available at the office of the Manager for inspection and is included as an
Exhibit to the Registration Statement of which this Prospectus is a part)
with each such Soliciting Dealer. Pursuant to such Soliciting Dealer
Agreements, subscriptions for Interests will be solicited on a "best efforts"
basis only 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. In addition, each Soliciting Dealer will be required in the
Soliciting Dealer Agreement to make customary representations and warranties
to and enter into customary covenants with the Company. 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 by the Manager or its
affiliates. 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. The Manager does not anticipate that any agreement will be
entered into by the Company with any Soliciting Dealer which differs
materially from the terms described herein.
CONTINGENT COMPENSATION. Additional sales commissions of up to 4.5% of
Residual Operating Cash Flow ("Contingent Compensation"), may be paid to the
Soliciting Dealers by the Company and cause a corresponding reduction in 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.
46
<PAGE>
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 consists of revenues from sales of production
reduced by operating expenses charged by the Operator(s) to the Company's
working interest(s), the Administrative Cost Allowance and Direct Costs 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.
Individual Soliciting Dealers may receive Contingent Compensation in
the form of payments of a portion of Company cash flow, computed as a PRO
RATA percentage (determined according to the table set forth below) of
Residual Operating Cash Flow based upon the proportion of the Aggregate
Capital Contributions which are represented by the purchase price of
Interests sold by that Soliciting Dealer. Payments of Contingent
Compensation in any period to any Soliciting Dealer(s) will cause a
corresponding decrease in the cash distributions to the Manager in such
period and will not cause a decrease in distributions to Investor
Interestholders in such period. Contingent Compensation with respect to any
year will be payable to Soliciting Dealers not later than April 15 of the
succeeding year. 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 minimum numbers of Interests in the Company
pursuant to the schedule provided below:
<TABLE>
<CAPTION>
Amount of Interests Sold Contingent Compensation
------------------------ -----------------------
<S> <C>
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%
</TABLE>
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
47
<PAGE>
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. 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.
48
<PAGE>
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 Manager 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 Prior Antrim Area, other portions of the Antrim
shale formation in northern lower Michigan, southeastern lower Michigan,
northeastern Indiana and northwestern Ohio, and in other Devonian shale or
similar formations elsewhere in the continental United States. The projects in
which such Company will 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
49
<PAGE>
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 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 after it assigns the balance of its
working interest to the Company,
50
<PAGE>
provided that the overall working interest in such property exceeds 75% of the
net revenue interest. This overriding royalty interest will entitle the Manager
to receive 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) prior to payment of all associated operating costs,
without being required to contribute capital to develop and operate wells on
such property. See "Proposed Activities and Policies" and "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 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.
51
<PAGE>
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.
PRIOR ANTRIM AREA. The Company anticipates that it utilize a substantial
portion of its net investable assets to acquire working interests in projects
located 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 southeastern lower Michigan, northeastern Indiana and northwestern
Ohio. The Manager has participated in the development of gas wells in the
Antrim shale formation in the Prior Antrim Area and believes that it will be
able to obtain for the Company working interests in projects in the Antrim
formation in the Prior Antrim Area and elsewhere which have a high potential to
produce gas in commercial quantities. However, the Company anticipates that it
will acquire working interests in natural gas development projects which are not
within the Prior Antrim 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 Prior Antrim Area and which have other likely advantages, e.g., lower
acquisition, development and/or operating costs, diversification or risk or
earlier revenues from production of gas. The Company will acquire working
interests in such areas as, 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 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.
52
<PAGE>
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 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
53
<PAGE>
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 Company will acquired 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;
(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
54
<PAGE>
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 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
55
<PAGE>
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.
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
56
<PAGE>
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 is a summary
only and is qualified in its entirety by reference to the full text of the
prototype form of Operating Agreement which 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 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
57
<PAGE>
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 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
58
<PAGE>
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.
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
59
<PAGE>
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 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
60
<PAGE>
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 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
61
<PAGE>
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.
62
<PAGE>
APPLICATION OF PROCEEDS
Approximately 91 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
Manager has not identified any working interests to be acquired by the
Company or entered into or caused the Company to enter into any agreement to
acquire any such working interests; the Manager will identify the working
interests to be acquired by the Company only following the Final closing of
the offering of Investor Interests. 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) (7,500) (125) (2.5%) 3.33%
------ --- --- ----
Investor subscriptions available
for investment 273,000 4,550 91.0% 86.67%
Total capital available to pay
Turnkey Cost $273,000 $4,550 91.0% 86.67%
-------- ------ ---- -----
-------- ------ ---- -----
</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 by the Company and cause a corresponding
reduction in 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 2.5% 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.
63
<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) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Additional development costs (5)(9) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Financing costs (5)(10) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Professional and other costs (5)(11) 5.24% (15) 4.76% (15) 90.00% (15) 94.76% (15)
* Contingent compensation (16) 0.00% 0.00% 0.00%
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
64
<PAGE>
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.
(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).
(16) Contingent compensation of up to 4.5% of Residual Operating Cash Flow
may be paid to Soliciting Dealers by the Company under specified
conditions; the amount shall be paid by the Company, but shall reduce
the amounts otherwise distributable to the Manager with respect to the
Manager's Promoted Interest. See "Plan of Distribution - Selling
Arrangements; Commissions; Due Diligence Fees - Contingent
Compensation."
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.
65
<PAGE>
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.
Upon the commencement of Company operations, the Manager will receive a
Management Fee in an amount equal to 2.5% of aggregate Interestholders' capital
contributions less return of capital from sale of the Company's profits, 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 2.5% 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 and Net Proceeds from the sale of
Company assets 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
66
<PAGE>
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
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 each Investor Interestholder is equal to his/her Net
Capital Contribution, then to the Manager to the extent of any deferred Net
Cash Flow and in an amount which would cause the Manager's capital account
with respect to its Promoted Interest to be in a ratio of 30.24% to 69.76%
for the Investor Interestholders (including the Manager with respect to the
Manager's Investment Interest) 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 Capital Accounts, until such Capital Accounts are zero, and,
thereafter, 69.76% to the Investor Interestholders and 30.24% to the Manager
with respect to its Promoted Interest. See Articles 4, 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
67
<PAGE>
Interestholders.
68
<PAGE>
COMPENSATION AND REIMBURSEMENT
The Manager or its affiliates will receive the following compensation
and/or reimbursement from the Company.
SUMMARY
<TABLE>
<CAPTION>
FORM OF IF MINIMUM AMOUNT
COMPENSATION METHOD OF COMPENSATION SOLD (1)
------------ ---------------------- -----------------
<S> <C> <C>
OFFERING AND ORGANIZATION STAGE
Management Fee 2.5% of aggregate Investor Interestholders' capital $7,500
contributions
ACQUISITION AND OPERATING STAGE
Administrative 2.5% of aggregate Investor Interestholders' capital $7,500 per year
cost allowance contributions per annum, net of PRO RATA returns of capital (1)(2)
to Investor Interestholders from sales of Company
properties, 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 Indeterminate
organizational costs allowance and actual costs of the organization of the
and offering Company and offering of Interests, including accounting,
costs profit filing and legal fees, printing and other costs and
marketing expenses
Possible Difference, if any, between the Turnkey Cost and actual Indeterminate
turnkey profit development, drilling, completion and identified post-
Completion Facilities costs
Compensation Fair market value, on an accountable basis, for services to Indeterminate
for services the 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 Indeterminate (3)
revenues Promoted Interest, after allocations of direct costs,
operating costs, administrative costs allowance and all
other expenses
Overriding 2% overriding royalty interest in the projects, provided, Indeterminate
royalty however, that the working interest, as a whole, exceeds 75%
of the entire net revenue interest of such property
LIQUIDATION STAGE
Asset 3.5% of gross proceeds of sales of Company property Indeterminate (4)
disposition fee
Interest in Percentage of proceeds of sales of Company assets in Indeterminate
proceeds of accordance with Manager's Promoted Interest from time to (3)(5)
sales time (5.24% until Payout, 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.
69
<PAGE>
(5) Payable only out of gains realized on such sales. See "Participation in
Costs and Revenues - Company Allocations."
INTEREST IN PROJECTS
THE MANAGER'S PROMOTED INTEREST. The Manager will generally receive 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 ROYALTY INTEREST. The Manager will retain a 2%
overriding royalty 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. This overriding royalty
interest will entitle the Manager to receive 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) prior to payment of all
associated operating costs, without being required to contribute capital to
develop and operate wells on such property. 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.
70
<PAGE>
ADMINISTRATIVE COST ALLOWANCE
The Manager will receive the annual administrative cost allowance at the
rate of 2.5% of aggregate Investor Interestholders' capital, net of PRO RATA
returns of capital to Investor Interestholders from sales of Company assets, 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 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
71
<PAGE>
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
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 2.5% 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.
72
<PAGE>
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 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 gross amount of revenue from sale of
production after reduction for landowner's and other overriding royalties, but
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
73
<PAGE>
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.
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.
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
74
<PAGE>
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 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
75
<PAGE>
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 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 nine 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
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 or his affiliates, and Mr. Arbaugh is its sole executive
officer.
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.
76
<PAGE>
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 21 Antrim shale formation natural
gas drilling investment programs. Financial information with respect to 19 of
these Antrim partnerships is provided herein under the caption "Prior
Activities." No information is provided herein with respect to the remaining 2
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
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 1978 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 1978 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 then.
77
<PAGE>
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, and in that capacity his 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 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. TOEPFER, AGE 56, Senior Vice President, Sales and
Marketing. Mr. Toepfer has been Senior Vice President, Sales and Marketing
for since October 1996. 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 in senior securities sales positions by Ridgewood Energy
Corporation from 1990 to 1992 and City Equity Group from 1992 to May 1994.
Mr. Toepfer 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
78
<PAGE>
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, 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.
79
<PAGE>
PRIOR ACTIVITIES
The Prior Manager, of which Mr. Arbaugh is a 42.5% equity owner and of
which Mr. Arbaugh shares management responsibilities, has participated in the
sponsorship, organization and management of 21 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. Mr. Arbaugh was a 50% equity
owner and President of the Prior Manager at the time of the organization and
commencement of operations of the Prior Antrim Programs. The Manager has
participated in the sponsorship, organization and management of a single
Delaware business trust in 1995 and four Michigan limited liability companies
which were organized and raised funds to acquire interests in Antrim shale
formation natural gas development projects and is engaged in the acquisition of
such interests currently, as of the date of this Prospectus.
PERSONS WHO SUBSCRIBE FOR AND ACQUIRE INTERESTS IN THIS OFFERING WILL NOT
ACQUIRE ANY INTEREST IN ANY OF THE PRIOR ANTRIM PROGRAMS OR IN ANY SECURITIES
ISSUED BY ANY SUCH PRIOR ANTRIM PROGRAMS.
The Prior Antrim Programs have generated the following approximate annual
returns on investment (ROIs) for their respective investors on a cash and
after-tax basis for the period commencing on the respective dates of
commencement of operations (NOT of the offering of interests to investors)
through December 31, 1997:
<TABLE>
<CAPTION>
ANNUAL ANNUAL
YRS. IN ROI ROI
PROGRAM OPERATION (cash) (AFTER-TAX)
<S> <C> <C> <C>
Wolverine Chester North Antrim Drilling Program #1 8.75 12.9% 31.4%
Wolverine Chester North Antrim Drilling Program #2 7.75 11.1% 32.6%
Wolverine Chester North Antrim Drilling Program #3 6.50 6.2% 26.4%
Wolverine Chester North Antrim Drilling Program #4 6.75 11.7% 35.5%
Wolverine Otsego County Antrim Drilling Program #5 6.50 10.3% 34.7%
Wolverine Charlton North Antrim Drilling Program #6 6.25 9.5% 31.9%
Wolverine Antrim Development Program #7 6.75 9.5% 30.5%
Wolverine Otsego County Antrim Development Program #8 6.25 7.7% 27.4%
Wolverine Antrim Development Program #11 6.00 5.5% 23.8%
Wolverine Antrim Development Program #14 6.00 2.6% 15.0%
Wolverine Antrim Development Program #15-1991 5.50 3.3% 17.2%
Wolverine Antrim Development Program #15-1992 5.00 5.9% 22.3%
Wolverine Antrim Development Program #16 5.00 4.2% 20.9%
Wolverine Antrim Development Program #17 5.00 3.1% 8.6%
Wolverine Antrim Development Trust #18 4.25 3.8% 14.6%
Wolverine Antrim Development Trust #19 4.00 4.9% 18.0%
Wolverine Antrim Development Trust #20 3.00 5.5% 22.9%
Wolverine Antrim Development Trust #21 3.00 5.6% 22.4%
Wolverine Antrim Development Trust #22 2.00 8.7% 33.1%
Wolverine Antrim Development Trust 1995 2.00 1.7% 21.7%
Wolverine Antrim Development 1996-1, L.L.C. 1.50 4.6% 28.6%
Wolverine Antrim Development 1996-2, L.L.C. 0.50 1.3% 63.8%
</TABLE>
The column headed "Annual ROI (cash)" reflects the average annual rate
of return to investors from cash distributions only, expressed as a
percentage of their initial investment in the respective Prior Antrim
Program. Prospective investors in Investor Interests should note that the
largest cash component of return on investment in natural gas investment
programs like the Prior Antrim Programs are distributions in later years
(after the costs of development, drilling and completion of wells is
completed and all capital acquisitions have been amortized and the wells are
producing at maximum volume over an extended period.
The column headed "Annual ROI (after-tax)" reflects the average annual rate
of return to investors from (i) cash distributions, and (ii) the federal income
tax effects of allocations of program income, loss, gain, credit and deductions
to such investors from the program, combined and expressed as a percentage of
their initial investment in the respective Prior Antrim Program. The increase
in rate of return from the "Annual ROI (cash)" to the "Annual ROI (after-tax)"
column for each program reflects the cumulative effects of, INTER ALIA, (i)
intangible drilling and development expenses of wells and other deductible items
and, (ii) with respect to Prior Antrim Programs through Wolverine Antrim
Development Trust #17, federal income tax credits under Section 29 of the
Internal Revenue Code of 1986, as amended, allocated to investors with respect
to working interests in natural gas wells invested in by such programs. Because
the level of deductible intangible drilling and development expenses is highest
in the initial stages of any Prior Antrim Program, the differences in rates of
return between the "Annual ROI (cash)" and the "Annual ROI (after-tax)" column
for each Prior Antrim Program is greatest in the more recent programs and less
in programs of longer duration.
SUMMARY DESCRIPTION OF PRIOR ACTIVITIES SCHEDULES
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, 1997, 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.
SUMMARY OF INVESTOR TAX BENEFITS AND CASH DISTRIBUTION RETURNS
This schedule provides a summary of the investment performance of the Prior
Antrim Programs in respect of cash distributions and tax benefits received by
investors in such programs. The amounts disclosed are those which were reported
to investors in such programs on the applicable tax reporting documentation and
actually distributed in the periods
80
<PAGE>
indicated. Each of the Prior Antrim Programs described had similar investment
objectives to those which the Companies will pursue and invested in Antrim shale
development projects in the Michigan Basin. Investors should note that Prior
Antrim Programs organized prior to December 31, 1992, operated in a federal
income tax environment which was materially different from the environment in
which subsequent Prior Antrim Programs operated and in which the Companies will
operate, inasmuch as prior to that date, the Code permitted a credit against the
taxpayer's federal income tax liability for qualifying expenditures to develop
Devonian shale natural gas wells. The estimated investment results described in
this schedule are subject to the assumptions made therein, particularly with
respect to the federal income tax circumstances of the taxpayer/investor, and
may not apply to any specific investor in the 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 the Manager or their
affiliates in reimbursement of the administrative costs incurred by the Prior
Manager or the Manager or their affiliates on behalf of all affiliated
programs in the years identified. Such expenses were allocated to the
specific Prior Antrim Program on a formula basis (i.e., a fixed percentage
per annum of investor capital raised) in accordance with generally accepted
accounting principles or standard industry practices which may have been in
effect. The costs of acquiring projects have not been taken into account for
this purpose. It should be noted, however, that the amount of administrative
costs actually 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 or the Manager or their affiliates during
the "start up" phase of the program's operations, and (ii) the portion of the
year during which such program is in operations. These two factors tend to
have opposite effects on the level of administrative costs actually 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 or the Manager or their affiliates than information with
respect to later years when operations have assumed greater regularity and
economies of scale in operations can be realized.
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.
SPONSOR OPERATING RESULTS IN PRIOR PROGRAMS THROUGH 12/31/97 AND INVESTOR
OPERATING RESULTS IN PRIOR PROGRAMS THROUGH 12/31/97
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
81
<PAGE>
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 the
deductible administrative and direct costs of the programs are allocated to
the investors and the Prior Manager-affiliate manager 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 12/31/97 - the allocable portion of
the program's cumulative revenues from sales of gas from commencement
of operations through December 31, 1997, inclusive, allocated as
provided in the respective program's equityholders' agreement.
CUMULATIVE OPERATING COSTS THROUGH 12/31/97 - 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, 1997, inclusive, as
determined by the Operator of the projects (not an affiliate of the
Manager or 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.
CUMULATIVE ADMINISTRATIVE COSTS THROUGH 12/31/97 - the program's
share of cumulative administrative costs of all programs administered by
the Prior Manager or the Manager or their affiliates from commencement of
operations of the respective program through December 31, 1997, inclusive,
as determined by the Prior Manager or the Manager or their affiliates in
accordance with the procedure described above in " - Administrative Costs
Incurred and As a Percentage of Gross Subscriptions," allocated to the
investor partners and the Prior Manager's or Manager's affiliate manager
as provided in the respective program's equityholders' agreement.
CUMULATIVE DIRECT COSTS THROUGH 12/31/97 - the program's direct
costs from commencement of operations of the respective program through
December 31, 1997, 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 to the investor partners and the Prior
Manager's or Manager's affiliate manager as provided in the respective
program's equityholders' agreement.
CUMULATIVE CASH FLOW FROM OPERATIONS THROUGH 12/31/97 - the
program's net operating cash flow from commencement of operations
through December 31, 1997, 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
12/31/97" and "Cumulative Operating Costs Through 12/31/97").
CUMULATIVE CASH FLOW THROUGH 12/31/97 - the program's net cash
flow from all sources from commencement of operations through December
31, 1997, inclusive, allocated as provided in the respective program's
equityholders' agreement (reflects difference between "Cumulative Cash
Flow From Operations Through 12/31/97" and "Cumulative Administrative
Costs Through 12/31/97" plus "Cumulative Direct Costs Through
12/31/97").
82
<PAGE>
CUMULATIVE REVENUES DISTRIBUTED THROUGH 12/31/97 - the program's
actual cash distributions to partners, regardless of source, from
commencement of operations through December 31, 1997, inclusive,
allocated as provided in the respective program's equityholders'
agreement.
CUMULATIVE SECTION 29 CREDIT THROUGH 12/31/97 - 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,
1997, inclusive, allocated as provided in the respective program's
equityholders' agreement.
REVENUES DISTRIBUTED FOR THE THREE MONTHS ENDED 12/31/97 - the
program's actual cash distributions to partners, regardless of source,
for the THREE MONTH PERIOD FROM OCTOBER 1, 1997, THROUGH DECEMBER 31,
1997, 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.
POLICIES OF MANAGER AND PRIOR MANAGER REGARDING CASH DISTRIBUTIONS
THE FOLLOWING SCHEDULES REFLECT CASH RECEIPTS AND PAYMENTS OF THE PRIOR
ANTRIM PARTNERSHIPS AND PRIOR ANTRIM TRUSTS AND WERE NOT PREPARED IN ACCORDANCE
WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) WHICH REQUIRE, INTER ALIA,
THAT ALL AMOUNTS PAYABLE ACCORDING TO THE TERMS OF THE OBLIGOR'S DUTY TO PAY BE
ACCRUED AS AN EXPENSE, REGARDLESS OF WHETHER THE PAYMENT IS ACTUALLY MADE. THE
MANAGER AND THE PRIOR MANAGER HAVE ADOPTED A REGULAR POLICY OF REVIEWING THE
PERFORMANCE OF INVESTMENT PROGRAMS MANAGED BY THEM PERIODICALLY AND DETERMINING
WHETHER TO DEFER OR PAY ALL OR ANY PORTION OF THE FEES, OTHER COMPENSATION OR
CASH DISTRIBUTIONS PAYABLE TO THE MANAGER OR THE PRIOR MANAGER, AS APPROPRIATE,
IN ORDER TO PRESERVE CASH FOR DISTRIBUTION TO INVESTORS. IN ACCORDANCE WITH
SUCH POLICY, THE MANAGER AND THE PRIOR MANAGER HAVE ELECTED, IN CERTAIN
INSTANCES WITH RESPECT TO THE PRIOR ANTRIM PARTNERSHIPS AND PRIOR ANTRIM TRUSTS,
TO DEFER THE PAYMENT BY SUCH ENTITIES OF CERTAIN FEES AND/OR REIMBURSABLE
EXPENSES OTHERWISE DUE AND PAYABLE TO THE MANAGER OR PRIOR MANAGER OR THEIR
AFFILIATES IN ORDER TO PRESERVE CASH FOR DISTRIBUTION TO INVESTORS. THE EFFECT
OF SUCH DEFERRALS HAS BEEN TO DECREASE THE EXPENSES AND INCREASE THE AMOUNT OF
CASH DISTRIBUTIONS TO INVESTORS IN SUCH PRIOR ANTRIM PARTNERSHIPS AND PRIOR
ANTRIM TRUSTS FROM THE LEVELS WHICH WOULD HAVE PREVAILED IF SUCH FEES AND
REIMBURSABLE EXPENSES HAD BEEN PAID AS AND WHEN DUE. THERE CAN BE NO ASSURANCE
THAT THE MANAGER OR THE PRIOR MANAGER WILL MAINTAIN THEIR CURRENT POLICY IN THIS
REGARD OR THAT THEY WILL CONTINUE TO DEFER SUCH PAYMENTS OR THAT THEY OR THEIR
AFFILIATES, INCLUDING THE MANAGER, WOULD DEFER THE PAYMENT, AS AND WHEN DUE, OF
LIKE AMOUNTS BY THE COMPANY. THEREFORE, THE INFORMATION CONTAINED IN THE
FOLLOWING SCHEDULES MAY NOT BE CONSIDERED INDICATIVE OF THE ACTUAL RESULTS OF
OPERATIONS OF THE PRIOR ANTRIM PARTNERSHIPS AND PRIOR ANTRIM TRUSTS ACCORDING TO
THE TERMS UNDER WHICH THEY WERE ORGANIZED, NOTWITHSTANDING THAT ANY DEVIATION
FROM SUCH TERMS WERE FOR THE PURPOSE OF AND DID FAVOR THE INVESTORS IN SUCH
PRIOR ANTRIM PARTNERSHIPS AND PRIOR ANTRIM TRUSTS.
83
<PAGE>
IDENTIFICATION AND INITIAL CAPITALIZATION OF PRIOR ANTRIM PROGRAMS
<TABLE>
<CAPTION>
Investors'
Commencement of Initial Number of
Name of Prior Antrim Program Operations Subscriptions Investors
---------------------------- ---------- ------------- ---------
<S> <C> <C> <C>
Wolverine Chester North March 1989 $847,154 22
Antrim Drilling Program #1
Wolverine Chester North March 1990 827,500 21
Antrim Drilling Program #2
Wolverine Chester North June 1991 362,700 13
Antrim Drilling Program #3
Wolverine Chester North March 1991 410,250 15
Antrim Drilling Program #4
Wolverine Otsego County June 1991 1,117,984 29
Antrim Drilling Program #5
Wolverine Charlton North October 1991 586,496 11
Antrim Drilling Program #6
Wolverine Antrim Development March 1991 447,188 11
Program #7
Wolverine Otsego County October 1991 827,566 30
Antrim Development Program #8
Wolverine Antrim Development December 1991 493,099 21
Program #11
Wolverine Antrim Development December 1992 1,059,250 23
Program #14
84
<PAGE>
Wolverine Antrim Development May 1992 267,000 12
Program #15-1991
Wolverine Antrim Development December 1992 1,568,500 49
Program #15-1992
Wolverine Antrim Development December 1992 1,200,000 3
Program #16
Wolverine Antrim Development December 1992 1,270,000 10
Program #17
Wolverine Antrim Development October 1993 2,172,132 52
Trust #18
Wolverine Antrim Development December 1993 1,910,383 37
Trust #19
Wolverine Antrim Development December 1994 2,500,000 53
Trust #20
Wolverine Antrim Development December 1994 1,109,290 34
Trust #21
Wolverine Antrim Development December 1995 1,700,000 56
Trust #22
Wolverine Antrim Development December 1995 2,207,000 45
Trust 1995
Wolverine Antrim Development June 1996 1,154,000 36
1996-1, L.L.C.
Wolverine Antrim Development December 1996 4,473,162 119
1996-2, L.L.C.
Wolverine Antrim Development June 1997 4,088,000 114
1997-1, L.L.C.
Wolverine Antrim Development December 1997 1,185,000 34
1997-2, L.L.C.
</TABLE>
85
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Summary of investor tax benefits and cash distribution returns
As of December 31, 1997
<TABLE>
<CAPTION>
CUMULATIVE CUMULATIVE
INVESTOR FIRST-YEAR FIRST-YEAR CUMULATIVE SECTION 29 OTHER TAX
PROGRAM CONTRIBUTIONS DEDUCTIONS IDC DEPLETION CREDITS DEDUCTIONS
------- ------------- ---------- --- --------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North $847,154 $62,406 $397,539 $242,025 $632,190 $1,603,086
Antrim Drilling Program #1
Wolverine Chester North 827,500 413,206 334,679 161,934 558,611 1,994,261
Antrim Drilling Program #2
Wolverine Chester North 362,700 29,439 187,899 38,586 198,156 618,864
Antrim Drilling Program #3
Wolverine Chester North 410,250 9,564 242,121 93,978 302,346 746,246
Antrim Drilling Program #4
Wolverine Otsego County 1,117,984 51,895 659,423 265,263 859,567 1,828,393
Antrim Development Program #5
Wolverine Charlton North 586,496 2,315 338,419 146,690 401,833 790,445
Antrim Development Program #6
Wolverine Antrim Development 447,188 1,613 245,899 87,269 310,429 711,177
Program #7
Wolverine Otsego County 827,566 4,604 483,575 126,779 494,429 1,070,606
Antrim Development Program #8
Wolverine Antrim Development 493,099 759 120,373 52,803 277,924 677,328
Program #11
Wolverine Antrim Development 1,059,250 11,097 541,250 43,455 317,768 925,016
Program #14
Wolverine Antrim Development 267,000 2,697 133,687 14,580 84,766 237,149
Program #15/1991
Wolverine Antrim Development 1,568,500 36,672 703,053 140,600 569,727 1,461,029
Program #15/1992
Wolverine Antrim Development 1,200,000 470 328,790 102,268 502,808 1,169,428
Program #16
Wolverine Antrim Development 1,270,000 0 262,500 40,412 0 579,046
Program #17
Wolverine Antrim Development 2,172,132 54,545 1,142,011 47,102 0 1,336,123
Trust #18
Wolverine Antrim Development 1,910,383 49,035 1,312,776 87,109 1,374 1,134,994
Trust #19
Wolverine Antrim Development 2,500,000 59,904 1,692,643 152,314 2,291 1,436,782
Trust #20
Wolverine Antrim Development 1,109,290 28,171 726,124 64,250 1,069 625,801
Trust #21
Wolverine Antrim Development 1,700,000 102,804 1,109,000 141,222 1,527 842,477
Trust #22
Wolverine Antrim Development 2,207,000 67,143 1,687,634 3,454 962 530,999
Trust 1995
Wolverine Antrim Development 1,154,000 85,257 791,782 2,647 0 252,018
1996-1, L.L.C.
Wolverine Antrim Development 4,473,162 106,890 3,311,513 11,602 0 206,834
1996-2, L.L.C.
Wolverine Antrim Development 4,088,000 103,215 3,289,539 0 0 103,215
1997-1, L.L.C.
Wolverine Antrim Development 1,185,000 31,106 879,267 0 0 31,106
1997-2, L.L.C.
<CAPTION>
CUMULATIVE
TOTAL CUMULATIVE CUMULATIVE TAX SAVINGS/
CUMULATIVE CUMULATIVE TAX SAVINGS CASH DISTRI- CASH DISTRI-
DEDUCTIBLE ASSUMED CUMULATIVE CASH AND CASH TIONS AS % OF TIONS AS % OF
PROGRAM TAX ITEMS TAX RATE TAX SAVINGS DISTRIBUTIONS DISTRIBUTIONS CONTRIBUTIONS CONTRIBUTIONS
------- --------- -------- ----------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Wolverine Chester North $2,242,650 33.0% $1,372,265 $953,958 $2,326,223 112.6% 274.6%
Antrim Drilling Program #1
Wolverine Chester North 2,490,874 33.0% 1,380,599 709,279 2,089,878 85.7% 252.6%
Antrim Drilling Program #2
Wolverine Chester North 845,349 33.0% 477,121 145,505 622,626 40.1% 171.7%
Antrim Drilling Program #3
Wolverine Chester North 1,082,345 33.0% 659,520 322,723 982,243 78.7% 239.4%
Antrim Drilling Program #4
Wolverine Otsego County 2,753,079 33.0% 1,768,083 750,283 2,518,366 67.1% 225.3%
Antrim Development Program #5
Wolverine Charlton North 1,275,554 33.0% 822,766 346,922 1,169,688 59.2% 199.4%
Antrim Development Program #6
Wolverine Antrim Development 1,044,345 31.0% 634,176 287,250 921,426 64.2% 206.0%
Program #7
Wolverine Otsego County 1,680,960 31.0% 1,015,527 399,501 1,415,028 48.3% 171.0%
Antrim Development Program #8
Wolverine Antrim Development 850,504 31.0% 541,580 161,291 702,871 32.7% 142.5%
Program #11
Wolverine Antrim Development 1,509,721 31.0% 785,782 167,835 953,617 15.8% 90.0%
Program #14
Wolverine Antrim Development 385,416 31.0% 204,245 47,676 251,921 17.9% 94.4%
Program #15/1991
Wolverine Antrim Development 2,304,682 31.0% 1,284,178 465,259 1,749,437 29.7% 111.5%
Program #15/1992
Wolverine Antrim Development 1,600,486 31.0% 998,959 254,645 1,253,604 21.2% 104.5%
Program #16
Wolverine Antrim Development 881,958 39.6% 349,255 196,248 545,503 15.5% 43.0%
Program #17
Wolverine Antrim Development 2,525,236 39.6% 999,993 348,290 1,348,283 16.0% 62.1%
Trust #18
Wolverine Antrim Development 2,534,879 39.6% 1,005,186 372,599 1,377,785 19.5% 72.1%
Trust #19
Wolverine Antrim Development 3,281,739 39.6% 1,301,860 413,314 1,715,174 16.5% 68.6%
Trust #20
Wolverine Antrim Development 1,416,175 39.6% 561,874 185,061 746,935 16.7% 67.3%
Trust #21
Wolverine Antrim Development 2,092,699 39.6% 830,236 295,368 1,125,604 17.4% 66.2%
Trust #22
Wolverine Antrim Development 2,222,087 39.6% 880,908 76,692 957,600 3.5% 43.4%
Trust 1995
Wolverine Antrim Development 1,046,447 39.6% 414,393 80,167 494,560 6.9% 42.9%
1996-1, L.L.C.
Wolverine Antrim Development 3,529,754 39.6% 1,397,860 29,637 1,427,497 0.7% 31.9%
1996-2, L.L.C.
Wolverine Antrim Development 3,392,754 39.6% 1,343,531 0 1,343,531 0.0% 32.9%
1997-1, L.L.C.
Wolverine Antrim Development 910,373 39.6% 360,508 0 360,508 0.0% 30.4%
1997-2, L.L.C.
</TABLE>
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Administrative Costs Incurred and as a Percentage of Gross Subscriptions
As of December 31, 1997
<TABLE>
<CAPTION>
1988 1989 1990 1991
----------------------- --------------------------------------------------------------------------
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 $7,500 0.9% $18,000 2.1% $19,094 2.3% $20,504 2.4%
Wolverine Chester North
Antrim Drilling Program #2 13,950 1.7% 27,900 3.4% 29,407 3.6%
Wolverine Chester North
Antrim Drilling Program #3 6,380 1.8% 18,972 5.2%
Wolverine Chester North
Antrim Drilling Program #4 5,984 1.5% 18,921 4.6%
Wolverine Otsego County
Antrim Development Program #5 10,179 0.9% 34,148 3.1%
Wolverine Charlton North
Antrim Development Program #6 0 0.0% 11,256 1.9%
Wolverine Antrim Development
Program #7 3,153 0.7% 17,090 3.8%
Wolverine Otsego County
Antrim Development Program #8 16,779 2.0%
Wolverine Antrim Development
Program #11 8,938 1.8%
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.
Wolverine Antrim Development
1997-1, L.L.C.
Wolverine Antrim Development
1997-2, L.L.C.
<CAPTION>
1992 1993 1994
---------------------------------------------------------------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
------- -------- ------------- -------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $21,087 2.5% $21,165 2.5% $21,927 2.6%
Wolverine Chester North
Antrim Drilling Program #2 30,245 3.7% 30,357 3.7% 31,450 3.8%
Wolverine Chester North
Antrim Drilling Program #3 19,513 5.4% 19,585 5.4% 20,291 5.6%
Wolverine Chester North
Antrim Drilling Program #4 19,461 4.7% 19,533 4.8% 20,236 4.9%
Wolverine Otsego County
Antrim Development Program #5 43,256 3.9% 43,416 3.9% 44,979 4.0%
Wolverine Charlton North
Antrim Development Program #6 22,765 3.9% 22,850 3.9% 23,672 4.0%
Wolverine Antrim Development
Program #7 17,577 3.9% 17,643 3.9% 18,278 4.1%
Wolverine Otsego County
Antrim Development Program #8 33,936 4.1% 34,061 4.1% 35,288 4.3%
Wolverine Antrim Development
Program #11 15,624 3.2% 15,682 3.2% 16,246 3.3%
Wolverine Antrim Development
Program #14 26,157 2.5% 48,338 4.6%
Wolverine Antrim Development
Program #15/1991 4,738 1.8% 8,755 3.3%
Wolverine Antrim Development
Program #15/1992 18,038 1.1% 51,610 3.3%
Wolverine Antrim Development
Program #16 30,425 2.5% 39,682 3.3%
Wolverine Antrim Development
Program #17 15,446 1.2%
Wolverine Antrim Development
Trust #18 4,583 0.2%
Wolverine Antrim Development
Trust #19 47,760 2.5%
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.
Wolverine Antrim Development
1997-1, L.L.C.
Wolverine Antrim Development
1997-2, L.L.C.
<CAPTION>
1995 1996 1997
-----------------------------------------------------------------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
------- -------- ------------- -------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $22,913 2.7% $23,869 2.8% $24,468 2.9%
Wolverine Chester North
Antrim Drilling Program #2 32,864 4.0% 34,236 4.1% 35,095 4.2%
Wolverine Chester North
Antrim Drilling Program #3 21,203 5.8% 22,088 6.1% 22,642 6.2%
Wolverine Chester North
Antrim Drilling Program #4 21,146 5.2% 22,029 5.4% 22,581 5.5%
Wolverine Otsego County
Antrim Development Program #5 47,002 4.2% 48,963 4.4% 48,968 4.4%
Wolverine Charlton North
Antrim Development Program #6 24,737 4.2% 23,192 4.0% 23,774 4.1%
Wolverine Antrim Development
Program #7 19,100 4.3% 19,897 4.4% 20,396 4.6%
Wolverine Otsego County
Antrim Development Program #8 36,874 4.5% 38,413 4.6% 39,377 4.8%
Wolverine Antrim Development
Program #11 16,977 3.4% 17,685 3.6% 18,129 3.7%
Wolverine Antrim Development
Program #14 53,692 5.1% 59,177 5.6% 60,652 5.7%
Wolverine Antrim Development
Program #15/1991 9,725 3.6% 10,718 4.0% 10,374 3.9%
Wolverine Antrim Development
Program #15/1992 56,006 3.6% 59,667 3.8% 52,317 3.3%
Wolverine Antrim Development
Program #16 42,689 3.6% 45,717 3.8% 0 0.0%
Wolverine Antrim Development
Program #17 31,911 2.5% 33,243 2.6% 34,077 2.7%
Wolverine Antrim Development
Trust #18 -0- 0.0% 13,826 0.6% 27,500 1.3%
Wolverine Antrim Development
Trust #19 65,863 3.5% 66,863 3.5% 66,863 3.5%
Wolverine Antrim Development
Trust #20 87,500 3.5% 87,500 3.5% 87,500 3.5%
Wolverine Antrim Development
Trust #21 40,106 3.6% 41,780 3.8% 42,828 3.9%
Wolverine Antrim Development
Trust #22 -0- 0.0% 61,330 3.6% 62,869 3.7%
Wolverine Antrim Development
Trust 1995 -0- 0.0% 60,435 2.7% 86,301 3.9%
Wolverine Antrim Development
1996-1, L.L.C. 30,139 2.6% 43,038 3.7%
Wolverine Antrim Development
1996-2, L.L.C. 31,083 0.7% 166,935 3.7%
Wolverine Antrim Development
1997-1, L.L.C. 67,069 1.6%
Wolverine Antrim Development
1997-2, L.L.C. 31,106 2.6%
</TABLE>
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Direct Costs Incurred and as a Percentage of Gross Subscriptions
As of December 31, 1997
<TABLE>
<CAPTION>
1988 1989 1990 1991
----------------------- -----------------------------------------------------------------------------
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 $39,187 4.6% $1,500 0.2% $3,951 0.5% $11,856 1.4%
Wolverine Chester North
Antrim Drilling Program #2 125 0.0% 0 0.0% 3,957 0.5%
Wolverine Chester North
Antrim Drilling Program #3 988 0.3% 2,462 0.7%
Wolverine Chester North
Antrim Drilling Program #4 2,494 0.6% 2,607 0.6%
Wolverine Otsego County
Antrim Development Program #5 1,365 0.1% 4,334 0.4%
Wolverine Charlton North
Antrim Development Program #6 114 0.0% 2,104 0.4%
Wolverine Antrim Development
Program #7 114 0.0% 2,351 0.5%
Wolverine Otsego County
Antrim Development Program #8 114 0.0% 3,136 0.4%
Wolverine Antrim Development
Program #11 600 0.1%
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.
Wolverine Antrim Development
1997-1, L.L.C.
Wolverine Antrim Development
1997-2, L.L.C.
<CAPTION>
1992 1993 1994
--------------------------------------------------------------------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
------- -------- ------------- -------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $5,380 0.6% $5,454 0.6% $4,929 0.6%
Wolverine Chester North
Antrim Drilling Program #2 6,021 0.7% 5,154 0.6% 4,475 0.5%
Wolverine Chester North
Antrim Drilling Program #3 2,695 0.7% 3,615 1.0% 2,100 0.6%
Wolverine Chester North
Antrim Drilling Program #4 3,565 0.9% 3,812 0.9% 5,480 1.3%
Wolverine Otsego County
Antrim Development Program #5 9,035 0.8% 4,886 0.4% 5,285 0.5%
Wolverine Charlton North
Antrim Development Program #6 2,002 0.3% 2,750 0.5% 3,080 0.5%
Wolverine Antrim Development
Program #7 4,862 1.1% 2,940 0.7% 2,600 0.6%
Wolverine Otsego County
Antrim Development Program #8 4,795 0.6% 3,690 0.4% 2,720 0.3%
Wolverine Antrim Development
Program #11 4,151 0.8% 2,147 0.4% 1,370 0.3%
Wolverine Antrim Development
Program #14 5,894 0.6% 4,375 0.4% 2,540 0.2%
Wolverine Antrim Development
Program #15/1991 1,450 0.5% 6,875 2.6% 2,090 0.8%
Wolverine Antrim Development
Program #15/1992 107 0.0% 7,975 0.5% 4,610 0.3%
Wolverine Antrim Development
Program #16 7,065 0.6% 3,860 0.3%
Wolverine Antrim Development
Program #17 5,302 0.4% 1,790 0.1%
Wolverine Antrim Development
Trust #18 153 0.0% 4,030 0.2%
Wolverine Antrim Development
Trust #19 4,166 0.2%
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.
Wolverine Antrim Development
1997-1, L.L.C.
Wolverine Antrim Development
1997-2, L.L.C.
<CAPTION>
1995 1996 1997
----------------------------------------------------------------------------------
COSTS PERCENTAGE OF COSTS PERCENTAGE OF COSTS PERCENTAGE OF
PROGRAM INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS INCURRED SUBSCRIPTIONS
------- -------- ------------- -------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $4,220 0.5% $4,075 0.5% $5,620 0.7%
Wolverine Chester North
Antrim Drilling Program #2 3,875 0.5% 3,080 0.4% 5,108 0.6%
Wolverine Chester North
Antrim Drilling Program #3 1,800 0.5% 1,502 0.4% 3,558 1.0%
Wolverine Chester North
Antrim Drilling Program #4 3,850 0.9% 3,312 0.8% 5,193 1.3%
Wolverine Otsego County
Antrim Development Program #5 8,538 0.8% 5,390 0.5% 7,461 0.7%
Wolverine Charlton North
Antrim Development Program #6 4,578 0.8% 2,738 0.5% 4,658 0.8%
Wolverine Antrim Development
Program #7 3,470 0.8% 2,093 0.5% 4,168 0.9%
Wolverine Otsego County
Antrim Development Program #8 4,242 0.5% 2,852 0.3% 4,908 0.6%
Wolverine Antrim Development
Program #11 1,973 0.4% 1,524 0.3% 3,533 0.7%
Wolverine Antrim Development
Program #14 2,656 0.3% 2,285 0.2% 4,623 0.4%
Wolverine Antrim Development
Program #15/1991 2,467 0.9% 2,265 0.8% 4,397 1.6%
Wolverine Antrim Development
Program #15/1992 4,610 0.3% 4,158 0.3% 6,777 0.4%
Wolverine Antrim Development
Program #16 3,962 0.3% 3,560 0.3% 3,150 0.3%
Wolverine Antrim Development
Program #17 1,790 0.1% 1,788 0.1% 5,207 0.4%
Wolverine Antrim Development
Trust #18 8,635 0.4% 5,434 0.3% 13,890 0.6%
Wolverine Antrim Development
Trust #19 8,635 0.5% 5,366 0.3% 10,293 0.5%
Wolverine Antrim Development
Trust #20 8,751 0.4% 5,323 0.2% 10,189 0.4%
Wolverine Antrim Development
Trust #21 8,751 0.8% 5,151 0.5% 9,128 0.8%
Wolverine Antrim Development
Trust #22 1,616 0.1% 12,416 0.7% 15,744 0.9%
Wolverine Antrim Development
Trust 1995 537 0.0% 2,056 0.1% 5,908 0.3%
Wolverine Antrim Development
1996-1, L.L.C. 937 0.1% 7,465 0.6%
Wolverine Antrim Development
1996-2, L.L.C. 68 0.0% 9,613 0.2%
Wolverine Antrim Development
1997-1, L.L.C. 15 0.0%
Wolverine Antrim Development
1997-2, L.L.C. 0 0.0%
</TABLE>
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Sponsor operating results in prior programs
As of December 31, 1997
<TABLE>
<CAPTION>
CUMULATIVE
CUMULATIVE CUMULATIVE CUMULATIVE CASH FLOW
CUMULATIVE OPERATING ADMINISTRATIVE DIRECT FROM CUMULATIVE
PROGRAM REVENUES COSTS COSTS COSTS OPERATIONS CASH FLOW
------- -------- ---------- -------------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $331,467 $188,026 $34,924 $11,625 $143,441 $96,892
Wolverine Chester North
Antrim Drilling Program #2 $176,957 $86,050 $26,550 $3,167 $90,907 $61,189
Wolverine Chester North
Antrim Drilling Program #3 $56,287 $32,733 $15,067 $1,872 $23,554 $6,615
Wolverine Chester North
Antrim Drilling Program #4 $79,302 $43,374 $14,989 $3,031 $35,928 $17,907
Wolverine Otsego County
Antrim Development Program #5 $164,251 $82,780 $24,068 $3,472 $81,471 $53,931
Wolverine Charlton North
Antrim Development Program #6 $43,675 $18,996 $6,800 $991 $24,679 $16,888
Wolverine Antrim Development
Program #7 $73,929 $36,333 $11,183 $1,898 $37,595 $24,514
Wolverine Otsego County
Antrim Development Program #8 $120,392 $56,242 $23,473 $2,634 $64,149 $38,042
Wolverine Antrim Development
Program #11 $67,608 $40,946 $10,928 $1,530 $26,663 $14,205
Wolverine Antrim Development
Program #14 $39,920 $21,659 $12,401 $824 $18,260 $5,036
Wolverine Antrim Development
Program #15/1991 $2,077 $1,091 $443 $181 $986 $362
Wolverine Antrim Development
Program #15/1992 $13,899 $7,548 $2,376 $281 $6,351 $3,693
Wolverine Antrim Development
Program #16 $122,220 $73,778 $15,851 $2,160 $48,442 $30,431
Wolverine Antrim Development
Program #17 $58,731 $30,314 $11,468 $1,588 $28,416 $15,361
Wolverine Antrim Development
Trust #18 $113,465 $80,098 $4,591 $3,214 $33,367 $25,562
Wolverine Antrim Development
Trust #19 $107,835 $58,692 $24,835 $2,846 $49,143 $21,462
Wolverine Antrim Development
Trust #20 $154,674 $78,177 $26,250 $2,426 $76,497 $47,820
Wolverine Antrim Development
Trust #21 $68,844 $32,882 $12,471 $2,303 $35,962 $21,188
Wolverine Antrim Development
Trust #22 $102,349 $46,588 $12,420 $2,978 $55,761 $40,364
Wolverine Antrim Development
Trust 1995 $77,630 $45,332 $29,347 $1,598 $32,107 $1,162
Wolverine Antrim Development
1996-1, L.L.C. $25,954 $15,508 $6,757 $1,129 $10,446 $2,560
Wolverine Antrim Development
1996-2, L.L.C. $12,212 $7,691 $23,351 $1,443 $4,521 ($22,272)
Wolverine Antrim Development
1997-1, L.L.C. $0 $0 $0 $0 $0 $0
Wolverine Antrim Development
1997-2, L.L.C. $0 $0 $0 $0 $0 $0
<CAPTION>
CUMULATIVE CUMULATIVE
NET REVENUES SECTION 29
PROGRAM DISTRIBUTED CREDIT
------- ------------ ----------
<S> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $130,707 $100,773
Wolverine Chester North
Antrim Drilling Program #2 $70,928 $55,861
Wolverine Chester North
Antrim Drilling Program #3 $14,551 $19,816
Wolverine Chester North
Antrim Drilling Program #4 $32,272 $30,235
Wolverine Otsego County
Antrim Development Program #5 $56,271 $64,468
Wolverine Charlton North
Antrim Development Program #6 $15,611 $18,082
Wolverine Antrim Development
Program #7 $23,611 $26,076
Wolverine Otsego County
Antrim Development Program #8 $39,950 $49,443
Wolverine Antrim Development
Program #11 $16,129 $27,792
Wolverine Antrim Development
Program #14 $8,392 $15,888
Wolverine Antrim Development
Program #15/1991 $445 $820
Wolverine Antrim Development
Program #15/1992 $4,606 $5,601
Wolverine Antrim Development
Program #16 $25,465 $50,281
Wolverine Antrim Development
Program #17 $19,625 $0
Wolverine Antrim Development
Trust #18 $34,829 $0
Wolverine Antrim Development
Trust #19 $37,260 $137
Wolverine Antrim Development
Trust #20 $41,331 $229
Wolverine Antrim Development
Trust #21 $18,506 $107
Wolverine Antrim Development
Trust #22 $29,537 $153
Wolverine Antrim Development
Trust 1995 $11,249 $192
Wolverine Antrim Development
1996-1, L.L.C. $6,651 $0
Wolverine Antrim Development
1996-2, L.L.C. $0 $0
Wolverine Antrim Development
1997-1, L.L.C. $0 $0
Wolverine Antrim Development
1997-2, L.L.C. $0 $0
</TABLE>
<PAGE>
WOLVERINE ENERGY, L.L.C.
Prior Performance Tables
Investor operating results in prior programs
As of December 31, 1997
<TABLE>
<CAPTION>
CUMULATIVE
CUMULATIVE CUMULATIVE CUMULATIVE CASH FLOW
CUMULATIVE OPERATING ADMINISTRATIVE DIRECT FROM
PROGRAM REVENUES COSTS COSTS COSTS OPERATIONS
------- ------- ----- ----- ----- ----------
<S> <C> <C> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $1,776,210 $831,735 $158,104 $74,547 $944,475
Wolverine Chester North
Antrim Drilling Program #2 $1,592,613 $774,452 $238,954 $28,503 $818,161
Wolverine Chester North
Antrim Drilling Program #3 $506,579 $294,593 $135,606 $16,849 $211,987
Wolverine Chester North
Antrim Drilling Program #4 $713,721 $390,370 $134,903 $27,282 $323,351
Wolverine Otsego County
Antrim Development Program #5 $2,025,765 $1,020,950 $296,843 $42,822 $1,004,815
Wolverine Charlton North
Antrim Development Program #6 $926,877 $403,127 $145,446 $21,033 $523,750
Wolverine Antrim Development
Program #7 $806,174 $396,205 $121,949 $20,700 $409,970
Wolverine Otsego County
Antrim Development Program #8 $1,083,525 $506,181 $211,256 $23,822 $577,345
Wolverine Antrim Development
Program #11 $608,474 $368,511 $98,353 $13,769 $239,963
Wolverine Antrim Development
Program #14 $758,473 $411,527 $235,614 $21,550 $346,947
Wolverine Antrim Development
Program #15/1991 $214,301 $100,807 $43,867 $19,363 $103,494
Wolverine Antrim Development
Program #15/1992 $1,406,833 $758,829 $235,261 $27,956 $648,004
Wolverine Antrim Development
Program #16 $1,099,980 $633,998 $142,663 $19,437 $435,982
Wolverine Antrim Development
Program #17 $528,576 $272,829 $103,209 $14,289 $255,748
Wolverine Antrim Development
Trust #18 $1,021,185 $720,884 $41,318 $28,928 $300,301
Wolverine Antrim Development
Trust #19 $970,516 $528,229 $223,514 $25,614 $442,287
Wolverine Antrim Development
Trust #20 $1,392,067 $703,597 $236,250 $21,837 $688,470
Wolverine Antrim Development
Trust #21 $619,592 $295,934 $112,243 $20,727 $323,658
Wolverine Antrim Development
Trust #22 $921,142 $419,292 $111,779 $26,799 $501,850
Wolverine Antrim Development
Trust 1995 $320,019 $189,690 $117,389 $6,903 $130,329
Wolverine Antrim Development
1996-1, L.L.C. $207,306 $126,153 $66,420 $7,273 $81,153
Wolverine Antrim Development
1996-2, L.L.C. $82,132 $52,923 $172,667 $8,238 $29,209
Wolverine Antrim Development
1997-1, L.L.C. 0 0 $67,069 $15 0
Wolverine Antrim Development
1997-2, L.L.C. $0 $0 $31,106 $0 $0
<CAPTION>
CUMULATIVE CUMULATIVE
CUMULATIVE NET REVENUES SECTION 29
PROGRAM CASH FLOW DISTRIBUTED CREDIT
------- --------- ----------- ------
<S> <C> <C> <C>
Wolverine Chester North
Antrim Drilling Program #1 $711,824 $823,251 $531,417
Wolverine Chester North
Antrim Drilling Program #2 $550,704 $638,351 $502,750
Wolverine Chester North
Antrim Drilling Program #3 $59,632 $130,955 $178,340
Wolverine Chester North
Antrim Drilling Program #4 $161,166 $290,451 $272,111
Wolverine Otsego County
Antrim Development Program #5 $665,149 $694,012 $795,099
Wolverine Charlton North
Antrim Development Program #6 $357,270 $331,311 $383,751
Wolverine Antrim Development
Program #7 $267,320 $263,639 $284,353
Wolverine Otsego County
Antrim Development Program #8 $342,267 $359,551 $444,986
Wolverine Antrim Development
Program #11 $127,841 $145,162 $250,132
Wolverine Antrim Development
Program #14 $89,783 $159,443 $301,880
Wolverine Antrim Development
Program #15/1991 $40,265 $47,231 $83,946
Wolverine Antrim Development
Program #15/1992 $384,788 $460,653 $564,126
Wolverine Antrim Development
Program #16 $273,882 $229,181 $452,527
Wolverine Antrim Development
Program #17 $138,249 $176,623 $0
Wolverine Antrim Development
Trust #18 $230,055 $313,461 $0
Wolverine Antrim Development
Trust #19 $193,159 $335,339 $1,239
Wolverine Antrim Development
Trust #20 $430,383 $371,983 $2,062
Wolverine Antrim Development
Trust #21 $190,688 $166,555 $962
Wolverine Antrim Development
Trust #22 $363,272 $265,831 $1,374
Wolverine Antrim Development
Trust 1995 $6,037 $65,443 $770
Wolverine Antrim Development
1996-1, L.L.C. $7,460 $73,516 $0
Wolverine Antrim Development
1996-2, L.L.C. ($151,696) $29,637 $0
Wolverine Antrim Development
1997-1, L.L.C. ($67,084) $0 $0
Wolverine Antrim Development
1997-2, L.L.C. ($31,106) $0 $0
</TABLE>
<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 Prospectus 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
Prospectus 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;
85
<PAGE>
(ii) 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 or elect to be treated
as an association taxable as a corporation;
(iii) The Company Operating Agreement will be entered into by and
among the Investor Interestholders and the Manager, 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;
(iv) 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;
(v) 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";
(vi) The Manager will cause the Company to properly elect to deduct
currently any intangible drilling and development costs;
(vii) The Company will have a December 31 taxable year and will
report its income on the accrual basis;
(viii) 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
(ix) 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.
86
<PAGE>
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
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.
87
<PAGE>
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 partnerships or limited liability
companies in which the Manager of the Prior Manager 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 repurchase (unless the
Manager determines, in its sole discretion, that it is unable from a financial
point of view to do so at the time) 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
1998 and 1999, 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 Service 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
88
<PAGE>
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 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
89
<PAGE>
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
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 any year, amounts incurred pursuant to BONA FIDE arm's-length
drilling contracts and constituting IDC should be deductible by the Company in
that year. To the extent that such services are performed in any year, however,
the Company will only be allowed to deduct in the prior year amounts which are:
(1) incurred pursuant to BONA FIDE arm's-length drilling contracts
which provide for absolute noncontingent liability for payment,
and
90
<PAGE>
(2) attributable to wells spudded within 90 days after December 31 of
the prior year. 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.
* * *
. . . 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 any year even though a portion
of such costs are attributable to services performed during the prior year.
Each Investor Interestholder, however, may deduct his/her share of amounts
paid in a prior year for services performed for the Company in such prior year
only to the extent of his/her "cash basis" in the Company as of the end of such
prior year. 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.
91
<PAGE>
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 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."
92
<PAGE>
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.
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 members) 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.
93
<PAGE>
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) 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
94
<PAGE>
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. Therefore, the
Investor Interestholders capital accounts will be less than the Manager's
Capital account, 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 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
95
<PAGE>
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.
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.
96
<PAGE>
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 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.
97
<PAGE>
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).
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 alternative 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:
98
<PAGE>
(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;
(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
99
<PAGE>
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 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
100
<PAGE>
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. 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.
101
<PAGE>
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.
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, the Code 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
102
<PAGE>
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.
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
103
<PAGE>
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 a maximum 20% tax rate if the Investor
Interestholder has held his/her Interests for greater than 12 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.
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
104
<PAGE>
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.
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.
105
<PAGE>
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.
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
106
<PAGE>
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.
To the extent that the Participating Investor Interestholders' liabilities
are not limited 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
107
<PAGE>
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 Nonparticipating 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 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")
108
<PAGE>
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 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
109
<PAGE>
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.
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
110
<PAGE>
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.
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."
111
<PAGE>
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
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
112
<PAGE>
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.
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
113
<PAGE>
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 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
114
<PAGE>
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 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
115
<PAGE>
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 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
116
<PAGE>
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.
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
117
<PAGE>
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 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.
118
<PAGE>
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
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
119
<PAGE>
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 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.
120
<PAGE>
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 Fraser, Trebilcock, Davis & Foster, Lansing, Michigan, counsel
to the Manager as to matters of Michigan law. Mr. Ewing and Fraser, Trebilcock,
Davis & Foster 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.
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
121
<PAGE>
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.
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 form of Turnkey Agreement; and
(c) the tax opinion of Special Tax Counsel.
122
<PAGE>
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.
"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.
"COMPANY PROJECTS" includes all interests, projects and rights of any type
owned by the Company.
"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.
123
<PAGE>
"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.
"DRY HOLE" refers to a well which has been drilled and which may or may not
have been completed and which testing shows will not or is unlikely to yield
commercial quantities of natural gas or natural gas liquids and in which no
further investment or completion activities will be undertaken.
"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.
"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 CASH FLOW" refers to 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
124
<PAGE>
Company Property, but excluding any Aggregate Capital Contributions of the
Interestholders.
"NET INVESTABLE CAPITAL" means the amount of Company capital remaining,
after payment of all organizational, offering, selling and administrative costs,
the Management 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 interest measured as a percentage of 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.
"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.
"PRIOR ANTRIM 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 southeastern lower Michigan, northeastern Indiana
125
<PAGE>
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.
"PROVED DEVELOPED RESERVES" are reserves that can be expected to be
recovered through existing wells with existing equipment and operating methods.
Additional gas expected to be obtained through the application of fluid
injection or other improved recovery techniques for supplementing the natural
forces and mechanisms of primary recovery are included as "PROVED DEVELOPED
RESERVES" only after testing by a pilot project or after the operation of an
installed program has confirmed through production response that increased
recovery will be achieved.
"PROVED UNDEVELOPED RESERVES" are reserves that are expected to be
recovered from new wells on undrilled acreage, or from existing wells where a
relatively major expenditure is required for recompletion. Reserves on
undrilled acreage are limited to those drilling units offsetting productive
units that are reasonably certain of production when drilled. "PROVED RESERVES"
for other undrilled units are claimed only where it can be demonstrated with
certainty that there is continuity of production from the existing productive
formation. Under no circumstances will estimates for "PROVED UNDEVELOPED
RESERVES" be attributable to any acreage for which an application of fluid
injection or other improved recovery technique is contemplated, unless such
techniques have been proved effective by actual tests in the area and in the
same reservoir.
"RESERVES" herein refers to "PROVED RESERVES." "PROVED RESERVES" are the
estimated quantities of natural gas, and natural gas liquids which geological
and engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
conditions, i.e., prices and costs as of the date the estimate is made. Prices
include consideration of changes in existing prices provided only by contractual
arrangements, but not on escalations based upon future conditions. Reservoirs
are considered proved if economic producibility is supported by either actual
production or conclusive formation test. The area of a reservoir considered
proved includes (A) that portion delineated by drilling and defined by gas-oil
and/or oil-water contacts, if any; and (B) the immediately adjoining portions
not yet drilled, hut which can be reasonably judged as economically productive
on the basis of available geological and engineering data. In the absence of
information on fluid contacts, the lowest known structural occurrence of
hydrocarbons controls the lower proved limit of the reservoir. Reserves which
can be produced economically through application of improved recovery techniques
(such as fluid injection) are included in the "proved" classification when
successful testing by a pilot project, or the operation of an installed program
in the reservoir, provides support for the engineering analysis on which the
project or program was based. Estimates of proved reserves do not include the
following: (A) natural gas, and natural gas liquids, the recovery of which is
subject to reasonable doubt because of uncertainty as to geology, reservoir
characteristics, or economic factors; (B) natural gas, and natural gas liquids,
that may occur in undrilled prospects; and (C) natural gas, and natural gas
liquids, that may be recovered from oil shales, coal, gilsonite and other such
sources. "PROVED RESERVES" includes "PROVED DEVELOPED RESERVES" and "PROVED
UNDEVELOPED RESERVES."
"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.
"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.
126
<PAGE>
"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.
127
<PAGE>
Wolverine Energy, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
Financial Report
December 31, 1997
F-1
<PAGE>
Wolverine Energy, L.L.C.
- --------------------------------------------------------------------------------
CONTENTS
<TABLE>
<CAPTION>
<S> <C>
REPORT LETTER 1
FINANCIAL STATEMENTS
Balance Sheet 2
Statement of Income 3
Statement of Member's Equity 4
Statement of Cash Flows 5
Notes to Financial Statements 6-11
</TABLE>
F-2
<PAGE>
Independent Auditor's Report
To the Member
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, 1997 and 1996, and
the related statements of income, member's equity, and cash flows for the years
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, 1997 and 1996, and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles.
February 19, 1998
F-3
<PAGE>
BALANCE SHEET
<TABLE>
<CAPTION>
December 31
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 55,312 $ 48,892
Accounts receivable:
Related entities (Note 4) 46,738 374,936
Other 75,000 15,629
Current portion of member note receivable
(Note 4) 200,000 100,000
Working interests held for resale 1,458,167 411,170
----------- -----------
Total current assets 1,835,167 950,927
EQUIPMENT
Office equipment 39,703 14,650
Accumulated depreciation (33,966) (14,650)
----------- -----------
Total fixed assets 5,737 --
ORGANIZATION COSTS, Net 7,776 10,521
MEMBER NOTE RECEIVABLE (Note 4) 400,000 200,595
INVESTMENTS IN RELATED ENTITIES (Note 2) 944,410 370,812
----------- -----------
Total assets $ 3,193,140 $ 1,532,855
----------- -----------
----------- -----------
LIABILITIES AND MEMBER'S EQUITY
CURRENT LIABILITIES
Line of credit (Note 3) $ 325,000 $ 249,500
Accounts Payable:
Trade 94,333 50,769
Operators 2,259,967 805,079
Related party (Note 4) 84,424 72,971
Other 98,821 --
Accrued expenses 22,270 14,913
----------- -----------
Total current liabilities 2,884,815 1,193,232
MEMBER'S EQUITY 308,325 339,623
----------- -----------
Total liabilities and member's equity $ 3,193,140 $ 1,532,855
----------- -----------
----------- -----------
</TABLE>
F-4
<PAGE>
STATEMENT OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
REVENUE
Turnkey revenue $ 6,333,944 $ 4,280,724
Management fees 362,832 250,547
Other Income 149,124 9,300
----------- -----------
Total revenue 6,845,900 4,540,571
EXPENSES
Cost of turnkey revenue and other related costs 5,182,605 3,470,477
General and administrative 1,190,994 688,715
----------- -----------
Total expense 6,373,599 4,159,192
----------- -----------
OPERATING INCOME 472,301 381,379
LOSS FROM RELATED ENTITIES (19,645) (53,173)
----------- -----------
NET INCOME $ 452,656 $ 328,206
----------- -----------
----------- -----------
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF MEMBER'S EQUITY
<S> <C>
Balance - January 1,1996 $ 11,417
Net Income 328,206
---------
Balance - December 31, 1996 339,623
Net Income 452,656
Distributions to Member (483,954)
---------
Balance - December 31, 1997 $ 308,325
---------
---------
</TABLE>
See Notes to Financial Statements
F-6
<PAGE>
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers $ 7,114,727 $ 5,235,832
Cash paid to operators and suppliers (5,763,807) (4,139,748)
Cash paid for interest (18,645) (29,071)
----------- -----------
Net cash provided by operating
activities (Note 5) 1,332,275 1,067,013
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets (25,053) --
Cash paid for investments in limited
liability corporations (610,662) (213,575)
Distributions from limited liability
corporations and a trust 17,419 --
----------- -----------
Net cash used in investing activities (618,296) (514,470)
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft -- (753,151)
Proceeds from line of credit, net of repayments 75,500 249,500
Loans to member (299,105) (300,895)
Distributions to member (483,954) --
----------- -----------
Net cash used in financing activities (707,559) (503,651)
----------- -----------
NET INCREASE IN CASH 6,420 48,892
CASH - Beginning of year 48,892 --
----------- -----------
CASH - End of Year $ 55,312 $ 48,892
----------- -----------
----------- -----------
</TABLE>
See Notes to Financial Statements
F-7
<PAGE>
WOLVERINE ENERGY., L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE I - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Wolverine Energy, L.L.C.--(WELLC) was formed on November 8, 1995; 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.
WORKING INTERESTS HELD FOR RESALE - WELLC has acquired certain oil and gas
working interests for the purpose of selling these interests to oil and gas
entities. Such working interests held for resale are periodically reviewed
to determine if they have been impaired. If impairment exists, a loss is
recognized by providing an impairment allowance. Abandonments of working
interests held for resale are charged to expense. As of December 31, 1997
and 1996, no impairment exists.
INVESTMENTS IN RELATED ENTITIES - Investments in related entities are
accounted for under the equity method since WELLC has significant
influence over the management of these entities. WELLC, is the manager of
the oil and gas entities and 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 investment accounts according to WELLC's ownership
interest in the entities, and distributions or withdrawals are deducted
from the investment accounts.
TURNKEY DRILLING REVENUE - WELLC enters into contracts with affiliated
entities to sell them oil and gas working interests under turnkey drilling
agreements. Under the terms of the agreements, the entities pay a fixed price
for acquisition, drilling and completion costs and receive working interests
in the wells. WELLC agrees to monitor the well operators obligation to
conduct the drilling and completion of each well. Turnkey revenue is
recognized when the relating services have been performed (working interests
have been sold) and substantially all future obligations have been settled.
COST OF TURNKEY REVENUE - The Company acquires oil and gas working interests for
resale that require the Company to pay a pro rata portion of all costs to drill
and complete a well. The Company sells these oil and gas working interests in
wells at a fixed price, generally before the drilling is completed. Actual
costs to drill and complete a well may exceed the sales price. The Company has
the burden of paying all costs in excess of the turnkey price. Included in
accounts payable at December 31, 1997 and 1996, and cost of turnkey sales, is
the estimated total cost that the Company will be required to pay on working
interests that have been sold. Due to uncertainties inherent in the estimation
process, it is at least reasonably possible that the Company may incur expenses
in excess of the amount recorded. Management is of the opinion that any
adjustment of the amount recorded would not have a material adverse effect on
the financial statements.
F-8
<PAGE>
WOLVERINE ENERGY., L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE I - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Management Fees - In connection with the organization and offering stage of
related oil and gas entities WELLC receives a management fee of 2.5 percent from
investor subscriptions, which is credited to income as earned.
EQUIPMENT - Equipment is recorded at cost. Depreciation is computed using
straight-line and accelerated methods over the estimated useful lives of the
assets. Costs of maintenance and repairs are charged to expense as incurred.
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 all income and expenses of the L.L.C. are allocated
to the member for inclusion on his respective income tax return.
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect 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 reporting
period. Actual results could differ from those estimates.
- --------------------
F-9
<PAGE>
WOLVERINE ENERGY,, L.L.C.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
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.,
Wolverine Antrim Development 1996-2, L.L.C., Wolverine Antrim
Development 1997-1, L.L.C., and Wolverine Antrim Development 1997-2,
L.L.C. WELLC serves as manager of these entities and, as such, has
full and exclusive discretion in their 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. Profits from oil and gas
properties are allocated based on the working interest ownership
percentage of the properties.
WELLC holds the following interest in the entities-.
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Wolverine Antrim Development Trust 1995 20.0% 20.0%
Wolverine Antrim Development 1996-1, L.L.C. 15.0% 15.0%
Wolverine Antrim Development 1996-2, L.L.C. 15.0% 15.0%
Wolverine Antrim Development 1997-1, L.L.C. 15.0% --
Wolverine Antrim Development 1997-2, L.L.C. 15.0% --
</TABLE>
F-10
<PAGE>
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
NOTE 2 - AFFILIATED OIL AND GAS ENTITIES (CONTINUED)
Following is a summary of financial position and results of operations
of entities whose investments are carried at equity:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Current assets $ 217,927 $ 577,528
Other assets (net) 11,238,505 6,843,265
------------ ------------
Total Assets $ 11,456,432 $ 7,420,793
------------ ------------
------------ ------------
Current liabilities $ 197,841 $ 577,134
Equity 11,258,591 6,843,659
------------ ------------
Total liabilities and equity $ 11,456,432 $ 7,420,793
------------ ------------
------------ ------------
Net Loss $ (1,092,526) $ (422,901)
------------ ------------
------------ ------------
</TABLE>
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 New York Citibank
prime rate (effective rate of 10.25 percent at December 31, 1997).
WELLC's credit line is $325,000.
NOTE 4 - RELATED PARTY TRANSACTIONS
Because of the nature of WELLC's business, a significant number of
transactions are with related parties.
During 1997 and 1996, WELLC earned turnkey revenue from related
entities in the amount of $5,888,335 and $4,280,724, respectively.
The balance of turnkey revenues and allocated expenses owed to WELLC
included in accounts receivable as of December 31, 1997 and 1996,
totaled $46,738 and $374,936, respectively.
During 1997 and 1996, WELLC charged management fees to related
entities in the amount of $362,832 and $250,547, respectively.
WELLC had outstanding loans totaling $600,000 and $300,895 December
31, 1997 and 1996, respectively, to the member. The note is payable
in equal installments over the next three years including interest at
8 percent and is unsecured.
WELLC owed related entities for administrative costs and member
contributions in the amount of $84,424 and $72,971 at December 31,
1997 and 1996, respectively.
F-11
<PAGE>
NOTE 5 - CASH FLOWS
A reconciliation of net income to net cash flows used in operating
activities is as follows:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Net income $ 452,656 $ 328,206
Adjustments to reconcile net
income to net cash from operating
activities:
Depreciation, depletion and
amortization expense 22,061 2,745
Loss from equity investments 19,645 53,173
(Increase) decrease in assets:
Accounts receivable 268,827 695,261
Working interests held for resale (1,046,997) (61,240)
Decrease in liabilities:
Accounts payable 1,608,726 33,955
Accrued expenses 7,357 14,913
----------- -----------
Net cash provided by operating
activities $ 1,332,275 $ 1,067,013
----------- -----------
----------- -----------
</TABLE>
There were no significant noncash investing and financing activities during
1997 and 1996.
NOTE 6 - COMMITMENT AND CONTINGENCIES
As managing member in various affiliated oil and gas L.L.C.'s and a Trust,
WELLC is subject to contingencies that may arise in the normal course of
business of these entities. Management is of the opinion that liabilities, if
any, related to such contingencies that may arise would not be material to the
financial statements..
F-12
<PAGE>
WOLVERINE ENERGY, L.L.C.
(A MICHIGAN LIMITED LIABILITY CORPORATION)
------------------------------------------
FINANCIAL REPORT (UNAUDITED)
JUNE 30, 1998
F-13
<PAGE>
WOLVERINE ENERGY, L.L.C.
- --------------------------------------------------------------------------
CONTENTS
FINANCIAL STATEMENTS (UNAUDITED)
Balance Sheet F-15
Statement of Operations and Changes in Member's Equity F-16
Statement of Cash Flows F-17
Notes to Financial Statements F-18 - F-24
The financial statements of Wolverine Energy, L.L.C., as of June 30,
1998, and for the six months then ended, and for the corresponding period in
1997, provided herein include, in the opinion of management, all adjustments
which are necessary in order to make such financial statements not
misleading.
F-14
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
BALANCE SHEET (UNAUDITED)
<TABLE>
<CAPTION>
June 30
-------------------------
1998 1997
----------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 540,275 $ 45,253
Accounts receivable:
Related entities (Note 5) 192,263 197,257
Other 2,575 59,251
Prepaid expenses 33,570 79,504
Current portion of member note receivable (Note 5) 200,000 100,300
Working interests held for resale 998,697 76,000
---------- ----------
Total current assets 1,967,380 557,565
EQUIPMENT
Office equipment 39,703 29,730
Accumulated depreciation (35,036) (15,750)
---------- ----------
Net carrying amount 4,667 13,980
ORGANIZATION COSTS, Net 7,659 9,146
MEMBER NOTE RECEIVABLE (Note 5) 689,884 513,829
INVESTMENTS IN RELATED ENTITIES (Note 2) 963,675 424,188
---------- ----------
Total assets $3,633,265 $1,518,708
---------- ----------
---------- ----------
LIABILITIES AND MEMBER'S EQUITY
CURRENT LIABILITIES
Line of credit (Note 3) $ 325,000 $ -
Current portion of long-term debt (Note 4) 53,251 -
Accounts payable:
Trade 95,812 108,238
Operators 2,236,542 1,072,250
Related party (Note 5) 10,859 77,024
Other 179,821 25,881
Accrued expenses 16,462 5,065
---------- ----------
Total current liabilities 2,917,747 1,288,458
LONG-TERM DEBT (Note 4) 693,673 -
MEMBER'S EQUITY 21,845 230,250
---------- ----------
Total liabilities and member's equity $3,633,265 $1,518,708
---------- ----------
---------- ----------
</TABLE>
See Notes to Financial Statements.
F-15
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
STATEMENT OF OPERATIONS AND CHANGES IN MEMBER'S EQUITY (UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30
-------------------------
1998 1997
----------- ------------
<S> <C> <C>
REVENUE
Turnkey revenue (Note 5) $1,098,989 $1,041,497
Management fees (Note 5) 64,286 58,806
Other income 73,783 -
---------- ----------
Total revenue 1,237,058 1,100,303
EXPENSES
Cost of turnkey revenue and other related costs 945,179 793,558
General and administrative 577,099 412,580
---------- ----------
Total expenses 1,522,278 1,206,138
---------- ----------
OPERATING LOSS (285,220) (105,835)
LOSS FOR RELATED ENTITIES (Note 2) (1,260) (3,538)
---------- ----------
NET LOSS (286,480) (109,373)
MEMBER'S EQUITY - Beginning of period 308,325 339,623
---------- ----------
MEMBER'S EQUITY - End of period $ 21,845 $ 230,250
---------- ----------
---------- ----------
</TABLE>
See Notes to Financial Statements.
F-16
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
STATEMENT OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30
-------------------------
1998 1997
----------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Cash received from customers $1,162,698 $1,230,822
Cash paid to operators and suppliers (1,067,378) (589,389)
Cash paid for interest (46,872) (10,344)
---------- ----------
Net cash provided by operating activities
(Note 6) 48,448 631,089
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment - (15,080)
Cash paid for investments in limited liability
corporations (61,225) (68,523)
Distributions from limited liability corporations
and a trust - 11,609
---------- ----------
(61,225) (71,994)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from line of credit, net of repayments - (249,500)
Proceeds from long-term debt 746,924 -
Loans to member (249,184) (313,234)
---------- ----------
Net cash provided by (used in) financing
activities 497,740 (562,734)
---------- ----------
NET INCREASE (DECREASE) IN CASH 484,963 (3,639)
CASH - Beginning of period 55,312 48,892
---------- ----------
CASH - End of period $ 540,275 $ 45,253
---------- ----------
---------- ----------
</TABLE>
See Notes to Financial Statements.
F-17
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
NOTE 1 - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Wolverine Energy, L.L.C. (WELLC) was formed on November 8, 1995; 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 all of
the entities.
CASH EQUIVALENTS - WELLC considers all highly liquid investments
with a maturity of three months or less to be cash equivalents.
WORKING INTERESTS HELD FOR RESALE - WELLC has acquired certain oil
and gas working interests for the purpose of selling these interests
to oil and gas entities. Such working interests held for resale are
periodically reviewed to determine if they have been impaired. If
impairment exists, a loss is recognized by providing an impairment
allowance. Abandonments of working interests held for resale are
charged to expense. As of June 30, 1998 and 1997, no impairment
exists.
INVESTMENTS IN RELATED ENTITIES - Investments in related entities
are accounted for under the equity method since WELLC has
significant influence over the management of these entities.
WELLC, is the manager of the oil and gas entities and 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 investment
accounts according to WELLC's ownership interest in the entities, and
distributions or withdrawals are deducted from the investment
accounts.
TURNKEY DRILLING REVENUE - WELLC enters into contracts with
affiliated entities to sell them oil and gas working interests under
turnkey drilling agreements. Under the terms of the agreements, the
entities pay a fixed price for acquisition, drilling and completion
costs and in return receive working interests in the wells. WELLC
agrees to monitor the well operators obligation to conduct the
drilling and completion of each well. Turnkey revenue is recognized
when the related services have been performed (working interests
have been sold) and substantially all future obligations have been
settled.
F-18
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
NOTE 1 - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
COST OF TURNKEY REVENUE - The Company acquires oil and gas working
interests for resale that require the Company to pay a pro rata
portion of all costs to drill and complete a well. The Company sells
these oil and gas working interests in wells at a fixed price,
generally before the drilling is completed. Actual costs to drill
and complete a well may exceed the sales price. The Company has the
burden of paying all costs in excess of the turnkey price. Included
in all accounts payable at June 30, 1998 and 1997, and cost of
turnkey sales, is the estimated total cost that the Company will be
required to pay on working interests that have been sold. Due to
uncertainties inherent in the estimation process, it is at least
reasonably possible that the Company may incur expenses in excess of
the amount recorded. Management is of the opinion that any adjustment
of the amount recorded would not have a material adverse effect on
the financial statements.
MANAGEMENT FEES - In connection with the organization and offering
stage of related oil and gas entities WELLC receives a management
fee of 5 percent from investor subscriptions, which is credited to
income as earned.
EQUIPMENT - Equipment is recorded at cost. Depreciation is computed
using straight-line and accelerated methods over the estimated useful
lives of the assets. Costs of maintenance and repairs are charged to
expense as incurred.
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 all income and expenses
of the LLC are allocated to the member for inclusion on his
respective income tax return.
USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect 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 reporting period. Actual results could differ from those
estimates.
F-19
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
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., Wolverine Antrim Development 1996-2, L.L.C., Wolverine
Antrim Development 1997-1, L.L.C., and Wolverine Antrim Development
1997-2, 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.
Profits from oil and gas properties are allocated based on the
working interest ownership percentage of the properties.
WELLC holds the following interest in the entities:
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Wolverine Antrim Development Trust 1995 18.9% 20.0%
Wolverine Antrim Development 1996-1, L.L.C. 12.9% 15.0%
Wolverine Antrim Development 1996-2, L.L.C. 14.5% 15.0%
Wolverine Antrim Development 1997-1, L.L.C. 14.8% 15.0%
Wolverine Antrim Development 1997-2, L.L.C. 14.0% -
</TABLE>
F-20
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
NOTE 2 - AFFILIATED OIL AND GAS ENTITIES (CONTINUED)
Following is a summary of financial position and results of
operations of entities whose investments are carried at equity:
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Current assets $ 296,570 $ 237,277
Other assets (net) 11,886,797 6,803,377
---------- ----------
Total assets $12,183,367 $7,040,654
---------- ----------
---------- ----------
Current liabilities $ 192,655 $ 200,256
Equity 11,990,712 6,840,398
---------- ----------
Total liabilities and equity $12,183,367 $7,040,654
---------- ----------
---------- ----------
Net Loss $ (264,453) $ (355,405)
---------- ----------
---------- ----------
</TABLE>
NOTE 3 - LINE OF CREDIT
The line of credit to a bank is due on demand and is secured by all
assets of the Company. The line of credit bears interest at 1.5
percent above the New York Citibank prime rate (effective rate of
10 percent at June 30, 1998). WELLC's credit line is $325,000. The
line of credit is guaranteed by the member.
F-21
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
NOTE 4 - LONG-TERM DEBT
The following is the detail of long-term debt:
<TABLE>
<CAPTION>
1998 1997
------------- ------------
<S> <C> <C>
Notes payable to unrelated parties, due in
monthly interest payments of $2,334 for the first
12 months and then principal and interest
payments of $4,833 thereafter, at an interest
rate of 14%, with any remaining balance due
January 2003. The note is collateralized
by certain investments of the Company and is
guaranteed by the member. $ 200,000 $ -
Notes payable to an unrelated company, due
in monthly interest payments of $3,083, at a
rate of prime plus 10% for an effective rate
of 18.5% at June 30, 1998. The note is
collateralized by all assets of the Company
and is guaranteed by the member. The
principal payment is due March 2000. 200,000 -
Note payable to bank, due in monthly
payments of $6,250 plus interest at a rate
of prime plus 1.5% for an effective rate
of 10% at June 30, 1998. The note is
collateralized by all assets of the Company
and is guaranteed by the member. Final
payment is due April 2003. 346,924 -
---------- ----------
Subtotal 746,924 -
Less current portion 53,251 -
---------- ----------
Long-term portion $ 693,673 -
---------- ----------
---------- ----------
The aggregate principal maturities at June 30, 1998 are as follows:
1998 $ 53,251
1999 109,989
2000 315,215
2001 121,221
2002 137,855
2003 9,393
---------
Total $ 746,924
---------
---------
</TABLE>
F-22
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
NOTE 5 - RELATED PARTY TRANSACTIONS
Because of the nature of WELLC's business, a significant number of
transactions are with related parties.
During 1998 and 1997, WELLC earned turnkey revenue from related
entities in the amount of $1,098,989 and $1,041,497, respectively.
The balance of turnkey revenues and allocated expenses owed to WELLC
included in accounts receivable as of June 30, 1998 and 1997,
totaled $192,263 and $197,257, respectively.
During 1998 and 1997, WELLC charged management fees to related
entities in the amount of $64,286 and $58,806, respectively.
WELLC had outstanding loans totaling $889,884 and $614,129 at June
30, 1998 and 1997, respectively, to the member. The note is payable
in installments over the next three years including interest at 8
percent and is unsecured.
WELLC owed related entities for administrative costs and member
contributions in the amount of $10,859 and $77,024 at June 30, 1998
and 1997, respectively.
F-23
<PAGE>
WOLVERINE ENERGY, L.L.C.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998 AND 1997
NOTE 6 - CASH FLOWS
A reconciliation of net loss to new cash flows used in operating
activities as follows:
<TABLE>
<CAPTION>
1998 1997
------------- ------------
<S> <C> <C>
Net loss $ (286,480) $ (109,373)
Adjustments to reconcile net loss to net cash
from operating activities;
Depreciation, depletion, and amortization
expense 1,187 2,475
Loss from equity investments 1,260 3,538
(Increase) decrease in assets:
Accounts receivable (73,100) 134,057
Working interests held for resale 459,470 335,170
Other (33,570) (79,504)
Increase (decrease) in liabilities:
Accounts payable (14,511) 354,574
Accrued expenses 5,808 9,848
--------- --------
Net cash provided by operating
activities $ 48,448 $631,089
--------- --------
--------- --------
</TABLE>
During 1998, WELLC sold certain investments in related entities to
the member for $40,700 in exchange for a note receivable.
There were no other significant non-cash investing and financing
activities during 1998 and 1997.
NOTE 7. COMMITMENTS AND CONTINGENCIES
As managing member in various affiliated oil and gas LLC's and a
a Trust, WELLC is subject to contingencies that may arise in the
normal course of business of these entities. Management is of the
opinion that liabilities, if any, related to such contingencies that
may arise would not be material to the financial statements.
F-24
<PAGE>
FORM OF COMPANY OPERATING AGREEMENT
COMPANY OPERATING AGREEMENT
of
WOLVERINE ENERGY 98-99( ) DEVELOPMENT COMPANY, L.L.C.
This 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 trustee(s) and managing Interestholder(s) under
this Agreement, is referred as the "Manager," and
as the Initial Investor Member under this Agreement.
W I T N E S S E T H:
WHEREAS, the Manager wishes to organize the WOLVERINE ENERGY 98-99( )
DEVELOPMENT COMPANY, L.L.C. (the "Company") as a limited liability company under
the Michigan Limited Liability Company Act pursuant to Sections
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 owners of interests; and
WHEREAS, Articles of Organization (the "Articles") shall be filed by the
Manager on __________________ __, 199_, with the State of Michigan Department
of Consumer and Industry Services in accordance with the Michigan Act, to
form the Company as a statutory limited liability company under the Michigan
Act;
ARTICLE 1
ORGANIZATION AND POWERS
1.1 COMPANY ESTATE; NAME. It is the intention of the parties hereto that
the Company constitute a limited liability company under the Michigan Act and
that this Agreement constitute the governing instrument of such limited
liability company. The Company created hereby shall be designated as
"Wolverine Energy 98-99( ) Development Company, L.L.C.," which name shall refer
to the Company and which shall not refer to the Manager or the officers, agents,
managing shareholders or beneficial owners of the Manager or the Company, and in
which name the Manager may conduct the business of the Company, make and execute
contracts, instruments and other documents on behalf of the Company and sue and
be sued. The Manager shall, to the extent possible, conduct all business and
execute all documents relating to the Company in the name of the Company. The
Manager may conduct the business of the Company or hold its property in trust
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.
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, 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
COA-1
<PAGE>
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
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 employees and agents of the
Company, a limited liability 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 owners of equity interests in the
Company to the Company and the Manager with only such rights as are conferred on
them by the Michigan Act, the Articles and this Agreement.
1.4 ORGANIZATION ARTICLES. 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, (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 resident 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 SUBSCRIPTION AND 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 Aggregate Capital
Contributions of the Investor Interestholders and accepted by the Company do not
exceed $ (which may be increased, in the sole discretion
of the Manager, to $ ) immediately following the
admission of such Investor Interestholders. The $ amount may
be increased, in the sole discretion of the Manager, to $ ,
but may not be increased beyond that amount at any time.
(b) Each person who or which subscribes for Interests of the Company,
intending to become an Investor Interestholder of the Company, shall execute a
Signature Page and Power of Attorney and thereby agree to the terms of the
Subscription Agreement and this Agreement and shall be bound by each, and shall
make such Capital Contribution to the Company as subscribed for by such person.
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 Aggregate Capital Contributions in the
aggregate amount of at least $300,000 have not been sold or if the
COA-2
<PAGE>
Manager 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 Investor Interestholder
Interests, PRO RATA, regardless of whether their subscriptions for such
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 Aggregate 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 Investor
Interestholder Interests.
(e) The full cash price for Investor Interestholder 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 be dissolved
unless sooner dissolved 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, mortgage or
otherwise encumber 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 the Company or any Company Property;
(b) To pay all indebtedness, taxes and assessments due or to become
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; and
COA-3
<PAGE>
(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
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 of the Company, then title to that part of the Company
Property shall be deemed to be vested in the Manager or any co-trustee, 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" - An 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 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 any amounts contributed by the
Manager pursuant to Section 14.7 hereof.
COA-4
<PAGE>
"Aggregate Net Capital Contributions" - The Aggregate Capital Contributions
of the Investor Interestholders and the Manager pursuant to Article 5 hereof,
less each Investor Interestholder's PRO RATA portion of the expenses described
in Sections 9.5 and 9.6 hereof, less the sum of all distributions pursuant to
Sections 8.1(b) and 8.1(c) hereof.
"Agreement" - This Operating Agreement of the Company, as amended or
otherwise modified from time to time.
"Articles" - The Articles of Organization of the Company, as amended from
time to time.
"Capital Account" - The dollar amount reflecting a Interestholder's capital
interest in the Company from time to time, computed in accordance with Sections
6.1 and 6.2 hereof.
"Capital Contribution" - Each Contributing Interestholder's "Initial
Capital Contribution" shall be equal to such Contributing Interestholder's
initial capital contribution (i.e., the subscription amount for each Investor
Interestholder and the Manager's Contribution for the Manager).
"Cause", when used in connection with the removal of the Manager by a
Majority 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" - The Michigan statutory limited liability company created and
existing pursuant to this Agreement, designated as "Wolverine 98-99( ) Antrim
Development Company. L.L.C."
"Company Property" - All property contributed to, owned or otherwise
acquired by the Company as part of the Company's assets 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.
"Contributing Interestholders" - Each of the Investor Interestholders, to
the extent of and in proportion to their individual capital contributions, and
the Manager to the extent of the Manager's Contribution only.
"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.
COA-5
<PAGE>
"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 Aggregate 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" - An Investor Interestholder Interest or a Manager Interest.
"Interestholder" - An owner of record of one or more Interests, 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.
"Investor" - Each Investor Interestholder and the Manager with respect to
and to the extent of the Manager's Investment Interest.
"Investor Interestholder" - A subscriber for 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 and who or which is admitted as a
member in accordance with Section 1.6 hereof.
"Investor Interestholder Interest" - A beneficial interest in the Company
representing an Initial Capital Contribution of $1,000, issued pursuant to
Section 1.6 hereof in a public offering conducted pursuant to and in accordance
with the terms of the Prospectus.
"Liquidation" - Either (a) the earlier of (i) the date upon which the
Company is terminated under Code Section 708(b)(1), or (ii) the date upon which
the Company ceases to be a going concern, or (b) 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 or approval 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 Aggregate 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 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
Contribution, representing a 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.
COA-6
<PAGE>
"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.
"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,
of the Michigan Compiled Laws, ET SEQ., as the same may be amended from
time to time and any successor to such statute.
"Net Capital Contributions" - The Aggregate 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 and 9.6
hereof, less the sum of all distributions pursuant to Sections 8.1(a) and 8.1(b)
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 Aggregate Capital Contributions of the
Interestholders.
"Participating Investor" - An Investor Interestholder who or which has made
the election provided in Section 11.6 to assume personal liability for the
Special Obligations of the Company and waive limited liability with respect to
such Special Obligations, but only 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.
"Properties" - Interests in mineral and other subsurface rights in parcels
of real property, which may be
COA-7
<PAGE>
evidenced by mineral leaseholds in such parcels or other similar property
interests under applicable law which have been granted by the fee owners thereof
and which provide, INTER ALIA, that the grantee of such leasehold or other
similar property interest may explore for and develop reserves of minerals
underlying such parcel of real property, shall acquire ownership of such
reserves if any are discovered and may occupy such parcel of real property to
the extent necessary to explore for, develop and extract such minerals, in
exchange for the payment to the grantor of a portion of the minerals so
extracted, whether in kind or from the proceeds of the sale thereof by the
grantee.
"Prospectus" - The Prospectus dated , 199 ,
of the Company, together with the Supplement thereto with respect to the
Company, to which this Agreement is Appendix I.
"Regulation" - A final, temporary or proposed Treasury regulation
promulgated under the Code.
"Residual Operating Cash Flow" - Revenues from sales of production reduced
by operating expenses charged by the Operator(s) to the Company's working
interest(s), the Administrative Cost Allowance and Direct Costs 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.
"Selling Agreement" - An agreement, in form and content approved by the
Manager on behalf of the Company, pursuant to which a Soliciting Dealer acts as
non-exclusive agent of the Company to offer and sell Investor Interestholder
Interests to persons who or which satisfy the suitability standards established
by the Manager in a public offering which is registered under the Act and the
securities regulatory statutes of the states in which such offers and sales are
conducted.
"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, and which executes a Selling Agreement
with 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 of whatever type or
description arising solely out of or in connection with its ownership of
working shares in such Initial Well or Additional Development Well, including
but not limited to the obligation to pay the costs of acquisition of the
Company's share in such Initial Well or Additional Development Well, the
drilling and completion of such Initial Well or Additional Development Well,
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 with respect to such
Initial Well or Additional Development Well.
"Subscription Agreement" - The subscription agreement (in substantially the
form which is attached to the Prospectus as Appendix III or such other form as
the Manager may prescribe or approve) which each prospective Investor
Interestholder must enter into with the Company through the execution of a
Signature Page and Power of Attorney in order to subscribe for Investor
Interestholder Interests.
"Termination Date" - 150 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.
COA-8
<PAGE>
(b) If the Company elects as provided in Section 1.6 hereof to
withdraw the offering of Investor Interestholder Interests, 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
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.
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 limitation on his
liability for the Company's acts, debts and obligations that are described in
Section 501(2) 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 Interestholder 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 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.
COA-9
<PAGE>
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;
(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
COA-10
<PAGE>
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 trustee
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 employee or agent of the Company who may provide 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.
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
COA-11
<PAGE>
ALLOCATION OF PROFIT AND LOSS
4.1 INITIAL ALLOCATIONS WITH RESPECT TO CAPITAL CONTRIBUTIONS. All tax
items attributable to expenditures of Aggregate 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 Aggregate Capital
Contributions until and through the dates on which the Aggregate 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 Investor Interestholders' Adjusted Capital
Accounts.
(b) After giving effect to the provisions of Sections 4.1, 4.4, 4.6,
4.7 and 7.4, Profits 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 for the
corresponding period is distributed pursuant to Section 8.1(a) hereof.
(c) Profits remaining after the allocations in Section 4.2 (a) and
(b) above shall be allocated, before Payout, 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 its Promoted Interest and, after Payout, 69.76% to the
Investors (including the Manager with respect to the Manager's Investment
Interest) and 30.24% to the Manager with respect to its Promoted Interest.
(d) Losses shall be allocated, after giving effect to the provisions
of Sections 4.1, 4.4, 4.6, 4.7 and 7.4, for any fiscal periods, first, to the
extent of Profits allocated in Section 4.2(c), then, before Payout, 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 its Promoted Interest and,
after Payout, 69.76% to the Investors (including the Manager with respect to the
Manager's Investment Interest) and 30.24% to the Manager with respect to its
Promoted Interest. The Losses allocated under this Section 4.2(d) shall not
exceed the maximum amount of Losses that can be so allocated without causing any
Investor or the Manager to have a negative amount in his/her/its Adjusted
Capital Account at the end of any fiscal period. All Losses in excess of the
limitation of this Section 4.2(d) shall be allocated to those Investors and/or
the Manager with positive Adjusted Capital Accounts.
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 Investors shall be bound by the provisions of this Agreement
in reporting their Interests 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 a Interestholder's interest in the Company.
COA-12
<PAGE>
(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 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 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 and 9.6 hereof 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.
(b) All organizational expenses of the Company paid pursuant to
Section 9.4 hereof 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.
(c) The management fee expense of the Company paid pursuant to
Section 9.2 hereof 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.
(d) All intangible drilling and development expenses allocated to the
Company with respect to 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 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 Investors
(including the Manager with respect to the Manager's Investment Interest) and to
the Manager with respect to the Manager's Promoted Interest, 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
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(f) 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.
COA-13
<PAGE>
4.5 ALLOCATIONS 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 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.
4.7 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 (including items of gross income, as necessary)
shall be allocated:
(i) first, PRO RATA to the extent of any negative balance in
the Manager's or Investor Interestholders' Adjusted
Capital Accounts;
(ii) second, 5.24% to the Manager with respect to its Promoted
Interest and 94.76% to the Investors (including the
Manager with respect to the Manager's Investment
Interest) until each such Interestholder's Capital
Account equals his Net Capital Contribution;
(iii) third, to the Manager to the extent of any deferred Net
Cash Flow not distributed to the Manager pursuant to the
language of Section 8.1(a) following Section
COA-14
<PAGE>
8.1(a)(3) hereof, to the extent such deferred amounts
have not been recovered;
(iv) fourth, to the Manager with respect to the Manager's
Promoted Interest, an amount equal to the difference
between (A) the quotient determined by dividing the
excess of (x) the Capital Accounts of the Investors
(including the Manager's Capitol Account computed only
with respect to the Manager's Investment Interest) over
(y) the Net Capital Contributions (such difference
between (x) and (y) being the "Computed Capital Account")
by .6976 and (B) the Computed Capital Account, and
(v) then, 30.24% to the Manager with respect to the Manager's
Promoted Interest and 69.76%, PRO RATA, to the Investors
(including the Manager with respect to the Manager's
Investment Interest); provided, however, that the amount
of profit or gain allocated to the Manager pursuant to
this Section 4.7(a)(v) shall be reduced by the amount of
any Contingent Compensation paid to any Soliciting Dealer
pursuant to Section 9.8 hereof.
To the extent required by Code Section 1254, such amounts will be
treated as ordinary income.
(b) Losses shall be allocated PRO RATA to the Investors and the
Manager in proportion to the Capital Account balances of the Investors and the
Manager until each Investor's and the Manager's Capital Account balance equals
zero and, thereafter, 69.76% to the Investors (including the Manager with
respect to the Manager's Investment Interest) and 30.24% to the Manager with
respect to the Manager's Promoted Interest.
ARTICLE 5
CAPITAL CONTRIBUTIONS OF INTERESTHOLDERS
5.1 CAPITAL CONTRIBUTIONS. The Aggregate Capital Contributions of the
Investor Interestholders shall aggregate not less than $300,000. Each Investor
Interestholder shall make a Capital Contribution in exchange for Investor
Interestholder Interests (including fractional Interests), subscribed for by and
issued to such Investor Interestholder in accordance with Section 1.6 hereof,
payable as set forth in Section 5.2 hereof.
5.2 PAYMENT OF CAPITAL CONTRIBUTION. The Capital Contribution 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 Contribution in excess of the
Aggregate Capital Contributions provided for under Section 5.1 hereof, for any
purpose whatsoever.
5.4 MANAGER CONTRIBUTION. The Manager Contribution shall equal 5%
COA-15
<PAGE>
of the Aggregate Capital Contributions of the Investor Interestholders, which
shall be made in cash by the Manager directly to the Company in exchange for
the Manager's Investment Interests to be issued to the Manager in the same
proportion as Interests are issued to the Investor Interestholders hereunder.
The Manager Contribution shall be made not later than December 31 of the year in
which such Aggregate Capital Contributions of the Investor Interestholders are
made. The Manager in its capacity as Manager shall also make capital
contributions in accordance with Section 14.7.
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 Losses
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).
COA-16
<PAGE>
(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.
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 INTERESTHOLDERS 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 a 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
COA-17
<PAGE>
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 of this Subsection
7.4(a), there shall be allocated to each Interestholder with a Interest 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. It is the intent of this provision
that Investors and the Manager will not be allocated any deductions or losses if
such allocation would cause such Investor or the Manager to have a negative
Capital Account balance when any Investor or the Manager has a positive Capital
Account balance.
(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
COA-18
<PAGE>
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, to the extent of
such loans, if any; and
(2) second, 5.24% to the Manager with respect to the
Manager's Promoted Interest and 94.76% to the Investors (including 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
(3) 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
the Manager with respect to the Manager's Investment Interest);
provided, however, that the amount of cash distributed to the Manager
pursuant to this Section 8.1(a)(3) shall be reduced by the amount of
any Contingent Compensation paid to any Soliciting Dealer pursuant to
Section 9.8 hereof.
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 for
Dispositions 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. An Interestholder may refuse to accept a distribution in
kind by giving written notice to the Company
COA-19
<PAGE>
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.
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 completion of 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 2.5% of 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 and amounts paid to the for its services, 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 Aggregate 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 Aggregate 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 Interest 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 2.5% 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 first full elapsed year of Company
operations. The management fee shall be payable on the Escrow Date as to
Aggregate 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.
COA-20
<PAGE>
(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.
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 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 SELLING, MARKETING AND OTHER EXPENSES. The Company shall sequester,
out of Company Property, an amount not to exceed 1.0% of the Aggregate Capital
Contributions with respect to each sale of any whole or fractional Interest to
an Investor Interestholder. Such amount shall be available for application by
the Company in accordance with the provisions of this Section 9.6 on the Escrow
Date as to Aggregate 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
Aggregate Capital Contributions in respect of such Interests. Such amounts
shall be applied by the Company to the payment of the expenses actually incurred
by the Company in the offer and sale of Interests, other selling and marketing
expenses, including fees and expenses of independent contractors (including
Soliciting Dealers) and employees who are engaged in the marketing and sales of
Interests, legal, accounting, and consulting fees and distribution and selling
costs.
COA-21
<PAGE>
Any such expenses incurred by the Company in excess of 1.0% of the Aggregate
Capital Contributions with respect to each sale of any whole or fractional
Interest to an Investor Interestholder shall be paid by the Manager.
9.7 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 and 9.6 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.
9.8 CONTINGENT COMPENSATION. Additional sales commissions ("Contingent
Compensation"), may be paid to the Soliciting Dealers, solely out 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. Contingent Compensation may be paid only from Residual
Operating Cash Flow for the period concerned.
Contingent Compensation shall consist of payments of a portion of Company
profits, computed as a pro rata percentage (determined according to the table
set forth below) of Residual Operating Cash Flow based upon the proportion of
the Aggregate Capital Contributions which are represented by the purchase price
of Interests sold by that Soliciting Dealer. Contingent Compensation with
respect to any year will be payable to Soliciting Dealers not later than April
15 of the succeeding year. Contingent Compensation may be paid only if, (i) the
Interestholders 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 does not 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 minimum numbers of Interests in the
Company pursuant to the schedule provided below:
<TABLE>
<CAPTION>
Amount of Interests Sold Contingent Compensation %
------------------------------------------------------------
<S> <C>
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%
</TABLE>
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
COA-22
<PAGE>
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 Company 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
accounting information for each Interestholder to take into account and report
separately such Interestholder's distributive Interest 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;
(e) Funds or financial instruments that are comprised of or backed by
substantially only those obligations described in clauses (a) through (d)
above; or
(f) advances to a single-purpose finance affiliate of the Manager (a
"Finance Subsidiary") which will utilize such funds solely to fund
acquisitions of rights to acquire working interests in natural gas
development projects, some or all of which may be subsequently acquired by
the Company, which (i) bear interest at a rate equivalent to that which
would obtain between arm's length parties under similar circumstances, and
(ii) are fully secured by first liens on rights to acquire working
interests in natural gas development projects.
COA-23
<PAGE>
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, Interestholder 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;
(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 requesting 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 the
information and documents to be furnished and the time and the location, if
appropriate, of furnishing such 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.
COA-24
<PAGE>
(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 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 Subscription 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 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
COA-25
<PAGE>
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.
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;
(6) Accepting a subscription that constitutes any other
person as a Manager, except as provided in Article 14;
(7) The merger of the Compoany into another or with another
entity; or
(8) The amendment of the Company's Articles of Organization.
(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
COA-26
<PAGE>
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/or
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 not been
accepted;
(g) To withdraw the offering of Interests at any time prior to the
Escrow Date as provided in Section 1.6;
(h) To defer payment by the Company of all or any fees or
compensation payable to it and to continue to be a creditor of the Company with
respect to any amounts so deferred and to cause the Company to pay to it all or
any portion of such amounts as and when the Manager, in its sole discretion,
deems it appropriate to do so; or
(i) 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 operation of the
Company business.
12.6 OFFICERS OF COMPANY; SIGNATORIES.
(a) The Manager may employ or retain such persons as may be necessary
or appropriate
COA-27
<PAGE>
for the conduct of the Company's business, including permanent, temporary or
part-time employees and attorneys, accountants, agents, consultants and
contractors and to have employees and agents who shall be designated as officers
with titles including but not limited to "president", "vice-president",
"treasurer," "secretary," "assistant treasurer," "assistant secretary,",
"managing director" and "chairman" and who in such capacity may act for and on
behalf of the Company, as and to the extent authorized by the Manager, including
without limitation to:
(i) represent the Company in its dealings with third parties, and
execute any kind of document or contracts on behalf of the Company;
(ii) approve the sale, purchase, exchange, lease, mortgage,
assignment, pledge or other transfer or acquisition of, of granting or
acquiring of a security interest in, any asset or assets of the
Company; or
(iii) propose, approve or disapprove of, and take, action for and on
behalf of the Company, with respect to the operations of the Company.
None of such persons need be Interestholders and any of such persons may be
affiliates of the Manager. Except as otherwise prescribed by the Manager or in
this Agreement, each such person shall have the powers and duties assigned to
such person by the Manager and shall serve at the pleasure and under the
direction of the Manager. Any two or more of such offices may be held by the
same person.
Any such 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 by 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 Articles 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 Articles.
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 its 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
COA-28
<PAGE>
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.
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 the product of the number of
Investor Interestholder Interests outstanding at any time (excluding Investor
Interestholder Interests created under Sections 12.9(b) or 12.10) multiplied by
.0524; 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 a Majority 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 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.
COA-29
<PAGE>
(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),
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 INTERESTS
13.1 TRANSFER BY MANAGER. The Manager shall not sell, assign or otherwise
transfer its Manager 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, and (ii) 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.
(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 and be bound by 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 Articles, 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
COA-30
<PAGE>
the transferee shall be admitted to the Company as 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.
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 be admitted to the Company as Investor
Interestholders 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 be admitted to the Company as
Investor Interestholders 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 1.6(c) 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.
COA-31
<PAGE>
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 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 Section
14.1(c), 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
COA-32
<PAGE>
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.
14.6 DEATH, INSANITY, DISSOLUTION OR INSOLVENCY OF AN INVESTOR
INTERESTHOLDER. The death, insanity, dissolution, winding up, insolvency,
bankruptcy, receivership or other legal termination of an Investor
Interestholder who is not a Manager shall have no effect on the form of the
Company and the Company shall not be dissolved thereby.
14.7 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).
14.8 ARTICLES OF CANCELLATION. Upon the winding up of the Company and its
termination, the Manager or liquidating trustee, as the case may be, shall cause
the Articles to be canceled by filing a Articles 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
COA-33
<PAGE>
meeting by proxy, provided that such authority is granted by a writing signed by
the Investor Interestholder and delivered to the Company at or prior to the
meeting.
(b) CONSENTS. Any consent or approval 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 entitled to give such consent or approval, 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 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 Interestholders' 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
Interestholdings 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 Interest 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 Articles,
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 or on behalf of such Investor Interestholder and all
conveyances and other instruments or other Articles necessary or appropriate to
effect an authorized dissolution, liquidation and termination of the Company.
The power of attorney granted herein shall be deemed to be coupled with an
interest, shall be irrevocable and shall survive and not be affected by the
subsequent death, incompetency, incapacity 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.
COA-34
<PAGE>
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.
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 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 possess and exercise all powers vested in such estate
as directed by the Manager.
15.8 AMENDMENT AND CONSTRUCTION OF AGREEMENT.
(a) Amendments to this Agreement may be proposed by either
the Manager or a Majority 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 of
the Investor Interestholders, or (ii) the holders of a Majority 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 his voting or
management rights set forth in this Agreement shall become effective as to
that Interestholder without his written approval thereof.
(b) The Manager shall have the power to construe this Agreement and
to act and cause the Company to act upon any such construction. Its
construction of the same and any action taken pursuant thereto by the Company,
the Manager or a Managing Person in good faith shall be final and conclusive.
15.9 BONDS AND ACCOUNTING. The Manager 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
COA-35
<PAGE>
respective heirs, legal representatives, successors and assigns. This Agreement
constitutes the entire agreement among the Company, the Manager, the 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.
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 trustee 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-36
<PAGE>
Exhibit A
INVESTOR INTERESTHOLDERS
Name
Address
Number of Interests
COA-37
<PAGE>
WOLVERINE ENERGY 1998-1999 DEVELOPMENT PROGRAM
INVESTOR INTERESTHOLDER SIGNATURE PAGE
- -------------------------------------------------------------------------------
PLEASE TYPE OR PRINT CLEARLY IN BLACK INK
- -------------------------------------------------------------------------------
Investor Name (If joint ownership, see below) (PLEASE PRINT)
X
- -------------------------------------------------------------------------------
Signature of Investor Interestholder (manager of fiduciary may sign on behalf of
trustee of qualified plans or other retirement accounts). See also backup
withholding statement below.
Interests $
- ----------------------------------------- --------------------------
Number of Interests Dollar Amount
Minimum 5 Interests, (2 Interests for IRAs) ($1,000 per Interest)
- -------------------------------------------------------------------------------
If Investor Interestholder is trust, qualified plan, other retirement account
partnership, or corporation, indicate capacity of signer
- -------------------------------------------------------------------------------
Social Security or Taxpayer Identification Number
X
- -------------------------------------------------------------------------------
Witness to signature of Investor Interestholder (or of manager of fiduciary
trustee of Investor Interestholder)
IF OTHER THAN INDIVIDUAL(S), CHECK ONE AND INDICATE CAPACITY OF SIGNATORY UNDER
THE SIGNATURE:
/ / Individual Retirement / / Corporation
Account (IRA) / / Other _______________
/ / Keogh / / Uniform Gift to Minors
/ / Trust / / Act of State of ______________
X
- -------------------------------------------------------------------------------
Name of joint Investor Interestholder (if any) (PLEASE PRINT)
IF JOINT OWNERSHIP, CHECK ONE: ALL PARTIES MUST SIGN.
/ / Joint Tenants with Right of Survivorship
/ / Tenant in Common / / Community Property
X
- -------------------------------------------------------------------------------
Signature of joint Investor Interestholder (if any)
Backup Withholding Statement:
/ / Please check this box only if the investor is subject to backup
withholding.
- --------------------------------------------------------------------------
Mailing address
- --------------------------------------------------------------------------
Residence address
- --------------------------------------------------------------------------
City State ZIP
- --------------------------------------------------------------------------
City State ZIP
Name of Investment Executive:
---------------------------------------------
Telephone: ( )
---------------------------------------------------------------
Send this Signature Page and check made payable to Franklin Bank, as escrow
Agent for Wolverine Energy 1998-1999 Development Program to Wolverine Energy,
L.L.C. If trusteed account, send to appropriate trustee for signatures and
witness. Trustee should then forward to Wolverine Energy, L.L.C, 4660 South
Hagadorn Road, Suite 230, East Lansing, Michigan 48823.
Each undersigned agrees to the terms of the Subscription Agreement and, as
required by Regulations pursuant to the Internal Revenue Code, certifies under
penalty of perjury that 1) the Social Security Number or Taxpayer Identification
Number provided above is correct, and 2) the undersigned is not subject to
backup withholding (unless the Backup Withholding Statement box above is
checked) either because he has not been notified that he is subject to backup
withholding as a result of a failure to report all interest or dividends, or
because the Internal Revenue Service has notified him that he is no longer
subject to backup withholding. Executed this _______ day of ________, 199__.
Signature(s):
(1) (X) (2) (X)
-------------------------------- ---------------------------------
(If trusteed account, trustee must sign.)
BROKER MUST COMPLETE BOTH BOXES BELOW. PLEASE TYPE OR PRINT CLEARLY IN BLACK
INK. A COPY WILL BE RETURNED AS CONFIRMATION OF RECEIPT OF SUBSCRIPTION BY
WOLVERINE ENERGY, L.L.C.
- --------------------------------------------------------------------------------
Investor Interestholder Name (print)
- --------------------------------------------------------------------------------
Joint Investor Interestholder Name (print)
- --------------------------------------------------------------------------------
Mailing address
- --------------------------------------------------------------------------------
City State ZIP
- --------------------------------------------------------------------------------
Broker name
- --------------------------------------------------------------------------------
Broker/dealer name
- --------------------------------------------------------------------------------
Mailing Address
- --------------------------------------------------------------------------------
City State ZIP
<PAGE>
WOLVERINE ENERGY
1998-1999
DEVELOPMENT PROGRAM
PROSPECTUS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
----
<S> <C>
Summary of Program 7
Summary of Tax Considerations 21
Management's Discussion and Analysis of
Financial Condition and Results of Operations;
Plan of Operations 23
Risk Factors 26
Investor Interestholder Limited Liability and
Potential Liabilities of Participating
Investor Interestholders 35
Terms of the Offering 38
Plan of Distribution 44
Proposed Activities and Policies 47
Financing 59
Application of Proceeds 61
Participation in Costs and Revenues 62
Compensation and Reimbursement 65
Conflicts of Interest 69
Management 73
Prior Activities 77
Tax Aspects 88
Investment by Pension and
Other Retirements Plans 114
Competition, Markets and Regulation 117
Summary of Company Operating Agreement 121
Legal Opinions 124
Reports and Accounting 124
Additional Information 124
Availability of Documents 126
Glossary of Terms 126
Financial Statements of Manager F-1
Form of Company Operating Agreement COA-1
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 1998-1999 DEVELOPMENT PROGRAM
DATED , 1998
WOLVERINE ENERGY 1998-1999 (A)
DEVELOPMENT COMPANY, L.L.C.
Wolverine Energy 1998-1999 (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 1998-1999 Development Program (the
"Program") dated as of , 1998 (the "Prospectus"), as
amended by this Supplement No. 1 dated , 1998
("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 activated 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 THE OFFERING
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. The offering of Interests of the Company commenced on the date
of this Supplement No. 1.
<PAGE>
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. The primary object of the Manager in
limiting the duration of the offering period and the number of Interests sold
will be to minimize the period during which subscription payments are held in
cash prior to investment in working interests. Therefore, the Manager
anticipates that the maximum offering period will be 180 days and the maximum
number of Interests sold will be $5,000,000. In all events, this offering
shall terminate not later than December 31, 1999.
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.
A-2
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<TABLE>
<S> <C>
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
-----------
-----------
</TABLE>
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;
S-1
<PAGE>
(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
S-2
<PAGE>
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.
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:
<TABLE>
<C> <S>
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 Fraser, Trebilcock Davis & Foster, P.C.*
8.1 Form of opinion of Patzik, Frank & Samotny Ltd.*
10.1 Form of Escrow Deposit Agreement*
10.2 Form of Turnkey Agreement*
24.1 Consent of Plante & Moran, LLP*
24.2 Consent of Fraser, Trebilcock Davis & Foster, P.C.+
24.4 Consent of Patzik, Frank and Samotny Ltd+
25.1 Power of attorney of George H. Arbaugh, Jr (++, if
necessary)
</TABLE>
--------------------------
+ Included in respective opinion
++ To be filed by amendment
/ / Included in Prospectus
* Previously filed
(b) Financial statements:
None
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
S-3
<PAGE>
(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;
(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.
(4) The registrant undertakes to send to each Investor Interestholder
at least on an annual basis a detailed statement of any transactions with the
Manager or its affiliates, and of fees, commissions, compensation and other
benefits paid, or accrued to the Manager or its affiliates for the fiscal
year completed, showing the amount paid or accrued to each recipient and the
services performed.
(5) The registrant undertakes to file a sticker supplement pursuant to
Rule 424(c) under the Act during the distribution period describing each
working interest in a natural gas development property not identified in the
prospectus at such time as there arises a reasonable probability that such
working interest in a natural gas development property will be acquired and
to consolidate all such stickers into a post-effective amendment filed at
least once every three months, with the information contained in such
amendment provided simultaneously to the existing Investor Interestholders.
Each sticker supplement should disclose all compensation and fees received by
the Manager and its affiliates in connection with any such acquisition. The
post-effective amendment shall include audited financial statements meeting
the requirements of Rule 3-14 of Regulation S-X only for working interest in
a natural gas development properties acquired during the distribution period.
The registrant also undertakes to file, after the end of the distribution
period, a current report on Form 8-K containing the financial statements and any
additional information required by Rule 3-14 of Regulation S-X, to reflect each
commitment (i.e., the signing of a binding purchase agreement) made after the
end of the distribution period involving the use of 10% or more (on a cumulative
basis) of the net proceeds of the offering and to provide the information
contained in such report to the Limited Partners at least once each quarter
after the distribution period of the offering has ended.
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.
S-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment No. 5 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 13th day of September 4, 1998.
WOLVERINE ENERGY 1998-1999 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.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
By: /s/ GEORGE H. ARBAUGH, JR. President, Chief Executive September 4, 1998
-----------------------------
George H. Arbaugh, Jr. Officer, Chief Accounting
Officer and sole Director
</TABLE>
S-5
