DEF 14A 1 d804762ddef14a.htm DEF 14A DEF 14A
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934

 

 

Filed by the Registrant  x                             Filed by a party other than the Registrant  ¨

Check the appropriate box:

 

¨ Preliminary Proxy Statement
¨ Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))
x Definitive Proxy Statement
¨ Definitive Additional Materials
¨ Soliciting Material Under Rule 14a-12

Sanchez Production Partners LLC

(Name of Registrant as Specified In Its Charter)

 

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

x No fee required.
¨ Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1)

Title of each class of securities to which transaction applies:

 

     

(2)

Aggregate number of securities to which transaction applies:

 

     

(3)

Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):

 

     

(4)

Proposed maximum aggregate value of transaction:

 

     

(5)

Total fee paid:

 

     

¨ Fee paid previously with preliminary materials.
¨ Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing:
(1)

Amount previously paid:

 

     

(2)

Form, Schedule or Registration Statement No:

 

     

(3)

Filing party:

 

     

(4)

Date Filed:

 

     

 

 

 


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LOGO

PROPOSED CONVERSION—YOUR VOTE IS VERY IMPORTANT

 

 

To the Unitholders of Sanchez Production Partners LLC:

The board of managers of Sanchez Production Partners LLC (the “Company”) approved a Plan of Conversion, including the conversion and agreement of limited partnership contemplated thereby (collectively, the “Plan of Conversion”), dated as of August 25, 2014, providing for the conversion of the Company from a limited liability company organized under the laws of the State of Delaware to a limited partnership organized under the laws of the State of Delaware, subject to the satisfaction of certain closing conditions (including the approval of the Company’s unitholders).

Pursuant to the Plan of Conversion, at the effective time of the conversion, each outstanding common unit of the Company will be converted into one common unit of Sanchez Production Partners LP (“Sanchez LP”), the outstanding Class A units of the Company will be converted into common units of Sanchez LP in a number equal to 2% of the Sanchez LP common units outstanding immediately after the Conversion (after taking into account the conversion of such Class A units) and the outstanding Class Z unit will be cancelled. In addition, an affiliate of Sanchez Oil & Gas Corporation (“SOG”) will become the general partner of Sanchez LP, and incentive distribution rights will be issued by Sanchez LP to another affiliate of SOG. We believe that SOG, due to SOG’s ownership of the general partner of our largest unitholder that also holds all of our Class A units and the Class Z unit, is our affiliate. The transactions contemplated by the Plan of Conversion, including the agreement of limited partnership of Sanchez LP contemplated thereby, are referred to herein collectively as the “Conversion.”

The board of managers of the Company, based on the recommendation of the conflicts committee, (1) has determined that the Plan of Conversion and the transactions contemplated by the Plan of Conversion, including the agreement of limited partnership of Sanchez LP contemplated thereby and the conversion of common units and Class A units of the Company into common units of Sanchez LP in the Conversion, an affiliate of SOG becoming the general partner of Sanchez LP and an affiliate of SOG being issued incentive distribution rights of Sanchez LP, are advisable and in the best interests of the Company and its unitholders and will not adversely affect the unitholders (or any class of unitholders) in any material respect, (2) has approved the Plan of Conversion (including the Conversion and the agreement of limited partnership of Sanchez LP contemplated thereby), (3) has approved an amendment and restatement of the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan as the Sanchez Production Partners LP Long-Term Incentive Plan (the “LTIP Restatement”) and (4) recommends that the unitholders of the Company approve the Plan of Conversion and the LTIP Restatement. The board of managers recommends that you vote FOR the approval of the Plan of Conversion, FOR the approval of the LTIP Restatement and FOR the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies.

Your vote is very important. We cannot complete the Conversion unless, among other things, the holders of a majority of the outstanding common units, Class A units and the Class Z unit of the Company, each voting as separate classes, vote to approve the Plan of Conversion. The Company will hold a special meeting of unitholders to vote on proposals related to the Conversion (the “Special Meeting”). The Special Meeting will be held at the date, time and location set forth below unless adjourned or postponed. Regardless of whether you plan to attend the Special Meeting, please take the time to submit your proxy by completing and mailing the enclosed proxy card. If you hold your common units through an account with a brokerage firm, bank or other nominee, please follow the instructions you receive from them to vote your units.

Special Meeting:

March 6, 2015 at 9:00 a.m. Central Time at the offices of Andrews Kurth LLP, 600 Travis, Suite 4200, Houston, Texas 77002.

The board of managers recommends that you vote FOR the approval of the Plan of Conversion, FOR the approval of the LTIP Restatement and FOR the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies.

 

 

Before casting your vote, please take the time to review carefully this proxy statement/prospectus, including the section entitled “Risk Factors” beginning on page 18 for a discussion of the risks relating to the Conversion.

Thank you for voting.

Sincerely,

 

LOGO

Richard S. Langdon

Chairman of the Board

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities to be issued under this proxy statement/prospectus or the transactions described herein, has passed upon the merits or fairness of the transactions described herein, or has passed upon the adequacy or accuracy of the disclosure in this proxy statement/prospectus. Any representation to the contrary is a criminal offense.

This proxy statement/prospectus is dated February 5, 2015, and is first being mailed to the Company’s unitholders on or about February 5, 2015.


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LOGO

SANCHEZ PRODUCTION PARTNERS LLC

1000 Main Street, Suite 3000

Houston, Texas 77002

NOTICE OF SPECIAL MEETING OF UNITHOLDERS

To be held on March 6, 2015

To the owners of Units of Sanchez Production Partners LLC:

Notice is hereby given that a Special Meeting of the common, Class A and Class Z unitholders of Sanchez Production Partners LLC, a Delaware limited liability company (the “Company”), will be held on March 6, 2015 at 9:00 a.m., Central Time, at the offices of Andrews Kurth LLP, 600 Travis, Suite 4200, Houston, Texas 77002 (the “Special Meeting”) for the following purposes:

 

  1. to approve the Plan of Conversion pursuant to which the Company will convert from a Delaware limited liability company into a Delaware limited partnership, a copy of which is attached as Annex A to the proxy statement/prospectus (Proposal No. 1);

 

  2. to approve an amendment and restatement of the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan as the Sanchez Production Partners LP Long-Term Incentive Plan (the “LTIP Restatement”), a copy of which is attached as Annex C to the proxy statement/prospectus (Proposal No. 2);

 

  3. to approve the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies in favor of the foregoing proposals (Proposal No. 3); and

 

  4. to transact any other business as may properly come before the Special Meeting or any adjournments or postponements thereof.

Attached to this notice is a proxy statement/prospectus setting forth information with respect to these proposals and certain other information.

The Company’s board of managers has fixed the close of business on February 4, 2015 as the record date for the determination of common unitholders, Class A unitholders and the Class Z unitholder entitled to notice of and to vote at the Special Meeting or any adjournment or postponement thereof. Only holders of record of the Company’s common units, Class A units or the Class Z unit at the close of business on the record date are entitled to notice of and to vote at the Special Meeting.

The Company’s board of managers recommends that you vote FOR the Plan of Conversion, FOR the LTIP Restatement and FOR the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies.

Your vote is important. All common unitholders, Class A unitholders and the Class Z unitholder of the Company are cordially invited to attend the Special Meeting. Regardless of whether you plan to attend the Special Meeting, please sign, date and return the enclosed proxy card as promptly as possible in the envelope provided, using the procedures in the voting instructions provided to you. No postage is required if mailed in the United States. Should you receive more than one proxy card because your units are registered in different names and addresses, each proxy card should be signed and returned to ensure that all your units will be voted. Your proxy may be revoked at any time prior to the time it is voted at the Special Meeting.

 

LOGO

Stephen R. Brunner

President, Chief Executive Officer

and Chief Operating Officer

Houston, Texas

February 5, 2015


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ADDITIONAL INFORMATION

This proxy statement/prospectus incorporates by reference important business and financial information about the Company from other documents filed with the Securities and Exchange Commission (the “SEC”) that are not included or delivered with this proxy statement/prospectus. See “Where You Can Find More Information; Incorporation by Reference” beginning on page 131 for a list of the documents incorporated by reference into this proxy statement/prospectus.

Documents incorporated by reference are available to you without charge upon written or oral request. You can obtain any of these documents by requesting them in writing or by telephone from the appropriate company at the following addresses and telephone numbers.

Sanchez Production Partners LLC

1000 Main Street, Suite 3000

Houston, Texas 77002

Attention: Corporate Secretary

Telephone number: (713) 783-8000

http://www.sanchezpp.com

To receive timely delivery of the requested documents in advance of the Special Meeting, you should make your request no later than February 27, 2015.

You may also obtain free copies of the documents filed by the Company with the SEC at the SEC’s web site at www.sec.gov. You may also read and copy any reports, statements or other information filed with the SEC at the SEC public reference room at 100 F Street N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at (800) 732-0330 or visit the SEC’s website for additional information on its public reference room.

Information contained on the Company’s website and any other website is not incorporated by reference herein.

ABOUT THIS DOCUMENT

This document, which forms part of a registration statement on Form S-4 filed with the SEC by Company (File No. 333-198440), constitutes a prospectus of the Company under Section 5 of the Securities Act of 1933, as amended (the “Securities Act”), with respect to the common units of Sanchez LP to be issued to the Company’s common unitholders and the Class A unitholder in connection with the Conversion. This document also constitutes a notice of meeting and a proxy statement under Section 14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to the Special Meeting, at which the Company’s unitholders will be asked to consider and vote upon certain proposals, including a proposal to approve the Conversion and the related transactions, as well as other matters described herein.

You should rely only on the information contained in, or incorporated by reference into, this document. No one has been authorized to provide you with information that is different from that contained in, or incorporated by reference into, this document. This document is dated February 5, 2014. The information contained in this document is accurate only as of that date or in the case of information in a document incorporated by reference, as of the date of such document, unless the information specifically indicates that another date applies. Neither our mailing of this document to the Company’s unitholders nor the conversion by the Company of its common units and Class A units into Sanchez LP common units in connection with the Conversion will create any implication to the contrary.

Unless otherwise stated or the context otherwise implies, references in this proxy statement/prospectus to “we,” “us,” “our” and “the Company” refer to Sanchez Production Partners LLC.


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TABLE OF CONTENTS

 

QUESTIONS AND ANSWERS ABOUT THE CONVERSION

     1   

QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING

     3   

SUMMARY

     7   

The Company

     7   

The Conversion

     7   

Risk Factors

     7   

Treatment of Equity Awards

     8   

Recommendation of the Board of Managers

     8   

Unitholders Entitled to Vote; Vote Required for Approval

     8   

Ownership of the Company

     9   

Appraisal Rights in the Conversion

     10   

Conditions to the Completion of the Conversion

     10   

Tax Consequences of the Conversion

     10   

Payment of Distributions

     10   

Comparison of Rights of Sanchez LP Common Unitholders and Company Common Unitholders

     11   

Executive Offices

     11   

SPECIAL FACTORS

     12   

General Description and Effects of the Conversion

     12   

Background of the Conversion and Relationship with SOG

     12   

Recommendation of Our Board of Managers and Its Reasons for the Conversion

     15   

Affiliate Considerations

     16   

Benefits and Detriments

     17   

Listing of Sanchez LP Common Units

     17   

RISK FACTORS

     18   

Risks Relating to the Conversion

     18   

Risks Inherent in an Investment in Sanchez LP Common Units

     19   

Tax Risks to the Common Unitholders of Sanchez LP

     27   

NOTE REGARDING FORWARD-LOOKING STATEMENTS

     32   

THE SPECIAL MEETING

     33   

Date, Time, Place and Purposes of the Special Meeting

     33   

Who Can Vote at the Special Meeting

     33   

Votes Required for Approval

     33   

Quorum

     33   

Adjournments

     34   

Manner of Voting

     34   

Proxy Voting by Holders of Record

     34   

Voting of Units Held in “Street Name”

     35   

How Proxies Will Be Voted

     35   

Revoking a Proxy

     35   

Solicitation of Proxies and Expenses

     36   

Questions About Voting or the Special Meeting

     36   

PROPOSAL NO. 1: APPROVAL OF THE PLAN OF CONVERSION

     37   

Structure of the Conversion

     37   

Effective Time of the Conversion

     37   

Conversion of Units; Conversion Procedures

     37   

Appraisal Rights

     38   

Treatment of Equity Awards

     38   

Conditions to the Conversion

     38   

Interests of Our Managers and Officers in the Conversion

     39   

Stock Exchange Listing

     40   

Vote Required

     40   

 

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Board Recommendation

     40   

CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS OF SANCHEZ LP

     41   

General

     41   

Our Minimum Quarterly Distribution

     42   

PROVISIONS OF THE PARTNERSHIP AGREEMENT RELATING TO CASH DISTRIBUTIONS

     44   

Distributions of Available Cash

     44   

Operating Surplus and Capital Surplus

     44   

Capital Expenditures

     47   

Incentive Distribution Rights

     48   

Percentage Allocations of Distributions from Operating Surplus

     48   

SP Holdings’ Right to Reset Incentive Distribution Levels

     49   

Distributions from Capital Surplus

     52   

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

     52   

Distributions of Cash Upon Liquidation

     53   

CONFLICTS OF INTEREST AND FIDUCIARY DUTIES

     55   

Conflicts of Interest

     55   

Fiduciary Duties

     59   

DESCRIPTION OF THE COMMON UNITS

     62   

The Units

     62   

Transfer Agent and Registrar

     62   

Transfer of Common Units

     62   

THE PARTNERSHIP AGREEMENT

     64   

Organization and Duration

     64   

Purpose

     64   

Cash Distributions

     64   

Capital Contributions

     64   

Voting Rights

     65   

Applicable Law; Forum, Venue and Jurisdiction

     66   

Limited Liability

     66   

Issuance of Additional Interests

     67   

Amendment of the Partnership Agreement

     68   

Merger, Consolidation, Conversion, Sale or Other Disposition of Assets

     70   

Dissolution

     70   

Liquidation and Distribution of Proceeds

     71   

Withdrawal or Removal of Our General Partner

     71   

Transfer of General Partner Interest

     72   

Transfer of Ownership Interests in the General Partner

     72   

Transfer of Incentive Distribution Rights

     72   

Change of Management Provisions

     73   

Limited Call Right

     73   

Non-Taxpaying Holders; Redemption

     73   

Non-Citizen Assignees; Redemption

     74   

Meetings; Voting

     74   

Voting Rights of Incentive Distribution Rights

     75   

Status as Limited Partner

     75   

Indemnification

     75   

Reimbursement of Expenses

     76   

Books and Reports

     76   

Right to Inspect Our Books and Records

     76   

Registration Rights

     77   

 

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COMPARISON OF RIGHTS OF SANCHEZ LP COMMON UNITHOLDERS AND COMPANY COMMON UNITHOLDERS

     78   

Purpose and Term of Existence

     78   

Distributions of Available Cash

     78   

Merger, Consolidation, Conversion, Sale or Other Disposition of Assets

     79   

Dissolution

     80   

Transfer of General Partner Interest

     81   

Withdrawal or Removal of the General Partner

     81   

Limited Call Right

     83   

Amendment of Governing Agreement

     84   

Liquidation

     88   

Management; Election of Board Members

     88   

Meetings; Voting

     90   

Indemnification

     92   

Transfer of Units

     92   

Non-Taxpaying Assignees and Non-Citizen Assignees; Redemption

     93   

PRICE RANGE OF COMMON UNITS

     95   

RATIO OF EARNINGS TO FIXED CHARGES

     95   

MANAGEMENT

     96   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     99   

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE CONVERSION

     101   

Assumptions Related to the U.S. Federal Income Tax Treatment of the Conversion

     101   

U.S. Federal Income Tax Treatment of the Conversion

     102   

Tax Consequences of the Conversion to the Company

     102   

Tax Consequences of the Conversion to the Company’s Common Unitholders

     102   

Tax Basis and Holding Period of the Sanchez LP Common Units Received

     103   

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES OF SANCHEZ LP COMMON UNIT OWNERSHIP

     104   

Partnership Status

     105   

Common Unitholder Status

     106   

Tax Consequences of Unit Ownership

     106   

Tax Treatment of Operations

     112   

Disposition of Units

     116   

Uniformity of Units

     118   

Tax-Exempt Organizations and Other Investors

     118   

Administrative Matters

     119   

Recent Legislative Developments

     121   

State, Local and Other Tax Considerations

     122   

APPRAISAL RIGHTS

     123   

CONVERSION COSTS AND EXPENSES

     123   

PROPOSAL NO. 2: APPROVAL OF THE AMENDMENT AND RESTATEMENT OF THE CONSTELLATION ENERGY PARTNERS LLC 2009 OMNIBUS INCENTIVE COMPENSATION PLAN AS THE SANCHEZ PRODUCTION PARTNERS LP LONG-TERM INCENTIVE PLAN

     124   

Purpose and Key Features of the LTIP

     124   

Number of Sanchez LP Common Units Subject to the LTIP

     124   

Administration

     125   

Eligibility

     125   

Term of the LTIP

     125   

Types of Awards

     125   

Miscellaneous

     128   

U.S. Federal Income Tax Aspects of the LTIP

     128   

Inapplicability of ERISA

     130   

 

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New Plan Benefits

     130   

Vote Required

     130   

Board Recommendation

     130   

LEGAL MATTERS

     131   

EXPERTS

     131   

WHERE YOU CAN FIND MORE INFORMATION; INCORPORATION BY REFERENCE

     131   

Annex A—Plan of Conversion

     A-1   

Annex B—Form of Agreement of Limited Partnership of Sanchez Production Partners LP

     B-1   

Annex C—Form of Sanchez Production Partners LP Long-Term Incentive Plan

     C-1   

Annex D—Annual Report on Form 10-K of Constellation Energy Partners LLC for the fiscal year ended December 31, 2013

     D-1   

Annex E—Quarterly Report on Form 10-Q of Sanchez Production Partners LLC for the fiscal quarter ended September 30, 2014

     E-1   

Annex F—Sanchez Entity Information

     F-1   

 

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QUESTIONS AND ANSWERS ABOUT THE CONVERSION

Important Information and Risks: The following are brief answers to some questions that you may have regarding the proposed Conversion and the proposals being considered at our Special Meeting of unitholders. We urge you to read and consider carefully the remainder of this proxy statement/prospectus, including the Risk Factors beginning on page 18 and the attached Annexes, because the information in this section does not provide all of the information that might be important to you. Additional important information and descriptions of risk factors are also contained in the documents incorporated by reference in this proxy statement/prospectus.

Your vote is very important. You are encouraged to submit a proxy as soon as possible.

 

Q: What is the Conversion?

 

A: Our board of managers has approved a Plan of Conversion, dated as of August 25, 2014, pursuant to which we will convert from a limited liability company formed under the laws of the State of Delaware into a limited partnership formed under the laws of the State of Delaware and change our name to Sanchez Production Partners LP. The holders of a majority of our outstanding common units, Class A units and the Class Z unit, each voting as a separate class, must approve the Plan of Conversion before the Conversion can occur.

 

Q: Why is the Conversion being proposed?

 

A: Our board of managers believes that the Conversion is in the best interests of our unitholders because, among other reasons, the limited partnership structure is the more traditional organizational structure for businesses such as ours, our affiliate, SOG, has demonstrated its commitment to being our sponsor and we will be better positioned to cooperate with SOG and its affiliates in prospective business acquisitions as a result of its affiliates’ ownership of the general partner interests and incentive distribution rights of Sanchez LP, and such alignment with SOG and its affiliates and potential asset acquisitions by Sanchez LP from such entities could result in more available cash for distribution to unitholders. We, SOG, Sanchez Energy Partners I, LP (“SEPI”), an affiliate of SOG, SP Holdings, LLC (“SP Holdings”), an affiliate of SOG through common ownership, and Messrs. Sanchez III and Willinger believe that the Plan of Conversion is fair to our unaffiliated unitholders.

 

Q: What will unitholders receive as a result of the Conversion?

 

A: At the effective time of the Conversion, each outstanding common unit of the Company will be converted into one common unit of Sanchez LP, the outstanding Class A units of the Company will be converted into common units of Sanchez LP in a number equal to 2% of the Sanchez LP common units outstanding immediately after the Conversion (after taking into account the conversion of such Class A units), and the outstanding Class Z unit will be cancelled.

 

Q: How will the business and control of the Company change as a result of the Conversion?

 

A: We do not anticipate that the business of Sanchez LP will be materially different from the business of the Company. However, control over our operations will change as a result of SP Holdings owning the general partner of Sanchez LP, with the general partner controlling the business and operations of Sanchez LP. Unlike the unitholders of the Company who have the right to elect members to the board of managers of the Company, the common unitholders of Sanchez LP will not have the right to elect members to the board of directors of the general partner of Sanchez LP, as they will be elected by SP Holdings.

Although we currently anticipate that the persons who are currently managers and officers of the Company will become directors and officers of the general partner of Sanchez LP after the effectiveness of the Conversion, no assurance can be provided that SP Holdings, as owner of the general partner of Sanchez LP, will not appoint new directors or that new officers will not be appointed.

 

 

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Q: When does the Company expect to complete the Conversion?

 

A: We are working to complete the Conversion as quickly as possible. We currently expect to complete the Conversion promptly following the Special Meeting. However, we are not able to predict the exact timing of the completion of the Conversion because it is subject to conditions both within and beyond our control. See “Proposal No. 1: Approval of the Plan of Conversion—Conditions to the Conversion,” beginning on page 37.

 

Q: What conditions are required to be fulfilled to complete the Conversion?

 

A: We are not required to complete the Conversion unless certain specified conditions, as described in the Plan of Conversion, are satisfied or waived. These conditions include, but are not limited to:

 

    obtaining approval by the holders of a majority of our outstanding common units, Class A units and Class Z unit, each voting as a separate class;

 

    the registration statement, of which this proxy statement/prospectus is a part, having been declared effective by the SEC;

 

    the common units representing limited partner interests in Sanchez LP being admitted to trading on the NYSE MKT, subject to official notice of issuance;

 

    any waivers, consents or amendments needed under the Company’s contracts, licenses and permits in connection with the Conversion being obtained;

 

    our board of managers not having revoked its recommendation that the unitholders vote in favor of the Plan of Conversion;

 

    our having received all other required regulatory approvals, other than approvals the absence of which would not have a material adverse effect on us; and

 

    the absence of any statute, order or injunction prohibiting the Conversion.

We cannot assure you that the required conditions will be satisfied. For a more complete description of the conditions that must be satisfied or waived prior to the effective time of the Conversion, see “Proposal No. 1: Approval of the Plan of Conversion—Conditions to the Conversion,” beginning on page 37.

 

Q: Are the Company’s unitholders entitled to appraisal rights?

 

A: Holders of our units will not have the right to seek appraisal of the fair value of their units in connection with the Conversion.

 

Q: What are the expected U.S. federal income tax consequences to the Company’s common unitholders as a result of the Conversion?

 

A: It is anticipated that no gain or loss will be recognized by a Company common unitholder solely as a result of the Conversion, other than to the extent a net decrease, if any, in such common unitholder’s share of partnership liabilities pursuant to Section 752 of the Internal Revenue Code of 1986, as amended (the “Code”), exceeds such common unitholder’s adjusted tax basis in its Company common units at the closing of the Conversion. See “Material U.S. Federal Income Tax Consequences of the Conversion” beginning on page 101.

 

Q: Are there risks associated with the Conversion that I should consider in deciding how to vote?

 

A: Yes. You should carefully read the detailed description of the risks associated with the Conversion and the differences that arise from owning interests in a limited partnership rather than a limited liability company, as described under the heading “Risk Factors” beginning on page 18 and “Comparison of the Rights of Sanchez LP Common Unitholders and Company Common Unitholders” beginning on page 78.

 

 

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QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING

 

Q: Why am I receiving this proxy statement/prospectus?

 

A: Our unitholders are being asked to approve the Plan of Conversion of Sanchez Production Partners LLC from a Delaware limited liability company into Sanchez LP, a Delaware limited partnership. In addition, our unitholders are being asked to approve a new long-term incentive plan for Sanchez LP.

 

Q: When and where will the Special Meeting take place?

 

A: The Special Meeting will be held on March 6, 2015, at 9:00 a.m., Central Time, at the offices of Andrews Kurth LLP, 600 Travis, Suite 4200, Houston, Texas 77002.

 

Q: Who can attend and vote at the unitholder’s meeting?

 

A: All holders of our common units, Class A units or Class Z unit of record, as of the close of business on February 4, 2015, the record date for the Special Meeting, are entitled to receive notice of and to vote at the Special Meeting.

 

Q: What proposals are to be considered and voted upon at the Special Meeting?

 

A: Our unitholders are being asked to consider and vote on:

 

  (1) a proposal to approve the Plan of Conversion and the transactions described in the Plan of Conversion (“Proposal No. 1”),

 

  (2) a proposal to approve the LTIP Restatement (“Proposal No. 2”), and

 

  (3) a proposal to approve the adjournment of the Special Meeting, if necessary or appropriate, to solicit additional proxies in favor of the proposal to approve the Plan of Conversion and/or the LTIP Restatement (“Proposal No. 3”).

These proposals are more fully described in the section “The Special Meeting,” beginning on page 33.

 

Q: How does the Company’s board of managers recommend that Company’s unitholders vote?

 

A: Our board of managers, based on the recommendation of the conflicts committee, recommends that our unitholders vote FOR the approval of the Plan of Conversion and FOR the approval of the LTIP Restatement. Our board of managers also recommends that our unitholders vote FOR the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies.

For a more complete description of the recommendations of our board of managers, see “Special Factors—Recommendation of the Company’s Board of Managers and Its Reasons for the Conversion,” beginning on page 12.

 

Q: What is the vote required to approve the proposal related to the Conversion?

 

A: The affirmative vote of the holders of a majority of the outstanding common units, a majority of the outstanding Class A units and the Class Z unit, each voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve the proposal related to the Conversion. Abstentions and broker non-votes will have the same effect as a vote against the proposal related to the Conversion. We believe that each of our managers and officers, as well as SEPI and SP Holdings, will vote in favor of the Plan of Conversion. As of the record date, our managers and executive officers and their affiliates (including SEPI and SP Holdings) owned 6,634,363 common units, all of the outstanding Class A units and the Class Z unit, which constitutes 23%, 100% and 100%, respectively, of the votes needed to approve the Plan of Conversion. See also “Security Ownership of Certain Beneficial Owners and Management” on page 99.

 

 

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Q: What is the vote required to approve the proposal related to the LTIP Restatement?

 

A: The affirmative vote of the holders of a majority of the votes cast by the holders of common units and Class A units, voting together as a single class, and the Class Z unit, voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve the proposal related to the LTIP Restatement. Abstentions and broker non-votes will not be counted either in favor of or against the approval of the LTIP Restatement.

 

Q: What is the vote required to approve the proposal to adjourn the Special Meeting?

 

A: The affirmative vote of the holders of a majority of the votes cast by the holders of common units and Class A units, voting together as a single class, and the Class Z unit, voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve the proposal to adjourn the Special Meeting. Abstentions and broker non-votes will not be counted either in favor of or against the proposal to adjourn the Special Meeting.

 

Q: How do I vote my units?

 

A: After you have carefully read this proxy statement/prospectus, please respond by completing, signing and dating your proxy card and returning it in the enclosed postage-paid envelope as soon as possible.

Please refer to your proxy card or the information forwarded by your broker, bank or other nominee to see which options are available to you.

The method you use to submit a proxy will not limit your right to vote in person at the Special Meeting if you later decide to attend the meeting. If your units are held in the name of a broker, bank or other nominee, you must obtain a proxy, executed in your favor, from the holder of record, to be able to vote in person at the Special Meeting.

 

Q: How are abstentions and broker non-votes treated?

 

A: Abstentions and broker non-votes count for purposes of determining the presence of a quorum. “Broker non-votes” occur when a bank, broker or other holder of record holding units for a beneficial owner does not vote on a particular proposal because that holder does not have discretionary voting power for that particular item and has not received instructions from the beneficial owner. For Proposal No. 1, abstentions and broker non-votes will have the same effect as a vote against the Proposal. For Proposal No. 2 and Proposal No. 3, abstentions and broker non-votes will not be counted either in favor of or against approval of either of the Proposals.

 

Q: How do I vote?

 

A: You may cause your units to be voted by any of the following methods:

 

    By Telephone or Internet—If you have telephone or Internet access, you may submit your proxy vote by following the instructions provided on your proxy card or voting instruction form.

 

    By Mail—You may submit your proxy vote by mail by signing a proxy card if your units are registered or, for units held beneficially in street name, by following the voting instructions included by your broker, trustee or nominee, and mailing it in the enclosed envelope. If you provide specific voting instructions, your units will be voted as you have instructed.

 

   

In Person at the Special Meeting—If your units are registered directly in your name with our transfer agent, Computershare Trust Company, N.A., you are considered, with respect to those units, the unitholder of record. As the unitholder of record, you have the right to vote in person at the Special Meeting. If your units are held in a brokerage account or by another nominee or trustee, you are considered the beneficial owner of units held in street name. As the beneficial owner, you are also

 

 

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invited to attend the Special Meeting. Because a beneficial owner is not the unitholder of record, you may not vote these units in person at the Special Meeting unless you obtain a “legal proxy” from your broker, trustee or nominee that holds your units, giving you the right to vote the units at the Special Meeting. If you plan on attending the Special Meeting in person and need directions to the meeting site, please contact the Corporate Secretary at (713) 783-8000.

 

Q: If I vote by telephone or Internet and received a proxy card in the mail, do I need to return my proxy card?

 

A: No.

 

Q: If my units are held in “street name” by my broker, will my broker vote my units for me?

 

A: If your units are held in a brokerage account, you will receive a full meeting package, including a voting instructions form to vote your units. Your brokerage firm may permit you to provide voting instructions by telephone or by the Internet.

Under the rules of the NYSE MKT, we anticipate that Proposal No. 1 and Proposal No. 2 in this proxy statement will be non-discretionary matters for which specific voting instructions from beneficial owners are required. As a result, brokers and other nominees subject to NYSE MKT rules will not be allowed to vote with respect to these proposals on behalf of a beneficial owner if the beneficial owner does not provide specific voting instructions on these proposals. We urge you to respond to your brokerage firm so that your vote will be cast in accordance with your instructions.

 

Q: What is a proxy?

 

A: A proxy is another person you authorize to vote on your behalf. We solicit proxy cards that are used to instruct the proxy how to vote so that all units may be voted at the Special Meeting even if the holders do not attend the Special Meeting in person.

 

Q: How will my proxy vote my units?

 

A: If you properly sign and return your proxy card or voting instructions form, your units will be voted as you direct. If you sign and return your proxy card or voting instructions form, but do not specify how you want your units voted, they will be voted:

 

    “FOR” the approval of the Plan of Conversion;

 

    “FOR” the approval of the LTIP Restatement; and

 

    “FOR” approval of the adjournment of the Special Meeting, if necessary or appropriate, to solicit additional proxies in favor of the proposal to approve the Plan of Conversion or to approve the LTIP Restatement.

 

     However, if your units are held in “street name” and you do not instruct your broker or other nominee on how to vote your units, your proxy will not be voted as our board of managers recommends.

 

Q: How do I vote using my proxy card?

 

A: There are three steps.

1. Vote on each of the matters as follows:

 

    Proposal No. 1. Check the box “FOR” or “AGAINST” or “ABSTAIN” (to not cast a vote);

 

    Proposal No. 2. Check the box “FOR” or “AGAINST” or “ABSTAIN” (to not cast a vote); and

 

    Proposal No. 3. Check the box “FOR” or “AGAINST” or “ABSTAIN” (to not cast a vote).

 

 

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  2. Sign and date your proxy card. If you do not sign and date your proxy card and do not submit a proxy by telephone or Internet, your votes cannot be counted.

 

  3. Mail your proxy card in the pre-addressed, postage-paid envelope.

 

  Please check the box on your proxy card if you plan to attend the Special Meeting.

 

Q: Can I vote by proxy even if I plan to attend the Special Meeting?

 

A: Yes. If you vote by proxy and decide to attend the Special Meeting in person, you do not need to fill out a ballot at the Special Meeting, unless you want to change your vote.

 

Q: Why might I receive more than one proxy card? Should I vote on each proxy card I receive?

 

A: First, you may have various accounts with us that are registered differently, perhaps in different names or with different social security or federal tax identification numbers. Second, you may also own units indirectly through your broker. Your broker will send you a proxy card or voting instructions form for these units. You should vote on each proxy card or voting instructions form you receive and mail it to the address shown on the applicable proxy card or form.

 

Q: How do I change my vote or revoke my proxy?

 

A: You may change your vote or revoke your proxy at any time before the Special Meeting by:

 

    notifying the Corporate Secretary in writing received prior to the commencement of the Special Meeting at Sanchez Production Partners LLC, 1000 Main Street, Suite 3000, Houston, Texas 77002, that you are changing your vote or revoking your proxy; or

 

    completing and sending in another proxy card or voting instructions form with a later date, which proxy card or voting instructions form is received prior to the closing of the polls at the Special Meeting; or

 

    attending the Special Meeting and voting in person by ballot.

 

Q: Who is soliciting my proxy, how is it being solicited, and who pays the cost?

 

A: Sanchez Production Partners LLC, on behalf of the board of managers, through its managers, officers and employees, is soliciting proxies primarily by mail. However, proxies may also be solicited in person, electronically or by telephone, facsimile, press release, the Internet or advertisements. No additional compensation will be paid to our board members, officers or employees for such services. The Company has also retained Georgeson, Inc. to assist in soliciting proxies from brokers, bank nominees, and other institutional holders for a fee not to exceed $20,000 plus reimbursement of expenses. We will pay the cost of soliciting proxies. We will also reimburse brokers, nominees, banks and other fiduciaries for their expenses in sending these materials to you and receiving your voting instructions.

 

Q: Where will the Sanchez Production Partners LLC Special Meeting be held?

 

A: The Special Meeting will be held on March 6, 2015, at 9:00 a.m. local time at the offices of Andrews Kurth LLP, 600 Travis, Suite 4200, Houston, Texas 77002.

 

 

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SUMMARY

The following is a summary that highlights information contained in this proxy statement/prospectus. This summary may not contain all of the information that is important to you. For a more complete description of the Conversion and the related transactions, we encourage you to read carefully this entire proxy statement/prospectus, including the attached Annexes and the Risk Factors beginning on page 18.

The Company

We are currently a limited liability company formed in 2005. We are focused on the acquisition, development and production of oil and natural gas properties, as well as midstream assets. Our proved reserves are located in the Cherokee Basin in Oklahoma, the Woodford Shale in the Arkoma Basin in Oklahoma, the Central Kansas Uplift in Kansas and in Texas and Louisiana. Our primary business objective is to create long-term value and to generate stable cash flows allowing us to invest in our business to grow our reserves and production.

The Conversion

Our board of managers has approved a plan to convert the company from a limited liability company formed under the laws of the State of Delaware to a limited partnership formed under the laws of the State of Delaware. The Plan of Conversion is attached as Annex A to this proxy statement/prospectus and is incorporated by reference herein. We encourage you to read the Plan of Conversion in its entirety because it is the legal document that governs the Conversion.

Risk Factors

There are risks associated with the Conversion and the limited partner interests that you would receive in connection with the Conversion, including the following:

 

    The general partner of Sanchez LP and its affiliates will have conflicts of interest with us and limited duties to the Sanchez LP unitholders, and they may favor their own interests to the detriment of us and the other unitholders.

 

    The Sanchez LP partnership agreement will restrict the remedies available to holders of Sanchez LP common units for actions taken by the general partner that might otherwise constitute breaches of fiduciary duty.

 

    Holders of Sanchez LP common units will have limited voting rights and will not be entitled to elect the general partner or its directors.

 

    In certain circumstances, holders of Company common units may recognize some income or gain for U.S. federal income tax purposes as a result of the Conversion.

 

    The tax treatment of Sanchez LP will depend on Sanchez LP’s status as a partnership for U.S. federal income tax purposes, as well as it not being subject to a material amount of entity level taxation by individual states.

 

    The unitholders of Sanchez LP will have Sanchez LP’s income taxable to them for U.S. federal income tax purposes even if they do not receive any cash distributions from Sanchez LP.

Please read “Risk Factors” beginning on page 18.

 

 

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Treatment of Equity Awards

The treatment of equity awards outstanding pursuant to the Constellation Energy Partners LLC Long-Term Incentive Plan and the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan is discussed under the heading “Proposal No. 1: Approval of the Plan of Conversion—Treatment of Equity Awards” beginning on page 37.

Recommendation of the Board of Managers

Our board of managers, based on the recommendation of the conflicts committee, (1) has determined that the Plan of Conversion and the transactions contemplated by the Plan of Conversion, including the agreement of limited partnership of Sanchez LP and the conversion of common units and Class A units of the Company into common units of Sanchez LP in connection with the Conversion, having an affiliate of SOG become the general partner of Sanchez LP, and issuing incentive distribution rights of Sanchez LP to an affiliate of SOG are advisable and in the best interests of the Company and its unitholders and will not adversely affect the unitholders (or any class of unitholders) in any material respect, (2) has approved the Plan of Conversion, (3) has approved the LTIP Restatement and (4) recommends that the unitholders of the Company approve the Plan of Conversion and the LTIP Restatement. Our board of managers recommends that you vote FOR the approval of the Plan of Conversion, FOR the approval of the LTIP Restatement and FOR the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies.

Unitholders Entitled to Vote; Vote Required for Approval

Record date: Unitholders can vote at the Special Meeting if they owned common units, Class A units or the Class Z unit at the close of business on February 4, 2015, which is referred to as the record date. On the record date, there were 28,792,584 common units outstanding and entitled to vote at the Special Meeting, held by approximately 55 unitholders of record, there were 484,505 Class A units outstanding and entitled to vote at the Special Meeting, held by SEPI, and there was one Class Z unit outstanding and entitled to vote at the Special Meeting, held by SEPI. A unitholder may cast one vote for each unit owned on the record date.

Quorum required: A quorum is the presence at the Special Meeting in person or by proxy of a majority of each class of unitholders then outstanding and entitled to vote. We must have a quorum of the common units, the Class A units and the Class Z unit to conduct any business at the Special Meeting. Abstentions and broker non-votes will be counted in determining whether a quorum is present at the Special Meeting. “Broker non-votes” occur when a bank, broker or other holder of record holding units for a beneficial owner does not vote on a particular proposal because that holder does not have discretionary voting power for that particular item and has not received instructions from the beneficial owner.

Votes required: With respect to Proposal No. 1 regarding approval of the Plan of Conversion, the affirmative vote of the holders of a majority of the outstanding common units, a majority of the outstanding Class A units and the Class Z unit, each voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve the Plan of Conversion. With respect to Proposal No. 2 and Proposal No. 3 regarding approval of the LTIP Restatement and any adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies, the affirmative vote of the holders of a majority of the votes cast by the holders of common units and Class A units, voting together as a single class, and the holder of the Class Z unit, voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve such proposals. For Proposal No. 1, abstentions and broker non-votes will have the same effect as a vote against the Proposal. For Proposal No. 2 and Proposal No. 3, abstentions and broker non-votes will not be counted either in favor of or against approval of either of the Proposals.

 

 

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Your vote is very important. You are encouraged to vote as soon as possible. If you do not indicate how your units should be voted, units represented by your properly completed proxy will be voted as our board of managers recommends and therefore will be voted FOR the Plan of Conversion, FOR the LTIP Restatement and FOR the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies. However, if your units are held in “street name” and you do not instruct your broker or other nominee on how to vote your units, your proxy will not be voted as our board of managers recommends.

Ownership of the Company

If the Conversion had occurred on the record date, SEPI and SP Holdings would collectively own approximately 20.5% of the outstanding common units of Sanchez LP, the current members of the board of managers and executive officers of the Company would own approximately 4.1% of the outstanding common units of Sanchez LP, and the remaining holders of common units of the Company would own approximately 75.1% of the outstanding common units of Sanchez LP. In addition, Sanchez Production Partners GP LLC (“Sanchez GP”), a wholly-owned subsidiary of SP Holdings and an affiliate of SOG, would own a non-economic general partner interest in Sanchez LP, and SP Holdings would own all of the incentive distribution rights in Sanchez LP.

The following charts illustrate the ownership of the Company before the Conversion and Sanchez LP after the Conversion, as if the Conversion had occurred on the record date:

 

LOGO

 

 

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Appraisal Rights in the Conversion

Pursuant to the Second Amended and Restated Operating Agreement of the Company, as amended to date, our unitholders are not entitled to appraisal rights in connection with the Conversion.

Conditions to the Completion of the Conversion

A number of conditions must be satisfied or waived, where legally permissible, before the proposed Conversion can become effective. These include, among others:

 

    obtaining approval of our common unitholders, Class A unitholders and the Class Z unitholder;

 

    the registration statement, of which this proxy statement/prospectus is a part, having been declared effective by the SEC;

 

    the common units representing limited partner interests in Sanchez LP being admitted to trading on the NYSE MKT, subject to official notice of issuance;

 

    any waivers, consents or amendments needed under the Company’s contracts, licenses and permits in connection with the Conversion being obtained;

 

    our board of managers not having revoked their recommendation that the unitholders vote in favor of the Conversion;

 

    our having received all other required regulatory approvals, other than approvals the absence of which would not have a material adverse effect on us; and

 

    the absence of any statute, order or injunction prohibiting the Conversion.

We cannot assure you when or if all or any of the conditions to the Conversion will be either satisfied or waived or whether the Conversion will occur as intended.

Tax Consequences of the Conversion

The U.S. federal income tax consequences of the Conversion to a common unitholder of the Company will depend, in part, on such common unitholder’s own personal tax situation. The tax discussions contained herein focus on the U.S. federal income tax consequences generally applicable to individuals who are residents or citizens of the United States that hold their Company common units as capital assets, and these discussions have only limited application to other unitholders, including those subject to special tax treatment. The Company’s common unitholders are urged to consult their tax advisors for a full understanding of the U.S. federal, state, local and foreign tax consequences of the Conversion that will be applicable to them.

In connection with the Conversion, the Company expects that a holder of the Company’s common units will not recognize gain as a result of the Conversion except to the extent any net reduction in such common unitholder’s share of liabilities for purposes of Section 752 of the Code exceeds such common unitholder’s adjusted tax basis in its Company common units immediately prior to the closing of the Conversion. Please read “Material U.S. Federal Income Tax Consequences of the Conversion” for a more complete discussion of the U.S. federal income tax consequences of the Conversion.

Payment of Distributions

The Company suspended payment of distributions in June 2009. Upon such time as the board of managers of Sanchez LP’s general partner determines that Sanchez LP has sufficient “available cash,” Sanchez LP intends to make a minimum quarterly distribution of at least $0.05 per unit ($0.20 per unit on an annualized basis) on all of its units. As of the date of this proxy statement/prospectus, we do not anticipate that Sanchez LP will have

 

 

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sufficient available cash to be able to make any distributions on its units during the next 12 months unless it consummates a significant acquisition that generates sufficient available cash, which is a strategy that we are pursuing. The amount of the available cash shortfall during the next twelve months is anticipated to be at least the full amount of the approximately $1.5 million that would be needed to make a distribution in each quarter. We cannot assure you on the timing or amount of distributions that will be made by Sanchez LP, if any. Please see page 43 for a discussion of the risks involved in our being able to make distributions.

Comparison of Rights of Sanchez LP Common Unitholders and Company Common Unitholders

In connection with the effectiveness of the Conversion, our common units and Class A units will automatically convert into common units representing limited partner interests in Sanchez LP. The rights of holders of our limited liability company interests differ from the rights of holders of limited partner interests under the limited partnership agreement of Sanchez LP, as more fully described under the section entitled “Comparison of Rights of Sanchez LP Common Unitholders and Company Common Unitholders,” beginning on page 78.

Executive Offices

The principal executive office of the Company is 1000 Main Street, Suite 3000, Houston, Texas 77002. The telephone number is (713) 783-8000, and the website address is www.sanchezpp.com. Information on our website is provided for informational purposes only and is not incorporated by reference into this proxy statement/prospectus.

 

 

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SPECIAL FACTORS

The following is a description of the material aspects of the Conversion. While the Company believes that the following description covers the material aspects of the Conversion, this description may not contain all of the information that is important to unitholders. The Company encourages its unitholders to carefully read this entire proxy statement/prospectus, including the Plan of Conversion and the form of Sanchez LP partnership agreement attached as Annex A and Annex B, respectively, to this proxy statement/prospectus and incorporated herein by reference, along with the other information contained or incorporated by reference into this proxy statement/prospectus, for a more complete understanding of the Conversion.

General Description and Effects of the Conversion

Our board of managers has approved the Plan of Conversion providing for the Conversion of the Company from a limited liability company formed under the laws of the State of Delaware into Sanchez LP, a limited partnership formed under the laws of the State of Delaware. Upon completion of the Conversion, all of the rights, privileges and obligations of the Company prior to the Conversion will be held by Sanchez LP after the Conversion.

The Plan of Conversion provides that each outstanding common unit of the Company will be converted into one common unit of Sanchez LP, the outstanding Class A units of the Company will be converted into common units of Sanchez LP in a number equal to 2% of the Sanchez LP common units outstanding immediately after the Conversion (after taking into account the conversion of such Class A units), and the outstanding Class Z unit of the Company will be cancelled. In addition, a non-economic general partner interest in Sanchez LP will be issued to Sanchez GP, and the incentive distribution rights of Sanchez LP will be issued to SP Holdings.

At the effective time of the Conversion, the certificate of formation and operating agreement of the Company will be terminated, and a new certificate of formation and partnership agreement of Sanchez LP will be in effect. For a description of the terms of the partnership agreement, and the rights of the unitholders of Sanchez LP thereunder, see “The Partnership Agreement” and the form of partnership agreement of Sanchez LP attached as Annex B to this proxy statement/prospectus.

Background of the Conversion and Relationship with SOG

Our board of managers and management regularly evaluate strategies to improve returns on capital and generation of distributable cash flow in an effort to increase unitholder value. Among other such strategies, we have been looking for a sponsor willing to support our business activities and growth prospects, including one that has, or has significant contact with persons who have, assets available for acquisition by us that could support our return to making distributions to our unitholders that we otherwise suspended in June 2009.

In August 2013, we entered into a contribution agreement with SEPI, an affiliate of SOG, pursuant to which we acquired oil and natural gas properties located in Oklahoma and Texas for $30.4 million. As a result of our issuing equity as partial consideration in connection with the transaction, SEPI acquired a controlling interest in our Class A units and 4,724,407 common units (or $2.01102 per common unit), or approximately 16.6% of our then-outstanding common units, along with our Class Z unit. In connection therewith, we entered into a registration rights agreement with SEPI pursuant to which we granted SEPI, among other things, demand registration rights with respect to the preparation and filing with the SEC of one or more registration statements for the purpose of registering the resale of the common units received as consideration in connection with the transaction.

In August 2013, Constellation Energy Partners Management LLC (“CEPM”), the former owner of all of our outstanding Class A units, filed a lawsuit in the Chancery Court of the State of Delaware against us, certain of our officers and then-existing managers, SOG and SEPI in connection with the foregoing asset acquisition. CEPM contended, among other things, that the issuance of Class A units to SEPI in connection with the

 

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acquisition was not permitted under the Company’s operating agreement, that the individuals appointed by CEPM to our board of managers should not have been removed as managers, and that SEPI, SOG and our then-existing Class A managers participated in the bad faith conduct of the other defendants and interfered with CEPM’s contractual rights under our operating agreement. The lawsuit was settled in March 2014, and in April 2014, SEPI acquired from CEPM all of the remaining Class A units not held by SEPI together with additional common units of the Company. The ownership of the Class A units has allowed SEPI the right to appoint two members to our five-person board of managers. In December 2014, pursuant to the terms of the settlement agreement, CEPM paid $239,631 to SP Holdings for the account of SEPI and transferred 224,851 common units to SP Holdings for the account of SEPI.

In May 2014, we entered into several agreements with our affiliates, SOG and SP Holdings, in order to provide significant integration of technical as well as general and administrative functions between the Company and SOG. These agreements were:

 

    a Shared Services Agreement (“Services Agreement”), pursuant to which SP Holdings provides the services that we require to operate our business, including overhead, technical, administrative, marketing, accounting, operational, information systems, financial, compliance, insurance, professionals and acquisition, disposition and financing services. In connection with providing the services under the Services Agreement, SP Holdings will receive compensation consisting of: (i) a quarterly fee equal to 0.375% of the value of our properties other than our assets located in the Mid-Continent region, (ii) a $1,000,000 administrative fee, which has been paid, (iii) reimbursement for all allocated overhead costs as well as any direct third-party costs incurred, and (iv) for each asset acquisition, asset disposition and financing, a fee not to exceed 2% of the value of such transaction. Each of the foregoing fees (not including the reimbursement of costs) will be paid in cash unless SP Holdings elects for such fee to be paid in equity of the Company. In addition, upon the first acquisition of assets, we are required to amend our operating agreement and issue to SP Holdings the incentive distribution rights described in this proxy statement/prospectus. The Services Agreement has a ten-year term and will be automatically renewed for an additional 10 years unless both SP Holdings and we provide notice to terminate the agreement; the agreement will renew for one-year terms thereafter unless either party provides notice to terminate the agreement. The Services Agreement can be terminated early (i) by either party at any time after July 1, 2016 with six months’ notice to the other party, (ii) by either party if there is an uncured material breach thereunder by the other party, (iii) by us if there is a change in control of SP Holdings and we pay the termination payment discussed below or (iv) by SP Holdings at any time after the Transition Agreement ends with six months’ notice to us. If there is a termination of the Services Agreement other than by either party at the end of the agreement’s term or by us for a breach by SP Holdings, then we will owe a termination payment to SP Holdings equal to $5,000,000 plus 5% of the transaction value of all asset acquisitions theretofore consummated; if we terminate after July 1, 2016 upon six months’ notice, we will also owe to SP Holdings all costs and expenses of SP Holdings that result from such termination;

 

    a Contract Operating Agreement (“Operating Agreement”) pursuant to which SOG provides all services to develop, manage and operate our oil and gas properties or to engage a third-party operator to do so, other than with respect to our properties in the Mid-Continent region. In connection with providing the services under the Operating Agreement, SOG will be reimbursed for all direct charges incurred under COPAS. The Operating Agreement will continue in existence until termination or expiration of the Services Agreement or the Transition Agreement (described below). The Operating Agreement can be terminated early by either party at any time after July 1, 2016 with six months’ notice to the other party or by either party if there is an uncured material breach thereunder by the other party. If we terminate after July 1, 2016 upon six months’ notice, we will also owe SOG all costs and expenses of SOG that result from such termination, to the extent not duplicative with the Services Agreement;

 

   

a Transition and Assistance Agreement (“Transition Agreement”) pursuant to which we make available to SOG and SP Holdings certain of our employees for them to provide services under the Services

 

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Agreement and Operating Agreement. No compensation is paid by any party for the provision or use of employees under the Transition Agreement. All employees remain under our day-to-day control, and we retain the right to terminate employees and have no obligation to hire new employees. SOG has the right to hire any of our employees (which SOG has done with respect to most employees that were resident in our Houston office) and thereafter, SOG will be responsible for all costs and expenses of such employees. The Transition Agreement will continue in existence until termination or expiration of both the Services Agreement and the Operating Agreement. The Transition Agreement can be terminated early by any party if there is an uncured material breach by another party, and SOG and SP Holdings have the right to terminate the Transition Agreement, with respect to their obligations only, upon the expiration or termination of the Operating Agreement or Services Agreement, respectively; and

 

    a Geophysical Seismic Data Use License Agreement (the “License Agreement”) pursuant to which SOG provides to us a non-exclusive, royalty-free license to use seismic, geophysical and geological information relating to our oil and gas properties that is proprietary to SOG and not restricted by agreements that SOG has with landowners or seismic data vendors. The License Agreement continues in effect until termination or expiration of the Services Agreement or such earlier date if we are acquired. SOG also has the right to terminate the License Agreement if there is an uncured material breach by us thereunder.

None of SOG, SP Holdings or their affiliates required or requested that we convert from a limited liability company to a limited partnership, with the incentive distribution rights already having been agreed upon in the Services Agreement as being issued to SP Holdings in connection with an acquisition, notwithstanding our Conversion. Although two of the managers on our board of managers are affiliated with SOG, such managers’ decisions regarding the Conversion were in their capacities as managers of the Company moreso than in connection with their relationships to SOG and its affiliates. Although SP Holdings, as the owner of the proposed general partner of Sanchez LP, has participated in organizational matters regarding the general partner, the Company and its counsel have taken the lead in structuring the Conversion and preparing the applicable documentation, including this proxy statement/prospectus.

In June 2014, we repurchased our outstanding Class C membership interests and Class D membership interests for $1.65 million from the holder thereof in settlement of outstanding litigation, and we subsequently cancelled those interests, thereby simplifying our capital structure.

On July 1, 2014, the “in-service date” occurred under the Services Agreement and the provision of services thereunder commenced without the prior conditions and limitations.

On July 14, 2014, our board of managers and our management began discussions about potentially converting the Company into a limited partnership. Our board of managers directed management to prepare the documentation needed for its review in connection with the Conversion. The sequence of events that had occurred made such time appropriate for converting the Company; namely, we consummated a successful acquisition with an affiliate of SOG, we entered into the Services Agreement, Operating Agreement, Transition Agreement and License Agreement with SP Holdings and SOG, and SP Holdings and SOG had commenced providing the services under these agreements.

On August 25, 2014, the conflicts committee of our board of managers held a special meeting in person, including its legal advisor, Andrews Kurth LLP. The conflicts committee discussed the benefits of the Conversion and unanimously approved the Plan of Conversion in the form attached to this proxy statement/prospectus in Annex A, including the form of partnership agreement attached to this proxy statement/prospectus in Annex B, and recommended the Plan of Conversion for approval by our board of managers.

On August 25, 2014, our board of managers held a special meeting in person, including its legal advisor, Andrews Kurth LLP. Our board of managers discussed the benefits of the Conversion and unanimously approved

 

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the Plan of Conversion in the form attached to this proxy statement/prospectus in Annex A, including the form of partnership agreement attached to this proxy statement/prospectus in Annex B, and recommended the Plan of Conversion for approval by our unitholders. Our board of managers has not retained an unaffiliated representative to act solely on behalf of unaffiliated unitholders for purposes of negotiating the Plan of Conversion or preparing a report on the fairness of the Conversion, nor has the Company, SEPI, SOG, SP Holdings or Messrs. Sanchez III or Willinger received any report, opinion or appraisal from a third party related to the Conversion. None of the Company, SOG, SEPI, SP Holdings or Messrs. Sanchez III or Willinger have made any special provision in connection with the Conversion to grant unaffiliated unitholders access to their respective files or obtained counsel or appraisal services at our or their expense.

We believe that each of our managers and officers, as well as SEPI and SP Holdings, will vote in favor of the Plan of Conversion for the reasons stated in the next section below. As of the record date, our managers and executive officers and their affiliates (including SEPI and SP Holdings) owned 6,634,363 common units, all of the outstanding Class A units and the Class Z unit, which constitutes 23%, 100% and 100%, respectively, of the votes needed to approve the Plan of Conversion.

Recommendation of Our Board of Managers and Its Reasons for the Conversion

After careful consideration, at a special meeting held on August 25, 2014, the conflicts committee and our board of managers, upon recommendation by the conflicts committee, each unanimously determined that the Plan of Conversion and the other transactions contemplated by the Plan of Conversion were advisable and in the best interests of the Company and its unitholders and will not adversely affect the unitholders (or any class of unitholders) in any material respect, approved the Plan of Conversion and the transactions contemplated thereby and directed that the Plan of Conversion be submitted for approval by our unitholders at the Special Meeting. Our board of managers considered both the substantive and procedural fairness of the Conversion and believe that the Conversion is fair to our unaffiliated unitholders. Accordingly, our board of managers recommends that our unitholders vote FOR approval of the Plan of Conversion.

In reaching its determination to approve and recommend the Plan of Conversion for approval by our unitholders, the conflicts committee and our board of managers each consulted with management as well as our legal counsel. In view of the wide variety of factors considered in connection with the Conversion, our board of managers did not consider it practicable to assign relative weights to the specific material factors it considered in reaching its decision. In addition, individual members of our board of managers may have given different weight to different factors. Our board of managers considered this information and these factors as a whole and, overall, considered the relevant information and factors to be favorable to, and in support of, its recommendation.

Our board of managers considered the following factors as generally supporting its decision to recommend that our unitholders approve the Plan of Conversion:

 

    with the one-to-one conversion of all common units of the Company into Sanchez LP common units and the conversion of Class A units of the Company into 2% of the outstanding common units of Sanchez LP immediately after the Conversion (after taking into account the conversion of such Class A units), the economic consequences to our common unitholders are the same under a limited partnership structure as they are under our limited liability company structure;

 

    the limited partnership structure is the more traditional organizational structure for master limited partnerships and a business such as ours, which certain investor groups may more favorably view as an investment alternative;

 

    our affiliate, SOG, has demonstrated its commitment to being our sponsor through the provision of substantially all of the services that we require to operate our business, directly or indirectly through SP Holdings, and ongoing discussions about asset acquisition opportunities, such that transferring control over our operations to an affiliate of SOG through the issuance of the general partner interests to Sanchez GP would more appropriately align SOG’s interests with those of our company;

 

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    as a result of such alignment with SOG, Sanchez LP will be better positioned to cooperate with SOG and its affiliates in prospective business acquisitions and combinations;

 

    with potentially lower general and administrative costs as a result of the Conversion and the enhanced alignment with a sponsor that has, or has affiliates with, assets to contribute to Sanchez LP, Sanchez LP may have more available cash for distribution to unitholders;

 

    Sanchez GP will continue to have a conflicts committee that is available to evaluate any conflict of interest transaction between Sanchez LP and SOG and its affiliates, should our general partner elect to refer a conflict transaction to the conflicts committee; and

 

    the Conversion is not generally expected to be taxable for U.S. federal income tax purposes to holders of the Company’s common units.

Risks and Challenges of the Conversion

The conflicts committee and our board of managers also considered the following potential risks related to the Conversion, but concluded that the anticipated benefits from the Conversion were likely to outweigh these risks:

 

    unlike the members of our board of managers, who are elected by our unitholders, the unitholders of Sanchez LP will not elect members to the board of directors of Sanchez GP;

 

    we will incur substantial transaction costs associated with the Conversion, even if the Conversion does not occur;

 

    the market’s reaction to the Conversion could cause the price of our common units or the common units of Sanchez LP to decline; and

 

    other matters described under “Risk Factors,” beginning on page 18.

Although the preceding list of factors considered is not intended to be exhaustive, in the judgment of our board of managers, the potential benefits of the Conversion outweigh the risks and the potential disadvantages. In view of the variety of factors considered in connection with its evaluation of the proposed Conversion and the terms of the Plan of Conversion, our board of managers did not quantify or assign relative weight to the factors considered in reaching its conclusion. Rather, our board of managers views its recommendation as being based on the totality of the information presented to and considered by it. In addition, individual managers may have given different weight to different factors.

It should be noted that this explanation of the reasoning of our board of managers and all other information presented in this section is forward-looking in nature and therefore should be read in light of the factors discussed under the heading “Note Regarding Forward-Looking Statements,” beginning on page 32.

Affiliate Considerations

Each of SOG, SEPI, SP Holdings and Messrs. Sanchez III and Willinger considered the same factors and risks that were considered by our board of managers as discussed above under “—Recommendation of Our Board of Managers and Its Reasons for the Conversion” in believing that the Plan of Conversion is fair to our unaffiliated unitholders. Each of them considered both the substantive and procedural fairness of the Conversion. In view of the wide variety of factors considered in connection with the Conversion, none of SOG, SEPI, SP Holdings or Messrs. Sanchez III or Willinger considered it practicable to assign relative weights to the specific material factors that were considered in reaching a decision. Each of them considered the information and factors as a whole and, overall, considered the relevant information and factors to be favorable in believing that the Plan of Conversion is fair to our unaffiliated unitholders.

 

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Benefits and Detriments

The following table summarizes the benefits and detriments of the Conversion, as described above and elsewhere in this proxy statement/prospectus, to each of the Company, SOG and its affiliates, and our unaffiliated unitholders:

 

Stakeholder

  

Benefits

  

Detriments

Company   

•     more traditional capital structure

 

•     expands investor base

 

•     aligns SOG’s interests with the Company

 

•     potentially lower general and administrative costs

  

•     incurrence of substantial transaction costs

 

•     potentially adverse market reaction

SOG and its affiliates   

•     same economic consequences as existing structure

 

•     control election of Sanchez GP board members

 

•     increases likelihood of distributions

 

•     no taxation consequences anticipated

  

•     enhances potential liability as owner of the general partner of Sanchez LP

Unaffiliated unitholders   

•     same economic consequences as existing structure

 

•     increases likelihood of distributions

 

•     potential enhancement of common unit liquidity

 

•     no taxation consequences anticipated

  

•     eliminates election of managers by unitholders

Listing of Sanchez LP Common Units

Upon consummation of the Conversion, the common units of the Company will be delisted from the NYSE MKT. The Company anticipates that the Sanchez LP common units will trade on the NYSE MKT under the ticker symbol “SPP” upon the effective time of the Conversion.

 

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RISK FACTORS

Before deciding how to vote, you should carefully consider the risks described below, in addition to the risks and uncertainties and all other information contained or incorporated by reference in this proxy statement/prospectus, including the matters addressed under “Note Regarding Forward-Looking Statements,” on page 32, the risks and uncertainties discussed under “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, as well any other risks discussed in our Quarterly Reports on Form 10-Q filed with the SEC subsequent to such Annual Report, all of which are incorporated by reference into this proxy statement/prospectus. You should also consider the other information in this proxy statement/prospectus and the other documents incorporated by reference into this proxy statement/prospectus. See “Where You Can Find More Information; Incorporation by Reference,” on page 131.

As used in this section, references to “we,” “us” and “our” refer to Sanchez LP. Unless the context otherwise requires, references in this section to any class of units refer to the units of Sanchez LP to be issued and outstanding upon consummation of the Conversion, and references to any unitholders refer to the unitholders of Sanchez LP.

Risks Relating to the Conversion

The date that the Company’s unitholders will receive Sanchez LP common units is uncertain.

The completion of the Conversion is subject to certain approvals and the satisfaction or waiver of certain other conditions. While it is currently anticipated that the Conversion will become effective promptly following the Special Meeting, the effective time might be later than expected due to delays in satisfying such conditions. Accordingly, we cannot provide you with a definitive date on which you will receive the Sanchez LP common units.

Any delay in completing the Conversion may reduce the benefits expected to be obtained from the Conversion.

The Conversion is subject to a number of conditions that are beyond the control of the Company and that may prevent, delay, or otherwise materially adversely affect its completion. See “Proposal No. 1: Approval of the Plan of Conversion—Conditions to the Conversion.” We cannot predict whether or when the conditions to closing will be satisfied. Any delay in completing the Conversion may reduce the benefits that we expect to achieve in the Conversion.

The Conversion may not be completed on a timely basis or at all. Failure to complete the Conversion could negatively impact the Company’s common unit price and the Company’s future business and financial results.

We cannot assure you that the Plan of Conversion will be approved by our unitholders or that the other conditions to the consummation of the Conversion will be satisfied. If the Conversion is not completed, the Company will not receive any of the expected benefits of the Conversion and will be subject to risks and/or liabilities, including the following:

 

    failure to complete the Conversion might be followed by a decline in the market price of the Company’s common units;

 

    certain costs relating to the Conversion (such as legal and accounting fees) will be payable by us regardless of whether the Conversion is completed; and

 

    the proposed Conversion may disrupt the Company’s business and distract its management and employees from day-to-day operations, because work related to the Conversion requires substantial time and resources, which could otherwise have been devoted to other business opportunities for the benefit of the Company.

 

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The rights of the Company’s unitholders who become Sanchez LP unitholders upon the effective time of the Conversion will be governed by Sanchez LP’s certificate of formation and agreement of limited partnership.

The Company’s unitholders who receive Sanchez LP common units in the Conversion will become subject to the Delaware Act, and they will be governed by Sanchez LP’s certificate of limited partnership and agreement of limited partnership, rather than the Company’s certificate of formation and operating agreement. As a result, there will be material differences between the current rights of the Company’s unitholders, as compared to the rights they will have as Sanchez LP common units. For more information, see “Comparison of Rights of Sanchez LP Common Unitholders and Company Common Unitholders,” beginning on page 78.

The Company’s common unitholders could recognize taxable income or gain for U.S. federal income tax purposes as a result of the Conversion.

The Company’s common unitholders who receive Sanchez LP common units in the Conversion will become limited partners of Sanchez LP for U.S. federal income tax purposes and will be allocated a share of Sanchez LP’s nonrecourse liabilities. Each common unitholder of the Company will be treated as receiving a deemed cash distribution equal to the excess, if any, of such common unitholder’s share of nonrecourse liabilities of the Company immediately before the Conversion over such common unitholder’s share of nonrecourse liabilities of Sanchez LP immediately following the Conversion. If the amount of any deemed cash distribution received by a common unitholder of the Company exceeds the common unitholder’s basis in his Company common units immediately prior to the Conversion, such common unitholder will recognize gain in an amount equal to such excess. While there can be no assurance, the Company does not expect that any common unitholders of the Company will recognize gain in this manner. The amount and effect of any gain that may be recognized by a common unitholder of the Company will depend on such common unitholder’s particular situation, including the ability of such common unitholder to utilize any suspended passive losses. For additional information, please read “Material U.S. Federal Income Tax Consequences of the Conversion.”

Risks Inherent in an Investment in Sanchez LP Common Units

Our general partner and its affiliates, including SOG, SP Holdings and SEPI, will have conflicts of interest with us. They will not owe any fiduciary duties to us or our common unitholders, but instead will owe us and our common unitholders limited contractual duties, and they may favor their own interests to the detriment of us and our other common unitholders.

After the Conversion, SP Holdings will own and control our general partner and will appoint all of the directors of our general partner. Although our general partner has a duty to manage us in a manner that is not adverse to us and our unitholders, the directors and officers of our general partner will have a fiduciary duty to manage our general partner in a manner that is beneficial to SP Holdings and its affiliates. Conflicts of interest will arise between SOG, SP Holdings, SEPI and their affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts of interest, our general partner may favor its own interests and the interests of SP Holdings and its affiliates over our interests and the interests of our unitholders. These conflicts include the following situations, among others:

 

    Neither our partnership agreement nor any other agreement will require SP Holdings and its affiliates to pursue a business strategy that favors us or utilizes our assets. The directors and officers of SP Holdings and its affiliates have a fiduciary duty to make these decisions in the best interests of the members of SP Holdings and its affiliates, which may be contrary to our interests. SP Holdings and its affiliates may choose to shift the focus of its investment and growth to areas not served by our assets.

 

    Our general partner is allowed to take into account the interests of parties other than us, such as SOG, SP Holdings, SEPI and their affiliates, in resolving conflicts of interest.

 

    SP Holdings and its affiliates may be constrained by the terms of their respective debt instruments from taking actions, or refraining from taking actions, that may be in our best interests.

 

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    Our partnership agreement will replace the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing its duties, limit our general partner’s liabilities and restrict the remedies available to our unitholders for actions that, without such limitations, might constitute breaches of fiduciary duty.

 

    Except in limited circumstances, our general partner will have the power and authority to conduct our business without unitholder approval.

 

    Disputes may arise under our commercial agreements with SP Holdings, SOG and their affiliates.

 

    Our general partner will determine the amount and timing of asset purchases and sales, borrowings, issuances of additional partnership units and the creation, reduction or increase of cash reserves, each of which can affect the amount of cash available for distribution to our unitholders.

 

    Our general partner will determine the amount and timing of any capital expenditures and whether a capital expenditure is classified as a maintenance capital expenditure, which will reduce operating surplus, or an expansion or investment capital expenditure, which will not reduce operating surplus. This determination can affect the amount of cash that is distributed to our unitholders.

 

    Our general partner will determine which costs incurred by it are reimbursable by us, the amount of which is not limited by the Sanchez LP agreement of limited partnership.

 

    Our general partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make incentive distributions.

 

    Our partnership agreement will permit us to classify up to $20.0 million as operating surplus, even if it is generated from asset sales, non-working capital borrowings or other sources that would otherwise constitute capital surplus. This cash may be used to fund distributions to SP Holdings as the holder of the incentive distribution rights.

 

    Our partnership agreement will not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf.

 

    Our general partner intends to limit its liability regarding our contractual and other obligations.

 

    Our general partner and its controlled affiliates may exercise their right to call and purchase all of the common units not owned by them if they own more than 80% of the common units.

 

    Our general partner will control the enforcement of the obligations that it and its affiliates owe to us, including the obligations of SOG and its affiliates under their commercial agreements with us.

 

    Our general partner will decide whether to retain separate counsel, accountants or others to perform services for us.

 

    Our general partner may elect to cause us to issue common units to SP Holdings in connection with a resetting of the target distribution levels related to our incentive distribution rights without the approval of the conflicts committee of the board of directors of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

Please read “Conflicts of Interest and Fiduciary Duties.”

SOG and its affiliates may compete with us.

SOG and its affiliates may compete with us. As a result, SOG and its affiliates have the ability to acquire and operate assets that directly compete with our assets.

SP Holdings may not allocate corporate opportunities to us.

Pursuant to the terms of our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, will not apply to our general partner or any of its affiliates, including SP Holdings and its executive officers and directors. Any such person or entity that becomes aware of a potential transaction, agreement,

 

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arrangement or other matter that may be an opportunity for us will not have any duty to communicate or offer such opportunity to us. Any such person or entity will not be liable to us or to any limited partner for breach of any fiduciary duty or other duty by reason of the fact that such person or entity pursues or acquires such opportunity for itself, directs such opportunity to another person or entity or does not communicate such opportunity or information to us. This may create actual and potential conflicts of interest between us and affiliates of our general partner and result in less than favorable treatment of us and our common unitholders. Please read “Conflicts of Interest and Fiduciary Duties.”

Our partnership agreement permits our general partner to redeem any partnership interests held by a limited partner who is an ineligible holder.

If our general partner, with the advice of counsel, determines that our not being treated as an association taxable as a corporation or otherwise taxable as an entity for U.S. federal income tax purposes, coupled with the tax status (or lack of proof thereof) of one or more of our limited partners, has, or is reasonably likely to have, a material adverse effect on the maximum applicable rates chargeable to customers by us or our subsidiaries, or we become subject to federal, state or local laws or regulations that create a substantial risk of cancellation or forfeiture of any property that we have an interest in because of the nationality, citizenship or other related status of any limited partner, our general partner may redeem the units held by the limited partner at their current market price. In order to avoid any material adverse effect on rates charged or cancellation or forfeiture of property, our general partner may require each limited partner to furnish information about his U.S. federal income tax status or nationality, citizenship or related status. If a limited partner fails to furnish information about his U.S. federal income tax status or nationality, citizenship or other related status after a request for the information or our general partner determines after receipt of the information that the limited partner is not an eligible holder, our general partner may elect to treat the limited partner as an ineligible holder. An ineligible holder assignee does not have the right to direct the voting of his units and may not receive distributions in kind upon our liquidation. Please read “The Partnership Agreement—Non-Taxpaying Holders; Redemption” and “The Partnership Agreement—Non-Citizen Assignees; Redemption.”

There is no existing market for the common units, and a trading market that will provide you with adequate liquidity may not develop. Following the Conversion, the market price of our common units may fluctuate significantly, and you could lose all or part of your investment.

Although the Company’s common units are currently publicly traded, there is currently no public market for the Sanchez LP common units. After the Conversion, SEPI and SP Holdings will collectively own              common units, representing an aggregate approximately 20.5% limited partner interest in us, in each case based on the number of the Company’s common units outstanding as of the record date. We do not know the extent to which investor interest will result in the continuation of a trading market or how liquid that market might be. You may not be able to resell your common units at or above the price per common unit of the Company on the Conversion date. In addition, the lack of liquidity may result in wide bid-ask spreads, contribute to significant fluctuations in the market price of the common units and limit the number of investors who are able to buy the common units.

The market price of our common units may be influenced by many factors, some of which are beyond our control, including:

 

    the level of our quarterly distributions;

 

    our quarterly or annual earnings or those of other companies in our industry;

 

    announcements by us or our competitors of significant contracts or acquisitions;

 

    changes in accounting standards, policies, guidance, interpretations or principles;

 

    general economic conditions, including interest rates and governmental policies impacting interest rates;

 

    the failure of securities analysts to cover our common units or changes in financial estimates by analysts;

 

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    future sales of our common units; and

 

    other factors described in this proxy statement/prospectus and the documents incorporated herein.

Our partnership agreement will replace our general partner’s fiduciary duties to holders of our common units with contractual standards governing its duties.

Our partnership agreement will contain provisions that eliminate the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law and replace those duties with several different contractual standards. For example, our partnership agreement will permit our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner, free of any duties to us and our unitholders other than the implied contractual covenant of good faith and fair dealing, which means that a court will fill gaps under the partnership agreement to enforce the reasonable expectations of the partners, but only where the language in the partnership agreement does not provide for a clear course of action. This provision entitles our general partner to consider only the interests and factors that it desires and relieves it of any duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or our limited partners. Examples of decisions that our general partner may make in its individual capacity include:

 

    how to allocate business opportunities among us and its other affiliates;

 

    whether to exercise its limited call right;

 

    whether to seek approval of the resolution of a conflict of interest by the conflicts committee of the board of directors of our general partner; and

 

    whether or not to consent to any merger or consolidation of the partnership or amendment to the partnership agreement.

At the time the Conversion becomes effective, our unitholders will be deemed to have agreed to become bound by the provisions in the partnership agreement, including the provisions discussed above. Please read “Conflicts of Interest and Fiduciary Duties—Fiduciary Duties.”

Our partnership agreement will restrict the remedies available to holders of our common units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.

The effect of eliminating fiduciary standards in our partnership agreement is that the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law will be significantly restricted. For example, our partnership agreement will provide that:

 

    whenever our general partner, the board of directors of our general partner or any committee thereof (including the conflicts committee) makes a determination or takes, or declines to take, any other action in their respective capacities, our general partner, the board of directors of our general partner and any committee thereof (including the conflicts committee), as applicable, is required to make such determination, or take or decline to take such other action, in good faith, and under our partnership agreement, a determination, other action or failure to act by our general partner and any committee thereof (including the conflicts committee) will be deemed to be in good faith unless the general partner, the board of directors of the general partner or any committee thereof (including the conflicts committee) believed that such determination, other action or failure to act was adverse to the interests of the partnership or, with regard to certain determinations by the board of directors of our general partner relating to the conflict transactions described below, the board of directors of our general partner did not believe that the specified standards were met, and, except as specifically provided by our partnership agreement, neither our general partner, the board of directors of our general partner nor any committee thereof (including the conflicts committee) will be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;

 

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    our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as such decisions are made in good faith;

 

    our general partner and its officers and directors will not be liable for monetary damages to us or our limited partners resulting from any act or omission unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors, as the case may be, acted in bad faith or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and

 

    our general partner will not be in breach of its obligations under the partnership agreement (including any duties to us or our unitholders) if a transaction with an affiliate or the resolution of a conflict of interest is:

 

    approved by the conflicts committee of the board of directors of our general partner, although our general partner is not obligated to seek such approval;

 

    approved by the vote of a majority of the outstanding common units, excluding any common units owned by our general partner and its affiliates;

 

    determined by the board of directors of our general partner to be on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or

 

    determined by the board of directors of our general partner to be fair and reasonable to us, taking into account the totality of the relationships among the parties involved, including other transactions that may be particularly favorable or advantageous to us.

In connection with a situation involving a transaction with an affiliate or a conflict of interest, any determination by our general partner or the conflicts committee must be made in good faith. If an affiliate transaction or the resolution of a conflict of interest is not approved by our common unitholders or the conflicts committee and the board of directors of our general partner determine that the resolution or course of action taken with respect to the affiliate transaction or conflict of interest satisfies either of the standards set forth in the third and fourth sub-bullets above, then it will be presumed that, in making its decision, the board of directors of our general partner acted in good faith, and in any proceeding brought by or on behalf of any limited partner or the partnership challenging such determination, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.

Furthermore, if any limited partner, our general partner or any person holding any beneficial interest in us brings any claims, suits, actions or proceedings described in “The Partnership Agreement—Applicable Law; Forum, Venue and Jurisdiction” (including, but not limited to, those asserting a claim of breach of a fiduciary duty) and such person does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then such limited partner, our general partner or person holding any beneficial interest in us shall be obligated to reimburse us and our “affiliates,” as defined in Section 1.1 of Sanchez LP’s partnership agreement included in Annex B (including our general partner, the directors and officers of our general partner, SOG, SP Holdings, SEPI and Messrs. Sanchez III and Willinger) for all fees, costs and expenses of every kind and description, including but not limited to all reasonable attorney’s fees and other litigation expenses, that the parties may incur in connection with such claim, suit, action or proceeding. Please read “Conflicts of Interest and Fiduciary Duties” and “The Partnership Agreement.”

Our partnership agreement includes exclusive forum, venue and jurisdiction provisions and limitations regarding claims, suits, actions or proceedings. By taking ownership of a common unit, including by way of the Conversion, a limited partner is irrevocably consenting to these provisions and limitations regarding claims, suits, actions or proceedings and submitting to the exclusive jurisdiction of Delaware courts.

Our partnership agreement is governed by Delaware law. Our partnership agreement includes exclusive forum, venue and jurisdiction provisions designating Delaware courts as the exclusive venue for most claims, suits, actions and proceedings involving us or our officers, directors and employees and limitations regarding claims, suits, actions or proceedings. Please see “The Partnership Agreement—Applicable Law; Forum, Venue

 

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and Jurisdiction.” By taking ownership of a common unit, including by way of the Conversion, a limited partner is irrevocably consenting to these provisions and limitations regarding claims, suits, actions or proceedings and submitting to the exclusive jurisdiction of Delaware courts. If a dispute were to arise between a limited partner and us or our officers, directors or employees, the limited partner may be required to pursue its legal remedies in Delaware, which may be an inconvenient or distant location and which is considered to be a more corporate-friendly environment. Furthermore, if any limited partner, our general partner or person holding any beneficial interest in us brings any claims, suits, actions or proceedings described in “The Partnership Agreement—Applicable Law; Forum, Venue and Jurisdiction” (including, but not limited to, those asserting a claim of breach of a fiduciary duty) and such person does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then such limited partner, our general partner or person holding any beneficial interest in us shall be obligated to reimburse us and our “affiliates,” as defined in Section 1.1 of Sanchez LP’s partnership agreement included in Annex B (including our general partner, the directors and officers of our general partner, SOG, SP Holdings, SEPI and Messrs. Sanchez III and Willinger) for all fees, costs and expenses of every kind and description, including but not limited to all reasonable attorneys’ fees and other litigation expenses, that the parties may incur in connection with such claim, suit, action or proceeding. This provision may have the effect of increasing a unitholder’s cost of asserting a claim and therefore, discourage lawsuits against us and our general partner’s directors and officers. Because fee-shifting provisions such as these are relatively new developments in corporate and partnership law, the enforceability of such provisions are uncertain; in addition, future legislation could restrict or limit this provision of our partnership agreement and its effect of saving us and our affiliates from fees, costs and expenses incurred in connection with claims, actions, suits or proceedings.

Holders of our common units will have limited voting rights and will not be entitled to elect our general partner or its directors.

Unlike the Company’s common unitholders, Sanchez LP’s unitholders will only have limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s and our general partner’s decisions regarding our business. Common unitholders will have no right on an annual or ongoing basis to elect our general partner or its board of directors. Rather, the board of directors of our general partner will be appointed by SP Holdings. Furthermore, if common unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. As a result of these limitations, the price at which the common units will trade could be diminished because of the absence or reduction of a takeover premium in the trading price. Our partnership agreement will also contain provisions limiting the ability of common unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the common unitholders’ ability to influence the manner or direction of management.

Our partnership agreement will restrict the voting rights of common unitholders owning 20% or more of our common units.

Common unitholders’ voting rights are further restricted by a provision of our partnership agreement providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, their transferees and persons who acquired such units with the prior approval of the board of directors of our general partner, cannot vote on any matter. SEPI and its affiliates will not be restricted by this provision in our partnership agreement.

Our general partner interest or the control of our general partner may be transferred to a third-party without unitholder consent.

Our general partner will be able to transfer its general partner interest to a third-party in a merger or in a sale of all or substantially all of any assets it may own without the consent of the common unitholders. Furthermore, there is no restriction in the partnership agreement on the ability of SP Holdings to transfer its membership interest in our general partner to a third party. The new members of our general partner would then be in a position to replace the board of directors and officers of our general partner with their own choices and to control the decisions taken by the board of directors and officers.

 

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The incentive distribution rights held by SP Holdings may be transferred to a third party without unitholder consent.

SP Holdings will be able to transfer its incentive distribution rights to a third party at any time without the consent of our common unitholders. If SP Holdings transfers its incentive distribution rights to a third party but retains its ownership interest in our general partner, our general partner may not have the same incentive to grow our partnership and increase quarterly distributions to unitholders over time as it would if SP Holdings had retained ownership of the incentive distribution rights. For example, a transfer of incentive distribution rights by SP Holdings could reduce the likelihood of SOG or its affiliates accepting offers made by us relating to assets owned by it or its affiliates, as they would have less of an economic incentive to grow our business, which in turn would impact our ability to grow our asset base.

We will be able issue additional units without common unitholder approval, which would dilute unitholder interests.

Our partnership agreement will not limit the number of additional limited partner interests, including limited partner interests that rank senior to the common units, that we may issue at any time without the approval of our common unitholders. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:

 

    our existing limited partners’ proportionate ownership interest in us will decrease;

 

    the amount of cash available for distribution on each limited partnership interest may decrease;

 

    because the amount payable to holders of incentive distribution rights is based on a percentage of the total cash available for distribution, the distributions to holders of incentive distribution rights will increase even if the per unit distribution on common units remains the same;

 

    the ratio of taxable income to distributions may increase;

 

    the relative voting strength of each previously outstanding limited partner interest may be diminished; and

 

    the market price of the common units may decline.

SEPI, SP Holdings and their affiliates may sell limited partner interests in the public or private markets, and such sales could have an adverse impact on the trading price of the common units.

Immediately after the Conversion, based on the number of the Company’s units held on the record date, SEPI and SP Holdings will collectively hold 6,011,362 common units. In addition, we have agreed to provide SEPI with certain registration rights. The sale of these units in the public or private markets could have an adverse impact on the trading price of the common units.

Our general partner intends to limit its liability regarding our obligations.

Our general partner intends to limit its liability under contractual arrangements so that the counterparties to such arrangements have recourse only against our assets and not against our general partner or its assets. Our general partner may therefore cause us to incur indebtedness or other obligations that are nonrecourse to our general partner. Our partnership agreement will permit our general partner to limit its liability, even if we could have obtained more favorable terms without the limitation on liability. In addition, we are obligated to reimburse or indemnify our general partner to the extent that it incurs obligations on our behalf. Any such reimbursement or indemnification payments would reduce the amount of cash otherwise available for distribution to our unitholders.

 

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SP Holdings, or any transferee holding a majority of the incentive distribution rights, may elect to cause us to issue common units to it in connection with a resetting of the minimum quarterly distribution and the target distribution levels related to the incentive distribution rights, without the approval of the conflicts committee of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

The holder or holders of a majority of the incentive distribution rights, which will initially be SP Holdings, will have the right, at any time when such holders have received incentive distributions at the highest level to which they are entitled (35.5%) for each of the prior four consecutive fiscal quarters (and the amount of each such distribution did not exceed adjusted operating surplus for each such quarter), to reset the minimum quarterly distribution and the initial target distribution levels at higher levels based on our cash distribution at the time of the exercise of the reset election. Following a reset election, the minimum quarterly distribution will be reset to an amount equal to the average cash distribution per unit for the two fiscal quarters immediately preceding the reset election (such amount is referred to as the “reset minimum quarterly distribution”), and the target distribution levels will be reset to correspondingly higher levels based on percentage increases above the reset minimum quarterly distribution. SP Holdings has the right to transfer the incentive distribution rights at any time, in whole or in part, and any transferee holding a majority of the incentive distribution rights shall have the same rights as SP Holdings with respect to resetting target distributions.

In the event of a reset of the minimum quarterly distribution and the target distribution levels, the holders of the incentive distribution rights will be entitled to receive, in the aggregate, the number of common units equal to that number of common units which would have entitled the holders to an average aggregate quarterly cash distribution in the prior two quarters equal to the distributions on the incentive distribution rights in the prior two quarters. We anticipate that SP Holdings would exercise this reset right in order to facilitate acquisitions or internal growth projects that would not otherwise be sufficiently accretive to cash distributions per common unit. It is possible, however, that SP Holdings or a transferee could exercise this reset election at a time when it is experiencing, or expects to experience, declines in the cash distributions it receives related to its incentive distribution rights and may therefore desire to be issued common units rather than retain the right to receive incentive distribution payments based on target distribution levels that are less certain to be achieved in the then-current business environment. This risk could be elevated if our incentive distribution rights have been transferred to a third party. As a result, a reset election may cause our common unitholders to experience dilution in the amount of cash distributions that they would have otherwise received had we not issued common units to SP Holdings in connection with resetting the target distribution levels. Please read “Provisions of the Partnership Agreement Relating to Cash Distributions—SP Holdings’ Right to Reset Incentive Distribution Levels.”

Your liability may not be limited if a court finds that unitholder action constitutes control of our business.

A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general partner. Our partnership will be organized under Delaware law, and we will conduct business in and outside of Delaware. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we will do business. You could be liable for any and all of our obligations as if you were a general partner if a court or government agency were to determine that:

 

    we were conducting business in a state but had not complied with that particular state’s partnership statute; or

 

    your right to act with other unitholders to remove or replace our general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitute “control” of our business.

For a discussion of the implications of the limitations of liability on a unitholder, please read “The Partnership Agreement—Limited Liability.”

 

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Unitholders may have liability to repay distributions that were wrongfully distributed to them.

Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act (the “Delaware Act”), we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of an impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Transferees of common units are liable both for the obligations of the transferor to make contributions to the partnership that were known to the transferee at the time of transfer and for those obligations that were unknown if the liabilities could have been determined from the partnership agreement. Neither liabilities to partners on account of their partnership interest nor liabilities that are non-recourse to the partnership are counted for purposes of determining whether a distribution is permitted.

The NYSE MKT does not require a publicly traded limited partnership like us to comply with certain of its corporate governance requirements.

We anticipate that our common units will trade on the NYSE MKT after the Conversion. Because we will be a publicly traded limited partnership, the NYSE MKT does not require us to have a majority of independent directors on our general partner’s board of directors or to establish a compensation committee or a nominating and corporate governance committee. Accordingly, unitholders will not have the same protections afforded to certain corporations that are subject to all of the NYSE MKT corporate governance requirements.

Tax Risks to the Common Unitholders of Sanchez LP

Unitholders may be required to pay taxes on income from us, including their share of ordinary income and any capital gains on dispositions of properties by us, even if they do not receive any cash distributions from us.

Unitholders are required to pay U.S. federal income and other taxes and, in some cases, state and local income taxes, on their share of our taxable income, whether or not they receive cash distributions from us. Generally, should we generate taxable income for a particular tax year and not pay any cash distributions, our unitholders will be required to pay the actual U.S. federal income tax liability that results from their share of such taxable income even though they received no cash distributions from us.

For example, during 2013, we did not pay any cash distributions on our units. Since we generated taxable income allocable to our unitholders for the 2013 tax year, unitholders who held our common units during 2013 did not receive cash distributions from us sufficient to pay any actual tax liability that resulted from their share of such 2013 taxable income. Further, if we generate taxable income from either operations or the sale of assets in future years and do not distribute the resulting cash, our unitholders may not receive sufficient cash distributions to pay the actual tax liability that results from their allocable share of our taxable income. The majority of the proceeds generated in 2013 from the sale of our properties in the Black Warrior Basin was used to pay down debt and did not result in sufficient distributions to unitholders to pay any actual tax liability of each unitholder attributable to such sale.

 

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Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes, as well as our not being subject to a material amount of entity-level taxation by states and localities. If the Internal Revenue Service (“IRS”) were to treat us as a corporation for U.S. federal income tax purposes or if we were to become subject to a material amount of entity-level taxation for state or local tax purposes, then our cash available for distribution would be substantially reduced.

The anticipated after-tax economic benefit of an investment in our common units depends largely on us being treated as a partnership for U.S. federal income tax purposes. A publicly traded partnership such as us may be treated as a corporation for U.S. federal income tax purposes unless it satisfies a “qualifying income” requirement. Based on our current operations we believe that we satisfy the qualifying income requirement and will continue to be treated as a partnership. Failing to meet the qualifying income requirement or a change in current law could cause us to be treated as a corporation for U.S. federal income tax purposes or otherwise subject us to taxation as an entity. We have not requested, and do not plan to request, a ruling from the IRS with respect to our treatment as a partnership for U.S. federal income tax purposes.

If we were treated as a corporation for U.S. federal income tax purposes, we would pay U.S. federal income tax on our taxable income at the corporate income tax rates, which is currently at a maximum marginal rate of 35%, and would likely pay state and local income tax at varying rates. Distributions to unitholders would generally be taxed as corporate distributions, and no income, gains, losses, deductions or credits would flow through to the unitholders. Because a tax would be imposed on us as a corporation, our cash available for distribution to our unitholders would be reduced. Therefore, treatment of us as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to our unitholders likely causing a substantial reduction in the value of our common units.

The Sanchez LP partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state or local income tax purposes, the Target Distributions (as defined in our partnership agreement) will be adjusted to reflect the impact of that law on us.

The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.

The present U.S. federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units, may be modified by administrative, legislative or judicial interpretation at any time. For example, from time to time, members of the U.S. Congress propose and consider substantive changes to the existing U.S. federal income tax laws that affect publicly traded partnerships. Any modification to the U.S. federal income tax laws and interpretations thereof may or may not be applied and could make it more difficult or impossible to meet the exception for us to be treated as a partnership for U.S. federal income tax purposes. We are unable to predict whether any of these changes, or other proposals, will ultimately be enacted. Any such changes could adversely affect an investment in our common units.

At the state level, changes in current state law may subject us to additional entity-level taxation by individual states. Due to widespread state budget deficits and for other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of any such taxes may materially reduce the cash available for distribution to our unitholders.

Certain federal income tax deductions currently available with respect to oil and natural gas exploration and development may be eliminated as a result of future legislation.

Legislation has been proposed that would, if enacted into law, make significant changes to U.S. tax laws, including the elimination of certain key U.S. federal income tax incentives currently available to oil and natural gas exploration and production companies. These changes include, but are not limited to, (i) the repeal of the

 

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percentage depletion allowance for oil and natural gas properties, (ii) the elimination of current deductions for intangible drilling and development costs, (iii) the elimination of the deduction for certain domestic production activities and (iv) an extension of the amortization period for certain geological and geophysical expenditures. Other proposed changes could affect our ability to remain taxable as a partnership for U.S. federal income tax purposes. The passage of any legislation with similar changes in U.S. federal income tax laws could eliminate or postpone certain tax deductions that are currently available with respect to oil and natural gas exploration and development, and any such change could increase the taxable income allocable to our unitholders and negatively impact the value of an investment in our common units.

The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for U.S. federal income tax purposes.

We will be considered to have technically terminated our existing partnership and having formed a new partnership for U.S. federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. For purposes of determining whether the 50% threshold has been met, multiple sales of the same interest will be counted only once. Our termination would, among other things, result in the closing of our taxable year for all unitholders, which would result in us filing two tax returns (and our unitholders could receive two Schedules K-1 if relief was not available, as described below) for one fiscal year and could result in a deferral of depreciation deductions allowable in computing our taxable income for the year of termination. In the case of a unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in such unitholder’s taxable income for the year of termination. Our termination currently would not affect our classification as a partnership for U.S. federal income tax purposes, but instead we would be treated as a new partnership for tax purposes. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we were unable to determine in a timely manner that a termination occurred. The IRS has announced a publicly traded partnership technical termination relief procedure whereby, if a publicly traded partnership that has a technical termination request, the partnership will only have to provide one Schedule K-1 to unitholders for the year, and the IRS grants special relief among other things, notwithstanding two partnership tax years resulting from the technical termination.

A successful IRS contest of the U.S. federal income tax positions we take may adversely affect the market for our common units, and the costs of any contest will reduce cash available for distribution.

We have not requested a ruling from the IRS with respect to our treatment as a partnership for U.S. federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from the positions we take. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take and a court may disagree with some or all of those positions. Any contest with the IRS may materially and adversely impact the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will result in a reduction in cash available for distribution to our unitholders and thus will be borne indirectly by our unitholders.

Tax-exempt entities and foreign persons face unique tax issues from owning common units that may result in adverse tax consequences to them.

Investment in common units by tax-exempt entities, including employee benefit plans and individual retirement accounts (known as IRAs), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations exempt from U.S. federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and may be taxable to such a unitholder. Distributions to non-U.S. persons will be reduced by withholding taxes imposed at the highest effective applicable tax rate, and non-U.S. persons will be required to file U.S. federal income tax returns and pay tax on their share of our taxable income.

 

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We will treat each purchaser of our common units as having the same tax benefits without regard to the common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

Because we cannot match transferors and transferees of common units, we will adopt depletion, depreciation and amortization positions that may not conform with all aspects of existing U.S. Treasury regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to our unitholders. It also could affect the timing of these tax benefits or the amount of gain on the sale of common units and could have a negative impact on the value of our common units or result in audits of and adjustments to our unitholders’ tax returns.

Tax gain or loss on the disposition of our common units could be more or less than expected because prior distributions in excess of allocations of income will decrease a unitholder’s tax basis in his common units.

If a common unitholder sells common units, the unitholder will recognize gain or loss equal to the difference between the amount realized and the tax basis in those common units. Because distributions in excess of a unitholder’s allocable share of our net taxable income decrease the unitholder’s tax basis in its common units, the amount if any, of such prior excess distributions with respect to the common units a unitholder sells will, in effect, become taxable income to the unitholder if it sells such common units at a price greater than its tax basis in those common units, even if the price received is less than its original cost. A substantial portion of the amount realized, whether or not representing gain, may be ordinary income to the unitholder. In addition, because the amount realized may include a unitholder’s share of our nonrecourse liabilities, a unitholder that sells common units may incur a tax liability in excess of the amount of cash received from the sale.

Unitholders may be subject to state and local taxes and return filing requirements in states where they do not live as a result of an investment in our common units.

In addition to U.S. federal income taxes, our unitholders are likely subject to other taxes, including state and local income taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we do business or own property now or in the future, even if they do not reside in any of those jurisdictions. Our unitholders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, our unitholders may be subject to penalties for failure to comply with those requirements. It is the responsibility of each unitholder to file all U.S. federal, state and local tax returns that may be required of such unitholder.

We have adopted certain valuation methodologies that may result in a shift of income, gain, loss and deduction between the holders of incentive distribution rights and the common unitholders. The IRS may challenge this treatment, which could adversely affect the value of our common units.

When we issue additional units or engage in certain other transactions, we determine the fair market value of our assets and allocate any unrealized gain or loss attributable to our assets to the capital accounts of our unitholders, including holders of our incentive distribution rights. Our methodology may be viewed as understating the value of our assets. In that case, there may be a shift of income, gain, loss and deduction between certain common unitholders and the holders of our incentive distribution rights, which may be unfavorable to such common unitholders. Moreover, under our current valuation methods, subsequent purchasers of common units may have a greater portion of their Internal Revenue Code Section 743(b) adjustment allocated to our tangible assets and a lesser portion allocated to our intangible assets. The IRS may challenge our valuation methods, our allocation of the Section 743(b) adjustment attributable to our tangible and intangible assets and our allocations of income, gain, loss and deduction between the holders of our incentive distribution rights and certain of our common unitholders.

A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss being allocated to our common unitholders. It also could affect the amount of gain from our

 

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unitholders’ sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.

We prorate our items of income, gain, loss and deduction between transferors and transferees of common units each month based upon the ownership of the common units on the first day of each month, instead of on the basis of the date a particular common unit is transferred. The IRS may challenge this treatment, which could change the allocation of income, gain, loss and deduction among our unitholders.

We prorate our items of income, gain, loss and deduction between transferors and transferees of common units each month based upon the ownership of the common units on the first day of each month, instead of on the basis of the date a particular common unit is transferred. The use of this proration method may not be permitted under existing or proposed Treasury regulations. If the IRS were to challenge this method or new Treasury regulations were issued, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders.

A unitholder whose common units are loaned to a “short seller” to cover a short sale of common units may be considered as having disposed of those common units. If so, he would no longer be treated for tax purposes as a partner with respect to those common units during the period of the loan and may recognize gain or loss from the disposition.

Because a common unitholder whose common units are loaned to a “short seller” to cover a short sale of common units may be considered as having disposed of the loaned units, he may no longer be treated for tax purposes as a partner with respect to those common units during the period of the loan to the short seller, and he may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of our income, gain, loss or deduction with respect to those common units may not be reportable by the unitholder and any distributions received by the unitholder as to those common units could be fully taxable as ordinary income. Unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller are urged to consult with their tax advisor about whether it is advisable to modify any applicable brokerage account agreements to prohibit their brokers from borrowing their common units.

 

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NOTE REGARDING FORWARD-LOOKING STATEMENTS

The information contained and incorporated by reference in this proxy statement/prospectus contains “forward-looking statements” as defined by the SEC that are subject to a number of risks and uncertainties, many of which are beyond our control. These statements may include discussions about our and Sanchez LP’s:

 

    business strategy;

 

    acquisition strategy;

 

    financial strategy;

 

    ability to resume, maintain and grow distributions;

 

    drilling locations;

 

    oil, natural gas and natural gas liquids reserves;

 

    realized oil, natural gas and natural gas liquids prices;

 

    production volumes;

 

    lease operating expenses, general and administrative expenses and developmental costs;

 

    future operating results; and

 

    plans, objectives, expectations, forecasts, outlook and intentions.

All of these types of statements, other than statements of historical fact included or incorporated by reference in this proxy statement/prospectus, are forward-looking statements. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “could,” “should,” “expect,” “plan,” “project,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “pursue,” “target,” “continue,” the negative of such terms or other comparable terminology.

The forward-looking statements contained and incorporated by reference in this proxy statement/prospectus are largely based on our expectations, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors. Although we believe such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. In addition, management’s assumptions about future events may prove to be inaccurate. Management cautions all readers that the forward-looking statements contained and incorporated in this proxy statement/prospectus are not guarantees of future performance, and we cannot assure any reader that such statements will be realized or the forward-looking events and circumstances will occur. Actual results may differ materially from those anticipated or implied in the forward-looking statements due to factors listed in the “Risk Factors” section and elsewhere in this proxy statement/prospectus. The forward-looking statements speak only as of the date made, and other than as required by law, we do not intend to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.

 

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THE SPECIAL MEETING

Date, Time, Place and Purposes of the Special Meeting

The Special Meeting will be held on March 6, 2015, at 9:00 a.m., Central Time, at the offices of Andrews Kurth LLP, 600 Travis, Suite 4200, Houston, Texas 77002 for the following purposes:

 

  1. to approve the Plan of Conversion of the Company from a limited liability company to a limited partnership, as set forth in the Plan of Conversion, a copy of which is attached as Annex A to the proxy statement/prospectus (Proposal No. 1);

 

  2. to approve the LTIP Restatement, a copy of which is attached as Annex C to the proxy statement/prospectus (Proposal No. 2);

 

  3. to approve the adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies in favor of the approval of the Plan of Conversion (Proposal No. 3); and

 

  4. to transact any other business as may properly come before the Special Meeting or any adjournments or postponements thereof.

Our board of managers recommends that unitholders vote FOR Proposal No. 1, Proposal No. 2 and Proposal No. 3.

For the reasons for these recommendations, see “Special Factors—Recommendation of Our Board of Managers and Its Reasons for the Conversion,” beginning on page 15.

Who Can Vote at the Special Meeting

Unitholders can vote at the Special Meeting if they owned common units, Class A units or the Class Z unit at the close of business on February 4, 2015, which is referred to as the record date. On the record date, there were 28,792,584 common units outstanding and entitled to vote at the Special Meeting, held by approximately 55 unitholders of record, there were 484,505 Class A units outstanding and entitled to vote at the Special Meeting, held by SEPI, and there was one Class Z unit outstanding and entitled to vote at the Special Meeting, held by SEPI. A unitholder may cast one vote for each unit owned on the record date.

Votes Required for Approval

With respect to Proposal No. 1 regarding approval of the Plan of Conversion, the affirmative vote of the holders of a majority of the outstanding common units, a majority of the outstanding Class A units and the Class Z unit, each voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve the Plan of Conversion. With respect to Proposal No. 2 and Proposal No. 3 regarding approval of the LTIP Restatement and any adjournment of the Special Meeting to a later date or dates, if necessary or appropriate, to solicit additional proxies, the affirmative vote of the holders of a majority of the votes cast by the holders of common units and Class A units, voting together as a single class, and the Class Z unit, voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve such proposals. No separate vote of our unaffiliated unitholders is required with respect to Proposal No. 1, Proposal No. 2 or Proposal No. 3.

For Proposal No. 1, abstentions and broker non-votes will have the same effect as a vote against the Proposal. For Proposal No. 2 and Proposal No.  3, abstentions and broker non-votes will not be counted either in favor of or against approval of either of the Proposals.

Quorum

A quorum will be present at Special Meeting if a majority of each class of unitholders then outstanding and entitled to vote is present in person or by proxy. Because there were 28,792,584 common units outstanding and eligible to vote on February 4, 2015, the presence in person or by proxy of 14,396,293 common units is required to

 

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constitute a quorum with respect to the common units. Because there were 484,505 Class A units outstanding and eligible to vote on February 4, 2015, the presence in person or by proxy of 242,253 Class A units is required to constitute a quorum with respect to the Class A units. The holder of the Class Z unit must be present in person or by proxy in order to constitute a quorum with respect to the Class Z unit.

Abstentions and broker non-votes will be treated as present at the Special Meeting for purposes of determining the presence or absence of a quorum for the transaction of all business. We must have a quorum with respect to each of the common units, the Class A units and the Class Z unit to conduct any business at the meeting.

Adjournments

If a quorum with respect to any of the common units, Class A units or the Class Z unit is not present in person or represented by proxy at the Special Meeting, the Special Meeting may be adjourned by the affirmative vote of the holders of a majority of the votes cast by the holders of common units and Class A units, voting together as a single class, and the Class Z unit, voting as a separate class, and entitled to vote at the Special Meeting. In addition, if the adjournment proposal is approved, adjournments of the Special Meeting may be made for the purpose of soliciting additional proxies in favor of Proposal No. 1 or Proposal No. 2.

Manner of Voting

We refer to a unitholder who holds units in the unitholder’s own name (as opposed to being held in the name of their broker, bank or other nominee) as a “holder of record.” Holders of record may vote in person at the Special Meeting or by proxy. We recommend that holders of record vote by proxy even if they plan to attend the Special Meeting. Holders of record can always revoke their proxy and change their votes at the Special Meeting.

Proxy Voting by Holders of Record

Voting instructions are attached to your proxy card. If you properly submit your proxy to us in time to vote, one of the individuals named as your proxy will vote your units at the Special Meeting as you have directed. You may vote for or against any or all of the proposals submitted at the Special Meeting or abstain from voting.

If you are a holder of record, please vote your proxy by mail as provided below. Your submission of proxy authorizes Stephen R. Brunner and Charles C. Ward, or each of them, with or without the other, proxies, with full power of substitution and re-substitution, to vote all common units that you are entitled to vote at the Special Meeting.

To submit your proxy by mail, there are three steps:

 

  1. Vote on each of the matters as follows:

 

    Proposal No. 1. Check the box “FOR” or “AGAINST” or “ABSTAIN” (to not cast a vote);

 

    Proposal No. 2. Check the box “FOR” or “AGAINST” or “ABSTAIN” (to not cast a vote); and

 

    Proposal No. 3. Check the box “FOR” or “AGAINST” or “ABSTAIN” (to not cast a vote).

 

  2. Sign and date your proxy card. If you do not sign and date your proxy card and do not submit a proxy by telephone or Internet, your votes cannot be counted.

 

  3. Mail your proxy card in the pre-addressed, postage-paid envelope.

Please check the box on your proxy card if you plan to attend the Special Meeting.

Only the latest dated proxy received from you will be voted at the Special Meeting.

 

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Voting of Units Held in “Street Name”

If your units are not held in your own name but rather by your broker, bank or another nominee, we refer to your units as being held in “street name” by your nominee.

If your units are held in “street name” and you wish to attend the Special Meeting and personally vote your units held in street name, you must obtain a legally sufficient proxy from your nominee authorizing you to vote your units held in street name. If your units are held in a brokerage account, you will receive a full meeting package, including a voting instructions form to vote your units. If you do not receive a request for voting instructions from your nominee well in advance of the Special Meeting, we recommend that you directly contact your nominee to determine how to cause your units to be voted as you wish. Your brokerage firm may permit you to provide voting instructions by telephone or by the Internet.

Under the rules of the NYSE MKT, we anticipate that Proposal No. 1 and Proposal No. 2 in this proxy statement/prospectus will be non-discretionary matters for which specific voting instructions from beneficial owners are required. As a result, brokers and other nominees subject to NYSE MKT rules will not be allowed to vote with respect to any proposal on behalf of a beneficial owner if the beneficial owner does not provide specific voting instructions on that proposal. Your units held in street name will, however, be counted for purposes of determining whether a quorum is present at the Special Meeting. We urge you to respond to your brokerage firm so that your vote will be cast in accordance with your instructions.

How Proxies Will Be Voted

All units entitled to vote and represented by properly completed proxies received prior to the Special Meeting (unless properly revoked) will be voted at the Special Meeting as instructed on the proxies.

If holders of record who submit a properly completed proxy do not indicate how their units should be voted on a matter, the units represented by their proxy will be voted (unless properly withdrawn) as our board of managers recommends and therefore will be voted:

 

    FOR the proposal to approve the Plan of Conversion,

 

    FOR the proposal to approve the LTIP Restatement, and

 

    FOR the proposal to adjourn the Special Meeting to a later date or date, if necessary or appropriate, to allow for the solicitation of additional proxies.

However, if your units are held in “street name” and you do not instruct your broker or other nominee on how to vote your units, your proxy will not be voted as our board of managers recommends.

Revoking a Proxy

You may revoke your proxy at any time prior to its exercise by:

 

    notifying the Company’s Corporate Secretary in writing received prior to the commencement of the Special Meeting at Sanchez Production Partners LLC, 1000 Main Street, Suite 3000, Houston, Texas 77002, that you are changing your vote or revoking your proxy; or

 

    completing and sending in another proxy card or voting instructions form with a later date, which proxy card or voting instructions form is received prior to the closing of the polls at the Special Meeting; or

 

    attending the Special Meeting and voting in person by ballot.

Your attendance at the Special Meeting in person without voting will not automatically revoke your proxy. If you revoke your proxy during the Special Meeting, this will not affect any vote previously taken. If you hold units in street name and you desire to revoke your proxy, you should follow the instructions provided by your nominee.

 

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Solicitation of Proxies and Expenses

Sanchez Production Partners LLC, on behalf of its board of managers, through its board members, officers and employees, is soliciting proxies primarily by mail. However, proxies may also be solicited in person, electronically or by telephone, facsimile, press release, the Internet or advertisements. No additional compensation will be paid to our managers, officers or employees for such services. The Company has also retained Georgeson, Inc. to assist in soliciting proxies from brokers, bank nominees, and other institutional holders for a fee not to exceed $20,000 plus reimbursement of expenses. We will pay the cost of soliciting proxies. We will also reimburse brokers, nominees, banks and other fiduciaries for their expenses in sending these materials to you and receiving your voting instructions.

Questions About Voting or the Special Meeting

If you have any questions or need further assistance in voting your units, please call the Company’s Investor and Media Relations at (877) 843-0009 (toll-free).

 

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PROPOSAL NO. 1: APPROVAL OF THE PLAN OF CONVERSION

The following summary describes material provisions of the Plan of Conversion, which is attached as Annex A to this proxy statement/prospectus and is incorporated by reference herein. This summary may not contain all of the information about the Plan of Conversion that is important to you. You are encouraged to carefully read the Plan of Conversion in its entirety for a more complete understanding of the terms and conditions of the Conversion.

Structure of the Conversion

Subject to the conditions of the Plan of Conversion, the Company will convert from a limited liability company formed under the laws of the State of Delaware to a limited partnership formed under the laws of the State of Delaware. Upon the effectiveness of the Conversion, the converted entity’s name will change to Sanchez Production Partners LP.

Effective Time of the Conversion

Consummation of the Conversion is expected to occur, subject to the satisfaction or waiver of all closing conditions, promptly following the Special Meeting. The Conversion will become effective, assuming satisfaction or waiver of all other closing conditions, immediately when the certificate of Conversion is accepted for filing by the Secretary of State of Delaware (or such later time as set forth in the certificate of Conversion). In this proxy statement/prospectus, the time when the Conversion becomes effective is referred to as the effective time of the Conversion.

Conversion of Units; Conversion Procedures

Conversion of Units

The Plan of Conversion provides that each outstanding common unit of the Company will be converted into one common unit of Sanchez LP, the outstanding Class A units of the Company will be converted into common units of Sanchez LP in a number equal to 2% of the Sanchez LP common units outstanding immediately after the Conversion (after taking into account the conversion of such Class A units), and the outstanding Class Z unit will be cancelled. In addition, a non-economic general partner interest will be issued to Sanchez GP, and the incentive distribution rights of Sanchez LP will be issued to SP Holdings.

At the effective time of the Conversion, the certificate of formation and operating agreement of the Company will be terminated, and a new certificate of formation and partnership agreement of Sanchez LP will be in effect. For a description of the terms of the partnership agreement, and the rights of the unitholders of Sanchez LP thereunder, see “The Partnership Agreement” and the form of partnership agreement of Sanchez LP attached as Annex B to this proxy statement/prospectus.

Conversion Procedures

All Sanchez LP common units issued in connection with the Conversion will be uncertificated. Sanchez LP will register, or cause to be registered in book-entry form, the Sanchez LP common units into which each uncertificated Company unit is converted as a result of the Conversion.

As soon as reasonably practicable after the effective time of the Conversion, Sanchez LP will send a letter of transmittal to each person who was a record owner of the Company’s units at the effective time of the Conversion and holds a certificate. This mailing will contain instructions on how to surrender any certificates formerly representing common units or Class A units of the Company in order for the common units of Sanchez LP received in the Conversion to be registered in book-entry form (or cancelled in the case of the Class Z unit).

 

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Until each certificate of the Company’s units is surrendered, such certificate or book-entry unit (other than such certificated or book-entry unit representing the Class Z unit) will be deemed at any time after the effective time of the Conversion to represent common units of Sanchez LP.

Lost Unit Certificates

If a certificate formerly representing common units or Class A units of the Company has been lost, stolen or destroyed, Sanchez LP will register in book-entry form the Sanchez LP common units issued in connection with the Conversion upon receipt of an affidavit as to that loss, theft or destruction, and, if required by Sanchez LP, the posting of a bond in such reasonable amount as Sanchez LP will direct as indemnity, with such assurances as Sanchez LP may reasonably require.

Distributions with Respect to Unexchanged Company Units

Distributions, if any, that are made to holders of the Company’s units prior to the effective time of the Conversion will be paid to such holders regardless whether such payment is made before or after the effective time of the Conversion and regardless whether such unitholder transmitted its Company unit certificate for book-entry registration of its Sanchez LP common units.

Appraisal Rights

The unitholders of the Company will not have any appraisal rights in connection with the Conversion.

Treatment of Equity Awards

The Company has two equity incentive plans pursuant to which awards are outstanding: the Constellation Energy Partners LLC Long-Term Incentive Plan and the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan.

As contemplated by Proposal No. 2, Sanchez LP proposes to amend and restate the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan and merge the Constellation Energy Partners LLC Long-Term Incentive Plan into such restated plan. Under the LTIP Restatement, awards under the Company’s existing plans will continue in effect in accordance with their terms, except that the right to receive the Company’s common units thereunder instead will represent the right to receive Sanchez LP common units.

If Proposal No. 2 is not approved by our unitholders, then a “change in control” will have been deemed to occur under each of the Company’s existing plans and each of the equity awards outstanding immediately prior to the effectiveness of the Conversion will be immediately vested and become free of any conditions or restrictions and will be treated in the Conversion equally with each Company common unit that is not subject to any such restrictions or conditions.

Conditions to the Conversion

Consummating the Conversion is subject to the satisfaction or waiver of the following conditions:

 

    obtaining approval of our common unitholders, Class A unitholders and the Class Z unitholder;

 

    the registration statement, of which this proxy statement/prospectus is a part, having been declared effective by the SEC;

 

    the common units representing limited partner interests in Sanchez LP being admitted to trading on the NYSE MKT, subject to official notice of issuance;

 

    any waivers, consents or amendments needed under the Company’s contracts, licenses and permits in connection with the Conversion being obtained;

 

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    our board of managers not having revoked their recommendation that the unitholders vote in favor of the Conversion;

 

    our having received all other required regulatory approvals, other than approvals the absence of which would not have a material adverse effect on us; and

 

    the absence of any statute, order or injunction prohibiting the Conversion.

No federal or state regulatory requirements must be complied with or approval must be obtained in connection with the Conversion, other than filing a certificate of conversion and certificate of limited partnership with the Secretary of State of the State of Delaware.

Interests of Our Managers and Officers in the Conversion

Although we currently anticipate that the persons who are currently managers and executive officers of the Company will become directors and executive officers of Sanchez GP upon the effectiveness of the Conversion, no assurance can be provided that SP Holdings, as the owner of Sanchez GP, will not appoint new directors or that new officers will not be appointed. See “Management.”

Each of our chief executive officer and chief financial officer has an employment agreement with us pursuant to which, upon a “change of control” and the subsequent termination of such executive’s employment by us without cause or by the executive for good reason within two years following such change of control, we will be required to:

 

    make a cash payment of (i) two times the executive’s then-current annual compensation, which includes (A) the target level bonus plus (B) the greater of the annual base salary in effect on the date of such termination, the annual base salary in effect 180 days prior to such termination, or the annual base salary in effect immediately prior to the change of control, plus (ii) the performance award and target-based grants payable under our incentive plans for the then-current year, paid as if the target-level performance was achieved for the entire year, prorated based on the number of whole or partial months completed at the time of such termination;

 

    cause any unvested awards granted under our incentive plans to become immediately vested and cause any and all nonqualified deferred compensation to become immediately non-forfeitable;

 

    cause a continuation of medical and dental benefits for one year following the change of control; and

 

    provide for a full tax gross-up in connection with any excise tax levied on the items described in the preceding three bullets.

Although a change of control under the employment agreements has already occurred on June 17, 2014 upon the election of two new Class B members to our board of managers, a further change of control is anticipated to occur upon the effective time of the Conversion, which will thereby extend the two-year change of control period under which our executive officers may receive enhanced severance benefits if their employment is terminated by us without cause or by the executive for good reason.

If Proposal No. 2 is not approved by our unitholders for Sanchez LP to adopt the new LTIP Restatement and the Conversion nevertheless is consummated, then a “change in control” will have been deemed to occur under each of the Company’s existing incentive plans and each of the equity awards outstanding immediately prior to the effectiveness of the Conversion will be immediately vested and become free of any conditions or restrictions and will be treated in the Conversion equally with each Company common unit that is not subject to any such restrictions or conditions. As of the record date, our managers and officers held an aggregate of 62,292 awards, the vesting of which would be accelerated if Proposal No. 2 is not approved by our unitholders.

 

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The following table sets forth the maximum compensation that would be payable under certain circumstances to the Company’s Chief Executive Officer and Chief Financial Officer related to consummating the Conversion, if approved by our unitholders:

Golden Parachute Compensation

 

Name

  Cash(1)      Equity(2)      Pension/
NQDC(3)
     Perquisites/
Benefits(4)
     Tax
Reimbursement(5)
     Other      Total  

Steven R. Brunner

  $ 2,280,000       $ 3,198,516         —         $ 22,300         —           —         $ 5,500,816   

President, Chief Executive Officer & Chief Operating Officer

                   

Charles C. Ward

  $ 1,365,375       $ 1,066,181         —         $ 22,300         —           —         $ 2,453,856   

Chief Financial Officer, Chief Accounting Officer, Treasurer & Secretary

                   

 

(1) Based on the compensation arrangements established as of January 26, 2015, this cash compensation would be payable under the executive’s employment agreement if his employment with us is terminated in 2015 other than for cause, death or disability.
(2) Represents the value of the unvested equity awards outstanding as of January 26, 2015 that would be accelerated based on a per common unit price of $3.92, which is the average closing price of the Company’s common units over the first five business days following the first public announcement of the Conversion. These awards would be accelerated either if the new LTIP Restatement is not approved by our unitholders or the executive’s employment with us is terminated other than for cause.
(3) We do not have any pension or deferred compensation plans.
(4) Represents the cost of COBRA continuation coverage required to be provided under the executive’s employment agreement if the executive’s employment with us is terminated other than for cause, disability or death.
(5) Payable under the executive’s employment agreement if the executive’s employment with us is terminated other than for cause, disability or death and the termination payment under the employment agreement results in an excise tax payable by the executive.

Stock Exchange Listing

We anticipate that the Sanchez LP common units will trade under the ticker symbol “SPP” upon the effective time of the Conversion.

Vote Required

The affirmative vote of the holders of a majority of the outstanding common units, a majority of the outstanding Class A units and the Class Z unit, each voting as a separate class, and entitled to vote at the Special Meeting, at which a quorum is present, is required to approve Proposal No. 1. Abstentions and broker non-votes will have the same effect as votes against Proposal No. 1.

Board Recommendation

Our board of managers recommends that the unitholders vote FOR Proposal No. 1 to approve the Plan of Conversion.

 

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CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS OF SANCHEZ LP

You should read the following discussion of the cash distribution policy of Sanchez LP in conjunction with the specific assumptions included in this section. In addition, you should read “Note Regarding Forward-Looking Statements” and “Risk Factors” for information regarding statements that do not relate strictly to historical or current facts and certain risks inherent in our business.

For additional information regarding our historical results of operations, you should refer to our historical Condensed Consolidated Financial Statements and the notes to those financial statements included elsewhere in this prospectus.

As used in this section, references to “we,” “us” and “our” refer to Sanchez LP. Unless the context otherwise requires, references in this section to any class of units references to the units of Sanchez LP to be issued and outstanding upon consummation of the Conversion, and references to any unitholders refer to the unitholders of Sanchez LP.

General

Rationale for Our Cash Distribution Policy

Upon such time as the board of managers of our general partner determines that we have sufficient “available cash,” we intend to make a minimum quarterly distribution of at least $0.05 per unit ($0.20 per unit on an annualized basis) on all of our units. As of the date of this proxy statement/prospectus, we do not anticipate having sufficient available cash to be able to make any distributions on our units during the next 12 months unless we consummate a significant acquisition that generates sufficient available cash, which is a strategy that we are pursuing. The amount of the available cash shortfall during the next twelve months is anticipated to be at least the full amount of the approximately $1.5 million that would be needed to make a distribution in each quarter.

We expect that if we are successful in executing our business strategy, we will grow our business in a steady and sustainable manner and distribute to our unitholders a portion of any increase in our earnings resulting from such growth. Our cash distribution policy reflects a judgment that our unitholders will be better served by our distributing rather than retaining a substantial amount of the cash derived from our earnings. However, since it will be our policy to set our distributions based on the level of success of our operations, the actual amount of cash that we distribute on our common units will depend principally on the amount of earnings that we can generate from our operations. In addition, as we discuss below, our ability to pay distributions is subject to various restrictions, as well as other factors.

The Company established the minimum quarterly distribution of $0.05 per unit in connection with entering into the Services Agreement with SP Holdings in May 2014. At that time, the Company’s common unit price had historically been trading on the NYSE MKT around $2.00 per common unit. The Company desired to have an approximate yield of 10% on its common units, which is the midpoint of the range for typical master limited partnership yields.

Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy

There is no guarantee that we will make quarterly cash distributions to our unitholders. We do not have a legal or contractual obligation to pay quarterly distributions at our minimum quarterly distribution rate or at any other rate. Our cash distribution policy is subject to certain restrictions and may be changed at any time. The reasons for such uncertainties in our stated cash distribution policy include the following factors:

 

    Our ability to make cash distributions may be limited by certain covenants in our revolving credit facility. Should we be unable to satisfy these covenants, we will be unable to make cash distributions notwithstanding our cash distribution policy.

 

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    Our general partner will have the authority to establish cash reserves for the prudent conduct of our business, including for future cash distributions to our unitholders, and the establishment of or increase in those reserves could result in a reduction in cash distributions from levels that we currently anticipate pursuant to our stated cash distribution policy. Our partnership agreement does not set a limit on the amount of cash reserves that our general partner may establish. Any decision to establish cash reserves made by our general partner in good faith will be binding on our unitholders.

 

    Prior to making any distribution on the common units, and pursuant to the Services Agreement, we will pay SP Holdings an administrative fee and reimburse our general partner and its affiliates, including SP Holdings, for all direct and indirect expenses they incur on our behalf. Our partnership agreement does not set a limit on the amount of expenses for which our general partner and its affiliates may be reimbursed. These expenses may include salary, bonus, incentive compensation and other amounts paid to persons who perform services for us or on our behalf and expenses allocated to our general partner by its affiliates. We currently estimate that the aggregate amount of fees and reimbursed expenses pursuant to the Services Agreement will be $3.9 million annually. Our partnership agreement provides that our general partner will determine in good faith the expenses that are allocable to us. The reimbursement of expenses and payment of fees, if any, to our general partner and its affiliates will reduce our ability to pay distributions to our unitholders.

 

    Even if our cash distribution policy is not modified or revoked, the amount of distributions that we pay under our cash distribution policy and the decision to make any distribution is determined by our general partner.

 

    Under Section 17-607 of the Delaware Act, we may not make a distribution if the distribution would cause our liabilities to exceed the fair value of our assets.

 

    We may lack sufficient cash to pay distributions to our unitholders due to cash flow shortfalls attributable to a number of operational, commercial or other factors as well as increases in our operating or general and administrative expenses, principal and interest payments on our outstanding debt, tax expenses, working capital requirements and anticipated cash needs.

 

    If we make distributions out of capital surplus, as opposed to operating surplus, any such distributions would constitute a return of capital and would result in a reduction in the minimum quarterly distribution and the target distribution levels. Please read “Provisions of the Partnership Agreement Relating to Cash Distributions—Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels.” We do not anticipate that we will make any distributions from capital surplus.

 

    Our ability to make distributions to our unitholders depends on the performance of our assets and subsidiaries and their ability to distribute cash to us. The ability of our subsidiaries to make distributions to us may be restricted by, among other things, the provisions of future indebtedness, applicable state limited liability company laws and other laws and regulations.

Our Ability to Grow may be Dependent on Our Ability to Access External Expansion Capital

We expect to generally distribute a significant percentage of our cash from operations to our unitholders on a quarterly basis, after the establishment of cash reserves and payment of our expenses. Therefore, our growth may not be as fast as businesses that reinvest most or all of their cash to expand ongoing operations. Moreover, our future growth may be slower than our historical growth. We expect that we will rely primarily upon external financing sources, including bank borrowings and issuances of debt and equity interests, to fund our expansion capital expenditures. To the extent we are unable to finance growth externally, our cash distribution policy will significantly impair our ability to grow.

Our Minimum Quarterly Distribution

Pursuant to our distribution policy, upon such time as our board of managers determines that we have sufficient available cash, we intend to declare a minimum quarterly distribution of $0.05 per unit for each complete quarter, or $0.20 per unit on an annualized basis. The payment of the full minimum quarterly

 

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distribution on all of the common units to be outstanding upon consummation of the Conversion based on the number of units of the Company outstanding as of January 26, 2015 would require us to have earnings providing amounts available for distribution of approximately $1.5 million per quarter, or $5.9 million per year. Our ability to make cash distributions at the minimum quarterly distribution rate will be subject to the factors described above under “—General—Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy.”

The table below sets forth the amount of common units that will be outstanding immediately after the effective time of the Conversion based on the number of units of the Company outstanding as of August 18, 2014, and the earnings needed to pay the aggregate minimum quarterly distribution on all of such units for a single fiscal quarter and a four quarter period:

 

     Number of
Units
     Distributions  
      One Quarter      Annualized  
            (in thousands)  

Publicly held common units

     23,368,826       $ 1,168       $ 4,673   

Common units held by affiliates of SOG

     6,011,362         301         1,202   
  

 

 

    

 

 

    

 

 

 

Total

     29,380,188       $ 1,469       $ 5,876   
  

 

 

    

 

 

    

 

 

 

SP Holdings will be the initial holder of the incentive distribution rights, which entitle the holder to increasing percentages, up to a maximum of 35.5%, of the cash we distribute in excess of $0.0875 per unit per quarter.

We expect to pay our distributions on or about the last day of each of February, May, August and November to holders of record on or about the 15th day of each such month. If the distribution date does not fall on a business day, we will make the distribution on the business day immediately preceding the indicated distribution date. We will adjust the quarterly distribution, if any, for the period after the effective time of the Conversion through March 31, 2015 based on the actual length of the period.

For each of the seven quarters ended September 30, 2014, the Company had no cash available to make a distribution on its common units, with the shortfall being at least the full amount of the approximate $1.5 million that would have been needed to make a distribution in each such quarter. We do not anticipate being able to make the minimum quarterly distribution on the Sanchez LP common units until we acquire assets that generate cash, sell existing assets for cash or undertake a recapitalization event that results in us having additional available cash, none of which we anticipate occurring before March 31, 2015. In addition to the limitations on our availability to make distributions discussed above under “—General,” please also see “Item 1A. Risk Factors—Risk Related to Our Distributions to Unitholders” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 included herein regarding the risks involved in our being able to make distributions, including:

 

    our having insufficient cash flow from operations;

 

    our reserve-based credit facility, which may limit our ability to make distributions;

 

    significant declines in natural gas prices that reduce our ability to invest in new drilling opportunities which would generate cash flow to make distributions;

 

    our incurrence of substantial capital expenditures that reduce cash available for distribution;

 

    estimating maintenance capital expenditures higher than actual capital expenditures, which would reduce the cash available for distribution;

 

    hedging activities that result in financial losses and reduced cash flow to make distributions; and

 

    the lack of acquisitions, which may limit any increases in distributions.

 

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PROVISIONS OF THE PARTNERSHIP AGREEMENT RELATING TO CASH DISTRIBUTIONS

Set forth below is a summary of the significant provisions of Sanchez LP’s partnership agreement that relate to cash distributions.

As used in this section, references to “we,” “us” and “our” refer to Sanchez LP. Unless the context otherwise requires, references in this section to any class of units references to the units of Sanchez LP to be issued and outstanding upon the effective time of the Conversion, and references to any unitholders refer to the unitholders of Sanchez LP.

Distributions of Available Cash

General

Our partnership agreement requires that, on or about the last day of each of February, May, August and November, beginning with the quarter in which the Conversion is consummated, we distribute all of our available cash to unitholders of record on the applicable record date. We will adjust the amount of our distribution for the period from and including the effective time of the Conversion through the end of the quarter in which the Conversion becomes effective based on the actual length of the period.

Definition of Available Cash

Available cash generally means, for any quarter, all cash on hand at the end of that quarter:

 

    less, the amount of cash reserves established by our general partner to:

 

    provide for the proper conduct of our business (including cash reserves for our future capital expenditures and anticipated future debt service requirements subsequent to that quarter);

 

    comply with applicable law, any of our debt instruments or other agreements; or

 

    provide funds for distributions to our unitholders for any one or more of the next four quarters (provided that our general partner may not establish cash reserves for distributions if the effect of the establishment of such reserves will prevent us from distributing the minimum quarterly distribution on all common units);

 

    plus, if our general partner so determines, all or any portion of the cash on hand on the date of determination of available cash for the quarter resulting from working capital borrowings made subsequent to the end of such quarter.

The purpose and effect of the last bullet point above is to allow our general partner, if it so decides, to use cash from working capital borrowings made after the end of the quarter but on or before the date of determination of available cash for that quarter to pay distributions to unitholders. Under our partnership agreement, working capital borrowings are generally borrowings that are made under a credit facility, commercial paper facility or similar financing arrangement, and in all cases are used solely for working capital purposes or to pay distributions to unitholders, and with the intent of the borrower to repay such borrowings within twelve months with funds other than from additional working capital borrowings.

Operating Surplus and Capital Surplus

General

Any distributions that we make will be characterized as made from “operating surplus” or “capital surplus.” Distributions from operating surplus are made differently than cash distributions that we would make from capital surplus. Operating surplus distributions will be made to our unitholders and, if we make quarterly

 

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distributions above the first target distribution level described below, to the holder of our incentive distribution rights. We do not anticipate that we will make any distributions from capital surplus. In such an event, however, any capital surplus distribution would be made pro rata to all unitholders, but the holder of the incentive distribution rights would generally not participate in any capital surplus distributions with respect to those rights.

In determining operating surplus and capital surplus, we will only take into account our proportionate share of our consolidated subsidiaries, provided they are not wholly owned, and our proportionate share of entities accounted for under the equity method.

Operating Surplus

We define operating surplus as:

 

    $20.0 million (as described below); plus

 

    all of our cash receipts, excluding cash from interim capital transactions (as defined below), provided that cash receipts from the termination of a commodity hedge or interest rate hedge prior to its specified termination date shall be amortized in operating surplus in equal quarterly installments over the remaining scheduled term of such commodity hedge or interest rate hedge; plus

 

    working capital borrowings made after the end of a quarter but on or before the date of determination of operating surplus for that quarter; plus

 

    cash distributions (including incremental distributions on incentive distribution rights) paid in respect of equity issued, other than equity issued in connection with consummating the Company’s initial public offering, to finance all or a portion of expansion capital expenditures in respect of the period from the date that we enter into a binding obligation to commence the replacement, improvement, addition, expansion, acquisition, construction or development of a capital asset and ending on the earlier to occur of the date the capital asset commences commercial service and the date that it is abandoned or disposed of; plus

 

    cash distributions (including incremental distributions on incentive distribution rights) paid in respect of equity issued, other than equity issued in connection with the Company’s initial public offering, to pay interest on debt incurred, or to pay distributions on equity issued, to finance the expansion capital expenditures referred to in the prior bullet; less

 

    all of our operating expenditures (as defined below); less

 

    the amount of cash reserves established by our general partner to provide funds for future operating expenditures; less

 

    all working capital borrowings not repaid within twelve months after having been incurred, or repaid within such twelve-month period with the proceeds of additional working capital borrowings; less

 

    any cash loss realized on disposition of an investment capital expenditure.

As described above, operating surplus does not reflect actual cash on hand that is available for distribution to our unitholders and is not limited to cash generated by our operations. For example, it includes a provision that will enable us, if we choose, to distribute as operating surplus up to $20.0 million of cash we receive in the future from non-operating sources such an asset sales, issuances of securities and long-term borrowings that would otherwise be distributed as capital surplus. In addition, the effect of including, as described above, certain cash distributions on equity interests in operating surplus will be to increase operating surplus by the amount of any such cash distributions. As a result, we may also distribute as operating surplus up to the amount of any such cash that we receive from non-operating sources.

The proceeds of working capital borrowings increase operating surplus and repayments of working capital borrowings are generally operating expenditures (as described below) and thus reduce operating surplus when

 

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repayments are made. However, if working capital borrowings, which increase operating surplus, are not repaid during the twelve-month period following the borrowing, they will be deemed repaid at the end of such period, thus decreasing operating surplus at such time. When such working capital borrowings are in fact repaid, they will not be treated as a further reduction in operating surplus because operating surplus will have been previously reduced by the deemed repayment.

We define interim capital transactions as (i) borrowings, refinancings or refundings of indebtedness (other than working capital borrowings and items purchased on open account or for a deferred purchase price in the ordinary course of business) and sales of debt securities, (ii) issuances of equity securities and (iii) sales or other dispositions of assets, other than sales or other dispositions of inventory, accounts receivable and other assets in the ordinary course of business and sales or other dispositions of assets as part of normal asset retirements or replacements.

We define operating expenditures as all of our cash expenditures, including, but not limited to, taxes, amounts paid under the Services Agreement, reimbursements of expenses of our general partner and its affiliates, director, officer and employee compensation, debt service payments, payments made in the ordinary course of business under interest rate hedge contracts and commodity hedge contracts (provided that payments made in connection with the termination of any interest rate hedge contract or commodity hedge contract prior to the expiration of its settlement or termination date specified therein will be amortized in operating expenditures in equal quarterly installments over the remaining scheduled life of such interest rate hedge contract or commodity hedge contract and amounts paid in connection with the initial purchase of a rate hedge contract or a commodity hedge contract will be amortized over the life of such rate hedge contract or commodity hedge contract), estimated maintenance capital expenditures (as discussed in further detail below), and repayment of working capital borrowings; provided, however, that operating expenditures will not include:

 

    repayments of working capital borrowings where such borrowings have previously been deemed to have been repaid (as described above);

 

    payments (including prepayments and prepayment penalties) of principal of and premium on indebtedness other than working capital borrowings;

 

    expansion capital expenditures;

 

    actual maintenance capital expenditures;

 

    investment capital expenditures;

 

    payment of transaction expenses (including taxes) relating to interim capital transactions;

 

    distributions to our partners; or

 

    repurchases of partnership interests (excluding repurchases we make to satisfy obligations under employee benefit plans).

Capital Surplus

Capital surplus is defined in our partnership agreement as any distribution of available cash in excess of our cumulative operating surplus. Accordingly, except as described above, capital surplus would generally be generated by:

 

    borrowings other than working capital borrowings;

 

    sales of our equity and debt securities; and

 

    sales or other dispositions of assets, other than inventory, accounts receivable and other assets sold in the ordinary course of business or as part of ordinary course retirement or replacement of assets.

 

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Characterization of Cash Distributions

Our partnership agreement requires that we treat all available cash distributed as coming from operating surplus until the sum of all available cash distributed since the closing of the initial public offering of the Company equals the operating surplus from the closing of the initial public offering of the Company through the end of the quarter immediately preceding that distribution. Our partnership agreement requires that we treat any amount distributed in excess of operating surplus, regardless of its source, as capital surplus. We do not anticipate that we will make any distributions from capital surplus.

Capital Expenditures

Expansion capital expenditures are cash expenditures incurred for acquisitions or capital improvements that we expect will increase our operating capacity, operating income or asset base over the long term. Examples of expansion capital expenditures include the construction, development or acquisition of assets associated with the upstream and midstream business to the extent such capital expenditures are expected to expand our operating capacity, our operating income or our asset base. Expansion capital expenditures include interest payments (and related fees) on debt incurred and distributions on equity issued to finance all or a portion of expansion capital expenditures in respect of the period from the date that we enter into a binding obligation to commence the replacement, improvement, addition, expansion acquisition, construction, development or capital contribution of a capital asset and ending on the earlier to occur of the date that such capital improvement commences commercial service and the date that such capital improvement is abandoned or disposed of.

Maintenance capital expenditures are cash expenditures made to maintain, over the long-term, our operating capacity, operating income or asset base. Examples of maintenance capital expenditures are expenditures to develop and replace our oil and natural gas reserves as well as the repair, refurbishment and replacement of gathering and transportation assets, to maintain equipment reliability, integrity and safety and to address environmental laws and regulations.

Because our maintenance capital expenditures can be very large and irregular, the amount of our actual maintenance capital expenditures may differ substantially from period to period, which could cause similar fluctuations in the amounts of operating surplus and cash available for distribution to our unitholders if we subtracted actual maintenance capital expenditures from operating surplus. As a result, to eliminate the effect on operating surplus of these fluctuations, our partnership agreement requires that an estimate of the average quarterly maintenance capital expenditures necessary to maintain our asset base over the long-term be subtracted from operating surplus each quarter as opposed to the actual amounts spent. The amount of estimated maintenance capital expenditures deducted from operating surplus is subject to review and change by our board of directors at least once a year. The estimate is made at least annually and whenever an event occurs that is likely to result in a material adjustment to the amount of our future estimated maintenance capital expenditures, such as a major acquisition or the introduction of new governmental regulations that will impact our business. For purposes of calculating operating surplus, any adjustment to this estimate will be prospective only.

The use of estimated maintenance capital expenditures in calculating operating surplus has the following effects:

 

    it reduces the risk that maintenance capital expenditures in any one quarter will be large enough to render operating surplus less than the minimum quarterly distribution to be paid on all the units for that quarter and subsequent quarters;

 

    it increases our ability to distribute as operating surplus cash we receive from non-operating sources;

 

    it is more difficult for us to raise our distribution above the minimum quarterly distribution and pay distributions on our incentive distribution rights; and

 

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    it reduces the likelihood that a large maintenance capital expenditure during one quarterly distribution period will prevent the payment of a distribution on the incentive distribution rights in respect of any quarterly distribution period since the effect of an estimate is to spread the expected expense over several periods, thereby mitigating the effect of the actual payment of the expenditure on any single period.

Investment capital expenditures are those capital expenditures that are neither maintenance capital expenditures nor expansion capital expenditures. Investment capital expenditures largely will consist of capital expenditures made for investment purposes. Examples of investment capital expenditures include traditional capital expenditures for investment purposes, such as purchases of securities, as well as other capital expenditures that might be made in lieu of such traditional investment capital expenditures, such as the acquisition of a capital asset for investment purposes or development of facilities that are in excess of the maintenance of our existing operating capacity or operating income, but that are not expected to expand our operating capacity or operating income over the long term.

Capital expenditures that are made in part for maintenance capital purposes, investment capital purposes and/or expansion capital purposes will be allocated as maintenance capital expenditures, investment capital expenditures or expansion capital expenditure by our general partner.

Incentive Distribution Rights

Incentive distribution rights represent the right to receive increasing percentages (13.0%, 23.0% and 35.5%) of quarterly distributions from operating surplus after the minimum quarterly distribution and the target distribution levels have been achieved. SP Holdings will hold the incentive distribution rights, but may transfer these rights at any time.

If, for any quarter, we have distributed cash from operating surplus to the common unitholders in an amount equal to the minimum quarterly distribution, then we will make additional distributions from operating surplus for that quarter among the unitholders and SP Holdings (as the holder of our incentive distribution rights) in the following manner:

 

    first, 100% to all unitholders, pro rata, until each unitholder receives a total of $0.0575 per unit for that quarter (the “first target distribution”);

 

    second, 87.0% to all common unitholders, pro rata, and 13.0% to the holders of our incentive distribution rights, until each unitholder receives a total of $0.0625 per unit for that quarter (the “second target distribution”);

 

    third, 77.0% to all common unitholders, pro rata, and 23.0% to the holders of our incentive distribution rights, until each unitholder receives a total of $0.0875 per unit for that quarter (the “third target distribution”); and

 

    thereafter, 64.5% to all common unitholders, pro rata, and 35.5% to the holders of our incentive distribution rights.

Percentage Allocations of Distributions from Operating Surplus

The following table illustrates the percentage allocations of distributions from operating surplus between the common unitholders and SP Holdings (as the holder of our incentive distribution rights) based on the specified target distribution levels. The amounts set forth under the column heading “Marginal Percentage Interest in Distributions” are the percentage interests of SP Holdings (as the holder of our incentive distribution rights) and the common unitholders in any distributions from operating surplus we distribute up to and including the corresponding amount in the column “Total Quarterly Distribution Per Common Unit.” The percentage interests shown for our common unitholders and SP Holdings (as the holder of our incentive distribution rights) for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the

 

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minimum quarterly distribution. The percentage interests set forth below assume that SP Holdings has not transferred its incentive distribution rights.

 

     Total Quarterly Distribution
Per Common Unit
   Marginal Percentage Interest
in Distributions
 
        Common
Unitholders
    SP Holdings
(as Holder of
Incentive
Distribution
Rights)
 

Minimum Quarterly Distribution

   up to $0.05      100.0     0.0

First Target Distribution

   above $0.05 up to
$0.0575
     100.0     0.0

Second Target Distribution

   above $0.0575 up
to $0.0625
     87.0     13.0

Third Target Distribution

   above $0.0625 up
to $0.0875
     77.0     23.0

Thereafter

   above $0.0875      64.5     35.5

SP Holdings’ Right to Reset Incentive Distribution Levels

SP Holdings, as the initial holder of our incentive distribution rights, has the right under our partnership agreement to elect to relinquish the right to receive incentive distribution payments based on the initial target distribution levels and to reset, at higher levels, the target distribution levels upon which the incentive distribution payments to SP Holdings would be set. If SP Holdings transfers all or a portion of our incentive distribution rights in the future, then the holder or holders of a majority of our incentive distribution rights will be entitled to exercise this right. The following discussion assumes that SP Holdings holds all of the incentive distribution rights at the time that a reset election is made. The right to reset the target distribution levels upon which the incentive distributions are based may be exercised, without approval of our unitholders or the conflicts committee of our general partner, at any time when we have made cash distributions to the holders of the incentive distribution rights at the highest level of incentive distribution for the prior four consecutive fiscal quarters. The reset target distribution levels will be higher than the target distribution levels prior to the reset such that there will be no incentive distributions paid under the reset target distribution levels until cash distributions per unit following the reset event increase as described below. We anticipate that SP Holdings would exercise this reset right in order to facilitate acquisitions or internal growth projects that would otherwise not be sufficiently accretive to cash distributions per common unit, taking into account the existing levels of incentive distribution payments being made to SP Holdings.

In connection with the resetting of the target distribution levels and the corresponding relinquishment by SP Holdings of incentive distribution payments based on the target cash distributions prior to the reset, SP Holdings will be entitled to receive a number of newly issued common units based on a predetermined formula described below that takes into account the “cash parity” value of the cash distributions related to the incentive distribution rights received by SP Holdings for the two quarters prior to the reset event as compared to the average cash distribution per common unit in such quarters.

The number of common units that SP Holdings would be entitled to receive from us in connection with a resetting of the minimum quarterly distribution amount and the target distribution levels then in effect would be equal to the quotient determined by dividing (x) the amount of cash distributions received by SP Holdings in respect of its incentive distribution rights for the two fiscal quarters ended immediately prior to the date of such reset election by (y) the average amount of cash distributed per common unit with respect to such quarters. SP Holdings would be entitled to receive distributions in respect of these common units pro rata in subsequent periods.

Following a reset election, a baseline minimum quarterly distribution amount will be calculated as an amount equal to the average of the cash distributions paid per common unit for the two full fiscal quarters

 

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immediately preceding the reset election (which amount we refer to as the “reset minimum quarterly distribution”) and the target distribution levels will be reset to be correspondingly higher such that we would make distributions from operating surplus for each quarter thereafter as follows:

 

    first, 100% to all common unitholders, pro rata, until each such unitholder receives an amount per unit equal to 115.0% of the reset minimum quarterly distribution for that quarter;

 

    second, 87.0% to all common unitholders, pro rata, and 13.0% to SP Holdings, until each such unitholder receives an amount per unit equal to 125.0% of the reset minimum quarterly distribution for the quarter;

 

    third, 77.0% to all common unitholders, pro rata, and 23.0% to SP Holdings, until each such unitholder receives an amount per unit equal to 175.0% of the reset minimum quarterly distribution for the quarter; and

 

    thereafter, 64.5% to all common unitholders, pro rata, and 35.5% to SP Holdings.

The following table illustrates the percentage allocation of distributions from operating surplus among our unitholders and SP Holdings (as the holder of our incentive distribution rights) at various distribution levels (1) pursuant to the distribution provisions of our partnership agreement in effect upon consummation of the Conversion, as well as (2) following a hypothetical reset of the target distribution levels based on the assumption that the quarterly distribution amount per common unit during the two fiscal quarters immediately preceding the reset election was $0.0875.

 

     Quarterly Distribution
per Unit Prior to Reset
   Common
Unitholders
    SP Holdings
(as Holder
of our
Incentive
Distribution
Rights)
    Quarterly Distribution Per
Unit Following Hypothetical
Reset

Minimum Quarterly Distribution

   up to $0.05      100.0     0.0   up to $0.0875(1)

First Target Distribution

   above $0.05 up to
$0.0575
     100.0     0.0   above $0.0875 up
to $0.1006(2)

Second Target Distribution

   above $0.0575 up
to $0.0625
     87.0     13.0   above $0.1006 up
to $0.1094(3)

Third Target Distribution

   above $0.0625 up
to $0.0875
     77.0     23.0   above $0.1094 up
to $0.1531(4)

Thereafter

   above $0.0875      64.5     35.5   above $0.1531

 

(1) This amount is equal to the hypothetical reset minimum quarterly distribution.
(2) This amount is 115.0% of the hypothetical reset minimum quarterly distribution.
(3) This amount is 125.0% of the hypothetical reset minimum quarterly distribution.
(4) This amount is 175.0% of the hypothetical reset minimum quarterly distribution.

 

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The following table illustrates the total amount of distributions from operating surplus that would be distributed to our unitholders and SP Holdings (as the holder of our incentive distribution rights), in respect of its incentive distribution rights, based on the amount distributed for the quarter immediately prior to the reset. The table assumes that immediately prior to the reset there would be 29,380,188 common units outstanding and the distribution to each common unit would be $0.0875 per quarter for the quarter prior to the reset.

 

     Quarterly
Distribution Per
Unit Prior to Reset
   Cash Distributions Prior to Reset  
        Common
Units
     Incentive
Distribution
Rights
     Total  
          (in thousands)  

Minimum Quarterly Distribution

   up to $0.05    $ 1,469       $ —         $ 1,469   

First Target Distribution

   above $0.05 up
to $0.0575
     220         —           220   

Second Target Distribution

   above $0.0575 up
to $0.0625
     147         22         169   

Third Target Distribution

   above $0.0625 up
to $0.0875
     735         219         953   

Thereafter

   above $0.0875      —           —           —     
     

 

 

    

 

 

    

 

 

 
      $ 2,571       $ 241       $ 2,812   
     

 

 

    

 

 

    

 

 

 

The following table illustrates the total amount of distributions from operating surplus that would be distributed to our unitholders and SP Holdings (as the holder of our incentive distribution rights) in respect of its incentive distribution rights, with respect to the quarter in which the reset occurs. The table reflects that as a result of the reset there would be 32,138,453 common units outstanding and the distribution to each common unit would be $0.0875. The number of common units to be issued to SP Holdings upon the reset was calculated by dividing (1) the amount received by SP Holdings in respect of its incentive distribution rights for the two quarters prior to the reset as shown in the table above, or $482,000 in the aggregate, by (2) the average cash distributed on each common unit for the two quarters prior to the reset, as shown in the table above, or $0.1750 per unit in the aggregate.

 

     Quarterly
Distribution Per
Unit After Reset
   Cash Distributions After Reset  
        Common
Units
     Incentive
Distribution
Rights
     Total  
          (in thousands, except per unit
amounts)
 

Minimum Quarterly Distribution

   up to $0.0875    $ 2,812       $ —         $ 2,812   

First Target Distribution

   above $0.0875 up
to $0.1006
     —           —           —     

Second Target Distribution

   above $0.1006 up
to $0.1094
     —           —           —     

Third Target Distribution

   above $0.1094 up
to $0.1531
     —           —           —     

Thereafter

   above $0.1531      —           —           —     
     

 

 

    

 

 

    

 

 

 
      $ 2,812       $  —         $ 2,812   
     

 

 

    

 

 

    

 

 

 

SP Holdings (as the holder of our incentive distribution rights) will be entitled to cause the target distribution levels to be reset on more than one occasion, provided that it may not make a reset election except at a time when it has received incentive distributions for the prior four consecutive fiscal quarters based on the highest level of incentive distributions that it is entitled to receive under our partnership agreement.

 

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Distributions from Capital Surplus

How Distributions from Capital Surplus Will Be Made

Our partnership agreement requires that we make distributions from capital surplus, if any, in the following manner:

 

    first, to all common unitholders, pro rata, until the minimum quarterly distribution is reduced to zero, as described below; and

 

    thereafter, we will make all distributions from capital surplus as if they were from operating surplus.

Effect of a Distribution From Capital Surplus

Our partnership agreement treats a distribution of capital surplus as the repayment of the initial unit price from the Company’s initial public offering, which is a return of capital. Each time a distribution of capital surplus is made, the minimum quarterly distribution and the target distribution levels will be reduced in the same proportion as the corresponding reduction in relation to the fair market value of the common units prior to the announcement of the distribution. Because distributions of capital surplus will reduce the minimum quarterly distribution and target distribution levels after any of these distributions are made, it may be easier for SP Holdings to receive incentive distributions. However, any distribution of capital surplus before the minimum quarterly distribution is reduced to zero cannot be applied to the payment of the minimum quarterly distribution.

Once we reduce the minimum quarterly distribution and target distribution levels to zero, all future distributions will be made such that 64.5% is paid to all unitholders, pro rata, and 35.5% is paid to the holder or holders of incentive distribution rights, pro rata.

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

In addition to adjusting the minimum quarterly distribution and target distribution levels to reflect a distribution of capital surplus, if we combine our common units into fewer common units or subdivide our common units into a greater number of common units, our partnership agreement specifies that the following items will be proportionately adjusted:

 

    the minimum quarterly distribution;

 

    the target distribution levels; and

 

    the initial unit price, as described below under “—Distributions of Cash Upon Liquidation.”

For example, if a two-for-one split of the common units should occur, the minimum quarterly distribution, the target distribution levels and the initial unit price would each be reduced to 50.0% of its initial level. Our partnership agreement provides that we do not make any adjustment by reason of the issuance of additional units for cash or property.

In addition, if as a result of a change in law or interpretation thereof, we are or any of our subsidiaries is treated as an association taxable as a corporation or are otherwise subject to additional taxation as an entity for U.S. federal, state, local or non-U.S. income or withholding tax purposes, our general partner may, in its sole discretion, reduce the minimum quarterly distribution and the target distribution levels for each quarter by multiplying each distribution level by a fraction, the numerator of which is cash for that quarter (after deducting our general partner’s estimate of our additional aggregate liability for the quarter for such income and withholdings taxes payable by reason of such change in law or interpretation) and the denominator of which is the sum of (1) cash for that quarter, plus (2) our general partner’s estimate of our additional aggregate liability for the quarter for such income and withholding taxes payable by reason of such change in law or interpretation thereof. To the extent that the actual tax liability differs from the estimated tax liability for any quarter, the difference will be accounted for in distributions with respect to subsequent quarters.

 

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Distributions of Cash Upon Liquidation

General

If we dissolve in accordance with the partnership agreement, we will sell or otherwise dispose of our assets in a process called liquidation. We will first apply the proceeds of liquidation to the payment of our creditors. We will distribute any remaining proceeds to the unitholders and the holders of the incentive distribution rights, in accordance with their capital account balances, as adjusted to reflect any gain or loss upon the sale or other disposition of our assets in liquidation.

The allocations of gain and loss upon liquidation are intended, to the extent possible, to entitle the holders of units to a repayment of the initial value contributed by unitholders for their units in the Company’s initial public offering, which we refer to as the “initial unit price” for each unit. Any further net gain recognized upon liquidation will be allocated in a manner that takes into account the incentive distribution rights of SP Holdings.

Manner of Adjustments for Gain

The manner of the adjustment for gain is set forth in the partnership agreement. We will generally allocate any gain to the partners in the following manner:

 

    first, 100% to the general partner until the amount allocated under this paragraph equals the amount of losses allocated to the general partner;

 

    second, 100% to the common unitholders, pro rata, until the capital account for each common unit is equal to: (A) the sum of (1) the initial unit price; (2) the amount of the minimum quarterly distribution for the quarter during which our liquidation occurs reduced by any distribution made from operating surplus in satisfaction of the minimum quarterly distribution with respect to such common unit for such quarter; and (3) the excess of the first target distribution per unit over the minimum quarterly distribution per unit for each quarter of our existence; less (B) the cumulative amount per unit of any distributions from operating surplus in excess of the minimum quarterly distribution per unit that we have distributed to the unitholders, pro rata, for each quarter of our existence;

 

    third, 87.0% to all unitholders, pro rata, and 13.0% to SP Holdings (as the holder of our incentive distribution rights), until we allocate under this paragraph an amount per unit equal to: (1) the sum of the excess of the second target distribution per unit over the first target distribution per unit for each quarter of our existence; less (2) the cumulative amount per unit of any distributions from operating surplus in excess of the first target distribution per unit that we distributed 87.0% to the unitholders, pro rata, and 13.0% to SP Holdings (as the holder of our incentive distribution rights) for each quarter of our existence;

 

    fourth, 77.0% to all unitholders, pro rata, and 23.0% to SP Holdings (as the holder of our incentive distribution rights), until we allocate under this paragraph an amount per unit equal to: (1) the sum of the excess of the third target distribution per unit over the second target distribution per unit for each quarter of our existence; less (2) the cumulative amount per unit of any distributions from operating surplus in excess of the second target distribution per unit that we distributed 77.0% to the unitholders, pro rata, and 23.0% to SP Holdings (as the holder of our incentive distribution rights) for each quarter of our existence; and

 

    thereafter, 64.5% to all unitholders, pro rata, and 35.5% to SP Holdings (as the holder of our incentive distribution rights).

The percentage interests set forth above for SP Holdings assume SP Holdings has not transferred the incentive distribution rights.

Manner of Adjustments for Losses

We will generally allocate any loss to our to our common unitholders in proportion to the positive balances in their capital accounts, until the capital accounts of the common unitholders have been reduced to zero and thereafter, to our general partner.

 

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Adjustments to Capital Accounts

We will make adjustments to capital accounts upon the issuance of additional units. In doing so, we generally will allocate any unrealized and, for tax purposes, unrecognized gain or loss resulting from the adjustments to the common unitholders and the holders of our incentive distribution rights in the same manner as we allocate gain or loss upon liquidation.

 

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CONFLICTS OF INTEREST AND FIDUCIARY DUTIES

As used in this section, references to “we,” “us” and “our” refer to Sanchez LP. Unless the context otherwise requires, references in this section to any class of units references to the units of Sanchez LP to be issued and outstanding upon consummation of the Conversion, and references to any unitholders refer to the unitholders of Sanchez LP.

Conflicts of Interest

Conflicts of interest exist and may arise in the future as a result of the relationships between our general partner and its affiliates, including SP Holdings, SOG and SEPI, on the one hand, and us and our limited partners, on the other hand. The directors and officers of our general partner have fiduciary duties to manage our general partner in a manner beneficial to SP Holdings. At the same time, our general partner has a duty to manage our partnership in a manner that it believes is not adverse to our interests. Our partnership agreement specifically defines the remedies available to unitholders for actions taken that, without these defined liability standards, might constitute breaches of fiduciary duty under applicable Delaware law. The Delaware Revised Uniform Limited Partnership Act (“Delaware Act”) provides that Delaware limited partnerships may, in their partnership agreements, expand, restrict or eliminate the fiduciary duties otherwise owed by the general partner to the limited partners and the partnership.

Whenever a conflict arises between our general partner or its affiliates, on the one hand, and us or our limited partners, on the other hand, the resolution or course of action in respect of such conflict of interest shall be permitted and deemed approved by all of our limited partners and shall not constitute a breach of our partnership agreement, of any agreement contemplated thereby or of any duty, if the resolution or course of action in respect of such conflict of interest is:

 

    approved by the conflicts committee of our general partner, although our general partner is not obligated to seek such approval;

 

    approved by the holders of a majority of the outstanding common units, excluding any such units owned by our general partner or any of its affiliates;

 

    determined by the board of directors of our general partner to be on terms no less favorable to us than those generally being provided to, or available from, unrelated third parties; or

 

    determined by the board of directors of our general partner to be fair and reasonable to us, taking into account the totality of the relationships between the parties involved, including other transactions that may be particularly favorable or advantageous to us.

Our general partner may, but is not required to, seek the approval of such resolutions or courses of action from the conflicts committee of its board of directors or from the holders of a majority of the outstanding common units as described above. If our general partner does not seek approval from the conflicts committee or from holders of common units as described above and the board of directors of our general partner approves the resolution or course of action taken with respect to the conflict of interest, then our partnership agreement provides that it will be presumed that, in making its decision, the board of directors of our general partner acted in good faith, and in any proceeding brought by or on behalf of us or any of our unitholders, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption. Unless the resolution of a conflict is specifically provided for in our partnership agreement, the board of directors of our general partner or the conflicts committee of the board of directors of our general partner may consider any factors that it determines in good faith to consider when resolving a conflict. An independent third-party is not required to evaluate the resolution. Under our partnership agreement, a determination, other action or failure to act by our general partner, the board of directors of our general partner or any committee thereof (including the conflicts committee) will be deemed to be “in good faith,” unless our general partner, the board of directors of our general partner or any committee thereof (including the conflicts committee) believed such determination, other action or failure to act was adverse to the interests of the partnership.

 

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Conflicts of interest could arise in the situations described below, among others:

Actions taken by our general partner may affect the amount of cash available to pay distributions to unitholders.

The amount of cash that is available for distribution to unitholders is affected by decisions of our general partner regarding such matters as:

 

    amount and timing of asset purchases and sales;

 

    cash expenditures;

 

    borrowings;

 

    entry into and repayment of current and future indebtedness;

 

    issuance of additional units; and

 

    the creation, reduction or increase of reserves in any quarter.

In addition, borrowings by us and our affiliates do not constitute a breach of any duty owed by our general partner to our unitholders, including borrowings that have the purpose or effect of enabling our general partner or its affiliates to receive distributions on the incentive distribution rights.

In addition, our general partner may use an amount, initially equal to $20.0 million, which would not otherwise constitute operating surplus, in order to permit the payment of distributions on the incentive distribution rights. All of these actions may affect the amount of cash or equity distributed to our unitholders and our general partner. Please read “Provisions of the Partnership Agreement Relating to Cash Distributions.”

For example, in the event we have not generated sufficient cash from our operations to pay the minimum quarterly distribution on our common units, our partnership agreement permits us to borrow funds, which would enable us to make such distribution on all outstanding units. Please read “Provisions of the Partnership Agreement Relating to Cash Distributions—Operating Surplus and Capital Surplus—Operating Surplus.”

The directors and officers of Sanchez GP have a fiduciary duty to make decisions in the best interests of the owners of Sanchez GP, which may be contrary to our interests.

Because it is anticipated that, following the Conversion, certain officers and/or certain directors of our general partner may also be directors, managers and/or officers of affiliates of our general partner, including SP Holdings, SOG, SEPI and certain of their affiliates, they have fiduciary duties to such entities that may cause them to pursue business strategies that disproportionately benefit them or which otherwise are not in our best interests.

Our general partner is allowed to take into account the interests of parties other than us, such as SP Holdings, SOG, SEPI and their affiliates, in exercising certain rights under our partnership agreement.

Our partnership agreement contains provisions that reduce the standards to which our general partner would otherwise be held by Delaware fiduciary duty law as permitted by the Delaware Act. For example, our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner. This entitles our general partner to consider only the interests and factors that it desires, and it has no duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or any limited partner. Examples include the exercise of its call right, its voting rights with respect to any units it owns, its registration rights and its determination whether or not to consent to any merger or consolidation.

 

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Our partnership agreement limits the liability of, and replaces the duties owed by, our general partner and also restricts the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty.

In addition to the provisions described above, our partnership agreement contains provisions that restrict the remedies available to our unitholders for actions that might otherwise constitute breaches of fiduciary duty. For example, our partnership agreement provides that:

 

    our general partner shall not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as it acted in good faith, meaning that it believed that the decision was not adverse to the interests of our partnership;

 

    our general partner and its officers and directors will not be liable for monetary damages to us or our limited partners for any acts or omissions unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or those other persons acted in bad faith or, in the case of a criminal matter, acted with knowledge that its conduct was criminal; and

 

    in resolving conflicts of interest, it will be presumed that in making its decision the general partner, the board of directors of the general partner or the conflicts committee of the board of directors of our general partner acted in good faith, and in any proceeding brought by or on behalf of any limited partner or us, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.

By taking ownership of a common unit, including by way of the Conversion, a common unitholder will agree to become bound by the provisions in our partnership agreement, including the provisions discussed above. Please read “—Fiduciary Duties.”

Common unitholders have no right to enforce obligations of our general partner and its affiliates under agreements with us.

Any agreements between us, on the one hand, and our general partner and its affiliates, on the other, will not grant to the unitholders, separate and apart from us, the right to enforce the obligations of our general partner and its affiliates in our favor.

Contracts between us, on the one hand, and our general partner and its affiliates, on the other, are not and will not be the result of arm’s-length negotiations.

Neither our partnership agreement nor any of the other agreements, contracts and arrangements between us and our general partner and its affiliates are or will be the result of arm’s-length negotiations. Our general partner will determine, in good faith, the terms of any of such future transactions.

Except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval.

Under our partnership agreement, our general partner has full power and authority to do all things, other than those items that require unitholder approval, necessary or appropriate to conduct our business, including, but not limited to, the following actions:

 

    expending, lending or borrowing money, assuming, guaranteeing or otherwise contracting for indebtedness and other liabilities, issuing evidences of indebtedness, including indebtedness that is convertible into our securities, and incurring any other obligations;

 

    preparing and transmitting tax, regulatory and other filings, periodic or other reports to governmental or other agencies having jurisdiction over our business or assets;

 

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    acquiring, disposing, mortgaging, pledging, encumbering, hypothecating, granting a security interest in or exchanging our assets or merging or otherwise combining us with or into another person;

 

    negotiating, executing and performing contracts, conveyance or other instruments;

 

    distributing cash;

 

    selecting or dismissing employees and agents, outside attorneys, accountants, consultants and contractors and determining their compensation and other terms of employment or hiring;

 

    maintaining insurance for our benefit;

 

    forming, acquiring an interest in, and contributing property and loaning money to, any further limited partnerships, joint ventures, corporations, limited liability companies or other relationships;

 

    controlling all matters affecting our rights and obligations, including bringing and defending actions at law or in equity or otherwise litigating, arbitrating or mediating, and incurring legal expense and settling claims and litigation;

 

    indemnifying any person against liabilities and contingencies to the extent permitted by law;

 

    purchasing, selling or otherwise acquiring or disposing of our partnership interests, or issuing, purchasing or otherwise acquiring additional options, rights, warrants, appreciation rights, phantom or tracking interests relating to our partnership interests; and

 

    entering into agreements with any of its affiliates to render services to us or to itself in the discharge of its duties as our general partner.

Please read “The Partnership Agreement” for information regarding the voting rights of unitholders.

Common units are subject to our general partner’s call right.

If at any time our general partner and its controlled affiliates own more than 80% of the common units, our general partner will have the right, which it may assign to any of its affiliates or to us, but not the obligation, to acquire all, but not less than all, of the common units held by unaffiliated persons at the market price calculated in accordance with the terms of our partnership agreement. As a result, you may be required to sell your common units at an undesirable time or price and may not receive any return on your investment. You may also incur a tax liability upon a sale of your units. Our general partner is not obligated to obtain a fairness opinion regarding the value of the common units to be repurchased by it upon exercise of the call right. There is no restriction in our partnership agreement that prevents our general partner from issuing additional common units and exercising its call right. Our general partner may use its own discretion, free of fiduciary duty restrictions, in determining whether to exercise this right. As a result, a common unitholder may have his common units purchased from him at an undesirable time or price. Please read “The Partnership Agreement—Limited Call Right.”

We may not choose to retain separate counsel for ourselves or for the holders of common units.

Attorneys, independent accountants and others who perform services for us may be retained by our general partner after the Conversion. Attorneys, independent accountants and others who perform services for us are selected by our general partner or the conflicts committee of the board of directors of our general partner and may perform services for our general partner and its affiliates. We may retain separate counsel for ourselves or the conflict committee in the event of a conflict of interest between our general partner and its affiliates, on the one hand, and us or the holders of common units, on the other, depending on the nature of the conflict, although we may choose not to do so.

Our general partner’s affiliates may compete with us, and neither our general partner nor its affiliates have any obligation to present business opportunities to us.

Our partnership agreement provides that our general partner is restricted from engaging in any business other than those incidental to its ownership of interests in us. However, affiliates of our general partner are not

 

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prohibited from engaging in other businesses or activities, including those that might be in direct competition with us, and may acquire, construct or dispose of assets in the future without any obligation to offer us the opportunity to acquire those assets. In addition, under our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, will not apply to our general partner and its affiliates. As a result, neither our general partner nor any of its affiliates have any obligation to present business opportunities to us.

The holder or holders of our incentive distribution rights may elect to cause us to issue common units to it in connection with a resetting of incentive distribution levels without the approval of our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

The holder or holders of a majority of our incentive distribution rights (initially SP Holdings) have the right, at any time when they have received incentive distributions at the highest level to which they are entitled (35.5%) for each of the prior four consecutive fiscal quarters, to reset the initial target distribution levels at higher levels based on our cash distribution levels at the time of the exercise of the reset election. Following a reset election, the minimum quarterly distribution will be reset to an amount equal to the average cash distribution per common unit for the two fiscal quarters immediately preceding the reset election (such amount is referred to as the “reset minimum quarterly distribution”), and the target distribution levels will be reset to correspondingly higher levels based on percentage increases above the reset minimum quarterly distribution.

We anticipate that SP Holdings would exercise this reset right in order to facilitate acquisitions or internal growth projects that would not be sufficiently accretive to cash distributions per unit without such conversion. However, SP Holdings may transfer the incentive distribution rights at any time. It is possible that SP Holdings or a transferee could exercise this reset election at a time when we are experiencing declines in our aggregate cash distributions or at a time when the holders of the incentive distribution rights expect that we will experience declines in our aggregate cash distributions in the foreseeable future. In such situations, the holders of the incentive distribution rights may be experiencing, or may expect to experience, declines in the cash distributions that it receives related to the incentive distribution rights and may therefore desire to be issued our common units, which are entitled to specified priorities with respect to our distributions and which therefore may be more advantageous for them to own in lieu of the right to receive incentive distribution payments based on target distribution levels that are less certain to be achieved. As a result, a reset election may cause our common unitholders to experience dilution in the amount of cash distributions that they would have otherwise received had we not issued new common units to the holders of the incentive distribution rights in connection with resetting the target distribution levels. Please read “Provisions of the Partnership Agreement Relating to Cash Distributions—Incentive Distribution Rights.”

Fiduciary Duties

Duties owed to unitholders by our general partner are prescribed by law and in our partnership agreement. The Delaware Act provides that Delaware limited partnerships may, in their partnership agreements, expand, restrict or eliminate the fiduciary duties otherwise owed by the general partner to limited partners and the partnership.

Our partnership agreement contains various provisions that eliminate and replace the fiduciary duties that might otherwise be owed by our general partner. We have adopted these provisions to allow our general partner or its affiliates to engage in transactions with us that otherwise might be problematic under otherwise applicable state law fiduciary standards and to take into account the interests of other parties in addition to our interests when resolving conflicts of interest. We believe this is appropriate and necessary because the board of directors of our general partner has a duty to manage our partnership in good faith and a duty to manage our general partner in a manner beneficial to its owner. Without these modifications, our general partner’s ability to make decisions involving conflicts of interest would be restricted. Replacing the fiduciary duty standards in this manner benefits our general partner by enabling it to take into consideration all parties (including it and its affiliates) involved in the proposed action. Replacing the fiduciary duty standards also strengthens the ability of

 

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our general partner to attract and retain experienced and capable directors. However, modifying the fiduciary duty standards represents a detriment to our public unitholders because it restricts the recourse otherwise available to our public unitholders for actions that, without those limitations, might constitute breaches of fiduciary duty, as described below, and permits our general partner to take into account the interests of third parties in addition to our interests when resolving conflicts of interests.

The following is a summary of the material restrictions of the fiduciary duties owed by our general partner to the limited partners:

 

State law fiduciary duty standards

Fiduciary duties are generally considered to include an obligation to act in good faith and with due care and loyalty. The duty of care, in the absence of a provision in a partnership agreement providing otherwise, would generally require a general partner to act for the partnership in the same manner as a prudent person would act on his own behalf. The duty of loyalty, in the absence of a provision in a partnership agreement providing otherwise, would generally require that any action taken or transaction engaged in be entirely fair to the partnership.

 

Partnership agreement modified standards

Our partnership agreement contains provisions that waive or consent to conduct by our general partner and its affiliates that might otherwise raise issues as to compliance with fiduciary duties or applicable law. For example, our partnership agreement provides that when our general partner is acting in its capacity as our general partner, as opposed to in its individual capacity, it must act in “good faith” and will not be subject to any other standard under applicable law. In addition, when our general partner is acting in its individual capacity, as opposed to in its capacity as our general partner, it may act without any fiduciary obligation to us or the unitholders whatsoever. These standards replace the obligations to which our general partner would otherwise be held.

 

  If our general partner does not obtain approval from the conflicts committee of the board of directors of our general partner or our common unitholders, excluding any such units owned by our general partner or its affiliates, and the board of directors of our general partner approves the resolution or course of action taken with respect to the conflict of interest, then it will be presumed that, in making its decision, its board, which may include board members affected by the conflict of interest, acted in good faith, and in any proceeding brought by or on behalf of any limited partner or the partnership, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption. These standards replace the obligations to which our general partner would otherwise be held.

 

Rights and remedies of unitholders

The Delaware Act generally provides that a limited partner may institute legal action on behalf of the partnership to recover damages from a third-party where a general partner has refused to institute the action or where an effort to cause a general partner to do so is not likely to succeed. These actions include actions against a general partner for breach of its duties or of our partnership agreement. In

 

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addition, the statutory or case law of some jurisdictions may permit a limited partner to institute legal action on behalf of himself and all other similarly situated limited partners to recover damages from a general partner for violations of its duties to the limited partners.

 

  The Delaware Act provides that, unless otherwise provided in a partnership agreement, a partner or other person shall not be liable to a limited partnership or to another partner or to another person that is a party to or is otherwise bound by a partnership agreement for breach of fiduciary duty for the partner’s or other person’s good faith reliance on the provisions of the partnership agreement. Under our partnership agreement, to the extent that, at law or in equity an indemnitee has duties (including fiduciary duties) and liabilities relating thereto to us or to our partners, our general partner and any other indemnitee acting in connection with our business or affairs shall not be liable to us or to any partner for its good faith reliance on the provisions of our partnership agreement.

By taking ownership of our common units, including by way of the Conversion, each common unitholder automatically agrees to be bound by the provisions in our partnership agreement, including the provisions discussed above. This is in accordance with the policy of the Delaware Act favoring the principle of freedom of contract and the enforceability of partnership agreements. The failure of a limited partner to sign a partnership agreement does not render the partnership agreement unenforceable against that person.

Under our partnership agreement, we must indemnify our general partner and its officers, directors, managers and certain other specified persons, to the fullest extent permitted by law, against liabilities, costs and expenses incurred by our general partner or these other persons. We must provide this indemnification unless there has been a final and non-appealable judgment by a court of competent jurisdiction determining that these persons acted in bad faith. We must also provide this indemnification for criminal proceedings unless our general partner or these other persons acted with knowledge that their conduct was criminal. Thus, our general partner could be indemnified for its negligent acts if it meets the requirements set forth above. To the extent these provisions purport to include indemnification for liabilities arising under the Securities Act in the opinion of the SEC, such indemnification is contrary to public policy and, therefore, unenforceable. Please read “The Partnership Agreement—Indemnification.”

 

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DESCRIPTION OF THE COMMON UNITS

As used in this section, references to “we,” “us” and “our” refer to Sanchez LP. Unless the context otherwise requires, references in this section to any class of units references to the units of Sanchez LP to be issued and outstanding upon consummation of the Conversion, and references to any unitholders refer to the unitholders of Sanchez LP.

The Units

The common units are a separate class of limited partner interests in us. The holders of units are entitled to participate in partnership distributions and exercise the rights or privileges available to limited partners under our partnership agreement. For a description of the relative rights and preferences of holders of common units in and to partnership distributions, please read this section and “Provisions of the Partnership Agreement Relating to Cash Distributions.” For a description of other rights and privileges of limited partners under our partnership agreement, including voting rights, please read “The Partnership Agreement.”

Transfer Agent and Registrar

Duties

Computershare Trust Company, N.A. is anticipated to serve as the registrar and transfer agent for the common units. We will pay all fees charged by the transfer agent for transfers of common units except the following, which must be paid by unitholders:

 

    surety bond premiums to replace lost or stolen certificates, taxes and other governmental charges;

 

    special charges for services requested by a holder of a common unit; and

 

    other similar fees or charges.

There will be no charge to unitholders for disbursements of our cash distributions. We will indemnify the transfer agent, its agents and each of their stockholders, directors, officers and employees against all claims and losses that may arise out of acts performed or omitted for its activities in that capacity, except for any liability due to any gross negligence or intentional misconduct of the indemnified person or entity.

Resignation or Removal

The transfer agent may resign, by notice to us, or be removed by us. The resignation or removal of the transfer agent will become effective upon our appointment of a successor transfer agent and registrar and its acceptance of the appointment. If no successor is appointed or a successor has not accepted its appointment, our general partner may act as the transfer agent and registrar until a successor is appointed.

Transfer of Common Units

Upon the transfer of a common unit in accordance with our partnership agreement, the transferee of the common unit shall be admitted as a limited partner with respect to the common units transferred when such transfer and admission are reflected in our books and records. Each transferee:

 

    represents that the transferee has the capacity, power and authority to become bound by our partnership agreement;

 

    automatically becomes bound by the terms and conditions of our partnership agreement; and

 

    gives the consents, waivers and approvals contained in our partnership agreement.

Our general partner will cause any transfers to be recorded on our books and records no less frequently than quarterly.

 

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We may, at our discretion, treat the nominee holder of a common unit as the absolute owner. In that case, the beneficial holder’s rights are limited solely to those that it has against the nominee holder as a result of any agreement between the beneficial owner and the nominee holder.

Common units are securities and any transfers are subject to the laws governing the transfer of securities. In addition to other rights acquired upon transfer, the transferor gives the transferee the right to become a substituted limited partner in our partnership for the transferred common units.

Until a common unit has been transferred on our books, we and the transfer agent may treat the record holder of the common unit as the absolute owner for all purposes, except as otherwise required by law or stock exchange regulations.

 

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THE PARTNERSHIP AGREEMENT

The following is a summary of the material provisions of our partnership agreement. The form of our partnership agreement is included in this prospectus as Annex B. We will provide prospective investors with a copy of our partnership agreement upon request at no charge.

We summarize the following provisions of our partnership agreement elsewhere in this prospectus:

 

    with regard to distributions, please read “Provisions of the Partnership Agreement Relating to Cash Distributions”;

 

    with regard to the duties of, and standard of care applicable to, our general partner, please read “Conflicts of Interest and Fiduciary Duties”;

 

    with regard to the transfer of common units, please read “Description of the Common Units—Transfer of Common Units”; and

 

    with regard to allocations of taxable income and taxable loss, please read “Material U.S. Federal Income Tax Consequences of Sanchez LP Common Unit Ownership.”

As used in this section, references to “we,” “us” and “our” refer to Sanchez LP. Unless the context otherwise requires, references in this section to any class of units are references to the units of Sanchez LP to be issued and outstanding upon consummation of the Conversion, and references to any unitholders refer to the unitholders of Sanchez LP.

Organization and Duration

Sanchez Production Partners LP will be created upon the effective time of the Conversion of the Company. Sanchez Production Partners LP will have a perpetual existence unless terminated pursuant to the terms of our partnership agreement.

Purpose

Our purpose, as set forth in our partnership agreement, is limited to any business activity that is approved by our general partner and that lawfully may be conducted by a limited partnership organized under Delaware law; provided that our general partner shall not cause us to take any action that the general partner determines would be reasonably likely to cause us to be treated as an association taxable as a corporation or otherwise taxable as an entity for U.S. federal income tax purposes.

Although our general partner has the ability to cause us and our current or future subsidiaries to engage in activities other than the business of engaging in oil and natural gas exploration and production activities, our general partner may decline to do so free of any fiduciary duty or obligation whatsoever to us or the limited partners, including any duty to act in good faith or in the best interests of us or the limited partners. Our general partner is generally authorized to perform all acts that it determines to be necessary or appropriate to carry out our purposes and to conduct our business.

Cash Distributions

Our partnership agreement specifies the manner in which we will make cash distributions to holders of our common units and other partnership securities as well as to SP Holdings in respect of its incentive distribution rights. For a description of these cash distribution provisions, please read “Provisions of the Partnership Agreement Relating to Cash Distributions.”

Capital Contributions

Unitholders are not obligated to make additional capital contributions, except as described below under “—Limited Liability.”

 

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Voting Rights

The following is a summary of the unitholder vote required for approval of the matters specified below. Matters that require the approval of a “unit majority” require the approval of a majority of the common units.

In voting their common units, our general partner and its affiliates will have no fiduciary duty or obligation whatsoever to us or the limited partners, including any duty to act in good faith or in the best interests of us or the limited partners.

The incentive distribution rights may be entitled to vote in certain circumstances.

 

Issuance of additional units

No approval right.

 

Amendment of the partnership agreement

Certain amendments may be made by our general partner without the approval of the unitholders. Other amendments generally require the approval of a unit majority. Please read “—Amendment of the Partnership Agreement.”

 

Merger of our partnership or the sale of all or substantially all of our assets

Unit majority in certain circumstances. Please read “—Merger, Consolidation, Conversion, Sale or Other Disposition of Assets.”

 

Dissolution of our partnership

Unit majority. Please read “—Dissolution.”

 

Continuation of our business upon dissolution

Unit majority. Please read “—Dissolution.”

 

Withdrawal of our general partner

Under most circumstances, the approval of a majority of the common units, excluding common units held by our general partner and its affiliates, is required for the withdrawal of our general partner prior to September 30, 2024 in a manner that would cause a dissolution of our partnership. Please read “—Withdrawal or Removal of Our General Partner.”

 

Removal of our general partner

Not less than 66 2/3% of the outstanding units, voting as a single class, including units held by our general partner and its affiliates. Please read “—Withdrawal or Removal of Our General Partner.”

 

Transfer of our general partner interest

No approval right. Please read “—Transfer of General Partner Interest.”

 

Transfer of incentive distribution rights

No approval right. Please read “—Transfer of Incentive Distribution Rights.”

 

Transfer of ownership interests in our general partner

No approval right. Please read “—Transfer of Ownership Interests in the General Partner.”

If any person or group other than our general partner and its affiliates acquires beneficial ownership of 20% or more of any class of units, that person or group loses voting rights on all of its units, unless otherwise required

 

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by law or approved by the board of directors of our general partner. This loss of voting rights does not apply to any person or group that acquires the units from our general partner or its affiliates and any transferees of that person or group approved by our general partner or to any person or group who acquires the units with the specific prior approval of our general partner.

Applicable Law; Forum, Venue and Jurisdiction

Our partnership agreement is governed by Delaware law. Our partnership agreement requires that any claims, suits, actions or proceedings:

 

    arising out of or relating in any way to the partnership agreement (including any claims, suits or actions to interpret, apply or enforce the provisions of the partnership agreement or the duties, obligations or liabilities among limited partners or of limited partners to us, or the rights or powers of, or restrictions on, the limited partners or us);

 

    brought in a derivative manner on our behalf;

 

    asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of us or our general partner, or owed by our general partner, to us or the limited partners;

 

    asserting a claim arising pursuant to any provision of the Delaware Act; or

 

    asserting a claim governed by the internal affairs doctrine

shall be exclusively brought in the Court of Chancery of the State of Delaware (or, if such court does not have subject matter jurisdiction thereof, any other court located in the State of Delaware with subject matter jurisdiction), regardless of whether such claims, suits, actions or proceedings sound in contract, tort, fraud or otherwise, are based on common law, statutory, equitable, legal or other grounds, or are derivative or direct claims. In addition, each party to such claims, suits, actions or proceedings irrevocably waives the right to trial by jury.

If any limited partner, our general partner or any person holding any beneficial interest in Sanchez LP (whether through a broker, dealer, bank, trust company or clearing corporation) brings any of the claims, suits, actions or proceedings described in the bullets above and such person does not obtain a judgment on the merits that substantially achieves, in substance and amount (if the extent of such achievement is disputed, then as determined by the Court of Chancery of the State of Delaware or such other court with subject matter jurisdiction of such claim, suit, action or proceeding), the full remedy sought, then such limited partner, our general partner or person holding any beneficial interest in Sanchez LP shall be obligated to reimburse Sanchez LP and its affiliates (including our general partner, the directors of our general partner and the owner of our general partner) for all fees, costs and expenses of every kind and description, including but not limited to all reasonable attorney’s fees and other litigation expenses, that the parties may incur in connection with such claim, suit, action or proceeding. Sanchez LP and its “affiliates,” as defined in Section 1.1 of Sanchez LP’s partnership agreement included in Annex B (including our general partner, the directors and officers of our general partner, SOG, SP Holdings, SEPI and Messrs. Sanchez III and Willinger) would be entitled to recover all of their fees, costs and expenses in any such action, and such losing party would be severally liable for all such fees, costs and expenses.

By taking ownership of a common unit, including by way of the Conversion, a limited partner is irrevocably consenting to these limitations and provisions regarding claims, suits, actions or proceedings and submitting to the exclusive jurisdiction of the Court of Chancery of the State of Delaware (or such other court) in connection with any such claims, suits, actions or proceedings. We intend to apply a broad interpretation to each of the foregoing provisions in our partnership agreement in order to apply the fee-shifting provision broadly.

Limited Liability

Assuming that a limited partner does not participate in the control of our business within the meaning of the Delaware Act and that he otherwise acts in conformity with the provisions of the partnership agreement, his

 

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liability under the Delaware Act will be limited, subject to possible exceptions, to the amount of capital he is obligated to contribute to us for his common units plus his share of any undistributed profits and assets. However, if it were determined that the right, or exercise of the right, by the limited partners as a group:

 

    to remove or replace our general partner;

 

    to approve some amendments to our partnership agreement; or

 

    to take other action under our partnership agreement

constituted “participation in the control” of our business for the purposes of the Delaware Act, then the limited partners could be held personally liable for our obligations under the laws of Delaware, to the same extent as our general partner. This liability would extend to persons who transact business with us under the reasonable belief that the limited partner is a general partner. Neither our partnership agreement nor the Delaware Act specifically provides for legal recourse against our general partner if a limited partner were to lose limited liability through any fault of our general partner. While this does not mean that a limited partner could not seek legal recourse, we know of no precedent for this type of a claim in Delaware case law.

Under the Delaware Act, a limited partnership may not make a distribution to a partner if, after the distribution, all liabilities of the limited partnership, other than liabilities to partners on account of their partnership interests and liabilities for which the recourse of creditors is limited to specific property of the partnership, would exceed the fair value of the assets of the limited partnership. For the purpose of determining the fair value of the assets of a limited partnership, the Delaware Act provides that the fair value of property subject to liability for which recourse of creditors is limited shall be included in the assets of the limited partnership only to the extent that the fair value of that property exceeds the nonrecourse liability. The Delaware Act provides that a limited partner who receives a distribution and knew at the time of the distribution that the distribution was in violation of the Delaware Act shall be liable to the limited partnership for the amount of the distribution for three years.

Limitations on the liability of members or limited partners for the obligations of a limited liability company or limited partnership have not been clearly established in many jurisdictions. If, by virtue of our ownership interest in our subsidiary or any subsidiaries we may have in the future, or otherwise, it were determined that we were conducting business in any jurisdiction without compliance with the applicable limited partnership or limited liability company statute, or that the right or exercise of the right by the limited partners as a group to remove or replace our general partner, to approve some amendments to our partnership agreement, or to take other action under our partnership agreement constituted “participation in the control” of our business for purposes of the statutes of any relevant jurisdiction, then the limited partners could be held personally liable for our obligations under the law of that jurisdiction to the same extent as our general partner under the circumstances. We will operate in a manner that our general partner considers reasonable and necessary or appropriate to preserve the limited liability of the limited partners.

Issuance of Additional Interests

Our partnership agreement authorizes us to issue an unlimited number of additional partnership interests for the consideration and on the terms and conditions determined by our general partner without the approval of the unitholders.

It is possible that we will fund acquisitions through the issuance of additional common units or other partnership interests. Holders of any additional common units that we issue will be entitled to share equally with the then-existing common unitholders in our distributions. In addition, the issuance of additional common units or other partnership interests may dilute the value of the interests of the then-existing common unitholders in our net assets.

In accordance with Delaware law and the provisions of our partnership agreement, we may also issue additional partnership interests that, as determined by our general partner, may have rights to distributions or

 

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special voting rights to which the common units are not entitled. In addition, our partnership agreement does not prohibit our current or future subsidiaries from issuing equity interests, which may effectively rank senior to the common units.

Amendment of the Partnership Agreement

General

Amendments to our partnership agreement may be proposed only by our general partner. However, our general partner will have no duty or obligation to propose any amendment and may decline to do so free of any fiduciary duty or obligation whatsoever to us or the limited partners, including any duty to act in good faith or in the best interests of us or the limited partners. In order to adopt a proposed amendment, other than the amendments discussed below, our general partner is required to seek written approval of the holders of the number of units required to approve the amendment or to call a meeting of the limited partners to consider and vote upon the proposed amendment. Except as described below, an amendment must be approved by a unit majority.

Prohibited Amendments

No amendment may be made that would:

 

    enlarge the obligations of any limited partner without his consent, unless approved by at least a majority of the type or class of limited partner interests so affected; or

 

    enlarge the obligations of, restrict, change or modify in any way any action by or rights of, or reduce in any way the amounts distributable, reimbursable or otherwise payable by us to our general partner or any of its affiliates without the consent of our general partner, which consent may be given or withheld in its sole discretion.

The provision of our partnership agreement preventing the amendments having the effects described in the clauses above can be amended upon the approval of the holders of at least 75.0% of the outstanding units, voting as a single class (including units owned by our general partner and its affiliates). Upon the effective time of the Conversion, SEPI and SP Holdings will collectively own approximately 20.5% of our outstanding common units, based on the number of the Company’s units owned as of the record date.

No Unitholder Approval

Our general partner may generally make amendments to our partnership agreement without the approval of any limited partner to reflect:

 

    a change in our name, the location of our principal place of business, our registered agent or our registered office;

 

    the admission, substitution, withdrawal or removal of partners in accordance with our partnership agreement;

 

    a change that our general partner determines to be necessary or appropriate to qualify or continue our qualification as a limited partnership or other entity in which the limited partners have limited liability under the laws of any state or to ensure that neither we nor any of our subsidiaries will be treated as an association taxable as a corporation or otherwise taxed as an entity for U.S. federal income tax purposes (to the extent not already so treated or taxed);

 

    a change in our fiscal year or taxable year and related changes;

 

   

an amendment that is necessary, in the opinion of our counsel, to prevent us or our general partner or its directors, officers, agents or trustees from in any manner being subjected to the provisions of the

 

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Investment Company Act of 1940, the Investment Advisers Act of 1940 or “plan asset” regulations adopted under the Employee Retirement Income Security Act of 1974, or (“ERISA”) whether or not substantially similar to plan asset regulations currently applied or proposed;

 

    an amendment that our general partner determines to be necessary or appropriate in connection with the creation, authorization or issuance of additional partnership interests or the right to acquire partnership interests;

 

    any amendment expressly permitted in our partnership agreement to be made by our general partner acting alone;

 

    an amendment effected, necessitated or contemplated by a merger agreement that has been approved under the terms of our partnership agreement;

 

    any amendment that our general partner determines to be necessary or appropriate for the formation by us of, or our investment in, any corporation, partnership or other entity, as otherwise permitted by our partnership agreement;

 

    conversions into, mergers with or conveyances to another limited liability entity that is newly formed and has no assets, liabilities or operations at the time of the conversion, merger or conveyance other than those it receives by way of the conversion, merger or conveyance in certain circumstances; or

 

    any other amendments substantially similar to any of the matters described in the clauses above.

In addition, our general partner may make amendments to our partnership agreement, without the approval of any limited partner, if our general partner determines that those amendments:

 

    do not adversely affect the limited partners, considered as a whole, or any particular class of limited partners, in any material respect;

 

    are necessary or appropriate to satisfy any requirements, conditions or guidelines contained in any opinion, directive, order, ruling or regulation of any federal or state agency or judicial authority or contained in any federal or state statute;

 

    are necessary or appropriate to facilitate the trading of limited partner interests or to comply with any rule, regulation, guideline or requirement of any securities exchange on which the limited partner interests are or will be listed for trading;

 

    are necessary or appropriate for any action taken by our general partner relating to splits or combinations of units under the provisions of our partnership agreement;

 

    are necessary or appropriate in connection with the creation, authorization or issuance of any class or series of partnership securities; or

 

    are required to effect the intent of the registration statement of which this proxy statement/prospectus forms a part or the provisions of our partnership agreement or are otherwise contemplated by our partnership agreement.

Opinion of Counsel and Unitholder Approval

Any amendment that our general partner determines adversely affects in any material respect one or more particular classes of limited partners will require the approval of at least a majority of the class or classes so affected, but no vote will be required by any class or classes of limited partners that our general partner determines are not adversely affected in any material respect. Any amendment that would have a material adverse effect on the rights or preferences of any type or class of outstanding units in relation to other classes of units will require the approval of at least a majority of the type or class of units so affected. Any amendment that would reduce the voting percentage required to take any action other than to remove the general partner or call a meeting of unitholders is required to be approved by the affirmative vote of limited partners whose aggregate

 

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outstanding units constitute not less than the voting requirement sought to be reduced. Any amendment that would increase the percentage of units required to remove the general partner or call a meeting of unitholders must be approved by the affirmative vote of limited partners whose aggregate outstanding units constitute not less than the percentage sought to be increased. For amendments of the type not requiring unitholder approval, our general partner will not be required to obtain an opinion of counsel that an amendment will neither result in a loss of limited liability to the limited partners nor result in our being treated as a taxable entity for federal income tax purposes in connection with any of the amendments. Any amendment relating to special unitholder meetings, notices of unitholder meetings, quorum and voting requirements, actions without a meeting and the amendment provisions in the LP Agreement require approval of 75% of the outstanding Sanchez LP units. No amendments to our partnership agreement, other than those the general partner can adopt without unitholder approval or in connection with a merger or consolidation, will become effective without the approval of holders of at least 90% of the outstanding units, voting as a single class, unless we first obtain an opinion of counsel to the effect that the amendment will not affect the limited liability under applicable law of any of our limited partners.

Merger, Consolidation, Conversion, Sale or Other Disposition of Assets

A merger, consolidation or conversion of us requires the prior consent of our general partner. However, our general partner will have no duty or obligation to consent to any merger, consolidation or conversion and may decline to do so free of any fiduciary duty or obligation whatsoever to us or the limited partners, including any duty to act in good faith or in the best interest of us or the limited partners.

In addition, our partnership agreement generally prohibits our general partner, without the prior approval of the holders of a unit majority, from causing us to sell, exchange or otherwise dispose of all or substantially all of our assets in a single transaction or a series of related transactions, including by way of merger, consolidation or other combination. Our general partner may, however, mortgage, pledge, hypothecate or grant a security interest in all or substantially all of our assets without such approval. Our general partner may also sell all or substantially all of our assets under a foreclosure or other realization upon those encumbrances without such approval. Finally, our general partner may consummate any merger without the prior approval of our unitholders if we are the surviving entity in the transaction, our general partner has received an opinion of counsel regarding limited liability and tax matters, the transaction would not result in a material amendment to the partnership agreement (other than an amendment that the general partner could adopt without the consent of other partners), each of our units will be an identical unit of our partnership following the transaction and the partnership securities to be issued do not exceed 20% of our outstanding partnership interests (other than incentive distribution rights) immediately prior to the transaction. If the conditions specified in our partnership agreement are satisfied, our general partner may convert us or any of our subsidiaries into a new limited liability entity or merge us or any of our subsidiaries into, or convey all of our assets to, a newly formed entity, if the sole purpose of that conversion, merger or conveyance is to effect a mere change in our legal form into another limited liability entity, we have received an opinion of counsel regarding limited liability and tax matters and the governing instruments of the new entity provide the limited partners and our general partner with the same rights and obligations as contained in our partnership agreement. Our unitholders are not entitled to dissenters’ rights of appraisal under our partnership agreement or applicable Delaware law in the event of a conversion, merger or consolidation, a sale of substantially all of our assets or any other similar transaction or event.

Dissolution

We will continue as a limited partnership until dissolved and terminated under our partnership agreement and the Delaware Act. We will dissolve upon:

 

    the election of our general partner to dissolve us, if approved by the holders of units representing a unit majority;

 

    there being no limited partners, unless we are continued without dissolution in accordance with applicable Delaware law;

 

    the entry of a decree of judicial dissolution of our partnership;

 

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    the withdrawal or removal of our general partner or any other event that results in its ceasing to be our general partner other than by reason of a transfer of its general partner interest in accordance with our partnership agreement or its withdrawal or removal following the approval and admission of a successor; or

 

    any other dissolution event as required by applicable Delaware law.

Upon a dissolution under the penultimate clause above, the holders of a unit majority may also elect, within specific time limitations, to continue our business on the same terms and conditions described in our partnership agreement by appointing as a successor general partner an entity approved by the holders of units representing a unit majority, subject to our receipt of an opinion of counsel to the effect that:

 

    the action would not result in the loss of limited liability under Delaware law of any limited partner; and

 

    neither we nor any of our subsidiaries would be treated as an association taxable as a corporation or otherwise be taxable as an entity for U.S. federal income tax purposes upon the exercise of that right to continue (to the extent not already so treated or taxed).

Liquidation and Distribution of Proceeds

Upon our dissolution, unless our business is continued, the liquidator authorized to wind up our affairs will, acting with all of the powers of our general partner that are necessary or appropriate, liquidate our assets and apply the proceeds of the liquidation as described in “Provisions of the Partnership Agreement Relating to Cash Distributions—Distributions of Cash Upon Liquidation.” The liquidator may defer liquidation or distribution of our assets for a reasonable period of time or distribute assets to partners in kind if it determines that a sale would be impractical or would cause undue loss to our partners.

Withdrawal or Removal of Our General Partner

Except as described below, our general partner has agreed not to withdraw voluntarily as our general partner prior to September 30, 2024 without obtaining the approval of the holders of at least a majority of the outstanding common units, excluding common units held by our general partner and its affiliates, and furnishing an opinion of counsel regarding limited liability and tax matters. On or after September 30, 2024, our general partner may withdraw as general partner without first obtaining approval of any unitholder by giving 90 days’ written notice, and that withdrawal will not constitute a violation of our partnership agreement. Notwithstanding the information above, our general partner may withdraw without unitholder approval upon 90 days’ notice to the limited partners if at least 50% of the outstanding common units are held or controlled by one person and its affiliates, other than our general partner and its affiliates. In addition, our partnership agreement permits our general partner to sell or otherwise transfer all of its general partner interest in us without the approval of the unitholders. Please read “—Transfer of General Partner Interest.”

Upon withdrawal of our general partner under any circumstances, other than as a result of a transfer by our general partner of all or a part of its general partner interest in us, the holders of a unit majority may appoint a successor to that withdrawing general partner. If a successor is not elected, or is elected but an opinion of counsel regarding limited liability and tax matters cannot be obtained, we will be dissolved, wound up and liquidated, unless within a specified period after that withdrawal, the holders of a unit majority agree in writing to continue our business and to appoint a successor general partner. Please read “—Dissolution.”

Our general partner may not be removed unless that removal is approved by the vote of the holders of not less than 66 2/3% of the outstanding units, voting together as a single class, including units held by our general partner and its affiliates, and we receive an opinion of counsel regarding limited liability and tax matters. Any removal of our general partner is also subject to the approval of a successor general partner by the vote of a unit majority. The ownership of more than 33 1/3% of the outstanding units by our general partner and its affiliates

 

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gives them the ability to prevent our general partner’s removal. Upon the effective time of the Conversion, based on the number of the Company’s units outstanding on the record date, SEPI and SP Holdings will collectively own 20.5% of our outstanding common units.

In the event of the removal of our general partner under circumstances where cause exists or withdrawal of our general partner where that withdrawal violates our partnership agreement, a successor general partner will have the option to purchase the general partner interest and incentive distribution rights of the departing general partner and its affiliates for a cash payment equal to the fair market value of those interests. Under all other circumstances where our general partner withdraws or is removed by the limited partners, the departing general partner will have the option to require the successor general partner to purchase the general partner interest and the incentive distribution rights of the departing general partner and its affiliates for fair market value. In each case, this fair market value will be determined by agreement between the departing general partner and the successor general partner. If no agreement is reached, an independent investment banking firm or other independent expert selected by the departing general partner and the successor general partner will determine the fair market value; if the departing general partner and the successor general partner cannot agree upon an expert, then an expert chosen by agreement of the experts selected by each of them will determine the fair market value.

If the option described above is not exercised by either the departing general partner or the successor general partner, then the departing general partner’s general partner interest and all of its affiliates’ incentive distribution rights will automatically convert into common units equal to the fair market value of those interests as determined by an investment banking firm or other independent expert selected in the manner described in the preceding paragraph.

In addition, we will be required to reimburse the departing general partner for all amounts due to the departing general partner, including, without limitation, all employee-related liabilities, including severance liabilities, incurred as a result of the termination of any employees employed for our benefit by the departing general partner or its affiliates.

Transfer of General Partner Interest

At any time, our general partner may transfer all or any of its general partner interest to another person without the approval of our common unitholders. As a condition of this transfer, the transferee must, among other things, assume the rights and duties of our general partner, agree to be bound by the provisions of our partnership agreement and furnish an opinion of counsel regarding limited liability and tax matters.

Transfer of Ownership Interests in the General Partner

At any time, the owners of our general partner may sell or transfer all or part of its ownership interests in our general partner to an affiliate or third-party without the approval of our unitholders.

Transfer of Incentive Distribution Rights

By transfer of incentive distribution rights in accordance with our partnership agreement, each transferee of incentive distribution rights will be admitted as a limited partner with respect to the incentive distribution rights transferred when such transfer and admission is reflected in our books and records. Each transferee:

 

    represents that the transferee has the capacity, power and authority to become bound by our partnership agreement;

 

    automatically becomes bound by the terms and conditions of our partnership agreement; and

 

    gives the consents, waivers and approvals contained in our partnership agreement.

 

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Our general partner will cause any transfers to be recorded on our books and records no less frequently than quarterly.

We may, at our discretion, treat the nominee holder of incentive distribution rights as the absolute owner. In that case, the beneficial holder’s rights are limited solely to those that it has against the nominee holder as a result of any agreement between the beneficial owner and the nominee holder.

Incentive distribution rights are securities and any transfers are subject to the laws governing transfer of securities. In addition to other rights acquired upon transfer, the transferor gives the transferee the right to become a limited partner for the transferred incentive distribution rights.

Until an incentive distribution right has been transferred on our books, we and the transfer agent may treat the record holder of the unit or right as the absolute owner for all purposes, except as otherwise required by law or stock exchange regulations.

Change of Management Provisions

Our partnership agreement contains specific provisions that are intended to discourage a person or group from attempting to remove Sanchez GP as our general partner or from otherwise changing our management. Please read “—Withdrawal or Removal of Our General Partner” for a discussion of certain consequences of the removal of our general partner. If any person or group, other than our general partner and its affiliates, acquires beneficial ownership of 20% or more of any class of units, that person or group loses voting rights on all of its units. This loss of voting rights does not apply in certain circumstances. Please read “—Meetings; Voting.”

Limited Call Right

If at any time our general partner and its controlled affiliates own more than 80% of the then-issued and outstanding limited partner interests of any class, our general partner will have the right, which it may assign in whole or in part to any of its affiliates or beneficial owners or to us, to acquire all, but not less than all, of the limited partner interests of the class held by unaffiliated persons, as of a record date to be selected by our general partner, on at least 10, but not more than 60, days’ notice. The purchase price in the event of this purchase is the greater of:

 

    the highest price paid by our general partner or any of its affiliates for any limited partner interests of the class purchased within the 90 days preceding the date on which our general partner first mails notice of its election to purchase those limited partner interests; and

 

    the average of the daily closing prices of the partnership securities of such class over the 20 consecutive trading days preceding the date that is three days before the date the notice is mailed.

As a result of our general partner’s right to purchase outstanding limited partner interests, a holder of limited partner interests may have his limited partner interests purchased at an undesirable time or at a price that may be lower than market prices at various times prior to such purchase or lower than a unitholder may anticipate the market price to be in the future. The tax consequences to a unitholder of the exercise of this call right are the same as a sale by that unitholder of his common units in the market. Please read “Material U.S. Federal Income Tax Consequences of Sanchez LP Common Unit Ownership—Disposition of Units.”

Non-Taxpaying Holders; Redemption

To avoid any adverse effect on the maximum applicable rates chargeable to customers by us or any of our future subsidiaries, or in order to reverse an adverse determination that has occurred regarding such maximum rate, our partnership agreement provides our general partner the power to amend the agreement. If our general partner, with the advice of counsel, determines that our not being treated as an association taxable as a

 

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corporation or otherwise taxable as an entity for U.S. federal income tax purposes, coupled with the tax status (or lack of proof thereof) of one or more of our limited partners, has, or is reasonably likely to have, a material adverse effect on the maximum applicable rates chargeable to customers by us or our subsidiaries, then our general partner may adopt such amendments to our partnership agreement as it determines necessary or appropriate to:

 

    obtain proof of the U.S. federal income tax status of our limited partners (and their owners, to the extent relevant); and

 

    permit us to redeem the units held by any person whose tax status has or is reasonably likely to have a material adverse effect on the maximum applicable rates or who fails to comply with the procedures instituted by our general partner to obtain proof of the federal income tax status. The redemption price in the case of such a redemption will be the average of the daily closing prices per unit for the 20 consecutive trading days immediately prior to the date set for redemption.

Non-Citizen Assignees; Redemption

If our general partner, with the advice of counsel, determines that we are subject to U.S. federal, state or local laws or regulations that create a substantial risk of cancellation or forfeiture of any property that we have an interest in because of the nationality, citizenship or other related status of any limited partner, then our general partner may adopt such amendments to our partnership agreement as it determines necessary or advisable to:

 

    obtain proof of the nationality, citizenship or other related status of our limited partners (and their beneficial owners, to the extent relevant); and

 

    permit us to redeem the units held by any person whose nationality, citizenship or other related status creates substantial risk of cancellation or forfeiture of any property or who fails to comply with the procedures instituted by the general partner to obtain proof of the nationality, citizenship or other related status. The redemption price in the case of such a redemption will be the average of the daily closing prices per unit for the 20 consecutive trading days immediately prior to the date set for redemption.

Meetings; Voting

Except as described below regarding a person or group owning 20% or more of any class of units then outstanding, record holders of units on the record date will be entitled to notice of, and to vote at, meetings of our limited partners and to act upon matters for which approvals may be solicited.

Our general partner does not anticipate that any meeting of our unitholders will be called in the foreseeable future. Any action that is required or permitted to be taken by the unitholders may be taken either at a meeting of the unitholders or without a meeting if consents in writing describing the action so taken are signed by holders of the number of units necessary to authorize or take that action at a meeting. Meetings of the unitholders may be called by our general partner or by unitholders owning at least 20% of the outstanding units of the class for which a meeting is proposed. Unitholders may vote either in person or by proxy at meetings. The holders of a majority of the outstanding units of the class or classes for which a meeting has been called, represented in person or by proxy, will constitute a quorum, unless any action by the unitholders requires approval by holders of a greater percentage of the units, in which case the quorum will be the greater percentage.

Each record holder of a unit has a vote according to his percentage interest in us, although additional limited partner interests having special voting rights could be issued. Please read “—Issuance of Additional Interests.” However, if at any time any person or group, other than our general partner and its affiliates, or a direct or subsequently approved transferee of our general partner or its affiliates and purchasers specifically approved by our general partner, acquires, in the aggregate, beneficial ownership of 20% or more of any class of units then outstanding, that person or group will lose voting rights on all of its units and the units may not be voted on any

 

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matter and will not be considered to be outstanding when sending notices of a meeting of unitholders, calculating required votes, determining the presence of a quorum or for other similar purposes. Common units held in nominee or street name account will be voted by the broker or other nominee in accordance with the instruction of the beneficial owner unless the arrangement between the beneficial owner and his nominee provides otherwise.

Any notice, demand, request, report or proxy material required or permitted to be given or made to record common unitholders under our partnership agreement will be delivered to the record holder by us or by the transfer agent.

Voting Rights of Incentive Distribution Rights

If a majority of the incentive distribution rights are held by our general partner and its affiliates, the holders of the incentive distribution rights will have no right to vote in respect of such rights on any matter, unless otherwise required by law, and the holders of the incentive distribution rights shall be deemed to have approved any matter approved by our general partner.

If less than a majority of the incentive distribution rights are held by our general partner and its affiliates, the incentive distribution rights will be entitled to vote on all matters submitted to a vote of unitholders, other than amendments and other matters that our general partner determines do not adversely affect the holders of the incentive distribution rights in any material respect. On any matter in which the holders of incentive distribution rights are entitled to vote, such holders will vote together with the common units as a single class, and such incentive distribution rights shall be treated in all respects as common units when sending notices of a meeting of our limited partners to vote on any matter (unless otherwise required by law), calculating required votes, determining the presence of a quorum or for other similar purposes under our partnership agreement. The relative voting power of the holders of the incentive distribution rights and the common units will be set in the same proportion as cumulative cash distributions, if any, in respect of the incentive distribution rights for the four consecutive quarters prior to the record date for the vote bears to the cumulative cash distributions in respect of such class of units for such four quarters.

Status as Limited Partner

By transfer of common units in accordance with our partnership agreement, each transferee of common units shall be admitted as a limited partner with respect to the common units transferred when such transfer and admission are reflected in our books and records. Except as described under “—Limited Liability,” the common units will be fully paid, and unitholders will not be required to make additional contributions.

Indemnification

Under our partnership agreement, in most circumstances, we will indemnify the following persons, to the fullest extent permitted by law, from and against all losses, claims, damages or similar events:

 

    our general partner;

 

    any departing general partner;

 

    any person who is or was an affiliate of our general partner or any departing general partner;

 

    any person who is or was a manager, managing member, general partner, director, officer, employee, agent, fiduciary or trustee of our partnership, our subsidiaries, our general partner, any departing general partner or any of their affiliates;

 

    any person who is or was serving at the request of a general partner, any departing general partner or any of their respective affiliates as a manager, managing member, general partner, director, officer, employee, agent, fiduciary or trustee of another person owing a fiduciary duty to us or our subsidiaries;

 

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    any person who controls our general partner or any departing general partner; and

 

    any person designated by our general partner.

Any indemnification under these provisions will only be out of our assets. Unless our general partner otherwise agrees, it will not be personally liable for, or have any obligation to contribute or lend funds or assets to us to enable us to effectuate, indemnification. We may purchase insurance against liabilities asserted against and expenses incurred by persons for our activities, regardless of whether we would have the power to indemnify the person against liabilities under our partnership agreement.

Reimbursement of Expenses

Our partnership agreement requires us to reimburse our general partner and its affiliates for all direct and indirect expenses they incur or payments they make on our behalf and all other expenses allocable to us or otherwise incurred by our general partner and its affiliates in connection with operating our business. Our partnership agreement does not set a limit on the amount of expenses for which our general partner and its affiliates may be reimbursed. These expenses may include salary, bonus, incentive compensation and other amounts paid to persons who perform services for us or on our behalf and expenses allocated to our general partner by its affiliates. Our general partner is entitled to determine in good faith the expenses that are allocable to us.

Books and Reports

Our general partner is required to keep appropriate books of our business at our principal offices. These books will be maintained for both tax and financial reporting purposes on an accrual basis. For tax and fiscal reporting purposes, our fiscal year is the calendar year.

We will furnish or make available to record holders of our common units, within 105 days after the close of each fiscal year, an annual report containing audited consolidated financial statements and a report on those consolidated financial statements by our independent public accountants. Except for our fourth quarter, we will also furnish or make available summary financial information within 50 days after the close of each quarter. We will be deemed to have made any such report available if we file such report with the SEC on EDGAR or make the report available on a publicly available website which we maintain.

We will furnish each record holder with information reasonably required for U.S. federal and state tax reporting purposes within 90 days after the close of each calendar year. This information is expected to be furnished in summary form so that some complex calculations normally required of partners can be avoided. Our ability to furnish this summary information to our unitholders will depend on their cooperation in supplying us with specific information. Every unitholder will receive information to assist him in determining his U.S. federal and state tax liability and in filing his U.S. federal and state income tax returns, regardless of whether he supplies us with the necessary information.

Right to Inspect Our Books and Records

Our partnership agreement provides that a limited partner can, for a purpose reasonably related to his interest as a limited partner, upon reasonable written demand stating the purpose of such demand and at his own expense, have furnished to him:

 

    a current list of the name and last known address of each record holder;

 

    information as to the amount of cash, and a description and statement of the agreed value of any other capital contribution, contributed or to be contributed by each partner and the date on which each became a partner;

 

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    copies of our partnership agreement, our certificate of limited partnership, related amendments and powers of attorney under which they have been executed;

 

    information regarding the status of our business and financial condition (provided that obligation shall be satisfied to the extent the limited partner is furnished our most recent annual report and any subsequent quarterly or periodic reports required to be filed (or which would be required to be filed) with the SEC pursuant to Section 13(a) of the Exchange Act); and

 

    any other information regarding our affairs that our general partner determines is just and reasonable.

Under our partnership agreement, however, each of our limited partners and other persons who acquire interests in our partnership interests do not have rights to receive information from us or any of the persons we indemnify as described above under “—Indemnification” for the purpose of determining whether to pursue litigation or assist in pending litigation against us or those indemnified persons relating to our affairs, except pursuant to the applicable rules of discovery relating to the litigation commenced by the person seeking information.

Our general partner may, and intends to, keep confidential from the limited partners trade secrets or other information the disclosure of which our general partner believes in good faith is not in our best interests or that we are required by law or by agreements with third parties to keep confidential.

Registration Rights

Under our partnership agreement, we have agreed to register for resale under the Securities Act and applicable state securities laws any common units or other limited partner interests proposed to be sold by our general partner or any of its affiliates or their assignees, including SEPI, if an exemption from the registration requirements is not otherwise available. These registration rights continue for two years following any withdrawal or removal of our general partner. We are obligated to pay all expenses incidental to the registration, excluding underwriting discounts.

 

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COMPARISON OF RIGHTS OF SANCHEZ LP COMMON UNITHOLDERS AND COMPANY COMMON UNITHOLDERS

The following is a summary of the material differences between the common units of the Company under the Company’s operating agreement (the “LLC Agreement”) and the common units of Sanchez LP under its agreement of limited partnership (the “LP Agreement”). While the Company believes that this summary covers the material differences between the Company’s common units, on the one hand, and the Sanchez LP common units, on the other hand, this summary may not contain all of the information that is important to you. This summary is not intended to be a complete description of the respective rights of the Company’s common unitholders and Sanchez LP common unitholders and is qualified in its entirety by reference to the Delaware Revised Uniform Limited Partnership Act, the LLC Agreement and the LP Agreement that is included as Annex B to this proxy statement/prospectus.

Purpose and Term of Existence

 

Sanchez LP

  

Company

Sanchez LP’s purpose is limited to any business activity that is approved by its general partner and that lawfully may be conducted by a limited partnership organized under Delaware law; provided that its general partner shall not cause it to take any action that the general partner determines would be reasonably likely to cause it to be treated as an association taxable as a corporation or otherwise taxable as an entity for U.S. federal income tax purposes.

 

Sanchez LP’s existence as a limited partnership will continue until dissolved pursuant to the terms of the LP Agreement.

  

Under the LLC Agreement, the Company is permitted to engage, directly or indirectly, in any activity that its board of managers approves and that a limited liability company organized under Delaware law lawfully may conduct; provided that its board of managers shall not cause it to engage, directly or indirectly, in any business activities that the board determines would cause the Company to be treated as an association taxable as a corporation or otherwise taxable as an entity for federal income tax purposes.

 

The Company’s existence as a limited liability company will continue until dissolved pursuant to the terms of the LLC Agreement.

Distributions of Available Cash

 

Sanchez LP

  

Company

On or about the last day of the second month after the end of each quarter, Sanchez LP will distribute all of its available cash to common unitholders.

 

Available cash is defined in the LP Agreement and generally means, with respect to any calendar quarter, all cash on hand at the end of such quarter:

 

•     less the amount of cash reserves established by the general partner to:

 

•     provide for the proper conduct of the business (including cash reserves for future capital expenditures and anticipated future debt service requirements subsequent to that quarter);

 

•     comply with applicable law, any of Sanchez LP’s debt instruments or other agreements; or

 

•     provide funds for distributions to Sanchez LP’s unitholders for any one or more of the

  

Within 45 days after the end of each quarter, the Company is required to distribute all of its available cash to unitholders of record on the applicable record date.

 

Available cash is defined in the LLC Agreement and generally means, for each fiscal quarter, all cash on hand at the end of the quarter:

 

•     less the amount of cash reserves established by the Company’s board of managers to:

 

•     provide for the proper conduct of its business (including reserves for future capital expenditures and credit needs);

 

•     comply with applicable law, any of its debt instruments, or other agreements; or

 

•     provide funds for distributions to the Company’s unitholders for any one or more of the next four quarters;

 

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Sanchez LP

  

Company

next four quarters (provided that Sanchez LP’s general partner may not establish cash reserves for distributions if the effect of the establishment of such reserves will prevent it from distributing the minimum quarterly distribution on all common units);

 

•     plus if Sanchez LP’s general partner so determines, all or any portion of the cash on hand on the date of determination of available cash for the quarter resulting from working capital borrowings made subsequent to the end of such quarter.

 

Please read “Provisions of the Partnership Agreement Relating to Cash Distributions—Distributions of Available Cash.”

  

 

•     plus all cash on hand on the date of determination of available cash for the quarter resulting from working capital borrowings made after the end of the quarter. Working capital borrowings are generally borrowings that are made under the reserve-based credit facility or another arrangement and in all cases are used solely for working capital purposes or to pay distributions to unitholders.

Merger, Consolidation, Conversion, Sale or Other Disposition of Assets

 

Sanchez LP

  

Company

A merger, consolidation or conversion of Sanchez LP requires the prior consent of Sanchez LP’s general partner. However, the general partner will have no duty or obligation to consent to any merger, consolidation or conversion and may decline to do so free of any fiduciary duty or obligation whatsoever to Sanchez LP or the limited partners, including any duty to act in good faith or in the best interest of it or the limited partners.

 

In addition, the LP Agreement generally prohibits Sanchez LP’s general partner, without the prior approval of the holders of a unit majority, from causing Sanchez LP to sell, exchange or otherwise dispose of all or substantially all of Sanchez LP’s assets in a single

  

The Company’s board of managers is generally prohibited, without the prior approval of a common unit majority and a Class A unit majority from causing the Company to, among other things, sell, exchange or otherwise dispose of all or substantially all of its assets in a single transaction or a series of related transactions, including by way of merger, consolidation or other combination, or approving on its behalf the sale, exchange or other disposition of all or substantially all of the assets of its subsidiaries, provided that the Company’s board of managers may mortgage, pledge, hypothecate or grant a security interest in all or substantially all of its assets without that approval. The Company’s board of managers

transaction or a series of related transactions, including by way of merger, consolidation or other combination. Sanchez LP’s general partner may, however, mortgage, pledge, encumber, hypothecate or grant a security interest in all or substantially all of Sanchez LP’s assets without such approval. Sanchez LP’s general partner may also sell all or substantially all of Sanchez LP’s assets under a foreclosure or other realization upon those encumbrances without such approval. Finally, Sanchez LP’s general partner may consummate any merger without the prior approval of the Sanchez LP unitholders if Sanchez LP is the surviving entity in the transaction, the general partner has received an opinion of counsel regarding limited liability and tax matters, the transaction would not result in a material amendment to the LP Agreement (other than an amendment that the general partner could adopt without   

may also sell all or substantially all of the Company’s assets under a foreclosure or other realization upon the encumbrances above without that approval.

 

If the conditions specified in the LLC Agreement are satisfied, the Company’s board of managers may merge the Company or any of its subsidiaries into, or convey all of its assets to, a newly formed entity if the sole purpose of that merger or conveyance is to effect a mere change in legal form into another limited liability entity. In addition, the Company may convert into any “other entity” as defined in the Delaware Limited Liability Company Act, whether such entity is formed under the laws of the State of Delaware or any other state in the United States. The Company’s unitholders are not entitled to dissenters’ rights of appraisal under the LLC Agreement or

 

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the consent of other partners), each of the Sanchez LP units will be an identical unit of the partnership following the transaction and the partnership securities to be issued do not exceed 20% of Sanchez LP’s outstanding partnership interests (other than incentive distribution rights) immediately prior to the transaction. If the conditions specified in the LP Agreement are satisfied, Sanchez LP’s general partner may convert Sanchez LP or any of its subsidiaries into a new limited liability entity or merge its or any of its subsidiaries into, or convey all of its assets to, a newly formed entity, if the sole purpose of that conversion, merger or conveyance is to effect a mere change in its legal form into another limited liability entity, Sanchez LP has received an opinion of counsel regarding limited liability and tax matters and the governing instruments of the new entity provide the limited partners and the general partner with the same rights and obligations as contained in the LP Agreement. Sanchez LP’s unitholders are not entitled to dissenters’ rights of appraisal under the LP Agreement or applicable Delaware law in the event of a conversion, merger or consolidation, a sale of substantially all of its assets or any other similar transaction or event.   

applicable Delaware law in the event of a merger or consolidation, a sale of all or substantially all of the Company’s assets or any other transaction or event.

Dissolution

 

Sanchez LP

  

Company

Sanchez LP will continue as a limited partnership until dissolved under the LP Agreement. It will dissolve upon:

 

•     the election of Sanchez LP’s general partner to dissolve it, if approved by the holders of units representing a unit majority;

 

•     there being no limited partners, unless Sanchez LP is continued without dissolution in accordance with applicable Delaware law;

 

•     the entry of a decree of judicial dissolution of the partnership;

 

•     the withdrawal or removal of Sanchez LP’s general partner or any other event that results in the general partner ceasing to be general partner other than by reason of a transfer of its general partner interest in accordance with the LP Agreement or its withdrawal or removal following the approval and admission of a successor; or

 

•     any other dissolution event as required by Delaware law.

 

Upon a dissolution under the penultimate clause above, the holders of a unit majority may also elect, within specific time limitations, to continue Sanchez LP’s business on

  

The Company will continue as a company until terminated under the LLC Agreement. The Company will dissolve upon:

 

•     the election of its board of managers to dissolve, if approved by a common unit majority and a Class A unit majority;

 

•     the sale, exchange or other disposition of all or substantially all of the assets and properties of the Company and its subsidiaries; or

 

•     the entry of a decree of judicial dissolution of the Company.

 

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the same terms and conditions described in the LP Agreement by appointing as a successor general partner an entity approved by the holders of units representing a unit majority, subject to Sanchez LP’s receipt of an opinion of counsel to the effect that:

 

•     the action would not result in the loss of limited liability under Delaware law of any limited partner; and

 

•     neither Sanchez LP nor any of its subsidiaries would be treated as an association taxable as a corporation or otherwise be taxable as an entity for U.S. federal income tax purposes upon the exercise of that right to continue (to the extent not already so treated or taxed).

  

Transfer of General Partner Interest

 

Sanchez LP

  

Company

At any time, Sanchez LP’s general partner may transfer all or any of its general partner interest to another person without the approval of the Sanchez LP common unitholders. As a condition of this transfer, the transferee must, among other things, assume the rights and duties of the general partner, agree to be bound by the provisions of the LP Agreement and furnish an opinion of counsel regarding limited liability and tax matters.    The Company is governed by its board of managers, and therefore the LLC Agreement does not contain provisions regarding transfer of the managing interest in the Company. After the Conversion, Sanchez LP unitholders will not have the right to elect the board of directors of Sanchez LP’s general partner. See “—Meetings; Voting” and “The Partnership Agreement—Voting Rights.”

Withdrawal or Removal of the General Partner

 

Sanchez LP

  

Company

Except as described below, Sanchez LP’s general partner has agreed not to withdraw voluntarily as general partner prior to September 30, 2024 without obtaining the approval of the holders of at least a majority of the outstanding Sanchez LP common units, excluding common units held by the general partner and its affiliates, and furnishing an opinion of counsel regarding limited liability and tax matters. On or after September 30, 2024, Sanchez LP’s general partner may withdraw as general partner without first obtaining approval of any Sanchez LP unitholder by giving 90 days’ written notice, and that withdrawal will not constitute a violation of the LP Agreement. Notwithstanding the foregoing, Sanchez LP’s general partner may withdraw without Sanchez LP unitholder approval upon 90 days’ notice to the limited partners if at least 50% of the outstanding Sanchez LP common units are held or controlled by one person and its affiliates, other than the general partner and its affiliates.    The Company is governed by its board of managers, and therefore the LLC Agreement does not contain provisions regarding transfer of the managing interest in the Company. After the Conversion, Sanchez LP unitholders will not have the right to elect the board of directors of Sanchez LP’s general partner. See “—Meetings; Voting” and “The Partnership Agreement—Voting Rights.”

 

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In addition, the LP Agreement permits Sanchez LP’s general partner to sell or otherwise transfer all of its general partner interest in Sanchez LP without the approval of the Sanchez LP unitholders. Please read “—Transfer of General Partner Interest.”

 

Upon withdrawal of the general partner under any circumstance, other than as a result of a transfer by the general partner of all or a part of its general partner interest in Sanchez LP, the holders of a unit majority may appoint a successor to that withdrawing general partner. If a successor is not elected, or is elected but an opinion of counsel regarding limited liability and tax matters cannot be obtained, Sanchez LP will be dissolved, wound up and liquidated, unless within a specified period after that withdrawal, the holders of a unit majority agree in writing to continue its business and to appoint a successor general partner. Please read “—Dissolution.”

 

The general partner may not be removed unless that removal is approved by the vote of the holders of at least 66 2/3% of the outstanding Sanchez LP units, voting together as a single class, including units held by the general partner and its affiliates, and Sanchez LP receives an opinion of counsel regarding limited liability and tax matters. Any removal of the general partner is also subject to the approval of a successor general partner by the vote of a unit majority, including common units held by the general partner and affiliates. The ownership of more than 33 1/3% of the

  

outstanding Sanchez LP units by the general partner and its affiliates gives them the ability to prevent the general partner’s removal. Upon the effective time of the Conversion, based on the number of the Company’s units outstanding on the record date, SEPI and SP Holdings will collectively own 20.5% of Sanchez LP’s outstanding common units.

 

In the event of the removal of the general partner under circumstances where cause exists or withdrawal of the general partner where that withdrawal violates the LP Agreement, a successor general partner will have the option to purchase the general partner interest and incentive distribution rights of the departing general partner and its affiliates for a cash payment equal to the fair market value of those interests. Under all other circumstances where the general partner withdraws or is removed by the limited partners, the departing general partner will have the option to require the successor general partner to purchase the general partner interest and the incentive distribution rights of the departing

  

 

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general partner and its affiliates for fair market value. In each case, this fair market value will be determined by agreement between the departing general partner and the successor general partner. If no agreement is reached within 30 days after withdrawal or removal, an independent investment banking firm or other independent expert selected by the departing general partner and the successor general partner will determine the fair market value; if the departing general partner and the successor general partner cannot agree upon an expert, then an expert chosen by agreement of the experts selected by each of them will determine the fair market value.

 

If the option described above is not exercised by either the departing general partner or the successor general partner, then the departing general partner’s general partner interest and all of its and its affiliates’ incentive distribution rights will automatically convert into common units equal to the fair market value of those interests as determined by an investment banking firm or other independent expert selected in the manner described in the preceding paragraph.

 

In addition, Sanchez LP will be required to reimburse the departing general partner for all amounts due to the departing general partner, including, without limitation, all employee-related liabilities, including severance liabilities, incurred as a result of the termination of any employees employed for Sanchez LP’s benefit by the departing general partner or its affiliates.

  

Limited Call Right

 

Sanchez LP

  

Company

If at any time the general partner and its controlled affiliates own more than 80% of the then-issued and outstanding limited partner interests of any class, the general partner will have the right, which it may assign in whole or in part to any of its affiliates or beneficial owners or to Sanchez LP, to acquire all, but not less than all, of the limited partner interests of the class held by unaffiliated persons, as of a record date to be selected by Sanchez LP’s general partner, on at least 10, but not more than 60, days’ notice. The purchase price in the event of this purchase is the greater of:

 

•     the highest price paid by Sanchez LP’s general partner or any of its affiliates for any limited partner interests of the class purchased within the

  

If at any time any person owns more than 80% of the then-issued and outstanding Company common units, it will have the right, which it may assign in whole or in part to any of its affiliates or to the Company, to acquire all, but not less than all, of the remaining Company common units held by unaffiliated persons as of a record date to be selected by the Company’s board of managers, on at least 10 days’ but not more than 60 days’ notice. The Company’s common unitholders are not entitled to dissenters’ rights of appraisal under the LLC Agreement or applicable Delaware law if this limited call right is exercised. The purchase price in the event of this purchase is the greater of:

 

 

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90 days preceding the date on which the general partner first mails notice of its election to purchase those limited partner interests; and

 

•     the average of the daily closing prices of the partnership securities of such class over the 20 consecutive trading days preceding the date that is three days before the date the notice is mailed.

 

As a result of the general partner’s right to purchase outstanding limited partner interests, a holder of limited partner interests may have his limited partner interests purchased at an undesirable time or at a price that may be lower than market prices at various times prior to such purchase or lower than a Sanchez LP unitholder may anticipate the market price to be in the future. The tax consequences to a unitholder of the exercise of this call right are the same as a sale by that Sanchez LP unitholder of his common units in the market. Please read “Material U.S. Federal Income Tax Consequences of Sanchez LP Common Unit Ownership—Disposition of Units.”

  

•     the highest cash price paid by such person for any Company common units purchased within the 90 days preceding the date on which such person first mails notice of its election to purchase the remaining common units; and

 

•     the closing market price of the Company’s common units as of the date three days before the date the notice is mailed.

 

As a result of this limited call right, a holder of the Company’s common units may have his limited liability company interests purchased at an undesirable time or price. The tax consequences to a Company common unitholder of the exercise of this call right are the same as a sale by such common unitholder of its common units in the market.

Amendment of Governing Agreement

 

Sanchez LP

  

Company

General

 

Amendments to the LP Agreement may be proposed only by Sanchez LP’s general partner. However, the general partner will have no duty or obligation to propose any amendment and may decline to do so free of any fiduciary duty or obligation whatsoever to Sanchez LP or the limited partners, including any duty to act in good faith or in the best interests of Sanchez LP

  

General

 

Amendments to the LLC Agreement may be proposed only by or with the consent of the Company’s board of managers. To adopt a proposed amendment, other than the amendments discussed below, the Company’s board of managers is required to seek written approval of the holders of the number of units of the Company required to approve the

or the limited partners. In order to adopt a proposed amendment, other than the amendments discussed below, Sanchez LP’s general partner is required to seek written approval of the holders of the number of Sanchez LP units required to approve the amendment or to call a meeting of the limited partners to consider and vote upon the proposed amendment. Except as described below, an amendment must be approved by a unit majority.

 

Prohibited Amendments

 

No amendment may be made that would:

 

•     enlarge the obligations of any limited partner without his consent, unless approved by at least a

  

amendment or call a meeting of the Company’s unitholders to consider and vote upon the proposed amendment. Except as described below, an amendment must be approved by a common unit majority and a Class A unit majority.

 

Prohibited Amendments

 

No amendment may be made that would:

 

•     enlarge the obligations of any Company unitholder without its consent, unless approved by at least a majority of the type or class of member interests so affected;

 

•     provide that the Company is not dissolved upon an election to dissolve the Company by its board

 

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majority of the type or class of limited partner interests so affected; or

 

•     enlarge the obligations of, restrict, change or modify in any way any action by or rights of, or reduce in any way the amounts distributable, reimbursable or otherwise payable by Sanchez LP to, the general partner or any of its affiliates without the consent of the general partner, which consent may be given or withheld in its sole discretion.

 

The provision of the LP Agreement preventing the amendments having the effects described in the clauses above can be amended upon the approval of the holders of at least 75.0% of the outstanding Sanchez LP units, voting as a single class (including units owned by the general partner and its affiliates). Upon the effective time of the Conversion, SEPI and SP Holdings will collectively own approximately 20.5% of the outstanding common units, based on the number of the Company’s units owned as of the record date.

 

No Unitholder Approval

 

Sanchez LP’s general partner may generally make amendments to the LP Agreement without the approval of any limited partner to reflect:

 

•     a change in Sanchez LP’s name, the location of its principal place of business, its registered agent or its registered office;

 

•     the admission, substitution, withdrawal or removal of partners in accordance with the LP Agreement;

 

•     a change that Sanchez LP’s general partner determines to be necessary or appropriate to qualify or continue Sanchez LP’s qualification as a limited partnership or other entity in which the limited

  

of managers that is approved by a common unit majority and a Class A unit majority;

 

•     entitle members holding the Company’s common units and/or Class A units to more or fewer than one vote per unit;

 

•     prohibit the holders of Class A units from acting without a meeting;

 

•     change the procedures for notice to members of business to be brought before a meeting and nominations to the board of managers;

 

•     require some percentage other than a majority of votes cast affirmatively or negatively by members holding units for approval of matters submitted for a member vote;

 

•     allow the calling of a special meeting by other than a majority of the board of managers;

 

•     change the term of existence of the Company;

 

•     give any person the right to dissolve the Company other than its board of managers’ right to dissolve the Company with the approval of a common unit majority and a Class A unit majority; or

 

•     enlarge the size of the Company’s board of managers without the approval of the holders of 66 2/3% of the Class A units.

 

The provision of the LLC Agreement preventing the amendments having the effects described in any of the clauses above can be amended upon the approval of the holders of at least 75% of the outstanding Company common units, voting together as a single class, and 75% of the outstanding Class A units, voting together as a single class.

partners have limited liability under the laws of any state or to ensure that neither Sanchez LP nor any of its subsidiaries will be treated as an association taxable as a corporation or otherwise taxed as an entity for U.S. federal income tax purposes (to the extent not already so treated or taxed);

 

•     an amendment that is necessary, in the opinion of Sanchez LP’s counsel, to prevent Sanchez LP or its general partner or its general partner’s directors, officers, agents or trustees from in any manner being subjected to the provisions of the Investment Company Act of 1940, the Investment Advisers

  

 

No Unitholder Approval

 

The Company’s board of managers may generally make amendments to the LLC Agreement without unitholder approval to reflect:

 

•     a change in the Company’s name, the location of its principal place of its business, its registered agent or its registered office;

 

•     the admission, substitution, withdrawal or removal of members in accordance with the LLC Agreement;

 

 

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Act of 1940 or “plan asset” regulations adopted under ERISA whether or not substantially similar to plan asset regulations currently applied or proposed;

 

•     an amendment that Sanchez LP’s general partner determines to be necessary or appropriate in connection with the creation, authorization or issuance of additional partnership interests or the right to acquire partnership interests;

 

•     any amendment expressly permitted in the LP Agreement to be made by Sanchez LP’s general partner acting alone;

 

•     an amendment effected, necessitated or contemplated by a merger agreement that has been approved under the terms of the LP Agreement;

 

•     any amendment that Sanchez LP’s general partner determines to be necessary or appropriate for the formation by Sanchez LP of, or its investment in, any corporation, partnership or other entity, as otherwise permitted by the LP Agreement;

 

•     a change in Sanchez LP’s fiscal year or taxable year and related changes;

 

•     conversions into, mergers with or conveyances to another limited liability entity that is newly formed and has no assets, liabilities or operations at the time of the conversion, merger or conveyance other than those it receives by way of the conversion, merger or conveyance; or

 

•     any other amendments substantially similar to any of the matters described in the clauses above.

 

In addition, Sanchez LP’s general partner may make amendments to the LP Agreement, without the approval of any limited partner, if its general partner determines that those amendments:

 

•     do not adversely affect the limited partners, considered as a whole, or any particular class of limited partners, in any material respect;

 

•     are necessary or appropriate to satisfy any requirements, conditions or guidelines contained in any opinion, directive, order, ruling or regulation of any federal or state agency or judicial authority or contained in any federal or state statute;

 

•     are necessary or appropriate to facilitate the trading of limited partner interests or to comply with any rule, regulation, guideline or requirement of any

  

•     a change that the Company’s board of managers determines to be necessary or appropriate for the Company to qualify or continue its qualification as a company in which its members have limited liability under the laws of any state or to ensure that neither the Company, its operating subsidiaries nor any of their subsidiaries will be treated as an association taxable as a corporation or otherwise taxed as an entity for federal income tax purposes;

 

•     the merger of the Company or any of its subsidiaries into, or the conveyance of all of the Company’s assets to, a newly formed entity if the sole purpose of that merger or conveyance is to effect a mere change in legal form into another limited liability entity;

 

•     an amendment that is necessary, in the opinion of the Company’s counsel, to prevent the Company, members of its board, or its officers, agents or trustees from in any manner being subjected to the provisions of the Investment Company Act of 1940, the Investment Advisors Act of 1940, or “plan asset” regulations adopted under ERISA whether or not substantially similar to plan asset regulations currently applied or proposed;

 

•     an amendment that the Company’s board of managers determines to be necessary or appropriate for the authorization of additional securities or rights to acquire securities;

 

•     any amendment expressly permitted in the LLC Agreement to be made by the Company’s board of managers acting alone;

 

•     an amendment effected, necessitated or contemplated by a merger agreement that has been approved under the terms of the LLC Agreement;

 

•     any amendment that the Company’s board of managers determines to be necessary or appropriate for the formation by the Company of, or its investment in, any corporation, partnership or other entity, as otherwise permitted by the LLC Agreement;

 

•     a change in the Company’s fiscal year or taxable year and related changes;

 

•     a merger, conversion or conveyance effected in accordance with the LLC Agreement; and

 

 

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securities exchange on which the limited partner interests are or will be listed for trading;

 

•     are necessary or appropriate for any action taken by Sanchez LP’s general partner relating to splits or combinations of units under the provisions of the LP Agreement;

 

•     are necessary or appropriate in connection with the creation, authorization or issuance of any class or series of partnership securities; or

 

•     are required to effect the intent of the registration statement of which this proxy statement/prospectus forms a part or the provisions of the LP Agreement or are otherwise contemplated by the LP Agreement.

 

Opinion of Counsel and Unitholder Approval

 

Any amendment that Sanchez LP’s general partner determines adversely affects in any material respect one or more particular classes of limited partners will require the approval of at least a majority of the class or classes so affected, but no vote will be required by any class or classes of limited partners that the general partner determines are not adversely affected in any material respect. Any amendment that would have a material adverse effect on the rights or preferences of any type or class of outstanding Sanchez LP units in relation to other classes of Sanchez LP units will require the approval of at least a majority of the type or class of Sanchez LP units so affected. Any amendment that would reduce the voting percentage required to take any action other than to remove the general partner or call a meeting of Sanchez LP unitholders is required to be approved by the affirmative vote of limited partners whose aggregate outstanding Sanchez LP units constitute not less than the voting requirement sought to be reduced. For amendments of the type not requiring unitholder approval, the general partner will not be required to obtain an opinion of counsel that an amendment will neither result in a loss of limited liability to the limited partners nor result in Sanchez LP being treated as a taxable entity for federal income tax purposes in connection with any of the amendments. Any amendment relating to special unitholder meetings, notices of unitholder meetings, quorum and voting

requirements, actions without a meeting and the amendment provisions in the LP Agreement require approval of 75% of the outstanding Sanchez LP units. No amendments to the LP Agreement, other than those the general partner can adopt without unitholder

  

•     any other amendments substantially similar to any of the matters described in the clauses above.

 

In addition, the Company’s board of managers may make amendments to the LLC Agreement without approval of the Company’s unitholders if the board of managers determines that those amendments:

 

•     do not adversely affect the Company’s unitholders (including any particular class of unitholders as compared to other classes of unitholders) in any material respect;

 

•     are necessary or appropriate to satisfy any requirements, conditions or guidelines contained in any opinion, directive, order, ruling or regulation of any federal or state agency or judicial authority or contained in any federal or state statute;

 

•     are necessary or appropriate to facilitate the trading of the Company’s common units or to comply with any rule, regulation, guideline or requirement of any securities exchange on which the Company’s common units are or will be listed for trading, compliance with any of which the Company’s board of managers deems to be in the best interests of the Company and its common unitholders;

 

•     are necessary or appropriate for any action taken by the Company’s board of managers relating to splits or combinations of units under the provisions of the LLC Agreement; or

 

•     are required to effect the intent of the provisions of the LLC Agreement or are otherwise contemplated by the LLC Agreement.

 

Opinion of Counsel and Unitholder Approval

 

The Company’s board of managers is not required to obtain an opinion of counsel that an amendment of the LLC Agreement will not result in a loss of limited liability to the Company’s unitholders or result in the Company being treated as an entity for federal income tax purposes if one of the amendments described above under “—Company—No Unitholder Approval” should occur. No other amendments to the LLC Agreement will become effective without the approval of holders of at least 90% of the Company’s common units and Class A units unless the Company

 

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approval or in connection with a merger or consolidation, will become effective without the approval of holders of at least 90% of the outstanding Sanchez LP units, voting as a single class, unless Sanchez LP first obtains an opinion of counsel to the effect that the amendment will not affect the limited liability under applicable law of any of the limited partners.   

obtains an opinion of counsel to the effect that the amendment will not affect the limited liability under applicable law of any Company unitholder.

 

Any amendment that would have a material adverse effect on the rights or preferences of any type or class of outstanding Company units in relation to other classes of Company units will require the approval of at least a majority of the type or class of Company units so affected. Any amendment that reduces the voting percentage required to take any action is required to be approved by the affirmative vote of the Company’s unitholders whose aggregate outstanding units constitute not less than the voting requirement sought to be reduced.

  

Liquidation

 

Sanchez LP

  

Company

Upon the dissolution of Sanchez LP, unless its business is continued, the liquidator authorized to wind up its affairs will, acting with all of the powers of Sanchez LP’s general partner that are necessary or appropriate, liquidate its assets and apply the proceeds of the liquidation as described in “Provisions of the Partnership Agreement Relating to Cash Distributions—Distributions of Cash Upon Liquidation.” The liquidator may defer liquidation or distribution of Sanchez LP’s assets for a reasonable period of time or distribute assets to partners in kind if it determines that a sale would be impractical or would cause undue loss to Sanchez LP’s partners.    Upon the dissolution of the Company, the liquidator authorized to wind up the Company’s affairs will, acting with all of the powers of the Company’s board of managers that the liquidator deems necessary or desirable in its judgment, liquidate the Company’s assets and apply the proceeds of the liquidation as provided in the LLC Agreement. The liquidator may defer liquidation or distribution of the Company’s assets for a reasonable period of time or distribute assets to the Company’s unitholders in kind if it determines that a sale would be impractical or would cause undue loss to the Company’s unitholders.

Management; Election of Board Members

 

Sanchez LP

  

Company

The general partner will conduct, direct and manage all of Sanchez LP’s activities. Except as specifically granted in the LP Agreement, all management powers over the business and affairs of Sanchez LP will be exclusively vested in the general partner, and no limited partner or assignee will have any management power over the business and affairs of Sanchez LP. Subject to certain restrictions contained in the LP Agreement, the general partner has full power and authority to do all things and on such terms as it, in its sole discretion, may deem necessary or appropriate to conduct the business of Sanchez LP.

 

  

At the first annual meeting of the holders of the Company’s Class A units and the Company’s common unitholders following the Company’s initial public offering:

 

•     two members of the Company’s board of managers were elected by Constellation Energy Partners Management, LLC, as the holder of all of the Company’s Class A units; and

 

•     three members of the Company’s board of managers were elected by the Company’s common unitholders.

 

 

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Company

The limited partners of Sanchez LP will not have the ability to vote in the election of the directors of Sanchez LP’s general partner. In addition, the limited partners are limited in their ability to remove the general partner. See “The Partnership Agreement—Withdrawal or Removal of Our General Partner.”   

The board of managers is subject to re-election on an annual basis in this manner at the annual meeting of the holders of the Company’s Class A units and the Company’s common unitholders.

 

Removal of Members of the Board of Managers

 

Any manager elected by the holder of the Company’s Class A units may be removed, with or without cause, by the holders of 66 2/3% of the outstanding Class A units then entitled to vote at an election of managers. Any manager elected by the holders of the Company’s common units may be removed, with or without cause, by the holders of at least a majority of the outstanding Company common units then entitled to vote at an election of managers.

 

Increase in the Size of the Board of Managers

 

The size of the Company’s board of managers may increase only with the approval of the holders of 66 2/3% outstanding Class A units. If the size of the board of managers is so increased, the vacancy created thereby shall be filled by a person appointed by the board of managers or a nominee approved by a majority vote of the Company’s common unitholders, unless such vacancy is specified by an amendment to the LLC Agreement as a vacancy to be filled by the Class A unitholders, in which case such vacancy shall be filled by a person approved by the Class A unitholders.

 

Elimination of Special Voting Rights of Class A Units

 

The holders of Class A units have the right, voting as a separate class, to elect two of the five members of

   the Company’s board of managers and any replacement of either of such members, subject to the matters described above under “—Increase in the Size of the Board of Managers.” This right can be eliminated only upon a proposal submitted by or with the consent of the Company’s board of managers and the vote of the holders of not less than 66 2/3% of the outstanding Company common units. If such elimination is so approved and the Company and its affiliates do not vote their Company common units in favor of such elimination, the Class A units will be converted into common units on a one-for-one basis.

 

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Meetings; Voting

 

Sanchez LP

  

Company

Voting Rights of Limited Partner Interests other than Incentive Distribution Rights

 

Except as described below regarding a person or group owning 20% or more of any class of Sanchez LP units then outstanding, record holders of Sanchez LP units on the record date will be entitled to notice of, and to vote at, meetings of the limited partners and to act upon matters for which approvals may be solicited.

 

Sanchez LP’s general partner does not anticipate that any meeting of unitholders will be called in the foreseeable future. Any action that is required or permitted to be taken by the Sanchez LP unitholders may be taken either at a meeting of the Sanchez LP unitholders or without a meeting if consents in writing describing the action so taken are signed by holders of the number of Sanchez LP units necessary to authorize or take that action at a meeting. Meetings of the Sanchez LP unitholders may be called by Sanchez LP’s general partner or by Sanchez LP unitholders owning at least 20% of the outstanding Sanchez LP units of the class for which a meeting is proposed. Sanchez LP unitholders may vote either in person or by proxy at meetings. The holders of a majority of the outstanding Sanchez LP units of the class or classes for which a meeting has been called, represented in person or by proxy, will constitute a quorum, unless any action by the Sanchez LP unitholders requires approval by holders of a greater percentage of the Sanchez LP units, in which case the quorum will be the greater percentage.

 

Each record holder of a Sanchez LP unit has a vote according to his percentage interest in Sanchez LP, although additional limited partner interests having special voting rights could be issued. Please read “The

  

All notices of meetings of the Company’s unitholders shall be sent or otherwise given in accordance with Sections 11.4 and 14.1 of the LLC Agreement not less than 10 days nor more than 60 days before the date of the meeting. The notice shall specify the place, date and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted (no business other than that specified in the notice may be transacted) or (ii) in the case of the annual meeting, those matters which the board of managers, at the time of giving the notice, intends to present for action by the unitholders (but any proper matter may be presented at the meeting for such action). The notice of any meeting at which managers are to be elected shall include the name of any nominee or nominees who, at the time of the notice, the board of managers intends to present for election. Any previously scheduled meeting of the Company’s unitholders may be postponed, and any special meeting of the Company’s unitholders may be cancelled, by resolution of the board of managers upon public notice given prior to the date previously scheduled for such meeting of the Company’s unitholders.

 

The Company’s units that are owned by an assignee who is a record holder, but who has not yet been admitted as a member, shall be voted at the written direction of the record holder by a proxy designated by the Company’s board of managers. Absent direction of this kind, the Company’s units will not be voted, except that the Company’s units held by the Company on behalf of non-citizen assignees will be voted in the same ratios as the votes of the Company’s unitholders on other Company units are cast.

Partnership Agreement—Issuance of Additional Interests.” However, if at any time any person or group, other than Sanchez LP’s general partner and its affiliates, or a direct or subsequently approved transferee of the general partner or its affiliates and purchasers specifically approved by the general partner, acquires, in the aggregate, beneficial ownership of 20% or more of any class of units then outstanding, that person or group will lose voting rights on all of its units and the units may not be voted on any matter and will not be considered to be outstanding when sending notices of a meeting of Sanchez LP unitholders, calculating required votes, determining the presence of a   

 

Any action required or permitted to be taken by the Company’s common unitholders must be effected at a duly called annual or special meeting of the Company’s unitholders and may not be effected by any consent in writing by such common unitholders.

 

Special meetings of the Company’s unitholders may only be called by a majority of the Company’s board of managers. Unitholders may vote either in person or by proxy at meetings. The holders of a majority of the outstanding Company units for which a meeting has been called represented in person or by proxy

 

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Sanchez LP

  

Company

quorum or for other similar purposes. Sanchez LP common units held in nominee or street name account will be voted by the broker or other nominee in accordance with the instruction of the beneficial owner unless the arrangement between the beneficial owner and his nominee provides otherwise.

 

Any notice, demand, request, report or proxy material required or permitted to be given or made to record common unitholders under the LP Agreement will be delivered to the record holder by Sanchez LP or by the transfer agent.

 

Voting Rights of Incentive Distribution Rights

 

If a majority of the incentive distribution rights are held by Sanchez LP’s general partner and its affiliates, the holders of the incentive distribution rights will have no right to vote in respect of such rights on any matter, unless otherwise required by law, and the holders of the incentive distribution rights shall be deemed to have approved any matter approved by the general partner.

 

If less than a majority of the incentive distribution rights are held by Sanchez LP’s general partner and its affiliates, the incentive distribution rights will be entitled to vote on all matters submitted to a vote of Sanchez LP unitholders, other than amendments and other matters that the general partner determines do not adversely affect the holders of the incentive distribution rights in any material respect. On any matter in which the holders of incentive distribution rights are entitled to vote, such holders will vote together with the Sanchez LP common units as a single class, and such incentive distribution rights shall be treated in all respects as Sanchez LP common units when sending notices of a meeting of the limited partners to vote on any matter (unless otherwise required by law), calculating required

  

shall constitute a quorum unless any action by the Company’s unitholders requires approval by holders of a greater percentage of the Company’s units, in which case the quorum shall be the greater percentage.

 

Each record holder of a Company unit has a vote according to his percentage interest in the Company, although additional units having special voting rights could be issued. The Company’s units held in nominee or street name accounts will be voted by the broker or other nominee in accordance with the instruction of the beneficial owner unless the arrangement between the beneficial owner and its nominee provides otherwise.

 

Any notice, demand, request, report or proxy material required or permitted to be given or made to record holders of the Company’s units under the LLC Agreement will be delivered to the record holder by the Company or by the transfer agent.

 

The LLC Agreement also restricts the voting rights of the Company’s common unitholders by providing that any Company units held by a person that owns 20% or more of any class of Company units then outstanding, other than the Company, SOG, SEPI, Constellation Energy Partners Management, LLC, their affiliates or transferees and persons who acquire such Company units with the prior approval of the board of managers, cannot vote on any matter.

votes, determining the presence of a quorum or for other similar purposes under the LP Agreement. The relative voting power of the holders of the incentive distribution rights or Sanchez LP common units, depending on which class the holders of incentive distribution rights are voting with, will be set in the same proportion as cumulative cash distributions, if any, in respect of the incentive distribution rights for the four consecutive quarters prior to the record date for the vote bears to the cumulative cash distributions in respect of such class of units for such four quarters.   

 

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Indemnification

 

Sanchez LP

  

Company

Under the LP Agreement, in most circumstances, Sanchez LP will indemnify the following persons, to the fullest extent permitted by law, from and against all losses, claims, damages or similar events:

 

•     its general partner;

 

•     any departing general partner;

 

•     any person who is or was an affiliate of its general partner or any departing general partner;

 

•     any person who is or was a manager, managing member, general partner, director, officer, employee, agent, fiduciary or trustee of Sanchez LP, its subsidiaries, its general partner, any departing general partner or any of their affiliates;

 

•     any person who is or was serving at the request of a general partner, any departing general partner or any of their respective affiliates as a manager, managing member, general partner, director, officer, employee, agent, fiduciary or trustee of another person owing a fiduciary duty to Sanchez LP or its subsidiaries;

 

•     any person who controls its general partner or any departing general partner; and

 

•     any person designated by its general partner.

 

Any indemnification under these provisions will only be out of Sanchez LP’s assets. Unless it otherwise agrees, Sanchez LP’s general partner will not be personally liable for, or have any obligation to contribute or lend funds or assets to Sanchez LP to enable Sanchez LP to effectuate, indemnification. Sanchez LP may purchase insurance against liabilities asserted against and expenses incurred by persons for its activities, regardless whether it would have the power to indemnify the person against liabilities under the LP Agreement.

  

Under the LLC Agreement and subject to specified limitations, the Company will indemnify to the fullest extent permitted by law from and against all losses, claims, damages or similar events any person who is or was the Company’s manager or officer, or while serving as its manager or officer, is or was serving as a tax matters member or, at the Company’s request, as a manager, officer, tax matters member, employee, partner, fiduciary or trustee of the Company or any of its subsidiaries. In addition, the Company will indemnify to the fullest extent permitted by law and authorized by its board of managers, from and against all losses, claims, damages or similar events, any person who is or was an employee or agent (other than an officer) of the Company.

 

Any indemnification under the LLC Agreement will only be out of the Company’s assets. The Company is authorized to purchase insurance against liabilities asserted against and expenses incurred by persons for its activities, regardless of whether the Company would have the power to indemnify the person against liabilities under the LLC Agreement.

Transfer of Units

 

Sanchez LP

  

Company

Upon the transfer of a Sanchez LP common unit in accordance with the LP Agreement, the transferee of the Sanchez LP common unit shall be admitted as a limited partner with respect to the common units transferred when such transfer and admission are reflected in Sanchez LP’s books and records. Each transferee:

 

   By transfer of the Company’s common units in accordance with the LLC Agreement, each transferee of the Company’s common units shall be admitted as a unitholder of the Company with respect to the common units transferred when such transfer and admission is reflected on the Company’s books and

 

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Company

•     represents that the transferee has the capacity, power and authority to become bound by the LP Agreement;

 

•     automatically becomes bound by the terms and conditions of the LP Agreement; and

 

•     gives the consents, waivers and approvals contained in the LP Agreement.

 

Sanchez LP’s general partner will cause any transfers to be recorded on its books and records no less frequently than quarterly.

 

Sanchez LP shall treat the nominee holder of a Sanchez LP common unit as the absolute owner. In that case, the beneficial holder’s rights are limited solely to those that it has against the nominee holder as a result of any agreement between the beneficial owner and the nominee holder.

 

Sanchez LP common units are securities and any transfers are subject to the laws governing the transfer of securities. In addition to other rights acquired upon transfer, the transferor gives the transferee the right to become a substituted limited partner in Sanchez LP for the transferred common units.

 

Until a Sanchez LP common unit has been transferred on its books, Sanchez LP and the transfer agent may treat the record holder of the common unit as the absolute owner for all purposes, except as otherwise required by law or stock exchange regulations.

  

records. In addition, each transferee of the Company’s common units:

 

•     becomes the record holder of the common units;

 

•     automatically agrees to be bound by the terms and conditions of, and is deemed to have executed, the LLC Agreement;

 

•     represents that the transferee has the capacity, power and authority to enter into the LLC Agreement;

 

•     grants powers of attorney to the Company’s officers and any liquidator of the Company as specified in the LLC Agreement; and

 

•     makes the consents and waivers contained in the LLC Agreement.

 

A transferee will become a Company unitholder of the transferred common units upon the recording of the name of the transferee on the Company’s books and records.

 

Until a Company common unit has been transferred on its books, the Company and the transfer agent, notwithstanding any notice to the contrary, may treat the record holder of the common unit as the absolute owner for all purposes, except as otherwise required by law or stock exchange regulations.

Non-Taxpaying Assignees and Non-Citizen Assignees; Redemption

 

Sanchez LP

  

Company

If Sanchez LP’s general partner, with the advice of counsel, determines that (i) Sanchez LP’s status other than as an association taxable as a corporation for U.S. federal income tax purposes or the failure of Sanchez LP otherwise to be subject to an entity-level tax for U.S. federal, state or local income tax purposes, coupled with the tax status of one or more limited partners or their beneficial owners (or lack of proof thereof), has or is reasonably likely to have a material adverse effect on the rates than can be charged to customers by Sanchez LP or its subsidiaries or (ii) Sanchez LP or any of its subsidiaries is subject to U.S. federal, state or local laws or regulations that create a substantial risk of cancellation or forfeiture of any property that Sanchez    If the Company or any of its subsidiaries are or become subject to federal, state or local laws or regulations that, in the reasonable determination of the Company’s board of managers, create a substantial risk of cancellation or forfeiture of any property that the Company has an interest in because of the nationality, citizenship or other related status of any unitholder or assignee, the Company may redeem, upon 30 days’ advance notice, the units held by the Company’s unitholder or assignee at their current market price. To avoid any cancellation or forfeiture, the board of managers may require each Company unitholder or assignee to furnish information about his nationality, citizenship or

 

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Sanchez LP

  

Company

LP or any of its subsidiaries has an interest in because of the nationality, citizenship or other related status of any limited partner, then, in each case, the general partner may adopt such amendments to the LP Agreement as it determines necessary or appropriate to:

 

•     obtain proof of the U.S. federal income tax status of the limited partners and, if relevant, their beneficial owners, as the general partner determines to be necessary or appropriate to reduce the risk of the occurrence of a material adverse effect on the rates that can be charged to customers by Sanchez LP or its subsidiaries;

 

•     obtain proof of the nationality, citizenship or other related status of the limited partners (and their beneficial owners, to the extent relevant); and

 

•     permit Sanchez LP to redeem the units held by any such person. The redemption price in the case of such a redemption will be the average of the daily closing prices per unit for the 20 consecutive trading days immediately prior to the date set for redemption.

 

In addition to other limitations on the rights of an assignee who is not a substituted limited partner, an ineligible holder does not have the right to direct the voting of his units and may not receive distributions in kind upon Sanchez LP’s liquidation.

   related status. If a Company unitholder or assignee fails to furnish information about his nationality, citizenship or other related status within 30 days after a request for the information or the board of managers determines after receipt of the information that the unitholder or assignee is not an eligible citizen, the unitholder or assignee may be treated as a non-citizen assignee. In addition to other limitations on the rights of an assignee who is not a substituted unitholder, a non-citizen assignee does not have the right to direct the voting of his units and may not receive distributions in kind upon the Company’s liquidation.

 

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PRICE RANGE OF COMMON UNITS

The following table presents the high and low sales prices for the Sanchez common units during the periods indicated (as reported on the NYSE MKT):

 

     Price Ranges  
     High      Low  

2015

     

First Quarter (through January 22, 2015)

   $ 1.53       $ 1.27   

2014

     

Fourth Quarter

   $ 3.95       $ 1.40   

Third Quarter

   $ 4.23       $ 2.63   

Second Quarter

   $ 2.74       $ 2.30   

First Quarter

   $ 2.85       $ 2.17   

2013

     

Fourth Quarter

   $ 2.52       $ 2.04   

Third Quarter

   $ 3.20       $ 1.82   

Second Quarter

   $ 2.20       $ 1.42   

First Quarter

   $ 1.90       $ 1.16   

As of January 22, 2015, the last trading price of our common units as reported on the NYSE MKT was $1.27. As of August 27, 2014, the date immediately before the announcement of the proposed Conversion, the last trading price of our common units as reported on the NYSE MKT was $3.55. As of the record date, there were approximately 55 holders of record of our common units, one holder of record of our Class A units and one holder of record of the Class Z unit.

The Company has not paid any cash distributions in respect of its common units during the past two years.

The book value per common unit of the Company was $3.245 as of September 30, 2014. The Conversion will have no effect on the interest of SOG, SEPI, SP Holdings or Messrs. Sanchez III or Willinger in our net book value or net earnings on both a dollar and percentage basis.

RATIO OF EARNINGS TO FIXED CHARGES

The following table sets forth the ratios of earnings to fixed charges for us for each of the periods indicated. All dollar amounts are reported in thousands

 

     Nine Months Ended September 30,
2014
    Fiscal Year Ended December 31,  
               2012                     2013          

Net Income (loss)(1)

   $ (2,262   $ (9,405   $ (26,883

Fixed Charges:

      

Total Fixed Charges(2)

     1,928        7,266        7,258   
  

 

 

   

 

 

   

 

 

 

Total

     1,928        7,266        7,258   
  

 

 

   

 

 

   

 

 

 

Earnings (loss)

   $ (334   $ (2,139   $ (18,623
  

 

 

   

 

 

   

 

 

 

Ratio of earnings (loss) to fixed charges(3)

     —          —          —     
  

 

 

   

 

 

   

 

 

 

 

(1) Net income is the equivalent of income from continuing operations, minus income from equity affiliates that exceeded dividends from affiliates.
(2) Fixed charges equal the sum of the following: interest expensed and capitalized; amortized premiums, discounts, and capitalized expenses related to indebtedness; and a reasonable approximation of the interest within rent expense.
(3) Earnings were inadequate to cover fixed charges. The coverage deficiency totaled approximately $2.3 million for the nine months ended September 30, 2014, $9.4 million for the fiscal year ended December 31, 2012, and $25.9 million for the fiscal year ended December 31, 2013.

 

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MANAGEMENT

Our current executive officers and managers and their biographical information are set forth below. We currently anticipate that these persons will become directors and executive officers of Sanchez GP upon the effectiveness of the Conversion. However, no assurance can be provided that SP Holdings, as the owner of Sanchez GP, will not appoint new directors or that new officers will not be appointed.

Richard S. Langdon, Chairman of Board of Managers has been an independent member of our board of managers and our audit, compensation, conflicts and nominating and governance committees since November 2006 and has served as the chairman of our board of managers since October 2011. Mr. Langdon is also currently the President, Chief Executive Officer and Chairman of KMD Operating Company LLC (KMD Operating) (2170 Buckthorne Place, The Woodlands, Texas 77380, 281-298-7690), a position held since November 2011. KMD Operating is a privately held exploration and production company. Mr. Langdon has been serving as the Interim President and Chief Executive Officer of Gasco Energy, Inc. (7979 E. Tufts Avenue, Suite 1150, Denver, Colorado 80237), a publicly traded exploration and production company, since May 2013. Mr. Langdon has also served as a Director of Gasco Energy, Inc. since 2003. Mr. Langdon was the President and Chief Executive Officer of Matris Exploration Company L.P. (2170 Buckthorne Pl, The Woodlands, Texas 77380), a privately held exploration and production company (Matris Exploration), from July 2004 and Executive Vice President and Chief Operating Officer of KMD Operating from August 2009 until the merger of Matris Exploration into KMD Operating in November 2011, which merger was effective January 2011. Mr. Langdon also served as President and Chief Executive Officer of Sigma Energy Ventures, LLC (2170 Buckthorne Pl, The Woodlands, Texas 77380), a privately held exploration and production company, from November 2007 until November 2013. From 1997 until 2002, Mr. Langdon served as Executive Vice President and Chief Financial Officer of EEX Corporation, a publicly traded exploration and production company that merged with Newfield Exploration Company in 2002. Prior to that, he held various positions with the Pennzoil Companies from 1991 to 1996, including Executive Vice President-International Marketing-Pennzoil Products Company; Senior Vice President-Business Development-Pennzoil Company; and Senior Vice President-Commercial & Control-Pennzoil Exploration & Production Company.

Alan S. Bigman has been an independent member of our board of managers since June 2014. Mr. Bigman is currently co-founder and Director of VistaTex Energy LLC (6363 Woodway Dr., Ste 970, Houston, Texas 77057, 713-338-2440), a privately held company created in 2010 to produce oil and natural gas from mature properties in the U.S., and Chairman of the board of directors of White Square Chemicals, Inc. 171 Hood Avenue, Unit 2, Tavernier, Florida 33070, 305-393-1832), a privately held, U.S.-based specialty chemical company. He was most recently Director, Capital Markets and M&A of KCAD Deutag (11757 Katy Freeway, Suite 600, Houston, Texas 77079), an oilfield services company based in Aberdeen, UK, from September 2011 to December 2012, where he was responsible for reorganizing and staffing the company’s finance, corporate development and tax functions. From June 1996 to March 1998, Mr. Bigman was Senior Vice President of Access Industries, a privately held, U.S.-based industrial group with worldwide holdings. From March 1998 until September 2003, Mr. Bigman served as Vice President and Director of Corporate Finance of Tyumen Oil Company (TNK), a major Russian oil and gas producer and refiner, based in Moscow, Russia, and then as Vice President and Director of Corporate Finance for SUAL, a large Russian aluminum smelter, from September 2003 to September 2004. From September 2004 until December 2005, Mr. Bigman rejoined Access Industries as Senior Vice President, Investments and was based in London. In January 2006, Mr. Bigman was appointed Chief Financial Officer of Basell Polyolefins, an international chemicals company based in Hoofddorp, The Netherlands, where he served until January 2008. In January 2008, Mr. Bigman became the Chief Financial Officer of LyondellBasell Industries (1221 McKinney St., Houston, Texas 77010), a successor company to Basell Polyolefins and Lyondell, which had been merged. Mr. Bigman was Chief Financial Officer of LyondellBasell until August 2009, when he took on a consulting role with the company, and exited the company in March 2010. Prior to assuming the role of Chief Financial Officer at Basell Polyolefins, Mr. Bigman was on the company’s board of directors, where he served as a member of the audit and compensation committees.

 

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G. M. Byrd Larberg has been an independent member of our board of managers since June 2014. Mr. Larberg is currently performs consulting services on an individual basis. From 2010 to 2012, Mr. Larberg served as a member of the board of directors of Risco Resources, a small independent exploration company headquartered in Jakarta, Indonesia which was sold in 2012. Mr. Larberg served as a member of the board of directors of 3GIG (1302 Waugh Drive, #124, Houston, Texas 77017, 281-501-1860), an exploration-focused software firm headquartered in Houston, Texas, from 2008 to 2013 and now serves as an advisor to the Board. He is active on the Board of the Houston Metropolitan YMCA (7101 Stella Link Road, Houston, Texas 77025), where he serves on the Financial Development Committee and as Chairman of the annual Partners Campaign. Previously he was a board member of Meridian Resources (1401 Enclave Parkway, Suite 300, Houston, Texas 77077), a Houston-based exploration company, from 2007 until it was acquired by Alta Mesa in 2010. Mr. Larberg began his career at Shell Exploration and Production Company as a geologist in 1976. Over the next twenty-one years, he held various leadership positions within Shell, ending as a Vice President of Exploration and Production, Africa and Latin America for Pecten International, an affiliate of Shell Oil Company, from 1993 to 1996. During his tenure he also served as Exploration Manager for Shell Western E&P Domestic USA Onshore, including the Mid Continent, from 1990 to 1993, and as the Division Exploration Manager for the Gulf Coast Division covering offshore Louisiana from 1987 to 1990. After successfully completing a fourteen month special assignment to the Director of New Business Development for Royal Dutch Shell’s Worldwide Deepwater efforts, Mr. Larberg left Shell and joined Burlington Resources in 1998. From 1998 to 2006, Mr. Larberg held several key positions at Burlington Resources, beginning as Vice President of Exploration for Burlington Resources International. In 2000, Mr. Larberg was elected Executive Vice President and Chief Operating Officer of Burlington Resources International, a position he held until 2003, when he moved to the corporate office as Vice President of Geosciences. In this capacity, he was responsible for technical excellence for the Geology and Geophysical programs across the company, G&G technology business development, and management of the company-wide exploration portfolio, Mr. Larberg retired from Burlington Resources in March 2006 following the company’s purchase by Conoco Phillips.

Antonio R. Sanchez, III has been a member of our board of managers since August 2013 and was appointed by SEPI, as the holder of our Class A units. Mr. Sanchez has served as the President and Chief Executive Officer of Sanchez Energy Corporation (1000 Main St., Suite 3000, Houston, Texas 77002, 713-783-8000), a publicly traded exploration and production company, and has been a member of the company’s board of directors since its formation in August 2011. He has been directly involved in the oil and gas industry for over 12 years. Mr. Sanchez, III is also the President of SOG (1000 Main St., Suite 3000, Houston, Texas 77002, 713-783-8000), which he joined in October 2001, as well as the President of SEP Management I, LLC (1000 Main St., Suite 3000, Houston, Texas 77002, 713-783-8000) and a Managing Director of SEPI (1000 Main St., Suite 3000, Houston, Texas 77002, 713-783-8000). In his capacities as a director and officer of these companies, Mr. Sanchez, III manages all aspects of their daily operations, including exploration, production, finance, capital markets activities, engineering and land management. From 1997 to 1999, Mr. Sanchez, III was an investment banker specializing in mergers and acquisitions with J.P. Morgan Securities Inc. From 1999 to 2001, Mr. Sanchez, III worked in a variety of positions, including sales and marketing, product development and investor relations, at Zix Corporation, a publicly traded encryption technology company. Mr. Sanchez, III was also a member of the board of directors of Zix Corporation (2711 N. Haskell Ave., Suite 2200, Dallas, Texas 75204-2960) from May 2003 to June 2014.

Gerald F. Willinger has been a member of our board of managers since August 2013 and was appointed by SEPI, as the holder of our Class A units. Mr. Willinger is currently a Managing Partner of Sanchez Capital Advisors, LLC (1000 Main St., Suite 3000, Houston, Texas 77002, 713-783-8000) and Manager and Co-founder of Sanchez Resources, LLC (1000 Main St., Suite 3000, Houston, Texas 77002, 713-783-8000), an oil and gas company since February 2010. Mr. Willinger currently serves as a Director of Sanchez Resources. From 1998 to 2000, Mr. Willinger was an investment banker with Goldman, Sachs & Co. Mr. Willinger served in various private equity investment management roles at MidOcean Partners, LLC and its predecessor entity, DB Capital Partners, LLC, from 2000 to 2003 and at the Cypress Group, LLC from 2003 to 2006. Prior to joining Sanchez Capital Advisors, LLC, Mr. Willinger was a Senior Analyst for Silver Point Capital, LLC, a credit-opportunity fund (Two Greenwich Plaza, Greenwich, Connecticut 06830), from 2006 to 2009.

 

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Stephen R. Brunner has served as our President and Chief Executive Officer since March 2008 and our Chief Operating Officer since February 2008. He has also served as a member of our board of managers from December 2008 until August 2011. Mr. Brunner also served as Vice President for Constellation Energy Commodities Group, Inc. from February 2008 to January 2009. From 2001 until November 2007, Mr. Brunner served as Executive Vice President, Operations of Pogo Producing Company, an oil and gas exploration company.

Charles C. Ward has served as our Chief Financial Officer and Treasurer since March 2008. Mr. Ward also served as a Vice President of Constellation Energy Commodities Group, Inc. from November 2005 until December 2008. Prior to that time, he was a Vice President of Enron North America Corp. from March 2002 to November 2005.

None of the Company, our executive officers or managers has been (i) convicted in a criminal proceeding during the past five years (excluding traffic violations or similar misdemeanors), or (ii) a party to any judicial or administrative proceeding during the past five years (except for matters that were dismissed without sanction or settlement) that resulted in a judgment, decree or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws, or a finding of any violation of federal or state securities laws. Each of our executive officers and managers is a citizen of the United States.

For information regarding SOG, SP Holdings, SEPI and certain persons related to them, please see Annex F included in this proxy statement/prospectus.

 

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth the beneficial ownership of our units held by:

 

    each unitholder who is a beneficial owner of more than 5% of our outstanding units;

 

    each of our managers and executive officers; and

 

    our managers and executive officers as a group.

The amounts and percentage of common units and Class A units beneficially owned are reported on the basis of the SEC rules governing the determination of beneficial ownership of securities. Under the SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the voting of such security, and/or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Under these rules, more than one person may be deemed a beneficial owner of the same securities and a person may be deemed a beneficial owner of securities as to which he has no economic interest.

Percentage of total units beneficially owned is based on 28,792,584 common units and 484,505 Class A units outstanding as of January 26, 2015. Except as indicated by footnote, to our knowledge the persons named in the table below have sole voting and investment power with respect to all units shown as beneficially owned by them, subject to community property laws where applicable. Unless otherwise set forth below, the address of all of all beneficial owners is c/o Sanchez Production Partners LLC, 1000 Main Street, Suite 3000, Houston, Texas 77002. Ownership amounts are as of January 26, 2015.

 

     Common Units Beneficially
Owned
    Class A Units
Beneficially Owned
    Percentage
of Total
Units
Beneficially
Owned
 

Name of Beneficial Owner

   Number      Percentage     Number      Percentage    

Sanchez Energy Partners I, LP(1)

     5,364,196         18.6     484,505         100     20.0

Raging Capital Master Fund, Ltd.(2)

     4,163,294         14.5     —           —          14.2

Bradley Louis Radoff(3)

     2,360,000         8.2     —           —          8.1

Dorsey R. Gardner(4)

     2,146,794         7.5     —           —          7.3

SP Holdings(5)

     59,562               —           —           

Alan S. Bigman

     —           —          —           —          —     

Stephen R. Brunner

     764,937         2.7     —           —          2.6

Richard S. Langdon

     55,468               —           —           

G. M. Larberg

     —           —          —           —          —     

Antonio R. Sanchez, III(1)(5)

     5,430,161         18.9     484,505         100     20.2

Charles C. Ward

     377,394         1.3     —           —          1.3

Gerald F. Willinger

     6,403               —           —           

All managers and executive officers as a group
(7 persons)

     1,210,605         4.2     —           —          4.1

 

* Less than 1%.
(1)

6,403 common units are held directly by Mr. Sanchez. Ownership data for 5,364,196 common units and 484,505 Class A units as reported on Form 13D/A filed on December 24, 2014 by SEPI, SOG, SEP Management I, LLC, Antonio R. Sanchez, Jr. and Antonio R. Sanchez, III. The business address of each filer is 1000 Main Street, Suite 3000, Houston, Texas 77002. These securities are owned directly by SEPI, which is controlled by its general partner, SEP Management I, LLC, a wholly-owned subsidiary of SOG. SOG is managed by Antonio R. Sanchez, Jr., Antonio R. Sanchez, III and other Sanchez family members as disclosed in Annex F in this proxy statement/prospectus. Each of SEP Management I, LLC, SOG, Antonio R. Sanchez, Jr. and Antonio R. Sanchez, III may be deemed to share voting and dispositive power over the units held by SEPI. Each of SEP Management I, LLC, SOG, Antonio R. Sanchez, Jr. and Antonio R.

 

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  Sanchez, III disclaims beneficial ownership of these securities except to the extent of such person’s pecuniary interest therein.
(2) Ownership data as reported on a Schedule 13G filed on November 10, 2014 by Raging Capital Master Fund, Ltd., Raging Capital Management, LLC and William C. Martin. The principal business address of each of Raging Capital Management, LLC and Mr. Martin is Ten Princeton Avenue, PO Box 228, Rocky Hill, New Jersey 08553; and the principal business address of Raging Capital Master Fund, Ltd. is c/o Ogier Fiduciary Services (Cayman) Limited, 89 Nexus Way, Camana Bay, Grand Cayman KY 1-9007, Cayman Islands. The filings lists each filing person as having shared voting and dispositive power over the units.
(3) Ownership data as reported on Schedule 13G/A filed on February 14, 2014 by Bradley Louis Radoff. The address of Mr. Radoff is 1177 West Loop South, Suite 1625, Houston, Texas 77027. The filing lists 2,360,000 Class B common units owned by Mr. Radoff, who has sole voting power.
(4) Ownership data as reported on Schedule 13G/A filed on November 13, 2014 by Dorsey R. Gardner. The address of Mr. Gardner is 401 Worth Avenue, Palm Beach, Florida 33480. The filing lists Mr. Gardner as having sole voting and dispositive power over the common units held by the DRG 2002 Revocable Trust (2,013,009), the DRG Rollover IRA (64,485), William G. Gardner (25,000), the DRG 2012 Trust (41,400) and the Robert O’Neill Trust (2,900).
(5) 59,562 common units are held by SP Holdings, of which Mr. Sanchez is a co-manager of its sole member. See Annex F included in this proxy statement/prospectus for additional information regarding SP Holdings.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE CONVERSION

The following is a discussion of the material U.S. federal income tax consequences of the Conversion that may be relevant to the Company’s common unitholders. Unless otherwise noted, the legal conclusions set forth in the discussion relating to the consequences of the Conversion to the Company and its common unitholders are the opinion of Andrews Kurth LLP, counsel to the Company, as to the material U.S. federal income tax consequences relating to those matters. This discussion is based upon current provisions of the Internal Revenue Code of 1986, as amended (the “Code”), existing and proposed Treasury regulations promulgated under the Code (the “Treasury Regulations”) and current administrative rulings and court decisions, all of which are subject to change, possibly with retroactive effect. Changes in these authorities may cause the tax consequences to vary substantially from the consequences described below.

This discussion does not purport to be a complete discussion of all U.S. federal income tax consequences of the Conversion. Moreover, the discussion focuses on the Company’s common unitholders who are individual citizens or residents of the United States (for U.S. federal income tax purposes) and has only limited application to corporations, estates, trusts, nonresident aliens or other unitholders subject to specialized tax treatment, such as tax-exempt institutions, employee benefit plans, foreign persons, financial institutions, insurance companies, real estate investment trusts (REITs), individual retirement accounts (IRAs), mutual funds, traders in securities that elect mark-to-market, persons who hold Company common units as part of a hedge, straddle or conversion transaction, persons who acquired the Company’s common units by gift, or directors and employees of the Company that received (or are deemed to receive) the Company’s common units as compensation or through the exercise (or deemed exercise) of options, unit appreciation rights, phantom units or restricted units granted under a Company equity incentive plan. Also, the discussion assumes that the Company’s common units are held as capital assets at the time of the Conversion (generally, property held for investment).

This discussion assumes that the Conversion will be consummated in the manner contemplated by, and in accordance with, the terms set forth in the Plan of Conversion and described in this proxy statement/prospectus. In addition, this discussion and any opinions of Andrews Kurth LLP will be based upon certain factual assumptions and representations made by the officers of the Company and any of its respective affiliates. The Company has not sought a ruling from the IRS with respect to any of the tax consequences discussed below, and the IRS would not be precluded from taking positions contrary to those described herein. As a result, no assurance can be given that the IRS will agree with all of the tax characterizations and the tax consequences described below. No assurance can be given that the below-described opinions and/or the statements contained herein with respect to tax matters would be sustained by a court if contested by the IRS. Furthermore, the tax treatment of the Conversion may be significantly modified by future legislative or administrative changes or court decisions. Any modifications may or may not be retroactively applied.

Accordingly, the Company strongly urge each common unitholder of the Company to consult with, and depend upon, such unitholder’s own tax advisor in analyzing the U.S. federal, state, local and foreign tax consequences particular to the unitholder of the Conversion.

Assumptions Related to the U.S. Federal Income Tax Treatment of the Conversion

The discussion below assumes that the Company will be classified as a partnership for U.S. federal income tax purposes at the time of the Conversion. Following the Conversion, a common unitholder of the Company that receives Sanchez LP common units will be treated as a partner in Sanchez LP. Please read the discussion of the opinion of Andrews Kurth LLP that Sanchez LP is classified as a partnership for U.S. federal income tax purposes under “Material U.S. Federal Income Tax Consequences of Sanchez LP Common Unit Ownership—Partnership Status” below.

 

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U.S. Federal Income Tax Treatment of the Conversion

Upon the terms and subject to the conditions set forth in the Plan of Conversion, the Company will be converted into Sanchez LP and all Company common units will be converted into Sanchez LP common units. For U.S. federal income tax purposes, the Conversion will be treated as a contribution by the Company’s common unitholders of their interests in the Company to Sanchez LP pursuant to Section 721 of the Code.

The remainder of this discussion, except as otherwise noted, assumes that the Conversion and the transactions contemplated thereby will be treated for U.S. federal income tax purposes in the manner described above.

Tax Consequences of the Conversion to the Company

We will not recognize any income or gain, or loss, for U.S. federal income tax purposes as a result of the Conversion.

We use the year ending December 31 as our taxable year and the accrual method of accounting for U.S. federal income tax purposes. Although we will be considered to have technically terminated our existing partnership and having formed a new partnership for U.S. federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period, the Conversion will not be treated as a sale or exchange for purposes of determining whether the 50% threshold has been met. As a result, our taxable year will not end as a result of the Conversion and we will be required to file a single U.S. federal income tax return for the taxable year that includes the effective date of the Conversion. Each Company common unitholder will receive a Schedule K-1 from Sanchez LP for our taxable year that includes the effective date of the Conversion and will be required to include in income its share of income, gain, loss and deduction for this period.

Tax Consequences of the Conversion to the Company’s Common Unitholders

In general, the receipt of Sanchez LP common units pursuant to the Conversion will not result in the recognition of taxable gain or loss to a common unitholder of the Company. However, as discussed below, a deemed distribution of cash resulting from a net reduction in the amount of nonrecourse liabilities allocated to a common unitholder of the Company will result in the recognition of taxable gain if such deemed distribution exceeds the adjusted tax basis in the Company’s common units surrendered in the Conversion.

As a partner in the Company, a Company common unitholder is entitled to include the nonrecourse liabilities of the Company attributable to its Company common units in the tax basis of its Company common units. As a partner in Sanchez LP after the Conversion, a Company common unitholder will be entitled to include the nonrecourse liabilities of Sanchez LP attributable to the Sanchez LP common units received in the Conversion in the tax basis of such units received. A partner in Sanchez LP will not have any share of the Company’s nonrecourse liabilities that are treated as recourse to the general partner following the Conversion. The amount of our liabilities treated as recourse to the general partner following the Conversion and the amount of nonrecourse liabilities attributable to a Company common unit or a Sanchez LP common unit are determined under complex regulations under Section 752 of the Code. It is not expected that the general partner will be allocated any of our liabilities upon the Conversion.

If the nonrecourse liabilities attributable to the Sanchez LP common units received by a Company common unitholder in the Conversion exceed the nonrecourse liabilities attributable to the Company’s common units surrendered by the Company’s common unitholder in the Conversion, the common unitholder’s tax basis in the Sanchez LP common units received will be correspondingly higher than the unitholder’s tax basis in the Company’s common units surrendered. If the nonrecourse liabilities attributable to the Sanchez LP common units received by a Company common unitholder in the Conversion are less than the nonrecourse liabilities

 

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attributable to the Company’s common units surrendered by the Company’s common unitholder in the Conversion, such common unitholder’s tax basis in the Sanchez LP common units received will be correspondingly lower than the unitholder’s tax basis in the Company’s common units surrendered. Please read “—Tax Basis and Holding Period of the Sanchez LP Common Units Received” below.

Any reduction in liabilities described in the preceding paragraph will be treated as a deemed cash distribution to the Company’s common unitholder. If the amount of any such deemed distribution of cash to the Company’s common unitholder exceeds such common unitholder’s tax basis in the Company’s common units surrendered, such common unitholder will recognize taxable gain in an amount equal to such excess. While there can be no assurance, the Company does not expect that any common unitholders of the Company will recognize gain in this manner. However, the application of the rules governing the allocation of nonrecourse liabilities in the context of the Conversion is complex and subject to uncertainty. There can be no assurance that a Company common unitholder will not recognize gain as a result of any distribution deemed received as a result of a net decrease in the amount of nonrecourse liabilities allocable to such Company common unitholder as a result of the Conversion.

The amount and effect of any gain that may be recognized by an affected Company common unitholder will depend on the affected Company common unitholder’s particular situation, including the ability of the affected Company common unitholder to utilize any suspended passive losses. Depending on these factors, any particular affected Company common unitholder may, or may not, be able to offset all or a portion of any gain recognized. Each Company common unitholder should consult such unitholder’s own tax advisor in analyzing whether the Conversion causes such unitholder to recognize actual and/or deemed distributions in excess of the tax basis of the Company’s common units surrendered in the Conversion.

Tax Basis and Holding Period of the Sanchez LP Common Units Received

A Company common unitholder’s initial aggregate tax basis in the Sanchez LP common units that the Company common unitholder will receive in the Conversion will be equal to the Company common unitholder’s adjusted tax basis in the Company’s common units received in connection with the Conversion, decreased by any basis attributable to the Company common unitholder’s share of the Company’s nonrecourse liabilities and increased by the Company common unitholder’s share of Sanchez LP’s nonrecourse liabilities immediately after the Conversion.

A Company common unitholder’s holding period in the Sanchez LP common units received in the Conversion will be determined by reference to its holding period in the Company’s common units converted in connection therewith.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES OF

SANCHEZ LP COMMON UNIT OWNERSHIP

This section summarizes the material federal income tax consequences that may be relevant to individual citizens or residents of the U.S. owning Sanchez LP common units received in the Conversion and, unless otherwise noted in the following discussion, is the opinion of Andrews Kurth LLP insofar as it relates to legal conclusions with respect to matters of federal income tax law. This section is based upon current provisions of the Code, existing and proposed Treasury Regulations and current administrative rulings and court decisions, all of which are subject to change. Changes in these authorities may cause the tax consequences to vary substantially from the consequences described below. Unless the context otherwise requires, references in this section to “us” or “we” are references to Sanchez LP and our limited liability company operating subsidiaries.

The following discussion does not comment on all federal income tax matters affecting Sanchez LP or its unitholders. Moreover, the discussion focuses on unitholders who are individual citizens or residents of the United States and has only limited application to corporations, estates, entities treated as partnerships for U.S. federal income tax purposes, trusts, nonresident aliens, U.S. expatriates and former citizens or long-term residents of the United States or other unitholders subject to specialized tax treatment, such as banks, insurance companies and other financial institutions, tax-exempt institutions, foreign persons (including, without limitation, controlled foreign corporations, passive foreign investment companies and non-U.S. persons eligible for the benefits of an applicable income tax treaty with the United States), IRAs, real estate investment trusts (REITs) or mutual funds, dealers in securities or currencies, traders in securities, U.S. persons whose “functional currency” is not the U.S. dollar, persons holding their units as part of a “straddle,” “hedge,” “conversion transaction” or other risk reduction transaction, and persons deemed to sell their units under the constructive sale provisions of the Code. In addition, the discussion only comments, to a limited extent, on state, local, and foreign tax consequences. Accordingly, Sanchez LP encourages each prospective unitholder to consult his own tax advisor in analyzing the state, local and foreign tax consequences particular to him of the ownership or disposition of common units and potential changes in applicable laws.

No ruling has been or will be requested from the IRS regarding any matter affecting Sanchez LP following the Conversion or the consequences of owning Sanchez LP common units received in the Conversion. Instead, Sanchez LP will rely on opinions of Andrews Kurth LLP. Unlike a ruling, an opinion of counsel represents only that counsel’s best legal judgment and does not bind the IRS or the courts. Accordingly, the opinions and statements made herein may not be sustained by a court if contested by the IRS. Any contest of this sort with the IRS may materially and adversely impact the market for the common units and the prices at which the common units trade. In addition, the costs of any contest with the IRS, principally legal, accounting and related fees, will be borne indirectly by Sanchez LP’s unitholders and Sanchez LP’s general partner because the costs will reduce the cash available for distribution. Furthermore, the tax treatment of Sanchez LP, or of an investment in Sanchez LP, may be significantly modified by future legislative or administrative changes or court decisions. Any modifications may or may not be retroactively applied.

All statements as to matters of federal income tax law and legal conclusions with respect thereto, but not as to factual matters, contained in this section, unless otherwise noted, are the opinion of Andrews Kurth LLP and are based on the accuracy of the representations made by us.

For the reasons described below, Andrews Kurth LLP has not rendered an opinion with respect to the following specific U.S. federal income tax issues:

 

    the treatment of a common unitholder whose units are loaned to a short seller to cover a short sale of units (please read “—Tax Consequences of Unit Ownership—Treatment of Short Sales”);

 

    whether our monthly convention for allocating taxable income and losses is permitted by existing Treasury Regulations (please read “—Disposition of Units—Allocations Between Transferors and Transferees”); and

 

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    whether our method for depreciating Section 743 adjustments is sustainable in certain cases (please read “—Tax Consequences of Unit Ownership—Section 754 Election” and “—Uniformity of Units”).

Partnership Status

Except as discussed in the following paragraph, a partnership is not a taxable entity and incurs no U.S. federal income tax liability. Instead, each partner is required to take into account his respective share of items of our income, gain, loss and deduction of the partnership in computing his U.S. federal income tax liability, even if no cash distributions are made to him. Distributions by a partnership to a partner are generally not taxable to the partner unless the amount of cash distributed to him is in excess of his adjusted basis in his partnership interest.

Section 7704 of the Internal Revenue Code provides that publicly traded partnerships will, as a general rule, be taxed as corporations. However, an exception, referred to in this discussion as the “Qualifying Income Exception,” exists with respect to publicly traded partnerships of which 90% or more of the gross income for every taxable year consists of “qualifying income.” Qualifying income includes income and gains derived from the exploration, development, mining or production, processing, transportation and marketing of natural resources, including oil, natural gas, and products thereof. Other types of qualifying income include interest (other than from a financial business), dividends, gains from the sale of real property and gains from the sale or other disposition of capital assets held for the production of income that otherwise constitutes qualifying income. We estimate that less than 3% of our current gross income does not constitute qualifying income; however, this estimate could change from time to time. Based on and subject to this estimate, the factual representations made by us, and a review of the applicable legal authorities, Andrews Kurth LLP is of the opinion that more than 90% of our current gross income constitutes qualifying income. The portion of our income that is qualifying income may change from time to time.

No ruling has been or will be sought from the IRS, and the IRS has made no determination as to our status or the status of our operating subsidiaries for U.S. federal income tax purposes or whether our operations generate “qualifying income” under Section 7704 of the Internal Revenue Code. Instead, we will rely on the opinion of Andrews Kurth LLP on such matters. Andrews Kurth LLP is of the opinion, based upon the Internal Revenue Code, its regulations, published revenue rulings, court decisions and factual representations made by us, that we are and will continue to be classified as a partnership, and each of our operating subsidiaries will be disregarded as an entity separate from us, for U.S. federal income tax purposes.

In rendering its opinion, Andrews Kurth LLP has relied on factual representations made by us. The representations made by us upon which Andrews Kurth LLP has relied include, without limitation:

 

    Neither we nor any of our operating subsidiaries have elected or will elect to be treated as a corporation; and

 

    For each taxable year, more than 90% of our gross income has been and will be income that Andrews Kurth LLP has opined or will opine is “qualifying income” within the meaning of Section 7704(d) of the Internal Revenue Code.

We believe that these representations have been true in the past and expect that these representations will continue to be true in the future.

If we fail to meet the Qualifying Income Exception, other than a failure that is determined by the IRS to be inadvertent and that is cured within a reasonable time after discovery, we will be treated as if we had transferred all of our assets, subject to liabilities, to a newly formed corporation, on the first day of the year in which we fail to meet the Qualifying Income Exception, in return for stock in that corporation and then distributed that stock to common unitholders in liquidation of their interests in us. This deemed contribution and liquidation would be tax-free to common unitholders and us so long as we, at that time, do not have liabilities in excess of the tax basis of our assets. Thereafter, we would be treated as a corporation for U.S. federal income tax purposes.

 

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If we were taxable as a corporation for U.S. federal income tax purposes in any taxable year, either as a result of a failure to meet the Qualifying Income Exception or otherwise, our items of income, gain, loss and deduction would be reflected only on our tax return rather than being passed through to common unitholders, and our net income would be taxed to us at corporate rates. In addition, any distribution made to a common unitholder would be treated as taxable dividend income to the extent of our current or accumulated earnings and profits, or, in the absence of earnings and profits, a nontaxable return of capital to the extent of the common unitholder’s tax basis in his units, or taxable capital gain, after the common unitholder’s tax basis in his units is reduced to zero. Accordingly, taxation as a corporation would result in a material reduction in a common unitholder’s cash flow and after-tax return and thus would likely result in a substantial reduction of the value of the units.

The remainder of this section assumes that we are and will continue to be classified as a partnership for U.S. federal income tax purposes.

Common Unitholder Status

Common unitholders who become limited partners of Sanchez LP will be treated as partners of Sanchez LP for U.S. federal income tax purposes. Also, common unitholders whose units are held in street name or by a nominee and who have the right to direct the nominee in the exercise of all substantive rights attendant to the ownership of their units will be treated as partners of Sanchez LP for U.S. federal income tax purposes. A beneficial owner of units whose units have been transferred to a short seller to complete a short sale would appear to lose his status as a partner with respect to those units for U.S. federal income tax purposes. Please read “—Tax Consequences of Unit Ownership—Treatment of Short Sales.” As there is no direct or indirect controlling authority addressing assignees of common units who are entitled to execute and deliver transfer applications and thereby become entitled to direct the exercise of attendant rights, but who fail to execute and deliver transfer applications, Andrews Kurth LLP’s opinion does not extend to these persons. Furthermore, a purchaser or other transferee of common units who does not execute and deliver a transfer application may not receive some U.S. federal income tax information or reports furnished to record holders of common units unless the common units are held in a nominee or street name account and the nominee or broker has executed and delivered a transfer application for those common units.

Items of our income, gain, loss, or deduction are not reportable by a common unitholder who is not a partner for U.S. federal income tax purposes, and any cash distributions received by a common unitholder who is not a partner for U.S. federal income tax purposes would therefore be fully taxable as ordinary income. These common unitholders are urged to consult their own tax advisors with respect to their status as partners in us for U.S. federal income tax purposes.

The references to “common unitholders” in the discussion that follows are to persons who are treated as partners in Sanchez LP for U.S. federal income tax purposes.

Tax Consequences of Unit Ownership

Flow-Through of Taxable Income

Subject to the discussion below under “—Entity-Level Collections,” neither we nor our subsidiaries pay any U.S. federal income tax. Instead, each common unitholder is be required to report on his income tax return his share of our income, gains, losses and deductions without regard to whether corresponding cash distributions are received by him. Consequently, we may allocate income to a common unitholder even if he has not received a cash distribution. Each common unitholder is required to include in income his share of our income, gain, loss and deduction for our taxable year or years ending with or within his taxable year. Our taxable year ends on December 31.

 

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Treatment of Distributions

Distributions made by us to a common unitholder generally are not be taxable to the common unitholder for U.S. federal income tax purposes to the extent of his tax basis in his units immediately before the distribution. Cash distributions made by us to a common unitholder in an amount in excess of his tax basis in his units generally are considered to be gain from the sale or exchange of those units, taxable in accordance with the rules described under “—Disposition of Units” below. To the extent that cash distributions made by us cause a common unitholder’s “at risk” amount to be less than zero at the end of any taxable year, the common unitholder must recapture any losses deducted in previous years. Please read “—Limitations on Deductibility of Losses.”

Any reduction in a common unitholder’s share of our liabilities for which no partner bears the economic risk of loss, known as “nonrecourse liabilities,” will be treated as a distribution of cash to that common unitholder.

A decrease in a common unitholder’s percentage interest in us because of our issuance of additional common units will decrease his share of our nonrecourse liabilities and thus will result in a corresponding deemed distribution of cash, which may constitute a non-pro rata distribution. A non-pro rata distribution of money or property may result in ordinary income to a common unitholder, regardless of his tax basis in his units, if the distribution reduces the common unitholder’s share of our “unrealized receivables,” including recapture of intangible drilling and development costs, depletion and depreciation recapture, and/or substantially appreciated “inventory items,” both as defined in Section 751 of the Internal Revenue Code, and collectively, “Section 751 Assets.” To that extent, he will be treated as having received his proportionate share of the Section 751 Assets and having exchanged those assets with us in return for the non-pro rata portion of the actual distribution made to him. This latter deemed exchange will generally result in the common unitholder’s realization of ordinary income. That income will equal the excess of (1) the non-pro rata portion of that distribution over (2) the common unitholder’s tax basis (generally zero) for the share of Section 751 Assets deemed relinquished in the exchange.

Basis of Units

A common unitholder’s initial tax basis in his units will equal such unitholder’s adjusted tax basis in the Company’s common units that were converted, decreased by any basis attributable to the unitholder’s share of the Company’s nonrecourse liabilities and increased by the unitholder’s share of our nonrecourse liabilities. That basis will be increased by his share of our income and by any increases in his share of our nonrecourse liabilities. That basis generally will be decreased, but not below zero, by distributions to him from us, by his share of our losses, by depletion deductions taken by him to the extent such deductions do not exceed his proportionate share of the adjusted tax basis of the underlying producing properties, by any decreases in his share of our nonrecourse liabilities and by his share of our expenditures that are not deductible in computing taxable income and are not required to be capitalized. A common unitholder’s share of our nonrecourse liabilities will generally be based on his share of our profits. Please read “—Disposition of Units—Recognition of Gain or Loss.”

Limitations on Deductibility of Losses

The deduction by a common unitholder of his share of our losses is limited to his tax basis in his units and, in the case of an individual, estate, trust or corporate common unitholder (if more than 50% of the value of its stock is owned directly or indirectly by or for five or fewer individuals or some tax-exempt organizations) to the amount for which the common unitholder is considered to be “at risk” with respect to our activities, if that amount is less than his tax basis. A common unitholder subject to these limitations must recapture losses deducted in previous years to the extent that distributions cause his at risk amount to be less than zero at the end of any taxable year. Losses disallowed to a common unitholder or recaptured as a result of these limitations will carry forward and will be allowable as a deduction in a later year to the extent that his tax basis or at risk amount, whichever is the limiting factor, is subsequently increased. Upon the taxable disposition of a unit, any gain recognized by a common unitholder can be offset by losses that were previously suspended by the at risk limitation but may not be offset by losses suspended by the basis limitation. Any loss previously suspended by the at risk limitation in excess of that gain is no longer utilizable.

 

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In general, a common unitholder will be at risk to the extent of his tax basis in his units, excluding any portion of that basis attributable to his share of our nonrecourse liabilities, reduced by (i) any portion of that basis representing amounts otherwise protected against loss because of a guarantee, stop loss agreement, or other similar arrangement and (ii) any amount of money the common unitholder borrows to acquire or hold his units, if the lender of those borrowed funds owns an interest in us, is related to another common unitholder or can look only to the units for repayment. A common unitholder’s at risk amount will increase or decrease as the tax basis of another common unitholder’s common units increases or decreases, other than tax basis increases or decreases attributable to increases or decreases in his share of our nonrecourse liabilities.

The at risk limitation applies on an activity-by-activity basis, and in the case of oil and natural gas properties, each property is treated as a separate activity. Thus, a taxpayer’s interest in each oil or gas property is generally required to be treated separately so that a loss from any one property would be limited to the at risk amount for that property and not the at risk amount for all the taxpayer’s oil and natural gas properties. It is uncertain how this rule is implemented in the case of multiple oil and natural gas properties owned by a single entity treated as a partnership for U.S. federal income tax purposes. However, for taxable years ending on or before the date on which further guidance is published, the IRS will permit aggregation of oil or gas properties we own in computing a common unitholder’s at risk limitation with respect to us. If a common unitholder must compute his at risk amount separately with respect to each oil or gas property we own, he may not be allowed to utilize his share of losses or deductions attributable to a particular property even though he has a positive at risk amount with respect to his units as a whole.

The passive loss limitation generally provides that individuals, estates, trusts and some closely held corporations and personal service corporations are permitted to deduct losses from passive activities, which are generally defined as trade or business activities in which the taxpayer does not materially participate, only to the extent of the taxpayer’s income from those passive activities. The passive loss limitation is applied separately with respect to each publicly traded partnership. Consequently, any passive losses we generate will be available to offset only our passive income generated in the future and will not be available to offset income from other passive activities or investments, including our investments, a common unitholder’s investments in other publicly traded partnerships, or a common unitholder’s salary or active business income. Passive losses that are not deductible because they exceed a common unitholder’s share of income we generate may only be deducted by the common unitholder in full when he disposes of his entire investment in us in a fully taxable transaction with an unrelated party. The passive activity loss limitations are applied after certain other applicable limitations on deductions, including the at risk rules and the tax basis limitation.

A common unitholder’s share of our net income may be offset by any of our suspended passive losses, but it may not be offset by any other current or carryover losses from other passive activities, including those attributable to other publicly traded partnerships.

Limitation on Interest Deductions

The deductibility of a non-corporate taxpayer’s “investment interest expense” is generally limited to the amount of that taxpayer’s “net investment income.” Investment interest expense includes:

 

    interest on indebtedness properly allocable to property held for investment;

 

    our interest expense attributable to portfolio income; and

 

    the portion of interest expense incurred to purchase or carry an interest in a passive activity to the extent attributable to portfolio income.

The computation of a common unitholder’s investment interest expense will take into account interest on any margin account borrowing or other loan incurred to purchase or carry a common unit.

 

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Net investment income includes gross income from property held for investment and amounts treated as portfolio income under the passive loss limitations, less deductible expenses, other than interest, directly connected with the production of investment income, but generally does not include gains attributable to the disposition of property held for investment. The IRS has indicated that net passive income earned by a publicly traded partnership will be treated as investment income to its common unitholders for purposes of the investment interest expense limitations. In addition, the common unitholder’s share of our portfolio income will be treated as investment income.

Entity-Level Collections

If we are required or elect under applicable law to pay any federal, state or local income tax on behalf of any common unitholder or any former common unitholder, we are authorized to pay those taxes from our funds. That payment, if made, will be treated as a distribution of cash to the common unitholder on whose behalf the payment was made. If the payment is made on behalf of a common unitholder whose identity cannot be determined, we are authorized to treat the payment as a distribution to all current common unitholders. We are authorized to amend our partnership agreement in the manner necessary to maintain uniformity of intrinsic tax characteristics of units and to adjust later distributions, so that after giving effect to these distributions, the priority and characterization of distributions otherwise applicable under our partnership agreement is maintained as nearly as is practicable. Payments by us as described above could give rise to an overpayment of tax on behalf of a common unitholder in which event the common unitholder would be required to file a claim in order to obtain a credit or refund.

Allocation of Income, Gain, Loss and Deduction

In general, if we have a net profit, our items of income, gain, loss and deduction will be allocated among the common unitholders in accordance with their percentage interests in us. If we have a net loss for an entire year, the loss will be allocated to our common unitholders according to their percentage interests in us to the extent of their positive capital account balances.

Specified items of our income, gain, loss and deduction will be allocated under Section 704(c) of the Internal Revenue Code to account for the difference between the tax basis and fair market value of our assets at the time we issue common units in an offering, which assets are referred to in this discussion as “Contributed Property.” These allocations are required to eliminate the difference between a partner’s “book” capital account, credited with the fair market value of Contributed Property, and the “tax” capital account, credited with the tax basis of Contributed Property, referred to in this discussion as the “book-tax disparity.” The effect of these allocations to a common unitholder who purchases common units in such an offering will be essentially the same as if the tax basis of our assets were equal to their fair market value at the time of the offering. In the event we issue additional common units or engage in certain other transactions in the future, Section 704(c) allocations will be made to all holders of common units to account for the difference between the “book” basis for purposes of maintaining capital accounts and the fair market value of all property held by us at the time of the future transaction. In addition, items of recapture income will be allocated to the extent possible to the common unitholder who was allocated the deduction giving rise to the treatment of that gain as recapture income in order to minimize the recognition of ordinary income by other common unitholders.

An allocation of items of our income, gain, loss or deduction, other than an allocation required by Section 704(c), will generally be given effect for U.S. federal income tax purposes in determining a common unitholder’s share of an item of income, gain, loss or deduction only if the allocation has substantial economic effect. In any other case, a common unitholder’s share of an item will be determined on the basis of his interest in us, which will be determined by taking into account all the facts and circumstances, including:

 

    his relative contributions to us;

 

    the interests of all the common unitholders in profits and losses;

 

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    the interest of all the common unitholders in cash flow; and

 

    the rights of all the common unitholders to distributions of capital upon liquidation.

Treatment of Short Sales

A common unitholder whose units are loaned to a “short seller” to cover a short sale of units may be considered as having disposed of those units. If so, he would no longer be a partner for tax purposes with respect to those units during the period of the loan and may recognize gain or loss from the disposition. As a result, during this period:

 

    none of our income, gain, loss or deduction with respect to those units would be reportable by the common unitholder;

 

    any cash distributions received by the common unitholder with respect to those units would be fully taxable; and

 

    all of these distributions would appear to be ordinary income.

Because there is no direct or indirect controlling authority on the issue relating to partnership interests, Andrews Kurth LLP has not rendered an opinion regarding the treatment of a common unitholder whose common units are loaned to a short seller. Therefore, common unitholders desiring to assure their status as partners and avoid the risk of gain recognition are urged to modify any applicable brokerage account agreements to prohibit their brokers from borrowing and loaning their common units. The IRS has announced that it is studying issues relating to the tax treatment of short sales of partnership interests. Please also read “—Disposition of Units—Recognition of Gain or Loss.”

Alternative Minimum Tax

Each common unitholder is required to take into account his distributive share of any items of our income, gain, loss or deduction for purposes of the alternative minimum tax. The current minimum tax rate for non-corporate taxpayers is 26% on the first $182,500 of alternative minimum taxable income in excess of the exemption amount and 28% on any additional alternative minimum taxable income. Prospective common unitholders are urged to consult their tax advisors with respect to the impact of an investment in our common units on their liability for the alternative minimum tax.

Tax Rates

Under current law, the highest effective U.S. federal income tax rate applicable to ordinary income of individuals currently is 39.6% and the maximum U.S. federal income tax rate for net long-term capital gains (generally, gains from the sale of certain investment assets held for more than one year) of an individual is 20%. Such rates are subject to change by new legislation at any time.

In addition, a 3.8% net investment income tax (“NIIT”) is imposed on certain net investment income earned by individuals, estates, and trusts. For these purposes, net investment income generally includes a common unitholder’s allocable share of our income and gain realized by a common unitholder from a sale of common units. In the case of an individual, the tax is imposed on the lesser of (i) the common unitholder’s net investment income from all investments, or (ii) the amount by which the common unitholder’s modified adjusted gross income exceeds $250,000 (if the common unitholder is married and filing jointly or a surviving spouse) or $200,000 (if the common unitholder is unmarried). In the case of an estate or trust, the tax is imposed on the lesser of (i) undistributed net investment income, or (ii) the excess adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.

 

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Section 754 Election

We have made the election permitted by Section 754 of the Internal Revenue Code. That election is irrevocable without the consent of the IRS. That election will generally permit us to adjust a unit purchaser’s tax basis in our assets (“inside basis”) under Section 743(b) of the Internal Revenue Code to reflect his purchase price. The Section 743(b) adjustment applies to a person who purchases common units in an offering from the selling unitholder, but does not apply to a person who purchases common units directly from us, and it belongs only to the purchaser and not to other common unitholders. Please also read, however, “—Allocation of Income, Gain, Loss and Deduction” above. For purposes of this discussion, a common unitholder’s inside basis in our assets has two components: (1) his share of our tax basis in our assets (“common basis”) and (2) his Section 743(b) adjustment to that basis.

The timing and calculation of deductions attributable to Section 743(b) adjustments to our common basis will depend upon a number of factors, including the nature of the assets to which the adjustment is allocable, the extent to which the adjustment offsets any Internal Revenue Code Section 704(c) type gain or loss with respect to an asset and certain elections we make as to the manner in which we apply Internal Revenue Code Section 704(c) principles with respect to an asset to which the adjustment is applicable. Please read “—Allocation of Income, Gain, Loss and Deduction.”

The timing of these deductions may affect the uniformity of our common units. Under our partnership agreement, our board is authorized to take a position to preserve the uniformity of common units even if that position is not consistent with these and any other Treasury Regulations or if the position would result in lower annual depreciation or amortization deductions than would otherwise be allowable to some common unitholders. Please read “—Uniformity of Units.” Andrews Kurth LLP is unable to opine as to the validity of any such alternate tax positions because there is no clear applicable authority. A common unitholder’s basis in a common unit is reduced by his share of our deductions (whether or not such deductions were claimed on an individual income tax return) so that any position that we take that understates deductions will overstate the common unitholder’s basis in his common units and may cause the common unitholder to understate gain or overstate loss on any sale of such common units. Please read “—Uniformity of Units.”

A Section 754 election is advantageous if the transferee’s tax basis in his common units is higher than the units’ share of the aggregate tax basis of our assets immediately prior to the transfer. In that case, as a result of the election, the transferee would have, among other items, a greater amount of depletion and depreciation deductions and the transferee’s share of any gain or loss on a sale of our assets would be less. Conversely, a Section 754 election is disadvantageous if the transferee’s tax basis in his common units is lower than those units’ share of the aggregate tax basis of our assets immediately prior to the transfer. Thus, the fair market value of the common units may be affected either favorably or unfavorably by the election. A basis adjustment is required regardless of whether a Section 754 election is made in the case of a transfer of an interest in us if we have a substantial built-in loss immediately after the transfer, or if we distribute property and have a substantial basis reduction. Generally a built-in loss or a basis reduction is substantial if it exceeds $250,000.

The calculations involved in the Section 754 election are complex and will be made on the basis of assumptions as to the fair market value of our assets and other matters. For example, the allocation of the Section 743(b) adjustment among our assets must be made in accordance with the Internal Revenue Code. The IRS could seek to reallocate some or all of any Section 743(b) adjustment we allocated to our tangible assets to goodwill instead. Goodwill, as an intangible asset, is generally either non-amortizable or amortizable over a longer period of time or under a less accelerated method than our tangible assets. We cannot assure you that the determinations we make will not be successfully challenged by the IRS or that the resulting deductions will not be reduced or disallowed altogether. Should the IRS require a different basis adjustment to be made, and should, in our opinion, the expense of compliance exceeds the benefit of the election, we may seek permission from the IRS to revoke our Section 754 election. If permission is granted, a subsequent purchaser of common units may be allocated more income than such purchaser would have been allocated had the election not been revoked.

 

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Tax Treatment of Operations

Accounting Method and Taxable Year

We use the year ending December 31 as our taxable year and the accrual method of accounting for U.S. federal income tax purposes. Each common unitholder is required to include in income his share of our income, gain, loss and deduction for our taxable year ending within or with his taxable year. In addition, a common unitholder who has a taxable year ending on a date other than December 31 and who disposes of all of his common units following the close of our taxable year but before the close of his taxable year must include his share of our income, gain, loss and deduction in income for his taxable year, with the result that he will be required to include in income for his taxable year his share of more than twelve months of our income, gain, loss and deduction. Please read “—Disposition of Units—Allocations Between Transferors and Transferees.”

Depletion Deductions

Subject to the limitations on deductibility of losses discussed above, common unitholders are entitled to deductions for the greater of either cost depletion or (if otherwise allowable) percentage depletion with respect to our oil and natural gas interests. Although the Internal Revenue Code requires each common unitholder to compute his own depletion allowance and maintain records of his share of the adjusted tax basis of the underlying property for depletion and other purposes, we intend to furnish each of our common unitholders with information relating to this computation for U.S. federal income tax purposes. Each common unitholder, however, remains responsible for calculating his own depletion allowance and maintaining records of his share of the adjusted tax basis of the underlying property for depletion and other purposes.

Percentage depletion is generally available with respect to common unitholders who qualify under the independent producer exemption contained in Section 613A(c) of the Internal Revenue Code. For this purpose, an independent producer is a person not directly or indirectly involved in the retail sale of oil, natural gas, or derivative products or the operation of a major refinery. Percentage depletion is calculated as an amount generally equal to 15% (and, in the case of marginal production, potentially a higher percentage) of the common unitholder’s gross income from the depletable property for the taxable year. The percentage depletion deduction with respect to any property is limited to 100% of the taxable income of the common unitholder from the property for each taxable year, computed without the depletion allowance. A common unitholder that qualifies as an independent producer may deduct percentage depletion only to the extent the common unitholder’s average net daily production of domestic crude oil, or the natural gas equivalent, does not exceed 1,000 barrels. This depletable amount may be allocated between oil and natural gas production, with 6,000 cubic feet of domestic natural gas production regarded as equivalent to one barrel of crude oil. The 1,000 barrel limitation must be allocated among the independent producer and controlled or related persons and family members in proportion to the respective production by such persons during the period in question.

In addition to the foregoing limitations, the percentage depletion deduction otherwise available is limited to 65% of a common unitholder’s total taxable income from all sources for the year, computed without the depletion allowance, net operating loss carrybacks, or capital loss carrybacks. Any percentage depletion deduction disallowed because of the 65% limitation may be deducted in the following taxable year if the percentage depletion deduction for such year plus the deduction carryover does not exceed 65% of the common unitholder’s total taxable income for that year. The carryover period resulting from the 65% net income limitation is unlimited.

Common unitholders that do not qualify under the independent producer exemption are generally restricted to depletion deductions based on cost depletion. Cost depletion deductions are calculated by (i) dividing the common unitholder’s share of the adjusted tax basis in the underlying mineral property by the number of mineral units (barrels of oil and thousand cubic feet, or Mcf, of natural gas) remaining as of the beginning of the taxable year and (ii) multiplying the result by the number of mineral units sold within the taxable year. The total amount of deductions based on cost depletion cannot exceed the common unitholder’s share of the total adjusted tax basis in the property.

 

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All or a portion of any gain recognized by a common unitholder as a result of either the disposition by us of some or all of our oil and natural gas interests or the disposition by the common unitholder of some or all of his common units may be taxed as ordinary income to the extent of recapture of depletion deductions, except for percentage depletion deductions in excess of the basis of the property. The amount of the recapture is generally limited to the amount of gain recognized on the disposition.

The foregoing discussion of depletion deductions does not purport to be a complete analysis of the complex legislation and Treasury Regulations relating to the availability and calculation of depletion deductions by the common unitholders. Further, because depletion is required to be computed separately by each common unitholder and not by us, no assurance can be given, and Andrews Kurth LLP is unable to express any opinion, with respect to the availability or extent of percentage depletion deductions to the common unitholders for any taxable year. Moreover, the availability of percentage depletion may be reduced or eliminated if recently proposed (or similar) tax legislation is enacted. For a discussion of such legislative proposals, please read “—Recent Legislative Developments.” We encourage each prospective common unitholder to consult his tax advisor to determine whether percentage depletion would be available to him.

Deductions for Intangible Drilling and Development Costs

We elect to currently deduct intangible drilling and development costs (“IDCs”). IDCs generally include our expenses for wages, fuel, repairs, hauling, supplies and other items that are incidental to, and necessary for, the drilling and preparation of wells for the production of oil, natural gas or geothermal energy. The option to currently deduct IDCs applies only to those items that do not have a salvage value.

Although we elect to currently deduct IDCs, each common unitholder will have the option of either currently deducting IDCs or capitalizing all or part of the IDCs and amortizing them on a straight-line basis over a 60-month period, beginning with the taxable month in which the expenditure is made. If a common unitholder makes the election to amortize the IDCs over a 60-month period, no IDC preference amount in respect of those IDCs will result for alternative minimum tax purposes.

Integrated oil companies must capitalize 30% of all their IDCs (other than IDCs paid or incurred with respect to oil and natural gas wells located outside of the United States) and amortize these IDCs over 60 months beginning in the month in which those costs are paid or incurred. If the taxpayer ceases to be an integrated oil company, it must continue to amortize those costs as long as it continues to own the property to which the IDCs relate. An “integrated oil company” is a taxpayer that has economic interests in oil and natural gas properties and also carries on substantial retailing or refining operations. An oil or gas producer is deemed to be a substantial retailer or refiner if it is subject to the rules disqualifying retailers and refiners from taking percentage depletion. In order to qualify as an “independent producer” that is not subject to these IDC deduction limits, a common unitholder, either directly or indirectly through certain related parties, may not be involved in the refining of more than 75,000 barrels of oil (or the equivalent amount of natural gas) on average for any day during the taxable year or in the retail marketing of oil and natural gas products exceeding $5 million per year in the aggregate.

IDCs previously deducted that are allocable to property (directly or through ownership of an interest in a partnership) and that would have been included in the adjusted basis of the property had the IDC deduction not been taken are recaptured to the extent of any gain realized upon the disposition of the property or upon the disposition by a common unitholder of interests in us. Recapture is generally determined at the common unitholder level. Where only a portion of the recapture property is sold, any IDCs related to the entire property are recaptured to the extent of the gain realized on the portion of the property sold. In the case of a disposition of an undivided interest in a property, a proportionate amount of the IDCs with respect to the property is treated as allocable to the transferred undivided interest to the extent of any gain recognized. Please read “—Disposition of Units—Recognition of Gain or Loss.”

 

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The election to currently deduct IDCs may be restricted or eliminated if recently proposed (or similar) tax legislation is enacted. For a discussion of such legislative proposals, please read “—Recent Legislative Developments.”

Deduction for United States Production Activities

Subject to the limitations on the deductibility of losses discussed above and the limitation discussed below, common unitholders will be entitled to a deduction, herein referred to as the Section 199 deduction, equal to 9% of our qualified production activities income that is allocated to such common unitholder but not to exceed 50% of such common unitholder’s actual or deemed IRS Form W-2 wages for the taxable year allocable to domestic production gross receipts.

Qualified production activities income is generally equal to gross receipts from domestic production activities reduced by cost of goods sold allocable to those receipts, other expenses directly associated with those receipts, and a share of other deductions, expenses and losses that are not directly allocable to those receipts or another class of income. The products produced must be manufactured, produced, grown or extracted in whole or in significant part by the taxpayer in the United States.

For a partnership, the Section 199 deduction is determined at the partner level. To determine his Section 199 deduction, each common unitholder will aggregate his share of the qualified production activities income allocated to him from us with the common unitholder’s qualified production activities income from other sources. Each common unitholder must take into account his distributive share of the expenses allocated to him from our qualified production activities regardless of whether we otherwise have taxable income. However, our expenses that otherwise would be taken into account for purposes of computing the Section 199 deduction are only taken into account only if and to the extent the common unitholder’s share of losses and deductions from all of our activities is not disallowed by the basis rules, the at-risk rules or the passive activity loss rules. Please read “—Tax Consequences of Unit Ownership—Limitations on Deductibility of Losses.”

The amount of a common unitholder’s Section 199 deduction for each year is limited to 50% of the IRS Form W-2 wages actually or deemed paid by the common unitholder during the calendar year that are deducted in arriving at qualified production activities income. Each common unitholder is treated as having been allocated IRS Form W-2 wages from us equal to the common unitholder’s allocable share of our wages that are deducted in arriving at our qualified production activities income for that taxable year. It is not anticipated that we or our subsidiaries will pay material wages that will be allocated to our common unitholders, and thus a common unitholder’s ability to claim the Section 199 deduction may be limited.

This discussion of the Section 199 deduction does not purport to be a complete analysis of the complex legislation and Treasury authority relating to the calculation of domestic production gross receipts, qualified production activities income, or IRS Form W-2 Wages, or how such items are allocated by us to common unitholders. Further, because the Section 199 deduction is required to be computed separately by each common unitholder, no assurance can be given, and Andrews Kurth LLP is unable to express any opinion, as to the availability or extent of the Section 199 deduction to the common unitholders. Moreover, the availability of Section 199 deductions may be reduced or eliminated if recently proposed (or similar) tax legislation is enacted. For a discussion of such legislative proposals, please read “—Recent Legislative Developments.” Each prospective common unitholder is encouraged to consult his tax advisor to determine whether the Section 199 deduction would be available to him.

Lease Acquisition Costs

The cost of acquiring oil and natural gas leaseholder or similar property interests is a capital expenditure that must be recovered through depletion deductions if the lease is productive. If a lease is proved worthless and abandoned, the cost of acquisition less any depletion claimed may be deducted as an ordinary loss in the year the

 

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lease becomes worthless. Please read “Tax Treatment of Operations—Depletion Deductions.” The amortization period for certain geological and geographical expenditures may be extended if recently proposed (or similar) tax legislation is enacted. For a discussion of such legislative proposal, please read “—Recent Legislative Developments.”

Geophysical Costs

Geophysical costs paid or incurred in connection with the exploration for, or development of, oil or gas within the United States are allowed as a deduction ratably over the 24-month period beginning on the date that such expense was paid or incurred.

Operating and Administrative Costs

Amounts paid for operating a producing well are deductible as ordinary business expenses, as are administrative costs to the extent they constitute ordinary and necessary business expenses which are reasonable in amount.

Tax Basis, Depreciation and Amortization

The tax basis of our assets, such as casing, tubing, tanks, pumping units and other similar property, will be used for purposes of computing depreciation and cost recovery deductions and, ultimately, gain or loss on the disposition of these assets. The U.S. federal income tax burden associated with the difference between the fair market value of our assets and their tax basis immediately prior to any offering subsequent to the Conversion will be borne by our common unitholders as of that time. Please read “—Tax Consequences of Unit Ownership—Allocation of Income, Gain, Loss and Deduction.”

To the extent allowable, we may elect to use the depreciation and cost recovery methods that will result in the largest deductions being taken in the early years after assets are placed in service. Property we subsequently acquire or construct may be depreciated using accelerated methods permitted by the Internal Revenue Code.

If we dispose of depreciable property by sale, foreclosure, or otherwise, all or a portion of any gain, determined by reference to the amount of depreciation previously deducted and the nature of the property, may be subject to the recapture rules and taxed as ordinary income rather than capital gain. Similarly, a common unitholder who has taken cost recovery or depreciation deductions with respect to property we own will likely be required to recapture some or all of those deductions as ordinary income upon a sale of his interest in us. Please read “—Tax Consequences of Unit Ownership—Allocation of Income, Gain, Loss and Deduction” and “—Disposition of Units—Recognition of Gain or Loss.”

The costs incurred in selling our units (called “syndication expenses”) must be capitalized and cannot be deducted currently, ratably or upon our termination. There are uncertainties regarding the classification of costs as organization expenses, which we may be able to amortize, and as syndication expenses, which we may not amortize. The underwriting discounts and commissions we incur will be treated as syndication expenses.

Valuation and Tax Basis of Our Properties

The U.S. federal income tax consequences of the ownership and disposition of common units will depend in part on our estimates of the relative fair market values and the tax bases of our assets. Although we may from time to time consult with professional appraisers regarding valuation matters, we will make many of the relative fair market value estimates ourselves. These estimates and determinations of basis are subject to challenge and will not be binding on the IRS or the courts. If the estimates of fair market value or basis are later found to be incorrect, the character and amount of items of income, gain, loss or deduction previously reported by common unitholders might change, and common unitholders might be required to adjust their tax liability for prior years and incur interest and penalties with respect to those adjustments.

 

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Disposition of Units

Recognition of Gain or Loss

Gain or loss will be recognized on a sale of common units equal to the difference between the common unitholder’s amount realized and the common unitholder’s tax basis for the common units sold. A common unitholder’s amount realized will equal the sum of the cash or the fair market value of other property he receives plus his share of our nonrecourse liabilities. Because the amount realized includes a common unitholder’s share of our nonrecourse liabilities, the gain recognized on the sale of common units could result in a tax liability in excess of any cash received from the sale.

Prior distributions from us in excess of cumulative net taxable income for a common unit that decreased a common unitholder’s tax basis in that unit will, in effect, become taxable income if the common unit is sold at a price greater than the common unitholder’s tax basis in that unit, even if the price received is less than his original cost.

Except as noted below, gain or loss recognized by a common unitholder, other than a “dealer” in units, on the sale or exchange of a common unit held for more than one year will generally be taxable as capital gain or loss. A portion of this gain or loss, which will likely be substantial, however, will be separately computed and taxed as ordinary income or loss under Section 751 of the Internal Revenue Code to the extent attributable to assets giving rise to “unrealized receivables” or “inventory items” that we own. The term “unrealized receivables” includes potential recapture items, including depreciation, depletion, and IDC recapture. Ordinary income attributable to unrealized receivables and inventory items may exceed net taxable gain realized on the sale of a common unit and may be recognized even if there is a net taxable loss realized on the sale of a common unit. Thus, a common unitholder may recognize both ordinary income and a capital loss upon a sale of common units. Net capital loss may offset capital gains and no more than $3,000 of ordinary income, in the case of individuals, and may only be used to offset capital gain in the case of corporations. For individuals, trusts and estates, both ordinary income and capital gain recognized on a sale of common units may be subject to NIIT in certain circumstances. Please read “—Tax Consequences of Unit Ownership—Tax Rates.”

The IRS has ruled that a partner who acquires interests in a partnership in separate transactions must combine those interests and maintain a single adjusted tax basis for all those interests. Upon a sale or other disposition of less than all of those interests, a portion of that tax basis must be allocated to the interests sold using an “equitable apportionment” method. Treasury Regulations under Section 1223 of the Internal Revenue Code allow a selling common unitholder who can identify common units transferred with an ascertainable holding period to elect to use the actual holding period of the common units transferred. Thus, according to the ruling, a common unitholder will be unable to select high or low basis common units to sell as would be the case with corporate stock, but, according to the regulations, may designate specific common units sold for purposes of determining the holding period of common units transferred. A common unitholder electing to use the actual holding period of common units transferred must consistently use that identification method for all subsequent sales or exchanges of common units. A common unitholder considering the purchase of additional common units or a sale of common units purchased in separate transactions is urged to consult his tax advisor as to the possible consequences of this ruling and application of the Treasury Regulations.

Specific provisions of the Internal Revenue Code affect the taxation of some financial products and securities, including partnership interests, by treating a taxpayer as having sold an “appreciated” partnership interest, one in which gain would be recognized if it were sold, assigned or terminated at its fair market value, if the taxpayer or related persons enter(s) into:

 

    a short sale;

 

    an offsetting notional principal contract; or

 

    a futures or forward contract with respect to the partnership interest or substantially identical property.

 

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Moreover, if a taxpayer has previously entered into a short sale, an offsetting notional principal contract or a futures or forward contract with respect to the partnership interest, the taxpayer will be treated as having sold that position if the taxpayer or a related person then acquires the partnership interest or substantially identical property. The Secretary of the Treasury is also authorized to issue regulations that treat a taxpayer who enters into transactions or positions that have substantially the same effect as the preceding transactions as having constructively sold the financial position.

Allocations Between Transferors and Transferees

In general, our taxable income or loss will be determined annually, will be prorated on a monthly basis and will be subsequently apportioned among the common unitholders in proportion to the number of units owned by each of them as of the opening of the applicable exchange on the first business day of the month (the “Allocation Date”). However, gain or loss realized on a sale or other disposition of our assets other than in the ordinary course of business will be allocated among the common unitholders on the Allocation Date in the month in which that gain or loss is recognized. As a result, a common unitholder transferring common units may be allocated income, gain, loss and deduction realized after the date of transfer.

Although simplifying conventions are contemplated by the Code and most publicly traded partnerships use similar simplifying conventions, the use of this method may not be permitted under existing Treasury Regulations. Recently, however, the Department of the Treasury and the IRS issued proposed Treasury Regulations that provide a safe harbor pursuant to which a publicly-traded partnership may use a similar monthly simplifying convention to allocate tax items among transferor and transferee unitholders, although such tax items must be prorated on a daily basis. Nonetheless, the proposed regulations do not specifically authorize the use of the proration method we have adopted. Existing publicly-traded partnerships are entitled to rely on those proposed Treasury Regulations; however, they are not binding on the IRS and are subject to change until the final Treasury Regulations are issued. Accordingly, Andrews Kurth LLP is unable to opine on the validity of this method of allocating income and deductions between common unitholders. If this method is not allowed under the Treasury Regulations, or only applies to transfers of less than all of the common unitholder’s interest, our taxable income or losses might be reallocated among the common unitholders. We are authorized to revise our method of allocation between common unitholders, as well as among common unitholders whose interests vary during a taxable year, to conform to a method permitted under future Treasury Regulations.

A common unitholder who owns units at any time during a quarter and who disposes of them prior to the record date set for a cash distribution for that quarter will be allocated items of our income, gain, loss and deductions attributable to that quarter but will not be entitled to receive that cash distribution.

Notification Requirements

A common unitholder who sells any of his common units, other than through a broker, generally is required to notify us in writing of that sale within 30 days after the sale (or, if earlier, January 15 of the year following the sale). A purchaser of common units who purchases units from another common unitholder is also generally required to notify us in writing of that purchase within 30 days after the purchase. Upon receiving such notifications, we are required to notify the IRS of that transaction and to furnish specified information to the transferor and transferee. Failure to notify us of a transfer of common units may, in some cases, lead to the imposition of penalties. However, these reporting requirements do not apply to a sale by an individual who is a citizen of the United States and who effects the sale or exchange through a broker who will satisfy such requirements.

Constructive Termination

We will be considered to have constructively terminated for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. A

 

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constructive termination results in the closing of our taxable year for all common unitholders. In the case of a common unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may result in more than 12 months of our taxable income or loss being includable in his taxable income for the year of termination. A constructive termination occurring on a date other than December 31 will result in us filing two tax returns for one calendar year and the cost of the preparation of these returns will be borne by all common unitholders. However, pursuant to an IRS relief procedure for publicly traded partnerships that have technically terminated, the IRS may allow, among other things, that we provide a single Schedule K-1 for the tax year in which a termination occurs. We would be required to make new tax elections after a constructive termination, including a new election under Section 754 of the Internal Revenue Code, and a constructive termination would result in a deferral of our deductions for depreciation. A constructive termination could also result in penalties if we were unable to determine that the constructive termination had occurred. Moreover, a constructive termination might either accelerate the application of, or subject us to, any tax legislation enacted before the constructive termination.

Uniformity of Units

Because we cannot match transferors and transferees of common units, we must maintain uniformity of the economic and tax characteristics of the units to a purchaser of these units. In the absence of uniformity, we may be unable to completely comply with a number of U.S. federal income tax requirements, both statutory and regulatory. A lack of uniformity can result from a literal application of Treasury Regulation Section 1.167(c)-1(a)(6) and Treasury Regulation Section 1.197-2(g)(3), neither of which is anticipated to apply to a material portion of our assets. Any non-uniformity could have a negative impact on the value of the common units. Please read “—Tax Consequences of Unit Ownership—Section 754 Election.”

Our partnership agreement permits us to take positions in filing our tax returns that preserve the uniformity of our common units even under circumstances like those described above. These positions may include reducing for some common unitholders the depreciation, amortization or loss deductions to which they would otherwise be entitled or reporting a slower amortization of Section 743(b) adjustments for some common unitholders than that to which they would otherwise be entitled. Andrews Kurth LLP is unable to opine as to validity of such filing positions. A common unitholder’s basis in common units is reduced by his share of our deductions (whether or not such deductions were claimed on an individual income tax return) so that any position that we take that understates deductions will overstate the common unitholder’s basis in his common units, and may cause the common unitholder to understate gain or overstate loss on any sale of such common units. Please read “—Disposition of Units—Recognition of Gain or Loss” and “—Tax Consequences of Unit Ownership— Section 754 Election.” The IRS may challenge one or more of any positions we take to preserve the uniformity of common units. If such a challenge were sustained, the uniformity of common units might be affected, and, under some circumstances, the gain from the sale of common units might be increased without the benefit of additional deductions.

Tax-Exempt Organizations and Other Investors

Ownership of units by employee benefit plans, other tax-exempt organizations, non-resident aliens, foreign corporations and other foreign persons raises issues unique to those investors and, as described below, may have substantially adverse tax consequences to them. Prospective common unitholders who are tax-exempt entities or non-U.S. persons should consult their tax advisor before investing in our common units.

Employee benefit plans and most other organizations exempt from U.S. federal income tax, including individual retirement accounts and other retirement plans, are subject to U.S. federal income tax on unrelated business taxable income. Virtually all of our income allocated to a common unitholder that is a tax-exempt organization will be unrelated business taxable income and will be taxable to them.

Non-resident aliens and foreign corporations, trusts or estates that own units will be considered to be engaged in business in the United States because of the ownership of units. As a consequence they will be

 

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required to file federal tax returns to report their share of our income, gain, loss or deduction and pay U.S. federal income tax at regular rates on their share of our net income or gain. Under rules applicable to publicly traded partnerships, we will withhold tax, at the highest effective applicable rate, from cash distributions made quarterly to foreign common unitholders. Each foreign common unitholder must obtain a taxpayer identification number from the IRS and submit that number to our transfer agent on a Form W-8 BEN or applicable substitute form in order to obtain credit for these withholding taxes. A change in applicable law may require us to change these procedures.

In addition, because a foreign corporation that owns units will be treated as engaged in a United States trade or business, that corporation may be subject to the United States branch profits tax at a rate of 30%, in addition to regular U.S. federal income tax, on its share of our income and gain, as adjusted for changes in the foreign corporation’s “U.S. net equity,” which is effectively connected with the conduct of a United States trade or business. That tax may be reduced or eliminated by an income tax treaty between the United States and the country in which the foreign corporate common unitholder is a “qualified resident.” In addition, this type of common unitholder is subject to special information reporting requirements under Section 6038C of the Internal Revenue Code.

A foreign common unitholder who sells or otherwise disposes of a common unit will be subject to U.S. federal income tax on gain realized on the sale or disposition of that unit to the extent the gain is effectively connected with a United States trade or business of the foreign common unitholder. Under a ruling published by the IRS interpreting the scope of “effectively connected income,” a foreign unitholder would be considered to be engaged in business in the United States by virtue of the ownership of common units, and part or all of that common unitholder’s gain would be effectively connected with that unitholder’s indirect U.S. trade or business. Moreover, under the Foreign Investment in Real Property Tax Act, a foreign common unitholder generally will be subject to U.S. federal income tax upon the sale or disposition of a unit if (i) he owned (directly or constructively applying certain attribution rules) more than 5% of our units at any time during the five-year period ending on the date of such disposition and (ii) 50% or more of the fair market value of all of our assets consisted of U.S. real property interests at any time during the shorter of the period during which such common unitholder held the units or the 5-year period ending on the date of disposition. Currently, more than 50% of our assets consist of U.S. real property interests and we do not expect that to change in the foreseeable future. Therefore, foreign common unitholders may be subject to U.S. federal income tax on gain from the sale or disposition of their common units.

Administrative Matters

Information Returns and Audit Procedures

We intend to furnish to each common unitholder, within 90 days after the close of each calendar year, specific tax information, including a Schedule K-1, which describes his share of our income, gain, loss and deduction for our preceding taxable year. In preparing this information, which will not be reviewed by counsel, we will take various accounting and reporting positions, some of which have been mentioned earlier, to determine each common unitholder’s share of income, gain, loss and deduction.

We cannot assure you that those positions will yield a result that conforms to the requirements of the Internal Revenue Code, Treasury Regulations or administrative interpretations of the IRS. Neither we nor Andrews Kurth LLP can assure prospective common unitholders that the IRS will not successfully contend in court that those positions are impermissible. Any challenge by the IRS could negatively affect the value of the units.

The IRS may audit our U.S. federal income tax information returns. Adjustments resulting from an IRS audit may require each common unitholder to adjust a prior year’s tax liability and possibly may result in an audit of his own return. Any audit of a common unitholder’s return could result in adjustments not related to our returns as well as those related to our returns.

 

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Partnerships generally are treated as separate entities for purposes of federal tax audits, judicial review of administrative adjustments by the IRS and tax settlement proceedings. The tax treatment of partnership items of income, gain, loss and deduction are determined in a partnership proceeding rather than in separate proceedings with the partners. The Internal Revenue Code requires that one partner be designated as the “Tax Matters Partner” for these purposes. The partnership agreement appoints our general partners as our Tax Matters Partner, subject to redetermination by our board of directors from time to time.

The Tax Matters Partner will make some elections on our behalf and on behalf of common unitholders. In addition, the Tax Matters Partner can extend the statute of limitations for assessment of tax deficiencies against common unitholders for items in our returns. The Tax Matters Partner may bind a common unitholder with less than a 1% profits interest in us to a settlement with the IRS unless that common unitholder elects, by filing a statement with the IRS, not to give that authority to the Tax Matters Partner. The Tax Matters Partner may seek judicial review, by which all the common unitholders are bound, of a final partnership administrative adjustment and, if the Tax Matters Partner fails to seek judicial review, judicial review may be sought by any common unitholder having at least a 1% interest in profits or by any group of common unitholders having in the aggregate at least a 5% interest in profits. However, only one action for judicial review will go forward, and each common unitholder with an interest in the outcome may participate in that action.

A common unitholder must file a statement with the IRS identifying the treatment of any item on his U.S. federal income tax return that is not consistent with the treatment of the item on our return. Intentional or negligent disregard of this consistency requirement may subject a common unitholder to substantial penalties.

Nominee Reporting

Persons who hold an interest in us as a nominee for another person are required to furnish to us:

 

    the name, address and taxpayer identification number of the beneficial owner and the nominee;

 

    a statement regarding whether the beneficial owner is:

 

    a person that is not a United States person,

 

    a foreign government, an international organization or any wholly-owned agency or instrumentality of either of the foregoing, or

 

    a tax-exempt entity;

 

    the amount and description of units held, acquired or transferred for the beneficial owner; and

 

    specific information including the dates of acquisitions and transfers, means of acquisitions and transfers, and acquisition cost for purchases, as well as the amount of net proceeds from sales.

Brokers and financial institutions are required to furnish additional information, including whether they are United States persons and specific information on units they acquire, hold or transfer for their own account. A penalty of $100 per failure, up to a maximum of $1,500,000 per calendar year, is imposed by the Internal Revenue Code for failure to report that information to us. The nominee is required to supply the beneficial owner of the units with the information furnished to us.

Accuracy-related Penalties

An additional tax equal to 20% of the amount of any portion of an underpayment of tax that is attributable to one or more specified causes, including negligence or disregard of rules or regulations, substantial understatements of income tax and substantial valuation misstatements, is imposed by the Internal Revenue Code. No penalty will be imposed, however, for any portion of an underpayment if it is shown that there was a reasonable cause for the underpayment of that portion and that the taxpayer acted in good faith regarding the underpayment of that portion.

 

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For individuals, substantial understatement of income tax in any taxable year exists if the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return for the taxable year or $5,000 ($10,000 for most corporations). The amount of any understatement subject to penalty generally is reduced if any portion is attributable to a position adopted on the return:

 

    for which there is, or was, “substantial authority,” or

 

    as to which there is a reasonable basis and the relevant facts of that position are disclosed on the return.

If any item of income, gain, loss or deduction included in the distributive shares of common unitholders could result in that kind of an “understatement” of income for which no “substantial authority” exists, we must disclose the pertinent facts on our return. In addition, we will make a reasonable effort to furnish sufficient information for common unitholders to make adequate disclosure on their returns to avoid liability for this penalty. More stringent rules would apply to an understatement of tax resulting from ownership of units if we were classified as a “tax shelter,” which we do not believe includes us, or any of our investments, plans or arrangements.

A substantial valuation misstatement exists if (a) the value of any property, or the tax basis of any property, claimed on a tax return is 150% or more of the amount determined to be the correct amount of the valuation or tax basis, (b) the price for any property or services (or for the use of property) claimed on any such return with respect to any transaction between persons described in Section 482 of the Internal Revenue Code is 200% or more (or 50% or less) of the amount determined under Section 482 to be the correct amount of such price, or (c) the net Section 482 transfer price adjustment for the taxable year exceeds the lesser of $5 million or 10% of the taxpayer’s gross receipts. No penalty is imposed unless the portion of the underpayment attributable to a substantial valuation misstatement exceeds $5,000 ($10,000 for most corporations). The penalty is increased to 40% in the event of a gross valuation misstatement. We do not anticipate making any valuation misstatements.

Reportable Transactions

If we were to engage in a “reportable transaction,” we (and possibly you and others) would be required to make a detailed disclosure of the transaction to the IRS. A transaction may be a reportable transaction based upon any of several factors, including the fact that it is a type of transaction publicly identified by the IRS as a “listed transaction” or that it produces certain kinds of losses for partnerships, individuals, S corporations, and trusts in excess of $2 million in any single taxable year, or $4 million in any combination of six successive tax years. Our participation in a reportable transaction could increase the likelihood that our U.S. federal income tax information return (and possibly a common unitholder’s tax return) is audited by the IRS. Please read “—Information Returns and Audit Procedures” above.

Moreover, if we were to participate in a reportable transaction with a significant purpose to avoid or evade tax or a listed transaction, our common unitholders could be subject to the following provisions of the American Jobs Creation Act of 2004:

 

    accuracy-related penalties with a broader scope, significantly narrower exceptions, and potentially greater amounts than described above at “—Accuracy-related Penalties,”

 

    for those persons otherwise entitled to deduct interest on federal tax deficiencies, non-deductibility of interest on any resulting tax liability, and

 

    in the case of a listed transaction, an extended statute of limitations.

We do not expect to engage in any reportable transactions.

Recent Legislative Developments

The present U.S. federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units, may be modified by administrative, legislative or judicial interpretation at any

 

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time. For example, from time to time members of Congress propose consider substantive changes to the existing U.S. federal income tax laws that would affect the tax treatment of certain publicly traded partnerships. We are unable to predict whether such changes, or other proposals, will ultimately be enacted. However, it is possible that a change in law could affect us and may be retroactively applied. Any such changes could negatively impact the value of an investment in our common units

Legislation has been proposed that would, if enacted, make significant changes to U.S. federal income tax laws, including the elimination of certain key U.S. federal income tax incentives currently available to oil and natural gas exploration and production companies. These changes include, but are not limited to, (i) the repeal of the percentage depletion allowance for oil and natural gas properties, (ii) the elimination of current deductions for intangible drilling and development costs, (iii) the elimination of the deduction for certain domestic production activities, and (iv) an extension of the amortization period for certain geological and geophysical expenditures. The passage of any legislation as a result of these proposals or any other similar changes in U.S. federal income tax laws could eliminate or postpone certain tax deductions that are currently available with respect to oil and natural gas exploration and development, and any such change could increase the taxable income allocable to our common unitholders and negatively impact the value of an investment in our common units.

State, Local and Other Tax Considerations

In addition to U.S. federal income taxes, you will be subject to other taxes, including state and local income taxes, unincorporated business taxes, and estate, inheritance or intangible taxes that may be imposed by the various jurisdictions in which we do business or own property or in which you are a resident. We currently do business and own property in multiple states, most of which impose income taxes on individuals, corporations, and other entities. We may also own property or do business in additional states in the future. Although an analysis of those various taxes is not presented here, each prospective common unitholder should consider their potential impact on his investment in us. You may not be required to file a return and pay taxes in some states because your income from that state falls below the filing and payment requirement. You will be required, however, to file state income tax returns and to pay state income taxes in many of the states in which we may do business or own property, and you may be subject to penalties for failure to comply with those requirements. In some states, tax losses may not produce a tax benefit in the year incurred and also may not be available to offset income in subsequent taxable years. Some of the states may require us, or we may elect, to withhold a percentage of income from amounts to be distributed to a common unitholder who is not a resident of the state. Withholding, the amount of which may be greater or less than a particular common unitholder’s income tax liability to the state, generally does not relieve a nonresident common unitholder from the obligation to file an income tax return. Amounts withheld may be treated as if distributed to common unitholders for purposes of determining the amounts distributed by us. Please read “—Tax Consequences of Unit Ownership—Entity-Level Collections.” Based on current law and our estimate of our future operations, we anticipate that any amounts required to be withheld will not be material.

It is the responsibility of each common unitholder to investigate the legal and tax consequences, under the laws of pertinent states and localities, of his investment in us. Andrews Kurth LLP has not rendered an opinion on the state local, or foreign tax consequences of an investment in us. We strongly recommend that each prospective common unitholder consult, and depend on, his own tax counsel or other advisor with regard to those matters. It is the responsibility of each common unitholder to file all tax returns, that may be required of him.

 

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APPRAISAL RIGHTS

Unitholders of the Company will have no appraisal, dissenters’ or similar rights (i.e., the right, instead of receiving units representing limited partner interests in Sanchez LP, to seek a judicial determination of the “fair value” of their units, and to compel the Company to purchase the holder’s units for cash in that amount) under state law or the Company’s Operating Agreement, as amended, nor will such rights be voluntarily accorded to the Company’s unitholders by the Company. If the Company’s unitholders approve the Conversion as provided in this proxy statement/prospectus, all holders of common units, Class A units and the Class Z unit will be bound by such approval although they, individually, may have voted against the Conversion.

CONVERSION COSTS AND EXPENSES

Set forth below are the estimated fees and expenses incurred or expected to be incurred by the Company in connection with the Conversion. With the exception of the filing fees, the amounts set forth below are estimates.

 

Legal Fees

   $ 370,000   

Accounting Fees

     125,000   

Solicitation, Printing and Mailing Costs

     235,000   

SEC Filing Fees

     11,746   

NYSE MKT Fees

     75,000   

Miscellaneous

     10,000   
  

 

 

 

Total

   $ 826,746   

 

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PROPOSAL NO. 2: APPROVAL OF THE AMENDMENT AND RESTATEMENT OF THE CONSTELLATION ENERGY PARTNERS LLC 2009 OMNIBUS INCENTIVE COMPENSATION PLAN AS THE SANCHEZ PRODUCTION PARTNERS LP LONG-TERM INCENTIVE PLAN

At the Special Meeting, our unitholders will be asked to approve the amendment and restatement of the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan as the Sanchez Production Partners LP Long-Term Incentive Plan (the “LTIP”), which shall include the merger of the Constellation Energy Partners LLC Long-Term Incentive Plan into such plan. The LTIP is a broad-based incentive plan that provides for granting options, unit appreciation rights, restricted unit awards, performance awards, stock units, bonus units, dividend equivalent rights, other unit-based awards and substitute awards to officers, employees, managers, directors and consultants who provide services to Sanchez LP. Our board of managers believes that Sanchez LP’s success and long-term progress are dependent upon the general partner of Sanchez LP attracting and retaining officers, employees, managers, directors and consultants to manage and operate our business. The LTIP will provide the general partner of Sanchez LP the maximum flexibility to use various forms of incentive awards as part of its overall compensation program.

The LTIP is an amendment and restatement of the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan and will include a merger of the Constellation Energy Partners LLC Long-Term Incentive Plan into such restated plan, with the resulting plan being renamed the Sanchez Production Partners LP Long-Term Incentive Plan (collectively, the “LTIP Restatement”). If the LTIP Restatement is approved, the LTIP will be the only broad-based equity incentive plan maintained by Sanchez LP.

Our board of managers unanimously approved the LTIP Restatement on August 25, 2014, subject to unitholder approval at the Special Meeting. The affirmative vote of at least a majority of the Company’s common units and Class A units cast at the Special Meeting, voting together as a single class, and the Class Z unit, voting as a separate class, is required to approve the LTIP Restatement. If the LTIP Restatement is not approved by the unitholders at the Special Meeting, then the amendment and restatement of the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan as the LTIP, the simultaneous merger of the Constellation Energy Partners LLC Long-Term Incentive Plan into the LTIP and the changing of its name to the Sanchez LP Production Partners LP Long-Term Incentive Plan will not become effective and the Constellation Energy Partners LLC Long-Term Incentive Plan and the Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan will continue as currently in effect.

The description of the LTIP set forth below is a summary of material features of the LTIP. This summary, however, does not purport to be a complete description of all the provisions of the LTIP. The summary is qualified in its entirety by reference to the LTIP, a copy of which is attached hereto as Annex C and incorporated herein by reference.

Purpose and Key Features of the LTIP

The LTIP is designed to enable Sanchez LP to provide those individuals who bear the responsibilities of management of Sanchez LP and its affiliates with equity-based incentive and reward opportunities designed to align their interests with those of the equityholders of Sanchez LP, thereby enhancing the profitable growth of Sanchez LP. A further purpose of the LTIP is to provide a means for Sanchez LP to attract and retain such individuals in the service of Sanchez LP and its affiliates.

Number of Sanchez LP Common Units Subject to the LTIP

The maximum number of common units of Sanchez LP that may be delivered under the LTIP with respect to awards will be 15% of the issued and outstanding common units of Sanchez LP at the time the LTIP becomes effective, subject to adjustments for certain unit splits and other events, as provided by the LTIP. Upon issuance of additional common units of Sanchez LP, the number of units that may be delivered under the LTIP with respect to awards will be increased automatically by 15% of such additional common units.

 

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The common units to be delivered under the LTIP may be units acquired in the open market and/or from any person. To the extent that an award terminates or is cancelled prior to and without the delivery of common units (or if an award is forfeited), the units subject to the award may be used again with respect to new awards granted under the LTIP. Common units that cease to be subject to an award because of the exercise or vesting of the award shall no longer be subject to or available for any further grant under the LTIP.

Administration

The LTIP will generally be administered by the board of directors of Sanchez GP or a committee thereof (such administering body, the “Committee”). The Committee has the full authority, subject to the terms of the LTIP, to, among other actions, establish, amend, suspend, or waive such rules and regulations and appoint such agents as it shall deem appropriate for the proper administration of the LTIP, to designate participants under the LTIP, to determine the number of units to be covered by awards, to determine the type or types of awards to be granted to a participant, and to determine the terms and conditions of any award.

Eligibility

All officers, employees, consultants, managers and directors of Sanchez GP, Sanchez LP and affiliates of either of the foregoing (including SOG, SP Holdings and their respective affiliates) and other individuals and entities selected by Sanchez GP (including SOG and SP Holdings) that perform services for Sanchez LP are eligible to be selected to participate in the LTIP. The selection of which eligible individuals will receive awards is within the sole discretion of the Committee. As of January 9, 2015, approximately 180 individuals, including two executive officers, three non-employee managers and 175 other persons, were eligible to receive awards under the LTIP. As of the date of this proxy statement/prospectus, no individuals have been granted awards under the LTIP.

Term of the LTIP

The term of the LTIP will expire on tenth anniversary of the date upon which the LTIP is approved by the unitholders of the Company.

Types of Awards

Common Unit Grants

The LTIP will permit the grant of common units. A common unit grant is a grant of common units that are fully vested at the time of grant. If Sanchez LP issues common units already held by Sanchez LP in connection with the grant of common units, the total number of common units outstanding will increase.

Common Unit Options and Common Unit Appreciation Rights

The LTIP will permit the grant of options covering common units and the grant of common unit appreciation rights. A common unit option is an award that entitles the plan participant to purchase a number of common units at a specified exercise price. A common unit appreciation right is an award that, upon exercise, entitles the participant to receive the excess of the fair market value of a common unit on the exercise date over the exercise price established for the common unit appreciation right.

The Committee will be able to make grants of common unit options and common unit appreciation rights under the LTIP to LTIP participants containing such terms as the Committee shall determine. Common unit options and common unit appreciation rights may not have an exercise price that is less than the fair market value of the common units on the date of grant. In general, common unit options and common unit appreciation rights granted will become exercisable over a period determined by the Committee.

 

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Unless provided otherwise by the Committee in the applicable award agreement, upon a change in control, as defined in the LTIP, or such time prior thereto as established by the Committee, to the extent that Sanchez GP or Sanchez LP does not survive as an independent organization and any surviving or successor organization and/or any of its affiliates does not assume or continue the unvested common unit options or common unit appreciation rights substantially on the same terms, then, immediately prior to the change in control (or any earlier date related to the change in control and established by the Committee), all outstanding unvested options and rights shall automatically vest and become exercisable in full. Any accelerated payout on account of a change in control will be made in a single payment within 30 days after the date of the change in control.

If a LTIP participant’s employment with or services to Sanchez GP, Sanchez LP or affiliates of either of the forgoing or membership on the board of directors of Sanchez GP terminates for any reason, the LTIP participant’s unvested common unit options and common unit appreciation rights will be automatically forfeited, unless and to the extent the Committee provides otherwise in the applicable award agreement or, in its discretion, waives in whole or in part such forfeiture. Except as otherwise provided in the terms of an award agreement pertaining to common unit options, if the LTIP participant ceases employment with or services to Sanchez GP, Sanchez LP or affiliates of either of the forgoing prior to the expiration of any vested common unit option, the vested common unit option will expire as follows:

(A) Termination Not For Retirement, Disability or Death—any vested common unit option will expire on the earlier of (i) the date that is 90 days after the effective date of any such termination that is not due to the participant’s retirement (as defined in the LTIP), disability (as defined in the LTIP) or death or (ii) the last day of the term of the common unit option; or

(B) Termination for Retirement, Disability or Death—any vested common unit option will expire on the earlier of (i) the date that is 60 months after the effective date of the LTIP participant’s retirement (as defined in the LTIP), disability (as defined in the LTIP) or death or (ii) the last day of the term of the common unit option.

Upon exercise of a common unit option (or a common unit appreciation right settled in common units), Sanchez LP will acquire common units on the open market or directly from any other person, use common units already owned by us, or any combination of the foregoing. If Sanchez LP issues common units already held by Sanchez LP upon exercise of the common unit options (or a common unit appreciation right settled in common units), the total number of common units outstanding will increase, and Sanchez LP will receive the proceeds from an optionee upon exercise of a common unit option.

Restricted Common Units and Notional Common Units

A restricted common unit is a common unit that is subject to forfeiture prior to the vesting of the award. A notional common unit is a notional common unit that entitles the LTIP participant to receive a common unit upon the vesting of the notional common unit or, in the discretion of the Committee, cash equivalent to the value of a common unit. The Committee may determine to make grants under the LTIP of restricted common units and notional common units to LTIP participants containing such terms as the Committee shall determine. The Committee will determine the period over and the terms under which restricted common units and notional common units granted to LTIP participants will vest.

Unless provided otherwise by the Committee in the applicable award agreement, upon a change in control, as defined in the LTIP, or such time prior thereto as established by the Committee, to the extent that Sanchez GP or Sanchez LP does not survive as an independent organization and any surviving or successor organization and/or any of its affiliates does not assume or continue the unvested restricted common units or notional common units substantially on the same terms, then, immediately prior to the change in control (or any earlier date related to the change in control and established by the Committee) all outstanding unvested restricted common units or notional common units shall automatically vest. In this regard, all restricted periods shall terminate and all performance criteria, if any, shall be deemed to have been achieved at the maximum level. Unless provided otherwise by the Committee in the applicable award agreement, any time-based restricted common units or

 

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notional common units that vest upon a change in control shall be settled by (i) the issuance of unrestricted common units based on the number of common units that were subject to the award on the date of grant of the award or (ii) the payment of cash and/or other property equal to the fair market value, as defined in the LTIP, of a common unit on the payout date for each notional common unit or restricted common unit or (iii) any combination of payouts under clauses (i) and (ii) of this sentence, as determined by the Committee. Unless provided otherwise by the Committee in the applicable award agreement, any performance-based restricted common units or notional common units that vest upon a change in control shall be settled by (i) the issuance of unrestricted common units based on the number of common units that were subject to the award as established on the date of grant of the award, prorated based on the number or complete months of the restricted period that have elapsed as of the payment date, and assuming that maximum performance was achieved or (ii) the payment of cash and/or other property equal to the fair market value of a common unit on the payout date for each notional common unit or restricted common unit which is payable under clause (i) of this sentence or (iii) any combination of payouts under clauses (i) and (ii) of this sentence, as determined by the Committee. Any accelerated payout will be made in a single payment within 30 days after the date of the change in control. If a LTIP participant’s employment with or services to Sanchez GP, Sanchez LP and affiliates of either of the forgoing or membership on the board of directors of Sanchez GP terminates for any reason, the LTIP participant’s unvested restricted common units and notional common units will be automatically forfeited unless, and to the extent, the Committee provides otherwise in the applicable award agreement.

Common units to be delivered in connection with the grant of restricted common units or upon the vesting of notional common units may be common units acquired by Sanchez LP in the open market, common units already owned by Sanchez LP, common units acquired by Sanchez LP from any other person, or any combination of the foregoing. If Sanchez LP issues common units already held by Sanchez LP in connection with the grant of restricted common units or upon vesting of the notional common units, the total number of common units outstanding will increase. The Committee, in its discretion, may grant tandem distribution rights with respect to restricted common units and tandem distribution equivalent rights with respect to notional common units.

Performance Awards

The LTIP will permit the grant of certain performance awards. The Committee, in its discretion, will determine the performance metrics and related performance goals to be achieved during any performance period, the length of any performance period, the vesting criteria, the amount of any performance award and the amount of any payment to be made pursuant to any performance award. Which factor or factors are to be used with respect to any grant, and the weight to be accorded thereto if more than one factor is used, shall be determined by the Committee, in its sole discretion, at the time of grant.

Performance awards that become vested shall, unless otherwise provided in the award agreement by the Committee, be paid in a single lump sum no later than the 15th day of the third month following the date on which vesting occurs and the restrictions lapse. Such payment(s) may be made in cash or common units as determined by the Committee.

Unless provided otherwise by the Committee in the applicable award agreement, upon a change in control, as defined in the LTIP, or such time prior thereto as established by the Committee, to the extent that Sanchez GP or Sanchez LP does not survive as an independent organization and any surviving or successor organization and/or any of its affiliates does not assume or continue the unvested performance awards on substantially the same terms, then, immediately prior to the change in control (or any earlier date related to the change in control and established by the Committee) all outstanding unvested performance awards shall automatically vest. Except as otherwise provided in the award agreement or determined by the Committee, any performance award that is deemed to have all applicable performance criteria achieved at the target level as of the date of a change in control (or any earlier date related to the change in control and established by the Committee), shall be paid in cash, prorated based on the number of complete months of the performance period that have elapsed as of the payment date, and assuming that target-level performance was achieved. Any accelerated payout will be made in

 

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a single payment within 30 days after the date of the change in control. If a LTIP participant’s employment with or services to Sanchez GP, Sanchez LP and affiliates of either of the foregoing or membership on the board of directors of Sanchez GP terminates for any reason, the LTIP participant’s unvested performance awards will be automatically forfeited unless, and to the extent, the Committee provides otherwise in the applicable award agreement. The Committee may, in its discretion, waive in whole or in part such forfeiture with respect to a LTIP participant’s performance awards, in which case, a prorated portion of such performance awards shall be deemed vested upon termination of employment or service.

Common units to be delivered in connection with the grant of restricted common units or upon the vesting of notional common units may be common units acquired by Sanchez LP in the open market, common units already owned by Sanchez LP, common units acquired by Sanchez LP from any other person, or any combination of the foregoing. If Sanchez LP issues common units already held by Sanchez LP in connection with the vesting of performance awards, the total number of common units outstanding will increase.

Miscellaneous

Sanchez GP’s board of directors may amend or modify the LTIP at any time, although unitholder approval will be obtained for any amendment to the LTIP to the extent necessary to comply with any applicable law, regulation or securities exchange rule. The Committee may amend any outstanding award made under the LTIP, provided that no change in any outstanding award may be made that would materially impair the vested rights of the participant without the consent of the affected participant.

U.S. Federal Income Tax Aspects of the LTIP

The following discussion is for general information purposes only and is intended to summarize briefly certain U.S. federal income tax consequences to participants arising from participation in the LTIP. This description is based on current law, which is subject to change (possibly retroactively). The tax treatment of participants in the LTIP may vary depending on their particular circumstances and, therefore, may be subject to special rules not discussed below. No attempt has been made to discuss any potential foreign, state, or local tax consequences. In addition, common unit options or unit appreciation rights that provide for a “deferral of compensation” within the meaning of Section 409A of the Internal Revenue Code (“Section 409A”), notional units, and certain other awards that may be granted pursuant to the LTIP could be subject to additional taxes unless they are designed to comply with certain restrictions set forth in Section 409A and the guidance promulgated thereunder.

Common Unit Grants

In general, the fair market value of a common unit will be taxable as ordinary compensation when it is granted to the LTIP participant.

Common Unit Options and Common Unit Appreciation Rights

LTIP participants generally will not realize taxable income upon the grant of a common unit option or a common unit appreciation right. Typically, upon the exercise of a common unit option or a common unit appreciation right, the LTIP participant will recognize ordinary compensation income in an amount equal to the excess of (i) the fair market value of the common units on the date of exercise (or the cash equivalent) over (ii) the exercise price (if any) paid for the common units. A LTIP participant will generally have a tax basis in any common units received pursuant to the exercise of a common unit appreciation right, or pursuant to the cash exercise of a common unit option, that equals the fair market value of the common units on the date of exercise. Subject to the discussion under “—Tax Code Limitations on Deductibility” below, Sanchez LP will be entitled to a deduction for federal income tax purposes that corresponds as to timing and amount with the compensation income recognized by a participant under the foregoing rules.

 

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When a LTIP participant sells the common units acquired as a result of the exercise of a unit option or unit appreciation right, any appreciation (or depreciation) in the value of the common units after the exercise date is treated as long- or short-term capital gain (or loss) for federal income tax purposes, depending on the holding period. The common units must be held for more than 12 months in order to qualify for long-term capital gain treatment.

Notional Common Units, Performance Awards and Restricted Common Units

A LTIP participant generally will not have taxable income at the time of a grant of an award in the form of a notional common unit award or performance award, but rather, will generally recognize ordinary compensation income at the time he receives common units or cash in settlement of the notional common unit award or performance award in an amount equal to the fair market value of the common units or the amount of cash received. In addition, the LTIP participant will be subject to ordinary income tax upon the payment of a contingent right, granted in tandem with a specific notional common unit, to receive an amount in cash equal to, and at the same time as, the cash distributions made by Sanchez LP with respect to a common unit during the period a notional common unit is outstanding (a “DER”).

In general, a LTIP participant will recognize ordinary compensation income as a result of the receipt of common units pursuant to a restricted common unit award in an amount equal to the fair market value of the common units when the common units vest. However, if the common units are not transferable or are subject to a substantial risk of forfeiture when granted, the LTIP participant will recognize ordinary compensation income in an amount equal to the fair market value of common units (i) when the common units first become transferable or are no longer subject to a substantial risk of forfeiture, in cases where a participant does not make an valid election under Section 83(b) of the Internal Revenue Code (“Section 83(b)”) or (ii) when the common units are granted, in cases where a LTIP participant makes a valid election under Section 83(b).

Withholding Taxes

A LTIP participant who is an employee will be subject to withholding for federal, and generally for state and local, income and employment taxes at the time he recognizes income under the rules described above with respect to common units (or cash with respect to a DER) received. Non-employee directors, managers and consultants must make their own arrangements for satisfying any tax obligations they may incur in connection with the receipt of an award under the LTIP. Distributions that are received by a LTIP participant prior to the time that the common units underlying an award are taxed to the LTIP participant under the rules described in the preceding paragraph are taxed as additional compensation, not as distributions on common units. The tax basis in the common units received by a LTIP participant will equal the amount recognized by him as compensation income under the rules described in the preceding paragraph, and the LTIP participant’s capital gains holding period in those common units will commence on the date of receipt of the common units.

Subject to the discussion immediately below, we will be entitled to a deduction for federal income tax purposes that corresponds in timing and amount with the compensation income recognized by a LTIP participant under the foregoing rules.

Tax Code Limitations on Deductibility

In order for the amounts described above to be deductible by Sanchez LP or one of its affiliates, the amounts must constitute reasonable compensation for services rendered or to be rendered and must be ordinary and necessary business expenses.

 

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Limited Partnership Interest

Sanchez LP is not a taxable entity, and as such, Sanchez LP does not incur any federal income tax liability. Instead, each holder of Sanchez LP common units is required to report on his income tax return his share of Sanchez LP income, gains, losses and deductions in computing his federal income tax liability, regardless of whether cash distributions are made to him by us. Distributions by Sanchez LP to a holder of common units are generally not taxable unless the amount of cash distributed is in excess of the holder’s adjusted basis in his interest. Usually at the beginning of each year, Sanchez LP will mail to each partner a Schedule K-1 showing the amounts of income, gains, losses, and deductions that the partner is required to reflect on his federal income tax return as a limited partner for the preceding year. A limited partner will not qualify for using Form 1040EZ or 1040A, and may not file his federal income tax return until he has received his Schedule K-1 and reflected the relevant information contained therein in his tax return.

Inapplicability of ERISA

Based upon current law and published interpretations, we do not believe that the LTIP will be subject to any of the provisions of the Employee Retirement Income Security Act of 1974, as amended.

New Plan Benefits

The following table sets forth the awards previously granted by the Company and outstanding as of January 9, 2015 under the existing Constellation Energy Partners LLC 2009 Omnibus Incentive Compensation Plan (which has 88,773 common units available for issuance) and the Constellation Energy Partners LLC Long-Term Incentive Plan (which has 26,990 common units available for issuance). The awards outstanding under these two existing plans will remain outstanding under the LTIP upon the effectiveness of the LTIP. All of the awards set forth in the table below are notional units or restricted common units that vest in 2015, 2016 or 2017.

 

Sanchez Production Partners LP Long-Term Incentive Plan

 

Name and Position

   Dollar value ($)(1)      Number of units  

Stephen R. Brunner

   $ 1,123,077         769,231   

Charles C. Ward

     374,359         256,410   

Executive Group

     1,497,436         1,025,641   

Non-Executive Director Group

     —           —     

Non-Executive Officer Employee Group

     —           —     

 

(1) Based on the last trading price of the Company’s common units as reported on the NYSE MKT on January 9, 2015 of $1.46.

Vote Required

The affirmative vote of the holders of a majority of the votes cast by the holders of common units and Class A units, voting together as a single class, and the Class Z unit, voting as a separate class, and entitled to vote at the special meeting, at which a quorum is present, is required to approve Proposal No. 2. Abstentions and broker non-votes will not be counted either in favor of or against approval of Proposal No. 2.

Board Recommendation

Our board of managers recommends that the unitholders vote FOR Proposal No. 2 to approve the LTIP Restatement.

 

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LEGAL MATTERS

The validity of the Sanchez LP common units to be issued in connection with the Conversion will be passed upon by Andrews Kurth LLP, Houston, Texas.

EXPERTS

The consolidated financial statements of the Company as of December 31, 2013 and for the year then ended, have been included herein in reliance upon the report of KPMG LLP, independent registered public accounting firm, appearing elsewhere herein, and upon the authority of said firm in accounting and auditing. KPMG LLP’s report refers to its audit of the adjustments that were applied to retrospectively adjust the 2012 consolidated financial statements for discontinued operations, as more fully described in Note 2 to the consolidated financial statements. However, KPMG LLP was not engaged to audit, review, or apply any procedures to the 2012 consolidated financial statements other than with respect to such adjustments.

The consolidated financial statements as of December 31, 2012 and for the year then ended, before the effects of the adjustments to retrospectively reflect the discontinued operations described in Note 2, included in this proxy statement/prospectus have been so included in reliance on the report (which contains an emphasis of matter paragraph relating to the company entering into an asset sale transaction and extending its reserve based credit facility to March 31, 2014) of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.

Certain information included or incorporated by reference in this proxy statement/prospectus regarding our estimated quantities of natural gas reserves was prepared by Netherland, Sewell & Associates, Inc.

WHERE YOU CAN FIND MORE INFORMATION; INCORPORATION BY REFERENCE

The Company files reports and other information with the SEC. The Company’s unitholders may read and copy these reports, statements or other information filed by the Company at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. The SEC filings of the Company are also available to the public from commercial document retrieval services and at the website maintained by the SEC at http://www.sec.gov. The Company’s unitholders also may obtain certain of these documents at the Company’s website, http://www.sanchezpp.com. Information contained on the Company’s website is expressly not incorporated by reference into this proxy statement/prospectus.

The Company has filed a registration statement on Form S-4 to register with the SEC the common units of Sanchez LP to be received by holders of the Company’s common units in connection with the Conversion. This proxy statement/prospectus forms a part of that registration statement and constitutes a prospectus and proxy statement of the Company for its Special Meeting. As allowed by SEC rules, this proxy statement/prospectus, which is part of the registration statement, does not contain all the information unitholders can find in the registration statement or the exhibits to the registration statement. For further information about the Company, please refer to the registration statement, including the exhibits.

The SEC allows the Company to “incorporate by reference” information into this proxy statement/prospectus. This means that the Company can disclose important information to unitholders by referring them to another document filed separately with the SEC. The information incorporated by reference is considered to be a part of this proxy statement/prospectus, except for any information that is superseded by information that is included directly in this proxy statement/prospectus or incorporated by reference subsequent to the date of this proxy statement/prospectus.

 

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This proxy statement/prospectus incorporates by reference the documents listed below that the Company has previously filed with the SEC (other than information furnished pursuant to Item 2.02 or Item 7.01 of a Current Report on Form 8-K). They contain important information about the Company and its financial condition.

 

    Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (filed with the SEC on March 27, 2014);

 

    Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2014 (filed with the SEC on May 15, 2014);

 

    Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2014 (filed with the SEC on August 14, 2014);

 

    Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2014 (filed with the SEC on November 13, 2014);

 

    Current Reports on Form 8-K filed with the SEC on March 28, 2014, April 1, 2014, April 11, 2014, May 6, 2014, May 8, 2014, June 18, 2014, June 26, 2014, August 28, 2014, September 29, 2014, October 3, 2014, December 11, 2014, December 23, 2014 and January 12, 2015;

 

    Proxy Statement on Schedule 14A (filed with the SEC on May 16, 2014); and

 

    All other documents that we file pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this proxy statement/prospectus will be deemed to be incorporated by reference into this proxy statement/prospectus and will be a part of this proxy statement/prospectus from the date of filing of the document.

The Company also incorporates by reference the following Annexes attached to this proxy statement/prospectus:

 

    the Plan of Conversion attached as Annex A;

 

    the form of agreement of limited partnership of Sanchez LP attached as Annex B; and

 

    the form of Sanchez Production Partners LP Long-Term Incentive Plan attached as Annex C.

Documents incorporated by reference are available to the Company’s unitholders and the public without charge upon written or oral request, excluding any exhibits to those documents, unless the exhibit is specifically incorporated by reference as an exhibit in this proxy statement/prospectus. The Company’s unitholders and the public can obtain any of these documents by requesting them in writing or by telephone from the appropriate company at:

Sanchez Production Partners LLC

1000 Main Street, Suite 3000

Houston, Texas 77002

Attention: Corporate Secretary

Telephone number: (713) 783-8000

http://www.sanchezpp.com

In order for the Company’s unitholders to receive timely delivery of the documents in advance of the Special Meeting, the Company should receive requests for documents no later than February 27, 2015.

 

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ANNEX A

PLAN OF CONVERSION

This PLAN OF CONVERSION, dated as of August 25, 2014 (including all of the Exhibits attached hereto, this “Plan of Conversion”), sets forth the terms, conditions and procedures governing the conversion of Constellation Energy Partners LLC, a Delaware limited liability company (the “LLC”) from a Delaware limited liability company to a Delaware limited partnership to be named “Sanchez Production Partners LP” (the “LP”) pursuant to Section 18-216 of the Delaware Limited Liability Company Act (the “LLC Act”) and Section 17-217 of the Delaware Revised Uniform Limited Partnership (the “DRULPA”).

W  I  T  N  E  S  S  E  T  H

WHEREAS, the LLC was formed on February 7, 2005 and has been operating under the Second Amended and Restated Operating Agreement of the LLC, dated as of November 20, 2006, as amended (the “Operating Agreement”);

WHEREAS, upon the terms and subject to the conditions of this Plan of Conversion and in accordance with the LLC Act and the DRULPA, the LLC will be converted to a Delaware limited partnership pursuant to and in accordance with Section 18-216 of the LLC Act and Section 17-217 of the DRULPA (the “Conversion”);

WHEREAS, the Board of Managers (the “Board”) of the LLC, pursuant to Sections 12.12(c) and 11.1 of the Operating Agreement, (i) has determined that the Conversion is advisable and in the best interests of the LLC and its members (the “Members”) and will not adversely affect the Members (or any class of Members) in any material respect, (ii) hereby approves and adopts this Plan of Conversion, the Conversion, and the other documents and transactions contemplated by this Plan of Conversion and (iii) recommends that the Members approve this Plan of Conversion; and

WHEREAS, in connection with the Conversion, (i) each outstanding Common Unit (as defined in the Operating Agreement) of th