<PAGE>   1
                                                                     EXHIBIT 2.2

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                         UNITED STATES BANKRUPTCY COURT
                            WESTERN DISTRICT OF TEXAS
                                MIDLAND DIVISION

IN RE:                                    )
                                          )
COSTILLA ENERGY, INC.,                    )          CASE NO. 99-70653
Tax I.D. No. 75-2658940                   )             CHAPTER 11
                                          )
DEBTOR.                                   )




      ------------------------------------------------------------------

                      DISCLOSURE STATEMENT WITH RESPECT TO
                 DEBTOR'S PLAN OF REORGANIZATION (LIQUIDATION),
                                   AS AMENDED
                              Dated: July 28, 2000
                                 Midland, Texas

      ------------------------------------------------------------------



      Henry J. Kaim                             Richard T. McMillan
      Robert K. Lum                             Dan G. LeRoy
      SHEINFELD, MALEY & KAY, P.C.              COTTON, BLEDSOE, TIGHE
      1001 Fannin Street, Suite 3700               & DAWSON
      Houston, TX 77002                         500 W. Illinois, Suite 300
      Telephone: (713) 658-8881                 Midland, Texas 79701-4337
      Facsimile: (713) 658-9756                 Telephone: (915) 684-5782
                                                Facsimile: (915) 682-3672

      Samuel M. Stricklin
      SHEINFELD, MALEY & KAY, P.C.
      1700 Pacific Avenue, Suite 4400
      Dallas, TX 75201-4618
      Telephone: (214) 953-0700
      Facsimile: (214) 953-1189



                            ATTORNEYS FOR THE DEBTOR



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<PAGE>   2



                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                       PAGE
                                                                                                       ----
<S>            <C>      <C>                                                                            <C>
ARTICLE I - INTRODUCTION ..........................................................................       1

               1.1      General Overview of Payment Plans .........................................       1
               1.2      Preliminary Statement .....................................................       6
               1.3      Purpose of Disclosure Statement ...........................................       8
               1.4      Explanation of Chapter 11 .................................................       9
               1.5      Procedure for Filing Proofs of Claim and Proofs of Interest ...............      10
                        A.      Bar Date for Filing of All Proofs of Claim (Other Than
                                Administrative Claims) and Proofs of Interest .....................      10
                        B.      Effect of Amendments to Schedules .................................      11
                        C.      Executory Contracts and Unexpired Leases ..........................      11
               1.6      Voting Procedures and Requirements ........................................      11
                        A.      Persons Entitled to Vote ..........................................      11
                        B.      Voting Instructions ...............................................      11
                                1.       Ballots ..................................................      11
                                2.       Returning Ballots ........................................      12
                                3.       Voting Claims with Respect to Publicly Traded Bonds ......      12
                        C.      Incomplete or Irregular Ballots ...................................      12
                        D.      Ballot Retention ..................................................      12
                        E.      Approval of Disclosure Statement ..................................      13
                        F.      Confirmation Hearing ..............................................      13
                        G.      Objections ........................................................      13

ARTICLE II - BACKGROUND ...........................................................................      14

               2.1      Background About the Debtor ...............................................      14
                        A.      Incorporated Information ..........................................      14
                        B.      Business ..........................................................      14
                                1.       General ..................................................      14
                                2.       1999 Activities ..........................................      15
                                3.       Environmental Matters ....................................      16
                                4.       Operational Hazards and Insurance ........................      16
                        C.      Market for the Debtor's Pre-Bankruptcy Common Stock ...............      17
                        D.      Related Party Transactions ........................................      17
                        E.      Other Business ....................................................      18

ARTICLE III - PROCEEDINGS IN THE CHAPTER 11 CASE ..................................................      18

               3.1      Administration of the Case ................................................      19
                        A.      The "First Day" Pleadings .........................................      19
                        B.      Payments of Prepetition Severance Tax and Obligations to Royalty
                                and Working Interest Owners .......................................      20
                        C.      Payables to Operators of Debtor's Non-Operated Properties .........      21
                        D.      Assumption and Rejection of Contracts .............................      21
</TABLE>


                                      -i-
<PAGE>   3

<TABLE>
<S>                     <C>                                                                                   <C>
                                (i)      Farmout Agreements .............................................     21
                                         a)    Farmout Agreement with Canyon Oil & Gas
                                               Exploration L.L.C. .......................................     21
                                         b)    Farmout Agreement with JUD, L.C. .........................     21
                                         c)    Farmout with Walter Oil and Gas Exploration Corp .........     22
                                         d)    Farmout Agreement with Petrogulf II Limited Partnership ..     22
                                (ii)     Houston Pipeline Contract ......................................     22
                                (iii)    Employee Contracts .............................................     22
                                (iv)     Non-Residential Real Property Leases ...........................     23
                        E.      Appointment of Committee of Unsecured Creditors .........................     23
                        F.      Retention of Professionals ..............................................     23
                        G.      Removal of Litigation ...................................................     23
                        H.      341 Meeting .............................................................     24
                        I.      Claims Process and Bar Date .............................................     24
                        J.      Motion to Appoint Examiner ..............................................     25
                        K.      Bankruptcy Code Section 363 Sale of Substantially All the Assets ........     25
                        L.      Closing and Post Closing Retention Pay for Certain Employees ............     25
                        M.      Payment of Undisputed Principal and Interest ............................     26

ARTICLE IV - GENERAL OVERVIEW OF THE PROPOSED - PLAN OF REORGANIZATION ..................................     26

               4.1      Bankruptcy Risks ................................................................     26
                        A.      Objection to Classifications ............................................     26
                        B.      Risk of Nonconfirmation of the Plan .....................................     26
                        C.      Nonoccurrence of Effective Date of the Plan .............................     27

ARTICLE V - TREATMENT OF CLAIMS WITHIN THE PROPOSED  PLAN OF REORGANIZATION .............................     27

               5.1      Classification and Treatment of Claims and Interests ............................     27
               5.2      Treatment of Administrative Expenses ............................................     28
               5.3      Treatment of Priority Tax Claims ................................................     28
               5.4      Class 1 -  The Allowed Bank Group Claim .........................................     29
               5.5      Class 2 -  Any Allowed Bankers Trust Swap Claim .................................     29
               5.6      Class 3 -  The Dawson Secured Claim .............................................     30
               5.7      Class 4 -  Other Secured Claims .................................................     30
               5.8      Class 5 -  Any Allowed Priority Non-Tax Claims ..................................     30
               5.9      Class 6 -  Any Allowed Administrative Convenience Claims ........................     31
               5.10     Class 7 -  Any Allowed General Unsecured Claims, Including Allowed Bond
                                   Claims ...............................................................     31
               5.11     Class 8 -  Disallowed Claims, Subordinated Claims, Securities Laws Claims
                                   and Penalty Claims ...................................................     32
               5.12     Class 9 -  Equity Interests in Costilla Energy, Inc. ............................     32

ARTICLE VI - THE LIQUIDATING TRUST ......................................................................     32
               6.1      Creation of the Trust ...........................................................     32
</TABLE>


                                      -ii-
<PAGE>   4

<TABLE>
<S>                     <C>                                                                                   <C>
               6.2      Funding of Res of Trust .........................................................     33
               6.3      Trustee to Liquidate or Abandon All Assets and Distribute Proceeds ..............     33
               6.4      Dissolution of Debtor ...........................................................     34

ARTICLE VII - PROCEDURES FOR RESOLVING AND TREATING CONTESTED DISPUTED CLAIMS UNDER THE PLAN ............     34

               7.1      Objection Deadline ..............................................................     34
               7.2      Prosecution of Objections .......................................................     34
               7.3      Timing of Distributions .........................................................     34
               7.4      Distributions to Bondholders ....................................................     34
               7.5      Means of Cash Payment ...........................................................     36
               7.6      Delivery of Distributions .......................................................     37
               7.7      Time Bar to Cash Payments .......................................................     37
               7.8      No Distributions Pending Allowance ..............................................     37
               7.9      Withholding of Distribution on Account of Contested Claims ......................     37
               7.10     Distributions After Allowance ...................................................     37
               7.11     Distributions After Disallowance ................................................     38
               7.12     Order of Distribution of Trust Cash .............................................     38

ARTICLE VIII - SELECT OTHER PROVISIONS OF THE PLAN ......................................................     39

               8.1      Plan is Motion to Sell ..........................................................     39
               8.2      Vesting of Assets ...............................................................     39
               8.3      The Committee ...................................................................     39
               8.4      Trustee to Liquidate or Abandon all Assets and Distribute Proceeds; Committee
                        May Terminate Plan Trustee, With or Without Cause ...............................     40
               8.5      Setoff and Other Rights .........................................................     40
               8.6      Discharge .......................................................................     40
               8.7      Injunctions .....................................................................     41
               8.8      Responsible Party Injunction ....................................................     41
               8.9      Lawsuits ........................................................................     41
               8.10     Release and Exculpation .........................................................     42
               8.11     De Minimis Distributions ........................................................     42
               8.12     Payment of Statutory Fees .......................................................     42
               8.13     Bankruptcy Restrictions .........................................................     42
               8.14     Binding Effect ..................................................................     42
               8.15     Governing Law ...................................................................     43
               8.16     Modification of Plan ............................................................     43
               8.17     Creditor Defaults ...............................................................     43
               8.18     Severability ....................................................................     43
               8.19     Closing the Case ................................................................     44

ARTICLE IX - LIQUIDATION ANALYSIS .......................................................................     44

ARTICLE X - OTHER LITIGATION ............................................................................     44

               10.1     Bankruptcy Causes of Action .....................................................     44
</TABLE>


                                     -iii-
<PAGE>   5

<TABLE>
<S>                     <C>                                                                                   <C>
                        A.      Preferences .............................................................     44
                        B.      Fraudulent Transfers ....................................................     45
                        C.      Potential Litigation ....................................................     45
               10.2     Pre-Bankruptcy Lawsuits .........................................................     46
               10.3     Plan Treatment of Lawsuits ......................................................     49

ARTICLE XI -FEDERAL INCOME TAX CONSEQUENCES OF THE PLAN .................................................     49

               11.1     General .........................................................................     49
                        A.      Statutory Overview ......................................................     49
               11.2     Tax Consequences to the Debtor ..................................................     50
                        A.      Summary of the Plan .....................................................     50
                        B.      Existing Tax Attributes of Debtor .......................................     50
                        C.      Tax Consequences of Sale ................................................     50
                        D.      Treatment of Debt Discharge Income Under the Plan .......................     50
                        E.      Effect of Section 382--General Rules ....................................     51
                        F.      Computation of Alternative Minimum Tax ..................................     51
               11.3     Federal Income Tax Consequences to Claimants ....................................     51
                        A.      General .................................................................     51
                        B.      Claimants Receiving Interest in Liquidating Trust .......................     51
                                1.      Receipt of Interest in Trust as a Taxable Event .................     51
                                2.      Tax Consequences of Trust Income and Subsequent
                                        Distributions ...................................................     52
                                3.      Character of Gain or Loss .......................................     52
                        C.      Receipt of Interest .....................................................     52
                        D.      Backup Withholding ......................................................     52

               11.4     Federal Income Tax Consequences to Equity Interests .............................     53

ARTICLE XII - REQUIREMENTS FOR CONFIRMATION OF THE PLAN .................................................     53

               12.1     General Confirmation Requirements ...............................................     53
               12.2     Potential Cramdown of the Plan ..................................................     54

ARTICLE XIII - CONCLUSION ...............................................................................     54


APPENDICES AND EXHIBITS

         Exhibit A         Plan of Reorganization
         Exhibit B         Order Approving Disclosure Statement
         Exhibit C         Payments Within 90 Days
</TABLE>


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                                    ARTICLE I
                                  INTRODUCTION


1.1 GENERAL OVERVIEW OF PLAN PAYMENTS

         The Plan contemplates that all of the remaining assets of the Debtor
will be placed in a Trust, to be liquidated and distributed by a Plan Trustee. A
general discussion of the projected assets and recoveries of the Trust are set
out below. The following summary is general in nature. Creditors are referred to
the full Disclosure Statement and Plan for a full discussion of these matters.

         Substantially all of the oil and gas assets of Costilla were sold on
June 15, 2000 to Louis Dreyfus Natural Gas Corp. The Plan provides for the
distribution of the proceeds to the creditors according to the classes described
therein. This analysis provides an estimate of the amounts each class may
receive under the Plan.

         This analysis is believed to reflect all relevant information known to
management as of the date of this Disclosure Statement. The Debtor is not aware
of any events subsequent to such date that would materially affect this
analysis. There can be no assurance that the assumptions underlying this
analysis would be made or accepted by the Bankruptcy Court.

         ACCORDINGLY, THERE CAN BE NO ASSURANCE THAT THE VALUES AND AMOUNTS
REFLECTED IN THIS ANALYSIS WILL BE REALIZED AND ACTUAL RESULTS COULD VARY
MATERIALLY FROM THOSE SHOWN HERE.

                  BASIS OF PRESENTATION

         This analysis is based on the Debtor's unaudited financial statements
as of June 30, 2000 and various adjustments thereto, as reflected in the
significant assumptions section below and the footnotes section following the
analysis, as well as other amounts estimated by the Debtor's management. The
analysis assumes that the Debtor's remaining assets will be liquidated in an
orderly manner over the next three months. Actual recoveries in liquidation may
differ materially from the preliminary estimate of recoveries included herein.
Liabilities are based on the amended Schedules and claims filed with the Court.
Expenses are estimates of the post-closing requirements. The Debtor may hold
claims against third-parties that will be conveyed to the Trust, investigated by
the Plan Trustee, and pursued or not as the Plan Trustee concludes is
appropriate. A discussion of such possible claims is contained in Article X of
the Disclosure Statement. Note that the discussion of assets does not include a
valuation of any potential recovery on claims held by the Trust, since those
recoveries are unknown and unliquidated at this time. Such recoveries are by no
means waived.

                  SIGNIFICANT ASSUMPTIONS

Order of distribution. The Plan assumes the following order of distribution:

(1)      Allowed Secured Claims

(2)      Allowed Chapter 11 Administrative Claims

(3)      Costs of administering the Trust

(4)      Allowed Priority Claims


                                       1
<PAGE>   7

(5)      Allowed General Unsecured Claims

                  OTHER  ASSUMPTIONS

o        Overhead expenses will continue through September 30, 2000 as staff is
         required to complete post-closing accounting and property title defect
         work.

o        Lawsuits filed against the company including the GNK Inc. judgement
         ($5.5 million) which will be appealed; and the Thomas J. Jones lawsuit
         ($8 million), which is still pending in the 319th District Court; have
         been determined by Management to be without merit and the GNK claim is
         subordinated in the Plan as a penalty claim. They have not been
         recorded on the books and records of the Company as contingent
         liabilities and are treated in the Plan under Class 8. This analysis
         assumes that such claims will not receive a distribution.

                              COSTILLA ENERGY INC.
                   Distribution of Estimated Proceeds Per Plan

<TABLE>
<CAPTION>
                     STATEMENT OF ASSETS                                    Preliminary
                        (in thousands)                                     Balance Sheet
                                                                           June 30, 2000          %             Plan
                                                                 Note       (unaudited)       Recovery      Liquidation
<S>                                                              <C>       <C>                <C>          <C>
Cash and cash equivalents                                          1         $ 114,884          100%       $  114,884
Accounts Receivable-Trade, net                                     2               582           40%              233
Accounts Receivable-Oil & Gas Sales                                3                --            0%               --
Prepaids                                                           4               370            0%               --
Total Current Assets                                                           115,836                        115,117

Oil & Gas Properties, net                                          5                --            0%               --
Other Property & Equipment, net                                    6             1,800           10%              180
Gas Balancing Receivable                                           7                --            0%               --
Other Assets, net                                                  8            12,580            0%               --
Title Defects Escrow                                               9             2,020           32%              646

Total Assets                                                                 $ 132,236                     $  115,943


NET PROCEEDS AVAILABLE FOR DISTRIBUTION                                                                     $ 115,943
</TABLE>


                                       2
<PAGE>   8


ALLOCATION OF NET ESTIMATED LIQUIDATION PROCEEDS TO SECURED,
ADMINISTRATIVE, PRIORITY AND UNSECURED CLAIMANTS


<TABLE>
<CAPTION>
                                                                    Allowable         %             Plan
                                                    Note             Claims        Recovery      Liquidation
<S>                                                 <C>             <C>            <C>           <C>
Secured Creditor Claims:
     Class 1: Banker's Trust Revolver                10             $      845      100.00%       $      845
     Class 2: Banker's Trust Hedging Obligation      11                 19,462      100.00%           19,462
     Class 3:  Dawson                                12                    525      100.00%              525
     Class 4:  Other Secured Claims                  13                    749      100.00%              749
     Non-default interest at 6-30-00                 14                  1,020      100.00%            1,020
     Default interest at 6-30-00                                           655      100.00%              655
                                                                    ----------                    ----------
          Subtotal                                                  $   23,256                    $   23,256


Estimated Amounts After Secured Claims:                                                           $   92,687

Administrative & Priority Claims:
       Trust Professional Fees                       15             $    1,800      100.00%       $    1,800
       Chapter 11 Professional Fees                  16                  1,200      100.00%            1,200
       Transaction Fee on Sale                       17                  1,250      100.00%            1,250
       Post-Petition Creditors                       18                  2,500      100.00%            2,500
       General and Administrative                    19                  1,200      100.00%            1,200
       Priority Tax Claims                           20                     --      100.00%       $       --
                                                                    ----------                    ----------
           Subtotal                                                 $    7,950                    $    7,950

Estimated Amounts After Administrative and Priority Claims                                        $   84,737

Unsecured Claims:

     Class 5:  Allowed Priority Non-Tax Claims       21                     --      100.00%               --
     Class 6:  Administrative Convenience Claims     22                    354      100.00%              354
     Class 7:  General Unsecured including Bonds     23                189,346       44.57%           84,383
     Class 8:  Disallowed Claims, etc.               24                 15,601        0.00%               --
                                                                    ----------                    ----------
          Subtotal                                                  $  205,301                    $   84,737

     Class 9  Equity                                 25             $       --                    $       --
</TABLE>


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<PAGE>   9


         FOOTNOTES TO THE  ANALYSIS

FOOTNOTES REGARDING PROCEEDS:

1)       The cash balance is actual cash on hand and depository accounts held by
         banks as of July 18, 2000, after payment to Bank Group of $25,759,000
         (undisputed principal and interest) on July 18, 2000.

2)       Trade receivables generally consist of amounts due from outside working
         interest owners for their proportionate share of costs incurred by the
         Debtor as operator of the related properties. Some of these receivables
         will be offset by the owner against amounts owing by the Debtor and
         some of the receivables are related to the properties sold to Louis
         Dreyfus. This Analysis assumes accounts receivable-trade are collected
         at 40% of estimated book value.

3)       The oil and gas receivables are primarily from large oil and gas
         purchasers. This asset was included in the sale to Louis Dreyfus.

4)       Other current assets consist primarily of prepaid items and deposits
         and are assumed to have no cash value.

5)       The oil and gas properties were sold to Louis Dreyfus on June 15, 2000,
         and the proceeds from the sale are included in cash.

6)       Owned computer equipment and office equipment is estimated to be
         liquidated at 10% of book value. A physical inventory has been
         performed but no third party bids have been obtained for these assets.
         Oil & gas operating equipment and vehicles were included with the sale
         of the oil & gas properties.

7)       The Gas Balancing Receivable is the net of amounts due to and from
         Costilla Energy for Costilla's over and under produced position in
         various properties. This asset was included in the sale of the
         properties to Louis Dreyfus on June 15, 2000.

8)       Other assets consist of deferred charges including deferred bond
         issuance costs, deferred hedge charges and other assets. These assets
         will not have any cash value.

         This analysis does not assume any recoveries that may result from
         potential litigation on avoidance or other actions due to the
         uncertainties involved in the litigation. If recoveries are obtained by
         the Debtor, however, they will have a positive effect on the recoveries
         obtained by the general unsecured claimants. These recoveries could
         result in material variations in the Analysis.


                                       4
<PAGE>   10


FOOTNOTES REGARDING APPLICATION OF PROCEEDS:

9)       A total amount of approximately $2,020,000 was funded to a Title
         Defects Escrow Account by Louis Dreyfus. Upon resolution of defects by
         Costilla, to the satisfaction of Louis Dreyfus, amounts will be
         released to Costilla. The 32% recovery estimate reflects the amount of
         title defects which Costilla believes it has resolved as of July 19,
         2000.

10)      The allowed secured claim of Banker's Trust will be paid in full, with
         non-default contract interest, or interest as allowed by the Court, and
         subject to resolution of the outstanding objection to its claim.
         Reflects payment of principal in the amount of $25,608,000 on July 18,
         2000. (Class 1)

11)      The allowed secured claim of Banker's Trust for the hedging obligations
         (Class 2) will be paid in full including interest as may be allowed by
         the Court (subject to resolution of the amount and any objection to
         such claim).

12)      Per the agreement entered into with Dawson Geophysical Inc., Dawson's
         claim will be set at $525,000 plus interest at 10% and shall be paid in
         cash at the effective date. (Class 3)

13)      Other secured claims (Class 4) in the analysis would include liens and
         assumes that any oil and gas lien claimants will receive cash for the
         secured portion of their claim. These claims have been estimated to be
         $748,516 which consists of unpaid royalty interest in suspense. The
         amount of these claims will be transferred to Louis Dreyfus to hold
         with the property from which they were derived.

14)      Interest on the Secured Banker's Trust Hedging Obligation (Class 2)
         totals $1,020,000 and will be paid, as allowed, as part of the secured
         claim. Default interest, if allowed, includes $482,000 applicable to
         the Bank Group and $173,000 applicable to the BT Hedging obligation.

15)      Professional fees to administer Trust and to pursue potential lawsuits,
         preferences and claims objections are estimated at $1,800,000.

16)      Professional fees to complete the Chapter 11 filing through
         confirmation estimated to be September 30, 2000 are estimated at
         $1,200,000.

17)      The transaction fee is payable to Petrie Parkman from the proceeds of
         the sale of the oil & gas properties.

18)      Post-petition creditors including normal trade payables, unpaid revenue
         interest owners, and unpaid professional fees as of June 30, 2000.


                                       5
<PAGE>   11


19)      G&A expenses are estimated for July 1 through October 31, 2000 for
         post-closing accounting and administrative functions including
         litigation support.

20)      All allowable priority tax claims have been paid in full. Property
         taxes assessed on January 1, 2000 will be paid as part of the
         settlements on the sale of the applicable property leases. Costilla has
         not projected that any priority tax claims would be payable under the
         Plan.

21)      Allowed Non-Priority Tax Claims have been estimated at $0. (Class 5)

22)      An administrative convenience class has been set up by the Plan. (Class
         6) Under a confirmed plan, those unsecured claimants owed under $5,000
         and those who elect to be treated in this class will be paid in full.

23)      In October 1996, the Debtor issued $100 million aggregate principal
         amount of 10.25% Senior Notes due October 1, 2006. In January 1998, the
         Debtor issued an additional $80 million aggregate principal amount of
         10.25% Senior Notes due October 1, 2006. The interest payment due
         October 1, 1999 was not paid and of this amount $7,790,000 was accrued
         pre-petition. These notes will be paid pro-rata with the general
         unsecured claims. (Class 7)

24)      Disallowed claims, subordinated claims, securities law claims and
         penalty will be paid with general unsecured claims only if allowed by
         the Bankruptcy Court after objections and hearing. (Class 8)

25)      Current equity will not receive any distribution under the Plan. (Class
         9)

THE DEBTOR RESERVES THE RIGHT TO OBJECT TO ANY CLAIM FILED IN THIS CASE. THE
DEBTOR IS INCLUDING CLAIMS WITHIN THIS ANALYSIS FOR PURPOSES OF ESTIMATING
CLAIMS ONLY. INCLUSION OF A CLAIM OR CLAIMS WITHIN THIS ANALYSIS IS NOT AN
ADMISSION REGARDING THE VALIDITY OR ALLOWANCE OF ANY CLAIM.

1.2 PRELIMINARY STATEMENT

         On September 3, 1999 (the "Petition Date"), Costilla Energy, Inc., a
Delaware Corporation (the "Debtor") filed its voluntary petition under chapter
11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United
States Bankruptcy Court for the Western District of Texas, Midland Division (the
"Court"). The case has been pending since that time before the Honorable Ronald
B. King, United States Bankruptcy Judge. Since the Petition Date, the Company
has operated its business as a debtor in possession pursuant to sections 1107
and 1108 of the Bankruptcy Code.


                                       6
<PAGE>   12


         This Disclosure Statement is submitted by the Debtor pursuant to
section 1125 of the Bankruptcy Code in connection with the Debtor's Plan of
Reorganization (Liquidation), As Amended dated July 28, 2000 (the "Plan"). A
copy of the Plan is attached to this Disclosure Statement as Exhibit A. For
purposes hereof, any term used in this Disclosure Statement (regardless of
capitalization), and not otherwise separately defined herein, shall have the
defined meaning ascribed to it in the Plan or in section 101 of the Bankruptcy
Code.

         On July 20,2000, after notice and a hearing, the Court approved this
Disclosure Statement as containing information of a kind and in sufficient
detail adequate to enable a hypothetical, reasonable investor typical of the
classes of claimants and stockholders entitled to vote pursuant to the Plan to
make an informed judgment on whether to accept or reject the Plan. APPROVAL OF
THIS DISCLOSURE STATEMENT BY THE COURT DOES NOT, HOWEVER, CONSTITUTE A
DETERMINATION BY THE COURT AS TO THE FAIRNESS OR MERITS OF THE PLAN.

         OTHER THAN THIS DISCLOSURE STATEMENT, NO STATEMENT OR INFORMATION GIVEN
FOR THE PURPOSE OF SOLICITING ACCEPTANCES OR REJECTIONS OF THE PLAN HAS BEEN
APPROVED BY THE COURT CONCERNING: (1) THE DEBTOR AND ITS BUSINESS, ASSETS OR
PROPERTY; (2) THE TRUST AND THE PROJECTED RESULTS OF ITS FUTURE BUSINESS
OPERATIONS AND FINANCIAL CONDITION; OR (3) DISTRIBUTIONS TO BE MADE UNDER THE
PLAN. YOU SHOULD USE CAUTION IN CONSIDERING ANY STATEMENT OR INFORMATION IN
MAKING YOUR VOTING DECISION BASED UPON INFORMATION NOT CONTAINED HEREIN.

         ANY ADDITIONAL REPRESENTATIONS OR INDUCEMENTS MADE TO YOU BY ANY PARTY
OTHER (1) THAN THE DEBTOR AND ITS PROFESSIONALS; AND (2) THE COMMITTEE AND ITS
PROFESSIONALS, SHOULD BE REPORTED TO COUNSEL FOR THE DEBTOR, HENRY J. KAIM,
ESQ., SHEINFELD, MALEY & KAY, P.C., 1001 FANNIN, SUITE 3700, HOUSTON, TEXAS
77002-6797, AND TO COUNSEL FOR THE CREDITORS' COMMITTEE, HARRY A. PERRIN, WEIL,
GOTSHAL & MANGES, L.L.P., 700 LOUISIANA, SUITE 1600, HOUSTON, TEXAS 77002.

         THE STATEMENTS AND THE FINANCIAL INFORMATION ABOUT THE DEBTOR AND/OR
THE TRUST, INCLUDING ALL FINANCIAL PROJECTIONS AND INFORMATION REGARDING CLAIMS
AND INTERESTS CONTAINED HEREIN, HAVE BEEN PREPARED FROM THE DEBTOR'S BOOKS AND
RECORDS. WHILE THE DEBTOR BELIEVES THE INFORMATION TO BE ACCURATE AND COMPLETE,
THE DEBTOR AND ITS PROFESSIONALS HAVE NOT TAKEN ANY INDEPENDENT ACTION TO VERIFY
THE ACCURACY OR COMPLETENESS OF SUCH STATEMENTS AND INFORMATION AND EXPRESSLY
DISCLAIM ANY REPRESENTATION CONCERNING THE ACCURACY OR COMPLETENESS THEREOF.


                                       7
<PAGE>   13


         THE STATEMENTS CONTAINED IN THIS DISCLOSURE STATEMENT ARE MADE AS OF
THE DATE HEREOF UNLESS ANOTHER TIME IS SPECIFIED, AND NEITHER DELIVERY OF THIS
DISCLOSURE STATEMENT NOR ANY EXCHANGE OF RIGHTS MADE IN CONNECTION WITH THE PLAN
SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE INFORMATION SET FORTH HEREIN SINCE THE DATE THE DISCLOSURE
STATEMENT OR OTHER DATE SPECIFIED AND THE MATERIALS RELIED UPON IN THE
PREPARATION OF THE DISCLOSURE STATEMENT WERE COMPILED.

         THIS DISCLOSURE STATEMENT MAY NOT BE RELIED UPON FOR ANY PURPOSE OTHER
THAN TO DETERMINE WHETHER TO VOTE TO ACCEPT OR REJECT THE PLAN. THIS DISCLOSURE
STATEMENT CONTAINS PROJECTED FINANCIAL INFORMATION REGARDING THE DEBTOR AND THE
TRUST AND CERTAIN OTHER FORWARD-LOOKING STATEMENTS, ALL OF WHICH ARE BASED ON
VARIOUS ASSUMPTIONS AND ESTIMATES AND WILL NOT BE UPDATED TO REFLECT EVENTS
OCCURRING AFTER THE DATE HEREOF OR SUCH OTHER DATE SPECIFIED. SUCH INFORMATION
AND STATEMENTS ARE SUBJECT TO INHERENT UNCERTAINTIES AND TO A WIDE VARIETY OF
SIGNIFICANT BUSINESS, ECONOMIC AND COMPETITIVE RISKS INCLUDING, AMONG OTHERS,
THOSE DESCRIBED HEREIN. CONSEQUENTLY, ACTUAL EVENTS, CIRCUMSTANCES, EFFECTS AND
RESULTS MAY VARY SIGNIFICANTLY FROM THOSE INCLUDED IN OR CONTEMPLATED BY
PROJECTED FINANCIAL INFORMATION AND SUCH OTHER FORWARD-LOOKING STATEMENTS.

         IN RELIANCE UPON THE EXEMPTION FROM REGISTRATION PURSUANT TO SECTION
1145 OF THE BANKRUPTCY CODE, ANY SECURITIES OFFERED AND ISSUED PURSUANT TO THE
PLAN IF CONSUMMATED, HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE
COMMISSION (THE "SEC") UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "1933
ACT"), OR UNDER ANY STATE SECURITIES ACT OR SIMILAR STATE LAWS, NOR HAVE THE
SECURITIES BEEN APPROVED BY THE SEC OR ANY STATE SECURITIES COMMISSION. NEITHER
THE SEC NOR ANY STATE SECURITIES COMMISSION HAS PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS DISCLOSURE STATEMENT OR UPON THE MERITS OF THE PLAN.

1.3 PURPOSE OF DISCLOSURE STATEMENT

         The purpose of this Disclosure Statement is to provide sufficient
information about the Debtor to enable the holders of impaired Claims and
Interests against the Debtor to make an informed decision with respect to
acceptance or rejection of the Plan. This Disclosure Statement should be read in
its entirety prior to voting on the Plan. This Disclosure Statement describes
various transactions contemplated under the Plan. No solicitation of any vote
for or against the Plan may be made except as is consistent with this Disclosure
Statement, and no person has been authorized to utilize any information
concerning the Debtor or its business other than the information contained in
this Disclosure Statement. Each Creditor, Equity Interest holder or other party
in interest is urged to carefully consider the Plan and this Disclosure
Statement in their entirety and to consult legal or other counsel, if necessary,
to understand the Plan and its effects, including possible tax consequences,
before voting.


                                       8
<PAGE>   14


1.4 EXPLANATION OF CHAPTER 11

         Chapter 11 is the principal reorganization chapter of the Bankruptcy
Code. Upon the commencement of a chapter 11 case, section 362 of the Bankruptcy
Code provides for an automatic stay of all attempts to collect upon claims
against a debtor that arose prior to the bankruptcy filing. Generally speaking,
the automatic stay prohibits interference with a debtor's property or business.

         Under chapter 11, a debtor attempts to reorganize its business for the
benefit of the debtor and its creditors and stockholders. Confirmation of a plan
of reorganization is the primary purpose of a reorganization case under chapter
11 of the Bankruptcy Code. A plan of reorganization sets forth the means for
satisfying all claims against, and interests in, a debtor. Generally, a claim
against a debtor arises from a normal debtor/creditor transaction, such as a
promissory note or a trade credit relationship, but may also arise from other
contractual arrangements or from alleged torts. An interest in a debtor is held
by a party that owns all or part of the debtor, such as a stockholder.

         After a plan of reorganization has been filed with a bankruptcy court,
it must be accepted by holders of impaired claims against, or interests in, the
debtor. Section 1125 of the Bankruptcy Code requires that a plan proponent fully
disclose sufficient information about the debtor, its assets and the plan of
reorganization to creditors and stockholders before acceptances of that plan may
be solicited. This Disclosure Statement is being provided to the holders of
Claims against, or Equity Interests in, the Debtor to satisfy such requirements
of section 1125 of the Bankruptcy Code.

         The Bankruptcy Code provides that creditors and stockholders are to be
grouped into "classes" under a plan and that they are to vote to accept or
reject a plan by class. While courts have disagreed on the proper method to be
used in classifying creditors and stockholders, a general rule of thumb (which
is subject to exceptions) is that creditors with similar legal rights are placed
together in the same class and that stockholders with similar legal rights are
placed together in the same class. For example, all creditors entitled to
priority under the Bankruptcy Code might be placed in one class, while all
creditors holding subordinated unsecured claims might be placed in a separate
class. Generally, each secured creditor will be placed in a class by itself,
because each such creditor usually has a lien on distinct property and,
therefore, has distinct legal rights.

         The Bankruptcy Code does not require that each claimant or stockholder
vote in favor of a plan for the Court to confirm a plan. Rather, a plan must be
accepted by each class of claimants and stockholders (subject to the exception
discussed below). A class of claimants accepts a plan if, of the claimants in
the class who actually vote on a plan, such claimants holding at least
two-thirds in dollar amount and more than one-half in number of allowed claims
vote to accept the plan. For example, if a hypothetical class has ten creditors
that vote and the total dollar amount of those ten creditors' claims is
$1,000,000, then for such class to have accepted the plan, six or more of those
creditors must have voted to accept the plan (a simple majority), and the claims
of the creditors voting to accept the plan must total at least $666,667 (a
two-thirds majority).


                                       9
<PAGE>   15


         The Court may confirm a plan even though fewer than all classes of
claims and interests vote to accept the plan. In this instance, the plan must be
accepted by at least one "impaired" class of claims, without including any
acceptance of the plan by an insider. Section 1124 of the Bankruptcy Code
defines "impairment" and generally provides that a claim as to which legal,
equitable or contractual rights are altered under a plan is deemed to be
"impaired." Under the Plan, all Classes except Classes 4 and 5 are impaired.
Class 6 may be unimpaired, depending on the number and amount of creditors that
opt for treatment in such Class as provided within the Plan.

         If all impaired Classes of Claims and Interests under the Plan do not
vote to accept the Plan, the Debtor is entitled to request that the Court
confirm the Plan pursuant to the "cramdown" provisions of section 1129(b) of the
Bankruptcy Code. These "cramdown" provisions permit a plan to be confirmed over
the dissenting votes of classes of claims and/or interests if at least one
impaired class of claims votes to accept a plan (excluding the votes of
insiders) and the Court determines that the plan does not discriminate unfairly
and is fair and equitable with respect to each impaired, dissenting class of
claims and interests.

         Independent of the acceptance of a plan as described above, to confirm
a plan, the Court must determine that the requirements of section 1129(a) of the
Bankruptcy Code have been satisfied. See, infra, "Requirements for Confirmation
of the Plan," Article 12, for a discussion of the Section 1129(a) requirements
for confirmation of a plan of reorganization.

              THE DEBTOR BELIEVES THAT THIS PLAN SATISFIES EACH OF
              THE CONFIRMATION REQUIREMENTS OF SECTION 1129(a) AND,
            IF NECESSARY, OF SECTION 1129(b) OF THE BANKRUPTCY CODE.

         Confirmation of the Plan makes the Plan binding upon the Debtor, the
Trust, Creditors, stockholders and other parties in interest irrespective of
whether they have filed proofs of Claim or voted to accept the Plan.

1.5 PROCEDURE FOR FILING PROOFS OF CLAIM

         A. BAR DATE FOR FILING OF ALL PROOFS OF CLAIM (OTHER THAN
            ADMINISTRATIVE CLAIMS) , JANUARY 24, 2000.

         To participate in the payments and other distributions under the Plan,
a Creditor must have an Allowed Claim against the Debtor. The first step in
obtaining an allowed claim or an allowed interest is generally filing a proof of
Claim.

         A proof of Claim is deemed filed for any Claim that appears in the
Schedules which were filed in the Chapter 11 Case, except a Claim that is
scheduled as disputed, contingent, unliquidated or in an unknown amount. In
other words, if a Creditor agrees with the amount of the Claim as scheduled by
the Debtor, and that Claim is not listed in the Schedules as being disputed,
contingent or unliquidated, it is not necessary that a separate proof of Claim
be filed.


                                       10
<PAGE>   16


         Claims that are unscheduled, or which are scheduled as disputed,
contingent or unliquidated, or which are scheduled in an amount that varies from
the amount claimed by the Creditor holder shall be recognized and allowed only
if a proof of Claim was timely filed.

         B. EFFECT OF AMENDMENTS TO SCHEDULES

         If the Debtor amends downward any Claim or Equity Interest shown on the
Schedules, the affected Creditor or Equity Interest holder will be notified and
will be given 30 calendar days from the date of the mailing of such notice to
file a proof of Claim or proof of interest if the affected Creditor or Equity
Interest holder so desires.

         C. EXECUTORY CONTRACTS AND UNEXPIRED LEASES

         A party to an executory contract or lease that is rejected by the
Debtor under the Plan (see Article 13.2 of the Plan) must file any claim for
damages resulting from such rejection within 30 calendar days after the
Confirmation Date. Claims allegedly arising from lease rejections made prior to
the Bar Date should have been filed prior to the Bar Date.

1.6 VOTING PROCEDURES AND REQUIREMENTS

         A. PERSONS ENTITLED TO VOTE

         Classes 1 through 7 may vote to accept or reject the Plan, except
Classes 4 and 5 which are unimpaired and cannot vote and Classes 8 and 9 which
receive nothing under the Plan, are deemed to have rejected it, and may not vote
to accept or reject the Plan. Class 6 may be unimpaired, depending on the number
and amount of creditors that opt for treatment in such Class as provided within
this Plan. Ballots are being solicited from holders of Class 6 Claims and the
Court will determine whether such Class is impaired or not at the confirmation
hearing, based on the number and amount of creditors that opt for treatment
within such Class as provided within the Plan.

         Any Claim as to which an objection is filed before voting has concluded
is not entitled to vote, unless the Court, upon application or motion of the
holder whose Claim has been objected to, temporarily allows the Claim in an
amount that the Court deems proper for the purpose of voting to accept or reject
the Plan. A vote may be disregarded or disallowed if the Court determines that
it was not solicited or procured in good faith or in accordance with the
provisions of the Bankruptcy Code.

         B. VOTING INSTRUCTIONS

                  1. Ballots

         IT IS IMPORTANT THAT CREDITORS EXERCISE THEIR RIGHT TO VOTE TO ACCEPT
OR REJECT THE PLAN. All known Creditors entitled to vote on the Plan have been
sent a ballot with this Disclosure Statement. Creditors should read the ballot
carefully and follow the instructions contained therein. In voting for or
against the Plan, use only the ballot or ballots sent with this Disclosure
Statement.


                                       11
<PAGE>   17


                  2. RETURNING BALLOTS

         THE VOTING DEADLINE IS SEPTEMBER 7, 2000, 5:00 P.M., CENTRAL SAVINGS
TIME. ALL BALLOTS MUST BE RETURNED SO THAT THEY ARE RECEIVED BY THE BALLOTING
AGENT PRIOR TO THE VOTING DEADLINE.

         THE NAME AND ADDRESS OF THE BALLOTING AGENT IS SET FORTH ON THE BALLOT.

         AGAIN, IN ORDER TO BE COUNTED, BALLOTS MUST BE ACTUALLY RECEIVED BY THE
BALLOTING AGENT ON OR BEFORE THE VOTING DEADLINE.

                  3. VOTING CLAIMS WITH RESPECT TO PUBLICLY TRADED BONDS

         If, as of the close of business on July 20, 2000, you own publicly
traded bonds issued by Costilla (i.e. the 10-1/4% Senior Notes Due 2006 issued
by Costilla) which are held in an account at a bank, broker or dealer, your
bank, broker or dealer will provide you with this Disclosure Statement and a
form of Ballot for "Beneficial Owners of Public Bond Claims." You should
complete such Ballot and return it to the address specified by your bank, broker
or dealer. Each bank, broker, or dealer will tally all votes received from each
of its customers or clients that hold such bonds and will reflect such tally on
a single "Master Ballot" to be cast by such bank, broker or dealer or its
nominee. If you own publicly traded bonds issued by Costilla which are held in
an account at a bank, broker or dealer you must submit your ballot to such bank,
broker or dealer on or before August 31, 2000, so that such bank, broker or
dealer has time to complete and timely submit its Master Ballot. If you do not
return your ballot to your bank, broker or dealer on or before August 31, 2000,
your vote will not be included on such bank, broker or dealer's Master Ballot
and, therefore, your vote will not count. If you own publicly traded bonds
issued by Costilla which are held in an account at a bank, broker or dealer DO
NOT return your Ballot directly to the Balloting Agent. Only your bank, broker
or dealer is empowered to cast your vote, as you may timely direct, with such
Balloting Agent.

         If you own Bonds registered in your name directly, you will receive the
Disclosure Statement and a ballot directly from the Debtor, you should return
such ballot as instructed on the face of the ballot.

         The Bond Indenture Trustee does not vote the Claims based upon the
Bonds.

         C. INCOMPLETE OR IRREGULAR BALLOTS

         Ballots that fail to provide the information to determine the Class to
which they apply shall be counted, subject only to contrary determinations by
the Court, in the Class determined by the Debtor. Ballots that are signed and
returned but not expressly voted either to accept or reject the Plan will be
counted as a vote to accept the Plan.

         D. BALLOT RETENTION

         Original ballots will be retained by the Debtor for six months
following the Confirmation Date.


                                       12
<PAGE>   18


         E. APPROVAL OF DISCLOSURE STATEMENT

         On July 20, 2000, the Court approved this Disclosure Statement as
containing adequate information in accordance with section 1125 of the
Bankruptcy Code. A copy of the "Order Approving Disclosure Statement; Fixing
Voting Record Date, Voting Deadline, Fixing Deadline for Objecting to
Confirmation; Approving the Forms of Ballots; Fixing a Date for Hearing on
Confirmation; and Addressing Matters Ancillary to Solicitation" is attached as
Exhibit B to this Disclosure Statement.

         F. CONFIRMATION HEARING

         The Court has set the Confirmation Hearing for 10:00 a.m., Central
Savings Time, on September 14, 2000, in the courtroom of the Honorable Ronald B.
King (courtroom number 3), United States Bankruptcy Judge for the Western
District of Texas, Midland Division, in the United States Bankruptcy Court for
the Western District of Texas, 615 E. Houston, 5th Floor, San Antonio, Texas.
The Confirmation Hearing may be adjourned by the Court from time to time without
further notice except for an announcement made in open court at the Confirmation
Hearing or any continued hearing thereon.

         G. OBJECTIONS

         Section 1128(b) of the Bankruptcy Code provides that any party in
interest may object, in writing, to confirmation of a plan of reorganization.
Written objections to confirmation of the Plan, if any, must be filed with the
Court and a copy of such written objections must be actually received by counsel
for the Debtor and the Creditors' Committee at the following addresses on or
before 5:00 p.m., Central Savings Time, on September 7, 2000.

                                  HENRY J. KAIM
                          SHEINFELD, MALEY & KAY, P.C.
                             1001 FANNIN, SUITE 3700
                            HOUSTON, TEXAS 77002-6797
                             COUNSEL FOR THE DEBTOR

                                      -AND-

                                 HARRY A. PERRIN
                         WEIL, GOTSHAL & MANAGES, L.L.P.
                            700 LOUISIANA, SUITE 1600
                              HOUSTON, TEXAS 77002
                      COUNSEL FOR THE CREDITORS' COMMITTEE

         OBJECTIONS NOT TIMELY FILED AND ACTUALLY RECEIVED BY COUNSEL AT THE
ABOVE ADDRESS WILL NOT BE CONSIDERED BY THE COURT.


                                       13
<PAGE>   19
                                   ARTICLE II
                   BACKGROUND OF THE DEBTOR AND ITS BUSINESS

2.1 BACKGROUND ABOUT THE DEBTOR

         This section of the Disclosure Statement describes the general
background of the Debtor. As noted above, any term used in this Disclosure
Statement (regardless of capitalization), and not otherwise separately defined
herein, shall have the defined meaning ascribed to it in the Plan or in section
101 of the Bankruptcy Code.

         A. INCORPORATED INFORMATION

         The following information is a summary description of the Debtor's
business, operations and organization. More detailed information is contained in
the Debtor's Annual Report on Form 10-K for the year ended December 31, 1998,
its Quarterly Reports on Form 10-Q for the periods ended March 31, 1999, June
30, 1999 and September 30, 1999. The Annual Report and the Quarterly Reports
were filed with the Securities Exchange Commission (the "Commission") and are
incorporated by reference into this Disclosure Statement. Such reports may be
reviewed and copied as described below.

         The Debtor is subject to the informational requirements of the
Securities Exchange Act of 1934 (the "Exchange Act") and, in accordance with the
Exchange Act, files reports, proxy statements and other information with the
Commission. You may review and copy those reports, proxy statements and other
information at the public reference facilities of the Commission, Judiciary
Plaza, 450 Fifth Street, N.W. Room 1024, Washington, D.C. 20549 or on the
Internet at http://www.sec.gov. Copies can be obtained by mail at prescribed
rates. Requests for copies should be directed to the Commissions' Public
Reference Section, Judiciary Plaza, 450 Fifth Street, N.W., Room 1024,
Washington, D.C. 20549.

         B. BUSINESS

               1. GENERAL

         Prior to the sale of substantially all of Costilla's oil and gas
property as discussed in Article 3.1(K), the Debtor was an independent energy
company that was engaged in the exploration, exploitation, development, and
acquisition of oil and gas properties. The Debtor 's primary operations were in
the South/East Texas region and the Permian Basin area of West Texas and
Southeast New Mexico.

         The Debtor (through its predecessors) began operating in 1988 and
conducted an initial public offering of its common stock in October 1996. As of
January 1, 2000, the Debtor had total estimated net proved reserves of 3.5
Mmbbls of oil and 78.0 Bcf of gas, aggregating 99.1 Bcfe, with a PV-10 Value of
$93.2 million. The Debtor also had a substantial undeveloped acreage position at
December 31, 1999. The Debtor's oil and gas reserves and undeveloped acreage
primarily consisted of interests acquired by the Debtor in a series of
acquisitions by the Debtor from January 1, 1993 to December 31, 1998. During
that period, The Debtor closed nine acquisitions for an aggregate purchase price
of approximately $149.0 million.


                                       14

<PAGE>   20


         A significant portion of the Debtor's oil and gas reserves and recent
successes were in the Southwest Speaks Field located in Lavaca County, Texas.
The Debtor' s drilling activities in this South Texas field began with a
discovery well in January 1998, and the Debtor drilled and completed 2 wells in
1999. The Debtor's estimated proved reserves in the field were 31.6 Bcfe at
January 1, 2000, attributable to 18 productive wells and 3 future drilling
locations, with average daily production of approximately 26.7 Mmcf. The Debtor
identified eight additional locations for future drilling in the Debtor's
leasehold interest in this property of approximately 6,553 gross acres in which
the Debtor owned a 100% working interest and 72% net revenue interest. The
Southwest Speaks Field accounted for 32% of the Debtor's proved reserves at
January 1, 2000.

                  2. 1999 ACTIVITIES

         The Debtor devoted a substantial amount of its efforts during the
fourth quarter of 1998 and the first quarter of 1999 to a proposed acquisition
the ("Pioneer Transaction") of oil and gas properties from Pioneer Natural
Resources USA, Inc. ("Pioneer"). The Debtor originally entered into a Purchase
and Sale Agreement with Pioneer in September 1998, which was subsequently
modified and ultimately terminated on April 15, 1999. The Debtor is reviewing
potential causes of action against Pioneer related to this transaction.

         Due in large part to the termination of the Pioneer Transaction and a
resultant lack of capital resources, the Debtor's operations during 1999 were
limited primarily to financial restructuring and divestitures of properties.
Some of the more significant activities which occurred prior to the bankruptcy
filing are described below.

         Ballard Sale. In March 1999, the Debtor closed a sale to Ballard
Petroleum LC ("Ballard") of substantially all of the assets the Debtor had
acquired from Ballard in a 1997 acquisition. The oil and gas properties included
in the sale are located primarily in the Rocky Mountain region and had assigned
proved reserves of 14.3 BCSE at January 1, 1999. The unadjusted cash purchase
price for the sale was $14,150,000. In addition to the sale of assets, the
transaction relieved the Debtor of certain ongoing obligations to Ballard which
the Debtor had assumed in the 1997 acquisition. On August, 28, 1997, the Company
consummated the purchase from Ballard of certain oil and gas properties for an
adjusted purchase price of approximately $41.2 million (the "Ballard
Acquisition"). The properties were located primarily in the Rocky Mountain
region of the United States. In addition, the Debtor and Ballard entered into an
agreement that established an area of mutual interest in the Rocky Mountain
region in which the parties would jointly own, acquire, explore and develop oil
and gas properties. This agreement was terminated in connection with the Ballard
Sale as noted above.

         Restructuring. In May 1999, the Debtor initiated a restructuring plan
that included significant cost reductions. The Debtor reduced its overhead
expenses as a result of a work force reduction and other cost savings measures.

         Sale of Rocky Mountain Properties. In June 1999, The Debtor sold
substantially all of its properties located in the Rocky Mountain region
remaining after the sale to Ballard in four transactions totaling $15.4 million.
The properties represented 22.9 Bcfe at January 1, 1999.


                                       15
<PAGE>   21


         Prize Agreement. The Debtor entered into an agreement with Prize Energy
Corp. ("Prize") related to certain of the properties that Prize acquired from
Pioneer, which properties would have been included in the Pioneer Transaction.
The Debtor obtained exploration rights to such properties and other
consideration in exchange for certain of the Debtor's due diligence data related
to the Pioneer properties acquired by Prize. These exploration rights provided
the Debtor with potential exploration and development opportunities. However,
these rights have been assigned as a result of the sale to the Purchaser.

                  3. ENVIRONMENTAL MATTERS

         Operations of the Debtor were subject to numerous and constantly
changing federal, state and local laws and regulations governing the discharge
of materials into the environment or otherwise relating to environmental
protection. In the opinion of the Debtor's management, the Debtor was and is in
substantial compliance with current applicable environmental laws and
regulations, and the cost of compliance with such laws and regulations has not
been material. Nevertheless, changes in existing environmental laws and
regulations or in interpretations thereof could have a significant impact on the
operating costs of the Debtor, as well as the oil and gas industry in general.
For instance, legislation has been proposed in Congress from time to time that
would reclassify certain oil and gas production wastes as "hazardous wastes,"
which reclassification would make exploration and production wastes subject to
much more stringent handling, disposal and clean-up requirements. State
initiatives to further regulate the disposal of oil and gas wastes and naturally
occurring radioactive materials could have similar impact on the Debtor.

         The Comprehensive Environmental Response, Compensation, and Liability
Act ("CERCLA"), also known as the "Superfund" law, imposes liability, without
regard to fault or the legality of the original conduct, on certain classes of
persons that are considered to have contributed to the released of a "hazardous
substance" into the environment. These persons include the owner or operator of
the disposal site or the site where the release occurred and companies that
disposed or arranged for the disposal of the hazardous substances found at the
site. Persons who are or were responsible for releases of hazardous substances
found at the site and persons who are or were responsible for releases of
hazardous substances under CERCLA may be subject to joint and several liability
for the costs of cleaning up the hazardous substances that have been released
into the environment and for damages to natural resources, and it is not
uncommon for neighboring landowners and other third parties to file claims for
personal injury and property damage allegedly caused by the hazardous substances
released into the environment. Notwithstanding the Debtor's lack of control over
wells operated by others, the failure of the operator to comply with applicable
environmental regulations may, in certain circumstances, be attributed to the
Debtor.

                  4. OPERATIONAL HAZARDS AND INSURANCE

         The Debtor's operations were subject to the hazards and risks inherent
in drilling and production and transportation of oil and gas, including fires,
natural disasters, explosions, encountering formations with abnormal pressures,
blowouts, cratering, pipeline ruptures, and spills, any of which can result in
loss of hydrocarbons, environmental pollution, personal injury or loss of life,
severe damage to and destruction of properties of the Debtor and others, and
suspension of operations.


                                       16
<PAGE>   22


         The Debtor maintains insurance of various types to cover its previous
operations. The Debtor believes that the limits provided under its liability
policies are consistent with standard industry practices. In addition, the
Debtor maintains operator's extra expense coverage which provides for care,
custody and control of all material wells drilled by the Debtor as operator. The
Debtor believes that its insurance is adequate and customary for companies of a
similar size engaged in operations similar to those previously engaged in by the
Debtor, but losses could occur for uninsurable or uninsured risks or in amounts
in excess of existing insurance coverage. The Debtor's general policy was to
only engage drilling contractors who provide substantial insurance coverage and
named the Debtor as an additional named insured.


         C. MARKET FOR THE DEBTORS PRE-BANKRUPTCY COMMON STOCK

         The Debtor completed its initial public offering of Common Stock on
October 2, 1996. On October 3, 1996 the Common Stock commenced trading on the
Nasdaq Stock Market's National Market under the trading symbol "COSE". In August
1999, the Debtor's Common Stock was delisted from the Nasdaq National Market,
and subsequently has been quoted on the OTC Bulletin Board under the symbol
"COSE" or "COSE.OB". The following table sets forth the high and low sales
prices for the periods presented (all information presented on or before August
16, 1999 is from Nasdaq; information presented since August 16, 1999 is from
Bloomberg).

<TABLE>
<CAPTION>
1998                                                                              HIGH            LOW
                                                                                --------         ------
<S>                                                                             <C>              <C>
First Quarter                                                                   $  12.75         $ 9.13
Second Quarter                                                                  $  11.50         $ 8.50
Third Quarter                                                                   $  10.50         $ 5.88
Forth Quarter                                                                   $   7.55         $ 2.75
</TABLE>


<TABLE>
<CAPTION>
1999                                                                              HIGH            LOW
                                                                                --------         ------
<S>                                                                             <C>              <C>
First Quarter                                                                   $   4.75         $ 2.06
Second Quarter                                                                  $   2.63         $ 0.13
Third Quarter (through 8/16/99)                                                 $   0.22         $ 0.13
Third Quarter (after 8/26/99)                                                   $   0.25         $ 0.06
Fourth Quarter                                                                  $   0.12         $ 0.04
</TABLE>

         D. RELATED PARTY TRANSACTION

         A&P Meter Sales and Service, Inc. ("A&P"), a corporation in which
Messrs. Liedtke, Grella and Musselman owned 60% of the outstanding common stock,
supplied meter reading services which measure gas production to the Debtor, as
well as to unaffiliated oil and gas companies. From time to time, the Debtor
advanced funds to A&P for working capital needs. These advances have been
consolidated into two promissory notes. One note was executed December 31, 1994
in the original principal amount of $370,000. The note bears interest at a
floating rate equal to the "prime rate" plus 1.0%. No principal or interest
payments are due until the maturity of the note at December 31, 2004. The note
is secured by a second lien on A&P's accounts receivable, inventory and
equipment. The second note is in the principal amount of $247,000 and is dated
May 22, 1996. The note bears interest at 6.0% per annum, is unsecured and is
payable upon demand.


                                       17
<PAGE>   23


         Each of these advances of working capital to A&P and the signing of the
two promissory notes occurred while Costilla was privately held by Messrs.
Liedtke, Grella and Musselman and were disclosed when Costilla went public and
thereafter in many public filings.

         During the fiscal year ended December 31, 1998, A&P received $575,000
from the Debtor for goods and services provided, which accounted for
approximately 95% of A&P's gross revenues. These transactions were disclosed in
Costilla's public filings. The Debtor believes that the goods and services and
charges therefor are comparable to those the Debtor could have obtained from, or
paid to, unaffiliated third parties. Due to a continued deterioration in A&P's
business activities and amounts owing to A&P's secured creditors, the Debtor
recorded a provision for the remaining unreserved balance of the notes at
December 31, 1998.

         E. OTHER BUSINESS

         In July 1995, the Republic of Moldova (located in Eastern Europe
between Romania and the Ukraine) granted a Concession Agreement to Resource
Development Company Limited, L.L.C. ("Redeco"), an entity not then affiliated
with the Debtor. William Liedtke, brother of the Chairman of the Debtor, Cadell
Liedtke, was an employee and minority shareholder in Redeco. Prior to August
1996, the Debtor paid Redeco $90,000 and agreed to bear the first $2.0 million
of concession expenses in return for a 50.0% interest in Redeco. In June 1998,
the Debtor purchased the remaining 50% interest from the other member of Redeco
for $350,000, forgiveness of $1.9 million of accounts payable owed by Redeco to
the Debtor and the conveyance to the other member of a net profit interest.
Effective October 1, 1998, the Company acquired additional assets from
affiliates of Redeco primarily consisting of Concession Agreements owned by such
affiliates covering three areas in the Republic of Romania (the "Romanian
Concessions"). Costilla paid $350,00, with an additional $206,250 due upon
closing, for such assets and granted the Seller a net profits interest of 12 1/2
% and 25% in both revenues from the Moldovan Concession arrangements and the
Romanian Concessions, respectively. These transactions were disclosed in
Costilla's public filings.

         In June 1999, due to the continued deterioration in Costilla's
financial condition, management of the Debtor discontinued its activities in
Moldova and Romania and sold its remaining assets to an unaffiliated third
party. The Debtor recorded an impairment of $4,597,000 at December 31, 1998,
related to these investments.

                                   ARTICLE III
                       PROCEEDINGS IN THE CHAPTER 11 CASE

         The Debtor filed for protection under chapter 11 of the Bankruptcy Code
on September 3, 1999 (hereinafter commonly referred to as the "Petition Date").
The case was assigned to the Honorable Ronald B. King, United States Bankruptcy
Judge, on the same day.


                                       18
<PAGE>   24


3.1 ADMINISTRATION OF THE CASE

         As with all chapter 11 cases of this type, the Debtor coordinated the
administration of the Case by the pursuit of a number of motions designed to
provide for the protection of the due process rights of the parties in interest
to the bankruptcy while, at the same time, minimizing cost to the estate. A
significant number of these motions were filed on the first day of the Case
while others followed as necessary.

                  A. THE "FIRST DAY" PLEADINGS

         The Debtor filed a number of "first day" motions, which are described
as follows:

         First, the Debtor filed its Emergency Motion by Debtor Costilla Energy,
Inc. For Authority to Pay Prepetition Wages, Salaries, Reimbursable Employee
Expenses, And Medical And Other Employee Benefits. As a general statement, the
Bankruptcy Code prohibits the Debtor from paying any prepetition expenses
including any wages which accrued prior to the Petition Date. This Motion filed
by the Debtor was designed to ensure that the employees of the Debtor, who were
critical to the successful reorganization of the Debtor, continued to remain
loyal to the Debtor to help it achieve a successful reorganization. The Motion
requested that the Debtor be given authority by the Court to honor all of the
Debtor's prepetition obligations to their employees. The Motion was granted by
Order dated September 13, 1999.

         Second, the Debtor filed its Emergency Motion For Authority To Maintain
And Use Prepetition Bank Accounts. The Bankruptcy Code and Bankruptcy Rules
(procedural rules promulgated by the United States Supreme Court) require that
upon the filing of a bankruptcy case, the trustee of the bankruptcy case, which
is the debtor in possession of the estate in such cases, must close all
prepetition bank accounts and open new bank accounts on behalf of the new debtor
in possession entity. By this Motion, the Debtor requested that the Debtor in
possession be allowed to use the same cash management system which was in place
prior to the Petition Date to save on the costs inherent in reforming a
complicated cash management system and to maintain advantageous terms with its
existing banks. The Court granted the Motion by Order dated September 10, 1999.

         Third, the Debtor filed its Motion to Establish Procedures For Interim
Compensation And Reimbursement Of Expenses of Professionals. Generally under the
Bankruptcy Code, professionals are compensated on an interim basis after the
submission of a fee application. The Debtor filed this motion to allow
professionals to be paid on a monthly basis after the professional submits their
invoices. Given the relatively large size of the bankruptcy and the involvement
of many complex issues with a case of this nature, the Motion was filed to allow
a steady flow of income to professionals working on behalf of the estate and to
avoid any undue hardship by professionals incurring large levels of fees and
expenses. This Motion was granted by Order dated September 13, 1999.

         Fourth, the Debtor filed its Emergency Motion To Use Cash Collateral.
This Motion was filed to allow on an interim basis the company's access to cash
vital to its continued operation. This Motion was granted by preliminary Order
dated September 10, 1999. This preliminary Order was subsequently followed by a
Final Order concerning use of cash collateral.

         Fifth, the Debtor filed its Emergency Motion To Establish Notice
Procedures. The Bankruptcy Code and Rules provide that notice of certain motions
be given to all creditors and other parties in


                                       19
<PAGE>   25


interest in a case. To do so in a case this size would be unduly burdensome on
the estate given there were approximately 7,000 creditors scheduled with over
21,000 additional parties that Debtor believed might assert creditor status, and
therefore were noticed of the bankruptcy case out of caution. The Motion
requested that pleadings be required to be served on only the United States
Trustee, the Debtor and its Counsel, the United States Securities and Exchange
Commission, the Internal Revenue Service, Bankers Trust, agent for the Debtor's
bank group, and its counsel, the Twenty largest unsecured creditors or the
members of any Official Unsecured Creditor's Committee and Committee counsel,
any other committee appointed pursuant to Section 1102 of the Bankruptcy Code
and its members and counsel, any party whose interests are directly affected by
a specific pleading, and parties that have requested service in the case. The
Motion provided, however, that notice of the critical events in the case, i.e.,
the notice of the meeting of creditors pursuant to Bankruptcy Code Section 341
and Rule 2002, notice of the time fixed for filing proofs of claims, notice of
time limits set with respect to the disclosure statement and plan of
reorganization and notice if any hearing on conversion or dismissal of the case.

         Sixth, the Debtor filed its Motion For Extension Of Time To File
Statement and Schedules. As with many cases of this size, it is quite a
complicated procedure to prepare the schedules and statements of financial
affairs of the Debtor required by the Bankruptcy Code. By this Motion, the
Debtor requested an extension of time in which to file them. The Court granted
the Motion by Order dated September 9, 1999.

         Seventh, the Debtor filed its Emergency Motion For Approval of
Rejection of Certain Leases Pursuant to 11 U.S.C. Section 365(a). The Debtor
formerly operated satellite offices at locations at Corpus Christi and Houston,
Texas. Given a move to smaller space in Corpus Christi and the closure of its
Houston location, the Debtor maintained leases that were no longer needed and
were thus rejected. The Court granted the Motion by Order dated September 13,
1999.

         Eighth, the Debtor filed its Ex Parte Motion of Costilla Energy, Inc.
Directing Debtor Service Notice of Case and Section 341 Meeting. Typically, the
clerk of the Court serves out notice of a case and other major events in a case.
To save costs, the Debtor filed this Motion, which would save money by allowing
the Debtor to utilize a less costly method of providing notice to parties in
interest. The Court granted this Motion by Order dated September 9, 1999.

         B. PAYMENTS OF PREPETITION SEVERANCE TAX AND OBLIGATIONS TO ROYALTY
            AND WORKING INTEREST OWNERS

         On September 14, 1999, the Debtor filed its Debtor's Emergency Motion
To Pay Prepetition Severance Tax and Obligations To Royalty And Working Interest
Owners. The Debtor submitted this Motion in order to avoid potential complex
litigation related to the existence of liens resulting from unpaid severance
taxes and royalties. In addition, the Motion was also filed to avoid the risk of
termination of vital oil and gas leases due to nonpayment of royalties. The
Court granted the authority to pay severance taxes and obligations related to
royalties and working interests accruing prepetition and after the petition date
by Order dated September 27, 1999. The authority to pay these obligations was
without prejudice to any avoidance actions that may be vested in the bankruptcy
estate. All avoidance actions are being retained and transferred to the Trust,
and are not released herein unless expressly set forth in the Plan.

         Under such order the Debtor has paid undisputed severance taxes and
royalty and working interest owners. Any outstanding claim related to royalties
or working interests is most likely due to


                                       20
<PAGE>   26


claims related to properties sold by the Debtor prepetition, and thus are due
and payable from other third parties. The Debtor believes that it was current on
its royalty and working interest obligations at the time the oil and gas assets
were sold.

         All royalty and working interest owners received notice of the Debtor's
bankruptcy filing as a courtesy and for their information only. Royalty and
working interest owners who are current and have no back due amounts will not be
entitled to vote on the Debtor's Plan and royalty and working interest owners
need not vote in order to maintain their rights to receive any obligations that
the Debtor may owe to them under relevant agreements.

         C. PAYABLES TO OPERATORS OF DEBTOR'S NON-OPERATED PROPERTIES

         On October 21, 1999 the Debtor filed its Emergency Motion To Pay
Prepetition Accounts Payable To Operators Of Debtor's Non-Operated Properties.
The Debtor was a non-operating party to numerous oil and gas leases. The Motion
sought the authority for the Debtor to pay payables related to expenses owed by
the Debtor on properties where the Debtor was not the operator. Through this
Motion, the Debtor avoided the recoupment of its revenues from those properties
to pay these expenses. The Court approved the Motion by Order dated December 1,
1999.

         D. ASSUMPTION AND REJECTION OF CONTRACTS

                  (i) FARMOUT AGREEMENTS - In order to continue to enhance the
value of its mineral producing properties, the Debtor assumed a variety of
farmout agreements. Under a farmout agreement, a debtor contracts with a party
to drill oil and gas wells, with the debtor typically retaining a royalty
interest in production. By way of motion, the debtor assumed the following
agreements which were subsequently assigned to the Purchaser of Costilla's oil
and gas assets as discussed herein in Article 3.1(K):

                        a) FARMOUT AGREEMENT WITH CANYON OIL & GAS EXPLORATION
L.L.C. - The Court by Order dated November 24, 1999, authorized the assumption
of a farmout agreement with Canyon Oil & Gas Exploration L.L.C. covering
property located in the East Hamel Gas Unit, Colorado County, Texas. Under the
farmout, Canyon Oil & Gas Exploration, L.L.C. bears 100% of the cost of drilling
the well as well as a making a cash payment to the Debtor. In addition, the
Debtor reserved an overriding royalty interest along with an option to convert
the overriding royalty into a working interest. This farmout agreement has been
assigned to the Purchaser as noted above.

                        b) FARMOUT AGREEMENT WITH JUD, L.C. - The Court by Order
dated December 6, 1999 authorized the assumption of a farmout agreement with
JUD, L.C. covering certain interests in property covering Frio and Yegua
formation rights under the S.W. Speaks Prospect in Lavaca County, Texas. Under
the farmout agreement JUD, L.C. is responsible for 100% of the cost attributable
to completion of the well. The well drilled under the farmout agreement must
reach commercial production to grant further assignments of the Debtor's
interest in the property. The Debtor retained a cost free 25% interest in the
well drilled by JUD, L.C. This farmout agreement has been assigned to the
Purchaser as noted above.


                                       21
<PAGE>   27


                        c) FARMOUT WITH WALTER OIL AND GAS EXPLORATION CORP. -
The Court by Order dated November 24, 1999 authorized the assumption of a
farmout agreement with Walter Oil and Gas Exploration Corp. covering the
drilling of a test well in the Cook Mountain formation, Northington Prospect,
Wharton County, Texas. Under the farmout, Walter Oil and Gas Exploration Corp.
must pay 100% of the cost attributable to completion of the well. Commercial
production under the well results in the assignment from the Debtor to Walter
Oil and Gas Exploration Corp. of certain rights in mineral producing properties.
Under the farmout, the Debtor retained a overriding royalty and the option to
convert the royalty in to a working interest. This farmout agreement has been
assigned to the Purchaser as noted above.

                        d) FARMOUT AGREEMENT WITH PETROGULF II LIMITED
PARTNERSHIP. - The Court authorized the assumption of a farmout agreement with
Petrogulf II Limited Partnership ("Petrogulf") covering the drilling of a test
well in the Upper Wilcox Formation of the East Hamel Prospect, Colorado County,
Texas. Under the farmout, Petrogulf must pay 100% of the cost associated with
drilling and completion of a well. Commercial production in this test well
results in Petrogulf earning an assignment of certain interests in the mineral
leasehold. Under the farmout, the Debtor retained an overriding royalty interest
and option to convert royalty interest into working interest. This farmout
agreement has been assigned to the Purchaser as noted above.

                  (ii) HOUSTON PIPELINE CONTRACT - On September 23, 1999, the
Debtor and Houston Pipeline Company filed their Agreed Motion To Assume Gas
Purchase Agreement With Houston Pipeline Company. Given that the purchase
agreement accounts for approximately 40% of the Debtor's revenues, the Debtor
sought the assumption of this contract. Prior to the submission of the Agreed
Motion, Houston Pipeline Company notified the Debtor that the contract had been
automatically terminated upon the bankruptcy filing. Houston Pipeline Company
argued that the Purchase Agreement is a "forward contract" under Section 556 of
the Bankruptcy Code, thus allowing for the termination due to bankruptcy. The
Debtor disputes that the Purchase Agreement is a forward contract and that it
can be terminated due to bankruptcy, insolvency or the inability to pay debts.
Houston Pipeline Company agreed to waive the bankruptcy termination provisions
of the contract upon the Debtor's assumption of the Purchase Agreement. This
contract has been subsequently assigned to the Purchaser of Costilla's oil and
gas assets as discussed in Article 3.1(K).

                  (iii) EMPLOYEE CONTRACTS - On September 17, 1999, the Debtor
filed its Debtor's Motion to Assume Employment Contracts And For Authority To
Continue Employee Retention Bonus Plan. Under this motion the Debtor sought the
assumption of prepetition employment agreements of Cadell S. Liedtke, Henry G.
Musselman and Bobby W. Page and a series of other employee termination and
severance agreements. In addition, the motion sought the assumption and
continuation of an Employee Retention Bonus Plan. As a result of this motion and
certain objections filed in the case, the Court entered two orders concerning
such motion. First, the Court entered its Order Authorizing Staff Retention
Payments. Under this order the Debtor gained authorization to pay nonexecutive
staff certain payments if those employees were employed at certain dates
throughout the course of the reorganization. Second, the Court entered its Order
Authorizing Employee Retention, Severance and Incentive Compensation upon the
occurrence of certain events. This order allowed for 17 officers and managers to
receive retention bonuses upon the sale of the company or the entry of an order
confirming a plan of reorganization. In addition, the order also allowed for
certain additional payments to key executives and managers. The order terminated
and superceded the employment, termination and severance contracts.


                                       22
<PAGE>   28


                  (iv)  NON-RESIDENTIAL REAL PROPERTY LEASES - On October 21,
1999, the Debtor filed is Emergency Motion To Extend Time To Assume or Reject
Unexpired leases of Nonresidential Real Property. Under the Bankruptcy Code, the
Debtor must within sixty (60) days assume or reject nonresidential leases on
real property. While the Debtor does not believe that its oil and gas leases are
non-residential real property leases or executory contracts under Section 365
that need to be assume or rejected, the Debtor to avoid any threat that such
leases would be canceled, filed the Motion to extend the deadline to assume or
reject such leases. The Court granted the Motion by Order dated November 3,
1999, extending the time to assume or reject through confirmation.

         E. APPOINTMENT OF COMMITTEE OF UNSECURED CREDITORS

         On or about September 29, 1999, Richard W. Simmons, United States
Trustee for Region 7, appointed an Official Committee of Unsecured Creditors
consisting of representatives of Varde Partners, Lehman Brothers, Inc., State
Street Bank & Trust Company, GNK, Inc., and Credit Suisse Asset Management.

         On October 8, 1999, the Unsecured Creditors Committee filed their
Application by Committee of Unsecured Creditors Of Costilla Energy, Inc. For
Order Under Bankruptcy Code Sections 328(a), 504 and 1103 and Bankruptcy Rule
2014(a) and 2016 (b) Approving Employment and Retention Nunc Pro Tunc To 9/21/99
Of Weil, Gotshal & Manges L.L.P. The Application was granted by Order dated
October 18, 1999.

         F. RETENTION OF PROFESSIONALS

         At the commencement of the case, the Debtor retained Sheinfeld, Maley &
Kay, P.C. as debtor's counsel. Subsequently, the Debtor retained Cotton,
Bledsoe, Tighe & Dawson, a Professional Corporation, as special counsel in the
areas of general corporate, litigation, oil and gas and securities law. The
Debtor also retained KPMG, L.L.C. as accountants and Petrie Parkman & Company as
investment bankers. In addition, the Debtor filed its Application to Employ
Professionals Utilized in the Ordinary Course of Business. The Application
sought the employment of a variety of professionals including law firms and oil
and gas reserve consultants for work not necessarily related to the bankruptcy
of the Debtor, but engaged in activities normally required by a company such as
the Debtor. This Motion was granted by order dated January 20, 2000.

         G. REMOVAL OF LITIGATION

         On November 30, 1999, the Debtor filed a notice of removal to remove
litigation captioned Costilla Energy Inc. v. Gilda C. Cant, Thomas Cisneros,
III, Elda C. Smith and Aide C. Ortiz pending in the District Court for Karens
County, Texas 218th Judicial District. The case was removed to the Federal
Bankruptcy Court.

         On November 18, 1999, Thomas L. Jones, Plaintiff in a case captioned
Thomas L. Jones v. Costilla Energy, Inc., Black Diamond Development, L.L.P.,
Frontera Energy Corp and Douglas J. Sutorius, in the District Court, 319th
Judicial District, Nueces County, Texas removed the case to the United States
Bankruptcy Court for the Southern District of Texas, Corpus Christi Division.
Subsequently, the Debtor moved the Court to transfer venue to the United States
Bankruptcy Court for the Western District of Texas.


                                       23
<PAGE>   29


         On or about November 19, 1999, Thomas L. Jones, Plaintiff in a case
captioned Thomas L. Jones, Jr. v. Costilla Energy, in the District Court, 94th
Judicial District, Nueces County, Texas removed the case to the United States
Bankruptcy Court for the Southern District of Texas, Corpus Christi Division.
Subsequently, the Debtor moved the Court to transfer venue to the United States
Bankruptcy Court for the Western District of Texas.

         H. 341 MEETING

         A meeting pursuant to Section 341 of the Bankruptcy Code was held in
Midland, Texas on October 28, 1999.

         I. CLAIMS PROCESS AND BAR DATE

         The Debtor filed with the Bankruptcy Court its schedules of assets and
liabilities and statements of financial affairs on October 18, 1999. The
Bankruptcy Court established January 24, 2000 (the "Bar Date") as the deadline
for filing proofs of Claim, except with respect to certain specified
Governmental Claims and Rejection Claims, against the Debtor.

         The Debtor will review all Claims filed and develop and analyze a
database of all Claims asserted against it. Each Proof of Claim and proof of
Interest will be analyzed to determine whether to object to the allowance of
such Claims or Interests.

         The Claims asserted against the Debtor are in excess of the total
amount of Allowed Claims estimated by the Debtor in development of the Debtor's
Plan because, among other things, certain Claims: (i) are filed in duplicate;
(ii) consist of amendments to previously filed Claims; (iii) are asserted in
excess of the amount actually owed; (iv) do not allege an obligation of the
Debtor; (v) assert contingent Claims; and/or (vi) include postpetition interest
and other disallowable charges.

         The Debtor intends to file motions objecting to, among others, those
Claims that are:

                  (A) duplicative;

                  (B) superseded by amended Claims;

                  (C) not obligations of the Debtor;

                  (D) filed after the Bar Date; or

                  (E) in excess of the amount actually owed, as evidenced by the
                      Debtor's books and records.

         The Debtor projects that the Claims asserted against it will be
resolved in and reduced to an amount that approximates the Debtor's estimates of
Allowed Claims contained in this Disclosure Statement. However, the actual
aggregate amount of Allowed Claims in any Class may differ significantly from
the Debtor's estimates thereof and any variance from such estimates will affect
Distribution in certain Classes.

         Confirmation of the Plan will not affect the right of a holder of Claim
to transfer its Claim using the procedure provided by Federal Rule of Bankruptcy
Procedure 3001(e). Notice of any such claims transfer, other than claims
represented by the Bonds, should be provided to the Plan Trustee. Bond claims
may be transferred in accordance with the Bond Indenture.


                                       24
<PAGE>   30


         J. MOTION TO APPOINT EXAMINER

         On March 30, 2000, a creditor, Baker Hughes, Inc. filed a motion to
appoint an examiner. This motion was initially joined by GNK, Inc., but later
GNK, Inc. withdrew its support for the motion. Baker Hughes asserted that the
original Disclosure Statement file by the Debtor did not adequately disclose
potential causes of action against a party involved in the failed Pioneer
transaction noted in Article II(B)(2). In addition the motion also alleged that
further disclosure was needed regarding farmout rights acquired by the property
in relation to the Pioneer transaction. The Debtor opposed the appointment of an
examiner. The Creditor's Committee further supported the Debtor in opposing the
motion. A hearing was held on July 20, 2000 to consider the motion. At the
hearing, the Court ordered the appointment of an examiner, with limited scope
and for limited duration. The examiner is charged with making a preliminary
investigation of the mechanics of the Debtor's proposed Plan, the causes of
action that the Debtor may hold, the remaining property the Debtor may hold,
and, if time allows, some review of the claims filed in the case. Based upon the
Court's oral ruling, it is contemplated that the examiner's appointment would
end at or near the time of confirmation of the Plan. It is believed that the
examiner's preliminary findings will be available prior to the confirmation
hearing.

         K. BANKRUPTCY CODE SECTION 363 SALE OF SUBSTANTIALLY ALL THE ASSETS

         On June 9, 2000, the Court entered an order approving the sale of
substantially all of Costilla's oil and gas properties to Louis Dreyfus Natural
Gas Corp. ("LDNG"). The base price under such sale was $133,250,000 subject to
certain price adjustments pursuant to an asset purchase agreement between the
parties. On June 15, 2000, the transaction with LDNG closed. Pursuant to the
transaction, Costilla actually received approximately $129 million in cash. The
purchase price was reduced by the net amount of approximately $4.2 million for
certain adjustments pursuant to the asset purchase agreement, including
approximately $2 million which was escrowed due to asserted title defects.
Costilla believes that a significant number of these title defects will be
resolved in the time period set forth in the asset purchase agreement and that
Costilla will receive a significant portion of the $2 million that has been
escrowed due to title defects. Except for certain permitted encumbrances, the
sale of the assets was accomplished free and clear of all liens and encumbrances
with such liens attaching to the proceeds of the sale in the priority existing
prior to the sale. The Purchaser has requested that certain of the properties
with the alleged title and/or environmental defects be transferred to a third
party without LDNG taking possession and thus placing LDNG in the chain of
title. The Debtor has currently pending a motion to approve the transfer of
these properties to a third party which could include, Cinco Resources, LLP, an
entity owned by family members of certain former management, including the wife
of Cadell Liedtke, Chairman of the Board and Director, to purchase these
properties. As LDNG has paid Costilla for these properties, this transaction
does not create any benefit or detriment to the estate.

         L. CLOSING AND POST CLOSING RETENTION PAY FOR CERTAIN EMPLOYEES

         On June 19, 2000 the Court ruled to grant Costilla the authority to
make retention payments to non-officer employees in order to create incentives
to maintain needed employees through the closing of the sale of the assets to
Purchaser as noted above and for periods post-closing. The company has authority
to spend at its discretion a maximum aggregate amount of $110,681 in retention
payments for work through the closing of the sale to LDNG and $290,000 in post
closing retention payments.


                                       25
<PAGE>   31


         M. PAYMENT OF UNDISPUTED PRINCIPAL AND INTEREST

         On September 23, 1999, this Court entered a Final Order Authorizing Use
of Cash Collateral by which Bankers Trust Company individually and as agent for
a group of lenders to Costilla Energy, Inc., consisting of Bankers Trust
Company, Den Norske Bank, ASA, Foothill Income Trust, L.P. and Wells Fargo Bank,
N.A. (the "Bank Group") agreed to the use of cash collateral. As a part of the
agreement authorizing the use of cash collateral, Costilla agreed to pay all
accrued and unpaid interest at a non-default rate to the Bank Group on the Bank
Group indebtedness. This amount was approximately $1.5 million for accrual
through February, 2000, paid in the first week of March, 2000. In addition,
Costilla has paid the interest accrued for March, 2000, April, 2000 and through
May 30, 2000, in the amount of approximately $758,000. The payment of
non-default interest was without prejudice to the argument by the Bank Group
that the default interest rate is lawfully due and owing, and without prejudice
to the argument of Costilla that only a contractual rate of interest is lawfully
due and owing. The Bankruptcy Court has granted the Debtor the authority to pay
the undisputed portion of the Bank Group's claim for principal in the amount of
$26,452,842 plus non-default rate of interest through the date of the payment
and any reasonable fees, costs, or charges that are undisputed and to which the
Bank Group would be entitled under the Bankruptcy Code and applicable law.
Costilla believes it is in the best interest of the estate to pay the undisputed
portion of the Bank Group's claim since Costilla is not able to invest the funds
at a rate higher than the non-default interest charged by the Bank Group. On
July 7, 2000, the Bankruptcy Court entered an order granting Costilla's request.
On July 18, 2000, the Bank Group was paid approximately $25,608,000.00, the
undisputed principal portion of the Bank Group's Claim.

                                   ARTICLE IV
                        GENERAL OVERVIEW OF THE PROPOSED
                             PLAN OF REORGANIZATION

         In general terms, the Plan calls for the distribution to creditors of
funds resulting from the sale of the assets of Costilla described in Article
3.1(K). The Plan also contemplates the formation of the a trust to liquidate
assets and distribute claims. The trust is more fully described in the Plan
attached hereto as Exhibit "A" and in Article VI herein.

4.1 BANKRUPTCY RISKS

         A. OBJECTION TO CLASSIFICATIONS

         Section 1122 of the Bankruptcy Code provides that a Plan may place a
claim or an interest in a particular class only if such claim or interest is
substantially similar to the other claims or interests of such class. The Debtor
believes that the classification of Claims and Interests under the Plan complies
with the requirements set forth in the Bankruptcy Code. However, there can be no
assurance that the Bankruptcy Court will reach the same conclusion.

         B. RISK OF NONCONFIRMATION OF THE PLAN

         Even if all Classes of Claims and Interests that are entitled to vote
accept the Plan, the Plan might not be confirmed by the Bankruptcy Court.
Section 1129 of the Bankruptcy Code sets forth the requirements for confirmation
and requires, among other things, that the confirmation of a plan of
reorganization is not likely to be followed by the need for further financial
reorganization of the Debtor, and that the value of distributions to dissenting
creditors and equity security holders not be less than the


                                       26
<PAGE>   32

value of distributions such creditors and equity security holders would receive
if the Debtor were liquidated under Chapter 7 of the Bankruptcy Code. The Debtor
believes that its Plan satisfies all the requirements for confirmation of a plan
of reorganization under the Bankruptcy Code. There can be no assurance, however,
that the Bankruptcy Court will also conclude that the requirements for
confirmation of the Plan has been satisfied.

         C. NONOCCURRENCE OF EFFECTIVE DATE OF THE PLAN

         Even if all Classes of Claims and Interests that are entitled to vote
accept the Plan, the Plan may not become effective. The Plan sets forth
conditions to the occurrence of the Effective Date of the Plan which may not be
satisfied. The Debtor believes that it will satisfy all requirements for
consummation under the Plan. There can be no assurance, however, that the
Bankruptcy Court will also conclude that the requirements for consummation of
the Plan have been satisfied.

                                    ARTICLE V
                         TREATMENT OF CLAIMS WITHIN THE
                        PROPOSED PLAN OF REORGANIZATION

         THE FOLLOWING SUMMARY OF THE PLAN IS QUALIFIED BY THE ACTUAL PROVISIONS
OF THE PLAN. TO THE EXTENT THE PROVISIONS OF THE PLAN DIFFER FROM THE SUMMARY
SET OUT BELOW OR DIFFER FROM ANY OTHER INFORMATION WITHIN THIS DISCLOSURE
STATEMENT, THE PROVISIONS OF THE PLAN SHALL CONTROL.


5.1 CLASSIFICATION AND TREATMENT OF CLAIMS AND INTERESTS

         The Bankruptcy Code requires the Debtor to classify Claims asserted
against its estate. The Bankruptcy Code prohibits dissimilar creditors from
being placed within the same class. Except for such prohibition, the Bankruptcy
Code is silent as to other guidelines to be used in classification. Generally,
every secured creditor is classified within a separate class. This is necessary
because a secured creditor's rights against unique collateral are generally
considered to be sufficiently dissimilar from any other creditor's rights to
allow for joint classification. Priority claims, except for section 507(a)(1),
(2) and (8) claims, are generally classified within the same class. To the
extent that a Claimant or an Interest Holder has more than one Claim or Interest
in a single class, such Claims or Interests shall be aggregated and treated as a
single Claim or a single Interest. To the extent that a Claimant and/or Interest
Holder has Claims and/or Interests in different classes, such Claims and/or
Interests shall not be aggregated.

         As provided in the Bankruptcy Code, certain groups of Claims (or
potential Claims) are not classified for treatment under the Plan. Those Claims
are also listed herein. Other Claims are placed in classes, and are listed below
as well.


                                       27
<PAGE>   33

5.2 TREATMENT OF ADMINISTRATIVE EXPENSES

         As of the end of June 2000, the Debtor had paid post-petition
approximately $1,076,000 in fees and expenses to its professionals and the
professionals hired by the Committee. Pursuant to Court order, 20% of monthly
fees of professionals of the Debtor and the Committee are held back for payment
upon presentation of a final fee application after confirmation. As of the end
of May 2000, it is estimated that $189,000 of fees have been held back under
this provision; the Debtor estimates that this hold back will be in an amount of
approximately $305,000 by the Effective Date. In addition, there are
approximately $98,000 in accrued fees due to a Court ordered cap on per hour
rates. Such amounts may be allowed by the Court pursuant to fee applications.
Moreover, it is the Debtor's estimate that approximately $1,200,000 of fees and
expenses of the Debtor's and Committee's professionals will be incurred by the
Debtor from and after May 2000 ($300,000 per month for June, July, August and
September 2000), which amount will either be paid during the case or shortly
after the Effective Date of the Plan as an Administrative Expense. In addition,
the Debtor owes $1,250,000 transaction fee to its financial advisor as a result
of the sale of the oil and gas assets. These amounts are estimates only and, as
such, may vary depending on a variety of factors, including whether or not
confirmation is subject to unforeseen litigation.

         Other Administrative Expenses include amounts incurred by the Debtor
post-petition in the ordinary course of business. Such amounts are not expected
to be atypical from the Debtor's usual business operations and are not estimated
herein. Treatment of Administrative Expenses under the Plan is described more
fully in the Plan attached hereto as Exhibit "A."

5.3 TREATMENT OF PRIORITY TAX CLAIMS

         As discussed earlier, on the first day that the Case was filed the
Debtor sought and later obtained a Court order authorizing the Debtor to pay all
payroll taxes current. Accordingly, all such taxes were paid and no longer exist
as claims in this Class. Nonetheless, the IRS has filed a proof of claim in this
Case for $3,054.71 in actual taxes and $15,823.15 in penalties associated with
such taxes. The Debtor has not undertaken a review of the merits of this Claim,
but intends to do so post-confirmation. The Debtor notes that the $15,823.15 may
be subject to classification as a Class 9 penalty claim under the Plan.

         The Debtor also had secured ad valorem tax claims. To avoid the
prospect of incurring any penalty upon such ad valorem claims, the Debtor
requested and obtained permission to pay such ad valorem tax claims before their
due date under Texas law, January 31. Pursuant to such Court order, the Debtor
paid approximately $965,000 in ad valorem tax claims prior to January 31, 2000.

         The Debtor also scheduled approximately $13,000 of severance taxes that
would be considered priority taxes. Moreover, proofs of claims have been filed
by other taxing authorities in the amount of $3,224,725, all of which the Debtor
believes to have been filed prior to the Debtor's obtaining permission to pay ad
valorem tax claims and all of which the Debtor believes are subject to review
and objection. The amount is also the result of a few taxing authorities that
have filed substantial claims, however, the Debtor after preliminary review does
not believe that any of the claims will be allowable.


                                       28
<PAGE>   34

         Each holder of an Allowed Priority Tax Claim against the Debtor shall
receive in full satisfaction of such holder's Allowed Priority Tax Claim Cash
from the Trust in the full amount of such Allowed Priority Tax Claim. Provided,
however, to the extent such claim has been assumed by the Purchaser, the holder
of such claim shall look solely to the Purchaser for payment and shall receive
nothing from the Debtor, this estate, or the Trust.

5.4 CLASS 1 -- THE ALLOWED BANK GROUP CLAIM

         Bankers Trust Company is acting agent (the "Agent") for a group of
lenders to the Debtor consisting of Agent, Den Norske Bank A.S.A., Foothill
Income Trustee, L.P., and Wells Fargo Bank (Texas) N.A. (the "Bank Group"). The
Bank Group asserts that it holds a valid and enforceable claim against the
Debtor of approximately $26.6 million as of the Petition Date. Prior to the sale
of the oil and gas assets, the Bank Group asserted that the Bank Group Claim was
secured by valid, enforceable and duly perfected liens and security interest in
and to, among other things, substantially all, but not completely all, of the
Debtor's oil and gas leases, working interests, proceeds thereof, real property,
hydrocarbons, inventory, accounts receivable, joint interest billings and
equipment as well as proceeds received from the sale or other disposition of any
of the Bank Groups collateral. The Bankruptcy Court has granted the Debtor the
authority to pay the undisputed portion of the $26.4 million principal plus any
undisputed non-default interest due to the Bank Group. On July 7, 2000, the
Bankruptcy Court entered an order granting Costilla's request. On July 18, 2000,
the Bank Group was paid approximately $25,608,000.00, the undisputed principal
portion of the Bank Group's Claim.

         On or about December 8, 1999, the Debtor filed its Objection By
Costilla Energy, Inc. To Claims Of The Bank Group. In summary, such objection
seeks to disallow or subordinate $845,000.00 of amendment fees on the basis of
fraudulent transfer, preference or equitable subordination. Such matter has not
yet been heard by the Court and is preserved under the terms of the Plan.

         The treatment of the Bank Group Claim is more fully described in the
Plan attached hereto as Exhibit "A."

5.5 CLASS 2 -- ANY ALLOWED BANKERS TRUST SWAP CLAIM

           In addition to the Bank Group Claim, Bankers Trust Company, in its
individual capacity asserts a claim against the Debtor of approximately $19.48
million as of September 7, 1999, asserting liens and security interests in and
to the same assets that compromise the Bank Group collateral, on account for
certain swap agreements.

         Pending resolution of the amount of such Claim by order of the
Bankruptcy Court, the Trust will reserve the full amount asserted upon such swap
claim, including the default rate of interest and costs and fees. Under the
terms of the Plan, in the event that Bankers Trust and the Plan Trustee cannot
agree on the amount of the reserve, the Plan Trustee may seek an order from the
Bankruptcy Court, on twenty days notice, estimating such interest, fees and
costs and may rely on such estimation in fixing its reserve.

         The treatment of the Bankers Trust Swap Claim is described in the Plan
attached hereto as Exhibit "A."


                                       29
<PAGE>   35

5.6 CLASS 3 -- THE DAWSON SECURED CLAIM

         Dawson Geophysical Company began performing seismographic work in
September 1998 on approximately 200 leases held by the Debtor over approximately
33 square miles in Eddy and Chaves Counties, New Mexico. The leases are commonly
referred to as the Harpo Prospect. The Debtor was unable to pay for these
seismographic services at the time that they were rendered. In May 1999, more
than ninety days prior to this Case filing, Dawson filed in the real property
records of such two New Mexico Counties its Claim of Lien Under Oil and Gas Lien
Act, asserting a lien on the entire Harpo Prospect to secure payment of
$521,883.05 plus interest and costs. Including such costs, Dawson has filed a
proof of claim in the amount of $540,330. Shortly thereafter, in June 1999,
Dawson filed suit to foreclose such liens. The foreclosure action was stayed by
the bankruptcy filing. Dawson sought relief from the stay. In connection with
such stay motion, the Debtor and Dawson reached a consensual plan treatment for
Dawson's claim, in exchange for Dawson withdrawing its request for further stay
relief. Pursuant to such agreement, Dawson agreed to take a discount on its
claim to $525,000, which amount is Dawson's Allowed Claim upon confirmation of
the Plan. Treatment of the Dawson Secured Claim is more fully described in the
Plan attached hereto as Exhibit "A."

5.7 CLASS 4 -- OTHER SECURED CLAIMS

         In addition to those listed above, proofs of claims were filed or
amounts scheduled asserting secured claims of $821,438 (the Debtor estimates
these will be Allowed at approximately $748,815). These proofs of claim
represent proceeds of the sale of oil or gas that are attributable to royalty or
working interest obligations that are in suspense for various reasons,
including: legal disputes to which the Debtor is not a party (e.g., divorces or
probate disputes), lack of division orders, amounts that fall below the minimum
requirement for disbursement, and royalty or working interest owners claims
associated with properties that have already been sold and thus are obligations
of other third parties.

          Each holder of an Allowed Secured Claim against the Debtor which is
not otherwise classified will be treated as though in a separate class as
described in the Plan attached hereto as Exhibit "A."

5.8 CLASS 5 -- ANY ALLOWED PRIORITY NON-TAX CLAIMS

         This Class would ordinarily consist of certain prepetition wage claims
(subject to Bankruptcy Code limitations) consumer deposits, and other priority
non-tax claims as described within the Bankruptcy Code. Pursuant to Court order
entered within the first few days of the case, the Debtor was authorized to pay
all of its priority prepetition wage claims. As such, the Debtor knows of no
creditors that would be included within this Class. Nonetheless, it is included
within the Plan out of an abundance of caution.

         Each holder of an Allowed Priority Non-tax Claim against a Debtor shall
receive on the Distribution Date on account of its Allowed Priority Non-tax
Claim the amount of such holder's Allowed Priority Non-tax Claim in one Cash
payment from the Trust. Provided, however, to the extent such claim has been
assumed by the Purchaser, the holder of such claim shall look solely to
Purchasers for payment and shall receive nothing from the Debtor, this estate or
the Trust.


                                       30
<PAGE>   36

5.9 CLASS 6 -- ANY ALLOWED ADMINISTRATIVE CONVENIENCE CLAIMS

         In lieu of treatment as any other class of claimant under the Plan, and
in full satisfaction of any and all Claims against the Debtor, a holder of an
Allowed Administrative Convenience Claim against the Debtor shall receive,
within 90 days of the Effective Date, Cash from the Trust equal to the full
amount of such Allowed Convenience Claim; provided, however, the total amount of
cash to be paid by the Trust to holders of Class 6 Allowed Claims shall not
exceed $500,000; if the total amount of Allowed Claims in Class 6 exceeds
$500,000 then each holder of an Allowed Claim in Class 6 shall each receive its
Pro Rata Share of $500,000.

         The Debtor has reviewed the Claims filed in the case that are under
$5,000. Claims under $5,000 aggregate in the amount of approximately $250,000.
In addition to those Claims, the Debtor believes that some holders of Claims in
excess of $5,000 will likely voluntarily reduce the amount of their Claims to
$5,000 to participate in this Class. It is impossible to estimate which holders
of Claims may voluntarily reduce their Claims and, thus, it is impossible to
estimate the total amount to be included within the Class. The Debtor does not
believe that the $500,000 cap in this Class will be reached, however, the Debtor
can make no assurances.

         Class 6 Administrative Convenience Class creditors should be aware that
if a substantial number and amount of holders of Claims opt to be treated as a
Class 6 creditor, and the total amount in Class 6 exceeds $500,000, a pro rata
distribution to such holders of Claims will be made. In such instance, holders
of Claims in Class 6 will receive less than 100 cents on the dollar. There
remains the prospect that the distribution to holders of Class 6 Claims will be
reduced to an amount less than the distribution to holders of Class 7 Claims.
This possibility exists because (1) the Plan Trustee may be successful in
collecting Claims that it holds against third parties, therefore creating a high
return for holders of Claims in Class 7, or (2) the percentage distribution to
Class 6 could be reduced if large numbers of creditors opt to be treated in
Class 6, causing holders of Class 6 Claims to receive a pro rata distribution of
the $500,000 maximum amount to be paid to this Class. The Debtor believes that
the possibility of Class 7 receiving a higher distribution percentage is remote
and, even if this does occur, such higher distribution will not occur until much
later than-possibly years later than-the date that a creditor could receive a
distribution if such creditor participates in Class 6.

         Creditors in Class 6 will NOT be allowed to participate in Class 7,
even if Class 7 ultimately obtains a higher distribution than Class 6.

5.10 CLASS 7 -- ANY ALLOWED GENERAL UNSECURED CLAIMS, INCLUDING ALLOWED BOND
     CLAIMS

         Proofs of claim have been filed asserting general unsecured claims in
Class 7 in the amount of $190,567,113. The Debtor estimates the allowable claims
in Class 7 to be $189,346,000. Included within such amount is bond debt of
approximately $187.8 million, which includes principal amount of $180 million
arising from the 10 1/4% Senior Notes Due 2006 and approximately $7.8 million
prepetition interest thereon. Such bond debt was incurred by the Debtor to fund
its acquisition and development of oil and gas properties.


                                       31
<PAGE>   37

         Allowed Claims in Class 7 shall be treated as follows in full
satisfaction of any and all Claims. On the Effective Date the Existing Bond
Indenture and Existing Bonds will be extinguished except as provided in the
Plan. Each Holder of an Allowed General Unsecured Claim, including Allowed Bond
Claims, will receive its Pro Rata Share of available unencumbered cash as
described in Article 11 of the Plan. Multiple distributions will be made from
time to time at the discretion of the Plan Trustee. Provided, however, to the
extent any such claim has been assumed by the Purchaser, the holder of such
claim shall look solely to the Purchaser for payment and shall receive nothing
from the Debtor, this estate, or the Trust.

5.11 CLASS 8 -- DISALLOWED CLAIMS, SUBORDINATED CLAIMS, SECURITIES LAWS CLAIMS
     AND PENALTY CLAIMS

         The holders of Disallowed Claims, Subordinated Claims, Securities Laws
Claims, Penalty Claims and any other Claims against the Debtor not otherwise
expressly provided for in this Plan shall receive no distributions under the
Plan on account of such Claims.

         The exemplary damages portion of the Claim of GNK, Inc., such exemplary
damages being in the amount of $5,000,000 plus interest as may be allowed by
law, as evidenced by judgment entered on August 18, 1999 in the case styled GNK,
Inc. v. Williford, et al. in the District Court, 87th Judicial District,
Freestone County, Texas, shall specifically be a "Penalty Claim" within this
Class, as are all other punitive or exemplary damage Claims, unless otherwise
ordered by the Court. The Debtor is appealing the entire amount of the GNK, Inc.
judgement.

         The Debtor asserts that, especially in the context of a liquidating
plan, the punitive damage award to GNK should be subordinated. Such
subordination is appropriate to satisfy the requirements of Bankruptcy Code
section 1129(a)(7), which requires, in part, that classes of creditors either
accept the plan or receive as much as they would under chapter 7. Pursuant to
Bankruptcy Code section 726(a)(4), such penalty claim would be subordinated in
chapter 7 as a matter of right. Moreover, a purpose of punitive damages-to deter
further alleged "bad acts"-is not served in the context of a liquidating chapter
11, where the Debtor will no longer exists.

         In the event that the Court declines to approve the classification of
GNK's punitive damage claim in Class 8, such Claim may treated as a Class 7
Claim.

5.12 CLASS 9-- EQUITY INTERESTS IN COSTILLA ENERGY, INC.

         All existing Equity Interests shall be canceled as of the Effective
Date. Holders of Equity Interests shall receive no distributions under the Plan.

                                   ARTICLE VI
                             THE LIQUIDATING TRUST

6.1 CREATION OF TRUST

         On the Effective Date, a trust is hereby created for the purpose of
liquidating the assets of the Debtor and satisfying Claims. The Trust will not
engage in the conduct of a trade or business except to the extent reasonably
necessary to, and consistent with, the liquidating purpose of the Trust. On or


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<PAGE>   38

before the Confirmation Date, the Committee shall designate the person to serve
as Plan Trustee, subject to the Courts approval at the Confirmation Hearing. The
Plan Trustee shall receive any and all assets coming into or becoming a part of
the Trust and disburse the proceeds from revenues realized from the operation,
lease, assignment, sale or other similar transaction involving the property
constituting the Trust consistent with the terms of this Plan. This Plan shall
serve as the trust instrument and no other trust instrument shall be prepared or
entered into. The beneficiaries of the Trust will be treated as the grantors and
deemed owners of the Trust. The Plan Trustee must file federal income returns
for the Trust as a grantor trust pursuant to 1.671-4(a) of the Federal Income
Tax Regulations.

         The transfer to the Trust must be treated for all purposes of the
Internal Revenue Code as a deemed transfer of assets to Creditors receiving
interests in the Trust followed by a deemed transfer to such Creditors to the
Trust.

6.2 FUNDING OF RES OF TRUST

         To fund the Trust, by operation of the Confirmation Order, the Plan
Trustee shall be in possession of and have title to all the Debtors Property as
of the Effective Date, including stocks, cash, bank deposits, certificates of
deposit, inventory, furniture, fixtures, equipment, real property, and all
documents evidencing and relating to the ownership of Debtor's property. The
Plan Trustee will be substituted as the plaintiff in all lawsuits pending in
which the Debtor is the plaintiff. All accounts receivable of the Debtor shall
be deemed, as of the Effective Date, to have been assigned to the Trust. The
conveyances of all property of the estate shall be accomplished pursuant to this
Plan and the Confirmation Order and shall be effective upon the Effective Date,
without the need of further documentation or instruments of conveyance, other
than the Plan and the Confirmation Order. Upon the Effective Date, the Trust
shall also be deemed to have taken (a) an assignment of all rights or causes of
action in which the Debtor may own an interest against third parties for
obligations existing on the Effective Date, unless expressly released herein,
(b) assignments of bank accounts containing cash in the possession of the
Debtor, and (c) an assignment, bill of sale, deed and/or release covering all
other Property of the Debtor. The Plan Trustee may present such orders as may be
necessary to require third-parties to accept and acknowledge such conveyance to
the Trust. Such orders may be presented without further notice other than as has
been given in this Plan. The beneficiaries of the Trust shall be the holders of
Allowed Claims in Class 7.

6.3 TRUSTEE TO LIQUIDATE OR ABANDON ALL ASSETS AND DISTRIBUTE PROCEEDS

         The Plan Trustee shall sell, transfer, assign, convey, lease, use, and
otherwise liquidate all assets of the Trust, to pay Allowed Claims as designated
within this Plan, unless the Plan Trustee deems any asset to be of
inconsequential value or burdensome to the Trust. The Plan Trustee may abandon
any asset upon approval by the Committee. The proceeds of such liquidation shall
be distributed as provided in this Plan.


                                       33
<PAGE>   39

6.4 DISSOLUTION OF DEBTOR

         As soon as the Debtor has performed all its obligations under the Plan
and when the Plan Trustee deems advisable, the Plan Trustee may dissolve the
Debtor and all of the issued and outstanding common stock of Debtor may be
canceled and rendered void. The Plan Trustee may also issue and sell new stock
in the Debtor, and any other property of the Trust with such stock as the Plan
Trustee deems advisable. The Plan Trustee shall be responsible for filing all
future tax returns of the Debtor.

                                  ARTICLE VII
                PROCEDURES FOR RESOLVING AND TREATING CONTESTED
                         DISPUTED CLAIMS UNDER THE PLAN

7.1 OBJECTION DEADLINE

         As soon as practicable, but in no event later than one year after the
Effective Date, unless extended by order of the Bankruptcy Court, objections to
Claims shall be filed with the Bankruptcy Court and served upon the holders of
each of the Claims to which objections are made.

7.2 PROSECUTION OF OBJECTIONS

         On and after the Effective Date, except as the Bankruptcy Court may
otherwise order, the filing, litigation, settlement or withdrawal of all
objections may be made by the Plan Trustee.

7.3 TIMING OF DISTRIBUTIONS

         The Plan Trustee shall make all payments upon the Effective Date that
are called for by the Plan to be made on the Effective Date. Otherwise,
distributions to claimants, or in the case of the Bonds to the Bond Indenture
Trustee, shall be made by the Plan Trustee each time the Plan Trustee, in his
sole discretion, has accumulated sufficient funds to merit a distribution,
considering the number of Creditors and dollar amount of Creditors in such Class
or group of claims, or when the Trustee has determined that no additional funds
are likely to be collected. The Plan Trustee shall have discretion to determine
the amount and timing of all distributions.

7.4 DISTRIBUTIONS  TO BONDHOLDERS

         A.       Surrender of Outstanding Securities. Except as otherwise
                  provided herein, each holder of a Bond evidencing an Allowed
                  Claim against a Debtor shall surrender such instrument or
                  certificated security to the Bond Indenture Trustee (with a
                  duly executed letter of transmittal); surrender of the Bonds
                  shall be made solely to the Bond Indenture Trustee; the Plan
                  Trustee and the Balloting Agent shall have no obligation to
                  accept the surrender of Bonds directly from any bondholder,
                  broker or dealer. No Distribution hereunder shall be made to
                  or on behalf of any holder of such Claim unless and until such
                  instrument or certificated security is received or the
                  nonavailability of such instrument or certificated security is
                  established to the satisfaction of the Bond Indenture Trustee.
                  The Bond Indenture Trustee may reasonably require security
                  and/or indemnity from the purported holder of such instrument
                  or certificated security to hold it harmless in respect of
                  such instrument or certificated security and any distributions
                  made in respect thereof.


                                       34
<PAGE>   40

                  Any such holder that fails to surrender such instrument or
                  satisfactorily explain its nonavailability to the Bond
                  Indenture Trustee within two years of the Effective Date shall
                  be deemed to have no further Claim against the Trust or its
                  property in respect of such Claim and shall not participate in
                  any distribution hereunder.

                  Following the Effective Date, holders of Bonds will receive
                  from the Bond Indenture Trustee specific instructions
                  regarding the time and manner in which the Bonds are to be
                  provided to the Bond Indenture Trustee. Pending such
                  surrender, such Bonds will be deemed canceled and shall
                  represent only the right to received the distributions to
                  which the holder is entitled under this Plan. Any bond which
                  is lost, stolen, mutilated or destroyed, shall be deemed
                  surrendered when the holder of a Claim based thereon delivers
                  to the Bond Indenture Trustee (a) evidence satisfactory to the
                  Bond Indenture Trustee of the loss, theft, mutilation or
                  destruction of such instrument or certificate, and (b) such
                  security or indemnity as may be required by the Bond Indenture
                  Trustee to hold it harmless with respect thereto.

                  Except with respect to any holder which elects treatment in
                  Class 6, the Certificates evidencing the Bonds shall be
                  returned to the holder with the INITIAL distribution by the
                  Bond Indenture Trustee, with the following legend added to the
                  certificate:

                           Initial distribution on Claim evidenced by this
                           certificate made as provided in the Plan of
                           Reorganization (Liquidation), as Amended, dated July
                           28, 2000, for Costilla Energy, Inc. on
                           ________________. The sole remaining right evidenced
                           by this certificate is the conditional/contingent
                           right to receive additional distributions, if any,
                           from the Costilla Liquidating Trust as provided
                           within such Plan.

                  In accordance with the Bond Indenture, the Debtor (or the Plan
                  Trustee on behalf of the Debtor) shall sign replacement bonds
                  as the Bond Indenture Trustee determines to be necessary, to
                  reflect the surrender of, and final distribution with respect
                  to, Bonds of holders that have made the election to be treated
                  in Class 6.

         B.       Cancellation of Bonds and Agreements. On the Effective Date,
                  except as otherwise provided for herein, the Bonds and any
                  other note, bond, indenture or other instrument or document
                  evidencing or creating any indebtedness or obligation of the
                  Debtor will be deemed canceled and of no further force or
                  effect without any further action on the part of the
                  Bankruptcy Court, any Person or any governmental entity or
                  agency, except for the right to receive the distributions made
                  under the Plan, as provided for herein. The holders of such
                  canceled Bonds and notes will have no rights arising from or
                  related to such Bonds or the cancellation thereof, except the
                  rights provided pursuant to the Plan.

         C.       Limited Survival of Certain Documents. Each indenture or
                  other agreement that governs the rights of the holder of a
                  Claim and that is administered by an indenture trustee, an
                  agent or a servicer shall (1) continue in effect solely for
                  the purposes of: (a) allowing such indenture trustee, agent or
                  servicer to process distributions made on a account of such
                  Claims under this Plan, and (b) permitting such indenture
                  trustee, including the Bond Indenture, and the Bonds agent or
                  servicer to maintain any rights or


                                       35
<PAGE>   41

                  liens it may have to distributions to holders of Claims for
                  fees, costs, expenses and indemnification under such indenture
                  or other agreement and to be paid or reimbursed for such
                  prepetition and postpetition fees, costs, expenses and
                  indemnification from the distributions (until payment in full
                  of such fees, costs, expenses or indemnification) that are
                  governed by the respective indenture of the agreement in
                  accordance with the provisions set forth therein and (2) shall
                  be of no further force or effect with respect to the
                  obligations of, and/or Claims against, the Debtor under,
                  relating or pertaining to any agreements, indentures or
                  certificates of designations, governing the Bonds and any
                  other note, bond, indenture or other instrument or documents
                  evidencing or creating any indebtedness or obligation of the
                  Debtor, all of which shall be released and discharged.

         D.       Instructions to Bond Indenture Trustee. Prior to any
                  Distribution on account of any Bonds, the Plan Trustee shall
                  advise the Bond Indenture Trustee of the amount anticipated to
                  be distributed on account of Bond Claims at such distribution,
                  including the amounts to be allocated to Bond Claims in Class
                  6, identification of such Bonds, the balance of the Bond
                  Claims in Class 7, and such other information as the Bond
                  Indenture Trustee may reasonably request to effect
                  distribution hereunder. The Bond Indenture Trustee may rely
                  conclusively upon such advise and information. The Plan
                  Trustee shall deliver any and all distributions allocated to
                  the Bonds to the Bond Indenture Trustee for redistribution to
                  the holders of Bonds in accordance with the Bond Indenture and
                  this Plan. No holder of Bonds shall have any right to a direct
                  distribution from the Trust; rather the Plan Trustee shall
                  make distributions to the Bond Indenture Trustee as though the
                  Bonds constitute a single claim against the Trust held by the
                  Bond Indenture Trustee.

         E.       Bondholder Record Date. The first record date for the holders
                  of Bonds to receive the initial distribution under the Plan
                  shall be at the close of business on the Effective Date. A
                  separate record date with respect to the Bonds shall be made
                  for each subsequent distribution. Such record date shall be
                  set by the Plan Trustee. The Plan Trustee shall give fifteen
                  (15) days advance notice of each such record date for any
                  subsequent distribution to (1) the Bond Indenture Trustee; and
                  (2) any person specifically requesting in writing delivered to
                  the Plan Trustee that they be given notice of any record date.
                  Notice shall be deemed given by and on the day that the Plan
                  Trustee deposits notice in the United States first class mail,
                  postage prepaid, to the address provided by any such person
                  and the Bond Indenture Trustee.

7.5 MEANS OF CASH PAYMENT

         Cash payments made pursuant to the Plan shall be in U.S. funds, by
check drawn on a domestic bank, or, at the Plan Trustee's option, by wire
transfer from a domestic bank, except that payments made to foreign creditors
holding Allowed Claims may be in such funds and by such means as are customary
or as may be necessary in a particular foreign jurisdiction.


                                       36
<PAGE>   42

7.6 DELIVERY OF DISTRIBUTIONS

         Subject to Bankruptcy Rule 9010, and with respect to Bond Claims, the
provisions of the Plan and the Bond Indenture, distributions to holders of
Allowed Claims shall be made at the address of each such holder as set forth on
the proofs of Claim filed by such holders (or at the last known addresses of
such a holder if no proof of Claim or proof of Equity Interest is filed or if
the Plan Trustee has been notified in writing of a change of address), except as
provided below. If any holder's distribution is returned as undeliverable, no
further distributions to such holder shall be made unless and until the Plan
Trustee is notified of such holder's then current address, at which time all
missed distributions shall be made to such holder without interest. Amounts in
respect of undeliverable distributions shall be returned to the Plan Trustee
until such distributions are claimed. All claims for undeliverable distributions
shall be made on or before the second anniversary of the Effective Date. After
such date, all unclaimed property shall revert to the Trust or any successor
thereto, and the claim of any holder with respect to such property shall be
discharged and forever barred.

7.7  TIME BAR TO CASH PAYMENTS

         Checks issued by the Plan Trustee in respect of Allowed Claims shall be
null and void if not negotiated within six months after the date of issuance
thereof. Requests for reissuance of any check shall be made directly to the Plan
Trustee by the holder of the Allowed Claim with respect to which such check
originally was issued. Any claim in respect of such a voided check shall be made
on or before the later of (1) the first anniversary of the Effective Date or (2)
90 days after the date of reissuance of such check. After such date, all Claims
in respect of void checks shall be discharged and forever barred.

7.8 NO DISTRIBUTIONS PENDING ALLOWANCE

         Notwithstanding any other provision of the Plan, no payment or
distribution shall be made with respect to any Claim to the extent it is a
Contested Claim unless and until such Contested Claim becomes an Allowed Claim.

7.9 WITHHOLDING OF DISTRIBUTION ON ACCOUNT OF CONTESTED CLAIMS

         Except as provided in paragraph 11.12 of the Plan, the Plan Trustee
shall withhold from any distribution an amount sufficient to be distributed on
account of the full amount of Contested Claims (the "Withheld Distribution
Amount"). The Withheld Distribution Amount shall be placed in the Contested
Claims Escrow held by the Plan Trustee. To the extent requested by the Plan
Trustee the Bankruptcy Court may estimate the amount to be placed in escrow on
account of any Contested Claim, which amount need not be the full amount of the
asserted Claim.

7.10 ALLOWANCE

         Payments and distributions to each holder of a Contested Claim, to the
extent that such Claim ultimately becomes an Allowed Claim, shall be made in
accordance with the provisions of the Plan governing the class of Claims to
which the respective holder belongs. With respect to any Claim that is a
Contested Claim on the Effective Date, as soon as practicable after the date
that the order or judgment of the Bankruptcy Court allowing such Contested Claim
becomes a Final Order the Plan Trustee shall distribute to the holders of such
Claim from the Contested Claims Escrow any distribution that would have been
distributed to such holder if the Claim had been Allowed on the Effective Date,
without


                                       37
<PAGE>   43

interest on such Claim or distribution, unless interest is required upon an
Allowed Secured Claim pursuant to Bankruptcy Code section 506.

7.11 DISTRIBUTIONS AFTER DISALLOWANCE

         Any Withheld Distribution Amount in the Contested Claims Escrow after
any and each objection to a Contested Claim has been resolved by Order of the
Bankruptcy Court shall be distributed in accordance with the provisions of the
Plan. The Plan Trustee in all things can and shall rely on an order of the
Bankruptcy Court fixing the amount of a Claim or disallowing a Claim; the Plan
Trustee shall make no further reserve on account of Claim that has been
disallowed or reduced by the Bankruptcy Court, unless the effected claimant
obtains a stay pending appeal that requires that the Plan Trustee reserve on
account of such Claim. In no event shall the reversal or modification on appeal
or reconsideration of a Bankruptcy Court order disallowing a Claim affect the
validity or require the disgorgement of any distributions having already been
made pursuant to the Plan, if such claimant did not obtain a stay pending
reconsideration or appeal which required a further reserve.

7.12 ORDER OF DISTRIBUTION OF TRUST CASH

         The Plan Trustee shall distribute or reserve available cash of the
Trust in the following order of priority:

         A.       to pay Allowed Secured Claims of Classes 1, 2, and 3 pursuant
                  to paragraphs 4.1, 4.2 and 4.3 of the Plan; and to pay any
                  Allowed Secured Claim in Class 4, but only to the extent that
                  such cash is the proceeds of the liquidation of the Collateral
                  of holder of such Allowed Secured Claim;

         B.       to pay Allowed Administrative Expense Claims of this chapter
                  11 case pursuant to paragraph 5.1 of the Plan;

         C.       to pay the post-confirmation expenses of the Trust and the
                  Committee, including a reserve of such cash to pay future
                  expenses of the Trust and the Committee as the Plan Trustee
                  deems advisable;

         D.       to pay Allowed Claims of Class 5 pursuant to paragraph 4.5 of
                  the Plan, in order of priority, with Bankruptcy Code section
                  507(a)(3) Allowed Claims being satisfied in full first,
                  Bankruptcy Code section 507(a)(4) being satisfied in full
                  next, and then Bankruptcy Code section 507(a)(5), and so on;

         E.       to pay the Allowed Claims entitled to priority pursuant to
                  Bankruptcy Code section 507(a)(8) pursuant to paragraph 5.2 of
                  the Plan;

         F.       to pay Allowed Claims of Class 6 pursuant to paragraph 4.6 of
                  the Plan; and

         G.       to pay Allowed Claims of Class 7 pursuant to paragraph 4.7 of
                  the Plan and, with respect to the Bonds, in accordance with
                  paragraph 11.5 of the Plan.


                                       38
<PAGE>   44

Provided, however, with respect to each of the categories in (A) through (G)
above, to the extent such claim has been assumed by the Purchaser, the holder of
such Claim shall look solely to the Purchaser for payment and shall receive
nothing from the Debtor, this estate, or the Trust. Allowed Claimants entitled
to distribution under this paragraph shall be deemed the sole beneficiaries of
the Trust until they are paid in full or the Trust has been exhausted.

                                  ARTICLE VIII
                      SELECT OTHER PROVISIONS OF THE PLAN

8.1 PLAN IS MOTION TO SELL

         This Plan is hereby offered and shall be considered a motion pursuant
to Section 363(b) and 363(f) of the Bankruptcy Code to sell any and all Property
of the Debtor as of the Effective Date to the Trust free and clear of all liens,
claims and encumbrances. Any objections to such motion should be made as an
objection to confirmation of the Plan for hearing at the time of confirmation.
All Property shall be conveyed to the Trust free and clear of all liens, claims,
and encumbrances. After the Effective Date, the Trust may present an order or
orders to the Court, suitable for filing in the real property records of every
county where real property of the Debtor is located, which provide that such
property is conveyed to the Trust free and clear of all liens, claims, and
encumbrances. The order or orders may designate all liens, claims, and
encumbrances which appear of record and/or from which the property is being
transferred free and clear. The Plan shall be conclusively deemed to be adequate
notice that such lien, claim, or encumbrance is being extinguished, and no
notice, other than by the Plan, shall be given prior to the presentation of such
order. Any party having a lien, claim, or encumbrance against Property shall be
conclusively deemed to have consented to the transfer of such Property to the
Trust free and clear of such lien, claim, or encumbrance by failing to object to
confirmation of this Plan.

8.2 VESTING OF ASSETS

On the Effective Date, the property of the estate of the Debtor, including but
not limited to any and all rights, claims, or causes of action, whether known or
unknown, asserted or unasserted, at law or equity, and whether arising pursuant
to the Bankruptcy Code or other applicable law, shall vest in the Trust.

         The Plan Trustee shall be and hereby is appointed the representative of
the estate for purposes of prosecuting any and all rights, claims, or causes of
action, including, but not limited to, actions arising pursuant to Chapter 5 of
the Bankruptcy Code, whether known or unknown, asserted or unasserted, at law or
equity, and whether arising pursuant to the Bankruptcy Code or other applicable
law. The Plan Trustee may prosecute, settle or dismiss rights, claims, or causes
of action as the Plan Trustee sees fit and all proceeds therefrom shall be the
property of the Trust, except as expressly released within this Plan. The
Debtor, its board of directors, officers, attorneys and other professional
advisors shall have no liability for pursuing or not pursuing any such rights,
claims, or causes of action vested in the Trust pursuant to this Plan.

8.3 COMMITTEE

         The Committee will continue to exist post-confirmation. The Committee
shall represent the holders of Allowed Claims in Class 7 in connection with the
provisions of the Plan. In so doing, the


                                       39
<PAGE>   45

Committee shall be obligated to provide for the earliest possible full payment
of Classes 1 through 6 and non-classified administrative and priority Claims to
allow for distributions to begin to Class 7.

8.4 TRUSTEE TO LIQUIDATE OR ABANDON ALL ASSETS AND DISTRIBUTE PROCEEDS;
    COMMITTEE MAY TERMINATE PLAN TRUSTEE, WITH OR WITHOUT CAUSE

         The Plan Trustee shall sell, transfer, assign, convey, lease, use, and
otherwise liquidate all assets of the Trust, to pay Allowed Claims as designated
within this Plan, unless the Plan Trustee deems any asset to be of
inconsequential value or burdensome to the Trust. The Plan Trustee may abandon
any asset upon approval by the Committee. The proceeds of such liquidation shall
be distributed as provided in this Plan.

         The Committee may dismiss the Plan Trustee, without cause, at any time
and name a successor Plan Trustee.

8.5 SETOFF AND OTHER RIGHTS

         In the event that the Debtor has a claim of any nature whatsoever
against the holder of a Claim, the Debtor may, but is not required to, setoff
against the Claim (and any payments or other distributions to be made in respect
of such Claim hereunder), subject to the provisions of section 553 of the
Bankruptcy Code. Neither the failure to setoff nor the allowance of any Claim
under the Plan shall constitute a waiver or release by the Debtor of any claim
that the Debtor has against the holder of a Claim. No holder of a Claim may, on
account of a pre-Effective Date Claim against the Debtor, setoff, offset,
suspend, freeze, or recoup any amount from funds or other payments that such
claimant may owe to the Debtor or Trust. The Confirmation Order shall include an
injunction prohibiting any such setoff, offset, suspend, freeze, or recoupment.

8.6 DISCHARGE

         The rights afforded in the Plan and the payments and distributions to
be made hereunder shall discharge all existing debts and Claims of any kind,
nature or description whatsoever against the Debtor or any of its assets or
properties to the fullest extent permitted by section 1141 of the Bankruptcy
Code; upon the Effective Date, all existing Claims against the Debtor shall be,
and shall be deemed to be, discharged; and all holders of Claims shall be
precluded from asserting against the Debtor, or any of its assets or properties,
any other or further Claim based upon any act or omission, transaction or other
activity of any kind or nature that occurred prior to the Effective Date,
whether or not such holder filed a proof of Claim. Confirmation of the Plan and
the obligations imposed on the Debtor therein shall be in complete satisfaction,
discharge and release of all Claims of any nature whatsoever against the Debtor
or any of its assets or properties; and, upon the Effective Date, the Debtor
shall be deemed discharged and released from any and all Claims, including but
not limited to demands and liabilities that arose before the Effective Date, and
all debts of the kind specified in sections 502(g), 502(h) or 502(i) of the
Bankruptcy Code, whether or not (a) a proof of Claim based upon such debt is
filed or deemed filed under section 501 of the Bankruptcy Code; (b) a Claim
based upon such debt is allowed under section 502 of the Bankruptcy Code; or (c)
the holder of a Claim based upon such debt has accepted the Plan. Except as
provided herein, the Confirmation Order shall be a judicial determination of
discharge of all liabilities of the Debtor. As provided in section 524 of the
Bankruptcy Code, such discharge shall void any judgment against the Debtor at
any time obtained to the extent it relates to a Claim discharged and


                                       40
<PAGE>   46

operates as an injunction against the prosecution of any action against the
Debtor, or its property, to the extent it relates to a Claim discharged.

8.7 INJUNCTIONS

         The Confirmation Order shall contain such injunctions as may be
necessary and helpful to effectuate the discharge of the Debtor provided herein.
Without limiting the generality of the foregoing, such injunction shall include
an absolute prohibition from collecting Claims in any manner other than as
provided for in the Plan. The injunction shall also prohibit any Utility from
seeking or obtaining a security deposit, altering usual billing practices or
otherwise refusing or discontinuing services for a period of 18 months after the
Effective Date; provided, however, that a Utility will no longer be subject to
such injunction in the event that the Trust fails to pay all post-confirmation
utility bills to such effected utility no later than 10 days after such bills
are due.

8.8 RESPONSIBLE PARTY INJUNCTION

         The Confirmation Order shall constitute and provide for an injunction
by the Bankruptcy Court as of the Effective Date against any holder of a
Priority Tax Claim or holder any other tax Claim from commencing or continuing
any action or proceeding against any responsible person or officer or director
of the Debtor that otherwise would be liable to such holder for payment of a
Priority Tax Claim or any other tax Claim. All amounts paid by the Trust on
account of any Allowed Claim held by a governmental entity shall be applied
first to any "trust fund" amounts owing, then to any other balances due.

8.9 LAWSUITS

         On the Effective Date, all lawsuits, litigations, administrative
actions or other proceedings, judicial or administrative, in connection with the
assertion of a Claim against the Debtor, shall be dismissed as to the Debtor and
the Trust, except proof of claims and/or objections thereto pending in the
Bankruptcy Court. Such dismissal shall be with prejudice to the assertion of
such Claim in any manner other than as prescribed by the Plan. All parties to
any such action shall be enjoined by the Bankruptcy Court in the Confirmation
Order from taking any action to impede the immediate and unconditional dismissal
of such actions. All lawsuits, litigations, administrative actions or other
proceedings, judicial or administrative, in connection with the assertion of a
claim(s) by the Debtor against a person shall remain in place only with respect
to the claim(s) asserted by the Debtor, and shall become property of the Trust
to prosecute, settle or dismiss as the Plan Trustee sees fit.


                                       41
<PAGE>   47

8.10 RELEASE AND EXCULPATION

         Neither the Debtor, the Committee, the Plan Trustee, the Plan Trustee
Representatives, the Debtor Representatives, or the Committee Representatives
shall have or incur any liability to any holder of a Claim or Equity Interest
for any act, event or omission in connection with, or arising out of, the
Chapter 11 Case, the confirmation of the Plan, the consummation of the Plan or
the administration of the Plan or the property to be distributed under the Plan,
except for willful misconduct. Each Representative of the Debtor and each
Representative of the Committee which served in such capacity from and after the
Petition Date shall hereby be released from all claims; demands or suit; known
or unknown; fixed or contingent; liquidated or unliquidated; whether or not
asserted; arising prior to, upon, or after the Petition Date; which may held or
asserted by the Debtor, the Trust, any Creditor, and current or former holder of
an Equity Interest as of the Effective Date.

8.11 DE MINIMIS DISTRIBUTIONS

         No distribution of less than $25.00 shall be required to be made to any
holder of an Allowed Claim. Such undistributed amount may be retained by the
Trust.

8.12 PAYMENT OF STATUTORY FEES
           All fees payable pursuant to section 1930 of title 28 of the United
States Code shall be paid through the entry of a final decree in the Chapter 11
Case.

8.13 BANKRUPTCY RESTRICTIONS

         From and after the Effective Date, the Trust shall no longer be subject
to the restrictions and controls provided by the Bankruptcy Code or Rules (e.g.,
section 363, 364, Rule 9019), the Bankruptcy Court, or the United States
Trustee's guidelines. The Plan Trustee may, on behalf of the Trust, compromise
claims and controversies post-Effective Date without the need of notice or
Bankruptcy Court approval. The Trust may operate the Debtor's business in such
manner as is consistent with companies not in bankruptcy without the need of
seeking Bankruptcy Court approval with regard to any aspect of the Trust's
business. No monthly operating reports will be filed after the Effective Date;
however, the Plan Trustee shall provide the U.S. Trustee such financial reports
as the U.S. Trustee may reasonably request until the entry of a final decree.

8.14 BINDING EFFECT

         The Plan shall be binding upon and inure to the benefit of the Debtor,
the holders of Claims, the holders of Equity Interests, and the Plan Trustee,
and all of their respective successors and assigns; provided, however, that if
the Plan is not confirmed, the Plan shall be deemed null and void and nothing
contained herein shall be deemed (i) to constitute a waiver or release of any
Claims by the Debtor or any other person, (ii) to prejudice in any manner the
rights of the Debtor or any other person or (iii) to constitute any admission by
the Debtor or any other person.


                                       42
<PAGE>   48

8.15 GOVERNING LAW

         Unless a rule of law or procedure is supplied by federal law (including
the Bankruptcy Code and Bankruptcy Rules) or the law of the jurisdiction of
organization of any entity, the internal laws of the State of Texas shall govern
the construction and implementation of the Plan and any agreements, documents
and instruments executed in connection with the Plan or the Chapter 11 Cases,
including the documents executed pursuant to the Plan.

8.16 MODIFICATION OF PLAN

         Modifications of the Plan may be proposed in writing by the Proponent
at any time before the Confirmation Date, provided that (a) the Plan, as
modified, meets the requirements of sections 1122 and 1123 of the Bankruptcy
Code and (b) the Proponent shall have complied with section 1125 of the
Bankruptcy Code. The Plan may be modified at any time after the Confirmation
Date and before substantial consummation by the Proponent, provided that (i) the
Plan, as modified, meets the requirements of sections 1122 and 1123 of the
Bankruptcy Code, (ii) the Bankruptcy Court, after notice and a hearing, confirms
the Plan as modified, under section 1129 of the Bankruptcy Code and (iii) the
circumstances warrant such modifications. A holder of a Claim or Equity Interest
that has accepted or rejected the Plan shall be deemed to have accepted or
rejected, as the case may be, such Plan as modified, unless, within the time
fixed by the Bankruptcy Court, such holder changes its previous acceptance or
rejection.

8.17 CREDITOR DEFAULTS

         Any act or omission by a creditor in contravention of a provision
within this Plan shall be deemed an event of default under this Plan. Upon an
event of default, the Plan Trustee may seek to hold the defaulting party in
contempt of the Confirmation Order. If such creditor is found to be in default
under the Plan, such party shall pay the reasonable attorneys' fees and costs of
the Plan Trustee in pursuing such matter. Furthermore, upon the finding of such
a default by a creditor, the Bankruptcy Court may (a) designate a party to
appear, sign and/or accept the documents required under the Plan on behalf of
the defaulting party, in accordance with Federal Rules of Civil Procedure, Rule
70, (b) may enforce the Plan by order of specific performance, (c) may award
judgment against such defaulting creditor in favor of the Trust in an amount,
including interest, to compensate the Trust for the damages caused by such
default; and (d) make such other order as may be equitable which does not
materially alter the terms of the Plan as confirmed.

8.18 SEVERABILITY

         Should the Bankruptcy Court determine that any provision of the plan is
unenforceable either on its face or as applied to any Claim or Equity Interest
or transaction, the Proponent may modify the Plan in accordance with Section
16.13 of the Plan so that such provision shall not be applicable to the holder
of any Claim or Equity Interest. Such a determination of unenforceability shall
not (1) limit or affect the enforceability and operative effect of any other
provision of the Plan or (2) require the resolicitation of any acceptance or
rejection of the Plan.


                                       43
<PAGE>   49

8.19 CLOSING THE CASE

         Upon the Plan being substantially consummated and, upon motion by the
Plan Trustee, a final decree entered containing such provisions as may be
equitable. The Court may close the case, but retain jurisdiction to hear and
decide: any and all pending adversary proceedings, applications and contested
matters, including any remands of appeals; any and all pending objections to
Claims or the allowance, including with respect to the classification, priority,
estimation or payment of any Claim; any and all pending Fee Applications.

                                   ARTICLE IX
                              LIQUIDATION ANALYSIS

         Section 1129 of the Bankruptcy Code provides that the Court may confirm
a plan of reorganization only if certain requirements are met. One of these
requirements is that each non-accepting holder of an Allowed Claim or Interest
must receive or retain under the Plan, on account of such Claim or Interest,
property as of the Effective Date of the Plan at least equal to the value such
holder would receive if the Debtor was liquidated under chapter 7 of the
Bankruptcy Code on the Effective Date.

         Costs of liquidation under Chapter 7 of the Bankruptcy Code would
include (i) the compensation of the Chapter 7 Trustee; (ii) asset disposition
expense; (iii) all unpaid expenses incurred by Debtor in the Chapter 11 that are
allowed in Chapter 7 case (such as compensation of attorneys and accountants);
(iv) litigation costs; and (v) claims arising from operations during the
pendency of the chapter 11 case. The liquidation itself could trigger certain
additional Priority Claims and would accelerate other priority payments that
otherwise would be due in the ordinary course of business. Any additional
priority claims also would be paid in full out of the liquidation proceeds
before the balance would be made available to pay general unsecured claims.

         Because all Assets of the Debtor are being liquidated and distributed
to creditors as contemplated in the Plan, no Chapter 7 liquidation analysis has
been performed. However, because of the cost of liquidation described above, the
Debtor believes that the liquidation contemplated by the Plan would afford
creditors a much greater recovery than if the Chapter 7 Trustee performed the
liquidation and distribution (see, Article I, Distribution of Estimated Proceeds
Per the Plan).

                                    ARTICLE X
                                OTHER LITIGATION

10.1 BANKRUPTCY CAUSES OF ACTION

         A. PREFERENCES

         Pursuant to the Bankruptcy Code, a debtor may recover certain
preferential transfers of property, including cash, made while insolvent during
the ninety (90) days immediately prior to the filing of its bankruptcy petition
with respect to pre-existing debts to the extent the transferee received more
than it would have in respect of the pre-existing debt had the debtor been
liquidated under chapter 7 of the Bankruptcy Code. In the case of "insiders,"
the Bankruptcy Code provides for a one-year preference period. There are certain
defenses to such recoveries. Transfers made in the ordinary course of the
debtor's and the transferee's business according to the ordinary business terms
are not recoverable.


                                       44
<PAGE>   50

Furthermore, if the transferee extended credit subsequent to the transfer (and
prior to the commencement of the bankruptcy case), such extension may constitute
a defense, to the extent of any new value, against any otherwise recoverable
transfer of property. The Plan Trustee reserves all rights to pursue, in its
sole discretion, any preference to the full extent allowed under the Bankruptcy
Code and applicable state laws. If a transfer is recovered by the Plan Trustee,
the transferee has a general unsecured claim against the debtor to the extent of
the recovery.

         Attached hereto as Exhibit "C," is a list of all payments of $600 or
more made by the Debtor within the ninety days prior to filing Chapter 11. The
Debtor has not made any analysis with regard to whether specific payments upon
the list are preferences, within the meaning of the Bankruptcy Code, nor whether
any such payment would have a defense available to a preference action, e.g.,
the ordinary course of payment defense. However, any party on the list is
cautioned that the Plan Trustee will be vested with the right to review and, if
the Plan Trustee believes appropriate, assert that any and all payments
contained on the attached Exhibit "C" are preference payments within the meaning
of the Bankruptcy Code and therefore should be returned to the bankruptcy
estate.

         B. FRAUDULENT TRANSFERS

         Under the Bankruptcy Code and various state laws, a debtor may recover
certain transfers of property, including the grant of a security interest in
property, made while insolvent or which rendered it insolvent if, and to the
extent, the debtor receives less than fair value for such property. Upon Plan
confirmation the Plan Trustee will be vested with all rights to pursue, in its
sole discretion, any fraudulent transfer to the full extent allowed under the
Bankruptcy Code and applicable state laws.

         Specifically, the Debtor at this time notes the Plan Trustee will be
vested with the right to bring suit against Pioneer Natural Resources USA, Inc.
("Pioneer") to recover amounts paid Pioneer consisting of approximately a
$25,000,000 payment, a $3,558,000 interest in oil and gas properties and 4
million shares of common stock. These amounts were transferred to Pioneer as a
result of certain transactions that occurred from December 1998 through April
1999 related to the attempted purchase of certain oil and gas properties from
Pioneer. Costilla reserves the right and puts Pioneer on notice herein of its
potential pursuit of these transfers as fraudulent conveyances under Section 548
of the Bankruptcy Code and under the Texas Uniform Fraudulent Transfer Act, as
well as any other legal rights and remedies the Debtor may have.

         C. POTENTIAL LITIGATION

         In addition to the foregoing, the Debtor believes that certain of the
Claims may be subject to offset. There also may exist claims and causes of
action against third parties arising prior to the Petition Date. These causes of
action may be enforced either by way of setoff against Claims filed against the
bankruptcy estate or may be prosecuted by the Plan Trustee. The Plan Trustee
will have sole discretion to object to any Claims and to prosecute any objection
as it sees fit.

         Enron Capital & Trade Resources Corp. The Plan Trustee reserves the
right to investigate and prosecute, if need be, potential claims against Enron
Capital & Trade Resources Corp. and/or its affiliate Joint Energy Development
Investments II Ltd. Partnership, concerning (i) a claim for a potential breach
of a funding commitment and (ii) other possible claims or causes of action
related to Costilla's unsuccessful attempt to purchase properties from Pioneer
Natural Resources USA, Inc.


                                       45
<PAGE>   51

         Prize Energy Corp. The Debtor entered into an agreement with Prize
Energy Corp. ("Prize") related to certain of the properties that Prize acquired
from Pioneer, which properties would have been included in the Pioneer
Transaction noted in Article 10.1. The Debtor obtained exploration rights to
such properties and other consideration in exchange for certain of the Debtor's
due diligence data related to the Pioneer properties acquired by Prize. These
exploration rights provided the Debtor with potential exploration and
development opportunities. The original disclosure statement previously filed by
Costilla, dated February 29, 2000, discussed potential litigation against Prize
Energy Corp. ("Prize") as a result of a Due Diligence Agreement reached between
Costilla and Prize on or about May 28, 1999. In relationship to such agreement,
a dispute existed between Prize and Costilla as to the amount of oil and gas
related interests that Costilla is entitled to receive. Due to the sale of the
oil and gas assets to Purchaser, the Debtor and Prize have resolved this dispute
with such rights to properties being conveyed to the Purchaser.

                    IMPORTANT NOTICE OF NON-WAIVER OF CLAIMS

The Debtor has attempted to disclose all material causes of action, including
avoidance and other actions under chapter 5 of the Bankruptcy Code, that it may
hold against third-parties. However, the Debtor has not performed an exhaustive
investigation or analysis of potential claims against third parties. It is the
contemplation of the Plan that such investigation and analysis will occur
post-confirmation by the Plan Trustee. The Debtor may hold other potential
claims or causes of actions against third-parties which the Debtor has not
disclosed herein. You should not rely on the omission of the disclosure of a
claim to assume that the Debtor holds no claim against any third-party,
including any creditor that may be reading this Disclosure Statement and/or
casting a ballot. Unless expressly released by the Plan, any and all such claims
against third parties are specifically reserved and transferred to the Trust.
The Debtor's failure to identify a claim herein is specifically not a waiver of
any claim or cause of action. The Debtor will not ask the Court to rule or make
findings with respect to the existence of any cause of action or the value of
the entirety of the Debtor's estate at the confirmation hearing; accordingly,
except claims which are expressly released by the Plan, the Debtor's failure to
identify a claim herein shall not give rise to any defense of judicial estoppel
with respect to claims which could be asserted against third parties, including
creditors of the Debtor which may be reading this Disclosure Statement and/or
casting a ballot. When casting your ballot, you should consider and take into
account the possibility that the Debtor may hold a claim against you which will
be transferred to the Trust and, if the Plan Trustee deems advisable, fully
pursued post-confirmation.

10.2 PRE-BANKRUPTCY LAWSUITS

         Costilla is involved in a variety of lawsuits either as plaintiff
and/or defendant. These suits, all commenced prior to the filing of the
bankruptcy petition, are summarized as follows:

         GNK, Inc., et al vs. Costilla Energy, Inc., et al., Cause No. 97-311-B
in the 87th Judicial District Court of Freestone County, Texas. On August 18,
1999, the state district court entered a judgment against the Debtor. The case
resulted from a dispute over the ownership and validity of certain undeveloped
oil and gas leases in Freestone County, Texas. The Court entered a Judgment
awarding the Plaintiffs actual damages against the Debtor and other defendants
in the approximate amount of $525,000, as well as exemplary damages against the
Debtor in the sum of $5,000,000. The Bankruptcy Court has allowed the Automatic
Stay to be lifted to allow the Debtor to prosecute an appeal of this judgment.


                                       46
<PAGE>   52

         Joe Armon Guerrero v. Costilla Energy, Inc., Cause no. 12,650 in the
County Court of Law, Ector County, Texas. Suit involves claim of personal injury
while plaintiff was working on a well owned by Costilla. Costilla believes that
liability, if any, would be covered by the company's relevant insurance
coverage. An order was entered by agreement of the parties to all the plaintiff
to liquidate his claim in the state court. Under such agreement, the plaintiff
may only look to recover from insurance proceeds in the event liability is
found.

         Delano Dale Nelson v. Costilla Energy, Inc., Cause no. 16263 in the
136th District Court, Jefferson County, Texas. Suite involves alleged personal
injury sustained on the company's property. Costilla believes that liability, if
any, would be covered by the company's insurance.

         Ceasar Martinez v. Costilla Energy, Inc., Cause no. 25,380-B, 87th
District Court, Limestone County, Texas. Suite involves alleged injuries
sustained while working on company job site. Costilla believes that liability,
if any, is covered by the companies insurance. An order was entered by agreement
of the parties to all the plaintiff to liquidate his claim in the state court.
Under such agreement, the plaintiff may only look to recover from insurance
proceeds in the event liability is found.

         Costilla Energy, Inc. v. Tenneco Energy Resources Corporation, Cause
No. 97-37484, 127th Judicial District, Harris County, Texas. Suit involves a
declaratory judgment action as to the validity of amendments certain contracts
and a counterclaim for breach of contract. The parties have recently reached a
settlement of this dispute and will be seeking approval of the settlement from
the Court.

         United Oil & Minerals, Inc., v. Costilla Energy, Inc., et al, Cause No.
98-04-18,144CV, 25th Judicial District Court, Lavaca County, Texas. Suit
involves a declaratory judgment action by plaintiff as to the validity of
certain alleged farmout agreements.

         Jerry Covington, Trustee v. Costilla Energy, Inc., Cause No. CV-41,691,
142nd District Court, Midland County. Suite involves gas balancing dispute,
payment of royalties and accounting. Such claim has been settled and liquidated
in an amount of $17,500 which the Debtor no longer disputes.

         Capstone Energy Corporation and Argent Petroleum Corporation v. Pioneer
Natural Resources USA, Inc.; Pioneer Resources, Inc., f/d/a Parker & Parsley,
Inc.; Pioneer Resources Producing, L.P. f/d/a/ Parker & Parlsey Development L.P.
v. Costilla Energy Inc., and Vintage Petroleum, Inc., Cause No. 22,268, 21st
District Court, Burleson County, Texas. Suit involves dispute over existence and
payment of overriding royalty interest.

         Thomas L. Jones, Jr. v. Costilla Energy, Inc., Black Diamond
Development, L.P., Frontierra Energy Corp and Douglas J. Sartoris, originally
styled as Cause No. 98-846-G, 319th District Court, Nueces County. This suite
has been removed to the United States Bankruptcy Court for the Western District
of Texas, Midland Division. However, suit will be heard in San Antonio Division
for convenience of the Court and parties involved. Suit involves existence and
validity of obligation to pay plaintiff overriding royalty interest.

         In re Magnolia Gas Company, L.L.C. and Magnolia Gas Transmission
Company, L.L.C. and MKP Production Company, L.L.C., Case No. 98-22060 B-H,
United States Bankruptcy Court for the Western District of Oklahoma. Bankruptcy
case in which Costilla is a working interest owner on certain properties.


                                       47
<PAGE>   53

         Circle K. Oil Field Supply, Inc. v. Costilla Energy, Inc., Cause No.
44,564-A, County Court of Law No.1., Midland County, Texas. Involves suit on
sworn account for $29,364.21 related to materials allegedly provided to Debtor.

         R.J. Stanley & Associates, Inc. v. Costilla Energy, Inc., Cause No.
99-00163-D, Dallas County Court of Law No. 4. Suit involves Claim for breach of
contract regarding payment for consulting services.

         William T. Spencer and Stephen D. Spencer, Individually, and as
CoTrustees of the Jean S. Spencer Trust v. Henry Musselman, Owen & King
Operating, Inc. and Costilla Petroleum Corporation, Cause No. 40,725, 238th
District Court, Midland County. Suite involves declaratory judgment regarding
the termination of contract.

         Glyn Snell, Ola Wright, Bruce Key, James A. Walton, Robert Herd Midkiff
and William Clayton Tatom, Jr. v. Dresser Industries, Inc., Titan Services,
Inc., BJ Services Company USA, B.J. Hughes Holding Company, Baker Hughes
Production Tools, Inc. and Baker Hughes Inc., Cause No B-38,435, 238th District
Court, Midland County, Texas. Costilla Energy, Inc. is an intervener seeking
award of settlement funds held in the registry of the court.

         Costilla Energy, Inc. v. Gilda C. Cantu, Thomas Cisneros III, Elda C.
Smith and Aide C. Ortiz, originally proceeding as Cause 99-01-0004CVK, 218th
District Court, Karnes County Texas. This suite has been removed to the United
States Bankruptcy Court for the Western District of Texas, Midland Division.
However, suit was heard in San Antonio Division for convenience of the Court and
parties involved. Suit involved declaratory judgment action regarding ownership
of surface property surrounding a Costilla gas plant. On or about May 31, 2000,
the court entered a final judgment in favor of Costilla, confirming Costilla's
good title in the disputed property along with the denial of any damages against
Costilla in connection with certain counterclaims made.

         In re Force Energy, Inc and Force Energy Resources, Inc, Case
99-1139TMD, United States Bankruptcy Court for the East District of Louisiana,
New Orleans Division. Case is a bankruptcy in which Costilla is a creditor
resulting from certain working interests held by Costilla.

         Mary Baker Walker v. Costilla Energy, Inc., Cause No 2533, County
Court, Pecos County, Texas. Suit involves claim by plaintiff that she is
entitled to percentage of production as alleged royalty owner under oil and gas
lease.

         Thomas L. Jones v. Costilla Energy, Inc., Cause No. 99-02515-00-O-C,
originally styled in the 94th Judicial District, Nueces County, Texas. This
suite has been removed to the United States Bankruptcy Court for the Western
District of Texas, Midland Division. However, suit will be heard in San Antonio
Division for convenience of the Court and parties involved Suit involves
plaintiffs claim for breach of contract, conversion and declaratory relief
associated to alleged overriding royalty interest. The court has recently
granted the plaintiff's motion on summary judgment, determining that the
plaintiff is entitled to a 2 percent overriding royalty interest in the subject
property. In light of this ruling, the parties are currently working on a
settlement of all claims.

         Dawson Geophysical Company v. Costilla Energy, Inc., Cause No.
CV99-244-JLS, 5th Judicial District Court, Eddy County, New Mexico. Suit to
foreclose alleged lien based on oil and gas lien statute


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<PAGE>   54

for seismic services performed by plaintiff. Costilla and Dawson have reached an
agreement allowing Dawson to be paid in the amount of $525,000 plus interest.

10.3 PLAN TREATMENT OF LAWSUITS

         On the Effective Date, all lawsuits, litigations, administrative
actions or other proceedings, judicial or administrative, in connection with the
assertion of a Claim against the Debtor, shall be dismissed as to the
Reorganized Debtor, except proof of claims and/or objections thereto pending in
the Bankruptcy Court and except Claims outside of Bankruptcy Court that the
Debtor asserts are Insured Claims. Such dismissal shall be with prejudice to the
assertion of such Claim in any manner other than as prescribed by the Plan. All
parties to any such action shall be enjoined by the Bankruptcy Court in the
Confirmation Order from taking any action to impede the immediate and
unconditional dismissal of such actions. All lawsuits, litigations,
administrative actions or other proceedings, judicial or administrative, in
connection with the assertion of a claim(s) by the Debtor against a person shall
remain in place only with respect to the claim(s) asserted by the Debtor, and
shall become property of the Trust to prosecute, settle or dismiss as the Plan
Trustee sees fit.

                                   ARTICLE XI
                  FEDERAL INCOME TAX CONSEQUENCES OF THE PLAN

11.1 GENERAL

         A. STATUTORY OVERVIEW

         Under the Internal Revenue Code of 1986, as amended (the "TAX CODE")
and income tax regulations (the "REGULATIONS") promulgated thereunder, there are
certain significant federal income tax consequences associated with the Plan
described in this Disclosure Statement. Certain of these consequences are
discussed below. Due to the unsettled nature of several of the tax issues
presented by the Plan, including the changes made by the Bankruptcy Tax Act of
1980 ("BTA80"), the Tax Reform Act of 1984, the Tax Reform Act of 1986
("TRA86"), the Omnibus Reconciliation Act of 1987 ("ORA87"), the Technical and
Miscellaneous Revenue Act of 1988 ("TAMRA"), the Omnibus Budget Reconciliation
Act of 1989 ("OBRA89") and the Revenue Reconciliation Act of 1990 ("RRA90") and
the Revenue Reconciliation Act of 1993 ("RRA93"), the differences in the nature
of the Claims of the various Claimants, their taxpayer status, residence and
methods of accounting (including Claimants within the same class of Claims) and
prior actions taken by Claimants with respect to their Claims, as well as the
possibility that events or legislation subsequent to the date hereof could
change the federal tax consequences of the transactions, the federal tax
consequences described herein are subject to significant uncertainties.

           Finally, this summary does not address foreign, state or local tax
law, or any estate or gift tax consequences of the Plan, nor does it purport to
address the federal income tax consequences of the Plan to special classes of
taxpayers (such as taxpayers who are not United States domestic corporations or
citizens or residents of the United States, S corporations, banks, mutual funds,
insurance companies, financial institutions, regulated investment companies,
broker-dealers, non-profit entities or foundations, small business investment
companies, persons that hold Claims or Equity Interests as part of a straddle or
conversion transaction and tax-exempt organizations).


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<PAGE>   55

           No administrative rulings will be sought from the Internal Revenue
Service (hereinafter "IRS") with respect to any of the federal income tax
aspects of the Plan. Consequently, there can be no assurance that the treatment
described in this Disclosure Statement will be accepted by the IRS. No opinion
of counsel has either been sought or obtained with respect to the federal income
tax aspects of the Plan.

           THE DISCUSSION SET FORTH IN THIS DISCLOSURE STATEMENT IS INCLUDED FOR
GENERAL INFORMATION ONLY. ALL CLAIMANTS AND STOCKHOLDERS SHOULD CONSULT THEIR
OWN TAX ADVISORS REGARDING THE FEDERAL INCOME TAX CONSEQUENCES CONTEMPLATED
UNDER OR IN CONNECTION WITH THE PLAN, INCLUDING STATE AND LOCAL TAX
CONSEQUENCES.

11.2 TAX CONSEQUENCES TO THE DEBTOR

           A. SUMMARY OF THE PLAN

           Pursuant to the Plan substantially all the assets of Debtor have been
sold and the cash and remaining assets will be transferred to the trustee of a
liquidating trust. To the extent the interests in the liquidating trust are
worth less than the face amount of the claims thereby satisfied, the Debtor will
realize debt forgiveness income (Debt Discharge Income), unless in accordance
with Section 108(e)(2), payment of the liability would have given rise to a tax
deduction. Some creditors will have their claims paid in full and in other cases
will be paid a pro-rata amount of their claims depending on the class of their
claims and the priorities applicable.

           B. EXISTING TAX ATTRIBUTES OF DEBTOR

           For its fiscal year ending December 31, 1998, Debtor had a net
operating loss carryforward of approximately $79 million. The Debtor believes
that the operating losses in 1999 will be about $115 million. The 1998 tax
return of Debtor reflects basis in depreciable assets of approximately $47
million and net leasehold costs of approximately $134 million. As a result of
certain dispositions in 1999, the Debtor believes that the tax basis in
depreciable and depletable assets as of the end of 1999 will be approximately
$30 million and $60 million, respectively.

           In addition to the potential reductions of the NOL carryovers as a
result of events occurring pursuant to the Plan, there could be further
adjustments to these carryover amounts as a result of Internal Revenue Service
(hereinafter "IRS") audits.

           C. TAX CONSEQUENCES OF SALE

           The total consideration received for the sale of assets was
approximately $133 million. The Debtor believes that it had sufficient tax basis
in the assets and/or otherwise available net operating loss carryforwards such
that it should not have any regular tax liability from the sale. It may however,
have a liability for the alternative minimum tax (AMT). See Article 11.2(F),
Computation of Alternative Minimum Tax.

           D. TREATMENT OF DEBT DISCHARGE INCOME UNDER THE PLAN

           The satisfaction of approximately $189 million of Bonds and trade
claims with interests in the liquidating trust having an estimated fair market
value of $84 million will give rise to Debt Discharge Income of approximately
$105 million. Since Debtor is in a Chapter 11 proceeding, the receipt of Debt


                                       50
<PAGE>   56

Discharge Income will not give rise to taxable income. However, pursuant to
Section 108(b), the Debtor will be required to reduce its tax attributes to
reflect the Debt Discharge Income. The tax attributes, and the order in which
they are required to be reduced, is set forth in Section 108(b).

         The Tax Code provides that attributes are reduced as of the first day
of the year following the year in which the Debt Discharge Income is realized.
Accordingly, all of Debtor's tax attributes will be available to reduce or
eliminate any gains from the asset sale. Since the Debtor will have no assets
after the close of the taxable year in which the Plan is consummated, it is of
academic interest only as to whether it has any tax attributes remaining.

         E. EFFECT OF SECTION 382--GENERAL RULES

         Under the Tax Code, when an ownership change occurs, a corporation is
limited in its ability to utilize NOLs. The Section 382 limitation is determined
by multiplying the value of the loss corporation (immediately before the
ownership change) by the Federal long term tax exempt rate.

         It is also noted that the Debtor experienced an ownership change in
1998 and is already subject to an annual limitation of approximately $4.3
million of the net operating losses in existence at that time. However, the
annual limitation does not apply to the extent the Debtor is recognizing gains
which were "built-in" at that time.

         F. COMPUTATION OF ALTERNATIVE MINIMUM TAX

         AMT must be paid by a corporation when and to the extent that its
liability for AMT is greater than its Regular Tax liability. AMT is equal to
twenty percent (20%) of alternative minimum taxable income (hereinafter "AMTI")
less certain allowable credit. Under the Tax Code, AMTI generally equals regular
taxable income, increased or decreased by certain adjustments and preference
items. However, only ninety percent (90%) of AMTI can be offset with NOL
carryovers. AMTI liability, regardless of the amount of available NOL
carryovers, will be at least twenty percent (20%) of the ten percent (10%) of
AMTI that cannot be offset with NOL carryovers.

11.3 FEDERAL INCOME TAX CONSEQUENCES TO CLAIMANTS

         A. GENERAL

         The tax consequences of the implementation of the Plan to a Claimant
will depend in part on the type of consideration received by the Claimant in
exchange for its Allowed Claim, whether the Claimant reports income on the
accrual basis, whether the Claimant receives consideration in more than one tax
year of the Claimant, whether the Claimant is a resident of the United States,
and whether all the consideration received by the Claimant is deemed to be
received by that Claimant in an integrated transaction.

         B. CLAIMANTS RECEIVING INTERESTS IN LIQUIDATING TRUST

              1. RECEIPT OF INTEREST IN TRUST AS A TAXABLE EVENT

         The transfer of the assets of the Debtor to the Liquidating Trust shall
be treated for all purposes of the Internal Revenue Code as a deemed transfer to
the Claimants receiving interests in the Liquidating Trust (the "Beneficiaries")
followed by a deemed transfer by the Beneficiaries to the Liquidating Trust. The
deemed transfer to creditors will constitute a taxable transaction to
Beneficiaries. Beneficiaries will


                                       51
<PAGE>   57

determine the gain or loss on the transfer by comparing the value of the
Liquidating Trust interest received in the exchange to the tax basis, if any, in
their claims. The value of the assets deemed transferred and the Liquidating
Trust interest received in the exchange will be determined by reference to each
Beneficiaries's pro rata share of the Debtor's assets as provided in the
Disclosure Statement, and such valuation will be used for all federal income tax
purposes. A Claimant's pro rata share of the Debtor's assets is determined by
dividing the amount of his claim by the total amount of claims in its class
against the Debtor.

                  2. TAX CONSEQUENCES OF TRUST INCOME AND SUBSEQUENT
                     DISTRIBUTIONS

           The Beneficiaries shall be treated for tax purposes as the grantors
and deemed owners of the Liquidating Trust. Consistent with the provisions of
Revenue Procedure 94-45, 1994-28 I.R.B. 124, the Trust shall be treated as a
grantor trust owned by the Beneficiaries. Accordingly, any items of income,
deduction, credit or loss of the Liquidating Trust shall be allocated for
federal income tax purposes on a pro rata basis among the Beneficiaries. Income
of the trust will be subject to current taxation to the Beneficiaries. The
Liquidating Trust will prepare annual income tax returns pursuant to Treas. Reg.
Sec. 1.671-4(a) and report to Beneficiaries their pro rata share of the income
of the Trust.

         Beneficiaries who receive distributions from the Liquidating Trust in
excess of their tax basis in the trust interests will realize additional gains
or income. The amount of gain or income is determined by comparing the amount of
distribution from the Liquidating Trust to the Creditors' tax basis in their
interests in the Liquidating Trust.

                  3. CHARACTER OF GAIN OR LOSS

         The character of gain or loss recognized by a holder of a Claim as
capital or ordinary gain or loss and, in the case of capital gain or loss, as
short term or long term, will depend on a number of factors, including: (i) the
nature and origin of the Claim; (ii) the tax status of the holder of the Claim;
(iii) whether the holder is a financial institution; (iv) whether the Claim is a
capital asset in the hands of the holder; (v) whether the Claim has been held
for more than one (1) year; (vi) the extent to which the holder previously
claimed a loss, bad debt deduction or charge to a reserve for bad debts with
respect to the Claim. CLAIMANTS ARE URGED TO CONSULT THEIR INDIVIDUAL TAX
ADVISORS REGARDING THESE ISSUES.

         C. RECEIPT OF INTEREST

         Under current tax consideration attributable to accrued but unpaid
interest will be treated as ordinary income, regardless of whether the
Claimant's existing Claims are capital assets in his hands and the exchange is
pursuant to a tax reorganization. A Claimant, who, under his accounting method,
was not previously required to include in income, accrued but unpaid interest
attributable to his existing Claims, and who exchanges his interest Claim for
cash, other property, or a combination thereof, pursuant to the Plan will be
treated as receiving ordinary interest income to the extent of any consideration
so received allocable to such interest, regardless of whether that Claimant
realizes an overall gain or loss as a result of the exchange of his existing
Claims.

         D. BACKUP WITHHOLDING

         Under current tax law, interest, dividends and other "reportable
payments" may, under certain circumstances, be subject to "backup withholding"
at a thirty-one percent (31%) rate. Withholding generally applies if the holder:
(i) fails to furnish his social security number or other taxpayer


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<PAGE>   58

identification number (hereinafter "TIN"), (ii) furnishes an incorrect TIN,
(iii) fails properly to report interest or dividends, or (iv) under certain
circumstances, fails to provide a certified statement, signed under penalty of
perjury, that the TIN provided is his correct number and that he is not subject
to backup withholding.

11.4 FEDERAL INCOME TAX CONSEQUENCES TO EQUITY INTERESTS

           Pursuant to the Plan, the existing equity holders will not receive
any consideration. They will be entitled to a loss to the extent of their tax
basis in their shares. Such loss will be a capital loss, assuming they hold
their shares for investment purposes.

                                  ARTICLE XII
                   REQUIREMENTS FOR CONFIRMATION OF THE PLAN

12.1 GENERAL CONFIRMATION REQUIREMENTS

         At the Confirmation Hearing, the Court will determine whether the
requirements of section 1129(a) of the Bankruptcy Code have been satisfied. If
those requirements have been satisfied, the Court will enter the Confirmation
Order. The requirements for confirmation under the Bankruptcy Code are as
follows:

         o        The Plan complies with the applicable provisions of the
                  Bankruptcy Code.

         o        The proponent of the Plan has complied with the applicable
                  provisions of the Bankruptcy Code.

         o        The Plan has been proposed in good faith and is not by any
                  means forbidden by law.

         o        Any payment made or promised by the proponents of the Plan or
                  by a Person issuing securities or acquiring property under the
                  Plan for services or for costs and expenses in or in
                  connection with the Chapter 11 Case, or in connection with the
                  Plan and incident to the Chapter 11 Case, was disclosed to the
                  Court, and any such payment made before confirmation of the
                  Plan is reasonable, or if such payment is to be fixed after
                  confirmation of the Plan, such payment is subject to the
                  approval of the Court as reasonable.

         o        The proponent of the Plan will disclose the identity and
                  affiliation of any individual proposed to serve, after
                  confirmation of the Plan, as director, officer or voting
                  trustee of the Debtor, any affiliate of the Debtor
                  participating in a joint plan with the Debtor, or a successor
                  to the Debtor under the Plan, and the appointment to, or the
                  continuance in, such office of such individual, is consistent
                  with the interests of Creditors and equity security holders
                  and with public policy.

         o        The proponent of the Plan will disclose the identity of any
                  insider that will be employed or retained by the Trust and the
                  nature of the compensation for such insider.

         o        Any governmental regulatory commission with jurisdiction,
                  after confirmation of the Plan, over the rates of the Debtor
                  have approved any rate change provided for in the Plan, or
                  such rate change is expressly conditioned on such approval.


                                       53
<PAGE>   59

         o        With respect to each Class of impaired Claims, either each
                  holder of a Claim in such Class has accepted the Plan, or will
                  receive or retain under the Plan on account of such Claims
                  property of a value, as of the Effective Date of the Plan,
                  that is not less than the amount such Claimant would receive
                  or retain if the Debtor was liquidated on such date under
                  chapter 7 of the Bankruptcy Code.

         o        Subject to the Plan proponent's "cramdown" right described in
                  section 14.2 which follows, each class of Claims or Interests
                  has either accepted the Plan or is not impaired under the
                  Plan.

         o        Except to the extent that the holder of a particular Claim has
                  agreed to a different treatment of such Claim and except as to
                  Cure Payments, the Plan provides that Administrative Expense
                  Claims will be paid in Cash in full on the Effective Date and
                  that any tax Claim entitled to priority under section
                  507(a)(7) is being paid in full in deferred Cash payments,
                  over a period not exceeding six years after the date of
                  assessment of such Claim, of a value, as of the Effective Date
                  of the Plan, equal to the allowed amount of such Claim.

         o        At least one impaired Class of Claims has accepted the Plan,
                  determined without including any acceptance of the Plan by any
                  insider holding a Claim in such Class.

         o        Confirmation of the Plan is not likely to be followed by the
                  liquidation of the Debtor or the need for further financial
                  reorganization of the Debtor or any successors to the Debtor
                  under the Plan, unless such liquidation or reorganization is
                  proposed in the Plan.

         The Debtor believes that the confirmation requirements applicable to
the Case is met under the Plan. The Debtor will present evidence in support of
each applicable requirement at the Confirmation Hearing.

12.2 POTENTIAL CRAMDOWN OF THE PLAN

         If any impaired Class of Claims does not vote to accept the Plan, the
Court may nevertheless confirm the Plan pursuant to the "cramdown" provisions of
section 1129(b) of the Bankruptcy Code. If the Court determines that the Plan
"does not discriminate unfairly" and is "fair and equitable" to each Class of
dissenting Creditors and/or Stockholders, the Court may confirm the Plan through
"cramdown." The Plan will not discriminate unfairly if no Class receives more
than it is legally entitled to receive.

         With respect to each dissenting Class of Unsecured Claims, "fair and
equitable" means either: (i) the members of each dissenting impaired Class of
Unsecured Claims receive property of a value, as of the Effective Date of the
Plan, equal to the amount of their Allowed Claim; or (ii) the holders of Claims
and Interests that are junior to each dissenting impaired Class of Unsecured
Claims will not receive any property under the Plan. The Plan is not fair and
equitable to a Class of interests if any Class of Claims is paid more than in
full.

                                  ARTICLE XIII
                                   CONCLUSION

         Through confirmation of the Plan, the Debtor believes that they can
resolve all Claims that have been, or could be, asserted against then in a
timely and cost effective manner. The Debtor believes that


                                       54
<PAGE>   60

the Plan provides a mechanism to resolve and provide just compensation to all
Claimants. The Debtor believes that the Plan is fair to all parties-in-interest
and should be approved by Creditors.


                                       55
<PAGE>   61

              COSTILLA ENERGY URGES YOU TO VOTE TO ACCEPT THE PLAN.

    DATED:   July 26, 2000
             Midland, Texas.


                                   COSTILLA ENERGY, INC.



                                   By:        /s/  Bobby W. Page
                                              ---------------------------------
                                              Bobby W. Page
                                              Interim Chief Executive Officer

                                   SHEINFELD, MALEY & KAY, P.C.


                                   By:        /s/ Henry J. Kaim
                                              ---------------------------------
                                              Henry J. Kaim
                                              Samuel M. Stricklin

                                   ATTORNEYS FOR THE DEBTOR


OF COUNSEL:

Richard T. McMillan
Dan G. LeRoy
COTTON, BLEDSOE, TIGHE & DAWSON
500 W. Illinois, Suite 300
Midland, Texas 79701-4337
Telephone: (915) 684-5782
Facsimile: (915) 682-3672


LIST OF EXHIBITS:

     Exhibit A-Plan of Reorganization

     Exhibit B-Order Approving Disclosure Statement

     Exhibit C-Payments in Excess of $600 Made with 90 Days of Filing Bankruptcy