Document:

Exhibit 10.1

PARTICIPATION AGREEMENT

RELATING TO

SOUTH LOUISIANA IV

This PARTICIPATION
AGREEMENT (this “Agreement”)
is made and entered into as of March 1, 2006 (the “Effective Date”), by and among
the Parties (as defined below).

FOR AND IN CONSIDERATION OF
the mutual covenants, rights, and obligations set forth in this Agreement, the
benefits to be derived from them, and other good and valuable consideration,
the receipt and the sufficiency of which are hereby acknowledged, the Parties
agree as follows:

ARTICLE I

DEFINITIONS

1.01         Certain
Definitions.  As used in this
Agreement, the following terms have the following meanings:

“Acquisition Costs” means (i) with respect
to any Designated Property relating to a Lease that was owned by CWEI
prior to the date such property became subject to this Agreement, the fair
market value of the portion of such Lease that is attributable to such
Designated Property as of the date it became subject to this Agreement, and
(ii) with respect to any Designated Property relating to a Lease that was
acquired by CWEI on or after the date such Designated Property became subject
to this Agreement, the portion of the costs of acquiring such Lease
(including, without limitation, direct costs of seismic data and
interpretation, lease broker services, title examinations, filing fees, and
recording costs) that is attributable to the Designated Property.

“Affiliate” means, when used with
reference to a specified Person, (a) any Person directly or indirectly owning,
controlling or holding power to vote 50% or more of the outstanding voting
securities of the specified Person, (b) any Person 50% or more of whose
outstanding voting securities are directly or indirectly owned, controlled or
held with power to vote by the specified Person, (c) any Person directly or
indirectly controlling, controlled by or under common control with the
specified Person, (d) if the specified Person is a corporation, any officer or
director of the specified Person or of any corporation directly or indirectly
controlling that specified Person, (e) if the specified Person is a
partnership, any general partner or if the general partner is a partnership,
the general partners of that partnership, and (f) if the specified Person is an
individual, such individual’s spouse and natural and adoptive lineal
descendants and trusts for the benefit of any such Persons.  For purposes of this definition, the ability
through share ownership or contractual arrangement to elect or cause the
election of a majority of the board of directors of a corporation shall
constitute “control.”

“Agreed Rate” means 4.54 % per annum.

“Agreement” means this
Participation Agreement, as amended or restated from time to time.

“Area of
Interest” means the area described in Exhibit B, as such may
amended from time to time by CWEI.

 

“Capital
Account” has the meaning set forth in Section 5.03.

“Code” means the Internal Revenue
Code of 1986, as amended.

“Contribution
Date” has the meaning set forth in Section 5.04(b).

“Contribution
Notice” has the meaning set forth in Section 5.04(b).

“CWEI” means Clayton Williams
Energy, Inc., a Delaware corporation.

“CWEI
Counsel” has the meaning set forth in Section 8.12.

“Designated
Property” means an undivided 5% of CWEI’s interests in the
Wells.

“Event
of Forfeiture” has the meaning set forth in Section 4.04.

“Indemnified Person” has the
meaning set forth in Section 8.11.

“Interest”
means an interest in Designated Property under this Agreement.  The number of Interests owned by each
Participant and the total number of Interests in this Agreement are set forth
on Exhibit A, as amended from time to time.

“Lease”
means a lease, mineral interest, royalty or overriding royalty, fee right,
mineral servitude, license, concession or other right covering oil, gas and
related hydrocarbons (or a contractual right to acquire such an interest) or an
undivided interest therein or portion thereof, together with all appurtenances,
easements, permits, licenses, servitudes and rights-of-way situated upon or
used or held for future use in connection with such an interest or the
exploration, development or production thereof, in each case, in the Area of
Interest.  A “Lease” shall also mean and
include all rights and interests in all lands and interests unitized or pooled
therewith pursuant to any law, rule, regulation or agreement.

“Majority in Interest” means a majority of the Interests held by
all Participants.

“Non-Contributing
Party” has the meaning set forth in Section 5.04(c).

“Operating
Agreement” means an
agreement between the operator and non-operating interest owners in a Lease for
the testing, development and operation of a tract of land or Lease for the
exploration and development of oil, gas, minerals or hydrocarbons.

“Party” means CWEI or any
Participant.

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“Participant” means each Person
listed as such on Exhibit A.

“Payout” means the earliest calendar month
during which CWEI shall have received cumulative cash proceeds relating to all
Designated Property (but only taking into account proceeds received with
respect to a Designated Property after such Designated Property became subject
to this Agreement) in an aggregate amount equal to the sum of (i) the
Acquisition Costs, Well Costs and other expenses incurred by CWEI relating to
the Designated Property, plus (ii) an annual internal rate of return on such
costs equal to the Agreed Rate.  For this
purpose, each proceed and expense shall be deemed to have been made on the last
day of the month during which it was received or made.

“Person” means an individual,
corporation, partnership, limited partnership, limited liability company,
business trust or other legal entity.

“Regulations” mean the regulations
promulgated by the United States Department of Treasury pursuant to the
Code.  All references herein to sections
of the Treasury Regulations shall include corresponding provision or provisions
of succeeding, similar, substitute, temporary or final Treasury Regulations.

“Tax
Partnership” means the relationship (constituting a tax
partnership for federal and applicable state law tax purposes) between the
Parties existing pursuant to this Agreement.

“Transfer” means any sale,
transfer, assignment, pledge, encumbrance, hypothecation, gift or disposition
of an Interest in whole or in part, or any rights or benefits to which a holder
of an Interest may be entitled as provided in this Agreement, including,
without limitation, the right to receive distributions in cash or in kind.

“Well” means a well in which CWEI holds a Working Interest derived from its
ownership of one or more Leases in the Area of Interest, as determined in
accordance with Section 8.16.  The
name and location of each “Well” is shown on Exhibit
C, as amended from time to time by CWEI.

“Well Costs” means CWEI’s share of
costs pursuant to any Operating Agreement for the drilling, completing,
equipping, deepening or sidetracking a Well, including, without
limitation:  (i) the costs of
surveying and staking the Well, the costs of any surface damages and the costs
of clearing, coring, testing, logging and evaluating the Well; (ii) the costs
of casing, cement and cement services for the Well; (iii) the cost of
plugging and abandoning the Well (including standard and customary remediation
activities associated therewith), if it is determined that the Well would not
produce in commercial quantities and should be abandoned; (iv) all direct
charges and overhead chargeable to CWEI with respect to the Well under any
applicable Operating Agreement until such time as all operations are carried
out as required by applicable regulations and sound engineering practices to
make such Well ready for production, including the installation and testing of
wellhead equipment, or to plug and abandon a dry hole; (v) all costs
incurred by CWEI in recompleting or plugging back any Well; (vi) all costs

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incurred
by CWEI in reworking any Well if the rework is covered by an authority for
expenditure under the applicable Operating Agreement; (vii) all costs incurred
by CWEI in locating, drilling, completing, equipping, deepening or sidetracking
any enhanced recovery producer or injector Well (including the costs of all
necessary surface equipment such as steam generators, compressors, water
treating facilities, injection pumps, flow lines and steam lines); and (viii)
the costs of constructing production facilities, pipelines and other facilities
necessary to develop property acquired pursuant to the terms hereof and
produce, collect, store, treat, deliver, market, sell or otherwise dispose of
oil, gas and other hydrocarbons and minerals therefrom; provided, that
Well Costs shall not include any Acquisition Costs.

“Working Interest” means an operating
interest in a Lease that permits CWEI to explore, develop and produce one or
more properties in the Area of Interest and bear its percentage of the costs
and expenses relating to the maintenance and development of and operations
relating to such properties.

1.02         Construction.  Whenever the context requires, the gender of
all words used in this Agreement includes the masculine, feminine and
neuter.  All references to Articles and
Sections refer to articles and sections of this Agreement, and all references
to exhibits are to Exhibits attached to this Agreement, each of which is made a
part of this Agreement for all purposes.

ARTICLE II

RELATIONSHIP OF THE PARTIES

2.01         Formation of Tax
Partnership; No Partnership for any Other Purpose.  This Agreement and its attachments are not
intended and shall not be construed to create a joint venture or other
partnership (general, limited, or otherwise) or association or to render the
Parties hereto liable as partners.  Each
of the Parties hereto hereby agrees that this Agreement creates a partnership
for United States federal and State income tax purposes only, which Tax
Partnership shall be deemed to own the Designated Property and shall function
and exist as set forth in Exhibit D attached hereto, which is hereby
incorporated by reference for all purposes of this Agreement.  Furthermore, each of the Parties agrees that
it shall not make an election for the Tax Partnership to be excluded from the
application of the provisions of Subchapter K of Chapter 1 of Subtitle A of the
Code (“Subchapter K”) or any
similar provisions of applicable state law; provided, however,
that each Participant acknowledges that CWEI may currently be, or may become in
the future, party to an Operating Agreement relating to one or more of the
Leases and/or Wells that requires each party thereto to make an election to be
excluded from the application of the provisions of Subchapter K and authorizes
CWEI to make such elections in the future on behalf of the Tax Partnership (as
an entity) if necessary to comply with the applicable Operating Agreement.

2.02         Purpose.  The purpose for which this Agreement is being
entered is to further align the interests of the Participants with those of
CWEI by permitting the Participants to participate with CWEI in the CWEI oil
and gas production (if any) developed, directly or indirectly, by CWEI and the
Participants.

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2.03         Term.  This Agreement shall commence on the
Effective Date and continue in effect until terminated in accordance with Section
7.01.

ARTICLE III

MANAGEMENT OF LEASES AND WELLS

3.01         Authority of CWEI.  CWEI shall have the full and exclusive power
and authority to do any and all things necessary, incidental, proper, advisable
or convenient for the furtherance of developing the Leases and Wells on behalf
of the Tax Partnership, including without limitation:

(a)           to determine whether
to acquire, hold, develop or produce properties and other assets and whether,
when and on what terms to farm-out, sell, promote or otherwise transfer any
particular prospect, or any interest therein;

(b)           to make all
decisions concerning the desirability of payment, and the payment or
supervision of payment, of all delay rentals, shut-in royalty payments, minimum
royalty payments and any other similar or related payments;

(c)           to drill, complete,
control, rework, side-track, redrill, recomplete, produce, plug and/or abandon
any or all of the Wells;

(d)           to form and
participate in partnerships, joint ventures or other relationships that it
deems desirable;

(e)           to make any
expenditures and incur any obligations it deems appropriate;

(f)            to acquire
(including, without limitation, to purchase at premium prices when deemed
appropriate by CWEI), exchange, sell, lease, or dispose of any or all
Designated Property;

(g)            to negotiate,
execute, deliver and perform any contracts, conveyances or other instruments
which it considers appropriate for the implementation of its powers under this
Agreement, including, without limitation, Operating Agreements, unit Operating
Agreements and joint development agreements, and the right to make any and all
elections that are required or necessary under the terms of any agreements;

(h)           to borrow money,
incur indebtedness or make guaranties and to secure the same by mortgages,
deeds of trust, security interests, pledges or other liens or encumbrances on
all or any part of the Designated Property;

(i)            to acquire and
maintain such insurance, if any, for the benefit of the Parties as it deems
appropriate; and

(j)            to construct
pipelines, drilling and production platforms and facilities, gas plants,
processing plants and other facilities incidental to the development of the
Area of Interest and the production and marketing of oil and gas therefrom.

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(k)           to execute and
deliver division orders and transfer orders upon such terms and conditions and
containing such provisions as CWEI may consider appropriate; and

(l)            to control any
matters affecting the Designated Property including the conduct of litigation
and other incurring of legal expenses and the settlement of claims in
litigation; provided, that, CWEI shall not be authorized to settle any claims
for which any Participant has, or may have, any individual liability without
the Participant’s prior written consent.

3.02         Duties and Services of
CWEI.  CWEI shall devote
such time and effort to the development of the Leases and Wells as it shall
deem appropriate.  The Parties
acknowledge and agree that neither CWEI nor any Affiliate thereof nor any of
their respective officers, directors, employees or agents shall be required to
devote full time to the development of the Leases and Wells and may from time
to time engage in and possess interests in other business ventures of any and
every type and description, independently or with others, including without
limitation, the ownership, acquisition, exploration, development, operation and
management of oil and gas properties and oil and gas drilling programs, and
that no Participant shall by virtue of this Agreement have any right, title,
interest or expectancy in or to such activities or ventures.

3.03         Operating Agreements.  CWEI shall
use its reasonable efforts to enter into, and act in accordance with the
provisions of, all applicable Operating Agreements relating to any Lease or
Well.  Following termination of this
Agreement, each Party agrees to become a party to all Operating Agreements in
which CWEI serves as operator, and further agrees to use its reasonable efforts
to become a party to all other applicable Operating Agreements.  To the extent any Party for any reason does
not become a party to an applicable Operating Agreement, such Party agrees to
use its reasonable efforts to act in accordance with the provisions of such
Operating Agreement as if it were a party to such Operating Agreement.

ARTICLE IV

ACCESS TO INFORMATION; TRANSFER RESTRICTIONS

4.01         Access to Information.  A Participant, on written request to CWEI
stating the purpose, may examine and copy, at any reasonable time, for any proper
purpose, and at the expense of the Participant, any information regarding the
business affairs and financial condition of any Designated Property as is just
and reasonable for the Participant to examine and copy.  Information provided to or obtained by a
Participant relating to Designated Property shall be used by such Participant
solely in furtherance of his or her interests hereunder and shall not be used
for any other purpose.  Participants
shall maintain the confidentiality of all such information and shall not
disclose such information to any other Person. 
If a Participant receives a request to disclose information relating to
the Designated Property or this Agreement under the terms of a subpoena,
investigative demand or order issued by a court or governmental agency, the
Participant shall promptly notify CWEI of the existence, terms and
circumstances surrounding such request, so that CWEI may seek a protective
order or confidential treatment of such information.

4.02         Transfer Restrictions.  Except as provided in Section 4.03, no Participant shall Transfer his
or her Interests without the prior written consent of CWEI.  Any attempted Transfer in violation of this Section 4.02 shall be null and void, and CWEI
shall refuse to recognize any such Transfer.

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4.03         Permitted Transfers;
Status as Assignee.  A
Participant may Transfer all or any portion of his or her Interests to his or
her spouse, parents or natural or adoptive lineal descendants, or to one or
more trusts or partnerships established exclusively for the benefit of his or
her spouse, parents or natural or adoptive lineal descendants; provided,
that any such permitted assignee shall receive and hold such rights subject to
the provisions of this Agreement, including, without limitation, the provisions
of this ARTICLE IV, and as a condition to such Transfer, shall execute
and deliver a written agreement with the Parties agreeing to be bound
hereby.  A Participant intending to
Transfer Interests pursuant to this Section 4.03 shall provide at least 10
days prior written notice of such proposed transfer to CWEI.

 

4.04         Forfeiture of Interests.  A Participant shall forfeit any and/or all of
his or her Interests held by such Participant if such Participant admits or
enters a plea of no contest to or is convicted of a felony or misdemeanor
offense against CWEI or any of its Affiliates (“Event of Forfeiture”).

4.05         Specific Performance.  The parties agree that each Party would be
irreparably damaged if any of the provisions of this ARTICLE IV are not performed
in accordance with their specific terms and that monetary damages would not
provide an adequate remedy in such event. 
Accordingly, it is agreed that, in addition to any other remedy to which
they may be entitled, at law or in equity, CWEI and any nondefaulting
Participant shall be entitled to injunctive relief to prevent breaches of the
provisions of this ARTICLE IV and specifically to enforce the terms and
provisions hereof in any action instituted in any court of competent
jurisdiction.

 

ARTICLE V

SHARING, ALLOCATIONS AND DISTRIBUTIONS

5.01         Allocation of Costs and
Expenses.  All costs and
expenses, including Acquisition Costs and Well Costs, relating to the
Designated Property shall be shared as follows: (i) 100% to CWEI before Payout
and (ii) 1% to CWEI and 99% to the Participants after Payout, apportioned among
the Participants in proportion to the percentages listed on Exhibit A
attached hereto.

5.02         Allocation of Revenues.  All revenues relating to the Designated
Property shall be allocated as follows: (i) 100% to CWEI before Payout and (ii)
1% to CWEI and 99% to the Participants after Payout, apportioned among the
Participants in proportion to the percentages listed on Exhibit A
attached hereto.

5.03         Allocations for Capital
Account and Tax Purposes. 
An individual capital account (a “Capital
Account”) shall be established and maintained for each Participant
as provided in Exhibit D.  Subject
to Section 7.02(c), all items of income, gain, deduction, loss, credit
and amount realized shall be allocated to the Parties in accordance with the
provisions of Exhibit D.

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5.04         Funding of Costs and
Expenses.

(a)           The Parties agree to
pay timely the costs and expenses allocated and charged to them pursuant to Section
5.01 and elsewhere herein.

(b)           To the extent that
costs and expenses are allocated and charged to Participants pursuant to Section
5.01 and elsewhere in this Agreement, and not retained by CWEI from a
distribution to Participants pursuant to Section 5.05, CWEI shall send
written notice to the Participants (a “Contribution
Notice”) setting forth (i) the date on which such additional funds
shall be payable (the “Contribution Date”),
which date shall be not less than 10 days after the date of the Contribution
Notice, and (ii) the total amount of funds required to be paid by each
Participant pursuant to this Section 5.04.  The funds required of each Participant shall
be in proportion to the number of Interests held by such Participant.

(c)           If a Participant
does not pay timely the costs and expenses allocated and charged to such
Participant (a “Non-Contributing Party”)
at the time or in the manner provided in the Contribution Notice, CWEI, in its
sole discretion, may pay the costs and expenses that the Non-Contributing Party
failed to pay within 20 days after the Contribution Notice, in which case the
Non-Contributing Party, without further action on his or her part, shall be
deemed to have assigned to CWEI the economic rights to the Interests held by
the Non-Contributing Party pursuant to this Agreement, and CWEI, as the
assignee of the Non-Contributing Party and the holder of such Interests, shall
be entitled to receive all allocations of income, gain, loss, deduction, credit
or similar items, and all distributions, to which the Non-Contributing Party
would otherwise be entitled from and after the Contribution Date.  CWEI shall hold such Interests attributable
to the Non-Contributing Party until such time as CWEI, as the holder of such
Interests, shall have received distributions pursuant to Section 5.05 in
an aggregate amount equal to 200% of the additional funds paid by CWEI pursuant
to this Section 5.04(c), whereupon CWEI, without further action on its
part, shall be deemed to have re-assigned the economic rights to such Interests
to the Non-Contributing Party.  CWEI may
use the power of attorney set forth in Section 8.13 to reflect any
assignment pursuant to this Section 5.04(c).  Furthermore, a Non-Contributing Party shall
indemnify and hold harmless each other Party to the fullest extent permitted by
law, from and against the costs and expenses that the Non-Contributing Party
failed to pay, including any losses, costs, liabilities, damages, and expenses
(including, without limitation, costs of suit and attorneys’ fees) paid or
incurred in attempting to collect the costs that the Non-Contributing Party
failed to pay.

5.05         Distributions of Revenues.  Subject to Section 5.04(c), all
revenues relating to the Designated Property shall be distributed to the Party
to whom such revenues are allocated pursuant to Section 5.02; provided,
however, that CWEI shall, in lieu of issuing Contribution Notices, be
entitled to retain from any distribution to any Participant an amount necessary
to discharge the costs and expenses allocated to such Participant pursuant to Section
5.01 that remains unpaid; provided, further, that if Payout
would occur as a result of a distribution of cash funds to CWEI, such
distribution shall be deemed to constitute two distributions:  (i) the first distribution shall consist of
the amount of cash funds necessary to cause Payout to occur, and (ii) the
second distribution shall consist of the balance of the funds then distributed.

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5.06         Withholding Taxes.  CWEI shall at all times be entitled (but not
obligated) to make payments required to discharge any obligation of CWEI to
withhold or make payments to any governmental authority with respect to any
federal, state or local tax liability of any Participant for such taxes arising
out of such Participant’s interest in the Designated Property.  The amount of each such payment made by CWEI
with respect to any Participant shall be deducted from any distributions
otherwise payable to such Participant pursuant to this Agreement.  Notwithstanding anything contained in this
Agreement to the contrary, in the event CWEI fails to withhold any federal,
state or local taxes in respect of any Participant when required to do so
(including as a result of any change in law or interpretation thereof or
otherwise) any liability incurred by CWEI (including any interest and
penalties) as a result of such failure shall be borne by such Participant (and
charged to such Participant’s Capital Account), and such Participant shall
indemnify and hold harmless CWEI from and against any and all claims, demands,
liabilities, costs, damages and causes of action of any nature whatsoever
related to such withholding obligation.

ARTICLE VI

BOOKS AND RECORDS

6.01         Maintenance of Books and
Records.  The books of
account for the Tax Partnership shall be maintained on an accrual basis in
accordance with the terms of this Agreement, except that the Capital Accounts
of the Parties shall be maintained in accordance with Exhibit D.  The accounting year of the Tax Partnership
shall be the calendar year.

ARTICLE VII

TERMINATION

7.01         Termination.  This Agreement shall terminate on the first
to occur of the following:

(a)           the third
anniversary of Payout;

(b)           the
election of CWEI, in its sole discretion, to terminate this Agreement.

7.02         Distributions upon
Termination.  Upon
termination of this Agreement, CWEI shall distribute all Designated Property
(or proceeds therefrom) to the Parties as follows:

(a)           CWEI may sell any or all Designated
Property and other assets, including to Parties, and any resulting gain or loss
from each sale shall be computed and allocated to the Capital Accounts of the
Parties in accordance with Section 7.02(c);

(b)           With respect to all Designated
Property that has not been sold, the fair market value of such Designated
Property shall be determined by CWEI and any unrealized income, gain, loss, and
deduction inherent in such property that has not been reflected in the Capital
Accounts of the Parties previously shall be allocated among the Parties in
accordance with Section 7.02(c);

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(c)           All items of income, gain, loss and
deduction referred to in Sections 7.02(a) and (b) shall be allocated
among the Parties in such a manner as to cause, to the maximum extent possible,
the positive Capital Account balance of each Party to equal the distribution
such Party would receive if the distributions upon liquidation of the proceeds
described in Section 7.02(a) and proceeds equal in amount to the fair
market value of property described in Section 7.02(d) were made in
accordance with Section 5.05 of this Agreement;

(d)           Designated
Property (and proceeds therefrom) shall then be distributed among the Parties
in accordance with the positive Capital Account balances of the Parties, as
determined after taking into account all Capital Account adjustments for the
taxable year of the Tax Partnership during which the termination of this
Agreement occurs (other than those made by reason of distributions pursuant to
this clause (d)), and those distributions shall be made by the end of the
taxable year of the Tax Partnership during which the termination of this
Agreement occurs (or, if later, 90 days after the date of the liquidation);

(e)           It is intended that the distributions
made to each Party pursuant to this Section 7.02
be equal to the distributions to which such Party would be entitled if
liquidating distributions were made in accordance with Section
5.05 of this Agreement.  To
the extent the Parties’ positive Capital Account balances after application of
Section 7.02(c) do not correspond to the amounts of such intended
distributions, the allocations provided for in Exhibit
D for the taxable year in which the liquidation occurs shall be
adjusted, to the maximum extent possible, to produce Capital Account balances
which correspond to the amount of such intended distributions.

All distributions in kind
to the Participants shall be made subject to the liability of each distributee
for his, her or its allocable share of costs, expenses and liabilities
previously incurred or for which CWEI has committed prior to the date of
termination and those costs, expenses and liabilities shall be allocated to the
distributee under this Section 7.02. The distribution of cash or
property to a Participant in accordance with the provisions of this Section 7.02 constitutes a complete
distribution to the Participant of his, her or its Interests and all the
Designated Property and other assets and constitutes a compromise to which all
Parties have consented. To the extent that a Participant returns funds to CWEI,
it has no claim against any other Party for those funds.

7.03         Termination.
On completion of the distribution of Partnership assets as provided in this
Agreement, the Tax Partnership shall be considered terminated.

ARTICLE VIII

GENERAL PROVISIONS

8.01         Offset.  Whenever CWEI is to pay any sum to any
Participant, any amounts that Participant owes CWEI or its Affiliates may be
deducted from that sum before payment.

8.02         Notices.  All notices, requests or consents required or
permitted to be given under this Agreement must be in writing and shall be
considered as properly given if mailed by first class United States mail,
postage paid, and registered or certified with return receipt requested, or if
delivered to the recipient in person, by courier or by facsimile
transmission.  Notices, requests and
consents shall be sent to a Participant at the address shown on its Signature
Page for 

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Participants.  A Participant may
change its address by giving written notice to CWEI.  Any notice, request or consent to CWEI shall
be sent to CWEI at its principal place of business, to the attention of the
Executive Vice President and Chief Operating Officer.

 

8.03         Entire
Agreement.  This Agreement
constitutes the entire agreement of the Parties relating to the Tax Partnership
and the Designated Property, and supersedes all prior contracts or agreements
with respect thereto, whether oral or written.

8.04         Effect
of Waiver or Consent.  A
waiver or consent, express or implied, to or of any breach or default by any
Person in the performance by that Person of its obligations with respect to
this Agreement is not a consent or waiver to or of any other breach or default
in the performance by that Person of the same or any other obligations of that
Person with respect to this Agreement. 
Failure on the part of a Person to complain of any act of any Person or
to declare any Person in default with respect to this Agreement, irrespective
of how long that failure continues, does not constitute a waiver by that Person
of its rights with respect to that default until the applicable statute of
limitations period has run.

8.05         Amendment
or Modification.

(a)           Except as otherwise
provided in this Section 8.05, any amendment to this Agreement must be
proposed by CWEI and approved in writing by CWEI and at least a Majority in
Interest of the Participants within 90 days of its proposal to be effective.

(b)           CWEI may amend this
Agreement without the consent of any Participant (i) to remove or correct
any inconsistency, ambiguity or error contained herein, provided that such
amendment does not materially and adversely affect the Participants, (ii) to
reflect any Transfer or forfeiture of Interests pursuant to Sections 4.03
and 4.04 , (iii) to amend Exhibit B from time to time to
amend the Area of Interest, or (iv) to amend Exhibit C from
time to time to add additional Wells to become subject to this Agreement.

(c)           Upon publication of final regulations
in the Federal Register (or other official pronouncement), CWEI shall have the
authority, without any requirement for consent by any Participant, to amend
this Agreement to the extent CWEI determines, in its sole discretion, is
necessary (a) to provide for the making and filing of any available election to
obtain the benefits of a safe harbor corresponding to that described under
proposed U.S. Treasury Regulations section 1.83-3(1) (or any similar provision)
under which the fair market value of an interest that is transferred in
connection with the performance of services is treated as being equal to the
liquidation value of that interest, and (b) to reflect the agreement of, and
the requirement that, the Tax Partnership and all of the Parties comply with
all of the requirements set forth in such regulations and Notice 2005-43 (and
any other guidance to a substantially similar effect provided by the IRS with
respect to such election) with respect to all interests transferred in
connection with the performance of services while the election remains
effective.

 

8.06         Binding
Effect.  Subject to the
restrictions on Transfers set forth in this Agreement, this Agreement is
binding on and inures to the benefit of the Parties and their respective
successors and assigns.

 11
 

 

8.07         Governing
Law; Severability.  THIS
AGREEMENT IS GOVERNED BY AND SHALL BE CONSTRUED IN ACCORDANCE WITH THE LAW OF
THE STATE OF TEXAS, EXCLUDING ANY CONFLICT OF LAWS RULE OR PRINCIPLE THAT MIGHT
REFER THE GOVERNANCE OR THE CONSTRUCTION OF THIS AGREEMENT TO THE LAW OF
ANOTHER JURISDICTION.  If any provision
of this Agreement or its application to any Person or circumstance is held
invalid or unenforceable to any extent, the remainder of this Agreement and the
application of that provision to other Persons or circumstances shall not be
affected and that provision shall be enforced to the fullest extent permitted
by law.

8.08         Further
Assurances.  In connection
with this Agreement and the transactions contemplated by it, each Party shall
execute and deliver any additional documents and instruments and perform any
additional acts that may be necessary or appropriate to effectuate and perform
the provisions of this Agreement and those transactions.

8.09         Waiver
of Certain Rights.  Except
for CWEI, each Party irrevocably waives any right it may have to maintain any
action for partition of the property of the Tax Partnership.

8.10         Insurance.  CWEI may purchase and maintain insurance or
enter into other arrangements on behalf of a Participant against any liability
asserted against the Participant and incurred by the Participant in that
capacity or arising out of this Agreement. 
In the absence of actual fraud, the judgment of CWEI as to the terms and
conditions of the insurance or other arrangement and the identity of the
insurer or other Person participating in an arrangement shall be conclusive,
and the insurance or other arrangement shall not be voidable and shall not
subject CWEI approving the insurance or other arrangement to liability, on any
ground, regardless of whether CWEI will be a beneficiary.

8.11         Indemnification.

(a)           CWEI agrees to indemnify and hold
harmless the Participants (each, an “Indemnified Person”) to the fullest extent permitted by law,
from and against all losses, costs, liabilities, damages, and expenses
(including, without limitation, costs of suit and attorneys’ fees) paid or
incurred in connection with or resulting from any and all claims, actions or
demands against such Indemnified Person that arise out of or in any way relate
to or are incidental to the Tax Partnership, the Designated Property or the
business or affairs of the Tax Partnership that occurs prior to the termination
of this Agreement; provided, however, that this indemnity shall
not extend to (i) any bad faith, willful misconduct, or gross negligence of
such Indemnified Person, or (ii) the failure of such Indemnified Person to
perform any of its obligations under this Agreement, including without limitation
obligations set forth in Sections  5.01, 5.04, and 5.06.  THE PARTIES INTEND THAT THE INDEMNIFIED
PERSONS BE INDEMNIFIED PURSUANT TO THIS AGREEMENT FROM LIABILITY FOR THEIR OWN
SOLE, PARTIAL OR CONCURRENT NEGLIGENCE.

(b)           The indemnification rights contained
in this Section 8.11 shall be cumulative
of and in addition to any and all other rights, remedies and recourses to which
any Indemnified Person or their respective heirs, personal representatives,
successors and assigns shall be entitled, whether pursuant to some other
provisions of this Agreement, at law or in equity.

 12
 

(c)           CWEI shall advance to any Indemnified
Person all reasonable fees, costs and expenses (including attorneys’ fees and
related costs), of defending any claim, action or demand that arises out of or
in any way relates to or is incidental to the Tax Partnership, the Designated
Property, business or affairs of the Tax Partnership that occurs during any
period in which such Indemnified Person is an employee of CWEI; provided,
that such Indemnified Person agrees in writing to repay to the Tax Partnership
all such advances in the event that it is finally determined that such
Indemnified Person is not entitled to indemnification hereunder with respect to
such claim, action or demand.

8.12         CWEI
Counsel.  CWEI has
selected Vinson & Elkins L.L.P. (“CWEI Counsel”) as legal counsel to it with respect to this
Agreement. Each Participant acknowledges that CWEI Counsel does not represent
such Participant, and that CWEI Counsel shall owe no duties directly to such
Participant.  Each Participant further
acknowledges that, whether or not CWEI Counsel has in the past represented or
is currently representing such Participant with respect to other matters, CWEI
Counsel has not advised or represented the interests of any Participant in the
negotiation, preparation, execution, delivery and performance of this
Agreement.

8.13         Power
of Attorney.  By the
execution of this Agreement, each Participant does irrevocably constitute and
appoint CWEI, with full power of substitution, as true and lawful
attorney-in-fact and agent with full power and authority to act in such
Participant’s name, place and stead and to execute all documents which such
attorney-in-fact deems necessary or reasonably appropriate in furtherance of
this Agreement.

8.14         Counterparts.  This Agreement may be executed in any number
of counterparts (including by facsimile transmission) with the same effect as
if all signing parties had signed the same document.  All counterparts shall be construed together
and constitute the same instrument.

8.15         No
Employment Contract. 
Nothing contained in this Agreement shall be construed as conferring
upon any Participant who is or may become an employee of CWEI or any Affiliate
of CWEI any right to continue in the employment of CWEI or any Affiliate of
CWEI for any period of time or interfere with or restrict in any way the rights
of CWEI or any Affiliate of CWEI or such Participant to terminate the
employment of such Participant at any time for any reason (or without any
reason) whatsoever, with or without cause. 
For the avoidance of doubt, any termination of a Participant’s
employment with CWEI shall not affect any of such Participant’s rights pursuant
to this Agreement.

8.16         Designation
of Wells.  Each of the
Parties hereby agrees that all Wells that are located within the Area of
Interest that are commenced after the date hereof and prior to the Cut-Off Date
shall be subject to this Agreement.  For
purposes of this Agreement, the “Cut-Off
Date” shall be the date that CWEI identifies in a written notice
delivered to each Participant indicating that no Wells within the Area of
Interest commenced after the Cut-Off Date will be made subject to this
Agreement.  Additionally, each Participant
acknowledges that certain circumstances may make it appropriate for CWEI to
deliver such a written notice to the Participants and to enter into agreements
similar to this Agreement with other parties (which may or may not include
certain of the Participants) that relate to Wells that are located in the Area
of Interest but are not subject to this Agreement.

 13
 

 

8.17         Acknowledgement
of 409A Issues.  Notwithstanding anything herein to the contrary, each
Participant (i) acknowledges that this Agreement and the underlying
transactions, as currently structured, may be considered to be a deferral of
compensation under section 409A of the Internal Revenue Code (“section 409A”) and (ii) agrees that CWEI may, in its own discretion and
upon its own initiative and without any action by or consent of the
Participants, if existing or future guidance from the Internal Revenue Service
or other interpretative authority indicates that such action is necessary or
advisable, modify this Agreement and/or restructure the transactions
contemplated by this Agreement in any manner CWEI determines is appropriate
under the circumstances in an effort to avoid any adverse tax consequences for
the Participants and/or CWEI that may otherwise be imposed by section 409A and
the Treasury Regulations thereunder, and the Participants hereby consent to any
such action that may be taken by CWEI and expressly ratify this Agreement as it
may be so amended.

[Signature
Pages Follow]

 14

IN WITNESS WHEREOF, the parties have executed this Participation
Agreement as of the Effective Date.

	
   

  	
   

  	
  CWEI:

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  CLAYTON WILLIAMS
  ENERGY, INC.

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
   

  	
  /s/ L. Paul Latham

  
	
   

  	
   

  	
   

  	
   

  	
  L. Paul Latham

  
	
   

  	
   

  	
   

  	
   

  	
  Executive Vice
  President

  

 

 

Exhibit A

Participants

 

	
  Participant

  	
   

  	
   

  	
   

  	
  Interests

  	
   

  	
   

  	
   

  
	
  Pat Reesby

  	
   

  	
   

  	
   

  	
  22.05

  	
  %

  	
   

  	
   

  
	
  Kelly Beckham

  	
   

  	
   

  	
   

  	
  11.03

  	
  %

  	
   

  	
   

  
	
  Kenneth Lipstreuer

  	
   

  	
   

  	
   

  	
  4.50

  	
  %

  	
   

  	
   

  
	
  Phil Amy

  	
   

  	
   

  	
   

  	
  5.00

  	
  %

  	
   

  	
   

  
	
  George Matthews

  	
   

  	
   

  	
   

  	
  2.50

  	
  %

  	
   

  	
   

  
	
  Sam Sheets

  	
   

  	
   

  	
   

  	
  2.50

  	
  %

  	
   

  	
   

  
	
  Martha Reesby

  	
   

  	
   

  	
   

  	
  2.00

  	
  %

  	
   

  	
   

  
	
  Dave Roberts

  	
   

  	
   

  	
   

  	
  1.67

  	
  %

  	
   

  	
   

  
	
  Chris Hanson

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Cheryl Strickland

  	
   

  	
   

  	
   

  	
  1.25

  	
  %

  	
   

  	
   

  
	
  Jana Craig

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Barbara Wynn

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Terri Lengfeld

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Tom Vinyard

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Jean Gathmann

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Patty Rohleder

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Paul Latham

  	
   

  	
   

  	
   

  	
  5.00

  	
  %

  	
   

  	
   

  
	
  Mel Riggs

  	
   

  	
   

  	
   

  	
  5.00

  	
  %

  	
   

  	
   

  
	
  Mark Tisdale

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Sam Lyssy

  	
   

  	
   

  	
   

  	
  2.00

  	
  %

  	
   

  	
   

  
	
  Greg Welborn

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Ron Gasser

  	
   

  	
   

  	
   

  	
  4.00

  	
  %

  	
   

  	
   

  
	
  Clarence Wolfshohl

  	
   

  	
   

  	
   

  	
  3.00

  	
  %

  	
   

  	
   

  
	
  Joe Stembridge

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  John Kennedy

  	
   

  	
   

  	
   

  	
  3.00

  	
  %

  	
   

  	
   

  
	
  Ron Ruetzel

  	
   

  	
   

  	
   

  	
  0.74

  	
  %

  	
   

  	
   

  
	
  Mike Pollard

  	
   

  	
   

  	
   

  	
  3.00

  	
  %

  	
   

  	
   

  
	
  Robert Thomas

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Kim Jones

  	
   

  	
   

  	
   

  	
  1.25

  	
  %

  	
   

  	
   

  
	
  Danny Alford

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Bob Langford

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Janet Hamilton

  	
   

  	
   

  	
   

  	
  0.62

  	
  %

  	
   

  	
   

  
	
  Kathy Schwope

  	
   

  	
   

  	
   

  	
  0.25

  	
  %

  	
   

  	
   

  
	
  Mark Smith

  	
   

  	
   

  	
   

  	
  0.25

  	
  %

  	
   

  	
   

  
	
  Dennis Polson

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Donnie Pruitt

  	
   

  	
   

  	
   

  	
  1.25

  	
  %

  	
   

  	
   

  
	
  Denise Kelly

  	
   

  	
   

  	
   

  	
  0.89

  	
  %

  	
   

  	
   

  
	
  Betsy Luna

  	
   

  	
   

  	
   

  	
  0.25

  	
  %

  	
   

  	
   

  
	
   

  	
   

  	
  Total

  	
   

  	
  100

  	
  %

  	
   

  	
   

  

 A-1

 

 

EXHIBIT B

AREA OF INTEREST

The Area of Interest
shall be the prospects located in the South Louisiana Parishes of Calcasieu,
Cameron, Iberia, Jefferson Davis, Acadia, Vermillion, West Baton Rouge, East
Baton Rouge, St. James, St. Charles, Orleans, Iberville, Livingston, Ascension,
Jefferson, St. Bernard, Plaquemines, St. John, Lafourche, Terrebonne,
Assumption, St. Martin and St. Mary, excluding prospects commonly referred to
as the Floyd Prospects located in Plaquemines Parish.

 B-1

 

SOUTH LOUISIANA IV

EXHIBIT C

Wells

 

	
  Well Name

  	
   

  	
  County, State

  
	
  Albert J Beshel #1 (Beshel)

  	
   

  	
  Plaquemines,
  LA

  
	
  Cobena #1

  	
   

  	
  Acadia,
  LA

  
	
   

  	
   

  	
   

  
	
  [Such other wells as may be
 added from time to time]

  	
   

  	
   

  

 

 

 C-1

 

Exhibit 10.1

EXHIBIT D

Allocations
of Profits and Losses and Other Tax Matters

 

ARTICLE I

TAX DEFINITIONS

Section 1.01           Definitions.  All capitalized terms used herein shall have
the meanings assigned to them in the Participation Agreement relating to South
Louisiana IV, dated March 1, 2006 (the “Agreement”), or as follows:

“Adjusted
Capital Account” means the Capital Account maintained for
each Party, (a) increased by any amounts that such Party is obligated to
restore or is treated as obligated to restore under Regulation Sections
1.704-1(b)(2)(ii)(c), 1.704-2(g)(1) and 1.704-2(i)(5)), and (b) decreased by
any amounts described in Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5) and
(6) with respect to such Party.

“Minimum
Gain” has the meaning assigned to that term in Regulation
Section 1.704-2(d).

“Partnership
Nonrecourse Liability” has the meaning assigned to that term
in Regulation Section 1.752-1(a)(2).

“Partner
Nonrecourse Debt” has the meaning assigned to that term in
Regulation Section 1.704-2(b)(4).

“Partner
Nonrecourse Deductions” has the meaning assigned to that term
in Regulation Section 1.704-2(i)(1).

“Simulated Basis” has the meaning set
forth in Section 5.01(b) of this Exhibit.

“Simulated Depletion” has the meaning set
forth in Section 5.01(b) of this Exhibit.

“Simulated Gain” has the meaning set forth
in Section 5.01(b) of this Exhibit.

“Simulated Loss” has the meaning set forth
in Section 5.01(b) of this Exhibit.

ARTICLE
II.

REFLECTION
OF ACTIVITIES FOR FEDERAL AND STATE TAX PURPOSES

Section 2.01           Entity Level Reflection of Activities.  For federal and state tax purposes, but
for no other purpose, all transactions effected by the Parties with respect to
the Designated Property pursuant to the Agreement shall be deemed to have been
effected through the Tax Partnership, rather than by the Parties individually,
as set out in this Article II.

 D-1
 

 

 

Section 2.02           Receipts, Profits, Income and Gains.  For purposes of applying the provisions
of this Exhibit D, all receipts by any Party in respect of the Designated
Property pursuant to the Agreement shall be deemed first to have been received
by the Tax Partnership and then to have been distributed to such Party by the
Tax Partnership in the manner specified in the Agreement.  All such items shall be taken into account in
computing the Tax Partnership’s gross income and gain or loss, as appropriate,
and shall be allocated among the Parties in accordance with Article III hereof.

Section 2.03           Costs, Expenses, Deductions and Losses.  For purposes of applying the provisions
of this Exhibit D, all costs incurred or payments made by any Party in
respect of the Designated Property pursuant to the Agreement shall be deemed
first to have been received by the Tax Partnership as a contribution by the
Party incurring the cost or making the payment pursuant to the terms of the
Agreement and then to have been paid, incurred or distributed by the Tax
Partnership to the payee or obligee of the cost or the recipient of the
payment.  All such items shall be taken
into account in computing the Tax Partnership’s basis, depreciation, depletion,
gross income, deductible expenses, and/or gain or loss, as appropriate, and
shall be allocated among the Parties in accordance with Article III hereof.

Section 2.04           Contributions and Distributions.  For purposes of applying the provisions
of this Exhibit D, contributions to the Tax Partnership (“Capital
Contributions”) shall include all Acquisition Costs, Well Costs, and any other
costs incurred or payments made in respect of the Designated Property pursuant
to the Agreement.  Similarly, for
purposes of applying the provisions of this Exhibit D, distributions
from the Tax Partnership shall include, in the case of any Party, all receipts
by such Party in respect of the Designated Property pursuant to the Agreement.

Section 2.05           Debt Financing.  For
purposes of applying the provisions of this Exhibit D, unless the
Parties agree otherwise and this Exhibit D is amended to reflect such
agreement, (a) all debt financing incurred by a Party shall be for the sole
account of that Party and shall not be considered debt financing of the Tax
Partnership, and (b) no Tax Partnership asset shall be acquired by assumption
of, or taking subject to, any debt financing.

Section 2.06           Record Title. 
For purposes of applying the provisions of this Exhibit D,  (a) all legal title to Designated Property
held by any Party shall be deemed to be held by such Party strictly as nominee
for the Tax Partnership, (b) all assignments made among the Parties with
respect to Designated Property prior to termination of the Tax Partnership
shall be disregarded, and (c) upon termination of the Tax Partnership each
Party holding record title to any Designated Property shall make such
assignments as are required to comply with the provisions of the Agreement.

ARTICLE III

ALLOCATIONS OF PROFIT AND
LOSS

Section 3.01           Allocations
for Capital Account and Tax Purposes.  Subject to Section 7.02 of the
Agreement and except as otherwise provided herein, for purposes of any
applicable 

 D-2
 

 

federal, state or
local income tax law, rule or regulation items of income, gain, deduction,
loss, credit and amount realized shall be allocated to the Parties as follows:

(a)         Income from the sale of oil or gas
production and any credits allowed by Section 29 of the Code relating
thereto shall be allocated in the same manner as proceeds therefrom are
allocated and credited pursuant to Section 5.02 of the Agreement.

(b)        Cost and percentage depletion deductions
and the gain or loss on the sale or other disposition of property the
production from which is subject to depletion (herein sometimes called “Depletable Property”)
as computed for tax purposes shall be taken into account separately by the
Parties rather than the Tax Partnership and, except to the extent and in the
manner provided in Section 5.01(b) of this Exhibit D, shall not
affect any Party’s Capital Account.  For
purposes of Section 613A(c)(7)(D) of the Code, the Tax Partnership’s
adjusted basis in each Depletable Property shall be allocated to the Parties in
proportion to each Party’s respective share of the costs and expenses which
entered into the Tax Partnership’s adjusted basis for each Depletable Property,
and the amount realized on the sale or other disposition of each Depletable
Property shall be allocated to the Parties in proportion to each Party’s
respective share of the proceeds from the sale or other disposition of such
property provided for in Section 5.02 of the Agreement.  For purposes of allocating amounts realized
upon any such sale or disposition which are deemed to be received for federal
or state income tax purposes and are attributable to Tax Partnership
indebtedness or indebtedness to which the Depletable Property is subject at the
time of such sale or disposition, such amounts shall be allocated in the same
manner as Partnership proceeds used for the repayment of such indebtedness
would have been allocated under Section 5.02 of the Agreement.

(c)         Items of deduction, loss and credit not
specifically provided for above (other than loss from the sale or other
disposition of Designated Property), including depreciation, cost recovery and
amortization deductions, shall be allocated to the Parties in the same manner
that the costs and expenses of the Tax Partnership that gave rise to such items
of deduction, loss and credit were allocated pursuant to Section 5.01 of
the Agreement.

(d)        Gain from the sale or other disposition
of Designated Property that is not specifically provided for above shall be
allocated to the Parties in a manner which reflects each Party’s allocable
share of the revenue from the sale of the Designated Property provided for in Section 5.02
of the Agreement, and loss from the sale or other disposition of Designated
Property that is not specifically provided for above shall be allocated to the
Parties in a manner which reflects each Party’s allocable share of the costs
and expenses of the Designated Property provided for in Section 5.01 of
the Agreement.

(e)         All recapture of income tax deductions
resulting from the sale or other disposition of Designated Property shall be
allocated to the Party to whom the deduction that gave rise to such recapture
was allocated hereunder to the extent that such Party is allocated any gain
from the sale or other disposition of such property.

(f)   Any other items of Tax Partnership income or
gain not specifically provided for above shall be allocated in the same manner
as the revenue that resulted in such income or gain is allocated and credited
pursuant to Section 5.02 of the Agreement.

 D-3
 

 

 

(g)        Notwithstanding any of the foregoing
provisions of this Section 3.01 to the contrary:

(i)   If during any fiscal year of the Tax
Partnership there is a net increase in Minimum Gain attributable to a Partner
Nonrecourse Debt that gives rise to Partner Nonrecourse Deductions, each Party
bearing the economic risk of loss for such Partner Nonrecourse Debt shall be
allocated items of Partnership deductions and losses for such year (consisting
first of cost recovery or depreciation deductions with respect to property that
is subject to such Partner Nonrecourse Debt and then, if necessary, a pro rata
portion of the Tax Partnership’s other items of deductions and losses, with any
remainder being treated as an increase in Minimum Gain attributable to Partner
Nonrecourse Debt in the subsequent year) equal to such Party’s share of Partner
Nonrecourse Deductions, as determined in accordance with applicable
Regulations.

(ii)  If for any fiscal year of the Tax Partnership
there is a net decrease in Minimum Gain attributable to Partnership Nonrecourse
Liabilities, each Party shall be allocated items of Tax Partnership income and
gain for such year (consisting first of gain recognized, including Simulated
Gain, from the disposition of Designated Property subject to one or more
Partnership Nonrecourse Liabilities and then, if necessary, a pro rata portion
of the Tax Partnership’s other items of income and gain, and if necessary, for
subsequent years) equal to such Party’s share of such net decrease (except to
the extent such Party’s share of such net decrease is caused by a change in
debt structure with such Party commencing to bear the economic risk of loss as
to all or part of any Partnership Nonrecourse Liability or by such Party
contributing capital to the Tax Partnership that the Tax Partnership uses to
repay a Partnership Nonrecourse Liability), as determined in accordance with
applicable Regulations.

(iii) If for any fiscal year of the Tax Partnership
there is a net decrease in Minimum Gain attributable to a Partner Nonrecourse
Debt, each Party shall be allocated items of Tax Partnership income and gain
for such year (consisting first of gain recognized, including Simulated Gain,
from the disposition of Designated Property subject to Partner Nonrecourse
Debt, and then, if necessary, a pro rata portion of the Tax Partnership’s other
items of income and gain, and if necessary, for subsequent years) equal to such
Party’s share of such net decrease (except to the extent such Party’s share of
such net decrease is caused by a change in debt structure or by the Tax
Partnership’s use of capital contributed by such Party to repay Partner
Nonrecourse Debt) as determined in accordance with applicable Regulations.

(h)        CWEI shall use all reasonable efforts to
prevent any allocation or distribution from causing a negative balance in a
Party’s Adjusted Capital Account. 
Consistent therewith, and notwithstanding any of the foregoing
provisions of this Section 3.01 of this Exhibit D to the
contrary, if for any fiscal year of the Tax Partnership the allocation of any
loss or deduction (net of any income or gain) to any Party would cause or
increase a negative balance in such Party’s Adjusted Capital Account as of the
end of such fiscal year (the “Deficit Party”) after taking into account the provisions of Section 3.01(g)
of this Exhibit D, only the amount of such loss or 

 D-4
 

 

deduction that reduces
the balance to zero shall be allocated to such Deficit Party and the remaining
loss or deduction shall be allocated to the Parties whose Adjusted Capital
Accounts have a positive balance remaining at such time (each, a “Positive Party”). 
After any such allocation, any Tax Partnership income or gain (including
Simulated Gain) that would otherwise be allocated to the Deficit Party shall be
allocated instead to the Positive Parties up to an amount equal to the Tax
Partnership loss or deduction allocated to each Positive Party under the
preceding sentence; provided, however, that no allocation of
income or gain realized shall be made under this sentence if the effect of such
allocation would be to cause the Adjusted Capital Account of the Deficit Party
to be less than zero.  If, after taking
into account the allocation in the first sentence of this Section 3.01(h),
the Adjusted Capital Account balance of the Deficit Party remains less than
zero at the end of a fiscal year, a pro rata portion of each item of Tax
Partnership income or gain (including Simulated Gain) otherwise allocable to
the Positive Parties for such fiscal year (or if there is no such income or
gain allocable to the Positive Parties for such fiscal year, all such income or
gain (including Simulated Gain) so allocable in the succeeding fiscal year or
years) shall be allocated to the Deficit Party in an amount necessary to cause
its Adjusted Capital Account balance to equal zero; provided, that no
allocation under this sentence shall have the effect of causing the Positive
Party’s Adjusted Capital Account to be less than zero.  After any such allocation, any Tax
Partnership gain (including Simulated Gain) resulting from the sale or other
disposition of Designated Property that would otherwise be allocated to the
Deficit Party for any fiscal year under this Section 3.01 shall be
allocated instead to the Positive Parties until the amount of gain so allocated
equals the amount of gain (including Simulated Gain) previously allocated to
such Deficit Party under the preceding sentence of this Section 3.01(h);
provided, however, that no allocation of gain (including
Simulated Gain) shall be made under this sentence if the effect of such
allocation would be to cause the Adjusted Capital Account of a Deficit Party to
be less than zero.

ARTICLE IV

OTHER TAX MATTERS

Section 4.01           Tax
Elections.

(a)           For tax purposes, the Tax Partnership
shall elect to use the calendar as its taxable year, and to report income and
loss under the accrual method of accounting.

(b)           In connection with any Transfer or
other assignment of an interest in the Tax Partnership permitted by the terms
and provisions of this Agreement, CWEI shall, at the written request of the
transferor, transferee or other successor, cause the Tax Partnership to make an
election to adjust the basis of the Tax Partnership’s property in the manner
provided in sections 734(b) and 743(b) of the Code (or any like statute or
regulation then in effect), and such transferor, transferee or other successor
shall pay all costs incurred by the Tax Partnership in connection therewith,
including, without limitation, reasonable attorneys’ and accountants’ fees.

(c)           Unless approved by the Participants,
the Tax Partnership shall not file any election pursuant to sections 761 or
7701 of the Code, section 301.7701-3 of the Regulations or otherwise, the
effect of which would cause the Tax Partnership not to be treated as a
partnership for Federal income tax purposes.

 D-5
 

 

 

(d)           Except as otherwise specifically
provided herein, CWEI shall have the sole and absolute discretion to make any
other available election under the Code on behalf of the Tax Partnership
without the prior approval by the Participants.

Section 4.02           Tax
Matters Partner.  CWEI is
hereby designated the “tax matters partner” of the Tax Partnership pursuant to
Section 6231(a)(7) of the Code.

ARTICLE V

CAPITAL ACCOUNT
MAINTENANCE

Section 5.01           Maintenance
of Capital Accounts.  An
individual Capital Account (a “Capital Account”) shall be maintained by the Tax Partnership
for each Party as provided below:

(a)           The Capital Account of each Party
shall, except as otherwise provided herein, be (A) credited by such Party’s
Capital Contributions when made (net of liabilities secured by contributed
property that the Tax Partnership is considered to assume or take subject to
under Section 752 of the Code), (B) credited with the amount of any item of
taxable income or gain and the amount of any item of income or gain exempt from
tax allocated to such Party, (C) credited with the Party’s share of Simulated
Gain as provided in Section 5.01(b) of this Exhibit D, (D)
debited by the amount of any item of tax deduction or loss allocated to such
Party, (E) debited with the Party’s share of Simulated Loss and Simulated
Depletion as provided in Section 5.01(b) of this Exhibit D,
(F) debited by such Party’s allocable share of expenditures of the Tax
Partnership not deductible in computing the Tax Partnership’s taxable income
and not properly chargeable as capital expenditures, including any
non-deductible book amortizations of capitalized costs, and (G) debited by the
amount of cash or the fair market value of any property distributed to such
Party (net of liabilities secured by such distributed property that such Party
is considered to assume or take subject to under Section 752 of the Code).  Immediately prior to any distribution of
assets by the Tax Partnership that is not pursuant to a liquidation of the Tax
Partnership or all or any portion of a Party’s interest therein, the Parties’
Capital Accounts shall be adjusted by (X) assuming that the distributed assets
were sold by the Tax Partnership for cash at their respective fair market
values as of the date of distribution by the Tax Partnership and (Y) crediting
or debiting each Party’s Capital Account with its respective share of the
hypothetical gains or losses, including Simulated Gains and Simulated Losses,
resulting from such assumed sales in the same manner as each such Capital
Account would be debited or credited for gains or losses on actual sales of
such assets.

(b)  The allocation of basis prescribed by Section
613A(c)(7)(D) of the Code and provided for in Section 3.01(b) of this Exhibit
D and each Party’s separately computed depletion deductions shall not
reduce such Party’s Capital Account, but such Party’s Capital Account shall be
decreased by an amount equal to the product of the depletion deductions that
would otherwise be allocable to the Tax Partnership in the absence of Section
613A(c)(7)(D) of the Code (computed without regard to any limitations which
theoretically could apply to any Party) times such Party’s percentage share of
the adjusted basis of the property (determined under Section 3.01(b) of this
Exhibit D) with respect to which such depletion is claimed (“Simulated Depletion”).  The Tax Partnership’s basis in any Depletable
Property as adjusted from time to time for the Simulated Depletion allocable to
all Parties (and where the context requires, each 

 D-6
 

 

Party’s allocable share
thereof, which share shall be determined in the same manner as the allocation
of basis prescribed in Section 3.01(b) of this Exhibit D) is herein
called “Simulated
Basis.”  No Party’s Capital
Account shall be decreased, however, by Simulated Depletion deductions
attributable to any Depletable Property to the extent such deductions exceed
such Party’s allocable share of the Tax Partnership’s remaining Simulated Basis
in such property.  The Tax Partnership
shall compute simulated gain (“Simulated Gain”) or simulated loss (“Simulated Loss”) attributable to
the sale or other disposition of a Depletable Property based on the difference
between the amount realized from such sale or other disposition and the
Simulated Basis of such property, as theretofore adjusted.  Any Simulated Gain shall be allocated to the
Parties and shall increase their respective Capital Accounts in the same manner
as the amount realized from such sale or other disposition in excess of
Simulated Basis shall have been allocated pursuant to Section 3.01(b) of
this Exhibit D.  Any Simulated Loss
shall be allocated to the Parties and shall reduce their respective Capital
Accounts in the same percentages as the costs of the property sold were
allocated up to an amount equal to each Party’s share of the Tax Partnership’s
Simulated Basis in such property at the time of such sale.

(c)  Any adjustments of basis of Designated
Property provided for under Sections 734 and 743 of the Internal Revenue Code
and comparable provisions of state law (resulting from an election under
Section 754 of the Code or comparable provisions of state law) and any election
by an individual Party under Section 59(e)(4) of the Code to amortize such
Party’s share of intangible drilling and development costs shall not affect the
Capital Accounts of the Parties (unless otherwise required by applicable
Treasury Regulations), and the Parties’ Capital Accounts shall be debited or
credited pursuant to the terms of this Section 5.01 as if no such
election had been made.

(d)  Capital Accounts shall be adjusted, in a
manner consistent with this Section 5.01, to reflect any adjustments in
items of Tax Partnership income, gain, loss or deduction that result from
amended returns filed by the Tax Partnership or pursuant to an agreement by the
Tax Partnership with the Internal Revenue Service or a final court decision.

(e)  In the case of property carried on the books
of the Tax Partnership at an amount which differs from its adjusted basis, the
Parties’ Capital Accounts shall be debited or credited for items of
depreciation, cost recovery, Simulated Depletion, amortization and gain or loss
(including Simulated Gain or Simulated Loss) with respect to such property
computed in the same manner as such items would be computed if the adjusted tax
basis of such property were equal to such book value, in lieu of the capital
account adjustments provided above for such items, all in accordance with
Regulation Section 1.704-1(b)(2)(iv)(g).

(f)   It is the intention of the Parties that the
Capital Accounts of each Party be kept in the manner required under Regulation
Section 1.704-1(b)(2)(iv).  To the extent
any additional adjustment to the Capital Accounts is required by such
regulations, CWEI is hereby authorized to make such adjustment after notice to
the Party.

[End of Exhibit D]

 

 D-7Exhibit 10.2

PARTICIPATION AGREEMENT

RELATING TO

NORTH LOUISIANA —
HOSSTON/COTTON VALLEY

This PARTICIPATION
AGREEMENT (this “Agreement”)
is made and entered into as of March 1, 2006 (the “Effective Date”), by and among
the Parties (as defined below).

FOR AND IN CONSIDERATION
OF the mutual covenants, rights, and obligations set forth in this Agreement,
the benefits to be derived from them, and other good and valuable
consideration, the receipt and the sufficiency of which are hereby
acknowledged, the Parties agree as follows:

ARTICLE I

DEFINITIONS

1.01         Certain
Definitions.  As used in this
Agreement, the following terms have the following meanings:

“Acquisition Costs” means (i) with respect
to any Designated Property relating to a Lease that was owned by CWEI
prior to the date such property became subject to this Agreement, the fair
market value of the portion of such Lease that is attributable to such
Designated Property as of the date it became subject to this Agreement, and
(ii) with respect to any Designated Property relating to a Lease that was
acquired by CWEI on or after the date such Designated Property became subject
to this Agreement, the portion of the costs of acquiring such Lease
(including, without limitation, direct costs of seismic data and interpretation,
lease broker services, title examinations, filing fees, and recording costs)
that is attributable to the Designated Property.

“Affiliate” means, when used with
reference to a specified Person, (a) any Person directly or indirectly owning,
controlling or holding power to vote 50% or more of the outstanding voting
securities of the specified Person, (b) any Person 50% or more of whose
outstanding voting securities are directly or indirectly owned, controlled or
held with power to vote by the specified Person, (c) any Person directly or
indirectly controlling, controlled by or under common control with the
specified Person, (d) if the specified Person is a corporation, any officer or
director of the specified Person or of any corporation directly or indirectly
controlling that specified Person, (e) if the specified Person is a
partnership, any general partner or if the general partner is a partnership,
the general partners of that partnership, and (f) if the specified Person is an
individual, such individual’s spouse and natural and adoptive lineal
descendants and trusts for the benefit of any such Persons.  For purposes of this definition, the ability
through share ownership or contractual arrangement to elect or cause the
election of a majority of the board of directors of a corporation shall
constitute “control.”

“Agreed Rate” means 4.54 % per annum.

 

 

“Agreement” means this
Participation Agreement, as amended or restated from time to time.

“Area of Interest” means the area
described in Exhibit B, as such may amended from
time to time by CWEI.

“Capital
Account” has the meaning set forth in Section 5.03.

“Code” means the Internal Revenue
Code of 1986, as amended.

“Contribution
Date” has the meaning set forth in Section 5.04(b).

“Contribution
Notice” has the meaning set forth in Section 5.04(b).

“CWEI” means Clayton Williams
Energy, Inc., a Delaware corporation.

“CWEI
Counsel” has the meaning set forth in Section 8.12.

“Designated
Property” means an undivided 5% of CWEI’s interests in the
Wells.

“Event
of Forfeiture” has the meaning set forth in Section 4.04.

“Indemnified Person” has the
meaning set forth in Section 8.11.

“Interest”
means an interest in Designated Property under this Agreement.  The number of Interests owned by each
Participant and the total number of Interests in this Agreement are set forth
on Exhibit A, as amended from time to time.

“Lease”
means a lease, mineral interest, royalty or overriding royalty, fee right,
mineral servitude, license, concession or other right covering oil, gas and
related hydrocarbons (or a contractual right to acquire such an interest) or an
undivided interest therein or portion thereof, together with all appurtenances,
easements, permits, licenses, servitudes and rights-of-way situated upon or
used or held for future use in connection with such an interest or the
exploration, development or production thereof, in each case, in the Area of
Interest.  A “Lease” shall also mean and
include all rights and interests in all lands and interests unitized or pooled
therewith pursuant to any law, rule, regulation or agreement.

“Majority in Interest” means a majority of the Interests held by
all Participants.

“Non-Contributing
Party” has the meaning set forth in Section 5.04(c).

“Operating
Agreement” means an
agreement between the operator and non-operating interest owners in a Lease for
the testing, development and operation of a tract of land or Lease for the
exploration and development of oil, gas, minerals or hydrocarbons.

“Party” means CWEI or any
Participant.

 2
 

 

 

“Participant” means each Person
listed as such on Exhibit A.

“Payout” means the earliest calendar month
during which CWEI shall have received cumulative cash proceeds relating to all
Designated Property (but only taking into account proceeds received with respect
to a Designated Property after such Designated Property became subject to this
Agreement) in an aggregate amount equal to the sum of (i) the Acquisition
Costs, Well Costs and other expenses incurred by CWEI relating to the
Designated Property, plus (ii) an annual internal rate of return on such costs
equal to the Agreed Rate.  For this
purpose, each proceed and expense shall be deemed to have been made on the last
day of the month during which it was received or made.

“Person” means an individual,
corporation, partnership, limited partnership, limited liability company,
business trust or other legal entity.

“Regulations” mean the regulations
promulgated by the United States Department of Treasury pursuant to the
Code.  All references herein to sections
of the Treasury Regulations shall include corresponding provision or provisions
of succeeding, similar, substitute, temporary or final Treasury Regulations.

“Tax
Partnership” means the relationship (constituting a tax
partnership for federal and applicable state law tax purposes) between the
Parties existing pursuant to this Agreement.

“Transfer” means any sale,
transfer, assignment, pledge, encumbrance, hypothecation, gift or disposition
of an Interest in whole or in part, or any rights or benefits to which a holder
of an Interest may be entitled as provided in this Agreement, including,
without limitation, the right to receive distributions in cash or in kind.

“Well” means a well in which CWEI holds a Working Interest derived from its
ownership of one or more Leases in the Area of Interest, as determined in
accordance with Section 8.16.  The
name and location of each “Well” is shown on Exhibit
C, as amended from time to time by CWEI.

“Well Costs” means CWEI’s share of
costs pursuant to any Operating Agreement for the drilling, completing,
equipping, deepening or sidetracking a Well, including, without
limitation:  (i) the costs of
surveying and staking the Well, the costs of any surface damages and the costs
of clearing, coring, testing, logging and evaluating the Well; (ii) the
costs of casing, cement and cement services for the Well; (iii) the cost
of plugging and abandoning the Well (including standard and customary
remediation activities associated therewith), if it is determined that the Well
would not produce in commercial quantities and should be abandoned; (iv) all
direct charges and overhead chargeable to CWEI with respect to the Well under
any applicable Operating Agreement until such time as all operations are
carried out as required by applicable regulations and sound engineering
practices to make such Well ready for production, including the installation
and testing of wellhead equipment, or to plug and abandon a dry hole;
(v) all costs incurred by CWEI in recompleting or plugging back any Well;
(vi) all costs 

 3
 

 

incurred
by CWEI in reworking any Well if the rework is covered by an authority for
expenditure under the applicable Operating Agreement; (vii) all costs incurred
by CWEI in locating, drilling, completing, equipping, deepening or sidetracking
any enhanced recovery producer or injector Well (including the costs of all
necessary surface equipment such as steam generators, compressors, water
treating facilities, injection pumps, flow lines and steam lines); and (viii)
the costs of constructing production facilities, pipelines and other facilities
necessary to develop property acquired pursuant to the terms hereof and
produce, collect, store, treat, deliver, market, sell or otherwise dispose of
oil, gas and other hydrocarbons and minerals therefrom; provided, that
Well Costs shall not include any Acquisition Costs.

“Working Interest” means an operating
interest in a Lease that permits CWEI to explore, develop and produce one or
more properties in the Area of Interest and bear its percentage of the costs
and expenses relating to the maintenance and development of and operations
relating to such properties.

1.02         Construction.  Whenever the context requires, the gender of
all words used in this Agreement includes the masculine, feminine and
neuter.  All references to Articles and
Sections refer to articles and sections of this Agreement, and all references
to exhibits are to Exhibits attached to this Agreement, each of which is made a
part of this Agreement for all purposes.

ARTICLE II

RELATIONSHIP OF THE PARTIES

2.01         Formation of Tax
Partnership; No Partnership for any Other Purpose.  This Agreement and its attachments are not
intended and shall not be construed to create a joint venture or other
partnership (general, limited, or otherwise) or association or to render the
Parties hereto liable as partners.  Each
of the Parties hereto hereby agrees that this Agreement creates a partnership
for United States federal and State income tax purposes only, which Tax Partnership
shall be deemed to own the Designated Property and shall function and exist as
set forth in Exhibit D attached hereto, which is hereby incorporated by
reference for all purposes of this Agreement. 
Furthermore, each of the Parties agrees that it shall not make an
election for the Tax Partnership to be excluded from the application of the
provisions of Subchapter K of Chapter 1 of Subtitle A of the Code (“Subchapter K”) or any similar provisions
of applicable state law; provided, however, that each Participant
acknowledges that CWEI may currently be, or may become in the future, party to
an Operating Agreement relating to one or more of the Leases and/or Wells that
requires each party thereto to make an election to be excluded from the
application of the provisions of Subchapter K and authorizes CWEI to make such
elections in the future on behalf of the Tax Partnership (as an entity) if
necessary to comply with the applicable Operating Agreement.

2.02         Purpose.  The purpose for which this Agreement is being
entered is to further align the interests of the Participants with those of
CWEI by permitting the Participants to participate with CWEI in the CWEI oil
and gas production (if any) developed, directly or indirectly, by CWEI and the
Participants.

 4
 

 

 

2.03         Term.  This Agreement shall commence on the
Effective Date and continue in effect until terminated in accordance with Section
7.01.

ARTICLE
III

MANAGEMENT OF LEASES AND WELLS

3.01         Authority of CWEI.  CWEI shall have the full and exclusive power
and authority to do any and all things necessary, incidental, proper, advisable
or convenient for the furtherance of developing the Leases and Wells on behalf
of the Tax Partnership, including without limitation:

(a)   to determine whether to
acquire, hold, develop or produce properties and other assets and whether, when
and on what terms to farm-out, sell, promote or otherwise transfer any
particular prospect, or any interest therein;

(b)   to make all decisions
concerning the desirability of payment, and the payment or supervision of
payment, of all delay rentals, shut-in royalty payments, minimum royalty
payments and any other similar or related payments;

(c)   to drill, complete, control,
rework, side-track, redrill, recomplete, produce, plug and/or abandon any or
all of the Wells;

(d)   to form and participate in
partnerships, joint ventures or other relationships that it deems desirable;

(e)   to make any expenditures and
incur any obligations it deems appropriate;

(f)    to acquire (including,
without limitation, to purchase at premium prices when deemed appropriate by
CWEI), exchange, sell, lease, or dispose of any or all Designated Property;

(g)    to negotiate, execute,
deliver and perform any contracts, conveyances or other instruments which it
considers appropriate for the implementation of its powers under this Agreement,
including, without limitation, Operating Agreements, unit Operating Agreements
and joint development agreements, and the right to make any and all elections
that are required or necessary under the terms of any agreements;

(h)   to borrow money, incur
indebtedness or make guaranties and to secure the same by mortgages, deeds of
trust, security interests, pledges or other liens or encumbrances on all or any
part of the Designated Property;

(i)    to acquire and maintain
such insurance, if any, for the benefit of the Parties as it deems appropriate;
and

(j)    to construct pipelines,
drilling and production platforms and facilities, gas plants, processing plants
and other facilities incidental to the development of the Area of Interest and
the production and marketing of oil and gas therefrom.

 5
 

 

 

(k)   to execute and deliver
division orders and transfer orders upon such terms and conditions and
containing such provisions as CWEI may consider appropriate; and

(l)    to control any matters
affecting the Designated Property including the conduct of litigation and other
incurring of legal expenses and the settlement of claims in litigation; provided,
that, CWEI shall not be authorized to settle any claims for which any
Participant has, or may have, any individual liability without the Participant’s
prior written consent.

3.02         Duties and Services of
CWEI.  CWEI shall devote
such time and effort to the development of the Leases and Wells as it shall
deem appropriate.  The Parties
acknowledge and agree that neither CWEI nor any Affiliate thereof nor any of
their respective officers, directors, employees or agents shall be required to
devote full time to the development of the Leases and Wells and may from time
to time engage in and possess interests in other business ventures of any and
every type and description, independently or with others, including without
limitation, the ownership, acquisition, exploration, development, operation and
management of oil and gas properties and oil and gas drilling programs, and
that no Participant shall by virtue of this Agreement have any right, title,
interest or expectancy in or to such activities or ventures.

3.03         Operating Agreements.  CWEI shall
use its reasonable efforts to enter into, and act in accordance with the
provisions of, all applicable Operating Agreements relating to any Lease or Well.  Following termination of this Agreement, each
Party agrees to become a party to all Operating Agreements in which CWEI serves
as operator, and further agrees to use its reasonable efforts to become a party
to all other applicable Operating Agreements. 
To the extent any Party for any reason does not become a party to an
applicable Operating Agreement, such Party agrees to use its reasonable efforts
to act in accordance with the provisions of such Operating Agreement as if it
were a party to such Operating Agreement.

ARTICLE IV

ACCESS TO INFORMATION; TRANSFER RESTRICTIONS

4.01         Access to Information.  A Participant, on written request to CWEI
stating the purpose, may examine and copy, at any reasonable time, for any
proper purpose, and at the expense of the Participant, any information
regarding the business affairs and financial condition of any Designated
Property as is just and reasonable for the Participant to examine and copy.  Information provided to or obtained by a
Participant relating to Designated Property shall be used by such Participant
solely in furtherance of his or her interests hereunder and shall not be used
for any other purpose.  Participants
shall maintain the confidentiality of all such information and shall not
disclose such information to any other Person. 
If a Participant receives a request to disclose information relating to
the Designated Property or this Agreement under the terms of a subpoena,
investigative demand or order issued by a court or governmental agency, the
Participant shall promptly notify CWEI of the existence, terms and
circumstances surrounding such request, so that CWEI may seek a protective
order or confidential treatment of such information.

4.02         Transfer Restrictions.  Except as provided in Section 4.03, no Participant shall Transfer his
or her Interests without the prior written consent of CWEI.  Any attempted Transfer in violation of this Section 4.02 shall be null and void, and CWEI
shall refuse to recognize any such Transfer.

 6
 

 

 

4.03         Permitted Transfers;
Status as Assignee.  A
Participant may Transfer all or any portion of his or her Interests to his or
her spouse, parents or natural or adoptive lineal descendants, or to one or
more trusts or partnerships established exclusively for the benefit of his or
her spouse, parents or natural or adoptive lineal descendants; provided,
that any such permitted assignee shall receive and hold such rights subject to
the provisions of this Agreement, including, without limitation, the provisions
of this ARTICLE IV, and as a condition to such Transfer, shall execute
and deliver a written agreement with the Parties agreeing to be bound
hereby.  A Participant intending to
Transfer Interests pursuant to this Section 4.03 shall provide at least
10 days prior written notice of such proposed transfer to CWEI.

 

4.04         Forfeiture of Interests.  A Participant shall forfeit any and/or all of
his or her Interests held by such Participant if such Participant admits or
enters a plea of no contest to or is convicted of a felony or misdemeanor
offense against CWEI or any of its Affiliates (“Event of Forfeiture”).

4.05         Specific Performance.  The parties agree that each Party would be
irreparably damaged if any of the provisions of this ARTICLE IV are not
performed in accordance with their specific terms and that monetary damages
would not provide an adequate remedy in such event.  Accordingly, it is agreed that, in addition
to any other remedy to which they may be entitled, at law or in equity, CWEI
and any nondefaulting Participant shall be entitled to injunctive relief to
prevent breaches of the provisions of this ARTICLE IV and specifically to
enforce the terms and provisions hereof in any action instituted in any court
of competent jurisdiction.

ARTICLE V

SHARING, ALLOCATIONS AND DISTRIBUTIONS

5.01         Allocation of Costs and
Expenses.  All costs and
expenses, including Acquisition Costs and Well Costs, relating to the
Designated Property shall be shared as follows: (i) 100% to CWEI before Payout
and (ii) 1% to CWEI and 99% to the Participants after Payout, apportioned among
the Participants in proportion to the percentages listed on Exhibit A
attached hereto.

5.02         Allocation of Revenues.  All revenues relating to the Designated
Property shall be allocated as follows: (i) 100% to CWEI before Payout and (ii)
1% to CWEI and 99% to the Participants after Payout, apportioned among the
Participants in proportion to the percentages listed on Exhibit A
attached hereto.

5.03         Allocations for Capital Account
and Tax Purposes.  An
individual capital account (a “Capital
Account”) shall be established and maintained for each Participant
as provided in Exhibit D.  Subject
to Section 7.02(c), all items of income, gain, deduction, loss, credit
and amount realized shall be allocated to the Parties in accordance with the
provisions of Exhibit D.

 7
 

 

 

5.04         Funding of Costs and
Expenses.

(a)           The Parties agree to
pay timely the costs and expenses allocated and charged to them pursuant to Section
5.01 and elsewhere herein.

(b)           To the extent that
costs and expenses are allocated and charged to Participants pursuant to Section
5.01 and elsewhere in this Agreement, and not retained by CWEI from a
distribution to Participants pursuant to Section 5.05, CWEI shall send
written notice to the Participants (a “Contribution
Notice”) setting forth (i) the date on which such additional funds
shall be payable (the “Contribution Date”),
which date shall be not less than 10 days after the date of the Contribution
Notice, and (ii) the total amount of funds required to be paid by each
Participant pursuant to this Section 5.04.  The funds required of each Participant shall
be in proportion to the number of Interests held by such Participant.

(c)           If a Participant
does not pay timely the costs and expenses allocated and charged to such
Participant (a “Non-Contributing Party”)
at the time or in the manner provided in the Contribution Notice, CWEI, in its
sole discretion, may pay the costs and expenses that the Non-Contributing Party
failed to pay within 20 days after the Contribution Notice, in which case the
Non-Contributing Party, without further action on his or her part, shall be
deemed to have assigned to CWEI the economic rights to the Interests held by
the Non-Contributing Party pursuant to this Agreement, and CWEI, as the
assignee of the Non-Contributing Party and the holder of such Interests, shall
be entitled to receive all allocations of income, gain, loss, deduction, credit
or similar items, and all distributions, to which the Non-Contributing Party
would otherwise be entitled from and after the Contribution Date.  CWEI shall hold such Interests attributable
to the Non-Contributing Party until such time as CWEI, as the holder of such
Interests, shall have received distributions pursuant to Section 5.05 in
an aggregate amount equal to 200% of the additional funds paid by CWEI pursuant
to this Section 5.04(c), whereupon CWEI, without further action on its
part, shall be deemed to have re-assigned the economic rights to such Interests
to the Non-Contributing Party.  CWEI may
use the power of attorney set forth in Section 8.13 to reflect any
assignment pursuant to this Section 5.04(c).  Furthermore, a Non-Contributing Party shall
indemnify and hold harmless each other Party to the fullest extent permitted by
law, from and against the costs and expenses that the Non-Contributing Party
failed to pay, including any losses, costs, liabilities, damages, and expenses
(including, without limitation, costs of suit and attorneys’ fees) paid or
incurred in attempting to collect the costs that the Non-Contributing Party
failed to pay.

5.05         Distributions of Revenues.  Subject to Section 5.04(c), all
revenues relating to the Designated Property shall be distributed to the Party
to whom such revenues are allocated pursuant to Section 5.02; provided,
however, that CWEI shall, in lieu of issuing Contribution Notices, be
entitled to retain from any distribution to any Participant an amount necessary
to discharge the costs and expenses allocated to such Participant pursuant to Section
5.01 that remains unpaid; provided, further, that if Payout
would occur as a result of a distribution of cash funds to CWEI, such
distribution shall be deemed to constitute two distributions:  (i) the first distribution shall consist of
the amount of cash funds necessary to cause Payout to occur, and (ii) the
second distribution shall consist of the balance of the funds then distributed.

 8
 

 

 

5.06         Withholding Taxes.  CWEI shall at all times be entitled (but not
obligated) to make payments required to discharge any obligation of CWEI to
withhold or make payments to any governmental authority with respect to any
federal, state or local tax liability of any Participant for such taxes arising
out of such Participant’s interest in the Designated Property.  The amount of each such payment made by CWEI
with respect to any Participant shall be deducted from any distributions
otherwise payable to such Participant pursuant to this Agreement.  Notwithstanding anything contained in this
Agreement to the contrary, in the event CWEI fails to withhold any federal,
state or local taxes in respect of any Participant when required to do so
(including as a result of any change in law or interpretation thereof or
otherwise) any liability incurred by CWEI (including any interest and
penalties) as a result of such failure shall be borne by such Participant (and
charged to such Participant’s Capital Account), and such Participant shall
indemnify and hold harmless CWEI from and against any and all claims, demands,
liabilities, costs, damages and causes of action of any nature whatsoever
related to such withholding obligation.

ARTICLE VI

BOOKS AND RECORDS

6.01         Maintenance of Books and
Records.  The books of
account for the Tax Partnership shall be maintained on an accrual basis in
accordance with the terms of this Agreement, except that the Capital Accounts
of the Parties shall be maintained in accordance with Exhibit D.  The accounting year of the Tax Partnership
shall be the calendar year.

ARTICLE VII

TERMINATION

7.01         Termination.  This Agreement shall terminate on the first
to occur of the following:

(a)           the third
anniversary of Payout;

(b)           the
election of CWEI, in its sole discretion, to terminate this Agreement.

7.02         Distributions upon
Termination.  Upon termination
of this Agreement, CWEI shall distribute all Designated Property (or proceeds
therefrom) to the Parties as follows:

(a)           CWEI may sell any or all Designated
Property and other assets, including to Parties, and any resulting gain or loss
from each sale shall be computed and allocated to the Capital Accounts of the
Parties in accordance with Section 7.02(c);

(b)           With respect to all Designated
Property that has not been sold, the fair market value of such Designated
Property shall be determined by CWEI and any unrealized income, gain, loss, and
deduction inherent in such property that has not been reflected in the Capital
Accounts of the Parties previously shall be allocated among the Parties in
accordance with Section 7.02(c);

 9
 

 

 

(c)           All items of income, gain, loss and
deduction referred to in Sections 7.02(a) and (b) shall be allocated
among the Parties in such a manner as to cause, to the maximum extent possible,
the positive Capital Account balance of each Party to equal the distribution
such Party would receive if the distributions upon liquidation of the proceeds
described in Section 7.02(a) and proceeds equal in amount to the fair
market value of property described in Section 7.02(d) were made in
accordance with Section 5.05 of this Agreement;

(d)           Designated
Property (and proceeds therefrom) shall then be distributed among the Parties
in accordance with the positive Capital Account balances of the Parties, as
determined after taking into account all Capital Account adjustments for the
taxable year of the Tax Partnership during which the termination of this
Agreement occurs (other than those made by reason of distributions pursuant to
this clause (d)), and those distributions shall be made by the end of the
taxable year of the Tax Partnership during which the termination of this
Agreement occurs (or, if later, 90 days after the date of the liquidation);

(e)           It is intended that the distributions
made to each Party pursuant to this Section 7.02
be equal to the distributions to which such Party would be entitled if
liquidating distributions were made in accordance with Section
5.05 of this Agreement.  To
the extent the Parties’ positive Capital Account balances after application of
Section 7.02(c) do not correspond to the amounts of such intended
distributions, the allocations provided for in Exhibit
D for the taxable year in which the liquidation occurs shall be
adjusted, to the maximum extent possible, to produce Capital Account balances
which correspond to the amount of such intended distributions.

All distributions in kind
to the Participants shall be made subject to the liability of each distributee
for his, her or its allocable share of costs, expenses and liabilities
previously incurred or for which CWEI has committed prior to the date of
termination and those costs, expenses and liabilities shall be allocated to the
distributee under this Section 7.02. The distribution of cash or
property to a Participant in accordance with the provisions of this Section 7.02 constitutes a complete
distribution to the Participant of his, her or its Interests and all the
Designated Property and other assets and constitutes a compromise to which all
Parties have consented. To the extent that a Participant returns funds to CWEI,
it has no claim against any other Party for those funds.

7.03         Termination.
On completion of the distribution of Partnership assets as provided in this
Agreement, the Tax Partnership shall be considered terminated.

ARTICLE VIII

GENERAL PROVISIONS

8.01         Offset.  Whenever CWEI is to pay any sum to any Participant,
any amounts that Participant owes CWEI or its Affiliates may be deducted from
that sum before payment.

8.02         Notices.  All notices, requests or consents required or
permitted to be given under this Agreement must be in writing and shall be
considered as properly given if mailed by first class United States mail,
postage paid, and registered or certified with return receipt requested, or if
delivered to the recipient in person, by courier or by facsimile transmission.  Notices, requests and consents shall be sent
to a Participant at the address shown on its Signature Page for 

 10
 

 

Participants.  A Participant may
change its address by giving written notice to CWEI.  Any notice, request or consent to CWEI shall
be sent to CWEI at its principal place of business, to the attention of the
Executive Vice President and Chief Operating Officer.

 

8.03         Entire Agreement.  This Agreement constitutes the entire
agreement of the Parties relating to the Tax Partnership and the Designated
Property, and supersedes all prior contracts or agreements with respect
thereto, whether oral or written.

8.04         Effect of Waiver or
Consent.  A waiver or
consent, express or implied, to or of any breach or default by any Person in
the performance by that Person of its obligations with respect to this
Agreement is not a consent or waiver to or of any other breach or default in
the performance by that Person of the same or any other obligations of that
Person with respect to this Agreement. 
Failure on the part of a Person to complain of any act of any Person or
to declare any Person in default with respect to this Agreement, irrespective
of how long that failure continues, does not constitute a waiver by that Person
of its rights with respect to that default until the applicable statute of limitations
period has run.

8.05         Amendment or Modification.

(a)   Except as otherwise provided
in this Section 8.05, any amendment to this Agreement must be proposed
by CWEI and approved in writing by CWEI and at least a Majority in Interest of
the Participants within 90 days of its proposal to be effective.

(b)   CWEI may amend this
Agreement without the consent of any Participant (i) to remove or correct
any inconsistency, ambiguity or error contained herein, provided that such
amendment does not materially and adversely affect the Participants, (ii) to
reflect any Transfer or forfeiture of Interests pursuant to Sections 4.03
and 4.04 , (iii) to amend Exhibit B from time to time to
amend the Area of Interest, or (iv) to amend Exhibit C from
time to time to add additional Wells to become subject to this Agreement.

(c)           Upon publication of final regulations
in the Federal Register (or other official pronouncement), CWEI shall have the
authority, without any requirement for consent by any Participant, to amend
this Agreement to the extent CWEI determines, in its sole discretion, is
necessary (a) to provide for the making and filing of any available election to
obtain the benefits of a safe harbor corresponding to that described under
proposed U.S. Treasury Regulations section 1.83-3(1) (or any similar provision)
under which the fair market value of an interest that is transferred in
connection with the performance of services is treated as being equal to the
liquidation value of that interest, and (b) to reflect the agreement of, and
the requirement that, the Tax Partnership and all of the Parties comply with
all of the requirements set forth in such regulations and Notice 2005-43 (and
any other guidance to a substantially similar effect provided by the IRS with
respect to such election) with respect to all interests transferred in
connection with the performance of services while the election remains
effective.

 

8.06         Binding Effect.  Subject to the restrictions on Transfers set
forth in this Agreement, this Agreement is binding on and inures to the benefit
of the Parties and their respective successors and assigns.

 11
 

 

 

8.07         Governing Law;
Severability.  THIS
AGREEMENT IS GOVERNED BY AND SHALL BE CONSTRUED IN ACCORDANCE WITH THE LAW OF
THE STATE OF TEXAS, EXCLUDING ANY CONFLICT OF LAWS RULE OR PRINCIPLE THAT MIGHT
REFER THE GOVERNANCE OR THE CONSTRUCTION OF THIS AGREEMENT TO THE LAW OF
ANOTHER JURISDICTION.  If any provision
of this Agreement or its application to any Person or circumstance is held
invalid or unenforceable to any extent, the remainder of this Agreement and the
application of that provision to other Persons or circumstances shall not be
affected and that provision shall be enforced to the fullest extent permitted
by law.

8.08         Further Assurances.  In connection with this Agreement and the
transactions contemplated by it, each Party shall execute and deliver any
additional documents and instruments and perform any additional acts that may
be necessary or appropriate to effectuate and perform the provisions of this
Agreement and those transactions.

8.09         Waiver of Certain Rights.  Except for CWEI, each Party irrevocably
waives any right it may have to maintain any action for partition of the
property of the Tax Partnership.

8.10         Insurance.  CWEI may purchase and maintain insurance or
enter into other arrangements on behalf of a Participant against any liability
asserted against the Participant and incurred by the Participant in that
capacity or arising out of this Agreement. 
In the absence of actual fraud, the judgment of CWEI as to the terms and
conditions of the insurance or other arrangement and the identity of the
insurer or other Person participating in an arrangement shall be conclusive,
and the insurance or other arrangement shall not be voidable and shall not
subject CWEI approving the insurance or other arrangement to liability, on any
ground, regardless of whether CWEI will be a beneficiary.

8.11         Indemnification.

(a)           CWEI agrees to indemnify and hold
harmless the Participants (each, an “Indemnified Person”) to the fullest extent permitted by law,
from and against all losses, costs, liabilities, damages, and expenses
(including, without limitation, costs of suit and attorneys’ fees) paid or
incurred in connection with or resulting from any and all claims, actions or
demands against such Indemnified Person that arise out of or in any way relate
to or are incidental to the Tax Partnership, the Designated Property or the
business or affairs of the Tax Partnership that occurs prior to the termination
of this Agreement; provided, however, that this indemnity shall
not extend to (i) any bad faith, willful misconduct, or gross negligence of
such Indemnified Person, or (ii) the failure of such Indemnified Person to
perform any of its obligations under this Agreement, including without
limitation obligations set forth in Sections  5.01, 5.04,
and 5.06.  THE PARTIES INTEND THAT
THE INDEMNIFIED PERSONS BE INDEMNIFIED PURSUANT TO THIS AGREEMENT FROM
LIABILITY FOR THEIR OWN SOLE, PARTIAL OR CONCURRENT NEGLIGENCE.

(b)           The indemnification rights contained
in this Section 8.11 shall be cumulative
of and in addition to any and all other rights, remedies and recourses to which
any Indemnified Person or their respective heirs, personal representatives,
successors and assigns shall be entitled, whether pursuant to some other
provisions of this Agreement, at law or in equity.

 12
 

 

 

(c)           CWEI shall advance to any Indemnified
Person all reasonable fees, costs and expenses (including attorneys’ fees and
related costs), of defending any claim, action or demand that arises out of or
in any way relates to or is incidental to the Tax Partnership, the Designated
Property, business or affairs of the Tax Partnership that occurs during any
period in which such Indemnified Person is an employee of CWEI; provided,
that such Indemnified Person agrees in writing to repay to the Tax Partnership
all such advances in the event that it is finally determined that such
Indemnified Person is not entitled to indemnification hereunder with respect to
such claim, action or demand.

8.12         CWEI Counsel.  CWEI has selected Vinson & Elkins L.L.P.
(“CWEI Counsel”)
as legal counsel to it with respect to this Agreement. Each Participant
acknowledges that CWEI Counsel does not represent such Participant, and that
CWEI Counsel shall owe no duties directly to such Participant.  Each Participant further acknowledges that,
whether or not CWEI Counsel has in the past represented or is currently
representing such Participant with respect to other matters, CWEI Counsel has
not advised or represented the interests of any Participant in the negotiation,
preparation, execution, delivery and performance of this Agreement.

8.13         Power of Attorney.  By the execution of this Agreement, each
Participant does irrevocably constitute and appoint CWEI, with full power of
substitution, as true and lawful attorney-in-fact and agent with full power and
authority to act in such Participant’s name, place and stead and to execute all
documents which such attorney-in-fact deems necessary or reasonably appropriate
in furtherance of this Agreement.

8.14         Counterparts.  This Agreement may be executed in any number
of counterparts (including by facsimile transmission) with the same effect as
if all signing parties had signed the same document.  All counterparts shall be construed together
and constitute the same instrument.

8.15         No Employment Contract.  Nothing contained in this Agreement shall be
construed as conferring upon any Participant who is or may become an employee
of CWEI or any Affiliate of CWEI any right to continue in the employment of
CWEI or any Affiliate of CWEI for any period of time or interfere with or
restrict in any way the rights of CWEI or any Affiliate of CWEI or such
Participant to terminate the employment of such Participant at any time for any
reason (or without any reason) whatsoever, with or without cause.  For the avoidance of doubt, any termination
of a Participant’s employment with CWEI shall not affect any of such
Participant’s rights pursuant to this Agreement.

8.16         Designation of Wells.  Each of the Parties hereby agrees that all
Wells that are located within the Area of Interest that are commenced after the
date hereof and prior to the Cut-Off Date shall be subject to this Agreement.  For purposes of this Agreement, the “Cut-Off Date” shall be the date that CWEI
identifies in a written notice delivered to each Participant indicating that no
Wells within the Area of Interest commenced after the Cut-Off Date will be made
subject to this Agreement.  Additionally,
each Participant acknowledges that certain circumstances may make it
appropriate for CWEI to deliver such a written notice to the Participants and
to enter into agreements similar to this Agreement with other parties (which
may or may not include certain of the Participants) that relate to Wells that
are located in the Area of Interest but are not subject to this Agreement.

 13
 

 

 

8.17         Acknowledgement of 409A Issues.  Notwithstanding
anything herein to the contrary, each Participant (i) acknowledges that this
Agreement and the underlying transactions, as currently structured, may be
considered to be a deferral of compensation under section 409A of the Internal
Revenue Code (“section 409A”) and (ii) agrees that CWEI may, in its own
discretion and upon its own initiative and without any action by or consent of
the Participants, if existing or future guidance from the Internal Revenue
Service or other interpretative authority indicates that such action is
necessary or advisable, modify this Agreement and/or restructure the
transactions contemplated by this Agreement in any manner CWEI determines is
appropriate under the circumstances in an effort to avoid any adverse tax
consequences for the Participants and/or CWEI that may otherwise be imposed by
section 409A and the Treasury Regulations thereunder, and the Participants
hereby consent to any such action that may be taken by CWEI and expressly
ratify this Agreement as it may be so amended.

[Signature
Pages Follow]

 14

 

IN WITNESS WHEREOF, the parties have executed this Participation
Agreement as of the Effective Date.

	
   

  	
   

  	
  CWEI:

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  CLAYTON WILLIAMS
  ENERGY, INC.

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
   

  	
   

  	
  By:

  	
   

  	
  /s/ L. Paul Latham

  
	
   

  	
   

  	
   

  	
   

  	
  L. Paul Latham

  
	
   

  	
   

  	
   

  	
   

  	
  Executive Vice
  President

  

 

 

 

Exhibit A

Participants

 

	
  Participant

  	
   

  	
   

  	
   

  	
  Interests

  	
   

  	
   

  	
   

  
	
  Pat Reesby

  	
   

  	
   

  	
   

  	
  20.00

  	
  %

  	
   

  	
   

  
	
  Kelly Beckham

  	
   

  	
   

  	
   

  	
  16.83

  	
  %

  	
   

  	
   

  
	
  Kenneth Lipstreuer

  	
   

  	
   

  	
   

  	
  5.00

  	
  %

  	
   

  	
   

  
	
  Phil Amy

  	
   

  	
   

  	
   

  	
  4.00

  	
  %

  	
   

  	
   

  
	
  George Matthews

  	
   

  	
   

  	
   

  	
  2.50

  	
  %

  	
   

  	
   

  
	
  Sam Sheets

  	
   

  	
   

  	
   

  	
  2.50

  	
  %

  	
   

  	
   

  
	
  Martha Reesby

  	
   

  	
   

  	
   

  	
  2.00

  	
  %

  	
   

  	
   

  
	
  Cheryl Strickland

  	
   

  	
   

  	
   

  	
  1.17

  	
  %

  	
   

  	
   

  
	
  Jana Craig

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Barbara Wynn

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Terri Lengfeld

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Tom Vinyard

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Chris Hanson

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Jean Gathmann

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Paul Latham

  	
   

  	
   

  	
   

  	
  5.00

  	
  %

  	
   

  	
   

  
	
  Mel Riggs

  	
   

  	
   

  	
   

  	
  5.00

  	
  %

  	
   

  	
   

  
	
  Mark Tisdale

  	
   

  	
   

  	
   

  	
  1.88

  	
  %

  	
   

  	
   

  
	
  Sam Lyssy

  	
   

  	
   

  	
   

  	
  2.00

  	
  %

  	
   

  	
   

  
	
  Greg Welborn

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Ron Gasser

  	
   

  	
   

  	
   

  	
  4.00

  	
  %

  	
   

  	
   

  
	
  Clarence Wolfshohl

  	
   

  	
   

  	
   

  	
  3.00

  	
  %

  	
   

  	
   

  
	
  John Kennedy

  	
   

  	
   

  	
   

  	
  3.00

  	
  %

  	
   

  	
   

  
	
  Ron Reutzel

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Mike Pollard

  	
   

  	
   

  	
   

  	
  3.00

  	
  %

  	
   

  	
   

  
	
  Robert Thomas

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Kim Jones

  	
   

  	
   

  	
   

  	
  1.25

  	
  %

  	
   

  	
   

  
	
  Danny Alford

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Bob Langford

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Janet Hamilton

  	
   

  	
   

  	
   

  	
  1.00

  	
  %

  	
   

  	
   

  
	
  Kathy Schwope

  	
   

  	
   

  	
   

  	
  0.25

  	
  %

  	
   

  	
   

  
	
  Mark Smith

  	
   

  	
   

  	
   

  	
  0.25

  	
  %

  	
   

  	
   

  
	
  Dennis Polson

  	
   

  	
   

  	
   

  	
  1.50

  	
  %

  	
   

  	
   

  
	
  Donnie Pruitt

  	
   

  	
   

  	
   

  	
  1.23

  	
  %

  	
   

  	
   

  
	
  Denise Kelly

  	
   

  	
   

  	
   

  	
  0.89

  	
  %

  	
   

  	
   

  
	
  Betsy Luna

  	
   

  	
   

  	
   

  	
  0.25

  	
  %

  	
   

  	
   

  
	
   

  	
   

  	
  Total

  	
   

  	
  100

  	
  %

  	
   

  	
   

  

 

 A-1

 

EXHIBIT B

AREA OF INTEREST

The Area of Interest shall be the prospects located in the Louisiana
Parishes of Caddo, Bossier, Webster, Claiborne, Lincoln, Union and Quachita, in
which the Hosston/Cotton Valley/Gray Sand Trend is the primary objective.

 B-1

 

NORTH LOUISIANA —
HOSSTON/COTTON VALLEY

EXHIBIT C

Wells

 

	
  Well Name

  	
   

  	
  County, State

  
	
  Weyerhaeuser #1 (Frazier Creek)

  	
   

  	
  Claiborne,
  LA

  
	
  Dugdale #1 (Choudrant)

  	
   

  	
  Lincoln,
  LA

  
	
   

  	
   

  	
   

  
	
  [Such other wells as may be

  added from time to time]

  	
   

  	
   

  

 

 

 C-1

 

Exhibit 10.2

EXHIBIT D

Allocations
of Profits and Losses and Other Tax Matters

ARTICLE I

TAX DEFINITIONS

Section 1.01           Definitions.  All capitalized terms used herein shall have
the meanings assigned to them in the Participation Agreement relating to North Louisiana
— Hosston/Cotton Valley, dated March 1, 2006 (the “Agreement”), or as follows:

“Adjusted
Capital Account” means the Capital Account maintained for
each Party, (a) increased by any amounts that such Party is obligated to
restore or is treated as obligated to restore under Regulation Sections
1.704-1(b)(2)(ii)(c), 1.704-2(g)(1) and 1.704-2(i)(5)), and (b) decreased by
any amounts described in Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5) and
(6) with respect to such Party.

“Minimum
Gain” has the meaning assigned to that term in Regulation
Section 1.704-2(d).

“Partnership
Nonrecourse Liability” has the meaning assigned to that term
in Regulation Section 1.752-1(a)(2).

“Partner
Nonrecourse Debt” has the meaning assigned to that term in
Regulation Section 1.704-2(b)(4).

“Partner
Nonrecourse Deductions” has the meaning assigned to that term
in Regulation Section 1.704-2(i)(1).

“Simulated Basis” has the meaning set forth in
Section 5.01(b) of this Exhibit.

“Simulated Depletion” has the meaning set forth in
Section 5.01(b) of this Exhibit.

“Simulated Gain” has the meaning set forth
in Section 5.01(b) of this Exhibit.

“Simulated Loss” has the meaning set forth
in Section 5.01(b) of this Exhibit.

ARTICLE
II.

REFLECTION
OF ACTIVITIES FOR FEDERAL AND STATE TAX PURPOSES

Section 2.01           Entity Level Reflection of Activities.  For federal and state tax purposes, but
for no other purpose, all transactions effected by the Parties with respect to
the Designated Property pursuant to the Agreement shall be deemed to have been
effected through the Tax Partnership, rather than by the Parties individually,
as set out in this Article II.

 D-1
 

 

 

Section 2.02           Receipts, Profits, Income and Gains.  For purposes of applying the provisions
of this Exhibit D, all receipts by any Party in respect of the
Designated Property pursuant to the Agreement shall be deemed first to have
been received by the Tax Partnership and then to have been distributed to such
Party by the Tax Partnership in the manner specified in the Agreement.  All such items shall be taken into account in
computing the Tax Partnership’s gross income and gain or loss, as appropriate,
and shall be allocated among the Parties in accordance with Article III hereof.

Section 2.03           Costs, Expenses, Deductions and Losses.  For purposes of applying the provisions
of this Exhibit D, all costs incurred or payments made by any Party in
respect of the Designated Property pursuant to the Agreement shall be deemed
first to have been received by the Tax Partnership as a contribution by the Party
incurring the cost or making the payment pursuant to the terms of the Agreement
and then to have been paid, incurred or distributed by the Tax Partnership to
the payee or obligee of the cost or the recipient of the payment.  All such items shall be taken into account in
computing the Tax Partnership’s basis, depreciation, depletion, gross income,
deductible expenses, and/or gain or loss, as appropriate, and shall be
allocated among the Parties in accordance with Article III hereof.

Section 2.04           Contributions and Distributions.  For purposes of applying the provisions
of this Exhibit D, contributions to the Tax Partnership (“Capital
Contributions”) shall include all Acquisition Costs, Well Costs, and any other
costs incurred or payments made in respect of the Designated Property pursuant
to the Agreement.  Similarly, for
purposes of applying the provisions of this Exhibit D, distributions
from the Tax Partnership shall include, in the case of any Party, all receipts
by such Party in respect of the Designated Property pursuant to the Agreement.

Section 2.05           Debt Financing.  For
purposes of applying the provisions of this Exhibit D, unless the
Parties agree otherwise and this Exhibit D is amended to reflect such
agreement, (a) all debt financing incurred by a Party shall be for the sole
account of that Party and shall not be considered debt financing of the Tax
Partnership, and (b) no Tax Partnership asset shall be acquired by assumption
of, or taking subject to, any debt financing.

Section 2.06           Record Title. 
For purposes of applying the provisions of this Exhibit D,  (a) all legal title to Designated Property
held by any Party shall be deemed to be held by such Party strictly as nominee
for the Tax Partnership, (b) all assignments made among the Parties with respect
to Designated Property prior to termination of the Tax Partnership shall be
disregarded, and (c) upon termination of the Tax Partnership each Party holding
record title to any Designated Property shall make such assignments as are
required to comply with the provisions of the Agreement.

ARTICLE III

ALLOCATIONS OF PROFIT AND
LOSS

Section 3.01           Allocations
for Capital Account and Tax Purposes.  Subject to Section 7.02 of the
Agreement and except as otherwise provided herein, for purposes of any
applicable 

 D-2
 

 

federal, state or
local income tax law, rule or regulation items of income, gain, deduction,
loss, credit and amount realized shall be allocated to the Parties as follows:

(a)           Income from the sale of oil or gas
production and any credits allowed by Section 29 of the Code relating
thereto shall be allocated in the same manner as proceeds therefrom are
allocated and credited pursuant to Section 5.02 of the Agreement.

(b)           Cost and percentage depletion
deductions and the gain or loss on the sale or other disposition of property
the production from which is subject to depletion (herein sometimes called “Depletable Property”)
as computed for tax purposes shall be taken into account separately by the
Parties rather than the Tax Partnership and, except to the extent and in the
manner provided in Section 5.01(b) of this Exhibit D, shall not
affect any Party’s Capital Account.  For
purposes of Section 613A(c)(7)(D) of the Code, the Tax Partnership’s
adjusted basis in each Depletable Property shall be allocated to the Parties in
proportion to each Party’s respective share of the costs and expenses which
entered into the Tax Partnership’s adjusted basis for each Depletable Property,
and the amount realized on the sale or other disposition of each Depletable
Property shall be allocated to the Parties in proportion to each Party’s
respective share of the proceeds from the sale or other disposition of such
property provided for in Section 5.02 of the Agreement.  For purposes of allocating amounts realized
upon any such sale or disposition which are deemed to be received for federal
or state income tax purposes and are attributable to Tax Partnership
indebtedness or indebtedness to which the Depletable Property is subject at the
time of such sale or disposition, such amounts shall be allocated in the same
manner as Partnership proceeds used for the repayment of such indebtedness
would have been allocated under Section 5.02 of the Agreement.

(c)           Items of deduction, loss and credit
not specifically provided for above (other than loss from the sale or other
disposition of Designated Property), including depreciation, cost recovery and
amortization deductions, shall be allocated to the Parties in the same manner
that the costs and expenses of the Tax Partnership that gave rise to such items
of deduction, loss and credit were allocated pursuant to Section 5.01 of
the Agreement.

(d)           Gain from the sale or other
disposition of Designated Property that is not specifically provided for above
shall be allocated to the Parties in a manner which reflects each Party’s
allocable share of the revenue from the sale of the Designated Property
provided for in Section 5.02 of the Agreement, and loss from the
sale or other disposition of Designated Property that is not specifically
provided for above shall be allocated to the Parties in a manner which reflects
each Party’s allocable share of the costs and expenses of the Designated
Property provided for in Section 5.01 of the Agreement.

(e)           All recapture of income tax
deductions resulting from the sale or other disposition of Designated Property
shall be allocated to the Party to whom the deduction that gave rise to such
recapture was allocated hereunder to the extent that such Party is allocated
any gain from the sale or other disposition of such property.

(f)            Any other items of Tax Partnership
income or gain not specifically provided for above shall be allocated in the
same manner as the revenue that resulted in such income or gain is allocated
and credited pursuant to Section 5.02 of the Agreement.

 D-3
 

 

 

(g)           Notwithstanding any of the foregoing
provisions of this Section 3.01 to the contrary:

(i)            If during any fiscal year of the Tax
Partnership there is a net increase in Minimum Gain attributable to a Partner
Nonrecourse Debt that gives rise to Partner Nonrecourse Deductions, each Party
bearing the economic risk of loss for such Partner Nonrecourse Debt shall be
allocated items of Partnership deductions and losses for such year (consisting
first of cost recovery or depreciation deductions with respect to property that
is subject to such Partner Nonrecourse Debt and then, if necessary, a pro rata
portion of the Tax Partnership’s other items of deductions and losses, with any
remainder being treated as an increase in Minimum Gain attributable to Partner
Nonrecourse Debt in the subsequent year) equal to such Party’s share of Partner
Nonrecourse Deductions, as determined in accordance with applicable
Regulations.

(ii)           If for any fiscal year of the Tax
Partnership there is a net decrease in Minimum Gain attributable to Partnership
Nonrecourse Liabilities, each Party shall be allocated items of Tax Partnership
income and gain for such year (consisting first of gain recognized, including
Simulated Gain, from the disposition of Designated Property subject to one or
more Partnership Nonrecourse Liabilities and then, if necessary, a pro rata
portion of the Tax Partnership’s other items of income and gain, and if
necessary, for subsequent years) equal to such Party’s share of such net
decrease (except to the extent such Party’s share of such net decrease is
caused by a change in debt structure with such Party commencing to bear the
economic risk of loss as to all or part of any Partnership Nonrecourse
Liability or by such Party contributing capital to the Tax Partnership that the
Tax Partnership uses to repay a Partnership Nonrecourse Liability), as
determined in accordance with applicable Regulations.

(iii)          If for any fiscal year of the Tax
Partnership there is a net decrease in Minimum Gain attributable to a Partner
Nonrecourse Debt, each Party shall be allocated items of Tax Partnership income
and gain for such year (consisting first of gain recognized, including
Simulated Gain, from the disposition of Designated Property subject to Partner
Nonrecourse Debt, and then, if necessary, a pro rata portion of the Tax
Partnership’s other items of income and gain, and if necessary, for subsequent
years) equal to such Party’s share of such net decrease (except to the extent
such Party’s share of such net decrease is caused by a change in debt structure
or by the Tax Partnership’s use of capital contributed by such Party to repay
Partner Nonrecourse Debt) as determined in accordance with applicable
Regulations.

(h)           CWEI shall use all reasonable efforts
to prevent any allocation or distribution from causing a negative balance in a
Party’s Adjusted Capital Account. 
Consistent therewith, and notwithstanding any of the foregoing
provisions of this Section 3.01 of this Exhibit D to the
contrary, if for any fiscal year of the Tax Partnership the allocation of any
loss or deduction (net of any income or gain) to any Party would cause or
increase a negative balance in such Party’s Adjusted Capital Account as of the
end of such fiscal year (the “Deficit Party”) after taking into account the provisions of Section 3.01(g)
of this Exhibit D, only the amount of such loss or 

 D-4
 

 

deduction that
reduces the balance to zero shall be allocated to such Deficit Party and the
remaining loss or deduction shall be allocated to the Parties whose Adjusted
Capital Accounts have a positive balance remaining at such time (each, a “Positive Party”). 
After any such allocation, any Tax Partnership income or gain (including
Simulated Gain) that would otherwise be allocated to the Deficit Party shall be
allocated instead to the Positive Parties up to an amount equal to the Tax
Partnership loss or deduction allocated to each Positive Party under the
preceding sentence; provided, however, that no allocation of
income or gain realized shall be made under this sentence if the effect of such
allocation would be to cause the Adjusted Capital Account of the Deficit Party
to be less than zero.  If, after taking
into account the allocation in the first sentence of this Section 3.01(h),
the Adjusted Capital Account balance of the Deficit Party remains less than
zero at the end of a fiscal year, a pro rata portion of each item of Tax
Partnership income or gain (including Simulated Gain) otherwise allocable to
the Positive Parties for such fiscal year (or if there is no such income or
gain allocable to the Positive Parties for such fiscal year, all such income or
gain (including Simulated Gain) so allocable in the succeeding fiscal year or
years) shall be allocated to the Deficit Party in an amount necessary to cause
its Adjusted Capital Account balance to equal zero; provided, that no
allocation under this sentence shall have the effect of causing the Positive
Party’s Adjusted Capital Account to be less than zero.  After any such allocation, any Tax
Partnership gain (including Simulated Gain) resulting from the sale or other
disposition of Designated Property that would otherwise be allocated to the
Deficit Party for any fiscal year under this Section 3.01 shall be
allocated instead to the Positive Parties until the amount of gain so allocated
equals the amount of gain (including Simulated Gain) previously allocated to
such Deficit Party under the preceding sentence of this Section 3.01(h);
provided, however, that no allocation of gain (including
Simulated Gain) shall be made under this sentence if the effect of such
allocation would be to cause the Adjusted Capital Account of a Deficit Party to
be less than zero.

ARTICLE IV

OTHER TAX MATTERS

Section 4.01           Tax
Elections.

(a)           For tax purposes, the Tax Partnership
shall elect to use the calendar as its taxable year, and to report income and
loss under the accrual method of accounting.

(b)           In connection with any Transfer or
other assignment of an interest in the Tax Partnership permitted by the terms
and provisions of this Agreement, CWEI shall, at the written request of the
transferor, transferee or other successor, cause the Tax Partnership to make an
election to adjust the basis of the Tax Partnership’s property in the manner
provided in sections 734(b) and 743(b) of the Code (or any like statute or
regulation then in effect), and such transferor, transferee or other successor
shall pay all costs incurred by the Tax Partnership in connection therewith,
including, without limitation, reasonable attorneys’ and accountants’ fees.

(c)           Unless approved by the Participants,
the Tax Partnership shall not file any election pursuant to sections 761 or
7701 of the Code, section 301.7701-3 of the Regulations or otherwise, the
effect of which would cause the Tax Partnership not to be treated as a partnership
for Federal income tax purposes.

 D-5
 

 

 

(d)           Except as otherwise specifically
provided herein, CWEI shall have the sole and absolute discretion to make any
other available election under the Code on behalf of the Tax Partnership
without the prior approval by the Participants.

Section 4.02           Tax
Matters Partner.  CWEI is
hereby designated the “tax matters partner” of the Tax Partnership pursuant to
Section 6231(a)(7) of the Code.

ARTICLE V

CAPITAL ACCOUNT
MAINTENANCE

Section 5.01           Maintenance
of Capital Accounts.  An
individual Capital Account (a “Capital Account”) shall be maintained by the Tax Partnership
for each Party as provided below:

(a)           The Capital Account of each Party
shall, except as otherwise provided herein, be (A) credited by such Party’s
Capital Contributions when made (net of liabilities secured by contributed
property that the Tax Partnership is considered to assume or take subject to
under Section 752 of the Code), (B) credited with the amount of any item of
taxable income or gain and the amount of any item of income or gain exempt from
tax allocated to such Party, (C) credited with the Party’s share of Simulated
Gain as provided in Section 5.01(b) of this Exhibit D, (D)
debited by the amount of any item of tax deduction or loss allocated to such
Party, (E) debited with the Party’s share of Simulated Loss and Simulated
Depletion as provided in Section 5.01(b) of this Exhibit D,
(F) debited by such Party’s allocable share of expenditures of the Tax
Partnership not deductible in computing the Tax Partnership’s taxable income
and not properly chargeable as capital expenditures, including any
non-deductible book amortizations of capitalized costs, and (G) debited by the
amount of cash or the fair market value of any property distributed to such
Party (net of liabilities secured by such distributed property that such Party
is considered to assume or take subject to under Section 752 of the Code).  Immediately prior to any distribution of
assets by the Tax Partnership that is not pursuant to a liquidation of the Tax
Partnership or all or any portion of a Party’s interest therein, the Parties’
Capital Accounts shall be adjusted by (X) assuming that the distributed assets
were sold by the Tax Partnership for cash at their respective fair market
values as of the date of distribution by the Tax Partnership and (Y) crediting
or debiting each Party’s Capital Account with its respective share of the
hypothetical gains or losses, including Simulated Gains and Simulated Losses,
resulting from such assumed sales in the same manner as each such Capital
Account would be debited or credited for gains or losses on actual sales of
such assets.

(b)           The allocation of basis prescribed by
Section 613A(c)(7)(D) of the Code and provided for in Section 3.01(b) of
this Exhibit D and each Party’s separately computed depletion deductions
shall not reduce such Party’s Capital Account, but such Party’s Capital Account
shall be decreased by an amount equal to the product of the depletion
deductions that would otherwise be allocable to the Tax Partnership in the
absence of Section 613A(c)(7)(D) of the Code (computed without regard to any
limitations which theoretically could apply to any Party) times such Party’s
percentage share of the adjusted basis of the property (determined under Section
3.01(b) of this Exhibit D) with respect to which such depletion is claimed
(“Simulated
Depletion”).  The Tax
Partnership’s basis in any Depletable Property as adjusted from time to time
for the Simulated Depletion allocable to all Parties (and where the context
requires, each 

 D-6
 

 

Party’s allocable
share thereof, which share shall be determined in the same manner as the
allocation of basis prescribed in Section 3.01(b) of this Exhibit D) is
herein called “Simulated
Basis.”  No Party’s Capital
Account shall be decreased, however, by Simulated Depletion deductions
attributable to any Depletable Property to the extent such deductions exceed
such Party’s allocable share of the Tax Partnership’s remaining Simulated Basis
in such property.  The Tax Partnership shall
compute simulated gain (“Simulated Gain”) or simulated loss (“Simulated Loss”) attributable to
the sale or other disposition of a Depletable Property based on the difference
between the amount realized from such sale or other disposition and the Simulated
Basis of such property, as theretofore adjusted.  Any Simulated Gain shall be allocated to the
Parties and shall increase their respective Capital Accounts in the same manner
as the amount realized from such sale or other disposition in excess of Simulated
Basis shall have been allocated pursuant to Section 3.01(b) of this Exhibit
D.  Any Simulated Loss shall be
allocated to the Parties and shall reduce their respective Capital Accounts in
the same percentages as the costs of the property sold were allocated up to an
amount equal to each Party’s share of the Tax Partnership’s Simulated Basis in
such property at the time of such sale.

(c)           Any adjustments of basis of
Designated Property provided for under Sections 734 and 743 of the Internal
Revenue Code and comparable provisions of state law (resulting from an election
under Section 754 of the Code or comparable provisions of state law) and any
election by an individual Party under Section 59(e)(4) of the Code to amortize
such Party’s share of intangible drilling and development costs shall not
affect the Capital Accounts of the Parties (unless otherwise required by
applicable Treasury Regulations), and the Parties’ Capital Accounts shall be
debited or credited pursuant to the terms of this Section 5.01 as if no
such election had been made.

(d)           Capital Accounts shall be adjusted,
in a manner consistent with this Section 5.01, to reflect any
adjustments in items of Tax Partnership income, gain, loss or deduction that
result from amended returns filed by the Tax Partnership or pursuant to an
agreement by the Tax Partnership with the Internal Revenue Service or a final
court decision.

(e)           In the case of property carried on
the books of the Tax Partnership at an amount which differs from its adjusted
basis, the Parties’ Capital Accounts shall be debited or credited for items of
depreciation, cost recovery, Simulated Depletion, amortization and gain or loss
(including Simulated Gain or Simulated Loss) with respect to such property
computed in the same manner as such items would be computed if the adjusted tax
basis of such property were equal to such book value, in lieu of the capital
account adjustments provided above for such items, all in accordance with
Regulation Section 1.704-1(b)(2)(iv)(g).

(f)            It is the intention of the Parties
that the Capital Accounts of each Party be kept in the manner required under
Regulation Section 1.704-1(b)(2)(iv).  To
the extent any additional adjustment to the Capital Accounts is required by
such regulations, CWEI is hereby authorized to make such adjustment after
notice to the Party.

[End of Exhibit D]

 

 D-7

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