Document:

exhibitpart81208.htm

    
      

    

    Exhibit
10.1

     

    PARTICIPATION
AGREEMENT

     

    RELATING
TO

     

    CWEI
- SACRAMENTO BASIN I

     

    This
PARTICIPATION AGREEMENT (this “Agreement”) is made and
entered into as of August 5, 2008 (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
1

    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 4.04% per
annum.

     

    
      
        
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    “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 7% 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
II

    RELATIONSHIP
OF THE PARTIES

    

    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;

     

    (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

    
      
        
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    in
violation of this Section 4.02 shall be null and void, and CWEI shall refuse to
recognize any such Transfer.

    

    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, 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; or

    

    (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;

     

    (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;

     

    
      
        
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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 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 in 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 Patti Hollums.

     

    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.

     

    
      
        
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    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.

     

    8.07           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.

     

    8.08           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.

     

    8.09           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.

     

    
      
        
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    (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.

     

    
      
        
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    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
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    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

            
	 
      	 
      	 
      	 
      

    

    

     

    
      
        
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    SIGNATURE
PAGE FOR PARTICIPANT

     

    The
undersigned does hereby agree to all the terms and provisions of the
Participation Agreement, including, without limitation, the power of attorney
set forth in Section
8.13 thereof.

     

    
      	
              Date:

            	 
      	 
      	 
      
	 
      	 
      	 
      	
              Name
      of Participant

            
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	
              Signature

            
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	
              Address:                                                                

            
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	
              Fax:                                                                

            
	 
      	 
      	 
      	 
      
	 
      	 
      	 
      	
              Taxpayer
      I.D. No.

            
	 
      	 
      	 
      	 
      

    

    

     

    

     

    

     

    
      
        
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    Exhibit
A

    Participants

    

    

    
      	
              Participant

            	
              Interests

            
	
              Clayton
      W. Williams, Jr.

            	
              28.57%

            
	
              L.
      Paul Latham

            	
              7.14%

            
	
              Mel
      Riggs

            	
              25.73%

            
	
              Mark
      Tisdale

            	
              10.71%

            
	
              Mike
      Senich

            	
              9.64%

            
	
              Mark
      Heinen

            	
              9.64%

            
	
              Mike
      Pollard

            	
              3.57%

            
	
              Robert
      Thomas

            	
              2.50%

            
	
              Danny
      Alford

            	
              2.50%

            
	
              Total

            	
              100.00%

            

    

    

    
      
        
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    EXHIBIT
B

     

    AREA
OF INTEREST

     

    The Area
of Interest shall be the prospects located in the State of California, Counties
of Colusa, Yuba, Sutter, Yolo and Sacramento.

     

    
      
        
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    EXHIBIT
C

     

    

     

    Wells

     

    

     

    
      	
              Well
      Name

            	
              County,
      State

            
	 
      	 
      
	 
      	 
      
	 
      	 
      
	
               [Such
      other wells as may be

            	 
      
	
                 added
      from time to time]

            	 
      

    

    

     

    

     

    
      
        
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    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 CWEI Sacramento Basin I, dated August 5,
2008  (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.

     

    

    
      
        
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    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

     

    
      
        
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    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.

    
      
        
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    (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

    
      
        
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    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.

     

    
      
        
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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

     

    
      
        
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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]

     

     

     

     

    
      H:\DOCS\26639\60\SacBasI\PRTAGR08.DOC
                                                                
D-7ex4_1.htm

    Exhibit 4.1

    
 

    THESE
SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR THE SECURITIES LAWS OF ANY STATE AND MAY NOT BE SOLD OR OFFERED FOR
SALE IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES OR
AN OPINION OF COUNSEL OR OTHER EVIDENCE ACCEPTABLE TO THE COMPANY THAT SUCH
REGISTRATION IS NOT REQUIRED.

     

    FOCUS
ENHANCEMENTS, INC.

     

    COMMON
STOCK PURCHASE WARRANT

     

    1. Issuance; Certain
Definitions. For good and valuable consideration, the receipt of which is
hereby acknowledged by FOCUS
ENHANCEMENTS, INC., a Delaware corporation (the “Company”), R. Keith Fetter, or registered
assigns (the “Holder”) is hereby granted the right to purchase at any time until
5:00 P.M., New York City time, on June 20, 2013 (the “Expiration
Date”), 37,500 (thirty-seven
thousand five hundred) fully paid and non-assessable shares of the
Company’s Common Stock, $0.01 par value per share (the “Common Stock”), at an
initial exercise price  (the “Exercise Price”) of $0.50 (fifty cents) per share, subject to
further adjustment as set forth herein.  These shares are exercisable
immediately.

     

    2. Exercise of
Warrants.

     

    (a) This
Warrant is exercisable in whole or in part at any time and from time to
time.  Such exercise shall be effectuated by submitting to the Company
(either by delivery to the Company or by facsimile transmission as provided in
Section 8 hereof) a completed and duly executed Notice of Exercise
(substantially in the form attached to this Warrant) as provided in this
paragraph.  The date such Notice of Exercise is faxed to the Company
shall be the “Exercise Date,” provided that the Holder of this Warrant tenders
this Warrant Certificate to the Company within five (5) business days thereafter
and at the time of such Notice of Exercise the Company has received payment for
the shares being purchased.  The Notice of Exercise shall be executed
by the Holder of this Warrant and shall indicate the number of shares then being
purchased pursuant to such exercise.  Upon surrender of this Warrant
Certificate, together with appropriate payment of the Exercise Price for the
shares of Common Stock purchased, the Holder shall be entitled to receive a
certificate or certificates for the shares of Common Stock so
purchased.

     

    The
Exercise Price per share of Common Stock for the shares then being exercised
shall be payable in cash by wire, certified or official bank
check.  )     Alternatively,
at any time after issuance of the Warrant, the Warrant may also be exercised by
means of a “cashless exercise” in which the Holder shall be entitled to receive
a certificate for the number of shares of Common Stock  equal to the
quotient obtained by dividing [(A-B) multiplied by (X)] by (A),
where: 

    
      	
               
      

            	
              (A) = 
      the Market Price (as defined below) of one share of Common Stock on the
      date that the Holder delivers a complete Notice of Exercise Form to
      the Company as provided herein

            

    

    

    
      
        
           

        

        
           

          
            

          

        

        
           

        

      

    

    

    
      	
               
      

            	
               

            

    

    
      	
               
      

            	
              (B) = 
      the Exercise Price of this Warrant, as adjusted;
  and

            

    

    
      	
               
      

            	
               

            

    

    
      	
               
      

            	
              (X) = 
      the number of Common Stock issuable upon exercise of this Warrant in
      accordance with the terms of this Warrant by means of a cash exercise
      rather than a cashless exercise.

            

    

    

    (b)  
The term “Market Price” as of a particular date (the “Valuation Date”) shall
mean the following: (a) if the Common Stock is then listed or quoted on a
national securities exchange or Nasdaq (each, a  “trading market”),
the closing sale price of one share of Common Stock on such exchange on the last
trading day prior to the Valuation Date or, if no such closing sale price is
available, the average of the high bid and the low asked price quoted thereon on
the last trading day prior to the Valuation Date; (b) if the Common Stock
is not then listed or quoted on a trading market and if prices for the Common
Stock are then quoted on the OTC Bulletin Board or such similar exchange or
association, the closing sale price of one share of Common Stock on the OTC
Bulletin Board or such other exchange or association on the last trading day
prior to the Valuation Date or, if no such closing sale price is available, the
average of the high bid and the low asked price quoted thereon on the last
trading day prior to the Valuation Date; or (c) if the Common Stock is not
then listed or quoted on a trading market or quoted on the OTC Bulletin Board or
such other exchange or association, the fair market value of one share of Common
Stock as of the Valuation Date shall be determined in good faith by the Board of
Directors of the Company and the Holder.  If the Common Stock is not then
listed or quoted on a trading market or quoted on the OTC Bulletin Board or such
other exchange or association, the Board of Directors of the Company shall
respond promptly, in writing, to an inquiry by the Holder prior to the exercise
hereunder as to the fair market value of a share of Common Stock as determined
by the Board of Directors of the Company.  In the event that the Board of
Directors of the Company and the Holder are unable to agree upon the fair market
value in respect of subpart (c) hereof, the Company and the Holder shall
jointly select an appraiser, who is experienced in such matters.  The
decision of such appraiser shall be final and conclusive, and the cost of such
appraiser shall be borne equally by the Company and the Holder.  Such
adjustment shall be made successively whenever such a payment date is
fixed.

     

    (c) In no
event shall Holder exercise this Warrant for less than one thousand (1,000)
Warrant Shares unless the Holder has a Warrant for less than one thousand
(1,000) Warrant Shares, in which case Holder shall be required to exercise the
Warrant for all remaining Warrant Shares on the Exercise Date.

     

    (d) The
Holder shall be deemed to be the holder of the shares issuable to it in
accordance with the provisions of this Section 2 only on and after the Exercise
Date.

     

    3. Reservation of
Shares. At all times during the term of this Warrant the
Company  shall  reserve for issuance upon exercise of this
Warrant such number of shares of its Common Stock as shall be required for
issuance upon exercise of this Warrant (the “Warrant Shares”).

     

    

    
      
        
           

        

        
           

          
            

          

        

        
           

        

      

    

    

    

     

    4. Mutilation or Loss of
Warrant.  Upon receipt by the Company of evidence satisfactory
to it of the loss, theft, destruction or mutilation of this Warrant, and (in the
case of loss, theft or destruction) receipt of reasonably satisfactory
indemnification, and (in the case of mutilation) upon surrender and cancellation
of this Warrant, the Company will execute and deliver a new Warrant of like
tenor and date and any such lost, stolen, destroyed or mutilated Warrant shall
thereupon become void.

     

    5. Rights of the
Holder.  Until the Warrant is exercised in whole or in part,
the Holder shall not, by virtue hereof, be entitled to any rights of a
stockholder in the Company, either at law or equity, and the rights of the
Holder shall be limited to those expressed in this Warrant and are not
enforceable against the Company except to the extent set forth
herein.

     

    6. Adjustments.

     

    
      	
              6.1  

            	
              Adjustment
      Mechanism.  If an adjustment of the Exercise Price is
      required pursuant to this Section 6, the Holder shall be entitled to
      purchase such number of shares of Common Stock as will cause (i) the total
      number of shares of Common Stock Holder is entitled to purchase pursuant
      to this Warrant, multiplied by (ii) the adjusted Exercise Price per share,
      to equal (iii) the dollar amount of the total number of shares of Common
      Stock Holder is entitled to purchase before adjustment multiplied by the
      total Exercise Price immediately before
  adjustment.

            

    

     

    
      	
              6.2  

            	
              Capital
      Adjustments.  In case of any stock split or reverse stock
      split, stock dividend, reclassification of the Common Stock,
      recapitalization, merger or consolidation, or like capital adjustment
      affecting the Common Stock of the Company prior to the exercise of this
      Warrant or its applicable portion, the provisions of this Section 6 shall
      be applied as if such capital adjustment event had occurred immediately
      prior to the exercise date of this Warrant and the original Exercise Price
      had been fairly allocated to the stock resulting from such capital
      adjustment; and in other respects the provisions of this Section shall be
      applied in a fair, equitable and reasonable manner, as determined by the
      Company’s Board of Directors in its absolute discretion,  so as
      to give effect, as nearly as may be practicable, to the purposes
      hereof.

            

    

     

    
      	
              6.3  

            	
              Spin
      Off.  If, for any reason, prior to the exercise of this
      Warrant in full, the Company spins off or otherwise divests itself of a
      part of its business or operations or disposes all or of a part of its
      assets in a transaction (the “Spin Off”) in which the Company does not
      receive compensation for such business, operations or assets, but causes
      securities of another entity to be issued to Common Stock security holders
      of the Company, then the Company shall  notify the Holder at
      least twenty (20) days prior to the record date with respect to such
      Spin-Off.

            

    

     

    

    
      
        
           

        

        
           

          
            

          

        

        
           

        

      

    

    

    

     

    7. Transfer to Comply with the
Securities Act; Restriction on Sales; Registration Rights.

     

    
      	
              7.1  

            	
              Transfer.  This
      Warrant has not been registered under the Securities Act of 1933, as
      amended, (the “Act”) and has been issued to the Holder for investment and
      not with a view to the distribution of either the Warrant or the Warrant
      Shares.  Neither this Warrant nor any of the Warrant Shares or
      any other security issued or issuable upon exercise of this Warrant may be
      sold, transferred, pledged or hypothecated in the absence of an effective
      registration statement under the Act relating to such security or an
      opinion of counsel satisfactory to the Company that registration is not
      required under the Act.  Each certificate for the Warrant, the
      Warrant Shares and any other security issued or issuable upon exercise of
      this Warrant shall contain a legend on the face thereof, in form and
      substance satisfactory to counsel for the Company, setting forth the
      restrictions on transfer contained in this
  Section.

            

    

     

    
      	
              7.2  

            	
              Registration Rights.
      As set forth in Exhibit 1, Holder shall have piggy-back
      registration rights with respect to the Warrant Shares then held by the
      Holder or then subject to issuance upon exercise of this Warrant
      (collectively, the “Remaining Warrant
Shares”).

            

    

     

    8.  Notices.  Any
notice or other communication required or permitted hereunder shall be in
writing and shall be delivered personally (including by recognized courier),
sent by facsimile transmission, or sent by certified, registered or express
mail, postage pre-paid.  Any such notice shall be deemed given when so
delivered personally, or sent by facsimile transmission, or, if mailed, four (4)
days after the date of prepaid deposit in the United States mail, certified,
registered or overnight delivery as follows:

     

    if to the
Company, to:

     

    FOCUS
ENHANCEMENTS, INC.

    1370 Dell
Avenue

    Campbell,
California 95008

    ATTN:
Gary Williams, Chief Financial  Officer

    Telephone
No.: (408) 866-8300

    Facsimile
No.:  (408) 866-4795

    

    with a
copy to:

    

    Manatt,
Phelps & Phillips, LLP

    1001 Page
Mill Road, Bldg. 2

    Palo
Alto, California 94304

    Attn:
Jerrold F. Petruzzelli, Esq.

    Telephone
No.: (650) 812-1335

    Telecopier
No.: (650) 213-0260

    

    
      
        
           

        

        
           

          
            

          

        

        
           

        

      

    

    

    

    

    (ii) if
to the Holder, to:

    __________________________

    __________________________

    __________________________

    __________________________

    

    Fax
No.:

    __________________________

    

     

    Any party may give notice to the other
parties designated in accordance with this Section to change its respective
address or addressee for notices.

     

    9.   Supplements and Amendments;
Whole Agreement.  This Warrant may be amended or supplemented
only by an instrument in writing signed by the parties hereto.  This
Warrant contains the full understanding of the parties with respect to
its  subject matter, and there are no representations, warranties,
agreements or understandings other than expressly contained herein and
therein.

     

    10.           Governing
Law.  This Warrant shall be deemed to be a contract made under
the laws of the State of Delaware for contracts to be wholly performed in such
state and without giving effect to the principles thereof regarding the conflict
of laws.  Each of the parties consents to the jurisdiction of the
federal courts whose districts encompass any part of the State of California,
Santa Clara County in connection with any dispute arising under this Warrant and
hereby waives, to the maximum extent permitted by law, any objection, including
any objection based on forum
non conveniens, to the bringing of any such proceeding in such
jurisdictions.

     

    11.  Jury Trial
Waiver.  The Company and the Holder hereby waive a trial by
jury in any action, proceeding or counterclaim brought by either of the parties
hereto against the other in respect of any matter arising out or in connection
with this Warrant.

     

    12.  Counterparts.  This
Warrant may be executed in any number of counterparts and each of such
counterparts shall for all purposes be deemed to be an original, and all such
counterparts shall together constitute but one and the same
instrument.

     

    13.  Descriptive
Headings.  Descriptive headings of the several Sections of this
Warrant are inserted for convenience only and shall not control or affect the
meaning or construction of any of the provisions hereof.

     

    

    
      
         

        
           

          
            

          

        

         

      

    

    

    IN
WITNESS WHEREOF, the parties hereto have executed this Warrant as of the 20th
day of June, 2008.

     

    FOCUS ENHANCEMENTS,
INC.

     

    By: /s/ Gary
Williams

    

    Name:
Gary Williams

    Title:
EVP of Finance & CFO

    

    
      
        
           

        

        
           

          
            

          

        

        
           

        

      

    

    

    NOTICE OF
EXERCISE OF WARRANT

     

    The
undersigned hereby irrevocably elects to exercise the right, represented by the
Warrant Certificate dated as of  ,  , to purchase
  shares
of the Common Stock, $0.01 par value, of FOCUS ENHANCEMENTS, INC., and
tenders herewith payment in accordance with Section 1 of said Common Stock
Purchase Warrant.

    

     

    CASH:$                                                         =
  (Exercise Price x Exercise Shares)

     

    Payment
is being made by:

     

    

     

    _______                      enclosed
check

     

    _______                      wire
transfer

     

    _______                      other

     

    Please
deliver the stock certificate to:

    

    

    Dated:

    

    

    

    

    [Name of
Holder]

    

    By:

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