Document:

exhibitpasunny.htm

    
      

    

    PARTICIPATION
AGREEMENT

     

    RELATING
TO

     

    CWEI
EAST TEXAS BOSSIER-SUNNY

     

    This
PARTICIPATION AGREEMENT (this “Agreement”) is made and
entered into as of November 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 3.73% 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
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;

     

    (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

     

    
      
        
        

      

      
        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 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.

     

    8.08           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.

     

    
      
        
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        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.  The
first well subject to this agreement is the Sunny #1 Unit, Burleson County,
Texas.  Thereafter 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
follow]

     

    
      
        
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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

            
	 
      	 
      	 
      	 
      

    

    

     

    

     

    
      
        
          Participation
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          Signature
Page for Participation Agreement

        

         

      

      
         

        
          

        

      

      
         

      

    

    

      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.

              
	 
      	 
      	 
      	 
      

      

      

       

    

     

     

    

     

    
      
        
          Participation
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          Signature
Page for Participation Agreement

        

         

      

      
         

        
          

        

      

      
         

      

    

    Exhibit
A

    Participants

    

    
      	Participant            	 	 	
              Interest 

            
	
              Clayton
      Williams

            	 	 	28.5714	%
	
              Paul
      Latham

            	 	 	5.5357	%
	
              Mel
      Riggs

            	 	 	5.5357	%
	
              Sam
      Lyssy

            	 	 	10.3571	%
	
              Jeff
      Shultz

            	 	 	6.4286	%
	
              Greg
      Welborn

            	 	 	7.1429	%
	
              Ed
      Uzzell

            	 	 	3.5714	%
	
              Mark
      Tisdale

            	 	 	2.1429	%
	
              John
      Kennedy

            	 	 	5.0000	%
	
              Jim
      Wolfshol

            	 	 	2.8571	%
	
              Ron
      Gasser

            	 	 	3.5714	%
	
              Clarence
      Wolfshol

            	 	 	2.8571	%
	
              David
      Grafe

            	 	 	3.2143	%
	
              Joe
      Stembridge

            	 	 	3.2143	%
	
              Mike
      Pollard

            	 	 	1.9643	%
	
              Danny
      Alford

            	 	 	1.4286	%
	
              Janet
      Hamilton

            	 	 	0.5357	%
	
              Kim
      Jones

            	 	 	0.7143	%
	
              Robert
      Thomas

            	 	 	1.4286	%
	
              Willson
      Beebe

            	 	 	0.5357	%
	
              Kathy
      Schwope

            	 	 	0.5357	%
	
              Dennis
      Polson

            	 	 	0.7143	%
	
              Donnie
      Pruitt

            	 	 	0.7143	%
	
              Joe
      Roome

            	 	 	0.7143	%
	
              Denise
      Kelly

            	 	 	0.7143	%
	 
      	 	 	 	 
	 
      	 	 	 	 
	
              Total

            	 	100	%

    

    

    

    
      
        
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    EXHIBIT
B

     

    AREA
OF INTEREST

     

    The Area
of Interest shall be the prospects located in Burleson County,
Texas.

     

    Sunny
#1 Unit – 640.0 acres

    Burleson
County, Texas

    

    
      	
               
      

            	
              1.

            	
              Oil,
      Gas and Mineral Lease dated December 11, 2006 from Sunny Wilkens Ernst, as
      Lessor, and Clayton Williams Energy, Inc., as Lessee, recorded by
      Memorandum of Oil, Gas and Mineral Lease in Volume 707, Page 173, Official
      Records, Burleson County, Texas, covering 899.3 acres, more or less (CWEI
      Lease No. 212312-A)

            

    

     

    

     

    
      	
               
      

            	
              2.

            	
              Oil,
      Gas and Mineral Lease dated December 11, 2006 from Richard B. Wilkens,
      III, as Lessor, and Clayton Williams Energy, Inc., as Lessee, recorded by
      Memorandum of Oil, Gas and Mineral Lease in Volume 708, Page 44, Official
      Records, Burleson County, Texas, covering 883.0 acres, more or less (CWEI
      Lease No. 212312-B)

            

    

     

    

     

    

     

    
      
        
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    EXHIBIT
B

    

    

    [Exhibit
B consists of a map depicting two leases held by the Employer in Burleson
County, Texas.]

    

    
      
        
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    EXHIBIT
C

     

    

     

    Wells

     

    

     

    
      	
              Well
      Name

            	
               County,
      State

            
	
              Sunny
      #1 Unit

            	
              Burleson
      County, Texas

            
	 
      	 
      
	 
      	 
      
	
               [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 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:

     

    
      
        
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    (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 deduction that reduces the balance to
zero shall be allocated to such Deficit Party and the 

     

    
      
        
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    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)           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
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    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]

     

    

    
      
        
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EXHIBIT 4.1

AMENDMENT TO RIGHTS AGREEMENT

     This AMENDMENT (“Amendment”) is made and entered into as of the 17th day of November,
2008, by and between Transmeta Corporation, a Delaware corporation (the “Company”), and
Mellon Investor Services LLC, a New Jersey limited liability corporation, as rights agent (the
“Rights Agent”).

W I T N E S S E T H

     WHEREAS, the Company and the Rights Agent are parties to the Rights Agreement, dated as of
January 15, 2002 (as amended, the “Rights Agreement”);

     WHEREAS, it is proposed that the Company enter into an Agreement and Plan of Merger (the
“Merger Agreement”), dated as of November 17, 2008, by and among the Company, Novafora,
Inc., a Delaware corporation (“Parent”), and Transformer Acquisition LLC, a Delaware
limited liability company and wholly owned subsidiary of Parent (“Merger Sub”), pursuant to
which, among other things, the Company will merge with and into Merger Sub (the “Merger”);

     WHEREAS, the Board of Directors of the Company (the “Board”) has approved and adopted
the Merger Agreement;

     WHEREAS, in connection with the Merger and the Merger Agreement, certain directors and
officers (collectively, the “Stockholders”) contemplate entering into voting agreements
(the “Voting Agreements”) with Parent pursuant to which, among other things, the
Stockholders would agree to vote all shares of common stock, par value $0.00001 par value per
share, of the Company (the “Common Stock”) and all shares of Preferred Stock, $0.00001 par
value per share, of the Company (the “Preferred Stock”) held by such Stockholders in favor
of adoption of the Merger Agreement and to certain restrictions on the transfer of their shares of
Common Stock and Preferred Stock;

     WHEREAS, pursuant to Section 27 of the Rights Agreement, the Company may, by resolution of the
Board, from time to time, and the Rights Agent shall, if the Company directs, supplement or amend
the Rights Agreement without the approval of any holders of Rights (as defined in the Rights
Agreement) in order to, among other things, make any changes with respect to the Rights which the
Company may deem necessary or desirable, including, without limitation, to modify or amend the
definition of Acquiring Person set forth in Section 1(a) of the Rights Agreement;

     WHEREAS, no Distribution Date has yet occurred and there is not any Acquiring Person and the
Company hereby certifies to the Rights Agent that this Amendment is in compliance with Section 27
of the Rights Agreement;

     WHEREAS, the Board has determined that an amendment to the Rights Agreement as set forth
herein is necessary and desirable in connection with the foregoing and directs the Rights Agent to
execute and deliver this Amendment; and

 

 

     WHEREAS, capitalized terms used but not otherwise defined herein shall have the respective
meanings ascribed to such terms in the Rights Agreement.

     NOW, THEREFORE, in consideration of the premises and agreements set forth herein and in the
Rights Agreement, the parties hereto, intending to be legally bound, agree as follows:

     Section 1. Defined Terms. Section 1 of the Rights Agreement is hereby amended to add
thereto the following paragraphs (t), (u), (v), (w) and (x) which provide as follows:

“(t) “Merger” shall mean the merger of the Company with and into Merger Sub pursuant to the
terms of the Merger Agreement.

(u) “Merger Agreement” shall mean that certain Agreement and Plan of Merger, dated as of
November 17, 2008, by and among the Company, Parent and Merger Sub, as it may be amended from
time to time.

(v) “Parent” shall mean Novafora, Inc., a Delaware corporation.

(w) “Merger Sub” shall mean Transformer Acquisition LLC, a Delaware limited liability company.

(x) “Voting Agreements” shall mean the “Voting Agreements” as defined in the Merger Agreement,
as they may be amended from time to time.”

     Section 2. Amendment to Definition of Acquiring Person. The definition of “Acquiring
Person” set forth in Section 1(a) of the Rights Agreement is hereby amended and supplemented by
adding a new paragraph (C) to the end thereof to read in its entirety as follows:

“(C) Neither Parent nor any of its existing or future Affiliates or Associates shall be deemed
to be an Acquiring Person solely by virtue of (i) the approval, execution or delivery of the
Merger Agreement, (ii) the approval, execution or delivery of the Voting Agreements, (iii) the
public or other announcement of the Merger Agreement, the Voting Agreements or the
transactions contemplated thereby, (iv) the consummation of the Merger or (v) the consummation
of any other transaction contemplated by the Merger Agreement or the Voting Agreements.”

     Section 3. Amendment to Definition of Expiration Date. Section 7(a) of the Rights
Agreement is amended by deleting the word “or” immediately preceding clause (iii) and by adding the
following at the end of clause (iii):

     “or (iv) immediately prior to the Effective Time (as defined in the Merger Agreement)”

     Section 4. Termination of Merger Agreement. If for any reason the Merger Agreement is
terminated, then this Amendment shall be of no further force and effect and the Rights

2

 

Agreement
shall remain exactly the same as it existed immediately prior to the effectiveness of this
Amendment.

     Section 5. Effectiveness. This Amendment shall be deemed effective as of, and
immediately prior to, the execution and delivery of the Merger Agreement and the Company hereby
agrees to provide prompt written notice of such occurrence the Rights Agent. The Rights Agent
shall be fully protected in relying on any such notice or statement therein contained and shall
have no duty or liability with respect thereto, and shall not be deemed to have knowledge thereof,
unless and until it shall have received such notice. Except as amended by this Amendment, the
Rights Agreement shall remain in full force and effect and shall be otherwise unaffected by this
Amendment.

     Section 6. Severability. If any provision of this Amendment, or the application of
such provision to any person or circumstance, shall be held by a court of competent jurisdiction or
other authority to be invalid, illegal or unenforceable, the remainder of the provisions of this
Amendment shall remain in full force and effect and shall in no way be affected, impaired or
invalidated.

     Section 7. Counterparts. This Amendment may be executed in any number of counterparts,
and each of such counterparts shall for all purposes be deemed an original, but all such
counterparts shall together constitute but one and the same instrument.

     Section 8. Governing Law. This Amendment shall be deemed to be a contract made under
the laws of the State of Delaware and for all purposes shall be governed by and construed in
accordance with the laws of such state applicable to contracts made and to be performed entirely
within such state.

     Section 9. Waiver of Notice. The Company and the Rights Agent hereby waive any notice
requirement under the Rights Agreement pertaining to the matters covered by this Amendment.

     Section 10. Descriptive Headings. Descriptive headings of the several sections of this
Amendment are inserted for convenience only and shall not control or affect the meaning or
construction of any of the provisions of this Amendment.

[Signature Page Follows]

3

 

     IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of
the day and year first written above.

	 	 	 	 	 	 	 	 	 	 	 
	Attest:	 	 	 	Transmeta Corporation	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	By: 

Name:

	 	/s/ John O’Hara Horsley
 

John O’Hara Horsley
	 	 	 	By:

Name:
	 	/s/ Lester M. Crudele
 

Lester M. Crudele
	 	 
	Title:

	 	Executive Vice
President, General
Counsel & Secretary
	 	 	 	Title:
	 	President & CEO	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	Attest:	 	 	 	Mellon Investor Services LLC, as Rights Agent	 	 
	 
	 	 	 	 	 	 	 	 	 	 
	By: 

Name:

	 	/s/ Asa Drew
 

Asa Drew
	 	 	 	By:

Name:
	 	/s/ Sharon D. Magidson
 

Sharon D. Magidson
	 	 
	Title:

	 	Assistant Vice President
	 	 	 	Title:
	 	Assistant Vice President	 	 

[Signature Page to Amendment to Rights Agreement]

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