Agreement Regarding Formation

AGREEMENT REGARDING FORMATION OF CORPORATION


by and among


SHERIDAN ENERGY, INC.


SHERIDAN CALIFORNIA ENERGY, INC.


CALPINE CORPORATION


and


CPN PRODUCTION COMPANY


dated as of


January 25, 1999


================================================================================


TABLE OF CONTENTS


PAGE
---- ARTICLE 1


DEFINITIONS................................................................... 1
Section 1.1 Certain Defined Terms.......................................... 1


ARTICLE 2


DFORMATION OF SCEI............................................................ 4
Section 2.1 Incorporation of SCEI.......................................... 4
Section 2.2 Capital Structure.............................................. 4
Section 2.3 Initial Board of Directors and Officers........................ 5
Section 2.4 Organizational Documents....................................... 5


ARTICLE 3


REPRESENTATIONS AND WARRANTIES OF SHERIDAN.................................... 6
Section 3.1 Corporate Existence............................................ 6
Section 3.2 Corporate Power and Authorization.............................. 6
Section 3.3 Binding Obligations............................................ 6
Section 3.4 No Violation................................................... 6
Section 3.5 Consents....................................................... 7
Section 3.6 Liens.......................................................... 7
Section 3.7 No Material Misstatements or Omissions......................... 7
Section 3.8 AHC Transactions............................................... 7
Section 3.9 Purchase for Investment........................................ 7
Section 3.10 Fees and Commissions........................................... 8
Section 3.11 Completeness of Schedules...................................... 8
Section 3.12 Representations and Warranties Regarding SCEI.................. 8


ARTICLE 4


REPRESENTATIONS AND WARRANTIES OF CPN......................................... 9
Section 4.1 Corporate Existence............................................ 9
Section 4.2 Corporate Power and Authorization.............................. 9
Section 4.3 Binding Obligations............................................ 9
Section 4.4 No Violation................................................... 9
Section 4.5 Purchase for Investment........................................ 10
Section 4.6 Fees and Commissions........................................... 10


TABLE OF CONTENTS
(Continued)


PAGE
---- ARTICLE 5


COVENANTS..................................................................... 10
Section 5.1 General........................................................ 10
Section 5.2 Full Access to Information..................................... 10
Section 5.3 Notice of Developments......................................... 10
Section 5.4 Special Covenants of Sheridan and SCEI......................... 11


ARTICLE 6


CLOSING CONDITIONS............................................................ 11
Section 6.1 Conditions to Obligation of Calpine............................ 11
Section 6.2 Conditions to Obligation of Sheridan........................... 13


ARTICLE 7


TERMINATION OF AGREEMENT...................................................... 14
Section 7.1 Termination.................................................... 14
Section 7.2 Effect of Termination.......................................... 15


ARTICLE 8


CLOSING MATTERS............................................................... 15
Section 8.1 Closing........................................................ 15


ARTICLE 9


MISCELLANEOUS................................................................. 15
Section 9.1 Mediation...................................................... 15
Section 9.2 Notices........................................................ 16
Section 9.3 Governing Law.................................................. 17
Section 9.4 Binding upon Successors and Assigns; No Assignment............. 17
Section 9.5 Severability................................................... 17
Section 9.6 Entire Agreement............................................... 17
Section 9.7 Amendment...................................................... 18
Section 9.8 No Waiver...................................................... 18
Section 9.9 Construction of Agreement...................................... 18
Section 9.10 Press Releases and Announcements; Transaction Costs............ 18
Section 9.11 Counterparts................................................... 18


AGREEMENT REGARDING FORMATION OF CORPORATION


THIS AGREEMENT REGARDING FORMATION OF CORPORATION (the "Agreement") is entered into as of the 25th day of January, 1999, by and among SHERIDAN ENERGY, INC., a Delaware corporation ("Sheridan"), SHERIDAN CALIFORNIA ENERGY, INC., a Delaware corporation ("SCEI"), CALPINE CORPORATION, a Delaware corporation (sometimes referred to herein as "Calpine Corporation") and CPN PRODUCTION COMPANY, a Delaware corporation (sometimes referred to herein as "CPN"). Calpine Corporation is a party to the Agreement solely for the purposes set forth in Section 2.2(d).


W I T N E S S E T H:
- - - - - - - - - -


Sheridan and Amerada Hess Corporation ("AHC") entered into a letter agreement dated November 9, 1998 (the "AHC Letter Agreement") that contemplated either (i) the formation of a limited liability company to own and operate certain oil and gas properties currently owned by AHC or (ii) the execution and delivery of an Agreement for Purchase and Sale in the form attached as Exhibit 1.1(a) (the "AHC Purchase Agreement"), in accordance with which Sheridan would acquire certain oil, gas and mineral leases, together with associated real and personal property and fixtures (collectively, the "AHC Properties") currently owned by AHC and located in the Sacramento Basin in California. Sheridan and AHC subsequently executed and delivered the AHC Purchase Agreement in substantially the form attached to AHC Letter Agreement. Sheridan has formed SCEI in which it is contemplated that Sheridan and CPN would own equity interests, and which has been formed for the purposes of acquiring Sheridan's rights under the AHC Purchase Agreement and owning and operating the Properties (hereinafter defined).


NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are acknowledged, the parties agree as follows:


ARTICLE 1


DEFINITIONS


SECTION 1.1 CERTAIN DEFINED TERMS. The following terms used in this Agreement have the meanings set forth below. Other terms are defined elsewhere in this Agreement.


"Administrative Services Agreement" shall mean the Administrative Services
--------------------------------- Agreement by and among Sheridan, SCEI and CPN, a form of which is attached hereto as Exhibit I.


"Affiliate" shall mean any Person who controls, is controlled by or is
--------- under common control with another Person. "Control," with respect to any Person, shall mean the power to direct the management and policies of such Person.


"AHC Contracts" shall mean the contracts and agreements included in the AHC
------------- Properties, or which SCEI will assume or otherwise become a party to or bound by as a result of the AHC Transactions or to which the AHC Properties are (or will be upon the closing of the AHC Transactions) subject, including but not limited to the Permitted Encumbrances (as defined in the AHC Purchase Agreement).


"AHC Properties" shall have the meaning set forth in the preamble to this
-------------- Agreement, and are more particularly described as the "Assets" in the AHC Purchase Agreement attached as Schedule 1.1(a).


"AHC Transactions" shall mean purchase by and sale to SCEI of the AHC
---------------- Properties pursuant to the AHC Purchase Agreement.


"Board of Directors" shall mean the Board of Directors of SCEI.
------------------


"Calpine Guarantee" shall mean the Calpine Guarantee by and between Calpine
----------------- Corporation and SCEI, a form of which is attached hereto as Exhibit J.


"Certificate of Designations" means the Certificate of Designations,
--------------------------- Preferences and Rights of Series N-A Preferred Stock relating to the CPN Preferred, a form of which is attached hereto as Exhibit A.


"Charter" means, for any Person, such Person's certificate of
------- incorporation, articles of incorporation or other organizational documents, as the same may be amended.


"Closing" shall have the meaning set forth in Section 8.1.
-------


"Closing Date" shall have the meaning set forth in Section 8.1.
------------


"Common Stock" means the common stock, par value $.01 per share, of SCEI .
------------


"CPN Preferred" shall mean the Series N-A Preferred Stock, par value $0.01
------------- per share of SCEI, having the rights, preferences, privileges and limitations set forth in the Certificate of Designations.


"Environmental Laws" shall mean any and all federal, state and local laws
------------------ including statutes, regulations, orders, ordinances, judgments, rulings and common law, relating to hazardous substances, pollution, naturally occurring radioactive materials or protection of the environment, including laws relating to actual or threatened emissions, discharges, or releases of pollutants, contaminants or hazardous substances, or other toxic materials or wastes into ambient air, surface water, groundwater or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants or hazardous substances or other toxic materials or wastes and specifically including without limitation, The Comprehensive Environmental Response, Compensation And Liability Act Of 1980, as amended


2


(42 U.S.C. (S)(S)9601 et. seq.), The Resource Conservation And Recovery Act of 1976 (42 U.S.C. (S)6901 et. seq.), The Clean Water Act (33 U.S.C. (S)(S)466 et. seq.), The Safe Drinking Water Act (14 U.S.C. (S)(S)1401-1450), The Hazardous Materials Transportation Act (49 U.S.C. (S)(S)1801 et. seq.), The Toxic Substance Control Act (15 U.S.C. (S)(S)2601-2629), The Clean Air Act (42 U.S.C. (S)7401 et. seq.) as amended, The Clean Air Act Amendments of 1990 and all state and local laws, and any replacement or successor legislation or regulation thereto.


"Gas Purchase Agreement" shall mean the Gas Purchase Agreement by and
---------------------- between Calpine Fuels Corporation and SCEI, a form of which is attached hereto as Exhibit G.


"Governmental Authority" means any foreign or domestic federal, state,
---------------------- county, municipal, or other governmental or regulatory authority, agency, board, body, commission, instrumentality, court, or any political subdivision thereof.


"Governmental Requirement" means any law, statute, code, ordinance, order,
------------------------ rule, regulation, judgment, decree, injunction, franchise, permit, certificate, license, authorization or other direction or requirement (including but not limited to any of the foregoing which relate to Environmental Laws, energy regulations and occupational, safety and health standards or controls) of any Governmental Authority.


"Knowledge" of a Person means the actual knowledge of such Person or
--------- information which such Person should have known following such reasonable investigations and inquiries as are appropriate to confirm the truth and accuracy in all material respects of the matters as to which a representation or warranty relates, and shall include in the case of a corporate entity the Knowledge (as aforesaid) of its President or any Vice President or any other officer.


"Lien" shall have the meaning given such term in the Senior Loan Facility.
----


"LOI" shall mean the letter of intent dated December 20, 1998 by and
--- between Sheridan and Calpine Corporation regarding the subject matter of this Agreement.


"Permit" shall mean any license, permit, exception, franchise,
------ accreditation, privilege, right, variance, waiver, approval or other authorization of, by or from Governmental Authorities necessary for the consummation of the transactions contemplated hereby or conduct of the business of SCEI as contemplated herein.


"Permitted Lien" shall have the meaning given such term in the Senior Loan
-------------- Facility.


"Person" means and includes any natural person, corporation, limited
------ partnership, general partnership, joint venture, association, company, trust, bank, trust company and other organization, whether or not a legal entity, any government and any agency and political subdivision thereof.


"Peterson Ranch Contracts" has the meaning ascribed to that term in Section
------------------------ 3.11.


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"Properties" shall mean the AHC Properties, the Sheridan Properties and
---------- such other interests in oil, gas and mineral fees and leaseholds as SCEI may deem appropriate to acquire from time to time.


"Senior Loan Facility" means that certain Credit Agreement by and among
-------------------- SCEI, as the borrower, and Bank One, Texas National Association ("Bank One"), as lender, and the other lenders from time to time parties thereto, in connection with the funding of the acquisition of the AHC Properties, with terms substantially the same as those set forth on the draft Credit Agreement between SCEI and Bank One attached hereto as Schedule 1.1(b).


"Sheridan Properties" shall mean Sheridan's interests in oil, gas and
------------------- mineral leases and associated real and personal property and fixtures located in the Sacramento Basin generally known as the Peterson Ranch properties, which are more particularly described in Exhibit B.


"Stock" shall mean and include all of the issued and outstanding Common
----- Stock or CPN Preferred.


"Stockholder" shall mean and include Sheridan, CPN and any other Person who
----------- now or hereafter owns Stock.


"Stockholders Agreement" shall mean the Stockholders Agreement by and among
---------------------- Sheridan, SCEI and CPN, a form of which is attached hereto as Exhibit F.


"Tax Sharing Agreement" shall mean the Tax Sharing Agreement by and between
--------------------- Sheridan and SCEI, a form of which is attached hereto as Exhibit H.


"Transaction Agreements" shall mean this Agreement, the Certificate of
---------------------- Designations, the Stockholders Agreement, the Administrative Services Agreement, the Gas Purchase Agreement, the Tax Sharing Agreement and the Calpine Guarantee.


ARTICLE 2


FORMATION OF SCEI


SECTION 2.1 INCORPORATION OF SCEI. Sheridan has incorporated SCEI for the principal purpose of exploring for, developing and producing oil, gas and other hydrocarbons from the Properties.


SECTION 2.2 CAPITAL STRUCTURE. (a) Generally. The authorized shares
--------- of SCEI are 5,000,000 shares of Common Stock and 5,000,000 shares of preferred stock. On or before the Closing Date, the Board of Directors of SCEI will designate 2,000,000 shares of preferred stock, as "Series N-A Preferred Stock" having such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, as shall be set forth in the Certificate of Designations and shall file the Certificate of Designations with the


4


Secretary of State of Delaware. On or before the Closing Date, 2,000,000 shares of Common Stock and 1,300,000 shares of Calpine Preferred shall be issued as follows: 1,600,000 shares of Common Stock to Sheridan (the "Sheridan Common Stock") and 400,000 shares of Common Stock (the "CPN Common Stock") to CPN, and 1,300,000 shares of the CPN Preferred to CPN, in consideration of the parties' contributions to the capital of SCEI pursuant to Sections 2.2(b) and 2.2(c) hereof.


(b) Common Stock Contributions. In consideration for the issuance
--------------------------
of the Sheridan Common Stock, Sheridan shall contribute a total of $7.6
million ("Sheridan's Equity Contribution"). Sheridan's Equity Contribution,
which shall be made on or before the Closing Date, shall consist of (i)
$3.0 million in cash, and (ii) the following assets, which the parties
agree have an aggregate value of $4.6 million: (A) the Sheridan Properties,
(B) Sheridan's rights under that certain Agreement to License the Use of
CGG Seismic Data dated May 4, 1998 by and between Georex, Inc. and SEI (the
"Seismic Data Agreement") and (C) Sheridan's rights under the AHC Letter
Agreement and the AHC Purchase Agreement. The assets described in Section
2.2(b)(ii) shall be conveyed to SCEI by an Assignment, Conveyance and Bill
of Sale in substantially the form of Exhibit C. Sheridan has made an
initial deposit of $5.8 million pursuant to the AHC Letter Agreement, $3.0
million of which shall be credited dollar-for-dollar to Sheridan's Equity
Contribution hereunder with the remainder of such deposit to be returned ...