CHAPTER 10 ARBITRATION AND JOINT OPERATING AGREEMENTS
| Jurisdiction | United States |
(Sep 2013)
ARBITRATION AND JOINT OPERATING AGREEMENTS
Partner, Norton Rose Fulbright *
Houston, Texas, USA
Mark Stadnyk
Counsel, Norton Rose Fulbright
Houston, Texas, USA
KEVIN O'GORMAN is a partner in Norton Rose Fulbright's arbitration, litigation, and international groups. He represents clients in international, energy, commercial, investor-state, and construction disputes. He also advises clients with respect to ongoing contractual relationships and contractual and treaty-based dispute resolution procedures. In addition to his client representation, Kevin regularly serves as arbitrator in domestic and international cases. Kevin is Co-Vice Chair of the Energy Arbitrators List Review Committee and serves on the board of the Houston International Arbitration Club. He previously chaired the Disputes Division and the International Arbitration Committee of the ABA Section of International Law, and served on its Council. He is an elected member of the Council of the State Bar of Texas Section of International Law. Kevin was formerly Team Leader and Senior Legal Secretary to the Claims Resolution Tribunal for Dormant Accounts in Zurich, Switzerland, which decided international claims against Swiss banks relating to Holocaust-era bank accounts. At the CRT, he supervised an international team of lawyers and was a member of the Tribunal's Policy Committee. After law school, Kevin clerked for the Honorable Howell Cobb, U.S. District Judge for the Eastern District of Texas. Kevin is admitted to practice in Texas, New York, and England and Wales (Solicitor). He is a Life Fellow of the American, Texas, and Houston Bar Foundations.
I. Introduction
A. General Purpose of JOAs
B. Economic Structure of JOAs
C. Duties (and Benefits) of the Operator
D. Relationship to Other Agreements
E. Contrast to Incorporated Joint Ventures
II. Leading JOA Model Forms
III. Typical JOA Dispute Resolution Clauses
A. Leading Model JOA Forms
B. Other Considerations and Selection of Arbitrators
C. Choice of Law in JOAs
IV. Types of Common JOA Disputes
A. Operator's Duties and Liability to the Non-Operators
1. Claims for Operator's Gross Negligence and the Exculpatory Clause
2. Defining Gross Negligence
3. Validity of JOA Indemnity Provisions
B. Relationship between the JOA Parties
C. Accounting Disputes and Cost Overruns
D. Consent/Non-Consent Operations
E. Transfer of Rights
F. Removal of Operator
G. Default
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I. Introduction
The Joint Operating Agreement, or "JOA," is a mainstay of modern complex oil and gas operations. This article identifies the typical structure and economic purpose of standard JOAs based on industry models, discusses JOA dispute resolution and choice of law issues, and provides an overview of common JOA disputes.
A. General Purpose of JOAs
The JOA governs the terms on which a mineral right, such as a hydrocarbons license, is shared and exercised in practice by its co-tenants. Many JOAs allocate participating interest shares in such assets between its parties. These participating interest shares affect the extent of the parties' stakes in costs, liabilities, and anticipated oil and gas production.
The JOA generally covers the major operational stages of a project: exploration, appraisal, development, production, and decommissioning.1 It details operational and financial responsibilities between a so-called operator and one or more non-operator(s) in accordance with each party's participating interest in the underlying asset. As Professors Smith and Weaver observe, "[t]he primary functions of the operating agreement are to designate one of the parties as the operator, describe the scope of the operator's authority, provide for the allocation of costs and production among the parties to the agreement, and provide for recourse among the parties if one or more default in their obligations."2 Thus, the JOA provides the contractual process for regulating the relationship between the parties involved. The JOA seeks to enhance certainty by defining the complex rights and obligations of the parties. It also identifies appropriate consequences and remedies for parties that act inconsistently with the JOA's terms. Both of these functions are crucial to the efficient operation of jointly-owned assets. Yet, implementing them in practice can lead to controversy, as will be discussed in the following sections.
B. Economic Structure of JOAs
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The JOA essentially allocates the financial burden for operations, as well as the stakes in anticipated profits and production, amongst the parties in accordance with their underlying participating interest shares in the project. At its core, it allows the parties to share the risks and costs associated with hydrocarbon exploration and development. It is a reality of contemporary operations that offshore deepwater exploration can entail costs of up to US$ 100 million per well, and development costs can run into the US$ billions.
The JOA facilitates exploration, development, and production. As Roberts explains, "there will be a significant frontloading of operating expenditure, associated principally with the activities of drilling, testing and conducting seismic surveys."3 The parties typically do not begin (if at all) to recover their initial expenditures until production. The JOA attempts to minimize the financial risks and uncertainty between the parties, in light of the delay between initial expenditure and anticipated recovery. In this way, its protections and framework provide a basis for parties to enter into long-term exploration and development with the expectation of eventual production.
Thus, the JOA defines and streamlines a complex and long-term relationship. For example, the 2012 Association of International Petroleum Negotiators ("AIPN") Model International JOA provides that it shall continue in force until the mineral rights or hydrocarbons concession terminates.4 In practice, many JOAs continue in effect between the same, or substantially similar, parties for decades.
Given this type of anticipated relationship, presumptive sharing of operational expenditures, production, and losses between parties in accordance with the parties' participating interests is at the heart of the JOA. This risk-sharing can be found in, for example, the AIPN 2012 Model International JOA, which states that "all the rights and interests in and under the Contract [with the host-state government], all Joint Property, and any Hydrocarbons produced
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from the Contract Area shall, subject to the terms of the Contract, be owned by the Parties in proportion to their respective Participating Interests."5 Similarly, the AIPN 2000 Accounting Procedure--an integral part of the Model International JOA--provides that the "Operator shall charge the Joint Account with all costs and expenditures incurred in connection with Joint Operations."6 The Accounting Procedure identifies a lengthy and non-exhaustive list of expenses chargeable to the Joint Account (and thus prima facie chargeable to each party in accordance with its participating interest share in the project). These include environmental remediation expenses7 and legal fees8 as well as "[a]ny other costs and expenditures incurred by Operator for the necessary and proper conduct of the Joint Operations in accordance with approved Work Programs and Budgets and not covered in this Section II or in Section III."9 The strong presumption in favor of sharing operational expenses is at the core of the JOA, and reflects its intended longevity between the same (or substantially similar) parties.
Yet, model JOAs are sensitive to the identity of their end-users. Long-term joint ownership of an asset under major legal systems generally would impose commercially undesirable obligations on the typically-sophisticated users of JOAs. As Smith argues, "[t]here is little question that--absent an operating agreement--two or more parties engaging in joint exploratory, drilling or similar activities would be deemed to have formed a joint venture and owe fiduciary duties to each other with respect to the venture. They would also have joint and several liability."10
Most model JOAs attempt to preclude (i) fiduciary relationships between the parties and (ii) joint and several liability of all parties. For example, the 2012 AIPN International Model JOA provides the following at Article 14.1:
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The rights, duties, obligations, and liabilities of the Parties under this Agreement shall be individual, not joint or collective. It is not the intention of the Parties to create, nor shall this Agreement be deemed or construed to create, a mining or other partnership, joint venture or association or (except as explicitly provided in this Agreement) a trust. This Agreement shall not be deemed or construed to authorize any Party to act as an agent, servant or employee for any other Party for any purpose whatsoever except as explicitly set forth in this Agreement. In their relations with each other under this Agreement, the Parties shall not be considered fiduciaries except as expressly provided in this Agreement.
This, and similar provisions in other model JOAs, are motivated essentially by preserving the arms-length commercial relationship between the parties. They are as important a part of the parties' economic bargain as the expenses and costs allocated between the parties in detail by the Accounting Procedure.
C. Duties (and Benefits) of the Operator
The day-to-day operation of the project is entrusted to the party designated in the JOA as the operator. As the 2012 AIPN Model International JOA recognizes, the operator "shall have exclusive charge of Joint Operations, and shall conduct all Joint Operations."11 Moreover, the operator may generally employ independent contractors, agents and in some cases its...
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