CHAPTER 10 ENFORCING AND LITIGATING THE OPERATING AGREEMENT
| Jurisdiction | United States |
(Mar 2008)
ENFORCING AND LITIGATING THE OPERATING AGREEMENT
Phillip D. Barber, P.C.
Denver, Colorado
PHILLIP D. BARBER
Phil Barber graduated from Dartmouth College in 1975, magna cum laude, with distinction, and received his J.D. from the University of Colorado School of Law in 1979. His practice has focused on oil and gas law and natural resources and commercial litigation. He represents a variety of clients in the oil and gas industry, including exploration and production companies, and parties who own surface, mineral or overriding royalty interests. He is the editor/author of "Oil & Gas Practice in Colorado" for the Colorado Methods of Practice, and is a contributing author to the Federal Law of Oil and Gas Leasing. He speaks annually at the Short Course on Oil and Gas Law, presented by the Rocky Mountain Mineral Law Foundation in Houston, Texas and Boulder, Colorado.
You may contact him at phillipbarber@aol.com.
I. Overview of Rights and Duties Created A.A.P.L. Form 610-1989 Model Form Operating Agreement
A. JOA is a contract which creates rights and liabilities between the participants. Provisions in the JOA where disputes frequently occur:
1. Operator error:
a) Liability for failure to act as a reasonably prudent operator. See 41 Nat.Res.J. 23 (Winter 2001), Gary B. Conine, The Reasonable Operator Standard: Applications Beyond the Oil and Gas Lease.
b) Removal of Operator under Articles V.A. and B.
c) Claims of excessive costs and expenses of operation and development. Art. VI. A.-D. Compare Shell Rocky Mountain Production LLC v. Ultra Resources, Inc., 415 F.3d 1158 (10 th Cir. 2005) (Operator may be liable for "excessive costs" under Art. V.D. for simple breach of contract) with Stine v. Marathon Oil Co., 976 F.2d 254 (5 th Cir. 1992) (Operator not liable for any act as Operator except for gross negligence or willful misconduct).
i) Differentiate from AFE overruns. M&T, Inc. v. Fuel Resources Development Co., 518 F.Supp. 285 (D.Colo. 1981) (AFE only an "estimate" of well costs).
d) COPAS disputes.
i) Overhead charges.
ii) Business arrangements with "affiliates".
iii) Beware of different COPAS versions and variations such as PASO accounting procedures.
2. Access to records and test results. Art. V.D.5-7.
3. Abandonment of dry holes, wells that have produced, and plugging liability. Art. VI.E.
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a) Determining "financial capability" to indemnify other parties when well taken over.
b) Quantifying salvage value less estimated P&A costs.
4. Advances requested by Operator exercising its discretion per Article VII.C.
5. Surrender of leases without consent. Art. VIII.A.
a) Meaning of lease surrender (Art. VIII.A.) vs. lease termination. Surrender involves a voluntary act, as opposed to an involuntary loss of rights based upon express or implied lease terms. Law of Federal Oil and Gas Leases, §14.18, p. 14-27.
b) Thirty-day advance notice required. Quit claim assignment in exchange for payment of salvage value less P&A costs.
c) Duty to offer renewal or extension of leases to other parties. Art. VIII.B. Protection against a "wash out". Generally, Lowe, Oil and Gas Law (4 th Ed.) pp. 357-59.
6. Cottage litigation industry caused by preferential right to purchase interest, such as that found in Article VII.F. Generally, Williams Gas Processing v. Union Pacific Resources Company, et al., 25 P.3d 1064 (Wyo. 2001) (discussion of concepts applicable to preferential rights); Hutcherson v. Cronin, 426 S.W. 2 nd 638 (Tex. Civ. App. Tyler 1968) (acceptance of option must be identical to terms offered); Questar Energy Corporation v. Vantage Point Energy, 887 S.W.2d 217 (Tex.App. - Amarillo 1994) (preferential right not triggered by intercompany transfers).
7. Absent amendment to Article XIV.B, JOA is interpreted and enforced under law of the state in which the Contract Area is located. Forum conflict-of-laws decisions may apply. Article XIV.B. does not address.
8. "Other Provisions" set out in Article XVI which are not clearly drafted.
9. Conflicts between JOA and other basic agreements; purchase and sale contract, assignment, COPAS, etc. Absent statement in agreements, rules of contract construction will apply.
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a) Specific language prevails over general wording, negotiated terms prevail over boilerplate.
B. Duties governing relationships among parties to JOA.
1. JOA is a contract to be enforced based upon express duties in the agreement. Article VII.A. largely eliminates claims based on fiduciary duty, partnership, agency or confidential relationships.
" A. Liability of Parties: The liability of the parties shall be several, not joint or collective. Each party shall be responsible only for its obligations and shall be liable only for its proportionate share of the costs of developing and operating the Contract Area. Accordingly, the liens granted among the parties in Article VII.B. are given to secure only the debts of each severally, and no party shall have any liability to third parties hereunder to satisfy the default of any other party in the payment of any expense or obligation hereunder. It is not the intention of the parties to create, nor shall this agreement be construed as creating, a mining or other partnership, joint venture, agency relationship or association, or to render the parties liable as partners, co-venturers, or principals. In their relations with each other under this agreement, the parties shall not be considered fiduciaries or to have established a confidential relationship but rather shall be free to act on an arm's-length basis in accordance with their own respective self-interest, subject, however, to the obligation of the parties to act in good faith in their dealings with each other with respect to activities hereunder."
a) Exception for Operator's fiduciary duty to account for funds. Art. V.D.4.
2. Common law remedies for failure to perform will apply; e.g. breach of contract. Measure of damages is making party whole as if contract had been performed. Decker v. Browning-Ferris Indus., 947 P.2d 937 (Colo. 1997); Guardian Trust Co. v. Brothers, 59 S.W.2d 343 (Tex.App. 1933).
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a) Potential for punitive damages arising from claims for conversion and non-payment of funds, Ferguson v. Coronado Oil Co., 884 P.2d 971 (Wyo. 1994), or for statutory penalties, e.g. Wyoming Royalty Payment Act, W.S. §§30-5-301 et seq.
3. Article VII.A. creates an express duty of good faith and fair dealing which requires parties to act consistent with their agreed common purpose of the contract, and not in a way that would prevent another party from receiving contract benefits. See Amoco Oil Co. v. Ervin, 908 P.2d 493 (Colo. 1995) (covenant does not create new contract term, and applies when a party exercises discretion over specific contract provision). Some states suggest punitive damages may be awarded for willful and wanton breach of this duty. Wilder v. Cody County Chamber of Commerce, 868 P.2d 211 (Wyo. 1994) (limited to situations where there is a special fiduciary of confidential relationship). Doubtful that a "special relationship" can exist given language of Article VII.A.
C. Default by Operator or Non-Operator.
1. Liens and security interests. Article VII.B. creates a lien and security interest from each party to all other parties to the JOA, which includes a security interest in all real and personal property, and monies to be paid. See Andrau v. Michigan Wisconsin Pipeline Co., 712 P.2d 372 (Wyo. 1986) (Operator can foreclose lien on defaulting party's interest).
a) To perfect the lien, each party must sign and record the JOA or a recording supplement -- A.A.P.L. Form 610RS -- in county records. Serves as a security agreement and financing statement under a state's uniform commercial code rules. See Attachment "1" to paper.
b) Each party warrants that the lien granted by each party is "first and prior lien", although this will often not be the case due to prior loans and other commitments. Consider requesting subrogation from holders of prior liens against owner's interest.
c) Operator and Non-Operators have right to demand that each non-defaulting party pay its proportionate share of any amount owed by a defaulting party, which shall also be subject to security interests created by Article VII.B. Note potential increase in pro rata share of operations.
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2. Remedies for default under Art. VII.D. include:
a) Suspension of rights. If default not cured within 30 days after notice all rights created by JOA may be suspended. Includes right to participate in operations, right to receive information, and right to receive proceeds of production attributable to defaulting party.
b) Suit for damages. Non-defaulting parties (or Operator for their benefit) may sue for amounts in default plus interest as provided in COPAS (typically U.S. Treasury three-month discount rate plus 3%).
c) Deemed non-consent. Following 30-day cure period, notice of deemed non-consent for all further operations may be delivered to defaulting party.
d) Advance payment. Following 30-day cure period, advance payment from defaulting party for its anticipated share of expenses for any item may be required.
e) Costs and attorney fees. In any action to enforce a financial obligation created by the JOA, "the prevailing party in such action shall be entitled to recover all court costs, costs of collection, and a reasonable attorney's fee". Also secured by lien created in Art. VII.B.
II. Effect of Anti-Indemnity Statutes
Art. VII. of the JOA creates a contractual right for parties to sue other parties for their pro rata share of any obligation created by JOA. Carter Baron Drilling v. Badger Oil Corporation, 1985 U.S.Dist.LEXIS 21013...
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