CHAPTER 10 ENFORCING AND LITIGATING THE OPERATING AGREEMENT
| Jurisdiction | United States |
(Dec 2007)
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) Contractual 24-month limitation on dispute over expenditures. Period begins at end of calendar year in which expense is incurred. COPAS, Section 1.4. Applies unless there is a written statement questioning the correctness of the expenditure.
ii) Overhead disputes
iii) Conflicts between accounting procedures and basic agreements
2. Access to records and test results. Art. V.D.5-7.
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3. Abandonment of dry holes, wells that have produced, and plugging liability. Art. VI.E.
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) Surrender vs. termination.
b) Thirty-day advance notice required. Quit claim assignment in exchange for payment of salvage value less P&A costs.
6. 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.
7. Preferential right to purchase interest; applications and exclusions 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).
8. "Other Provisions" set out in Article XVI which are not clearly drafted.
B. Absent amendment to Article XIV.B, JOA is interpreted and enforced under law of the state in which the Contract Area is located.
1. Forum conflict-of-laws decisions may apply. Article XIV.B. does not address.
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C. Duties governing relationships among parties to JOA.
1. 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 is 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.
a) Implied duty of good faith and fair dealing does not create separate claim. See Amoco Oil Co. v. Ervin, 908 P.2d 493 (Colo. 1995) (covenant applies when a party exercises discretion over specific contract term). Some states permit punitive damages for breach of this duty.
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b) Potential for punitive damages arising from claims for conversion and non-payment, or for statutory penalties, e.g. Wyoming Royalty Payment Act, W.S. §§30-5-301 et seq.
D. 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.
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 owner's prior liens.
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.
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%).
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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
JOA would appear to create a right for parties to seek indemnification from all 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 (D.Colo. 1985) (Operator and non-party vendor allowed recovery from non-operators for default in payments). Consider whether contribution and indemnity can be required for liability based on tort or negligence.
A. Anti-Indemnity statutes may limit a party's ability to seek contribution for its negligent acts.
B. Case study using N.M. Stat. Ann. § 56-7-2 (2006).
1. §§56-7-2. Oil, gas or water wells and mineral mines; agreements, covenants and promises to indemnify void:
A. An agreement, covenant or promise, foreign or domestic, contained in, collateral to or affecting an agreement pertaining to a well for oil, gas or water, or mine for a mineral, within New Mexico, that purports to indemnify the indemnitee against loss or liability for damages arising from the circumstances specified in Paragraph (1), (2) or (3) of this subsection is against public policy and is void:
(1) the sole or concurrent negligence of the indemnitee or the agents or employees of the indemnitee;
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(2) the sole or concurrent negligence of an independent contractor who is directly responsible to the indemnitee; or
...(3) an accident that occurs in operations carried on at the direction or under the
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