CHAPTER 12 OPERATIONS IN THE ABSENCE OF AN OPERATING AGREEMENT: CONSIDERATIONS UNDER STATE FORCE POOLING LAWS

• Jurisdiction: United States

Joint Operations and the New AAPL Form 610-2015 Model Form Operating Agreement (Dec 2017)
CHAPTER 12
OPERATIONS IN THE ABSENCE OF AN OPERATING AGREEMENT: CONSIDERATIONS UNDER STATE FORCE POOLING LAWS
Lawrence Bender
Shareholder
Fredrikson & Byron, P.A.
Bismarck, ND

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LAWRENCE BENDER is a Shareholder with Fredrikson & Byron, P.A. in Bismarck, ND. Lawrence represents oil and gas exploration companies, drilling companies, oil field service companies, pipeline companies, and other businesses in state and federal litigation and contested proceedings before various state and federal agencies. He represents and advises a wide variety of natural resources and energy related companies regarding contractual matters and compliance with state and federal regulations. Lawrence's extensive experience in real estate law allows him to offer professional assistance with the sale and purchase of oil and gas properties, as well as title examination and complex financing transactions. Prior to joining the firm, Lawrence served as an Assistant Attorney General of the State of North Dakota and as Counsel for the North Dakota Industrial Commission, Oil & Gas Division, and the North Dakota Board of University & School Lands. He is admitted to practice in Minnesota, North Dakota, and South Dakota.

INTRODUCTION

Oil and gas development can be a complicated and significant enterprise involving large areas of lands, costly capital expenditures, the involvement of numerous parties, changes in ownership, and operations that extend over long periods of time. The life of a single Bakken well, for example, has been estimated at approximately 30 years.¹ It comes as no surprise, then, that many who participate in oil and gas development operations choose to enter into agreements that govern those operations. The American Association of Professional Landmen ("A.A.P.L.") Form 610 Model Form Operating Agreement ("Form 610") has enjoyed widespread usage as the standard joint operating agreement, or JOA, for onshore oil and gas exploration in the United States.² A JOA is intended to facilitate the development of variously owned oil and gas interests. The parties to a JOA will designate a single Operator with the right and responsibility to conduct operations on behalf of all the parties for the development of the oil and gas interests identified in the JOA.³ The parties to a JOA will also agree to share costs and expenses, and to share in production, according to their proportionate ownership of the oil and gas interests as set forth in the JOA.⁴ A JOA also outlines procedures for initial and subsequently proposed operations, which may be undertaken by some or all of the parties.⁵ Various other provisions of a JOA deal with liens on the parties' interests, remedies in the event that a party defaults, transfers of interests subject to the JOA, and the term of the JOA, among other things.⁶

Despite the importance of an operating agreement and the availability of a comprehensive JOA such as Form 610, it is common practice in some producing states for parties to conduct oil and gas operations without a JOA.⁷ The prevalence of this practice in states like North Dakota may be attributable in part to the perceived ease with which a person may obtain force pooling orders that obviate the need for obtaining the consent of all interest owners within a given spacing unit.⁸ Whatever its cause, operating in the absence of a JOA exposes both operators and nonoperators to the risk of uncertain rights and obligations. Rather than the industry-developed terms of a Form 610, parties operating without a JOA may find their rights determined by a state's common law, force pooling statutes, and oil and gas agency decisions, often with unexpected and unfavorable results. With these considerations in mind, it comes as no surprise that one author underscored the importance of the JOA to oil and gas operations by declaring that "[o]nly the terminally reckless are likely to undertake pooling operations without first entering into an operating agreement."⁹

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This paper provides a practical overview of the laws that may govern pooled operations in the absence of a JOA and some of the problems that operators and nonoperators may encounter when operating under these circumstances. In the first Part, this paper identifies ways in which common law doctrines of co-tenancy, mining partnerships, and joint ventures govern oil and gas operations that are undertaken without a JOA. In the second Part, this paper discusses how states' force pooling laws affect the rights and liabilities of operators and nonoperators in the absence of a JOA. This paper then concludes by arguing that, in light of the disadvantages and uncertainties posed by common law and force pooling arrangements, operators and nonoperators should endeavor to use JOAs such as Form 610¹⁰ whenever possible.

OPERATING WITHOUT A JOA: CONSIDERATIONS UNDER STATE COMMON LAW

[To be prepared by Bruce Kramer]

OPERATING WITHOUT A JOA: CONSIDERATIONS UNDER STATE FORCE POOLING LAWS

The primary purpose of a JOA is to establish and govern the rights and duties of an operator and nonoperators in developing their oil and gas interests.¹¹ Similarly, state pooling laws¹² were enacted to modify the cotenancy relationship between an operator and nonoperators

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that would normally arise under the common law during the joint development of oil and gas interests.¹³ The goal of both Form 610 and a state's pooling statute is to ensure that the parties bound thereby share costs and production in accordance with their proportionate ownership in the contract area or spacing unit. Accordingly, in enacting and enforcing pooling laws, state officials strive to fairly balance the diverse interests of the parties to such joint development operations.¹⁴ However, disputes between parties that find themselves in a force pooling arrangement can arise in a variety of factual circumstances.¹⁵ Frequently, these disputes are resolved differently under a force pooling scheme than they would be under a JOA.

The remainder of this Part compares and contrasts certain provisions of Form 610 and state pooling laws as applied to issues arising in joint oil and gas operations, with a focus on North Dakota, where operations conducted without a JOA are common. Specifically, this Part focuses on: (1) the operator's removal and replacement, as well as its duties with respect to operations information; (2) subsequent operations by some or all of the parties; and (3) the expenditures and liability of the parties. This Part concludes by briefly identifying additional JOA provisions that lack equivalent provisions under state pooling laws, and noting ways in which certain states have attempted to incentivize voluntary pooling.

Article V: The Operator

The most important provisions pertinent to the operator appear in Article V of Form 610. Article V not only designates the party that will act as operator, but also sets out the operator's rights and duties and provides for replacement of the operator. There are two topics covered by Article V that illustrate the risks of reliance on force pooling laws: (1) the removal of the operator and selection of a successor; and (2) the operator's duties with respect to information access.

Removal of the Operator and Selection of a Successor

Article V.B(4) of of Form 610-2015 provides that the "Operator may be removed only for good cause by the affirmative vote of Non-Operators owning a majority interest based on ownership as shown in Exhibit 'A' remaining after excluding the voting interest of Operator."

"Good cause" is defined to include "(i) gross negligence or willful misconduct, (ii) material breach of or inability to meet the standards of operation contained in Article V.A. or (iii) material failure or inability to perform its obligations or duties under this agreement."¹⁶ Form

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610 qualifies this removal procedure by providing that before removal can become effective, an operator must be given an opportunity to cure any defaults.¹⁷

A successor operator may be selected by the vote of the party or parties holding a majority of the interests covered by the JOA, which may include the former operator or its transferee.¹⁸ If there is a tie between successor candidates, the candidate supported by the former operator, or the majority of its transferees, will become the successor.¹⁹ Form 610 also provides that the former operator has an obligation to deliver all data and records related to the joint operations to the successor operator if they are not already in the successor operator's possession.²⁰

By contrast, in a force pooled unit, the decision to remove the operator and designate a successor will be made by a state's oil and gas conservation agency in most cases. Some states, such as Oklahoma and North Dakota, have specific regulations that set out the procedures for changing an operator within a pooled unit. The regulations of the Oklahoma Corporation Commission permit the change of an operator under a force pooling order upon "[a]pplication, [at least fifteen days] notice and hearing."²¹ The regulation contains no express criteria for granting such applications, but the regulations permit written protests to be filed within a certain timeframe, which then result in a hearing on the application.²² If there are no protests within the required timeframe, applications will be summarily granted.²³

North Dakota's Industrial Commission provides somewhat clearer guidance as to the basis for removal of an operator, or "permitholder." The Commission's regulations provide that on its own, or on the application of an interest owner, after notice and hearing, the Commission "may revoke a drilling, recompletion, or reentry permit or limit its duration."²⁴ The factors considered in such actions include:

a. The technical ability of the permitholder and other owners

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