CHAPTER 15 DEVELOPMENT AGREEMENTS
| Jurisdiction | United States |
(Dec 2010)
DEVELOPMENT AGREEMENTS
Thompson & Knight LLP
Dallas, Texas
DEBRA J. VILLARREAL is a partner in Thompson & Knight, LLP and is a member of the firm's Oil and Gas Section. Her practice primarily focuses on acquisitions and dispositions of exploration and production properties, including offshore (Outer Continental Shelf) interests. She counsels clients and prepares agreements in relation to exploration and production activities. Her work includes the representation of borrowers and lenders in oil and gas secured lending, including title due diligence in connection with such financings. She has represented exploration and production companies in the negotiation and drafting of complex participation agreements and exploration and development agreements. Debra is a co-founder and currently serves as Secretary of the Women's Energy Network - North Texas. She is the past-Chair of the Dallas Bar Association Energy Section. Debra has been named in Best Lawyers in America (Oil and Gas Law) 2010 and 2011. Debra obtained her BBA from Washburn University in Topeka, Kansas, and her JD from Kansas University Law School, where she was on the Law Review and a member of The Order of the Coif and Phi Kappa Phi.
Introduction.
Companies in the oil and gas industry form relationships with other industry players that they hope will be beneficial to all of the parties. Industry players seek out others who possess something that they lack. Some companies have acquired sizable leasehold acreage but lack the funds to timely develop the acreage. Others have cash to invest but lack technical know-how. Some industry players have developed a geologic idea for a project but lack the resources necessary to acquire the acreage and develop the property.
The great unconventional gas plays that have dominated the industry news over the last few years -- the Barnett Shale, the Marcellus, the Haynesville Shale, and the most recent of the group, the Eagle Ford1 -- each require acreage, technical know-how and substantial cash for development. The shale plays have had a tremendous impact on the oil and gas industry. Some industry consultants are predicting a continued surge in gas production from U.S. shale plays in 2011. If the predictions are accurate, domestic shale gas production will have increased 171.5% from 2008 to 2011 and will comprise nearly one-fourth of all the U.S. gas output.2
Companies always need to allocate their capital among their various projects. To avoid spending all of their capital on one project, companies have historically formed joint ventures or entered into participation agreements with other companies who can help provide additional capital for development. In addition to the ongoing need to properly allocate funds, at a time when companies have needed substantial amounts of capital to develop their acreage, the credit crisis that started in 20083 continues to plague the industry. Capital markets have not fully recovered. Companies without sufficient funds to finance development on their own have been
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actively seeking other industry players who can fulfill their need for cash. So, we have seen a surge in the number of companies that have entered into joint development programs with other companies to develop these unconventional gas plays.
The first step for companies wanting to enter into a relationship for the joint development of a project is to determine what form their relationship will take. The potential forms are numerous, but two of the most common are a joint venture and a contractual arrangement under which the parties agree to jointly explore and develop property without forming a separate legal entity.
Joint Ventures.
Some parties who want to jointly explore and develop acreage form joint ventures. A joint venture is in the nature of a partnership that is formed for a one-time business undertaking. The joint venture is a separate legal entity. The parties contribute acreage and money to the joint venture in exchange for an interest in the joint venture. The costs and profits of the project are typically divided between the joint venturers in relation to their respective participating interests. Given that a joint venture is in the nature of a partnership, each of the joint venturers is jointly and severally liable for the obligations of each other joint venturer with respect to the business undertaking for which the joint venture was formed. Parties to a joint venture incur fiduciary responsibilities to one another and to mutually conduct the venture.
The management of a joint venture may be divided between a management committee and a manager. Each joint venturer is allowed to appoint a certain number of members of the management committee. The number of appointees can be determined in proportion to the joint venturers' respective participating interests, with each member of the management committee having an equal vote. For example, if one joint venturer has a participating interest of seventy-five percent, such joint venturer could appoint three members of a four member management committee. As an alternative, each joint venturer may appoint an equal number of members to the committee, for example two each, but the voting power of each committee member would be based on the applicable joint venturer's participating interest. In such a case, the votes of the members of a joint venturer with a seventy-five percent participating interest would hold the voting power of three times that of the members appointed by the other joint venturer.
Specific activities are performed by the manager of the joint venture. The manager acts as the agent for the joint venture. Typically the manager is responsible for the day-to-day operations of the joint venture and has the authority to bind the joint venture to contracts entered into in the ordinary course of business, subject to established limitations on the amount of obligations incurred by the joint venture in each contract.4 The manager is also generally responsible for the preparation of reports to be delivered to the management committee. Whereas, more major decisions, such as determining the plan of development of the project, are left to the management committee.
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Participation Agreements.
Frequently companies desiring to pursue an opportunity with other companies do not want to incur liability for the others' obligations. Rather than forming a joint venture, industry participants enter into contracts to govern the joint exploration and development. The agreements are known as "exploration agreements", "development agreements", "joint development agreements", or "participation agreements." This paper will refer to such agreements as "participation agreements". There is certainly no one form of participation agreement. Participation agreements range in length from two-page letter agreements addressing one commitment well to sixty-plus page documents with numerous exhibits that cover thousand of acres of land. The simplicity or complexity of a participation agreement results from the size of the area to be covered by the agreement and the business deal struck by the parties.
In a typical participation agreement, the parties pursue an opportunity as co-participants. A participation agreement almost always specifies that neither party has any fiduciary obligation to the other and that the parties specifically disclaim any joint liability or the creation of a partnership or joint venture.
[1] Identifying the Exploration Area.
One of the fundamental business issues to be decided by companies entering into a participation agreement is what area of land will be covered by the participation agreement (herein called the "exploration area"). The exploration area is typically defined by geographic area and may also be defined by geological structure.
[a] Geological Exploration Area. The parties may want to jointly explore and develop a particular geological structure (a "zone"). For example, in South Texas, the industry has spent years developing the Austin Chalk formation that is directly above the Eagle Ford Shale. Now, development of the Eagle Ford formation, particularly with its "rich gas" that allows producers to capture the value of liquids, is an attractive objective.5 To exploit this rich formation, parties are, therefore, entering into participation agreements that define the exploration area by the depths covered by the Eagle Ford Shale formation.
In describing an exploration area by geological structure, the structure needs to be described with some particularity, preferably using parameters established by a geologist. A simple reference to the formation, such as the "Eagle Ford Formation" is not sufficient. A formation may have different names in the same area. Similar names may describe different formations. To adequately describe a formation it must be identified and located, and its name must be clearly discernible.6
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The depths of the formation should be given, and it is preferable to include a reference to an existing well that has tested the intended formation. If a formation has been described in a publication by a state or federal geological surveyor, that description may be the best way to describe the formation. An example of a definition for a geologic exploration area would be:
"Prospect" means the geological formation known as the Eagle Ford formation, as more particularly described by the zone between 10,340' and 10,590' measured depth on the Induction Electric Log of the H.R. Smith & Gulf Corporation, #1 George Sealy Estate, API #42-311-01237, underlying the contiguous geographic area described in Exhibit A hereto.
If the exploration area is defined by one or more geological structures, the parties need to determine whether the parties will have the ability to participate in different...
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