CHAPTER 16 THE 1989 AAPL MODEL FORM OPERATING AGREEMENT--WHY ARE YOU NOT USING IT?

• Jurisdiction: United States

Oil & Gas Agreements: Joint Operations
(Dec 2007)
CHAPTER 16
THE 1989 AAPL MODEL FORM OPERATING AGREEMENT--WHY ARE YOU NOT USING IT?
Andrew B. Derman
Isabel Amadeo
Thompson & Knight L.L.P.
Dallas and Houston, Texas
Greg W. Curry
Thompson & Knight L.L.P.
Dallas and Houston, Texas

Presented at the Southwest Land Institute April 10, 2003 in Fort Worth, Texas

GREG W. CURRY

Greg W. Curry focuses his practice on general commercial, oil and gas, and environmental matters. He has an active trial practice, having secured settlements and judgments for plaintiffs valued in excess of $80 million and defending numerous complex cases with claims over $100 million. Mr. Curry has represented clients in matters in Texas, Oklahoma, Louisiana, Arkansas, New Mexico, Minnesota, Ohio, Arizona, and Washington. He practices before federal and state trial and appellate courts, in federal bankruptcy courts, and before arbitration panels. He was named to The Best Lawyers in America (Commercial Litigation); 2007-2008 and Texas Super Lawyers, Texas Monthly; 2003-2007. He is a Member, State Bar of Texas; Litigation Section; Environmental & Natural Resources Section; Oil & Gas Section; and a Member, Texas Association of Defense Counsel; Executive Vice President, 2007-2008; Secretary-Treasurer, 2005-2007; Vice President-Legislative, 2004. He has written a number of articles on oil and gas issues.

ANDREW B. DERMAN

Andrew B. Derman is the Firm's International Energy practice group leader. With a concentration on oil and gas investment projects and cross-border transactions, he practice focuses on acquisitions, divestments, trades, and mergers; strategic commercial and business advice; large infrastructure projects, including LNG and GTL nationalization/expropriation; unitizations; exploration, development, and production operations; negotiations; and expert testimony, arbitration, and dispute resolution. Mr. Derman has assisted clients in more than 50 countries on six continents and offers clients a comprehensive understanding of oil and gas activities through experience in a broad spectrum of countries and companies. Prior to joining Thompson & Knight, he served as in-house counsel and later an executive for a large international oil and gas company for nearly 20 years. Mr. Derman's practice is equally divided between providing clients with traditional legal representation (contract negotiation and drafting) and business development/commercial counseling (the identification and capture of oil and gas opportunities). Mr. Derman is Board Certified in Oil, Gas and Mineral Law by the Texas Board of Legal Specialization. He was named to The Best Lawyers in America (Natural Resources Law); 2005-present; and Texas Super Lawyers, Texas Monthly; 2003-2007. His activities include Member, Advisory Board of the Institute for International and Comparative Law, Center for American and International Law; Vice President Conference/Programs, Association of International Petroleum Negotiators, 1999-2000; and he has written and lectured extensively throughout the world on oil and gas issues.

I. Introduction

To facilitate the annual drilling of thousands of wells within the United States, the oil industry has relied on form agreements. The American Association of Professional Landmen (AAPL) has, since 1956, provided industry with standardized Joint Operating Agreements (JOA). The 1956 form was revisited in 1977, 1982 and again in 1989.

The 1989 AAPL 610 Model Form Operating Agreement is clearly superior to the prior AAPL Form Operating Agreements. Why then is it still not universally accepted and used? Is it because the drafting committee that developed the new form was viewed by many as exclusionary and not transparent? Is it because the drafting committee was thought to be controlled by the "independents," the "majors" or "outside law firms?" Is it because one or two early drafts were circulated "before their time?" Is the 1982 AAPL 610 Model Form simply "good enough?"

The 1989 AAPL Form is an improvement over its progeny. We live in a dynamic age where rules should be modified to fit the times. The 1982 AAPL 610 Form Operating Agreement has served the industry well, but as the oil industry evolves so must the form. The 1989 AAPL 610 Form Operating Agreement was, in part, a reaction to the 1986 pricing collapse and, in part, a general improvement in the form.

The 1989 Form significantly influenced the Association of International Petroleum Negotiators (AIPN) 1990 International Model Form Operating Agreement (as well as the 1995 and 2002 AIPN International JOAs). The AIPN International JOA is now customarily used worldwide, outside the United States and the United Kingdom where standardized model operating agreements have been adopted. It is rather ironic that the 1989 Form contains provisions that are today used worldwide, but the industry has not universally adopted this provision for use in the onshore United States. Why?

II. The Debate: Investors vs. Operator

Certain authors suggest that the standard AAPL form of JOA fails to provide adequate protection for investors while others explain that the parties to a JOA are experienced investors and therefore do not need special protection.

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John McArthur in "Coming of Age: Initiating the Oilfield into Performance Disclosure,"¹ suggests that the AAPL has no any incentive to side with investors in drafting provisions in which the investors interests conflicts with those of the operators. McArthur claims that the JOA has remained incomplete for at least two reasons. One is based on the youthful age of the legal form (the first AAPL JOA form was issued in 1956). The second reason is due to "the limited pool of drafters and their industry orientation." McArthur goes on to saying that "landmen have many obligations, but serving investors in not chief among them." The author claims that AAPL has not found an effective way to give voice to non-industry investors.

Ernest E. Smith in "Joint Operating Agreement Jurisprudence,"² argues that the disparity in bargaining position between parties to a JOA is rarely present. He claims that "[n]on-operators are never marginal farmers and ranchers and are rarely lacking either in financial resources or in formal education." Smith goes on saying that "the parties to an operating agreement are either oil and gas companies or experienced investors." The author concludes that non-operators can include special provisions to protect themselves in the operating agreements.

Parties to a JOA are able to negotiate and establish their rights and duties and they can tailor the JOA to accommodate their objectives. The AAPL Form is a standardized form that does not contain language that fits every situation nor that is acceptable to all the parties to the JOA. The AAPL Form is destined to provide a basis from which negotiations may be commenced. Standardized form are widely used in the oil and gas industry in order to reduce negotiation and drafting expenses; provide the parties with well-written, comprehensive agreement and allow for efficient interpretation of the agreement in the future.

III. Review of the Provisions of the 1989 AAPL 610 Model Form Agreement

For those who have not been using the 1989 AAPL 610 Model Form, consider re-examining your reasons for using an "old" form. Within the text of this article, I offer a sampling of the improvements contained in the 1989 AAPL 610 Model Form.

Definitions - Article I

Definitions are important. Several additional terms have been defined in the 1989 Form. The inclusion of definitions for the terms "sidetrack, rework, zone, plug back, completion or complete, deepen, nonconsent well, initial well and AFE" should eliminate ambiguity and, consequently, conflict. The word "affiliate" is used several times, and it also should be defined. Affiliate can be defined as--"a company, partnership or other legal entity which controls, or is controlled by or which is controlled by an entity which controls a party to this agreement. Control means the ownership directly or indirectly of more than 50% of the shares or voting rights in a company, partnership or legal entity." The term "related party" appears in the last sentence of Article V.D.1. and it should be deleted to avoid confusion.

The definitions of the terms "completion" or "complete" are extremely broad. They are defined as a "single operation intended to complete a well as a producer of oil and gas in one

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or more zones, including, but not limited to the setting of production casing, perforating, artificial stimulation and production testing conducted in such operation."³ The terms "completion" or "complete" have traditionally not been clearly defined. Rather, the definition was one determined in the eyes of the beholder. It has been argued that completion occurred when a well was connected to a pipeline or was capable of pumping into a tank truck and all that was required was the turning of a valve. It has also been argued (sometimes by the same party) that completion occurred after a well had been tested or just perforated. Note that since the operating agreement may be attached as an exhibit to a farmout agreement or an exploration agreement, the definition of completion in the operating agreement may be used to help define this otherwise undefined term in the farmout agreement or exploration agreement.

If drilling a horizontal well is contemplated, the definition of deepen should be expanded. Consider including language such as--"deepen as used in conjunction with horizontal drilling shall mean a simple operation whereby a well is drilled to a distance greater than the proposed horizontal targeted total measured distance." In addition, the terms "initial objective" or "objective zone" as used in conjunction with horizontal drilling, shall also mean the proposed horizontal targeted total measured distance.

Define other...