CHAPTER 3 OPERATING AGREEMENTS AND OTHER AGREEMENTS AMONG PRODUCTION OWNERS - DEVELOPING THE PROSPECT AFTER THE TEST WELL
| Jurisdiction | United States |
(May 2005)
OPERATING AGREEMENTS AND OTHER AGREEMENTS AMONG PRODUCTION OWNERS - DEVELOPING THE PROSPECT AFTER THE TEST WELL
Locke Liddell & Sapp LLP
Houston, Texas
David Patton is co-chairman of the Locke Liddell & Sapp LLP Energy Practice Group. He has been a partner in the firm since 1981 and has over 27 years experience with virtually every legal aspect of the oil and gas industry.
He earned a J.D. from the University of Houston Law Center (1977) and a B.A. from the University of Texas (1973). He is a member of the State Bar of Texas, the Houston Bar Association, and the College of the State Bar of Texas and the Federal Bar Association.
He is a Trustee, Rocky Mountain Mineral Law Foundation; Chairman, RMMLF Regional Planning Committee (2002-05); Member, RMMLF Special Institutes Committee; Advisory Director, Center for American and International Law. He is listed in the 2005 Chambers USA's Leading Lawyers in America in Energy & Natural Resources.
A. Introduction
B. What is not covered by the JOA?
C. Non-consent provisions
D. Non-payment issues under the JOA
E. Effect of lease provisions
1. Economic Effect
a. Restrictions on the right to pool
b. Drilling commitments
2. Termination for Breach vs. Right to Cure
F. Surface use issues
1. Mineral Estates
2. The Mineral Estate is the Dominant Estate
3. Incidents of Mineral Ownership
4. The Accommodation Doctrine
5. Damages for Operations
6. Surface Damage Statutes
a. North Dakota, Montana and South Dakota
b. Oklahoma
c. Tennessee and West Virginia
d. Illinois and Kentucky
e. Pennsylvania, Alaska, and Indiana
7. Local Regulation
8. The Surface Use Agreement
a. Introduction
b. Parties
c. Lands Covered
d. Subsurface Issues
e. Notification, Consultation and Agreement
f. Time Period
g. Non-Exclusivity
h. Payments
i. Operations
j. Restoration
k. Reseeding
l. Hunting and Fishing
m. Safety:
n. Surface Owner's Water
o. Produced Water
p. Enforcement Costs
q. Indemnification and Release
r. Recording
s. Opportunity to Cure Breach
G. Farmouts
H. Changes in Unit Size
A. Introduction
The following discussion focuses upon how joint operating agreements and other contracts commonly used in the oil patch govern operations after the first producing test well is completed. This paper assumes a circumstance in which multiple parties own undivided interests in the leases covering the lands where drilling has occurred. It is further assumed that before the bit first turned to the right to commence drilling the test well, the owners of the working interests created one or more written agreements addressing how the leasehold estate would be further developed.
The operating agreement is the most frequently used agreement among interested parties for the testing and development of oil and gas on a tract of land where there are multiple owners of the mineral leasehold estate. One of the parties is designated as the operator and the others participate as non-operators. Since the mid 1950's the oil and gas industry has heavily relied upon the use of standardized forms of operating agreements which are modified to fit particular circumstances. An operating agreement contains detailed provisions concerning the drilling of a test well, the drilling of additional wells, subsequent operations, the sharing of expenses and accounting methods. The authority of the operator, the restrictions upon the operator and the relationship between operator and non-operators are addressed in the operating agreement.
While many forms exist, none are more commonly used than AAPL Model Form Operating Agreements. Recognizing the need for standardization, the American Association of Petroleum Landmen published its first standard form in 1956 after seeking input from all corners of the oil and gas industry. New, amended versions came along in 1977, 1982 and 1989, each having the basic format of its predecessors. With each successive version changes were made in response to the then existing deficiencies in existing forms and the perceived needs of the industry. Not all changes have been universally accepted as desirable. But most agree that there has been steady improvement. Despite the experience and skill of those involved in the difficult task of creating such an incredibly useful tool, even after all of these years no single perfect document exists. The AAPL Model Form Operating Agreement (the "JOA") is a good starting point--but parties needing such an agreement should carefully consider their own particular facts and circumstances and edit the printed form to fit their needs.
B. What is not covered by the JOA?
Since there is not a "one size fits all" solution, it is imperative that consideration be given to what is not covered by the JOA. A full treatment of all issues not adequately addressed is beyond the scope of this paper, but a few of the most important focal points include:
1. Agency, Independent Contractor and Acting in Good Faith. Until the 1989 JOA, the AAPL forms did not expressly negate that an Operator acted as agent for the Non-Operators. The 1989 JOA revisions were the first to expressly bestow independent contractor status upon the Operator. Prior versions did not expressly obligate the parties to act in good faith or affirmatively allow parties the right to act in their own self-interest. The 1989 JOA remedied those deficiencies. If an older JOA form is used, the parties should add language that makes clear that while the Operator may act in its own self-interest, it must act in good faith as an independent contractor and is not the agent of the Non-Operators.
2. Fiduciary Status. The parties should consider whether the Operator is to be considered a fiduciary to the Non-Operators for all purposes, for only certain designated duties, or not at all. With one exception first appearing in 1989, the AAPL JOA forms disclaim that there is a fiduciary relationship between the parties to the JOA. The exception is found in Article V.D.4 of the 1989 form which imposes a fiduciary relationship, but only with respect to the Operator's treatment of Non-Operator funds, providing: "nothing in this paragraph shall be construed to establish a fiduciary relationship between Operator and Non-Operator for any purpose other than to account for Non-Operator funds...."
Historically, the courts have looked at the actual relationship of the parties to determine if a special relationship exists between an Operator and a Non-Operator. I think the JOA language should be controlling in all but the clearest cases. As long as no joint venture or partnership is found to exist, and no other special relationship exists which creates a fiduciary duty, it is my view that an Operator does not serve in a fiduciary capacity simply because it is a party to a JOA. However, in our age of rampant litigation, absent express language in the JOA, a plaintiff may seek to impose a fiduciary relationship where none is intended. Conversely, an Operator may contend that no fiduciary duty exists even though the Non-Operators thought such duty existed. In my view, the preferred approach is for the parties to expressly stipulate in the JOA that no fiduciary relationship exists among the parties to the JOA, except as to the handling of money by the operator-- following the 1989 JOA provision model. On the other hand, if the Non-Operators desire that an Operator act as a fiduciary for certain purposes, they should make that clear in the JOA.
3. Standard of Conduct. If the Operator is not required to act as a fiduciary, the parties should consider what standard of conduct should govern the conduct of an Operator? Prior to 1989 the AAPL JOA forms required only that the Operator conduct all operations in a "good and workmanlike manner." The 1989 JOA went further by requiring in Article V.A. that the Operator conduct itself "as a reasonable prudent Operator, in a good and workmanlike manner, with due diligence and dispatch, in accordance with good oilfield practice, and in compliance with applicable law and regulation...." One should consider whether the broader clause is appropriate and, if so, borrow such language for inclusion in the "Other Provisions" section when using pre-1989 JOA forms. It is unclear as how the standard of conduct required of an Operator by the 1989 JOA meshes with the exculpatory clause set discussed below. If an Operator failed to act as a reasonable prudent Operator but was not grossly negligent and did not commit willful misconduct, what remedy does the Non-Operator have?
4. Exculpatory Clause. Before things go wrong, all parties should agree in advance as to how liabilities and risks of loss are to be divided among them. Pre-1989 AAPL forms provided that an Operator had no responsibility for losses or liabilities, except those resulting from the Operator's gross negligence or willful misconduct. Article V of the 1989 JOA contains similar language: "in no event shall it (the Operator) have any liability as Operator to the other parties for losses sustained or any liabilities incurred except as may result from gross negligence or willful misconduct." The same Article V of the 1989 JOA requires the Operator to conduct its activities under the JOA as a reasonable prudent operator in good faith. In negotiated transactions, Operators routinely propose that no liability be imposed against them for simple negligence in their role as operator. However, an Operator plays many roles, some of which pertain to operations and some of which pertain to contractual obligations. A Texas case, Abraxus Petroleum Corp. v. Honburg, 1 FN1 stands for the proposition that the JOA exculpatory clause is limited to claims that an Operator failed to act as a reasonably prudent Operator in conducting operations and does not apply to a breach of contract claim that...
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