CHAPTER 3 PROPERTY PROVISIONS OF THE JOINT OPERATING AGREEMENT
| Jurisdiction | United States |
(Mar 2008)
PROPERTY PROVISIONS OF THE JOINT OPERATING AGREEMENT
Research Professor
Judge Leon Karelitz Chair in Oil & Gas Law
University of New Mexico School of Law
Albuquerque, New Mexico
Bruce M. Kramer
Maddox Professor of Law
Texas Tech University
School of Law
Lubbock, Texas
GARY B. CONINE
Gary B. Conine is a Research Professor and holds the Judge Leon Karelitz Chair in Oil & Gas Law at the University of New Mexico School of Law. He was previously an Associate Professor and Shell Interdisciplinary Scholar at the University of Houston Law Center. Before beginning his academic career, he was a partner in the Houston firm of Liddell, Sapp, Zivley, Hill & LaBoon. He also has served as a legal consultant to a variety of government agencies and companies involved in the petroleum industry.
Prof. Conine's academic work has focused on both domestic and international petroleum law. In addition to teaching courses in Oil & Gas Law; Oil & Gas Contracts; Federal Energy Regulation; Regulated Industries; and International Petroleum Transactions, he was Director of the Graduate Program in Energy, Natural Resources and Environmental Law at the University of Houston and Associate Director of the Russian Petroleum Legislation Project funded by the World Bank, the European Bank for Reconstruction and Development, and private foundations and corporations.
He has been a frequent speaker at programs on U.S. oil and gas matters and has participated as an instructor or author for educational programs presented for or by various international companies and agencies, including the U.S. State Department's Agency for International Development; the European Community; Petróleos Mexicanos; the Chinese National Petroleum Corporation; the Chinese National Offshore Drilling Corporation; and the State Oil Company of the Azerbaijan Republic. In 1993 and 1994, he served on the Policy Panel for the Fund for Democracy and Development's Study on U.S. Assistance to Russia.
Prof. Conine has a B.A. in Economics from Southern Methodist University; a J.D. from the University of Oklahoma Law Center; and an LL.M. from Harvard Law School.
BRUCE M. KRAMER
Bruce M. Kramer received a B.A. in International Relations from UCLA, a J.D. from the UCLA School of Law, and an L.L.M. in Environmental and Natural Resources Law from the University of Illinois College of Law.
He has been teaching at Texas Tech University School of Law since 1974 and has been the Maddox Professor since 1992.
Professor Kramer is the co-author of The Law and Pooling and Unitization (3d ed.), Williams and Meyers Oil and Gas Law (since 1996, Cases and Materials on Oil and Gas Law (6th and 7th eds.) and International Petroleum Transactions. He is the author of numerous law review articles on oil and gas law including "The Sisyphean Task of Interpreting Mineral Deeds and Leases: An Encyclopedia of Canons of Construction" and "Royalty Interests in the United States: Not Cut From the Same Cloth." He has been an editor of the Oil and Gas Reporter and was recently named the Administrative Editor of that publication.
Joint operations have always been an important feature of the oil and gas industry. Since the industry's birth, joint operations have facilitated the exploration of tracts whose operating rights have been dispersed among co-owners with undivided interests and, for much of the last century, they have enabled the development of pooled and unitized tracts, contributing to efficiency in the industry and conservation of a depleting resource. The coordination necessary for all types of joint operations has been achieved primarily through the operating agreement,1 which has become the most common instrument in the industry after the oil and gas lease.
Most analytical papers dealing with the joint operating agreement (or JOA) have focused on the crucial details of conducting exploration, development and production operations within the designated contract area and the legal relationship of the parties to the agreement. These papers emphasize the functional aspects of the JOA which commit the parties to participate in and share expenses for, and production from, joint operations. But there are other important provisions in the JOA used to adjust the rights and duties of the parties outside the context of actual operations. These provisions expand, limit and define the property interests of the parties both inside and outside the contract area. They not only clarify the parties' rights with respect to the transfer, acquisition and loss of
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interests but also facilitate such matters as the deferral of commitments to participate in future operations.
Although at first glance these provisions may resemble a random collection of property clauses, many of which are found in other instruments in the industry and appear to be only peripherally important to joint operations, they actually are essential to the structure and effectiveness of the JOA as a long-term transaction. In a sense, these provisions are the "mortar" that holds the procedural "bricks" of the JOA together.
The purpose of this paper is to review the various provisions typically included in the JOA which affect the property interests of the parties and to examine (1) how they are used to structure the operating agreement, (2) the ways in which they are used to protect the integrity of the transaction during its protracted term and promote fair dealing among the parties through restrictions on transfers and acquisitions, and (3) the legal issues that often arise with respect to the validity and enforceability of these provisions.
I. Structuring the JOA
The JOA is designed to organize operations on a specific collection of properties. Consequently, the transaction will be dependent on an accurate identification of the boundaries within which its provisions apply. Given the fact that allocation of costs and production among the parties for future operations will be determined by the property interests contributed by each, it is also essential that the interests contributed by each party be clearly described and that some agreement exist on how each party's share of costs and production will be affected if title to all or part of its interest turns out to be defective or fails during the term of the agreement. These functions are performed by Exhibit A to the JOA and the provisions on Failure of Title.
But the role of property interests in structuring the JOA does not stop there. The instrument also uses the property interests of the parties to facilitate some of its most important provisions. Specifically, they are employed in the provisions on Subsequent Operations to provide incentives and rewards for participating in future operations and in creating the Operator's Lien to assure that each participating party adheres to its commitment to bear a share of costs in future operations. Each of these provisions and mechanisms is crucial to the purpose and effectiveness of the JOA.
A. Creating the Contract Area
Operations conducted under the JOA take place within the Contract Area created by the instrument. This area is comprised of the leasehold and mineral interests2
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contributed by the individual parties who execute the JOA, as identified in Exhibit A to the agreement. Within this aggregation of property interests, the operating agreement controls what mineral activities will take place, the party that will conduct those projects, and the manner in which costs and production will be allocated among the parties.
Despite the natural tendency to want to conceptualize the Contract Area as a region within certain surface boundaries, it is actually a multi-dimensional zone that may cover less than all mineral substances, less than all development rights, and less than all subsurface depths and formations within its surface perimeter.3 For this reason, Exhibit A prescribes several pieces of information that should be included to obtain a full description of the Contract Area. Among the information usually listed for inclusion are any depth restrictions that may apply, the specific leases or mineral properties involved, and the percentage of ownership held by each party within the Contract Area.4 In order for many of the JOA's provisions to comply with the statute of frauds and to avoid future controversies over the precise share of each party, all these elements of the Contract Area's description must be accurate and complete.5
Although compilation of the information in Exhibit A may seem perfunctory, it is incumbent on each party to check and understand not only what it is committing to the JOA but also what each of the other parties is contributing to the joint operations. The significance of precision in compiling and reviewing the information in Exhibit A to the JOA is illustrated in three relatively recent cases.
In two of the cases, Exhibit A's information on the composition of the Contract Area failed to reveal that a principal lease being contributed by one of the parties did not cover all of the mineral rights within the leased acreage. In one instance, the lease did not cover all depths anticipated by the parties to the JOA.6 In the other, the lease covered only an undivided one-half of the mineral estate in an important tract.7 Rather than accurately indicating the rights being dedicated to the Contract Area, the information on these properties inserted into Exhibit A suggested that all mineral rights at all depths were included. In both cases, the party contributing less than all the operating rights in the leased area later acquired the outstanding interest and asserted that the JOA did not apply to the newly acquired property. The other JOA parties claimed that the additional leasehold interests were already committed to the Contract Area of their JOAs. The court decisions in both cases held...
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