CHAPTER 4 BUILDING INFRASTRUCTURE - GATHERING SYSTEMS AND CENTRAL FACILITIES

• Jurisdiction: United States

Oil and Gas Agreements: The Production and Marketing Phase
(May 2005)
CHAPTER 4
BUILDING INFRASTRUCTURE - GATHERING SYSTEMS AND CENTRAL FACILITIES
Arthur J. Wright
Craig A. Haynes
Thompson & Knight LLP
Dallas, Texas
ARTHUR J. WRIGHT

Arthur J. Wright is a Senior Partner of the firm of Thompson & Knight L.L.P. and was formerly an Assistant General Counsel of Texas Oil and Gas and Associate General Counsel of Delhi Gas Pipeline Corporation. He received a bachelor's degree from Tulane University and graduated with Honors from the University of Texas School of Law where he was a member of the Order of the Coif.

The present focus of his work is matters related to the acquisition and sales of oil and gas assets and the exploration for and production and marketing of oil and gas and the downstream products made therefrom. He also has represented both producers and pipelines before various regulatory agencies, such as the Federal Energy Regulatory Commission.

Mr. Wright currently serves on the ABA's Negotiated Acquisitions Committee and Asset Acquisition Task Force and on the Advisory Board of the Institute for Energy Law. He has been on the Council of the Oil and Gas Section of the State Bar of Texas, Chair of various Committees of the ABA's Natural Resources and Law Section and President of the North Texas Energy Council. He is also past Chairman of the Oil, Gas & Mineral Law Section of the Dallas Bar Association and has taught oil and gas law at SMU's School of Law.

He is a frequent speaker on oil-and-gas-related subjects at State and local Bar Association meeting and has authored numerous articles relating to natural gas, the acquisition of oil and gas properties, and legal ethics for the AAPL's Landman Magazine, Rocky Mountain Mineral Law Foundation, Universities of Texas, Houston and Tulsa and the Dallas, Oklahoma and Texas Bar Associations. He has also co-edited a book entitled Natural Gas Contracts for the American Bar Association.

CRAIG A. HAYNES

Craig Haynes is a senior partner in the Trial Section of Thompson & Knight, LLP. He is a member of the firm's management committee and is chair of the firm's energy trial practice group. He has a complex commercial litigation practice with a focus on energy litigation. He represents both defendants and plaintiffs in commercial cases. He has significant trial and appellate experience handling major energy litigation in state and federal courts in all parts of Texas, as well as in Oklahoma, Wyoming, and Alaska.

Mr. Haynes was recently listed by Texas Lawyer as one of the five selected "Top Notch" lawyers in the state of Texas in the area of Civil Litigation -- Plaintiffs (non-personal injury cases).

Mr. Haynes is a former Barrister of the Patrick E. Higginbotham American Inn of Court (Dallas, Texas) and a former Chair of the Dallas Bar Association Judiciary Committee.

He earned his Juris Doctor degree, with high honors, from University of Texas School of Law in 1985, and clerked for the Hon. Jerre S. Williams of the United States Fifth Circuit Court of Appeals.

TABLE OF CONTENTS

JOA ISSUES

OVERVIEW -- ENTITY SELECTION AND STRUCTURE

GENERAL PARTNERSHIP

%sEntity Description%s

%sManagement%s

%sLiability%s

LIMITED PARTNERSHIPS

%sEntity Description%s

%sManagement%s

%sLiability%s

LIMITED LIABILITY COMPANIES

%sEntity Description%s

%sManagement%s

DRAFTING ISSUES

%sManagement Quorum%s

%sDisengagement Overview%s

%sTransfers Upon Death%s

%sManagement Issues%s

%sAuthority%s

%sCapital%s

EXIT STRATEGIES

%sLiquidation%s

ROFR

%sDrag Along And Tag Along%s

%sPut%s

%sTriggering Events%s

%sGeneral Comments on Sale%s

CHECKLISTS

%sEntity Drafting Checklist%s

%sOperating Agreements Checklist%s

%sNew Entity Formation Checklist%s

SAMPLE CLAUSES DEALING WITH SALE ISSUES

%sRights of First Refusal%s (ROFR)

%sNotice of Sales; Assignment of Company Right of First Refusal%s

%sTag-Along Provisions for a Limited Partnership%s

%sPreferential Right%s

SAMPLE CLAUSES - AGREEMENTS

%sPartnership Agreement%s

Formation

Name

Business

Defined Terms

Capital Contributions of Partners

No Other Required Capital Contributions

Additional Capital Contributions

Non-payment of Capital Contributions

Return of Capital Contributions

Payments and Advances by General Partner

Allocations

Section 704(c) Allocations

Distributions

Power and Authority of General Partner

Contracts With Affiliates

Tax Elections

Tax Returns; Tax Matters Partner

Reimbursement of Expenses

Other Operations

Liability of Partners and Indemnification

Certain Decisions

Rights of Limited Partner

Limitations on Limited Partner

Liability of Limited Partner

Withdrawal and Return of Capital Contributions

Outside Activities

Capital Accounts, Books and Records

Reports

Bank Accounts

Information Relating to the Partnership

Dissolution

Liquidation and Termination

Reconstitution

Assignment by Partners

Right of First Refusal on Sale

Representations, Acknowledgements and Warranties of the Partners

Meetings of the Partners

Successors and Assigns

Sole Discretion

%sOperating Agreement%s

Operator's Duties

Reimbursement of and Compensation to Operator

Relationship of the Parties

Contracts With Affiliates

Insurance

Inspections and Audits

Assignment and Subcontracting

%sAccounting Procedures%s

PARTNERSHIPS -- ALTERNATE PROVISIONS

%sPartnership Borrowing%s

%sAdditional Financing%s

%sPartnership Capital%s

%sCapital Accounts%s

%sSpecial Federal Income Tax Allocations%s

OPERATIONS -- ALTERNATE PROVISIONS

%sDefinitions%s

%sGeneral Scope of Operation Services%s

%sDuties to be Performed in Operating the Facility%s

%sStandard of Conduct%s

%sFacility Modification%s

%sReimbursement of Operation and Maintenance Expense and Capital Expenses%s

%sExpenditure for Operation of the Facility%s

%sAnnual Budget of Operating Expenses and Capital Expense%s

%sIndemnification of Operator%s

%sIndemnification of Owner%s

%sRemoval of Operator%s

%sRelationship of the Parties%s

%sAccounting Procedure%s

ROYALTY ISSUES DEALING WITH POST-PRODUCTION COSTS, INCLUDING MARKETING AFFILIATES: OPERATOR'S PERSPECTIVE

%sIntroduction%s

PART I. THE ROYALTY OBLIGATION

A. Calculating Gas Royalties

B. Calculating Oil Royalties

C. Determining Market Value or Market Price

D. Implied Covenant to Market

E. The In Kind Royalty Provision

PART II. ISSUES RELATED TO SALES TO AFFILIATES

A. Royalties Based on Market Value

B. Royalties Based upon Amount Realized

C. Post-Production Costs

D. Piercing the Corporate Veil In Texas

CONCLUSION

This article shall discuss selected issues in documenting the formation and operation of legal entities for the ownerships of gathering systems and JOA related issues. It will include an outline or checklist of issues and a discussion of certain critical issues. What will not be covered is any tax issues!

JOA ISSUES

Pursuant to Article VI.D., "Other Operations" costs in excess of a certain specified amount agreed to by the parties require the consent of all the parties. Absent such consent, the operator must either forego higher cost projects such as gathering lines or other marketing facilities, or acquire the assets by itself and operate them for a fee. This creates the potential for conflicts of interest and problems of self dealing or over charging.

There are two solutions to solve this problem. One is to create another entity to construct and operate the joint facilities. The parties with an interest in constructing such facilities can have the opportunity to participate in that entity in proportion to their working interest ownership. The other approach is to modify the provisions of the JOA. Modifying the JOA is not as desirable for a variety of reasons.

First, it is a belt and suspenders approach. The JOA is not designed to construct and operate pipelines -- much less deal with account for non-consent issues and requires 100% consent to proceed in most instances. Another problem with using the JOA approach is that there can often be multiple parties and JOAs in a potential area to be serviced by the gathering system. Finally, there can be liability and regulatory issues in the event separate entities are not utilized.

If the parties desire to proceed under the JOA, the most simple way to proceed is to apply the non-consent approach, which is applicable to drilling, deepening, plugging back, and reworking a well (VI.B.2.) or to additional operations such as artificial lift or salt water disposal wells in VI.D, to the construction of any additional facilities which are not otherwise subject to the non-consent provisions and which would otherwise require 100% approval. However, in many instances, it is very difficult to determine what specific amount of additional production results from certain non-consent operations or if multiple wells are benefited to allocate the costs among them. The simpler approach is to avoid the non-consent penalties and have all the parties bear the cost of production and facilities. This approach prevents the "spoiler" or underfunded party from preventing prudent operations that benefit the properties. It is suggested that a provision that a majority vote or a higher "super majority" is sufficient to approve a proposed AFE for facilities which benefit production from the Contract Area be included and thereby force the expenses to be shared by all parties to the JOA. In the event that not all parties are benefited by the non-consent operation, then the benefits and the detriments associated with the operation could be pro-rated based on production benefited at the time of the vote.

Article VI.D. permits certain additional work relating to wells to be done if approved by a percentage of the JOA owners. Therefore, it is further recommended that the provision excepting gathering lines, transportation, marketing, facilities, etc., be deleted, and that such provision apply to any approved operation which...