CHAPTER 4 ISSUES RAISED BY A DISTRESSED ECONOMY BY JOINT OPERATING AGREEMENTS AND OTHER COMMON EXPORATION AND DEVELOPMENT AGREEMENTS
| Jurisdiction | United States |
(Feb 2010)
ISSUES RAISED BY A DISTRESSED ECONOMY BY JOINT OPERATING AGREEMENTS AND OTHER COMMON EXPORATION AND DEVELOPMENT AGREEMENTS
Locke Lord Bissell & Liddell LLP
Houston, Texas
David Patton is co-chair of the Energy Practice Group at Locke Lord Bissell & Liddell LLP in Houston. He has over 30 years experience in various legal aspects of the oil and gas industry, including acquisitions and sales of assets or equity interests, drafting and negotiating leases, contracts, and agreements related to field, pipeline and plant operations. Mr. Patton has represented clients in connection with surface use conflicts, day to day exploration and development activities, and the resolution of oil and gas disputes. In addition, he was lead attorney in over $3 billion in oil and gas property transactions in 2007-2009. He is a frequent speaker on oil and gas issues.
ISSUES RAISED BY A DISTRESSED ECONOMY WITH RESPECT TO JOINT OPERATING AGREEMENTS AND OTHER COMMON OIL AND GAS EXPLORATION AND DEVELOPMENT AGREEMENTS
David Patton
Locke Lord Bissell & Liddell LLP
I. Introduction
This paper will address issues that a distressed economy raises with respect to common agreements relating to oil and gas exploration and development. In other presentations at this Special Institute detailed attention will be given to the impact of bankruptcy upon such agreements. In contrast, my focus will be upon issues that result from the failure to pay or perform by one or more parties where bankruptcy has not yet occurred. The key to successful joint operations is in anticipating potential problems resulting from lean financial times and addressing those problems in drafting Join Operating Agreements, Exploration Agreements, Participation Agreements and Farmout Agreements. I will discuss practical considerations and provide suggested solutions to avoid unwanted consequences of financial distress.
There are three basic tenets that should be considered in every negotiation of oil and gas agreements:
1. A printed form is like Miss America: just because she is pretty doesn't mean she can sing.
2. Someone else's form usually protects someone else.
3. For reasons that cannot be explained, according to the laws of probability, if you do not contemplate the worst and address the consequences in your document, the worst is likely to happen.
II. The Joint Operating Agreement
A. Introduction.
The Joint Operating Agreement (the "JOA") is a frequently used agreement among interested parties for the testing and development of oil and gas on lands 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. For many decades the oil and gas industry has relied upon the use of standardized forms of operating agreements which are modified to fit particular circumstances. A JOA contains detailed provisions concerning the drilling of a test well (if a test well is to be drilled), the drilling of additional wells, subsequent operations, and 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 JOA.
While many forms exist, none are more commonly used than AAPL Model Form Operating Agreements. Recognizing the need for standardization, the American Association of
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Petroleum Landmen (now known as the American Association of Professional Landmen) published its first standard on-shore 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. AAPL offshore forms were generated as recently as 2002 and 2007. There are also standard JOA's in widespread use for international operations--the most common being created by the Association of International Petroleum Negotiators. With each successive version of the various forms changes were made in response to perceived deficiencies in existing forms and the needs of the industry. Despite the experience and skill of those involved in the difficult task of creating standardized JOA forms, no single perfect form exists. Although the AAPL and other standardized forms are good starting points, one should carefully consider one's own particular facts and circumstances and edit the printed form to fit specific needs.
B. Relationship of the Parties.
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. In negotiating a JOA the parties should consider whether the Operator may act in its own self-interest as an independent contractor and not as the agent of the Non-Operators. Obviously, an Operator will prefer to adopt express language providing that it will act as an independent contractor and not as the agent of Non-Operators. Although the industry norm is to establish non-agency status, not all JOA's contain such language in the pre-printed text. If the concept is not present, I recommend adding it.
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: "[n]othing 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...." In a distressed economy an important protection available to Non-Operators is a requirement that the Operator will be held to a fiduciary standard with respect to funds in the joint account.
Absent express agreement between the parties, courts have looked on a case by case basis at the actual relationship of the parties to determine if a special relationship exists between an Operator and a Non-Operator. 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 unlikely that an Operator will be deemed to be in a fiduciary capacity simply because it is a party to a JOA. If it is their intent, the parties should expressly stipulate in the JOA that no fiduciary relationship exists among the parties to the JOA, except as to the handling of Non-Operators' money by the Operator--following the 1989 JOA provision model. On
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the other hand, if the Operator and Non-Operators agree that as part of the business deal the Operator will act as a fiduciary for certain purposes, they should make that clear in the JOA.
3. No Partnership. To avoid having the parties to a JOA being treated as partners in a general partnership, the parties should expressly disclaim partnership status by making certain that the JOA contains language similar to the following clause:
The liability of the parties shall be several and not joint or collective. The parties do not intend to create, nor shall this agreement be construed to create, a partnership, mining partnership, joint venture, or other relationship of mutual agency between the parties, their relation with respect to this agreement and all rights, interests, and obligations hereunder being solely one of co-owners or co-tenants.
4. Standard of Conduct, Independent Contractor Status and the Exculpatory Clause. 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." If an Operator fails to act as a reasonable prudent Operator or breaches a non-operational provision of the JOA, but is not grossly negligent and does not commit willful misconduct, what remedy does the Non-Operator have? Except for the 1956 AAPL form, 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 1982 Form provides:
[ ______ ] shall be the Operator of the Contract Area, and shall conduct and direct and full control of all operations of the Contract Area as permitted and required by, and within the limits of this agreement. It shall conduct all such operations in a good and workmanlike manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except such as they may result from gross negligence.
This provision became commonly known as the "exculpatory clause." Article V of the 1989 JOA contains similar language but goes much further:
...Company shall be the Operator of the Contract Area, and shall conduct and direct and full control of all operations on the Contract Area as permitted and required by, and written within the limits of this agreement. In its performance of services hereunder for the Non-Operators, Operator shall be an independent contractor not subject to the control or direction of the Non-Operators except as to the type of operation to be undertaken in accordance with the election procedures contained in the agreement. Operator shall not
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