CHAPTER 5 LIABILITIES OF THE PARTIES TO A MODEL FORM JOINT OPERATING AGREEMENT: WHO IS RESPONSIBLE FOR WHAT?

• Jurisdiction: United States

Oil & Gas Agreements: Joint Operations
(Dec 2007)
CHAPTER 5
LIABILITIES OF THE PARTIES TO A MODEL FORM JOINT OPERATING AGREEMENT: WHO IS RESPONSIBLE FOR WHAT?
Milam Randolph Pharo
Vice President - Land and Legal
St. Mary Land and Exploration Company
Denver, Colorado
Constance L. Rogers
Davis Graham & Stubbs LLP
Denver, Colorado

MILAM RANDOLPH PHARO

Randy Pharo is admitted to practice before the State Bars of Texas (1977) and Colorado (1979). He earned a B.A. at the University of Texas (1974) and a J.D. from Southern Methodist University (1977). He is a member of the Denver, Colorado, and Texas Bar Associations. The first two years of Mr. Pharo's practice were in the area of insurance defense litigation. Beginning in 1979, his practice became limited to oil and gas matters. This included extensive title examination experience in the states of Colorado, Wyoming, Montana, North Dakota, Nebraska, Kansas, and Nevada. Mr. Pharo also represented clients in all facets of the upstream E&P business including operating matters, exploration and development agreements, lending matters, and the purchase and sale of producing and non-producing properties. He left private practice in 1996 and is now the Vice President - Land and Legal for St. Mary Land & Exploration Company in its Denver, Colorado, headquarters. Mr. Pharo has served as the President of the Denver Association of Oil and Gas Title Lawyers. He also has served as the Colorado reporter for the Rocky Mountain Mineral Law Foundation Mineral Law Newsletter and as a trustee for this foundation. Mr. Pharo has spoken to both the Colorado Bar Association and the Denver Bar Association on natural resource issues. He has presented papers at various Rocky Mountain Mineral Law Foundation Annual Institutes and Special Institutes focusing primarily on upstream transaction matters, joint operating agreements and unitization. Additionally, Mr. Pharo has spoken to the AAPL - International Conference, the AAPL - 2003 National Conference, the National Association of Lease and Title Analysts, the Denver Association of Division Order Analysts and the Denver Association of Petroleum Landmen. He has written articles for the DAPL's Newsletter and the AAPL magazine, Landman. In the Spring of 1999, the University of Denver, College of Law recognized Mr. Pharo as its Distinguished Natural Resources Practitioner in Residence, and he has assisted in the instruction of a number of classes at the law school concentrating on contract negotiations.

CONSTANCE L. ROGERS

Connie Rogers is a senior associate at Davis Graham & Stubbs LLP in Denver, Colorado where she represents clients in the oil and gas and mining industries in transactions, litigation and permitting and in environmental law, public lands, cultural resources law and Indian law matters. Ms. Rogers is admitted to practice in the State of Colorado, the Tenth Circuit Court of Appeals, and the United States Supreme Court. Ms. Rogers earned her undergraduate degree from William Jewell College, and a J.D. from Georgetown University Law Center, magna cum laude. Ms. Rogers has spoken to the Colorado Bar Association and the Denver Association of Petroleum Landman on Indian law and cultural resources issues and regulatory updates, and has written articles for the DAPL newsletter and the Colorado Lawyer.

TABLE OF CONTENTS

I. INTRODUCTION

II. WHAT DOES THE JOA PROVIDE?

A. ARTICLE III--INTERESTS OF PARTIES

B. ARTICLE IV--TITLE ISSUES

C. ARTICLE V--THE OPERATOR

D. ARTICLE VI--DRILLING AND DEVELOPMENT

E. ARTICLE VII--EXPENDITURES AND LIABILITIES

F. ARTICLE X--CLAIMS AND LAWSUITS

III. HEIGHTENED DUTIES AND RESPONSIBILITIES

IV. CIRCUMSTANCES WHERE PARTIES TRY TO ALTER THEIR RESPONSIBILITIES

A. THE OPERATOR IS INCOMPETENT

B. I'M NOT RIDING YOU DOWN; I'M JUST NOT NON-CONSENT

C. YOU CAN'T DO THAT

D. THOSE COSTS AREN'T PROPER

V. CAN A NON-OPERATOR BE LIABLE FOR ENVIRONMENTAL MATTERS?

A. STATUTORY ENVIRONMENTAL LIABILITY

B. TORT AND CONTRACT LIABILITY

C. WHO PAYS?

VI. CONCLUSIONS

I. INTRODUCTION

This paper will explore specific approaches the parties to an operating agreement have taken to allocate responsibility for the payment of costs and sharing of liabilities. Through the operating agreement, the parties have further expressly stated how they will share the fruits of their collective effort, and this will also be examined. The Foundation and its authors have provided a treasure-trove of articles and analysis of the statutory and jurisprudential law insofar as it pertains to the liabilities and responsibilities of the operator and non-operators vis a vis each other and third parties.¹ While these authors have looked both at the model form operating agreements and the judicial interpretations, the purpose of this paper is to take a systematic pass through the agreement and explore what the parties have actually agreed.

A common thread fortunately appears while reviewing the various forms of the AAPL Model Form Operating Agreement. While the focus of this paper will concentrate on the 1989 Form, many of the referenced cases will refer to earlier agreements.² The 1977 and later forms do not have materially different concepts with regard to the sharing of costs, liabilities, and revenue. When attempting to analyze how the parties have elected to treat one another, it is instructive to consider what would happen if an individual or single party was attempting to develop by itself a property and the burdens that party would bear. In this context, that single party should have presumed that it would individually bear the costs, liabilities, and benefits of its commercial endeavor, and fundamentally this is what the joint operating agreement tends to provide. As another author at this Institute has noted, "the operating agreement is

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principally a mechanism to provide for the efficient development and operation of separately owned mineral interest by co-tenants [and those who are not legal co-tenants] and creates the added benefit of avoiding imposition of joint and several liability associated with mining partnerships."³ As one looks at the many provisions in the operating agreement which allocate risk and responsibility, one is left with the distinct impression that a party will bear its proportionate share of all of the rights, duties, benefits, and obligations that such party would assume were it to develop the property individually, but with the added benefits of third party liability protection and the ability to delegate the day-to-day responsibility for conducting operations to another, and thus avoid incurring the operational and administrational expenses attendant to performing such tasks.

II. WHAT DOES THE JOA PROVIDE?

In the preamble to the agreement the parties state their intention to explore and develop the affected leases to the extent and as provided in the agreement. Given that Article I is a set of definitions and Article II enumerates the attached exhibits, the parties waste no time in setting forth their most pivotal overarching principle regarding the allocation of costs, risks, and revenues between the parties in Article III.B.

A. Article III--Interests of the Parties

This is where the general rules and concepts regarding responsibility and benefits are first laid out.

Article III.B. provides:

Unless changed by other provisions, all costs and liabilities incurred in operations under this agreement shall be borne and paid, and all equipment and materials acquired in operations on the Contract Area shall be owned, by the parties as their interests are set forth in Exhibit "A." In this same manner, the parties shall own all production of Oil and Gas from the Contract Area subject, however, to the payment of royalties and other burdens on production as described hereafter.

The use of the phrase "costs and liabilities incurred in operations under this agreement" is not narrow. It's not limited to paying bills. It's consistent with the notion that if you are developing your own lease you would stand responsible for the costs and liabilities incurred in such development. Likewise, you own the equipment and materials acquired in the conducted operations, and you receive the rewards of such activity by receiving the production attributable to your interest. Thus, in the first substantive paragraph of the operating agreement, the parties specify that they intend to bear their stated share of all costs and liabilities and enjoy

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the ownership of all equipment, materials, and revenue that stem from the development of the Contract Area⁴ in a like manner.

The remaining three paragraphs in Article III.B. continue this theme whereby a party stays responsible for the leases that it brings to the Contract Area. While the second paragraph contains the blank into which is inserted the share of common burdens all parties will bear in their Exhibit A shares, it further provides that any excess royalty, overriding royalty, production payment, or other burden on production in excess of the amount stipulated in Exhibit A shall be borne solely by the party whose lease is so burdened with such excess obligations. In fact, this party shall indemnify, defend and hold the other parties harmless from any claims attributable to any such excess burden.⁵

In addition, while each working interest owner pays a proportionate share of the landowner royalty interest burden (and possibly other non-cost bearing burdens), any one party is not to be responsible for paying any price higher than the price such party received for its sale of production, and the party contributing the affected non-cost bearing interest must bear any risk that the non-cost bearing owner can claim payment based on a higher price than that received. Thus, again, if a party delivers a lease with pricing parameters that are beyond those achieved by a non-lessee selling party, the affected lessee must bear the duties and...