CHAPTER 6 DON'T GET STUCK WITH THE CHECK WHEN IT'S NOT YOUR DINNER: INDEMNITY AND INSURANCE ISSUES UNDER JOINT OPERATING AGREEMENTS
| Jurisdiction | United States |
(Mar 2008)
DON'T GET STUCK WITH THE CHECK WHEN IT'S NOT YOUR DINNER: INDEMNITY AND INSURANCE ISSUES UNDER JOINT OPERATING AGREEMENTS
Attorney
Liskow & Lewis
Houston, Texas
Harold J. Flanagan 1
Attorney
Liskow & Lewis
New Orleans, Louisiana
Jana L. Grauberger
Attorney
Liskow & Lewis
Houston, Texas, USA
WILLIAM W. PUGH
William W. Pugh is a shareholder in the admiralty section of Liskow & Lewis in New Orleans, Louisiana. He graduated from the University of Virginia in 1976, received his J.D. from Louisiana State University Law Center in 1979, and served as Editor-in-Chief of the Louisiana Law Review from 1978-79. He has practiced maritime, tort, and insurance law with Liskow & Lewis since 1980, and his practice has involved a wide variety of matters, including litigation and drafting, revising, or negotiating numerous energy and offshore related contracts such as drilling contracts, offshore construction contracts, master service agreements, charters, and various other contracts. He is a member of the Council of the Louisiana Law Institute, the Louisiana Association of Defense Counsel, and the Maritime Law Association of the United States and speaks frequently on maritime and contract subjects.
HAROLD J. FLANAGAN
Harold J. Flanagan is a shareholder in the Liskow & Lewis's Maritime, Oilfield, and Insurance Coverage Section, and he concentrates his practice primarily in contractual and litigation matters involving insurance coverage, oil and gas drilling and service contracts, construction, and commercial transactions. Mr. Flanagan is a Lieutenant Colonel in the Marine Corps Reserve and is a member of the Tulane Law School adjunct faculty, where he lectures in insurance law. He received a B.S. in 1984 and a law degree, cum laude, in 1995 from Loyola University where he was a member of the Loyola Law Review.
JANA L. GRAUBERGER
Jana L. Grauberger is a shareholder at Liskow & Lewis. She practices energy and commercial litigation in the firm's Houston office. Ms. Grauberger has experience in all types of oil and gas matters, including royalty disputes involving private and public royalty owners, advice to federal lessees in connection with their offshore properties, pipeline expropriation, joint operating agreement issues, franchisee/franchisor litigation under the Petroleum Marketing Practices Act, and other oil and gas industry business disputes. Her undergraduate degrees in Journalism and French Literature are from the University of Kansas, and she graduated magna cum laude from Tulane University School of Law. She was Senior Managing Editor of the Tulane Law Review and a member of Order of the Coif. Ms. Grauberger is licensed in both Texas and Louisiana.
Rocky Mountain Mineral Law Institute
Institute on Oil and Gas Agreements: Joint Operations
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Oil and gas exploration and development ventures are huge undertakings, often requiring the participation and coordination of numerous entities. In these situations, the proper allocation of financial risks and operational responsibilities among those participants is crucial. In most cases, this allocation is accomplished via a Joint Operating Agreement, or JOA. In the United States today, the most common JOA form governing E&P work is known as the AAPL Model Form Operating Agreement 610.2 The form had its genesis in 1956 as an amalgamation of company-specific forms by the oil company members of the Mid-Continent Oil and Gas Association's Legal Committee. Since that time, the AAPL Model Form Operating Agreement has been revised three times, in 1977, 1982, and 1989.
The fundamental financial proposition of a JOA is that the participants share joint expenses in proportion to their interest in the enterprise. The 1982 version of the AAPL Model Form makes the point in this way:
ARTICLE VII.
EXPENDITURES AND LIABILITY OF PARTIES
A. LIABILITY OF PARTIES:
The liability of the parties shall be several, not joint or collective. Each party shall be responsible only for its obligations, and shall be liable only for its proportionate share of the costs of developing and operating the Contract Area. . . . It is not the intention of the parties to create, nor shall this agreement be construed as creating, a mining or other partnership or association, or to render the parties liable as partners.
There are some circumstances, however, under which the operator, non-operators, and their respective insurers may not see eye-to-eye as to whether expenses should be shared. The Joint Operating Agreement provides a starting point for determining how particular expenses should be allocated. For example, there are some circumstances in which non-operating working interest owners are not required by the JOA to pay their share of joint expenses, such as provided by the exculpatory clause discussed below.
A. The Exculpatory Clauses
The so-called "exculpatory clause" found in all AAPL Model Form Operating Agreements is one clause that provides non-operators with a basis for a refusal to contribute to expense of the operations. This is the clause that provides non-operators with a basis for their refusal to contribute. The most prevalent exculpatory clause addressed in the case law appears to be from the AAPL 1982 form, which reads as follows:
[Company] shall be Operator of the Contract Area, and shall conduct and direct and have full control of all operations of the
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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 may result from gross negligence or willful misconduct.
While the AAPL 1989 form modified the exculpatory clause to address additional issues (such as the operator's role as an "independent contractor" rather than an "agent" of the non-operators), the focus of that form's exculpatory clause remains the operator's "gross negligence or willful misconduct."3 For years, operators and non-operators alike have offered varying interpretations of the exculpatory clause in efforts to, depending on one's perspective, enforce or shift the costs associated with or attendant to well operations. Courts in Louisiana, Texas, and elsewhere have generally held that the higher standard of liability set out in the exculpatory provision of a JOA precludes the existence of a fiduciary relationship between the operator and the non-operators. McFarland Energy Inc. v. TexOil Co., No. 89-5298, 1990 U.S. Dist. LEXIS 7958 (E.D.La. 1990) (Louisiana law); Dime Box Petroleum v. Louisiana Land & Exploration Co., 938 F.2d 1144 (10th Cir. 1991) (Colorado law); see generally, Norman v. Apache Corp., 19 F.3d 1017, 1024-26 (5th Cir. 1994) (Texas Law).4
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Even in the absence of an exculpatory clause, however, courts have been reluctant to impose a fiduciary duty on a well operator if the non-operators are experienced in the oil and gas industry. See, e.g., Norman, 19 F.3d at 1025-26. Nonetheless, landmen and others involved in oil and gas development should be aware that, in the absence of an exculpatory clause in a JOA, an operator's liability to its working interest owners could be triggered by either simple negligence or the breach of a fiduciary duty to unsophisticated investors. See e.g., Huggs, Inc. v. LPC Energy, Inc., 889 F.2d 649 (5th Cir. 1989) (operator liable in negligence to working interest owners for failure to provide notification of lease's expiration and in gross negligence to overriding royalty interest owners for lease loss due to cessation of production); but see Fuller v. Phillips Petroleum Co., 872 F.2d 655 (5th Cir. 1989) (applying Texas law and finding that, under provisions of an operating agreement executed in 1964, the operator had not breached the contract by allowing certain leases to expire due to cessation of production).5
B. Gross Negligence of the Operator in Exploration and Development Activities
Courts have uniformly held that the standard of "gross negligence or willful misconduct" applies to an operator's activities in the exploration and development of a well. In IP Petroleum Co. v. Wevanco Energy, LLC, 116 S.W.3d 888, 895-96 (Tex. App. --Houston [1st Dist.] 2003, pet. denied), the Houston Court of Appeals explained that interpretation as follows:
Generally, exculpatory clauses in a contract are utilized to exempt one party from future liability for negligence. Allright, Inc. v. Elledge, 515 S.W.2d 266, 267, 17 Tex. Sup. Ct. J. 414 (Tex. 1974) . . . . Here the basis of the plaintiff's claims [regarding sufficiency of well depth] is alleged misconduct arising from the manner in which IP, as operator, conducted drilling operations on the lease. Unlike in Cone and Abraxas [discussed below in this paper], the plaintiffs allege that IP failed to conduct operations in a good workmanlike manner and failed to act as a reasonably prudent operator . . . . Accordingly, the exculpatory clauses in the JOA applied, and the plaintiffs had to establish that IP was grossly negligent or acted with willful misconduct when it breached the contract.
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1. Gross Negligence and Willful Misconduct Defined
- IP Petroleum Co. v. Wevanco Energy, LLC, 116 S.W.3d 888 (Tex. App. --Houston [1st Dist.] 2003, pet. denied) a) Texas Law
"To support a finding of gross negligence, there must be evidence that [the operator] had `actual subjective knowledge of an extreme risk of serious harm.'" Transp. Ins. Co. v. Moriel, 879 S.W.2d 10, 22 (Tex. 1994). The magnitude of the risk is judged from the viewpoint of the defendant at the time the events occurred. Id. at 23. The harm anticipated must be extraordinary harm, not the type of harm ordinarily associated with breaches of contract or even with bad faith denials of contract...
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