CHAPTER 7 COMPLEX EXPLORATION AGREEMENTS; GETTING DOWN TO BUSINESS
| Jurisdiction | United States |
(May 2004)
COMPLEX EXPLORATION AGREEMENTS; GETTING DOWN TO BUSINESS
Haynes and Boone, LLP
One Houston Center
1221 McKinney Street, Suite 2100
Houston, Texas 77010
cumminga@haynesboone.com
Mr. Cummings specializes in energy transactions and litigation. He has practiced law in the energy arena, in corporate legal departments and in private practice, since 1975. He is board certified in Oil, Gas and Mineral Law by the Board of Specialization of the State Bar of Texas.
Mr. Cummings has:
• Represented producers, large and small - onshore and offshore, in all aspects of exploration, exploitation and production, including title examination, exploration, operating and other participation and sharing agreements, pooling and unitization, production purchases and sales, and financing.
• Represented financial institutions and producers in reserve-based financing and specialized financing vehicles, such as tax credit, net profits and production payment purchases.
• Represented producers and financial institutions in the trial of oil and gas issues.
Mr. Cummings has recently:
• Represented a large independent oil and gas producer in royalty and drainage lawsuits.
• Represented a large independent oil and gas producer in the acquisition of producing oil and gas properties and financing of the acquisition by the sale of a volumetric production payment.
• Represented a large independent oil and gas operator in a lawsuit concerning title and possession of a gas well.
• Represented an independent oil and gas operator in a breach of operating agreement duties lawsuit.
Education
J.D., Southern Methodist University Dedman School of Law, 1974; Order of the Coif
B.A., State University of New York, 1964
Admitted to Practice
Texas, 1975; U.S. District Court, Southern and Eastern Districts of Texas
Memberships
State Bar of Texas (Past Chair, Oil, Gas and Energy Resources Law Section); Houston Bar Association (Past Chair, Oil, Gas and Mineral Law Section); Houston Producer's Forum; American Association of Professional Landmen
A. INTRODUCTION
B. DRAFTING CONSIDERATIONS
1. KISS Principle
2. What is the Business Deal?
3. Words Have Consequences
4. Incentives for Cooperation Not Competition
5. Clear Allocation of Responsibilities
6. Who Pays What, When And What If They Don't Pay?
7. Who Owns What, When And How Do They Get Ownership?
8. When the Romance Ends (and it will) - What Is The Exit Strategy?
C. THE EXPLORATION AGREEMENT
1. Participants
2. Recitals
3. Definitions
4. Exhibits
5. Data Acquisition, Ownership and Use
6. Prospect Identification and Selection
7. Lease and Land Acquisition
8. Ownership; Liability for and Payment of Expenditures
9. Initial Well Commitments
10. Subsequent Operations
11. Confidentiality, Non-disclosure and Non-competition
12. Area of Mutual Interest (AMI)
13. Term and Termination
14. Assignments and Preferential Rights
15. Insurance and Indemnification
16. Dispute Resolution
17. Representations of the Parties
18. Miscellany
19. Execution and Acknowledgement
A. INTRODUCTION
In this author's experience, the form of exploration agreements is as varied as the companies and individuals who explore for oil and gas and the exploration trades they put together. It would be foolhardy then to suggest there is a usual form of exploration agreement. Moreover, it would be an insurmountable task to analyze and present the law in each jurisdiction that might be applicable to the drafting of the various provisions of a complex exploration agreement. This paper is, therefore, intended only to provide practitioners with a checklist of the issues that may need to be addressed when preparing any exploration agreement.
B. DRAFTING CONSIDERATIONS
1. KISS Principle.
• When disagreements arise, and they will, the agreement will be read and interpreted by lawyers, arbitrators, judges and jurors who are strangers to the deal (and to the industry).
• If you have to be a landman, an accountant, a petroleum engineer or other oil and gas professional to understand the agreement, then simple disagreements can become real trouble.
• If the business deal is so complex that it cannot be explained in a short executive summary, then simplify the business deal.
2. What is the Business Deal?
• Have the parties describe the business deal in a written term sheet.
• Based on their term sheet, tell the parties your understanding of the business deal.
• Ask questions about the business deal upfront and as you draft - it is unlikely that parties have considered all the issues.
3. Words Have Consequences.
• Don't use words like "partner" and "joint venture" if you don't intend to create a partnership with joint and several liability and fiduciary duties among the participants.
• If disagreements arise, undefined terms will likely be understood by their "plain meaning," to folks not in the "oil bidness." Don't count on evidence of custom in the industry to interpret your agreement.
• Avoid more than one provision on any topic or insure that the language used is consistent and not in conflict.
4. Incentives for Cooperation not Competition.
• Forfeiture provisions create problems; consider farmout with either retained or back-in interest or non-consent penalty
• Look ahead and provide incentives that will work not only today, but also one year from today.
• If one party is in control, because of financial strength, lease position or ownership of data, then less powerful companies will want protection from, for example, being drilled out of the deal.
• Parties with financial strength, lease position or ownership of data will want provisions which will prevent delays in data acquisition, lease acquisition or drilling of wells.
• Smaller companies with, for example, an exclusive data position, may have to give up control to obtain participation by a party with financial strength or a superior lease position.
5. Clear Allocation of Responsibilities.
• Avoid agreements to agree; it may be easy now, but it will be a problem later.
• Avoid provisions that will lead to turf battles
• Consider using different parties for different responsibilities, for example, data acquisition or processing, prospect generation, lease acquisition, drilling, based on what they bring to the transaction or special skills. For example, if the generator of the geological concept in not an experienced operator, it makes sense for one of the other parties to be the operator for drilling of the initial well. If one of the parties has a large lease position in the exploration area, it may make sense for that party to be responsible for obtaining leases on unleased mineral fee interests.
6. Who Pays What, When And What If They Don't Pay?
• Elections to participate should be based on payment not merely an election;
• If there are carried interests, then clearly define what costs are carried. For example, what does "carried to the tanks" for a gas well prospect mean?
7. Who Owns What, When And How Do They Get Ownership?
• Consider bankruptcy risk of unassigned and unrecorded interests
• Payment of money should be accompanied with assignment of ownership
• What is evidence of ownership for a carried party
8. When the Romance Ends (and it will) - What Is The Exit Strategy?
• Know your co-participants - if you don't trust them at the outset, it does not get any better.
• Can and will you sell the deal to mullets?
• There will be disagreements - how do the parties get a no-fault divorce?
• Make sure the client carefully reads and understands the document before signing. Avoid: THEY CAN'T DO THAT - CAN THEY?
C. THE EXPLORATION AGREEMENT
The following is a checklist of possible provisions that could be included in an exploration agreement, together with comments and suggestions on issues that may need to be addressed with respect to each of the provisions.
1. Participants. An exploration agreement may be negotiated among parties who agree to jointly develop an area of mutual interest or it may be drafted by a promoter with a geological concept, who then attempts to sell participation in the concept to third parties with money or with a lease position in the area of the geological concept.
a. An exploration agreement negotiated among the prospective participants may be detailed, complex and provide the parties with more flexibility in participating in the acquisition of data, assembling the lease position, identification of prospects, and participation in prospects.
b. On the other hand, an exploration agreement prepared by a promoter will probably need to be a simple, barebones agreement in which one of the parties has the responsibility to obtain the geological and geophysical data, designate prospects, assemble the land position and drill the initial test well on each prospect.
• Caution: a promoter may be tempted to negotiate changes to the form of exploration agreement in order to entice the participation of third parties. However, the result may be a series of different participation agreements that do not work together, even though there is a recitation that they are all counterparts of the same agreement. Question: Is there an exploration agreement among the participants?
• A promoter with a geological concept but of limited financial means may give up control to a prospective participant to induce its participation to fully subscribe the project. Question: is there an agreement between the early participants and the participant taking control from the promoter?
• It may not be possible to solve these types of problems with drafting. Participants may need to condition their participation in a partially subscribed project to (i) satisfying themselves that all other participants are financially capable of paying and performing their obligations, and...
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