CHAPTER 9 LIABILITIES OF THE PARTIES TO A MODEL FORM JOINT OPERATING AGREEMENT: WHO IS RESPONSIBLE FOR WHAT?

• Jurisdiction: United States

Joint Operations and the New AAPL Form 610-2015 Model Form Operating Agreement (Dec 2017)
CHAPTER 9
LIABILITIES OF THE PARTIES TO A MODEL FORM JOINT OPERATING AGREEMENT: WHO IS RESPONSIBLE FOR WHAT?
Milam Randolph Pharo
Of Counsel
Davis Graham & Stubbs LLP
Denver, CO

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TABLE OF CONTENTS

I. INTRODUCTION

II. WHAT DOES THE JOA PROVIDE?

A. Article III - Interests of the Parties

B. Article IV - Title Issues

C. Article V - The Operator

D. Article VI - Drilling and Development

E. Article VII - Expenditures and Liabilities

1. Considerations When Dealing With a Financially Distressed Operator or Non-Operator

A. Grant of Lien and Security Interest

B. Remedies Upon Default

F. Article VIII.D. Assignment; Maintenance of Uniform Interest

G. Article X - Claims and Lawsuits

H. Article XIV - Compliance With Laws and Regulations

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 - Who's Liable?

B. Tort and Contract Liability for Environmental Contamination - Who's Liable?

C. Who Pays Under the JOA?

VI. CONCLUSION

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I. Introduction .

This paper is an update of one prepared in 2007 for a prior Special Institute conference. While parts of the original paper survived the intervening years, various sections have been significantly changed to accommodate new cases, new thinking, and the new A.A.P.L. Form 610 Model Form Joint Operating Agreement - 2015. That said, this paper will continue to 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 efforts, 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 the author has looked at both model form operating agreements and judicial interpretations, the purpose of this paper is to take a systematic pass through the agreement.

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 2015 Model Form² that has recently been released, the referenced cases will refer to earlier agreement forms. The 1977 and later forms do not have materially different concepts with regard to the

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sharing of costs, liabilities, and revenues. When attempting to analyze how the parties have elected to treat one another, it is instructive to consider what would happen if a single party was attempting to develop a property by itself. What burdens and obligations will that party 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 the prior iteration of this conference has noted, "the operating agreement is principally a mechanism to provide for the efficient development and operation of separately owned mineral interests 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 that 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 for Non-Operators 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 efforts and expenses attendant to performing these 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 provides a set of definitions (which have been materially expanded in the AAPL Model Form 610-2015, primarily to accommodate horizontal drilling and completion matters) 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 conducted under this agreement 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.

This language is essentially unchanged from the prior Model Forms.

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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 the ownership of all equipment, materials, and revenue that stem from the development of the Contract Area⁴ in a like manner.⁵

The AAPL Model Form 610-2015 expands Article III.B. by adding a mechanism by which Exhibit "A" can be amended to correct mistakes or to reflect changes in ownership in the Contract Area. While consent of the affected party or parties is contemplated,⁶ this can be overridden and the operator may act unilaterally if its amendment is consistent with a received title opinion and the affected parties fail to grant the consent.⁷

It is unclear to this author if this right to amend goes far enough to avoid certain issues. The right to amend is to correct mistakes or reflect ownership changes within the Contract Area.⁸ Often the need to amend Exhibit "A" arises in the context where the spacing unit for a particular well is configured differently than the entire Contract Area. Thus, while production and revenue are customarily shared on a Contract Area basis, given the divided nature of working interest ownership that often occurs in the large units required for horizontal wells, this inconsistent ownership can prove difficult if the spacing unit for a particular well is changed and is smaller than the entire Contract Area. It does not appear that the Operator is unilaterally empowered to amend Exhibit "A" for this circumstance.

The remaining paragraphs in Article III.B. continue this interpretation theme that a party stays responsible for any Lease it brings to the Contract Area, with a possible exception by virtue of the insertion of a new burden sharing Option 2.⁹ This new option states that a party will bear all burdens on its share of production from the Contract Area except Subsequently Created Interests of other parties to this agreement. If this option is chosen, a party could bear burdens on a Lease that it did not bring to the Contract Area because such party is allocated production from all of the lands within the Contract Area by virtue of its Exhibit "A" percentage. While Option 1 continues to contain a blank into which is inserted the share of common burdens all parties will bear in their Exhibit "A" shares, it further provides that any royalty, overriding

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royalty, production payment, or other burden on production in excess of the amount stipulated shall be borne solely by the party whose Lease is so burdened with such excess obligation(s).¹⁰ In fact, this party shall indemnify, defend and hold the other parties harmless from any claims attributable to any such excess burden.¹¹

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 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, if a party delivers a Lease with pricing parameters that are beyond those created by other Leases, the affected lessee must bear the duties and obligations created by its Lease;¹² again, no different than if that lessee was to develop its lease alone.

Assuming that you use Option 1, what interest should be placed in the blank for the common burden to be paid by all? The conventional thinking is that the lowest common burden affecting each of the Leases should be the...