CHAPTER 9 THE HARDROCK EXPLORATION DRILLING CONTRACT

• Jurisdiction: United States

Mining Agreements Institute
(May 1979)
CHAPTER 9
THE HARDROCK EXPLORATION DRILLING CONTRACT
William R. Marsh ¹
Dawson, Nagel, Sherman & Howard
Denver, Colorado

INTRODUCTION AND BACKGROUND

The topic of this paper is the negotiation and preparation of drilling contracts for use by the hardrock exploration industry.² Drilling is really nothing more than a means of obtaining samples of minerals for examination by the geologist, geochemist, or geophysicist. Drilling has always been and (at least until development of the long-awaited "black-box") will continue to be a fundamental and indispensible tool for the exploration industry. Nevertheless, the industry has not yet developed any particular form of drilling contract of general application.

Hardrock exploration drilling contracts have sometimes been prepared by modifying one of the several "standard" forms of drilling contract used by the oil and gas industry. A general knowledge of oil and gas drilling contract provisions is, of course, helpful to the draftsman of a hardrock exploration drilling contract.³ However, oil and gas drilling contracts were developed for use in sedimentary basins of relatively predictable lithology and under relatively mild or stable climatic conditions at lower elevations. Adaptation of an oil and gas drilling contract for use in connection with hardrock exploration is time-consuming and a dangerous practice unless the draftsman is extremely well acquainted with the technical aspects and terminology of both industries.

A surprising (and perhaps alarming) amount of hardrock exploration drilling is conducted either without benefit of any written agreement or under a general understanding reached between

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the exploration company (or "Operator") and the Driller which is memorialized in a one or two-page letter referred to as a "drilling proposal." There is not much qualitative difference between these two practices. A drilling proposal is essentially a "letter of intent" signed by the Operator and returned to the Driller. It consists almost entirely of blanks completed by the Driller with variable information concerning the Driller's fees for performing various types of drilling services and for furnishing specified equipment and materials. Drilling proposals do not define the legal relationships between the parties and a fully executed drilling proposal may not even constitute a binding contract.⁴

The reasons for this traditional informal approach to hardrock exploration drilling contracts are of little or no importance to the lawyer. Drilling at depth in rugged terrain involves substantial amounts of money and considerable potential liabilities for both parties. Past or even existing practice in the exploration industry is neither a justification nor a defense in connection with a legally inadequate agreement.

The informal approach to hardrock exploration drilling contracts is rapidly disappearing. The necessity to protect a substantial financial commitment through a formal contract will occur to the prudent Operator when it receives a drilling proposal with impressive drilling rates. At that point, the drilling rates and some other variable business terms have usually been set through the drilling proposal and informal discussions between the Operator and the Driller. The parties are both anxious to sign an agreement. The Operator wants the comfort of a binding commitment from a reputable Driller to complete an important drilling program. The Driller wants a binding commitment from the Operator so that the Driller can proceed to plan its own field season and avoid conflicting drilling commitments to other Operators. Consequently, it has been the author's experience that most formal hardrock exploration drilling contracts are prepared on a "rush" basis by the Operator's counsel. The

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draftsman may be asked to delete legally and practically essential provisions so that the parties can stop "wasting time" in a lawyer's office. Unfortunately, this pressurized situation may cause the interests of the draftsman (and his malpractice insurance carrier) to conflict with the desires of his own client as well as with the purposes of the other party.

The draftsman of the drilling contract must prepare a document which minimizes the seeming maze of potential problems described below and must do so as fast as possible. Obviously, he should have a pre-existing form of contract which is sufficiently adaptable to be legally adequate in connection with drilling programs of highly variable scope.

The author developed the form of contract attached to this paper as an Appendix ("the Contract") to serve as a negotiation and drafting checklist and to facilitate rapid preparation of an integrated agreement. The Contract has three basic parts. Sections 1 through 19 ("General Provisions") concern the legal relationships between the parties and should appear in some form in every hardrock exploration drilling contract. Sections 1 through 19 do not contain any blanks to be completed with variable information except for purposes of identification and execution by the parties.

Exhibit A to the Contract ("Drilling Provisions") is similar to a drilling proposal. Exhibit A must be completed by inserting drilling rates and other variable business terms. Exhibit B to the Contract ("Insurance") must be completed by inserting the particular coverage limitations of insurance to be maintained by the Driller.

There are certain dangers involved in the use of any "standard" form of contract. Technical personnel do not always consult counsel before using or even modifying a form contract. Conversely, the lawyer faced with short deadlines imposed by his client is tempted to draft or approve clauses involving technical matters outside his area of expertise without consulting operational

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personnel. The structure of the Contract is designed to avoid these types of problems.

When pressed for time, the lawyer should retain the General Provisions and immediately send Exhibits A and B to the Operator (preferably by messenger) with a letter of transmittal asking that Exhibits A and B be completed by the Operator's technical and insurance personnel and returned to the lawyer "at your earliest convenience." This delightful procedure is referred to as "putting the ball in the client's court" and is a truly satisfying experience for any lawyer. When Exhibits A and B have been returned, counsel can review the entire Contract and insure that it is properly integrated before execution by the parties.

Having prepared a contract which he considers reasonable and legally adequate under the circumstances, the draftsman must be prepared to "negotiate" its provisions with his own client as well as with the other party. In this context, negotiation is the art of recognizing, understanding, and explaining the problems of the Operator, the Driller, and the lawyer. The remainder of this paper attempts to facilitate the draftsman's ability to negotiate by discussing the relationship between the general problems described below and the contractual solutions proposed in the Contract.

THE FACTORS AND PROBLEMS

There are a number of geographic, geologic, and practical factors which cause problems for the drilling contract draftsman. Promising exploration targets are often found on public lands in the western United States deep beneath the surface of rugged and sometimes pristine terrain at high altitude. Under these conditions, the projected date of initiation of an exploration program is at best approximate, and the program must be conducted during a field season of generally short and always unpredictable duration. The exploration target is often subject to access and other restrictions imposed through intensive regulation by federal land management agencies.

Precise geologic information is, of course, unavailable in advance of the drilling program. Drilling at depth may involve any type of lithology ranging from relatively soft sedimentary beds to hard intrusive formations. Furthermore, it is difficult or impossible to predict the scope of the drilling program. If drilling proceeds rapidly and resultant geologic data is obviously favorable, it is advisable for the Operator to extend exploration operations for as long as permitted by climatic conditions even though the program initially planned has been completed. On the other hand, difficult drilling conditions with or without unfavorable geologic results may dictate reformulation or even termination of the exploration program at a preliminary stage.

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Exploration and drilling are simply unpredictable activities. This uncertainty makes negotiation and preparation of a mutually acceptable contract difficult because the Operator and the Driller inevitably have some conflicting interests. At the worst, an inflexible Operator will seek a presently binding commitment from the Driller to commence operations in unknown lithology on an uncertain date and to conduct a program of indefinite duration consisting of drilling to unspecified depths at the most economical cost. However, the Driller must attempt to maximize his profits through continuous utilization of equipment and personnel. To the Operator's dismay, the Driller may seek to accomplish this by making conflicting commitments to several Operators at drilling rates which contain hefty safety margins to account for lack of information concerning conditions in the field under force majeure provisions which are designed to permit breach of contract.

PROPOSED CONTRACTUAL SOLUTIONS

Several basic types of drilling contracts are used in both the hardrock and the oil and gas drilling industries.⁵ The attached Contract is the type most commonly used in the hardrock exploration industry and is referred to as a "footage" contract because the Driller is generally paid at specified rates for each foot drilled at particular depths.

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