Patrick Murphy

Patrick Murphy
Joint Operating Agreements: Should Elements of the AIPN Model Form
International Operating Agreement Influence a New AAPL Joint Operating Agreement?
Abstract:
Oil and gas development takes significant amounts of time and money. Either by choice
or out of necessity, an oil company will enter into a Joint Operating Agreement (herein “JOA”)
with other oil companies. The JOA is a beneficial means of allocating costs and risks between
different companies so that no single company takes on all the risk. In domestic oil and gas
development, typically the AAPL Form 610 Model Operating Agreement (either the 1982 or
1989 version) is used (herein “AAPL 1982 JOA” and “AAPL 1989 JOA”).1 In oil and gas
development outside of the United States, the AIPN 2002 Model Form International Operating
Agreement (herein “AIPN 2002 JOA”) is often used.2 I intend to highlight some of the key
differences between the domestic and international Model JOAs, particularly the differences in
regard to the authority and liability of the Operator under each. I will conclude by suggesting
1
As Lynn Hendrix notes: In domestic JOAs, while many oil companies utilize the AAPL 1989
JOA, “[a] number of changes made in 1989 are viewed as radical by the industry and,
accordingly, a number of producers continue to use the 1982 version.” Lynn P. Hendrix, The
New Model Operating Agreement Forms: Why Change the Rules in the Ninth Inning?, 43B
RMMLF-INST 6, § II.A.1 (1997). In this paper, I will focus primarily on the AAPL 1989 JOA
but will note instances where the AAPL 1982 JOA differs.
2
During the writing of this paper, the AIPN published a 2012 update to their JOA. It is still too
early to analyze the industry’s receptiveness to the revisions. However all provisions quoted in
this paper remain substantially unchanged by the revisions. This paper will focus on the AIPN
2002 JOA.
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Patrick Murphy
that, because of complexities in modern domestic operations, the AAPL should draft a new
Model JOA utilizing some elements of the AIPN 2002 JOA that promote greater cooperation
between the contracting parties.
Introduction
The JOA is a contract. Though contracting parties can freely negotiate all provisions of
the contract, “[t]he oil and gas operating agreement has evolved as an industry-wide document
over several decades…result[ing] in the development of a relatively uniform agreement.”3 The
use of model agreements with only minor changes is the norm.
In a JOA, there are two types of parties: the Operator and the non-Operators. The
Operator is the “party who implements the collective will of the [parties] and is responsible for
day-to-day management of the operations.”4 All other parties are the non-Operators.
One party is designated as the Operator. Though it is not necessary, the party to the
agreement with the largest production interest is often the Operator. “It is usually considered
imperative by the parties to a JOA that the Operator should have a substantial [production
3
A. Timothy Martin, Model Contracts: A Survey of the Global Petroleum Industry, 22 No. 3 J.
Energy
&
Nat.
Resources
L.
281
(2004),
available
at
http://www.timmartin.ca/qualifications/publications, p. 11 (quoting Bruce M Kramer and Gary B
Conine, ‘Joint Development and Operations’ in International Petroleum Transactions, p. 561
(2nd ed., Ernest E Smith et al eds., Rocky Mountain Mineral Law Foundation 2000)).
4
Nkaepe Etteh, Joint Operating Agreements: Which Issues are Likely to be the Most Sensitive to
the Parties and How Can a Good Contract Design Limit the Damage from Such Disputes?
available
at
www.dundee.ac.uk/cepmlp/gateway/files.php?file=cepmlp_car14_27_215967689.pdf, p. 2.
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interest] in the [contract area].”5 The Operator receives no additional financial benefit for acting
as the Operator6 but is merely entitled to its share of production under the JOA. The duty of care
that Operator owes to non-Operators is still unsettled.7 Non-Operators have limited duties in the
JOA, the most important duty being providing funds to the Operator.8
The JOA has two main purposes. First, it provides a way for the parties to allocate risks
and costs amongst themselves.9 Usually, costs and risks are shared according to each party’s
production interest in the contract area. Second, the JOA sets out the rules and procedures
governing the relationship between the Operator and non-Operators in connection with
operations in the contract area.10
These rules include the designation of an Operator, the
authority of the Operator, the grounds for removal of the Operator, and the authority, if any, of
the non-Operators.
AAPL Form 610 Model Operating Agreement
The AAPL 1989 JOA and the AAPL 1982 JOA are the primary JOAs used in domestic
oil and gas development. United States JOAs have two main characteristics that set them apart
from international agreements: standardization and autonomy. As opposed to the AIPN 2002
5
Id. at 3.
6
However, parties often desire to be the Operator for non-financial reasons, but this discussion is
outside the scope of this paper.
7
Ernest E. Smith & John S. Lowe, The Operator: Liability to Non-Operators, Resignation,
Removal and Selection of a Successor, RMMLF-INST Paper No. 2, § I (2008).
8
Etteh, supra at 3.
9
Id. at 2.
10
Id.
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JOA, which has numerous optional provisions, the AAPL 1989 JOA has rather few options for
the parties to choose between.11 Indeed, such standardization is the result of a less complicated
operating environment within the United States than internationally.12 Moreover, domestic oil
companies are primarily concerned with making a profit, rendering numerous optional provisions
unnecessary.
Oil and gas leasing in the United States is highly competitive, so it is not surprising that
most provisions of the AAPL 1989 JOA emphasize the autonomy of the parties. The expression
of autonomy and self-interest of all parties is no more clearly expressed than in Article VII:
The liability of the parties shall be several, not joint or collective… It is not the
intention of the parties to create, nor shall this agreement be construed as creating,
a mining or other partnership, joint venture, agency relationship or association…
the parties shall not be considered fiduciaries… but rather shall be free to act on
an arms-length basis in accordance with their own respective self-interest…13
Such an explicit disclaimer of joint liability and of any partnership relationship between the
parties highlights that self-interest is key to the AAPL 1989 JOA. Indeed, the AAPL 1989 JOA
is so explicit in its disclaimer that it is coupled with a reminder that the self-interest of the parties
11
See American Association of Professional Landmen, Form 610-1989 Model Form Operating
Agreement, art VI.C.1 and VI.G (1989) [hereinafter AAPL 1989 JOA] for examples of optional
provisions.
12
Martin, supra at 12.
13
AAPL 1989 JOA, art. VII.A. The AAPL 1982 JOA is slightly less explicit: “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.” American
Association of Professional Landmen, Form 610-1982 Model Form Operating Agreement, art.
VII.A (1982) [hereinafter AAPL 1982 JOA].
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is “subject… to the obligation of the parties to act in good faith in their dealings with each other
with respect to activities hereunder.”14
Article V.A vests significant authority in the Operator, leaving it “largely unaccountable”
to the non-Operators:15
[The Operator] shall conduct and direct and have full control of all operations on
the Contract Area as permitted and required by, and within the limits of this
agreement… Operator shall be an independent contractor not subject to the
control or direction of the Non–Operators except as to the type of operation to be
undertaken in accordance with the election procedures contained in this
agreement… Operator shall conduct its activities under this agreement as a
reasonable prudent Operator, in a good and workmanlike manner, with due
diligence and dispatch, in accordance with good oilfield practice, and in
compliance with applicable law and regulation, but in no event shall it have any
liability as Operator to the other parties for losses sustained or liabilities incurred
except such as may result from gross negligence or willful misconduct.16
The Operator that conducts activities “as a reasonable prudent Operator” is shielded from most
liability.
Article V.A thus promotes Operator autonomy by maximizing its control over
operations and minimizing non-Operator oversight of the Operator’s decisions.
14
15
AAPL 1989 JOA, art. VII.A. The AAPL 1982 JOA does not contain this phrase.
Andrew B. Derman & James Barnes, Autonomy versus Alliance: An Examination of the
Management and Control Provisions of Joint Operating Agreements, 42 RMMLF-INST 4,
§4.03[1] (1996) [hereinafter Autonomy versus Alliance]
16
AAPL 1989 JOA, art. V.A. The AAPL1982 JOA is not as explicit: The Operator “shall
conduct and direct and have full control of all operations on the 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.” AAPL 1982 JOA, art. V.A.
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Patrick Murphy
Moreover, the Operator has complete discretion to undertake certain actions in
emergencies for the benefit of the non-Operators and at the cost of the non-Operators (and
Operator) up to a specified dollar amount:
Operator shall not undertake any single project reasonably estimated to require an
expenditure in excess of _______ Dollars…except in connection with the drilling,
Sidetracking, Reworking, Deepening, Completing, Recompleting or Plugging
Back of a well that has been previously authorized by or pursuant to this
agreement; provided, however, that, in case of explosion, fire, flood or other
sudden emergency, whether of the same or different nature, Operator may take
such steps and incur such expenses as in its opinion are required to deal with the
emergency to safeguard life and property but Operator, as promptly as possible,
shall report the emergency to the other parties…17
Non-Operators do not have the power to contest the expenditures of the Operator in these
situations, leaving the Operator rather unaccountable for the expenditures that it deems
necessary.
Coupled with the immense autonomy of the Operator in the AAPL 1989 JOA is the
limited authority of the non-Operators. Two areas where the non-Operator has “authority” are in
the proposal of subsequent operations and in Operator removal. However, the non-Operator’s
authority is still limited even in these areas.
During the drafting of the JOA, an Initial Well is contemplated by the parties. Article
VI.A discusses the location of the contemplated Initial Well and stipulates that “[t]he drilling of
the Initial Well and the participation therein by all parties is obligatory…”18 The non-Operators
cannot opt out of participation in this initial drilling. Not until subsequent operations, not
17
AAPL 1989 JOA, art. VI.D. The AAPL 1982 JOA provision is substantially the same. See
AAPL 1982 JOA, art. VII.D.3.
18
AAPL 1989 JOA, art. VI.A. The AAPL 1982 JOA does not contain this phrase.
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specifically contemplated in the JOA, are being proposed do the non-Operators have any
authority in the development of the Contract Area:19
If any party hereto should desire to drill any well on the Contract Area other than
the Initial Well… the party desiring to drill… such a well shall give written notice
of the proposed operation to the parties who have not otherwise relinquished their
interest in such objective Zone under this agreement… specifying the work to be
performed, the location, proposed depth, objective Zone and the estimated cost of
the operation… If all parties to whom such notice is delivered elect to participate
in such a proposed operation, the parties shall be contractually committed to
participate therein…and Operator shall, no later than ninety (90) days after
expiration of the notice period of thirty (30) days (or as promptly as practicable
after the expiration of the forty-eight (48) hour period when a drilling rig is on
location, as the case may be), actually commence the proposed operation and
thereafter complete it with due diligence at the risk and expense of the parties
participating therein.20
However, the authority of the non-Operators in the conducting of subsequent operations is still
limited.
19
Indeed, “[s]ince the Operator is managing the operation, it is the Operator who
Article VI.A does provide for a few limited occasions where the non-Operators can decide to
terminate work on the Initial Well.
20
AAPL 1989 JOA, art. VI.B.1. The AAPL 1982 JOA states that: “Should any party hereto
desire to drill any well on the Contract Area other than the well provided for in Article VI.A…
the party desiring to drill… such a well shall give the other parties written notice of the proposed
operation, specifying the work to be performed, the location, proposed depth, objective
formation and the estimated cost of the operation…If all parties elect to participate in such a
proposed operation, Operator shall, within ninety (90) days after expiration of the notice period
of thirty (30) days (or as promptly as possible after the expiration of the forty-eight (48) hour
period when a drilling rig is on location, as the case may be), actually commence the proposed
operation and complete it with due diligence at the risk and expense of all parties hereto.” AAPL
1982 JOA, art. VI.B.1.
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generally proposes the drilling of wells and the development of fields.”21 Moreover, even if a
non-Operator proposes the additional drilling, the Operator will still be the party to conduct
operations, and the Operator will have the same autonomy in subsequent operations as in the
Initial Well.22 A great weakness of the subsequent operations method in the AAPL 1989 JOA is
that it “has a procedure for electing in or out of any proposal, but does not provide a procedure
under which parties periodically meet to discuss and analyze the area, propose specific
operations, and/or make decisions.”23
Non-Operators also have “authority” in the removal of the Operator. However, under the
AAPL 1989 JOA, such authority is severely limited:
Operator may be removed only for good cause by the affirmative vote of Non–
Operators owning a majority interest based on ownership…remaining after
excluding the voting interest of Operator; such vote shall not be deemed effective
until a written notice has been delivered to the Operator by a Non–Operator
detailing the alleged default and Operator has failed to cure the default… For
purposes hereof, "good cause" shall mean not only gross negligence or willful
misconduct but also the material breach of or inability to meet the standards of
operation contained in Article V.A. or material failure or inability to perform its
obligations under this agreement.24
21
Autonomy versus Alliance, § 4.04[1].
22
Unless of course the Operator elects not to participate or to act on behalf of the non-Operators.
See AAPL 1989 JOA, art. VI.B.2(a), AAPL 1982 JOA, art. VI.B.2.
23
Autonomy versus Alliance, § 4.04[1].
24
AAPL 1989 JOA, art. V.B.1. The AAPL 1982 JOA is significantly different as it does not
discuss a removal standard: “Operator may be removed if it fails or refuses to carry out its duties
hereunder, or becomes insolvent, bankrupt or is placed in receivership, by the affirmative vote of
two (2) or more Non–Operators owning a majority interest… remaining after excluding the
voting interest of Operator.” AAPL 1982 JOA, art. V.B.1.
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While the AAPL 1989 JOA does provide a removal standard, “[h]istorically, it has been
extremely difficult to remove an Operator for violating the standard of ‘gross negligence or
willful misconduct.’”25 Indeed, removal for good cause still remains difficult under the AAPL
1989 JOA:
The combination of ‘for cause’ removal clauses along with such a high standard
of liability under [older AAPL JOAs] makes an operator virtually removal proof,
and even though the AAPL’s 1989 Form contains the reasonable prudent operator
standard, this may be of little practical value as the non-operators still must prove
a material breach of these standards or inability to meet these standards.26
AIPN Model Form International Operating Agreement
The AIPN 2002 JOA differs greatly from the AAPL 1989 JOA. While the AAPL 1989
JOA is characterized by autonomy and standardization, the AIPN 2002 JOA is characterized by
cooperation and flexibility. The AIPN 2002 JOA:
aims to be a flexible one, to accommodate the preferences of individual parties
and the different legal regimes that may govern the joint venture operations. It
achieves this by providing text alternatives for many of its provisions as well as
drafting and guidance notes which call attention to legal issues that may be
relevant to the context in which the document is proposed to be used.27
While the AIPN 2002 JOA involves more cooperation between the parties, the AIPN 2002 JOA
still makes it clear that each party is individual and autonomous:
25
Autonomy versus Alliance, § 4.05[1].
26
Brian R. Bjella, Removing the Operator Under the Joint Operating Agreement: Breaking Up is
Hard to Do, 45 RMMLF-INST 11, §11.05[1] (1999).
27
C tia
alaquias
iles, AIPN 2002 Model Form Joint Operating Agreement in Oil and Gas
Joint Ventures, 22 Austl. Res. and Energy L.J. 153, 153 (2003).
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The rights, duties, obligations and liabilities of the Parties under this Agreement
shall be individual, not joint or collective. It is not the intention of the Parties to
create, nor shall this Agreement be deemed or construed to create, a mining or
other partnership, joint venture or association or (except as explicitly provided in
this Agreement) a trust. This Agreement shall not be deemed or construed to
authorize any Party to act as an agent, servant or employee for any other Party for
any purpose whatsoever except as explicitly set forth in this Agreement. In their
relations with each other under this Agreement, the Parties shall not be considered
fiduciaries except as expressly provided in this Agreement.28
Like the AAPL 1989 JOA, authority in the AIPN 2002 JOA is vested in the Operator,
who “shall have all of the rights, functions and duties of Operator under the Contract and shall
have exclusive charge of and shall conduct all Joint Operations.”29 Moreover, the Operator must
“conduct all Joint Operations in a diligent, safe and efficient manner in accordance with such
good and prudent petroleum industry practices and field conservation principles as are generally
followed by the international petroleum industry under similar circumstances.”30
While the AIPN 2002 JOA vests authority in the Operator to carry out the agreement and
to perform operations, the Operator’s responsibility is to carry out the joint will of all parties.
Under the AIPN 2002 JOA, an Operating Committee is created to discuss and authorize
operations. “To provide for the overall supervision and direction of Joint Operations, there is
established an Operating Committee composed of representatives of each Party holding a
Participating Interest.,”31 and, “[t]he Operating Committee shall have power and duty to
authorize and supervise Joint Operations that are necessary or desirable to fulfill the Contract and
28
Association of International Petroleum Negotiators, Model Form International Operating
Agreement, art. 14.1 (2002) [hereinafter AIPN 2002 JOA].
29
Id., art. 4.2.A.
30
Id., art. 4.2.B.2.
31
Id., art. 5.1.
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properly explore and exploit the Contract Area in accordance with this Agreement and in a
manner appropriate in the circumstances.”32 The Operating Committee provides a forum for all
the parties to interact, and because “[t]he process contemplates the presence of not only the
voting representatives at meetings, but also technical advisors,”33 it is more likely that the parties
will reach a consensus for the best overall course of the operations.
Once the Operating
Committee makes its decision, the Operator is responsible for carrying out the joint will of the
parties: “In the conduct of Joint Operations Operator shall… perform Joint Operations in
accordance with…the decisions of the Operating Committee not in conflict with this
Agreement.”34
Unlike the AAPL 1989 JOA, which severely limits the ability of the non-Operators to
remove the Operator, the AIPN 2002 JOA contains much more comprehensive removal
provisions. The “mandatory” removal provision says that:
Operator may be removed by the decision of the Non-Operators if Operator has
committed a material breach of this Agreement and has either failed to commence
to cure that breach within thirty (30) Days of receipt of a notice from NonOperators detailing the alleged breach or failed to diligently pursue the cure to
completion.35
This removal provision does not differ much in theory from the AAPL 1989 JOA removal
provision.
Where the AIPN 2002 JOA differs, however, is in its three optional removal
provisions. The first optional provision allows the removal of an Operator whose Participating
32
Id., art. 5.2.
33
Derman and Barnes, supra § 4.04[4].
34
AIPN 2002 JOA, art. 4.2.B.1.
35
Id., art. 4.10.B.
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Interest in the Contract Area falls below a certain predetermined percentage.36 The second
optional provision allows the removal of an Operator who undergoes a direct or indirect change
in control.37 Of most importance, however, is the third optional provision: “Operator may be
removed at any time without cause by the affirmative vote of __________ (______) or more of
the total number of Non-Operators holding a combined Participating Interest of at least
________________ percent (________%).” [emphasis added]38 The power of non-Operators to
vote out an Operator for any reason gives significantly more power and leverage to the nonOperators. But that power is rarely utilized, for:
in international operations, the Non-Operators are even less inclined to remove
the Operator as such a decision would necessitate taking over of operations in a
host country where, often times, only the Operator has any real in-country
operating experience. Despite the natural reluctance to remove an Operator, the
authority to remove will tend to restrain the Operator from becoming too creative
in charging its internal costs, and will tend to cause the Operator to be attentive to
the balance of its wants and needs with those of the Non-Operators.39
In addition to the previously mentioned cooperation in the AIPN 2002 JOA, the optional
provisions for Secondment in Article 4.3 further enhance party cooperation. ““Secondment”
means placement within Operator’s organization in accordance with this Article 4.3 of one or
more persons who are employed by a Non-Operator or an Affiliate.”40
[T]he concept of Secondment [is that] Non-Operator personnel with particular
expertise and experience are integrated into the Operator’s organization for the
limited purpose of conducting a particularly complex Joint Operation [as] a way
36
Id., art. 4.10.C.
37
Id., art. 4.10.D.
38
Id., art. 4.10.E.
39
Derman and Barnes, supra § 4.05.
40
AIPN 2002 JOA, art. 4.3.A. [Alternative No. 3].3
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to enhance the Operator’s technical capabilities without diluting overall
accountability and the Operator’s responsibility for Joint Operations.41
The concept of Secondment is nowhere to be found in the AAPL JOAs, but is a beneficial means
to increase the technical capabilities of the Operator, “in order to more effectively conduct Joint
Operations.”42
Conclusion: Changing the Domestic JOA
The cooperation principles highlighted in the AIPN 2002 JOA suggest that it is time for
the AAPL to revise its JOA. Indeed, since the AAPL’s last revision, the AIPN has gone through
4 revisions. “In this regard, the drafting and structure of the [AIPN JOAs] have been simplified
by the deletion of options that were not often used, the introduction of new or clearer definitions
and the use of examples as a means of clarifying the operation of certain provisions.”43
Domestic operations have changed from smaller ventures to those that are larger in scope and
require more capital.44 Therefore, the near-absolute autonomy of the Operator and the limited
avenues for non-Operators to present ideas in the AAPL 1989 JOA must be changed. Because of
the complexity of current domestic shale developments, the AAPL should draft a new model
41
Philip Weems & Michael Bolton, Highlights of Key Revisions – 2002 AIPN Model
International
Operating
Agreement,
OGEL
5
(2003),
available
at
www.kslaw.com/library/pdf/2002_JOA.pdf, p. 3.
42
Id., at 4.
43
Miles, supra at 154.
44
John B. Connally IV & Patrick T. Maguire, Recent Trends in Joint Ventures for Shale Oil and
Gas and Other Capital-Intensive Oil and Gas Projects, 57 RMMLF-INST 18-1, § 18.01 (2011).
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JOA that gives the parties the option to utilize an Operating Committee. This would help create
a long-term plan for development, rather than forcing the parties to merely accept or reject
proposed operations that occur with little or no communication. Moreover, the complexity of
shale development suggests that a Secondment agreement would be a viable way to increase
production. And finally, the power to remove the Operator without cause would be a beneficial
means to ensure Operator responsiveness to the non-Operators.
With the recent surge of
international investments in domestic operations45, these international investors who are
accustomed to international agreements may have the leverage to encourage this change. Indeed,
it is no harm to draft a new form in light of modern considerations, for just as the AAPL 1982
JOA is often preferred over the AAPL 1989 JOA, a new revision would not require changing the
nature domestic operations, but would allow those who desire cooperation to achieve it through a
model domestic JOA.
45
For a list of recent international investments, see id., § 18.02.
14