INTRODUCTION

The JOA is one of the most frequently used agreements in Oil and Gas law. The parties enter the contract to conduct joint-operations.

They bring with them their different ideas of how the operations will be conducted. The JOA must provide a set of rules which will govern the parts for the duration of the JV. These rules must last a very long time and apply to a vast range of activities The design of the JOA must therefore address issues that are most sensitive to the parts

and which can lead to disputes which threaten the stability and longevity of the JV. The question posed in this Paper „Which issues are likely to be the most sensitive to the

parts and how can a good contract design limit the damage from such disputes?

JOINT OPERATING AGREEMENTS

What Is a Joint Operating Agreement ? A JOA is a contract between two or more parts creating a contractual framework for a JV

between them under which they will conduct petroleum operations. The JOA sets out the structure of the JV, the allocation of risks and costs and the method

for sharing production and profit. Petroleum operations are hardly ever conducted by a single part. This is because the risk,

expense and investment required for such operations are too great for one company to shoulder alone.

Oil exploration is a capital intensive and risky enterprise with heavy upfront costs albeit one which offers high rewards to successful parts.

The JV will also enable cost savings and economies of scale.

Functions of a Joint Operating Agreement

The JOA serves two main functions:1) A basis for the sharing of rights and liabilities under the PL. Usually this is allocated

according to each parts PI under the JOA. The declaration of PI is one of the essential provisions in a JOA. All rights and liabilities arising in connection with the PL will be shared between the licensees in proportion to their PIs

2) To provide a set of rules for the conduct of operations under the PL. Operation involves designating one of the licensees as operator for the responsible for conducting the day-to-day operations subject to the supervision of a JOC which is representative of all licensees.

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THE PARTS TO A JOINT OPERATING AGREEMENT

There are two classes of part to a JOA. The operator and the non-operators. 1) The operator is the part who implements the collective will of the JV and is responsible for

day-to-day management of the operations. 2) The other members are known as non-operators. The „institutional link between the ‟

operator and the non-operators is the JOC on which all the parts to the JOA sit.8

The Operator In most international JO As the operator is the part with the largest interest in the PL. It is usually considered imperative by the parts to a JOA that the operator should have a

substantial PI in the PL. This is because a part with a less substantial interest may not be willing to commit limited technical resources to the project.

Further the non- operators may doubt the operator’s commitment to the project and fear that its motivation arises from a desire to make a profit from its position. As a result the companies in the JV will expect that the operator is financially sound and technically capable to carry out the operations.

Fundamental feature of the JOA is that the operator works gratuitously on behalf of the JV. He only takes the profit that it is entitled to pursuant to its PI. Why then would any

member of the JOA choose to act as an operator? Possibly because of the degree of control that the operator is able to exert over the project.

The reward for being operator is greater power as opposed to greater profits. The operator has the same liabilities as the other parties to the JOA. When contracting on

behalf of the JV, the operator will be acting as agent for the JV who is the principal. The operator will owe a duty of care to the other parties in its capacity as operator.

The Non-Operators The role of the non-operators in the JV is „one of non-operating. The most important duty of a non-operator is to provide a share of the funds whenever

there is a cash-call. Non-operators are active investors and they can have an active say in the managing of the

JV through the JOC. He has the ultimate responsibility for the management of the JV is entrusted to the JOC in

some JOAs. The JOC will supervise and control all matters related to the joint-operation. The JOC arrives at decisions according to a voting procedure specified in the JOA.17 Voting

on the JOC is usually weighted to reflect each parts PI. The value of any percentage voting right is affected by the pass-mark laid down in the JOA.

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ISSUES MOST SENSITIVE TO THE PARTS AND CONTRACTUAL SOLUTIONS

CONTROL AND DECISION MAKING Oil and gas industry practice is to permit the operator to act on behalf of the JV and to have

full control of day-to day operations within the limits of the JOA. JOAs usually exclude any liability on the operator’s part for a failure to act which is

anything other than willful misconduct or gross negligence, and these are particularly difficult to prove.

Strict and continuing supervision over the operator’s activities is necessary and will be a most sensitive issue .

If such control is not exerted, the parts to the JOA run the risk of losing their investment. Such control can be achieved by the following means:

Joint Operating Committee The principal method of addressing this issue is by making the operator’s conduct of the

JV subject to the supervision of the JOC. The AIPN JOA provides that the operator shall “perform Joint-operations in accordance

with the provisions of the Contract, the Laws / Regulations, this Agreement, and the decisions of the Operating Committee not in conflict with this Agreement.”

The operator may prefer to act without the restriction of JOC supervision. AAPL JOA provides that the operator has full control of all operations in the contract area

and is not subject to the control of the non-operators. The CAPL JOA26 provides that the operator has freedom to act subject only to the

obligation to consult with the parts and to keep them informed about the joint-operations.

Voting Procedure As mentioned above, the JOC reaches decisions according to a voting procedure and the

requisite pass-mark specified in the JOA. This is crucial as it determines which of the parts has the power to veto any proposed

activity. The part with a large percentage may seek a high pass-mark so that it can approve or veto

any decision. Parts with smaller interests may seek protection to ensure against the risk of one or two

parts preventing or forcing a cause of action. This issue would be very sensitive to the parts.

If the operator has the largest percentage share which meets the threshold of the pass-mark, it can carry the vote. This could make this provision fail to adequately control the operator.

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This problem can be avoided by imposing a requirement for unanimity in respect of certain items in the JOA.

Most JOAs which provide for the possibility of unanimity of voting do not provide a meaningful deadlock resolution provision

The implication being that the parties can’t progress in the JOC until some sort of mutually acceptable position is achieved.

Approval of Programs, Budgets and Expenditure The approval of such is of utmost importance to the parts in controlling the joint

operations and their exposure to costs. Therefore an effective method of controlling expenditure is vital. AIPN JOA at 6.7B

Alternative 2 and 3 provides for express approval. Alternative 2 allows for approval by conduct where the JOC fails to approve an AFE within

the permitted time period.

ISSUES RELATING TO JOINT-OPERATION Parts with small PIs may not want to be bound to activities they do not support or cannot

afford. Also, parts with significant interest may not want to be prevented from developing the

particular project. In order to protect these diverging interests, JOA s usually permit sole risk and non-‟

consent operations.

Sole Risk A sole risk provision allows parts to undertake a project rejected by a majority of the JOC. The effect of this provision is that all costs and all entitlements to petroleum from the

project costs rest wholly with the sole risk part or parts. The clause recognizes that a project may be considered worthwhile by some of the parts

but may fail to meet pass-mark. The AIPN JOA39 provides for what it calls ‘exclusive operations .‟ Under this mechanism, a part can propose an operation (outside of the agreed joint-

operations program) such that a partymay proceed with that exclusive operation in its own right.

The other parts are free to participate or not, as they prefer. The CAPL JOA40 has a similar provision known as independent operations.

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Non-Consent A non-consent clause will provide that no part can be compelled to participate in any

major operation, such as drilling without its consent. Non consent and the sole risk rights represent the possibility that operations can carried

out under the JOA by less than all the parts. However these rights are incompatible with the intended JOA philosophy which is

majority rule. This is particularly the case with the non-consent right, where the consenting parts are left

with the burden of having to share the particular project costs in proportions which are greater than the original PIs they had bargained for

An operator might be eager to see these rights excluded, or at least greatly limited, under the JOA.

However, a non-consent right is particularly valuable to non-operating parts in protecting such a part from being forced into an operation which it might not have the financial ability to pursue.

ISSUES RELATING TO DEFAULT These relate to the long term protection of the parties rights and interests in the JV. Each JOA is built on the presumption that the burden if financial operations shall be

shared. The most important duty of all parts to a JOA is to provide funds when they are requested

under a cash-call. If a co-venture breaches its financial obligations, it breaches its most basic duty under the

JOA. A default situation arises where a part fails to meet its PI share of the expenditure made

on behalf of the JV. When such default occurs one or more of the non- defaulting parties have to step in the

meet the defaulter’s share of the expenditure. Provisions should be made in the JOA to protect the operator from having to bear the

burden of funding the default. Default is more relevant now as production in the north-sea matures coupled with the

current financial climate. The non-defaulting parts will be keen to see that default and remediation does not become

an established pattern of behavior by a part and so the JOA will need to provide a swift and effective sanction in circumstances of default.

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Suspension of Rights The JOA can stipulate that in the event of default some of the defaulting part rights become

suspended. As a practical solution, the threat of selective suspension may prove to be an effective

influence against the defaulter. The AIPN JOA provides for a suspension of the aforementioned rights during the „default

period .‟ If the default is still un-remedied then the ultimate sanction is that all of the defaulting

parts interest in the JV is forfeited to the non defaulting parts.

Forfeiture Forfeiture is basically a forced transfer of the defaulting parts interest. The AIPN JOA provides an option for forfeiture in the event of default. However such forfeiture may be held to be penal because the amount in question is

“extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.”

A further consideration relating to the forfeiture remedy is whether a defaulting part could claim equitable relief against forfeiture.

In practice the risk of a forfeiture clause being struck down by the courts is small because the only relief which the courts will be willing to grant is to give the debtor to time to pay his debt. The time period is arguably provided by most JOAs.

Another consideration is that such a clause maybe seen to frustrate the operations of insolvency law.

Buying Out the Defaulting Party’s Interest The consideration for such sale would be assessed on the presumption of a fair market

value and with recourse to an independent expert in the event of a dispute between the parts.

The AIPN JOA64 includes a buy-out alternative to forfeiture to allow parts completely ignore forfeiture enforceability issues.

The CAPL JOA requires a forced sale of the defaulting party's JOA interest on the open market.

The operator is granted a first-ranking lien over each parts interest under the JOA in order to secure payment by that part of its share of the costs of the joint-operations.

The proceeds of the sale are used to remedy the default and the balance is returned to the defaulting part.

Security For Decommissioning Costs Decommissioning is an issue which is becoming more relevant as existing oil fields

mature.

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If all the parts to a JOA decide to withdraw they will have to wind up the JOA in a manner that satisfies the relevant governing laws and regulations.

Usually the parts are jointly and severally liable for the costs of decommissioning under the PL.

The parts will be keen to ensure that they bear only that share of decommissioning costs that is proportionate to their PI.

This makes decommissioning an important issue for JV members which if not immediately sensitive to them, should be brought to their attention during negotiations.

To prevent this, most JOAs will authorize several types of security including a guarantee or a standby letter of credit issued by an accredited bank, an on demand bond issued by a surety company, a corporate guarantee, or some financial security agreed on by the parts.

The AIPN JOA provides an option for „Abandonment Security which obliges the parts to ‟negotiate a security agreement during the preparation of the development plan in respect of decommissioning.

The advantage of this is that decommissioning issues will be dealt with from the outset in the JOA.

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