Guidance on Joint Operating Agreements 1.0
This is the first in a series of notes on Joint Operating Agreements.
Trinidad and Tobago has a long history of oil and gas production and as a result there are Joint Operating Agreements (‘JOAs’) dating back to the 1990s that are still governing arrangements between parties to production sharing contracts and licences. There are numerous model form JOAs in existence which are regularly updated therefore parties to older JOAs and those entering into new JOAs have multiple approaches available to them when seeking to amend an existing JOA or enter into a new agreement. The following are a few of the key areas that such parties need to carefully consider when drafting and negotiating JOAs.
Liability of the Operator
The party appointed as the operator under the JOA takes on the responsibility of conducting operations on behalf of all co-venturers that are a party to the production sharing contract or licence. One of the main issues to be agreed between the parties is the extent to which the operator may be held liable, separate and apart from its co-venturers, for any action taken or not taken by the operator.
The Operator will be required to conduct operations in a safe and efficient manner in accordance with good and prudent petroleum industry practices. In doing so the operator should neither gain advantage nor suffer a loss by virtue of being the operator. The JOA as a general rule will therefore specifically provide that neither the operator nor its affiliates or those who work for the operator, shall be liable for performing or failing to perform its duties as an operator and the operator’s co-venturers will indemnify the operator against such liability. The area to be negotiated and agreed between the parties is to what extent this general rule will be inapplicable thereby making the operator solely liable for its actions.
Parties need to agree the circumstances in which a co-venturer’s agreement to indemnify an operator for breach will be inapplicable.
The usual practice among co-venturers is that the operator’s limitation of liability will apply even where the operator is found to be negligent but the limitation of liability will not apply where the operator is guilty of gross negligence or willful misconduct. The operator however will usually only accept liability for the gross negligence or willful misconduct of a particular group of persons defined as its senior management personnel. This group is generally defined to include the directors and senior management which is broadly appropriate however, smaller companies with flatter organizational structures may find that more persons within their organizations fall within a general definition of senior management personnel than expected. It may therefore be useful for such companies to seek to replace the traditional definition and specify the job grades or titles to which this additional responsibility applies.
Post Macondo, non-operators have attempted to make operators solely responsible for environmental liability but this has been firmly resisted. Parties have however sought to specifically provide that the operator has a duty to conduct operations in an environmentally responsible manner. This is with a view to making an operator solely liable for environmental liability due to the gross negligence or willful misconduct of its senior management personnel.
Given that an operator receives no financial benefit over and above its co-venturers for acting as operator, it will be in the operator’s best interests to seek a cap on any potential sole liability. The operator may therefore seek to cap its liability to a fixed dollar amount or to an amount that is ascertainable such as the cost to repair or replace damaged property. In all circumstances the operator should also seek to include clear provisions excluding liability for any consequential loss suffered by its co-venturers.
Default
Where a party to a JOA fails to perform its obligations, usually the payment of cash calls, that party is deemed to be a defaulting party. Traditionally, the remedy for default under a JOA was forfeiture whereby the defaulting party’s interest in the production sharing contract or licence was assigned to the non-defaulting parties without compensation and the defaulting party remained liable for the sums due under the JOA. There has however been considerable legal debate about the enforceability of traditional forfeiture provisions in JOAs.
In common law legal systems such as Trinidad and Tobago, where a contract sets out a remedy for a breach, that remedy is enforceable if it is a reasonable pre-estimation of the loss that the party that is not in breach may suffer. If the ‘remedy’ is found to be a penalty in that it is disproportionate to the loss suffered, it will not be enforceable and many have argued that forfeiture provisions in JOAs may amount to an unenforceable penalty. Forfeiture provisions also raise insolvency issues in that it arguably offends against the rule that a party cannot enter into an arrangement which allows that party’s property to be taken away in the event of insolvency.
There has been considerable legal debate about the enforceability of traditional forfeiture provisions in JOAs.
In drafting a JOA parties should seek to ensure that the steps to be taken and the rights of the parties are clearly set out where there is a default. The overriding principle should be to have provisions which would encourage the default to be cured in the minimum amount of time and to allow operations to continue despite the default. Where there is a default, the non-defaulting parties will be called upon to pay the amounts due by the defaulting party in proportion to their participating interest and, at the very minimum, a defaulting party should be required to pay an agreed rate of default interest on those outstanding sums. Where there is production, the JOA should provide that the defaulting party’s petroleum entitlement can be sold by the operator and the sums received should be used to repay the outstanding sums plus the default interest to the non-defaulting parties with the balance, if any, being returned to the defaulting party. Until the defaulting party has cured the default such party should have no right to attend or vote at any joint operating committee meetings. The parties can also consider providing that any developments approved while a party is in default would be considered as a sole risk operation thus requiring the defaulting party to pay a ‘buy-in’ premium if it wants to be part of the development at a later date.
Finally, if the default continues, instead of the traditional forfeiture provisions where no compensation is due to the defaulting party, the JOA may be drafted to require the defaulting party to sell its interest to the non-defaulting parties at a significant discount thereby avoiding the legal insolvency and penalty issues. The task for the parties will be to negotiate and clearly document the mechanism to determine the value of the interest to be sold and to determine the discount available to the non-defaulting parties.
