The main function and aspects (or clauses) of a Joint Operating Agreement (JOA) in oil and gas industry

Introduction

Joint Operating Agreement (JOA) is the common methods through which companies join to form a joint venture in their exploration and production of oil and gas. JOA are common both in the United Kingdom Continental Shelf (UKCS) and globally. JOA is required mainly because of the economics of the oil and gas industry, a high risk and high cost industry with initial capital very high, but then, once successful, the rewards are also very high (Styles 2012). Entering into a JOA offers the parties involved various benefits with the primary one being joint risk mitigation and sharing in the outlays required for capital-intensive search, development, and production. This paper therefore discusses the concept and the function of JOA and identifies what is considered to be the key clauses in a JOA. This is done through review of relevant literature and application of knowledge acquired through class work.

The concept and function of a JOA

Joint venture happens when two or more parties in the oil and gas industry come together into a relationship with the aim of making a profit (Styles, 2012). JOA is the instrument that governs a joint venture thus it (joint venture) is unincorporated association. A feature of joint venture is that there is an areas of mutual interests where the parties involved purpose to go business together to the exclusion of others. In the United Kingdom, the 2009 Model JOA is used to govern the right joint-venture functions with the aim being to minimize cost and to maximize competencies in the joint venture within a defined scope of operations. As a result, the area of mutual interest is captured through an agreement, the JOA, through which the parties involved commit to working together but distinctly and separately.

A joint venture is different from a partnership because in a typical partnership, partners share profits and there are joint operations. While in relevant joint ventures there is an inevitable sharing of interests, each party takes a share of the profits based on the party’s level of participation to the joint operations (Dike 2014). In the UK, a joint bidding agreement precedes a typical joint venture and it indicates the desire of the parties to work together under an appropriate license (Styles, 2012). Another difference of a joint venture to a partnership is that the liabilities of the parties to the JOA are not joint. Moreover, in a JOA, each party is expected to dispose of his/her share of the oil or/and gas independently therefore realizing his/her profit. In a JOA, the relationship means joint investment in the production process and not joint sharing of the profits realized, contrary to the case in partnerships.

In the UK oil and gas industry, for parties engaging in a joint venture means there is a presumption in favor of the existence of a joint venture rather than a partnership. As indicated in the case of Spree Engineering and Testing Ltd v O’Rourke Civil and Structural Engineering Ltd, (2007) where the high court made a presumption in favor of the existence of an unincorporated joint venture, this presumption has been a long standing tradition in the UK. The reasoning by the court was that the parties had carried out a distinct activity they had specifically avoided using partnership in their relationship. This was the same reasoning in Brian Pty Ltd v United Dominions Corporation Ltd.(1985) where Samuel J stated that a joint venture was an association of persons, corporate or natural, who have agreed by contract to participate in a common undertaking for joint profit by combinations of their respective sources without formation of a partnership in the legal parameters.

Roberts (2008) argues that JOA is a definitive framework for the proportionate interests of parties and an explanatory document for the relationship of the parties under an appropriate license. This definition is based on the fact that in the UK, JOA contains details of the appropriate rights granted by licensee under the 1989 Petroleum Act. These rights and duties should be apportioned clearly in JOA otherwise is could lead to dispute for the parties. The UK JOA covers exploration, development, storage, and petroleum logistics (Aldersey-Williams, Ashle, Riddle & Rutherford 2016). These activities are and stand until when all commercially recoverable petroleum and decommissioning has occurred. This aspect of the JOA differs from the 2002 JOAs where liabilities of the parties didn’t extend to the decommissioning stage of the activities. Under the UK JOA 2009, the most important clause is that which deals with the parties ‘interests’.

This clause means that all duties and rights are borne by the parties involved on a pro rata basis as per the percentage contributions to the license except where there is sole-risk operator (Aldersey-Williams et al. 2016). Moreover, for the properties and assets under JOA, each party has undivided share equivalent to a chose in action – a transferable interest subject to approval by the UK secretary of state. The assignment of the JOA interest was faced by restrictions in the earlier versions of JOA but the government eliminated them for they were considered as being barriers to free trade in the UKCS. This was achieved through institutions of a master deed that is signed by JOA parties therefore ensuring smoother transfer of assignment of any JOA interest (Styles, 2012).

Key clauses within a JOA

Sole risk and non-consent clause

This clause can also be used to understand the roles of the operator and the non-operator. A sole risk is a scenario where the venture has failed to secure the approved pass mark by the Joint Operating Committee (JOC) but one party chooses to anyway proceed with the venture. Taverne (2013) argues that the purpose of the sole risk is to protect participant’s economic interests where his/her proposal for making an appropriate investment in the joint venture has been rejected by the JOC or he/she is against a termination proposal for a production facility that he/she supports. In this scenario, the sole-risk-taker incurs the burden of the particular undertaking as well as enjoys the benefits. In addition, the JOA may make provisions for a non-sole-risk-taker to partake in the JOA after payment of a premium or a penalty to the sole-risk-taker.

Styles (2012) states that the sole-risk clause is increasingly relevant in the UK compared to the non-consent clause. This is evidenced in the 20^th round draft JOA presented by the United Kingdom Offshore Operators Association (UKOOA), currently referred to as the Oil and Gas UK. A non-consent project is that where the JOC has consented to the necessary activities but one of the parties has decided to pull out from the project. In such a case, and in many of the JOAs, it is the operator who ends up undertaking a sole-risk venture, but still, there are cases where the non-operator ends up being a sole-risk undertaker. The JOA may make provision where non-operators are sole-risk undertakers, that the operator stops acting voluntarily or through a request for hand in his/her resignation thus allowing for the appointment of a new operator by the non-operators.

Default clause

This is an important clause in that it determines the relationship of the parties to a JOA. A default is used to refer to a situation where one of the parties has failed to pay his/her financial contribution to the JOA, referred to as a cash-call. Should one of the parties be in default, the JOA provides for the necessary consequences by stipulating that, after a given period elapses with the party still in default and upon relevant notices having been served to the defaulting party, then he/she stand to lose the percentage of interested entitled to him/her in the JOA (Roberts 2008; Aldersey-Williams et al. 2016). In the UK, a sole-risk normally takes precedence over subsequence developments made by the secretary of state and care should be taken to prevent conflict between the existing joint venture and the sole0risk business.

In case the non-defaulting party can’t compensate for the required financial responsibilities as per the JOA, then there can be abandonment or decommissioning of the relevant project and subsequent sharing of the liabilities among the parties. This is because in such a case, the JOA has broken down irretrievably in terms of the parties’ common objectives and liabilities will thus be divided on a pro rata basis (Styles 2012). As a result, a JOA should have a safety net for non-defaulters by way of penalty payment of forfeiture clauses in case any of the parties involved fails to meet their financial requirements to the joint venture.

Penalty and forfeiture clauses

This is a remedy open for the non-defaulting parties in a JOA and it can be expressed through an action for liquidating damages or penalty and not as an action for forfeiture. A penalty is termed as a recovery of a sum over and above that owned by the defaulting party and liquidated damages are termed to be the recovery of sums owed by a defaulting party with the potential to recover both damages and interests (Styles 2012; Aldersey-Williams et al. 2016). Forfeiture or penalty can be granted as equitable remedies, but as a matters of course because a person coming to equity must do so with ‘clean hands’ and equity won’t consider a wrong in a the absence of a relevant cause. Given this undertaking, it is argued that a claim for penalty must be equitable.

Atiyah (2006) argues that a penalty and forfeiture are closely related because; a penalty is an action to recover money from a party in default, commonly in the form of damages, and forfeiture is where the aggrieved party is seeking forfeiture of assets aiming to settle a debt or other damages. Nevertheless, the difference between a clause and an action for liquidated damages can e drawn from Commissioner for Public Works v Hill (1906) where the court determined that where the sum claimed was nit a genuine pre-estimation of the creditors probable interests in due performance of the principal obligation, but more of a form of a penalty. But often, courts are reluctant to enforce penalty clauses in place of liquidated damages clauses based on concerns that the claimed amount might not be a genuine estimation of losses suffered but an unconscionable and extravagant amount (Dike 2014).

In the UK, the current position for most JOAs is that the courts prefer a forfeiture or withering-interest clause to a penalty clause (Styles 2012). A withering-interest scenario is more like a depreciation of the defaulting party’s interests calculated on a pro-rata basis alongside his/her level of default rather than an outright penalty or forfeiture payment. This attitude shift is in response to concerns that penalty clauses damaged existing relationships between parties to a JOA, concerns arising from the UK oil and gas industry. As a result, the current position is set out in the Butter vs. BBC Worldwide Ltd. (2009) case where the House of Lords put into consideration the effectiveness of a forfeiture clause in an intellectual property license. The court upheld the clause that gives non-defaulting parties in a JOA rights over an insolvent party in a joint undertaking.

Conclusion

The JOA is a concept common in the oil and gas industry, through which companies join to form a joint venture in their exploration and production of oil and gas. The two key functions of JOA is to establish a basis for international oil companies for sharing rights and liabilities as a joint venture under the license, and to provide for conduct of operations under the license. Three key clauses are established herein: sole risk and non-consent clause used to understand the roles of the operator and the non-operator by protecting participant’s economic interests where his/her proposal for making an appropriate investment in the joint venture has been rejected by the JOC or he/she is against a termination proposal for a production facility that he/she supports; default clause that determines the relationship of the parties to a JOA thus used in a situation where one of the parties has failed to pay his/her financial contribution to the JOA, referred to as a cash-call; and penalty and forfeiture clauses which is a remedy open for the non-defaulting parties in a JOA and it can be expressed through an action for liquidating damages or penalty and not as an action for forfeiture.

References

Aldersey-Williams J, Ashley PS, Riddle E & Rutherford D. (2016). Default clauses in joint operating agreements: recent guidance from the English courts, International Energy Law Review
Atiyah P, (2006). Introduction to the Law of Contract (2^nd Clarendon Law Series, 2006), p.269
Brian Pty Ltd v United Dominions Corporation Ltd (1985) 157 C.L.R. 1, 10
Butters v BBC Worldwide Ltd [2009] EWHC 1954 (Ch); [2009] B.P.I.R. 1315.
Commissioner for Public works v Hills [1906] A.C. 368; (1906) 22 T.L.R. 589 PC.
Dike SC, (2014). Appraising the legal relationship between the operator, the non-operator and the operating committee in a joint venture – the UK example, International Energy Law Review
Roberts P, (2008). Fault lines in the joint operating agreement: decision-making, International Energy Law Review
Roberts P, (2010). Joint Operating Agreements: A Practical Guide (2^nd), (London, UK: Globe Business Publishing Ltd.
Spree Engineering and Testing Ltd v O’Rourke Civil and Structural Engineering Ltd [2007] NICA 11.
Styles SC, (2012). “JOINT OPERATING AGREEMENTS,” in Gordon G, Paterson J and Usenmez E.Oil And Gas Law- Current Practices And Emerging Trends. 2^nd Dundee: Dundee University Press.
Taverne B, (2013). Petroleum, Industry and Government, A Study of the Involvement of the Industry and Government in Exploring for and Producing Petroleum (Kluwer Law International,), 3rd edn, p.359.