Guidance on Joint Operating Agreements 2.0
Note: This is the second in a series of notes on Joint Operating Agreements.
In the previous article issues surrounding the liability of an operator and defaulting co-venturers were considered. In this article we shall highlight the joint operating committee and sole risk activities.
Joint Operating Committee
While the operator has the authority and duty to carry out operations on behalf of co-venturers, the co-venturers retain overall supervision and control through the joint operating committee (‘JOC’). The JOC is comprised of representatives appointed by each of the co-venturers with the representative of the operator being the chairman of the JOC. The areas where the operator requires the approval of the JOC before it acts is negotiable but usually the JOC approves: all work programs and budgets, appraisal and development plans, determination as to the commerciality of discoveries, the drilling, deepening, testing, side tracking or completion of wells; decommissioning and abandonment, and all other major decisions that the joint venture will need to make.
Each party needs to analyze its participating interest as against that of the other co-venturers and seek to negotiate pass marks that are in its best interests.
Given that the JOC has the ultimate approval authority; parties need to carefully consider the manner in which decisions of the JOC are made. The voting procedure of the JOC will provide that a certain percentage pass mark is required in order to approve a proposal put to the JOC. There are numerous ways in which a pass mark may be achieved such as: the approval of the co-venturers holding a specified percentage of the participating interests; or a minimum number of co-venturers holding a specified percentage of the participating interests; or varying percentage pass marks for different decisions. It will be up to each party to analyze its participating interest as against that of the other co-venturers and seek to negotiate pass marks that are in its best interests. Often, parties will attempt to ensure that they have ‘negative control’ which means that while that party may not on its own have the power to ensure that a proposal it favors will be passed, that party may want to ensure that by withholding its vote it can block the JOC from passing proposals to which it is opposed. The parties also need to be mindful that if every party has ‘negative control’ or there are very high pass mark thresholds it may lead to situations of deadlock where the JOC is unable to function as proposals cannot be approved. Parties should therefore attempt to restrict the requirement for unanimity to the most important decisions and consider mechanisms to avoid or break any deadlock. One example may be that where there are multiple alternatives to a particular course of action, the proposal with the highest percentage of votes is approved or alternatively the operator may be granted a casting vote to break a deadlock in certain situations.
Another area which requires attention so as to allow the proper functioning of the joint venture is to have clear mechanisms for the approval of budgets, authorizations for expenditure (‘AFE’) and the entering into of contracts by the operator on behalf of the joint venture. These are areas where the approval of the JOC is required and the operator will be keen to ensure that approvals are received in good time so as to maintain efficient operations. Some of the issues that the parties will need to consider in this regard include: in what situations does the operator need JOC approval before entering into a contract, usually monetary thresholds are established; the parties may wish to set up clear time frames within which a party is required to provide their approval of a proposal; the issue of whether a party’s failure to grant its approval within a prescribed time period will be deemed to be an approval or rejection of the proposal; establishing circumstances in which a party may reject an AFE for an item of expenditure that is included in a previously approved budget; and the right of the operator to exceed an approved budget or AFE by a prescribed amount.
Sole Risk
All co-venturers may not always agree to a particular course of action and thus the required JOC pass mark may not be achieved. In certain situations a joint operating agreement (‘JOA’) may allow one or some of the co-venturers to proceed with the proposal as a sole risk project. Given that a development can proceed without one or some of the co-venturers, there is often debate among co-venturers as to whether a proposal is one that is eligible to be carried out as a sole risk project therefore it is essential that the sole risk provisions of the JOA are unambiguous and the process to be followed is clear.
Traditionally drilling, seismic work, testing and developments are the types of projects that can be carried out as a sole risk project.
The JOA should set out the type of projects that can be carried out as a sole risk project. This will usually include drilling, seismic work, testing and developments. As a general rule, a sole risk project must first be proposed to the JOC and if not approved it may be carried out as a sole risk project provided that it does not conflict with any joint operation which has already been approved. The co-venturers that are participating in the sole risk project will be required to pay all costs associated with the project and indemnify the co-venturers that are not participating against any loss or liability. Where the sole risk project involves the deepening or side tracking of a well which is in the course of being drilled, special provisions are required because the rig is already on site thus decisions of the co-venturers will need to be taken quickly, usually within forty eight (48) hours, in order to minimize costs.
Once the sole risk project has been conducted, the co-venturers that did not participate in the project are usually granted a specified period of time within which they may exercise the option to participate in any further work that may be undertaken pursuant to the sole risk project. Such a co-venturer will need to ‘buy in’ to the project at an agreed premium above the cost of the project as compensation to the co-venturers that participated in the sole risk project from the onset. Failure to exercise the option to ‘buy in’ within the prescribed time period or failure to pay the ‘buy in’ cost will result in such co-venturer losing the right to participate in any further developments stemming out of the sole risk project.
