UK: The Joint Operating Agreement

Last Updated: 12 March 2014

Following the entry into a Joint Study and Bidding Agreement ("JSBA") and the submission of an application for the award of a new licence on a consortium basis, where a licence application has been successful on that basis the immediate focus of the consortium parties should be on the entry into a joint operating agreement ("JOA") in order to provide for the impending unincorporated joint venture to be effective.

The JOA is the vehicle necessary to structure and govern the unincorporated joint venture and to allocate the joint venture's liability to the government amongst the joint venture members. The unincorporated joint venture lacks any inherent constitution, save for that which may have been contemplated by a forward-thinking JSBA pre-licence award; and, in the case of the UK continental shelf ("UKCS"), licences are awarded on the basis of each of the parties to the licence being jointly and severally liable to the government for the performance of its terms - in essence, the government considers each of the licensees collectively as being a sole licensee. It is necessary therefore that the workings of the relationships between each of the joint venture parties and between the joint venture collectively as the sole licensee and the government are properly recorded.

The JOA is an inherently complex agreement, the provisions of which are likely to benefit (and in some cases burden) the joint venture members and the licence for the life of the licence. The negotiation and drafting of the JOA can be subject to lengthy contention. The purpose of this paper is not to engage in a detailed analysis of the intricacies of the negotiation and operation of a JOA but rather is intended to serve as an accessible high-level reminder of the critical issues for joint venture members to consider as they embark upon entry into a JOA in the UKCS.

1. Timing of the negotiation of the JOA

Although not always possible due to the time constraints imposed by the licencing round timetable, it is recommended to agree the JOA at the time of the negotiation of the JSBA and to have the agreed form appended to the JSBA. The JOA could also be executed at this stage with a condition precedent to its effectiveness relating to the execution of the licence. Such an approach provides a degree of certainty about the purpose and longevity of the JSBA, gives the consortium members an opportunity to manage contentions and to fine tune the content of the JSBA and the JOA in advance of any licence award, and leads to quicker progress on the satisfaction of the work obligations which the licence contains. 

An alternative approach is to negotiate the JOA only when the consortium is made aware of the success of its licence application. Such an approach may seem economically efficient, as there are no guarantees that the consortium's application will be successful and thus the expense of negotiating a JOA which ultimately is never used may be saved. Although not ideal, this is not an uncommon situation. 

The opposite proposition however is that the consortium may have made a successful licence application in the absence of an agreed JOA existing amongst the consortium members. Continuing the joint venture without a JOA in place could be an alarming proposition for the consortium. A number of factors will influence the complexity of the situation the consortium faces as a result of this position: the quality and foresight of the JSBA; previous working relationships amongst the consortium members; the experience of the consortium members of the UKCS; and the particular legal, cultural and political characteristics of the consortium members' respective home countries. The consortium members should keep these factors in mind when they form the decision as to the timing of the negotiation of the JOA. 

2. Model forms

The joint venture parties may wish to consider utilising a standard form JOA as the basis for their negotiations in order to increase economic efficiency by potentially reducing negotiations and the requirement for bespoke drafting.

Oil and Gas UK Ltd ("OGUK") published a model form JOA in 2009 which was intended to reflect common UKCS industry practice at that time and which was intended to create consistency with the provisions of the Oil and Gas UK standard decommissioning security agreement ("DSA")1 which is commonly used alongside the JOA at the appropriate time in the evolution of the licence. The OGUK JOA has traditionally been favoured as the model form for use on the UKCS. With increasing frequency however, the international nature of UKCS joint ventures sees joint venture parties opting to use, as the basis of their negotiations, other model forms of JOA with which they have greater familiarity, and a hybrid approach which combines the positions of more than one model form JOA.

On an international basis, the Association of International Petroleum Negotiators ("AIPN") JOA has seen the widest use. The familiarity of international joint venture partners with its content has lead to a preference for its use being expressed by international entrants to the UKCS. Where, in respect of a particular joint venture, its use is not preferred by the majority of the members, recent experience shows an approach where the OGUK JOA has formed the base agreement but with certain AIPN JOA positions intertwined.

Whilst model form JOAs may be useful as a starting basis for negotiations between the joint venture parties, they are not a 'silver bullet' and should never be a substitute for the application of legal, commercial and technological logic and analysis; the diverse requirements of UKCS licences, acreage and joint venture parties means the automatic adherence to and acceptance of the terms of a model form JOA is bound to be problematic.

3. Parties and collateral support

It is not uncommon for a joint venture party, particularly in the case of an overseas joint venture party, to require its licence interest to be held by a newly incorporated subsidiary. This could be a subsidiary which lacks a strong financial covenant. Experience also shows that it is common for an overseas new entrant to the UKCS to utilise its parent company for the purposes of the licence application but, upon a successful licence application, to vest the licence interest in a newly incorporated subsidiary. Such propositions result in a party of potential low creditworthiness becoming party to the licence and the JOA.

Key to the JOA is the requirement for the parties to be able to fund the financial commitments under the licence and the JOA in a timely manner by making payments in response to cash calls or invoices by the operator. Where the initial and/or ongoing creditworthiness of a party is lacking, it is prudent (and should be expected) that the remaining parties will require a form of collateral support in respect of that party's payment commitments. Given the joint and several nature of the licence obligations to the government, it should be a condition of such party's entry to the JOA that collateral support is in place simultaneously with its entry to the JOA in respect of its several liability for its obligations under the JOA and to the government.

Joint venture parties should also be aware that where subsidiaries are used as licensees, wherever there is a parent company with significant financial capacity, the Department of Energy and Climate Change ("DECC") will normally require a further parent company guarantee. The standard forms of parent company guarantee can be found on DECC's website.

4. Scope of joint operations

It is essential for the JOA to make a clear distinction between those licence activities which will be deemed to be performed as 'joint operations' under the JOA and those which will be undertaken by the parties to the JOA on an individual basis. Although it is not difficult to distinguish which activities are joint and which are individual (necessity and pragmatism usually spell it out), the parties should aim to include in the JOA a mechanism which clearly makes such a distinction in order to avoid any uncertainty over who should perform which activity and how it will be paid for. This is usually in the form of either a carefully crafted definition of 'joint operations' in a general sense, or in the form of a more technical definition with specific reference to technical elements, thus identifying and reciting those activities which are 'joint' and those which are undertaken on an individual basis as operations 'excluded' from the joint operations. 

Where the general definitional approach is taken, what constitutes 'joint operations' must be established with care. An excessively wide definition can result in a lack of clarity as to where the boundaries of joint operations are set; an overly prescriptive definition could result in the exclusion of certain activities which should have been included as joint operations. Care should be taken to include in the drafting scope for the inclusion of all activities which are necessary in order to exercise the rights and perform the obligations which result from the licence as joint operations.

Where technical references are used, care should be taken to accommodate the sometimes overlapping nature of certain sequential JOA activities in the light of the lifecycle of the licence and the JOA. Where the definition of joint operations makes reference to what constitutes joint operations by sequence, it must also recognise that certain activities may overlap or fall out of sequence (for example, a part of the licence acreage may be explored and developed at a different time from other parts) and must ensure that it does not inadvertently exclude such activities from the defined joint operations.

The parties may also wish the JOA to recognise that the parties may not be supportive of each and every activity which falls as a 'joint operation' and thus should provide for a mechanism to allow for parties not to participate in certain joint operations. Such a mechanism is commonly referred to as 'exclusive operations'.

In such a case, the JOA should carefully set out a number of matters in respect of exclusive operations: what is permitted and prohibited; the allocation of costs and profits; the governance of exclusive operations; the allocation of liabilities; buy-back rights; data access; operator non-participation; the extent of non-participation; and access to joint property.

5. The operator and its role

At the time of submission of the licence application to DECC, the prospective joint venture parties are required to have identified and specified therein which of the parties will function as operator. This decision as to who will be operator will therefore be made in advance of the negotiation and entry into the JOA. This is not an area that is likely to be subject to contention. The parties will typically share a pre-determined understanding of the general role of the operator and will want to have the joint operations properly performed, and so will have identified one of their members as the most suitable candidate.

The operator's role is usually set out by express reference to each element of its rights, responsibilities, obligations and liabilities. The JOA will typically make reference to: the operator's right to conduct joint operations; its responsibility to prepare work programmes, budgets and authorisations for expenditure; representation of the parties before the government and third parties; staffing; contracting for materials and services; and responsibility to deliver a certain standard of performance.

In defining the operator's role, careful consideration should be given to seeking a balance between utilising general statements in respect of the elements of its role and setting out such elements of its role with great detail. The former will be useful in that it may provide for enough scope for new elements of its role to be included as the role and licence evolves over time, but a risk with this approach is that it may make enforcement of the operator's performance of its role more difficult. In the contrary case, including significant detail will be useful in compelling performance but may lack the necessary flexibility to properly accommodate evolution of the operator's role.

6. Voting control

The voting control mechanism is key in determining how the non-operating parties to the JOA may have some influence and control over how their interests are served by the operator. It is likely that the JOA will require the unanimous approval of the parties in respect of a limited number of certain major decisions, and in respect of other decisions the affirmative vote of the parties will be required to pass a certain defined threshold. 

The body constituted under the JOA for the purpose of representing the JOA parties in the taking of such decisions is commonly known as the 'operating committee' or the 'OpCom'. The OpCom is formed of a nominated representative of each party, with each representative having a single voting right weighted in accordance with the participating percentage interest of the party which it represents. 

Key to the parties' considerations will be deciding which decisions of the OpCom require unanimous approval, and deciding the threshold 'passmark' for the remaining decisions. Too high a passmark, or where a high number of decisions require unanimity, will frustrate the ability of the operator to perform its role and generally frustrate progress under the licence. Furthermore, too high a passmark will provide parties holding a comparatively low participating interest in the licence with disproportionally large power. Too low a passmark, on the other hand, will provide for the dominance of a party holding a comparatively high participating interest in the licence. 

7. Transfers

During the lifetime of the JOA, a party may wish to transfer its interests in the licence, the JOA and the wider project to a third party in order to realise some of the value of the asset. The JOA should make provision for such an occurrence. The parties should consider the following matters:

  • the insertion of minimum levels of participating interest-holding in order to protect against the frustration of the operating committee which may result where many parties hold small equity interests;
  • the transfer of operatorship where the operator transfers all or a certain part of its participating interest;
  • the right of the non-transferring parties to approve the accession of a new transferee on the basis of financial competence and technical competence (in the case of that transferee assuming operatorship); and
  • the allocation of liability for costs, liabilities and obligations pre and post transfer between the transferor and the transferee, and sufficient indemnities in order to enhance enforceability of the same. In practice, this will be recorded in the novation agreement which is used to effect the transfer. The parties may opt to scope this out in advance of any transfer and append a deed of novation to the JOA.

The parties should also be mindful that DECC will generally not approve a JOA which contains pre-emption rights, save in exceptional circumstances. 

8. Withdrawal

The inclusion in the JOA of the right of a party to withdraw from the JOA should be considered carefully. Withdrawal provisions allow the withdrawing party to surrender its interests in the JOA and the licence to the other parties, in effect abandoning its rights and obligations. The case for and against inclusion of such provisions often triggers debate.

Where the parties wish to include such a right, the parties should consider adding some conditionality as to when the right can and cannot be used.

Consideration should be given to the inclusion of prohibited periods, particularly in respect of the period up until the satisfaction of the minimum work obligations under the licence. It may be prudent to provide for withdrawal during the exploration phase only, and only after the minimum work obligations have been satisfied within such phase. It may also be in the interests of the parties to apply restrictions in respect of periods of force majeure, periods of default and where interests are subject to an encumbrance. Caution must also be exercised in respect of withdrawal near the end of the licence's life.

Ultimately, it should be the goal of the parties to achieve a commercially acceptable balance of ensuring the delivery of their joint venture intentions and providing for withdrawal where the project risk and uncertainty make such a concept acceptable.

9. Default

The consequences of the default of a party under the JOA can be significant. Once the parties have agreed on what constitutes a default under the JOA, significant focus should be placed on the remedies for default.

The remedies should be crafted such that default is not viewed as facilitating short-term financing of a defaulting party's obligations by the other JOA parties, and such that it provides a mechanism for recompensing appropriately the non-defaulting parties for their intervention. The default remedies should disincentivise default but should not be overly penal.

It is common that the default remedies operate on a sliding scale of severity; the longer the period of default is, or the more frequent the periods of default are, then it should be expected that the severity of the sanction will increase accordingly. At the lower end of the scale, the defaulting party may find itself paying interest on moneys owing and losing certain rights in respect of operations under the JOA. At the higher end of the scale, consideration should be given to the inclusion of provisions for forfeiture of the defaulting party's interests to the non-defaulting parties and the sale of the defaulting party's interests.

In respect of decommissioning liability, a default under the JOA should also trigger a corresponding default remedy under the DSA (see below). Parties to the JOA should ensure consistency of the operation of the JOA and DSA in respect of default.

10. Decommissioning

Consideration should be given to the necessity for collateral support in respect of the period where the production of petroleum from the licence has come to an end. The costs of the parties' decommissioning obligations are likely to be very significant and accordingly the drafting of the related provisions in the JOA should not be taken lightly. 

The decommissioning provisions in the JOA should take account of the laws and regulations which govern decommissioning on the UKCS. The provisions should address the complexity of the detail of the Petroleum Act 1998 and other relevant applicable laws and regulations, the relationships between the past and present parties to the licence and the requirement for collateral support. Commonly, UKCS JOA participants agree in the JOA to enter into (at a later stage) the DSA, the purpose of which is to provide the necessary security by each of the parties in respect of future decommissioning obligations.

Conclusion

Model forms of the JOA exist which make a reasonable attempt at engaging with the key issues and which have largely stood the test of time. However, as participation in the UKCS diversifies, the requirements of the participants also becomes more diverse, thus leading to positions being taken in UKCS JOAs which are not simply an adherence to what has traditionally been accepted as common UKCS practice. This diversification and the gradual acceptance of non-traditional practices provides participants with a greater opportunity to negotiate and to achieve the inclusion of individual requirements in the delivery of increasingly bespoke UKCS JOAs. In order to maximise the opportunity that this shift presents, drawing on the experience of practitioners which have negotiated and drafted JOAs both locally and internationally must be a priority.

Footnote

1. A new Oil and Gas UK DSA was published in late 2013. It is advisable to check that the provisions of the 2009 Oil and Gas UK model form JOA are aligned prior to making use of each.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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