ENFORCEABILITY OF DEFAULT PROVISIONS UNDER JOINT OPERATING AGREEMENTS.

• Author: Pereira, Eduardo

ABSTRACT

Default provisions are commonly included in joint operating agreements (JOAs) in the context of petroleum operations. Among other contractual provisions, default provisions memorialize the commitment among the parties to share cost and underscore the consequences of any failure to do so. However, transnational petroleum contracts and their default provisions might not be consistently enforceable across jurisdictions, depending heavily on factors including the precise terms of the provision as well as the jurisdiction's adherence to civil or common law systems. Despite the fact that the usefulness of a default provision hinges on its enforceability, this issue remains largely unexamined in the context of international petroleum transactions under a number of common and civil law jurisdictions. This article explores the reasons behind Operators' choice to include a default provision in a JOA, the issues arising out of the possible unenforceability of such provisions across jurisdictions, and finally, the suite of remedies available for default that extend beyond forfeiture, including buyouts, liens, transfer-of-interest rights, or withdrawal.

1. INTRODUCTION II. ENFORCEABILITY OF THE DEFAULT PROVISION A. Context Behind the Default Provision 1. Default Rationale 2. Default Procedures 3. Default Definition 4. Default Timing 5. Pay Now, Argue Later? 6. Remedies Available? 7. Industry Practices B. Common Law Perspective C. Civil Law Perspective III. CONCLUSION APPENDIX A I. INTRODUCTION (1)

   A joint operating agreement (JOA) is based on the principle of shared risk and cost. (2) Hence, one of the most important issues that the JOA addresses is the parties' financial obligations within the consortium. The preservation of financial resources under the JOA allows the consortium to perform its joint operations. (3) Conversely, a member's failure to meet those obligations might put the viability of the JOA at risk even though a JOA party could legally/contractually challenge certain obligations and/or payments that are inconsistent with the JOA terms or applicable law. (4)

   In the context of petroleum operations, the aim of the default provision is to provide certainty and stability for the financial contributions that are required throughout the life of the specific project. (5) Thus, it is crucial for the JOA to bear a provision stipulating the so-called situation of "default" (default provision). This is a common approach in the petroleum industry, (6) but the precise definition of default and the implementation of such a provision might vary between different JOAs and Model Forms available in the industry. (7)

   However, regardless of the Model Form used, the two main critical issues for the default provision are the commercial rationale for using such a provision and its enforceability. (8) On one hand, the default provision is meant to be used in a phase when the given assets or project has commercial value. (9) This is why the likelihood of a member's default varies, depending on the stage of joint operations, and the associated costs. (10)

   On the other hand, a default provision (specifically its remedies) might not be enforceable during a phase with "commercial value" (i.e., after a commercial discovery and prior to the decommissioning stage). (11) This paper will analyze the second concern, which refers to the enforceability of the default provision.

2. ENFORCEABILITY OF THE DEFAULT PROVISION

   Whereas a few decades ago, the term default would be completely absent from the JOA, a large variety of JOA Model Forms now bear sophisticated provisions that define default and stipulate the remedies that will apply upon its occurrence. (12) Each type of remedy bears its own features (both advantages and weaknesses). (13) Despite the chosen remedy, however, a default provision should have a commercial rationale to be used (i.e., project with positive cash-flow or value) and must be governed by fairness and a balance of the conflicting interests of the defaulting and the non-defaulting parties. (14) After all, the provision is intended to apply equally to all members of the JOA. In the words of Peter Roberts:

   [W]hile the forfeiture provisions in a JOA will need to be drafted carefully and applied sensibly, they should afford some measure of protection against a party's default. In defence of these provisions, they are intended to be a legitimate means of protecting the expectation of all the parties under the JOA that all of the parties will contribute their respective shares of the costs of the performance of the petroleum project as they have committed to. They are also intended to apply equally against all of the parties (including the party-operator) in respect of any default and are not intended to be exercisable only to protect, in its capacity as a party, the interests of any one particular party. (15) In other words, it is important to protect the joint venture (JV) interest as "[t]he business of exploring for and producing petroleum cannot simply stop because a party has decided not to pay its share of the cost of those activities...." (16) But on the other hand, the parties should not adopt unreasonable and possibly unenforceable provisions to deal with such a sensitive matter for the consortium. Therefore, the goal of the default provision is to protect against the lack of financial resources to cover the joint expenditures. (17) The JOA must be drafted carefully so as to avoid abuse resulting from the prescribed procedures prior to the full consequences of a default (i.e., repetitive defaults). As Peter Roberts adds:

   The parties should be interested to ensure that the JOA does not allow the prospect of defaulting to become attractive as a credible short-term financing option, and to this end the JOA should provide a series of swift and effective sanctions that will apply to a defaulting party. Over the longer term, the aim of the remedies for default should be to balance up the proportionality greater level of financings contributed by the non-defaulting parties with a correspondingly greater level of interests under the JOA and the concession for those non-defaulting parties. (18) So, the most critical legal challenge associated with default remedies is the uncertainty that exists with respect to their enforceability. Absent a fixed set of transnational rules regarding contractual obligations, the question of a provision's enforcement in court rests on the national rules governing the contract. (19) Based on their features, jurisdictions are largely classified into two families: "common" law (e.g., England, US, Australia) and "civil" law (e.g., Germany, Italy, France, Greece, Brazil). (20) The former emphasizes the use of case law and the rules of equity, whereas the latter applies the principles of Roman law. (21) These two traditions may differ in their view of interpretation of contracts and duties between parties as well as the stability of the contract and available remedies, to name a few. (22) In general, the uncertainty about the enforceability of the default provision (especially forfeiture) is greater in common law, (23) but as the following paragraphs will explain, this problem is also prevalent in civil law countries.

   1. Context Behind the Default Provision

      1. Default Rationale

         The purpose of the default provision is to provide certainty and stability for the financial contributions that will be required throughout the life of the consortium. (24) The principal means to achieve that stability--as a psychological approach taken by the default provision--is the threat that JOA parties might lose their assets. On some occasions, this threat can successfully hold the consortium together. (25) That is mainly the case if and when the default provision is enforceable. However, in other situations, it can have the opposite effect. For instance, a party of the JV may default in order to be released from its financial commitments to an unsuccessful exploration program, or to withdraw from a project that is near completion and decommissioning costs are due to be paid. (26)

         Traditionally, the JOA default provision was not intended to be used. (27) Its real purpose was to act as a constant threat to the parties if they failed to meet their required financial commitments to the joint operations. (28) However, back in the early days of oil and gas operations, the JOA parties were not concerned about such failure of "performance," as their reputations were extremely valuable. (29) Peter Roberts describes the psychology behind the JOA party's views as follows:

         The risk of a party's failure to meet its share of a cashcall or invoice request when due is ever-present within any JOA relationship. Historically, the greatest mitigant of this risk has been a combination of the operational sociology and the commercial logic of the JOA--that the parties to the JOA have been solvent and able to meet all of their cashcall or invoice request commitments; that the character of each party is such that it would do nothing to incur the reputational risk associated with becoming known as a defaulter; and that the parties have had an obvious commercial interest in maintaining their interest in a concession (and a JOA) which relates to a project which has significant prospectivity associated with it. Because of the existence of these factors, the remedies contained in the JOA which would be applied to a party's default, while important to have in place, have typically played a secondary role in keeping the JOA relationship on track. Part of the philosophy behind the JOA has been that the threat to a defaulting party of the loss by forfeiture (at least in part, and possibly completely) of its interests, and the resulting reputational damage, were generally sufficient to prevent the failure by a party to pay its share of a cash call or of an invoice request when due. This mentality in the past of treating a default as...