June 06 2011
The use of model form joint operating agreements as a starting point for negotiations between parties is common practice in the oil and gas industry. There are numerous model form joint operating agreements in circulation and parties generally tend to select as a base the agreement which they believe is most applicable to their particular joint venture in order to streamline the drafting and negotiation process. Although their basic principles are very similar, the various agreements were drafted by different groups of contributors and each was developed within a particular legal framework and commercial environment. As a result, they take a different approach to certain issues. It is important to be aware of these differences when selecting a model form joint operating agreement as a starting point for negotiations and during the negotiation process. This is particularly true where an entity has a number of assets in different jurisdictions and wants consistency across its joint operating agreements, or where an entity is a new entrant in a jurisdiction and is unfamiliar with the particular agreement that is typically used there.
This update focuses on the key differences in relation to operator liability between two model form joint operating agreements. The first was issued by Oil and Gas UK (OGUK), a representative body for the UK offshore oil and gas industry, for use in offshore operations on the UK continental shelf. The second is the model form international joint operating agreement produced by the Association of International Petroleum Negotiators (AIPN), which is the most commonly used agreement internationally.
The OGUK agreement and the AIPN agreement both impose an obligation on the operator:
There are variations in the standards to which the operator is required to adhere in the conduct of joint operations. For example, the OGUK agreement requires the operator to conduct joint operations in a "proper and workmanlike manner" in accordance with:
"those methods and practices customarily used in good and prudent oil and gas field practice in the United Kingdom Continental Shelf with that degree of diligence and prudence reasonably and ordinarily exercised by experienced operators engaged in the United Kingdom Continental Shelf in a similar activity under similar circumstances and conditions."
However, the AIPN agreement requires the operator to conduct all joint operations in:
"[a] diligent, safe and efficient manner in accordance with such good and prudent petroleum industry practices and field conservation principles as are generally followed by the international petroleum industry under similar circumstances."
However, the principle that the operator should diligently carry out its duties and obligations under the relevant joint operating agreement is broadly similar.
The utility of including these obligations in a joint operating agreement will partly depend on the limitations on the operator's liability. A party that agrees to act as operator will often insist on the inclusion of a provision to limit or exclude its liability to the other joint venture parties and any third parties for loss or damage incurred as a result of acting in such capacity under the agreement. Both model form joint operating agreements contain provisions that:
In contrast to the OGUK agreement, the AIPN agreement extends the exclusion of liability and the indemnity in favour of the operator to the operator's affiliates, and to the directors, officers and employees of the operator and its affiliates. The main purpose of this extension is to ensure that a person which suffers loss or damage as a result of the joint operations cannot avoid the exclusion of liability and the indemnity provisions in the joint operating agreement by bringing a claim against an affiliate of the operator or a director, officer or employee of the operator or its affiliate. Parties that use the OGUK agreement should consider whether it is desirable to include a similar extension.
Gross negligence and wilful misconduct
Under the OGUK agreement, the exclusion of liability and the indemnity in favour of the operator apply irrespective of the operator's negligence or breach of duty. In contrast, if the parties to the AIPN agreement do not use the optional provision relating to gross negligence or wilful misconduct, the exclusion of liability and the indemnity potentially apply more widely, even if the loss or damage is caused by "a pre-existing defect, or the negligence… gross negligence, wilful misconduct, strict liability or other legal fault" of the operator. The position in the AIPN agreement (if the optional provision is not used) is very favourable to the operator and effectively means that the only remedy available to the joint venture parties against the operator in respect of a breach of the operator's obligation to conduct the joint operations to the standard prescribed in the AIPN joint operating agreement is to remove the operator, even if the joint venture parties have suffered loss or damage due to the operator's gross negligence or wilful misconduct.
Under the OGUK agreement, the exclusion of liability and the indemnity in favour of the operator do not apply in respect of loss or damage resulting from or arising out of the operator's wilful misconduct. The OGUK agreement defines 'wilful misconduct' as:
"[an] intentional or reckless disregard by Senior Managerial Personnel of [those methods and practices customarily used in good and prudent oil and gas field practice in the United Kingdom Continental Shelf with that degree of diligence and prudence reasonably and ordinarily exercised by experienced operators engaged in the United Kingdom Continental Shelf in a similar activity under similar circumstances and conditions] or any of the terms of the [agreement] in utter disregard of avoidable and harmful consequences."
This definition specifically excludes:
"[any] act, omission, error of judgment or mistake made in the exercise in good faith of any function, authority or discretion vested in or exercisable by such Senior Managerial Personnel and which in the exercise of such good faith is justifiable by special circumstances, including safeguarding of life, property or the environment and other emergencies."
The exclusion qualifies the act of wilful misconduct and thereby reduces the possibility of such an act being committed for the purposes of the OGUK agreement. Consequently, the operator is more likely to be entitled to rely on the exclusion of liability and to be indemnified by the joint venture parties under the OGUK agreement.
In contrast, the AIPN agreement contains only an optional provision which may be used by the parties to limit the exclusion of liability and the indemnity in favour of the operator in the event of the operator's gross negligence or wilful misconduct. In the context of the optional provision in the AIPN agreement, 'gross negligence or wilful misconduct' is defined as:
"any act or failure to act… by any person or entity which was intended to cause, or which was in reckless disregard of or wanton indifference to, harmful consequences such person or entity knew, or should have known, such act or failure would have on the safety or property of another person or entity."
This optional provision is similar to the OGUK agreement in that it limits the act of gross negligence or wilful misconduct to those acts committed by the operator's "senior supervisory personnel", but the AIPN agreement definition does not exclude acts or omissions which are justifiable in special circumstances.
The optional provision in the AIPN agreement provides three options for the extent of the operator's liability for acts of gross negligence or wilful misconduct. The loss or damage resulting from gross negligence or wilful misconduct for which the operator is liable is:
From the operator's perspective, capping liability is desirable and consideration should be given when negotiating joint operating agreements based on the OGUK agreement as to whether caps should be imposed in relation to loss or damage caused by wilful default of the operator.
Failure to obtain insurance
The OGUK agreement contains a further exception to the exclusion of operator liability and the indemnity in favour of the operator that is not included in the AIPN agreement. This exclusion applies in relation to the operator's failure to obtain or maintain insurance that it is required to obtain or maintain, except where the operator has used all reasonable endeavours to obtain or maintain such insurance, but has been unable to do so and has promptly notified the parties that participate or propose to participate therein.
The final key difference between the approaches in the agreements relates to the treatment of operator liability for consequential loss. The OGUK agreement expressly provides that the operator is not liable for consequential loss which a joint venture party may incur arising out of the operator's non-performance or misperformance of any of its duties or obligations as operator. Each joint venture party is required to indemnify the operator from and against such liability.
This exclusion and indemnity applies even in the event of the operator's negligence, breach of duty or wilful misconduct. The OGUK agreement defines 'consequential loss' as:
"any indirect or consequential loss howsoever caused or arising whether under contract, by virtue of any fiduciary duty, in tort or delict (including negligence), as a consequence of breach of any duty… or under any other legal doctrine whatsoever whether or not recoverable at common law or in equity."
The agreement expressly sets out certain categories of loss which, for the purposes of the agreement, are deemed to be included in the definition of 'consequential loss', regardless of whether they might normally constitute indirect or consequential loss. These are:
"(a) loss or damage arising out of any delay, postponement, interruption or loss of production, any inability to produce, deliver or process hydrocarbons or any loss of or anticipated loss of use, profit or revenue; (b) loss or damage incurred or liquidated or pre-estimated damages of any kind whatsoever borne or payable under any contract for the sale, exchange, transportation, processing, storage or other disposal of hydrocarbons; (c) losses associated with business interruption including the cost of overheads incurred during business interruption; (d) loss of bargain, contract, expectation or opportunity; (e) damage to any reservoir, geological formation or underground strata or the loss of hydrocarbons from any of them; (f) any other loss or anticipated loss or damage whatsoever in the nature of or consequential upon the foregoing."
Under the AIPN agreement, where the optional provision relating to gross negligence or wilful misconduct is not used, no express exclusion of consequential loss is included. Without the optional provision, there is simply a blanket exclusion of operator liability and the joint venture parties are required to indemnify the operator against all loss, consequential or otherwise. However, where the optional provision is used, the AIPN agreement contains an express provision excluding liability of the operator for consequential loss. In the context of the agreement, 'consequential loss' is defined as:
"any loss, damages, costs, expenses or liabilities caused…by any of the following arising out of, relating to or connected with [the agreement] or the operations carried out under [the agreement]: (i) reservoir or formation damage; (ii) inability to produce, use or dispose of hydrocarbons; (iii) loss or deferment of income; (iv) punitive damages; or (v) other indirect damages or losses whether or not similar to the foregoing."
In contrast to the OGUK agreement, the optional provision under the AIPN agreement also contains an express provision excluding operator liability for environmental loss. Under the AIPN agreement, 'environmental loss' is defined as:
"any loss or damages, costs, expenses or liabilities…caused by the discharge of Hydrocarbons, pollutants or other contaminants into or onto any medium (such as land, surface water, ground water and/or air) arising out of, relating to, or connected with [the agreement] or operations carried out under [the agreement], including any of the following: (i) injury or damage to, or destruction of, natural resources or real or personal property; (ii) cost of pollution control, cleanup and removal; (iii) cost of restoration of natural resources; and (iv) fines, penalties or other assessments."
There are circumstances in which certain heads of environmental loss could be considered direct loss; therefore, consideration should be given as to whether liability for environmental loss should be dealt with under the OGUK agreement.
For further information on this topic please contact Peter Roberts or Julia Derrick at Ashurst by telephone (+44 20 7638 1111), fax (+44 20 7638 1112) or email (email@example.com or firstname.lastname@example.org).
ILO provides online commentaries as specialist Legal Newsletters. Written in collaboration with over 500 of the world's leading experts and covering more than 100 jurisdictions, it delivers individually requested information via email to an influential global audience of law firm partners and international corporate counsel. Please click here to register for the service.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription. Register at www.iloinfo.com.