Presenting a live 90-minute webinar with interactive Q&A

Oil and Gas Joint Operating

and Farmout Agreements
Crafting Instruments That Address Modern Exploration and Production Challenges
THURSDAY, FEBRUARY 2, 2012

1pm Eastern

12pm Central | 11am Mountain

10am Pacific

Todays faculty features:

Phillip D. Barber, Partner, Phillip D. Barber, P.C., Denver

Timothy Dowd, Elias Books Brown & Nelson, Oklahoma City

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OPERATING AGREEMENTS -PRINCIPLES AND PROBLEMS

Phillip D. Barber
Phillip D. Barber, P.C.
1675 Larimer Street, Ste. 620
Denver, CO 80202
303-894-0880

I. EXPLORATION AND
DEVELOPMENT WITHOUT AN
AGREEMENT
In order to understand the place of
operating agreements, we will first
review the rights of owners who do
not have such an agreement. Then
we will focus on the particulars of
this important document.
5

Joint Ownership
Basic issues of property law and the need for
cooperation arise when different parties own an
interest in a mineral estate or an oil and gas
leasehold. Most states have laws which deal
with operations where there are no joint
development or exploration agreements.

Joint Ownership
Attributes of Joint Ownership

Each has the right to lease, sell or otherwise dispose of her

interest without consent from the other. Joint tenancy may
become tenancy-in-common if one joint tenant acts without the
consent of the other.

Subject to the duty to account, each has the right to develop the
property without consent from the other.

A joint tenants interest passes to the other joint tenant upon death.
The interest of each tenant-in-common will pass according to a will
or laws of intestacy.

Disputes Involving Joint Ownership

Partition

Most states have partition statutes which allow

the following:

Physical division of a parcel of land to allocate among

the co-owners. This is not practical where only a
mineral interest is at issue because of the difficulty in
equitably dividing a mineral estate.
Forced sale of property to a third-party as an
alternative.

Effect of Force Pooling Statutes

Pooling statutes are pro-development and provide
a mechanism to force co-owners or lessees to put
up or shut up. Applies to fee owner or lessee who
doesnt want to participate in an oil and gas
operation. Each owner is given the option to commit
its interest and pay share of costs. Remedies vary
for nonjoinder, depending upon whether the
nonconsenting party is a lessee or unleased mineral
owner.

Obligations of Co-Owners to Third

Parties Mining Partnerships

Mining partnerships are a creature of the court

system. They are a legal fiction with sobering
consequences. If a mining partnership is found
to exist, each co-venturer is liable for 100% of
the ventures obligation.

10

Normal rule is that each owner is responsible for only

pro rata share. Carter Baron Drilling v. Excel Energy
Corporation, 581 F.Supp. 592 (D.Colo. 1984).
But see Blocker Exploration v. Frontier Exploration, 740
P.2d 983 (Colo. 1987) (joint ownership, agreement to
show profits and losses, and joint operation control.

Duties Owed to Co-Owners.

While a fiduciary relationship does not typically

exist among co-owners, a fiduciary duty may be
created where a person creates the duty to act
on anothers behalf, especially if one party
occupies a superior position relative to another.
Dime Box Petroleum v. Louisiana Land &
Exploration, 938 F.2d 1144 (10th Cir. 1991) and
Atlantic Richfield v. Farm Credit Bank, 226 F.3d
1138 (10th Cir. 2000).

11

Fiduciary duty requires that a party act primarily for the

benefit of another in matters connected with the
undertaking.
How has the oil and gas industry addressed these
uncertainties?

ANALYSIS OF A.A.P.L. FORM

OPERATING AGREEMENT 1989
FORM
Standard operating agreements JOAs
deal with the problems that arise when mineral
interests are owned by many.

12

How JOAs are used.

Operating agreements can stand on their own or

are used as an exhibit or an attachment to
another agreement, such as a farmout
agreement.

13

Versions.

There have been several versions of the Standard

Operating Agreement; 1956, 1977, 1982, 1989. This
presentation focuses on the 1989 form; however, do
not assume that all provisions in the different forms
are the same.

Operating Agreements involving federal leases use a

federal form, which has some similarities.

14

Recording the Operating Agreement.

A basic principle in most states is that an interest in

real property is not effective against third parties who
later purchase the same interest and who do not
have notice of the interest, unless constructive notice
of the interest is recorded in the public records of the
county in which the property is located.

15

Recording the Operating Agreement.

Types of property interest which are created or

affected by an operating agreement:

Operating agreement may create security interests, the

right to file liens or allow preferential rights that trump
the BFPs rights.

When in doubt, record. Example is A.A.P.L. Form 610

RS recording supplement. Include property
description, names of parties, description of potential
security interests and preferential rights, and how copy
can be obtained.

16

Article I Definitions.

Contract area.

Distinctions between:

Drilling.
Deepening.
Sidetracking.
Reworking.
Recompleting.
Plugging Back.

Many other terms defined.

17

Article II Exhibits

Exhibit A describes, among other things:

Lands and Formations

Parties
Percentage or Fractional Interests

18

What if there is a conflict with record title ownership?

Article II Exhibits.

Exhibit B Form of Lease.

Exhibit C COPAS.

Exhibit B to the JOA should be a form lease for unleased

interests which may be acquired within the Contract Area. Parties
need to attach.
Detailed accounting provisions and agreements regarding
compensation of the operator; expenses for operations, purchase
of material, etc.
Note section 4- Two-year limitation on adjustments.

Exhibit E Gas Balancing Agreement.

19

Allows parties to equal out their interests in production either

through gas balancing or cash balancing if product is sold to more
than one buyer.

Article III Interests of Parties

Parties agree to share costs and liabilities in

proportion to their interests as set forth in
Exhibit A.

20

Article IV Titles

Article IVA. Requires that there be a title examination

of the drillsite for any proposed well.
The 1989 Form incorporates a change that allows
only the Drilling Parties (i.e., those who pay) to
receive title information.

21

Is the title opinion protected by the attorney-client

privilege? Yes, if state recognizes common interest rule.
Skaggs v. Conoco, Inc. 957 P.2d 526 (N.M.App. 1998).

Article IV Titles

Title defects losses Article IV.B

22

Failure of title is not borne jointly by the parties, but

solely by the party who contributed the oil and gas lease,
(example, lessor didnt own the property).
Party who is required to make lease payment and fails to
make payment bears entire loss of lease interest and has
its rights reduced in the contract area.
Party responsible for loss has 90 days to cure defect and
to acquire a new lease.

Article IV Titles

23

All other title losses are joint losses borne by the parties
in proportion to their interest in Exhibit A, such as leases
that expire or are cancelled for breach of implied
covenants.

Article V Operator

Why would anyone want to be the Operator?

Usually owns majority interest.

Can control pace, location and who performs the
operations.

Operator Liability. Article V.A. designates the

operator and limits its liability with respect to the
other parties. The basic standard of care is as
follows:

24

Article V Operator

25

Operator shall conduct its activities under this agreement

as a reasonable, prudent operator, in a good and
workmanlike manner, with due diligence and dispatch, in
accordance with good oil field practice, and in compliance
with applicable laws and regulations, but in no event shall
it have any liability as operator to other parties for losses
sustained or liabilities incurred except such as may result
from gross negligence or willful misconduct.

Article V Operator

26

Authorities split on whether operators may be sued for

simple breach of contract. Compare Shell Rocky
Mountain Production LLC v. Ultra Resources, Inc., 415
F.3d 1158 (10th Cir. 2005) (exculpatory clause in Art.V.A.
does not insulate operator for simple breach), with Stine v.
Marathon Oil Co., 976 F.2d 254 (5th Cir. 1992) (operator
not liable for any act taken as operator including breach
of express duties -- unless there is gross negligence or
willful misconduct).

Article V Operator

Operator may be removed only for good cause by

affirmative vote of majority of non-operators after
excluding voting interest of Operator. Good Cause
is not limited to gross negligence or willful misconduct
by Operator. Thus, may be able to remove Operator
even though it cannot be sued for poor performance.
Article V.B.

27

Article V Operator

28

[C]hange of corporate name or structure of operator or

transfer of Operators interest to any single subsidiary,
parent or successor corporation shall not be the basis for
removal of Operator. Art. V.B.1.

Article V Operator

Some of the Rights and Duties of Operator.

29

Art. V.D.I. states that wells must be drilled at competitive

rates. Shell v. Ultra, supra.
Operator must pay bills and keep operations free of liens.
Art. V.D. 2, 3.
Fiduciary duty only when accounting for funds. Compare
Arts. V.D.4 and VII.A.
Provide access to books and records. Art. V.D.5.

Article V Operator

30

1989 Form requires periodic updates on expenditures.

Under Article V.D. 8., the Operator must furnish an
estimate of current and cumulative costs incurred for
the joint account at reasonable intervals during the
course of any operation, if a request is made. No
liability if estimate made in good faith.
Cost overruns where there is an AFE. AFEs are just
estimates and consenting parties are liable for share
of overruns. M & T, Inc. v. Fuel Resources Dev. Co.,
518 F.Supp. 285 (D.Colo. 1981).

Article VI Drilling and Development

Initial Well.

31

No right to go non-consent on initial well in 1989 Form.

Article VI Drilling and Development

Subsequent operations and operations by less than

all parties. Art. VI.B.2.

32

Any party may propose a subsequent operation.

If less than all parties consent to participate in a
subsequent operation, then the Operator shall give
consenting parties right to limit participation or acquire a
proportionate share of the non-consenting parties
interest. Art. VI.B.2.a. Proposal can be withdrawn if less
than 100% participation.

Article VI Drilling and Development

Article VI.B. describes the interest of a non-consenting

party in any subsequent operations (nonconsent
penalties). Penalties for nonparticipation must be
severe enough to encourage maximum participation
and prevent free ride. Typically:

33

100 200% for equipment

300-500% for costs of drilling which pose a greater risk

Competing proposals. 15 days to submit alternative

proposal. Decided by majority vote of voting parties. If
tied, initial proposal prevails. Art. VI.B.6.

Article VI Drilling and Development

Well abandonment and termination of

operations.

34

Decision to abandon dry hole belongs to parties who

consented to the operation. Art. VI.E.1.
Parties opposing abandonment must provide
satisfactory evidence of financial capability to conduct
operations, or Operator has authority to plug and
abandon wells. Art. VI.E.1.

Article VI Drilling and Development

Taking production-in-kind.

35

The Operator typically acts as the agent of all parties to sell

production from a well. Sometimes each owner will take in kind
and sell its share of the production. Each party must execute
necessary division orders and contracts for the sale of its interest
in production if it is sold by the Operator. The authority of the
Operator may be revoked. Art. VI.G.

Article VII Expenditures And

Liabilities Of Parties

Article VII.A. negates concept of joint liability, as well

as the notion that the parties are fiduciaries or
partners.

36

All rights and obligations are several, not joint. Good

faith still required in dealings with each other. What does
that mean?

Article VII Expenditures And

Liabilities Of Parties

Article VII.B. creates lien rights and security interests

among the parties to secure performance of their
obligations.

37

Operator has right to suspend payment of revenues to

defaulting parties, bring suit, make party non-consent,
require advance payment, etc.
All performing parties have lien and security interests
against defaulting party to assure payment. See Article
VII.B. and Andrau v. Michigan Wisconsin Pipeline Co.,
712 P.2d 372 (Wyo. 1986).

Article VIII Acquisition, Maintenance

Or Transfer Of Interests

Leases may not be surrendered unless all

parties consent. Art. VIII.A.
Right of partition is waived. Art. VIII.E.
Preferential Right to Purchase. Art. VIII.F.
Parties have right to impose a preferential right
to purchase by checking the box. Consideration
needs to be given to the potential benefits and
burdens of pref. rights.

38

Article VIII Acquisition, Maintenance

Or Transfer Of Interests

Under the 1989 Form, a preferential right is not triggered by

mortgages, transfers to subsidiary or parent companies, by a
disposition of interests by merger, reorganization, consolidation,
or by sale of all or substantially all of the Oil and Gas assets of a
party.

39

A sale of the companys stock generally did not trigger the right.
Rainbow Oil Co. v. Christmann, 656 P.2d 538 (Wyo. 1982)
Preferential rights were not triggered by intercompany transfers.
Questa Energy Corporation v. Vantage Point Energy, 887 S.W.2d
217 (Tex.App.- Amarillo 1994)

Article VIII Acquisition, Maintenance

Or Transfer Of Interests

Practical Problems with Preferential Rights.

40

Uncertainty generated by a package sale.

Allocate value where there is more than one asset
involved.
Diminishment of value of burdened interest.
Disputes.
Remedies for breach of preferential right to purchase.
Wrongful exercise of preferential right.
Conclusion. Carefully weigh the benefits and burdens
before checking the box.

Article XIII Term of Agreement

Two choices. Option No. 1 continues JOA as long

as any lease is in effect. Option No. 2 continues
JOA as long as any well drilled under JOA is capable
of producing in paying quantities.
Option No. may be longer if there is more than one
lease.

41

Article XVI Miscellaneous

Additional Provisions

Consider inserting language to the effect that the

operating agreement controls in the event of a
conflict with any other agreement among the parties.
Consider alternative dispute resolution, such as
mediation, arbitration. Especially useful where there
is a deadlock over change of operator, conduct of
operations, or alleged breach of duty by operator.

42

Timothy C. Dowd
Elias, Books, Brown and Nelson P.C.
211 N. Robinson, Suite 1300
Oklahoma City, OK 73102
(405) 232-3722
tdowd@eliasbooks.com
February 12, 2012

A farmout agreement is a transaction wherein

the owner of an oil and gas lease (farmor)
agrees to an assignment of a part of a lease to a
party (farmee) who agrees, as consideration for
the assignment, to drill a well to a certain depth
or condition.

Timothy C. Dowd - Elias, Books, Brown & Nelson 44

The farmout agreement allows that the farmee

earns its interest upon either drilling.

Timothy C. Dowd - Elias, Books, Brown & Nelson

45

Under a drill to earn farmout, the farmee earns

the interest under the Farmout Agreement once
drilling commences or reaches the contracted
depth.
Under a produce to earn farmout, the farmee
must, generally, drill a well that produces in
paying quarterly to earn the interest in the
farmout acreage.

Timothy C. Dowd - Elias, Books, Brown & Nelson 46

It is common for the farmor to retain a nonoperating interest in the farmed out acreage.

Timothy C. Dowd - Elias, Books, Brown & Nelson47

Few farmout agreements are recorded.

However, once an agreement has been fully
performed, the farmee is entitled to a
recordable assignment of interest. It is
important that the terms of the farmout
agreement and the terms of the assignment do
not conflict, or a dispute may arise as to which
prevails.

Timothy C. Dowd - Elias, Books, Brown & Nelson 48

A frequent reason for a discrepancy between

record title as shown in the County Clerks
records and the interest shown to be paid in the
deck is the absence of an executed assignment
pursuant to a farmout agreement.

Timothy C. Dowd - Elias, Books, Brown & Nelson 49

Companies have frequently turned to term

assignments instead of farmout agreements.

Timothy C. Dowd - Elias, Books, Brown & Nelson 50

The term assignments convey an interest from

the assignor/farmor to the assignee/farmee for
a specific term. The assigned interest is to
revert to the assignor if the assignee doesnt
drill a producing well to a certain depth by a
certain date.

Timothy C. Dowd - Elias, Books, Brown & Nelson 51