Some background on JOAs
A joint operating agreement (JOA) is a form of unincorporated joint venture agreement used to govern the relationship between multiple parties jointly engaged in operating an oil and gas exploration or production project. The basic functions of a JOA are to:
- confirm the participating interest (PI) of each party – being the party’s proportionate share in the benefits and assets of the project undertaken pursuant to the relevant production sharing contract (PSC) or other government concession agreement; and
- define and allocate the rights, benefits, costs and obligations of the parties in proportion to their PIs.
As the joint venture formed under a JOA is unincorporated, one party will be appointed as the operator of the project under the JOA (Operator), with responsibility and authority to manage the operations of the project and its dealings with third parties, including the government, on behalf of the joint venturers.
Typically, the PSC (or other concession agreement) will establish a management committee (MC) made up of members designated by the State and by the Operator, as the contractor entity. The MC will review and approve key operational matters, such as work programs and budgets and development plans, as proposed to the MC by the Operator. An operating committee (OC) will be established under the JOA as the ultimate decision-making body at the unincorporated joint venture level, subject to specific decisions reserved for MC review and approval under the PSC.
The OC will usually be made up of a representative from each JOA party. The decisions of the OC will be based on information, reports or proposals presented to the OC by the Operator. Different thresholds of votes may be specified for approval of different categories of decisions. In particular, a joint venturer with a low PI will usually seek to impose a high approval threshold, or require unanimous approval, for important or sensitive decisions to limit its risk of being bound by majority decisions with which it does not agree. Some fairly well-settled examples of the types of matters reserved for unanimous approval are: determination of a commercial discovery; development of new fields; relinquishment; and decommissioning or abandonment.
However, as the party principally responsible for the project’s operations, the Operator will bear most of the obligations, and associated potential liability, under the JOA. The Operator will therefore generally want to ensure that it has a high degree of control and discretion in conducting project operations, with limits to its obligations to obtain approval from, and to provide information to, the non-operator parties.
Issues in JOAs
The decision-making structures, differing positions as between Operators and non-operators and between majority and minority parties, and the cost, value and risk associated with oil and gas projects, places a significant emphasis on careful consideration of the structuring of JOAs, in particular in relation issues of control, funding and liability. The following are some brief summary points on five of the most important issues in the effective planning and preparation of JOAs.
1. Control and approvals
As noted above, there are a number of areas and issues in respect of which it is generally well-accepted that high approval thresholds or unanimous approval should be required for OC decisions to protect minority non-operators. However, the situation can be more complex in respect of approvals relating to ongoing operations, in particular annual work programs and budgets prepared by the Operator. To allow project operations to continue and progress, it is important to try to avoid delays or deadlock in approving these items. Approval of work programs and budgets therefore usually requires a specified threshold, rather than unanimous approval.
However, this raises the prospect of a minority party potentially being bound by a decision to approve operations or an expense in which it may not wish to participate. Approval thresholds can therefore be a contentious issue. Further, the PIs of parties may change over the life of the project if parties divest and new parties enter the joint venture. Control and decision-making issues may therefore need to be considered on an ongoing basis.
2. Non-consent rights and sole risk
To provide mechanisms to facilitate continuation of operations where there is disagreement on budgets and programs, many JOAs will include provisions granting non-consent rights and/or allowing certain sole risk operations.
- Non-consent rights allow a party to refuse to participate in an approved activity where that party voted against approval, but the approval threshold was nevertheless met.
- Sole risk provisions allow one or more parties that voted in favour of an activity for which the approval threshold was not met to nevertheless undertake the activity without the support of the other parties.
It may not always be practical to allow one or more parties the right to either opt out of an approved activity or to undertake non-approved operations. Typically, a JOA will require all operations to be undertaken jointly by all parties until the minimum work obligations (agreed with the State under the PSC) are fulfilled to make sure all parties prioritise and contribute to meeting minimum commitments to the State. Thereafter, the JOA may specify which operations must still be conducted jointly, and which operations can be opted out of or undertaken on a sole risk basis. Where exclusive operations are permitted, the JOA will need to clearly address practical issues in relation to responsibility for exclusive operations and the consequences of those operations, rights to make use of joint property in exclusive operations, and any effects on production sharing.
The activities of the unincorporated joint venture under the JOA are funded through cash calls issued by the Operator to the other parties based on approved work programs and budgets. If there is a shortfall in the funding provided by a party, or a party defaults altogether on a cash call, the default or shortfall will usually be allocated pro rata amongst, and covered by, the remaining parties. Consequently, even where the initial consortium of joint venturers seems financially robust, the default of one joint venture partner can significantly affect the economics of the project for the remaining partners and potentially create risk for the viability of the joint venture. The risks arising from payment defaults and from the potential withdrawal or forfeiture of a defaulting party must be considered when drafting funding provisions and related aspects of default and remedy provisions.
4. Default and remedies
The main events that will usually be treated as a default under a JOA are where a party:
- Becomes subject to an insolvency event;
- Breaches a material term of the JOA;
- Fails to pay its share of a cash call or other funding contribution;
- Fails to provide any security required under the JOA or the PSC;
- Fails to satisfy its indemnity obligations under the JOA or the PSC.
The JOA will usually provide for a default notification process, with an opportunity for the relevant party to remedy the default. Depending on the nature of the default, a number of key rights of the relevant party under the JOA – in particular in relation to decision-making, production entitlements and PI transfers – will be suspended during the notice period.
The party will be deemed to be in default under the JOA if the default is not remedied, including the making of any required payment, within a specified number of business days. The options typically provided to the non-defaulting parties to recover or otherwise remedy their losses arising from the default will usually include:
- Forfeiture – where the defaulting party is required to forfeit its rights and legal and beneficial interests under the JOA and the PSC.
- Forced sale or buy-out – where the defaulting party is required to sell its PI at a discounted price to non-defaulting parties.
- Dilution or “withering” – where the defaulting party’s PI is reduced in proportion to the amount in default.
- Enforcement of security granted over the defaulting party’s PI.
A number of issues need to be considered within the JOA regarding the availability and enforcement of remedies for default, including:
- Whether applicable local laws may pose any barrier to any remedies, for example in relation to the recognition and enforceability of trust interests or any security interests.
- The fact that the assignment or other transfer of the PI of a defaulting party will usually require State approval under the PSC or otherwise under local law.
- Calculation of the discounted price at which a forced sale or buy-out will be undertaken. The discount will usually be calculated by reference to fair market value. The non-defaulting parties will usually want a high level of discount to provide additional compensation to them. However, disagreements over the calculation of the fair market price, and a related risk of litigation, may arise.
- Dilution or withering is calculated by reference to a detailed formula that will be specified in the JOA. Extensive negotiation may be required to agree on the composition of this formula. The parties must also consider any risk the that dilution or withering will be able to be used by a party as a means of reducing its interest and liability where an asset proves to be less productive than expected.
5. Transfer of participating interest
The PSC or applicable law may impose taxes or other fees and government approval requirements in respect of transfer of a party’s PI. The JOA may also impose additional conditions or approval requirements for transfers, such as requiring the prior consent of the continuing parties under the JOA, granting pre-emption rights to the continuing parties under the JOA, and requiring the transferring party to obtain further government consents or approvals (or confirmation that these are not required).
It is common for JOAs to provide exceptions to some of the restrictions on transfers where the transfer is to an affiliate of the transferring party, or is part of an underlying transaction involves a sale of various interests in multiple licences or PSCs.