How Case Law Has Affected Form Joint Operating Agreements—Problems and Solutions (Part One) Christopher S

Oil and Gas, Natural Resources, and Energy Journal Volume 1 | Number 1 January 2015 Old Faves and New Raves: How Case Law Has Affected Form Joint Operating Agreements—Problems and Solutions (Part One) Christopher S. Kulander South Texas College of Law, [email protected] Follow this and additional works at: http://digitalcommons.law.ou.edu/onej Part of the Energy and Utilities Law Commons, Natural Resources Law Commons, and the Oil, Gas, and Mineral Law Commons Recommended Citation Christopher S. Kulander, Old Faves and New Raves: How Case Law Has Affected Form Joint Operating Agreements—Problems and Solutions (Part One), 1 Oil & Gas, Nat. Resources & Energy J. 1 (2015), http://digitalcommons.law.ou.edu/onej/vol1/iss1/2 This Article is brought to you for free and open access by University of Oklahoma College of Law Digital Commons. It has been accepted for inclusion in Oil and Gas, Natural Resources, and Energy Journal by an authorized administrator of University of Oklahoma College of Law Digital Commons. For more information, please contact [email protected]. ONE J Oil and Gas, Natural Resources, and Energy Journal VOLUME 1 NUMBER 1 OLD FAVES AND NEW RAVES: HOW CASE LAW HAS AFFECTED FORM JOINT OPERATING AGREEMENTS—PROBLEMS AND SOLUTIONS * (PART ONE) ** CHRISTOPHER S. KULANDER Table of Contents I. Introduction ............................................................................................... 2 A. Paper Goal and Format ........................................................................ 3 B. History of Joint Operations and Form JOAs ........................................ 4 II. Joint Operations Without a Joint Operating Agreement .......................... 7 A. Incomplete and Unexecuted JOAs and Ancillary Documents ........... 10 III. Relationship of the Parties and Form JOA Interpretation ..................... 11 A. Standards of Conduct Required of the Operator ................................ 11 B. Liability Among JOA Parties—Generally ......................................... 14 1. Limitations of Leasehold Burdens ................................................. 16 * Due to considerations of length, this article is being published in two parts. The second part will appear in vol. 1, no. 2. ** Christopher Kulander, Of Counsel, Haynes and Boone, LLP, & Director, Harry L. Reed Oil & Gas Law Institute, South Texas College of Law. Licensed in New Mexico and Texas. B.S. (Geology) 1993, Wright State University; M.S. (Geophysics) 1995, Wright State University; Ph.D. (Geophysics—Petroleum Seismology) 1999, Texas A&M; J.D. 2005, University of Oklahoma College of Law. The author thanks the following people who assisted in various ways in the completion of this report: Owen Anderson, Buddy Clark, Michel Curry, James Franks, Donald Jackson, Byron Kulander, John Lowe, Riva Laughlin, Mark Mathews, John Reeves, Glynn Starling, Lucas Tanner, and Natalie Tarenko. Background portions of this paper, updated as necessary, appear in John Lowe, et al. CASES AND MATERIALS ON OIL AND GAS LAW (6th Ed. West 2012). Some case law descriptions included in this paper appear in Christopher Kulander, Oil, Gas, and Energy Case Summaries, TEX. J. OIL, GAS & ENERGY L., Vol. 9, No. 2 (2014). 1 Published by University of Oklahoma College of Law Digital Commons, 2015 2 Oil and Gas, Natural Resources, and Energy Journal [Vol. 1 2. Tax Considerations ......................................................................... 17 C. Operator Authority ............................................................................. 17 1. Operator’s Ability to Set Rates ...................................................... 17 2. Contact with Third Parties .............................................................. 20 D. Liability to JOA Creditors ................................................................. 21 E. Form Interpretation and Deleted Language ....................................... 22 IV. Authorization for Expenditures (“AFEs”) ............................................ 24 A. Consent to Operations Clauses and AFEs Generally ......................... 24 B. Consent to Operations Clauses and Co-tenancy ................................ 25 C. AFEs and Modifications of JOA ........................................................ 27 D. Cost Overruns .................................................................................... 28 E. Consent to Subsequent Operations ..................................................... 30 1. Proper Notice of Subsequent Operations ....................................... 31 2. Commencement of Operations ....................................................... 32 3. Changing a Consent or Non Consent ............................................. 35 4. No Written Consent Given ............................................................. 36 F. “In or Out” Clause and Changes in Ownership Percentages .............. 37 G. “Other Operations” Clauses, AFEs, and JIBs .................................... 39 I. Introduction Joint ownership of oil and gas exploration and production rights— whether held through fee mineral ownership or ownership of an oil and gas lease—arise in many ways. Co-tenants of a mineral estate may each lease to different companies, or companies leasing adjacent acreage may be required to pool their leases to form a drilling unit. Individual leases may be jointly held by several lessees. Farmout agreements may give rise to co- ownership of working interest once, for example, payout is achieved. Mineral title also tends to become increasingly fragmented over time, leaving many working interest owners with undivided leasehold interests covering a production area or even a single well. Other times, joint ownership is the result of a deliberate decision to spread the cost and risk of drilling and development. For example, the holder of a lease may partially assign or farmout part of their lease to another party to share risk. Regardless of how joint ownership arises, an agreement should be reached on a variety of matters including initial drilling, payment of expenses, operation of the well, division of production, and further development of the property. The joint operating agreement (“JOA”) serves this function. A JOA describes the geographic area it covers and specifies the fractional interests owned in this area by the various parties having working interests in the area. Typically, one of these parties is designated http://digitalcommons.law.ou.edu/onej/vol1/iss1/2 2015] Form Joint Operating Agreements (Part One) 3 the “operator” with authority to incur expenses and make operational decisions. Occasionally, a party, such as a lease owner who has assigned all of its lease interests to investors, is named as a “contract” operator. A contract operator has standing to enforce the JOA and may bring suit on behalf of the participants, even though it lacks any interest in the area covered by the JOA.1 The other contracting parties are referred to as “non- operators.” Each non-operator’s share of both costs and production is usually based on its fractional interest in the JOA’s area. A typical JOA is a lengthy agreement that addresses many issues, including whether and how different combinations of parties can develop the area and how the operator will incur costs and bill the non-operators for their share of costs. A JOA also addresses how production is to be physically divided among the parties in accordance with each party’s interest in the area or well.2 A JOA almost always provides the operator with ample remedies against non-operators who do not pay their share of operating expenses.3 A. Paper Goal and Format A domestic onshore JOA, at its core, is typically about a 10-20 page (legal-sized) standardized document (a “Form JOA”), plus exhibits, containing comprehensive provisions addressing the ownership of oil and gas drilling rights and the drilling, operation, and production of onshore oil and gas wells on those rights. Common sense seasoned with experience makes clear, however, that the words of a form contract like a Form JOA cannot possibly account for every permutation of oil and gas operations, resulting in a close, but often conflicting, reading by lawyers when conflicts arise. In addition, the parties to a JOA that was signed more than a dozen years ago could not have foreseen the current era of unconventional shale oil and shale gas development. Yet, a JOA, like a deed, may govern the rights of the parties for many decades and long survive any individual who was involved in its negotiation. Judges, litigators, and non-oil and gas corporate attorneys have often been unsatisfied concerning what they often see as a lack of lucidity and specifics in JOAs concerning the rights and duties of parties conducting joint operations. Conversely, oil and gas lawyers and landmen have 1. See Basic Energy Service, Inc. v. D-S-B Properties, Inc., 367. S.W.3d 254 (Tex. App. 2011, no pet.); Long v. Rim Operating, Inc., 345 S.W.3d 79 (Tex. App.—2011, pet. denied). 2. ERNEST SMITH & JACQUELINE WEAVER, TEXAS LAW OF OIL AND GAS § 17.3(A) (1) (Matthew Bender 2007) (2d ed. 1998). 3. Id. Published by University of Oklahoma College of Law Digital Commons, 2015 4 Oil and Gas, Natural Resources, and Energy Journal [Vol. 1 complained that even with the form aspect of the terms, negotiating a JOA for each drilling project still takes too long and is unresponsive to the need for quick operational action. Both complaints are at times correct, and when litigious disputes erupt among JOA signatories, the forms are

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