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Problem Spotting for Non-Operators under Inherited JOAs

Perhaps no routinely utilized form in the oil and gas industry is as misunderstood and loathed as the Joint Operating Agreement (“JOA”). Despite numerous attempts to standardize the JOA, as a Non-Operator, you’ve likely received a zip folder of small font-edited JOAs with strikethroughs, marginal notes, and pages of exhibits and wondered out loud how to make sense of it all.

To start, it is crucial to identify those particular articles of the JOA where there have been substantial amounts of litigation in the past and those for which the court will apply a standard in recognition of or despite the language of the JOA.

The first thing you want to read in a JOA is Article XVI. This is where most of the changes to the standard language are going to be located. Be careful. These provisions will often override portions of the standard JOA (even when those provisions are not struck) and can contain things like white out provisions (where you lose all working interest in a unit by non-consenting) and can include other custom provisions like making the JOA subject to an external document between the parties, making subsequently created interests subject to the JOA, or creating tag-along and drag-along rights for the parties.

Next, a Non-Operator should confirm that there is a Non-Operator shield to liability against third parties for debts, torts, and other breaches of contract where the Non-Operator does not have any operational control. This element of a standard JOA is critical to a Non-Operator.

Third, a Non-Operator should confirm that the Operator is held to a “reasonably prudent Operator” standard under the terms of the JOA and that the JOA has not been modified to correspond with some lessened standard of conduct. Usually, the surrounding language in the JOA will contain operator liability exceptions only for gross negligence or willful misconduct. Still, without explicit reference to a standard, the aggrieved Non-Op may be required to prove a breach of contract with a more exhaustive factual showing.

Next, a Non-Operator should scrutinize all language regarding Operator resignation or removal. The life of a Non-Operator is much like that of a backup quarterback. At any given point in the operational life cycle, you should consider the ramifications of being forced into operations, the risks attendant to attempts to remove the Operator, and the relative costs and expenses associated with the appointment of another Operator. The Operator resignation and removal mechanism vary widely from JOA form to JOA form and is one of the more often litigated portions of the JOA.

Finally, a Non-Operator should review the JOA to ascertain whether the Operator has an automatic lien on the Non-Operator’s share of production if expenses and invoices are not paid through Joint Interest Billings (“JIBs”). The language surrounding this process is highly variable and includes various perfection scenarios where the Operator is required to prove a contractual lien under the JOA. The Non-Operator will want to confirm compliance with this process and the inclusion of any language allowing for an Operator’s right to set off for non-payment (sometimes called revenue or rev netting) as a part of its due diligence review.

It is worth noting that the exhibits to the JOA are also sources of the hidden language that affects the Non-Operator’s general rights and obligations. Nevertheless, by focusing on the high-level concerns noted in this article and engaging counsel early in your asset integration as a Non-Operator, you can help mitigate risk in the process. Please contact RR&A today for more guidance as to your process when onboarding JOAs.

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Andrew Clinton

Andrew Clinton

Andrew is a Partner at R. Reese & Associates and head of the Transactions and Corporate teams. His practice consists of energy and business transactional matters with additional competencies in real estate and title representation. To learn more about Andrew, visit his attorney page.

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