The New and Improved 1989 Joint Operating Agreement: A Working Manual By Andrew B. Derman © 1991 Andrew B. Derman. All rights reserved. Table of Contents INTRODUCTION............................................................................................. 1 Acknowledgements............................................................................................ 1 1989 Joint Operating Agreement with Commentary AAPL Form 610-1989 Model Form Operating Agreement................................... 2 COVER PAGE ....................................................................................... 3 TABLE OF CONTENTS........................................................................ 5 PREAMBLE........................................................................................... 9 I. DEFINITIONS........................................................................................ 9 II. EXHIBITS.............................................................................................. 13 III. INTERESTS OF PARTIES..................................................................... 15 A. OIL AND GAS INTERESTS........................................................................ 15 B. INTERESTS OF PARTIES IN COSTS AND PRODUCTION................................ 15 C. SUBSEQUENTLY CREATED INTERESTS.................................................... 17 IV. TITLES................................................................................................... 19 A. TITLE EXAMINATION............................................................................. 19 B. LOSS OR FAILURE OF TITLE.................................................................... 21 1. Failure of Title................................................................... 21 2. Loss by Non-Payment or Erroneous Payment of Amount Due.................................................................. 23 3. Other Losses...................................................................... 25 4. Curing Title....................................................................... 25 V. OPERATOR........................................................................................... 27 A. DESIGNATION AND RESPONSIBILITIES OF OPERATOR.............................. 27 B. RESIGNATION OR REMOVAL OF OPERATOR AND SELECTION OF SUCCESSOR..................................................................... 31 1. Resignation or Removal of Operator.................................. 31 2. Selection of Successor Operator......................................... 35 3. Effect of Bankruptcy.......................................................... 35 C. EMPLOYEES AND CONTRACTORS........................................................... 37 D. RIGHTS AND DUTIES OF OPERATOR........................................................ 37 1. Competitive Rates and Use of Affiliates............................ 37 2. Discharge of Joint Account Obligations............................. 37 3. Protection from Liens........................................................ 37 i Table of Contents 4. Custody of Funds............................................................... 39 5. Access to Contract Area and Records ............................... 39 6. Filing and Furnishing Governmental Reports .................... 41 7. Drilling and Testing Operations......................................... 39 8. Cost Estimates .................................................................. 39 9. Insurance........................................................................... 41 VI. DRILLING AND DEVELOPMENT....................................................... 41 A. INITIAL WELL........................................................................................ 47 B. SUBSEQUENT OPERATIONS..................................................................... 47 1. Proposed Operations.......................................................... 47 2. Operations by Less Than All Parties.................................. 49 3. Stand-By Costs.................................................................. 51 4. Deepening......................................................................... 55 5. Sidetracking....................................................................... 55 6. Order of Preference of Operations..................................... 57 7. Conformity to Spacing Pattern........................................... 57 8. Paying Wells...................................................................... 57 C. COMPLETION OF WELLS; REWORKING AND PLUGGING BACK.................. 59 1. Completion........................................................................ 59 2. Rework, Recomplete or Plug Back.................................... 61 D. OTHER OPERATIONS.............................................................................. 63 E. ABANDONMENT OF WELLS.................................................................... 63 1. Abandonment of Dry Holes............................................... 63 2. Abandonment of Wells That Have Produced ..................... 65 3. Abandonment of Non-Consent Operations......................... 65 F. TERMINATION OF OPERATIONS .............................................................. 67 G. TAKING PRODUCTION IN KIND............................................................... 67 (Option 1) Gas Balancing Agreement .......................................... 69 (Option 2) No Gas Balancing Agreement..................................... 69 VII. EXPENDITURES AND LIABILITY OF PARTIES............................... 71 A. LIABILITY OF PARTIES........................................................................... 71 B. LIENS AND SECURITY INTERESTS ........................................................... 83 C. ADVANCES............................................................................................ 91 D. DEFAULTS AND REMEDIES..................................................................... 95 1. Suspension of Rights ......................................................... 95 2. Suit for Damages............................................................... 95 3. Deemed Non-Consent........................................................ 95 4. Advance Payment.............................................................. 95 5. Costs and Attorneys' Fees.................................................. 95 E. RENTALS, SHUT-IN WELL PAYMENTS AND MINIMUM ROYALTIES........... 97 F. TAXES................................................................................................... 97 ii Table of Contents VIII. ACQUISITION, MAINTENANCE OR TRANSFER OF INTEREST................................................................... 99 A. SURRENDER OF LEASES......................................................................... 99 B. RENEWAL OR EXTENSION OF LEASES..................................................... 99 C. ACREAGE OR CASH CONTRIBUTIONS...................................................... 101 D. ASSIGNMENT; MAINTENANCE OF UNIFORM INTEREST............................ 103 E. WAIVER OF RIGHTS TO PARTITION......................................................... 107 F. PREFERENTIAL RIGHT TO PURCHASE...................................................... 107 IX INTERNAL REVENUE CODE ELECTION.......................................... 111 X. CLAIMS AND LAWSUITS................................................................... 111 XI. FORCE MAJEURE ................................................................................ 113 XII. NOTICES............................................................................................... 113 XIII. TERM OF AGREEMENT...................................................................... 115 XIV. COMPLIANCE WITH LAWS AND REGULATIONS.......................... 117 A. LAWS, REGULATIONS AND ORDERS....................................................... 117 B. GOVERNING LAW.................................................................................. 117 C. REGULATORY AGENCIES........................................................................ 117 XV. MISCELLANEOUS............................................................................... 119 A. EXECUTION........................................................................................... 119 B. SUCCESSORS AND ASSIGNS.................................................................... 121 C. COUNTERPARTS..................................................................................... 123 D. SEVERABILITY....................................................................................... 123 XVI. OTHER PROVISIONS........................................................................... 127 A. ADVANCE OF WELL COSTS.................................................................... 129 ADVANCE OF WELL COSTS -- INTEREST AND RELINQUISHMENT.............. 131 B. ESCROW AGREEMENT............................................................................ 135 C. RIGHTS OF OPERATOR AGAINST A DEFAULTING PARTY......................... 140 D. OBLIGATORY WELL -- WITH OPPORTUNITY TO EXTEND OR RENEW........................................... 141 OBLIGATORY WELL............................................................................... 142 E. RELINQUISHMENT PROVISION -- EXPLORATORY WELL........................... 143 RELINQUISHMENT PROVISION -- ALL WELLS 143 RELINQUISHMENT PROVISION -- HORIZONTAL WELL.............................. 144 iii Table of Contents F. FARMOUT.............................................................................................. 146 FARMOUT -- HORIZONTAL WELLS.......................................................... 149 G. CHANGE OF OPERATOR -- FINANCIAL..................................................... 151 CHANGE OF OPERATOR -- DILUTION OF INTEREST.................................. 153 H. PRIORITY OF OPERATIONS...................................................................... 154 I. LANDS EXCLUDED FROM THE OPERATING AGREEMENT.......................... 156 J. WELL PROPOSAL................................................................................... 157 K. AREA OF MUTUAL INTEREST.................................................................. 158 L. GEOSCIENCE OPERATIONS..................................................................... 161 M. BANKRUPTCY........................................................................................ 164 N. MEMORANDUM OF OPERATING AGREEMENT AND FINANCING STATEMENT................................................................. 165 O. PROPRIETARY TECHNOLOGY -- HORIZONTAL WELL............................... 182 P. COST OVERRUNS................................................................................... 183 Q. REMOVAL OF OPERATOR -- FINANCIAL INTEREST................................... 185 REMOVAL OF OPERATOR -- WITHOUT CAUSE......................................... 185 MEMORANDUM OF OPERATING AGREEMENT AND FINANCING STATEMENT and Related Forms............................................... 191 Memorandum of Operating Agreement and Financing Statement .......................................................................................... 192 Exhibit A to Memorandum of Operating Agreement ......................................... 194 Supplemental List of Farmout and Option Farmout Summaries............................................................................... 195 Instructions........................................................................................................ 196 Continuation Statement...................................................................................... 198 Release of Memorandum of Operating Agreement and Termination of Financing Statement............................................................ 199 Ratification of Memorandum of Operating Agreement and Financing Statement.................................................................................... 200 Model Form Recording Supplement to Operating Agreement and Financing Statement.................................................................. 201 iv Table of Contents FORMS TO OPERATING AGREEMENT EXHIBIT "A" CONTRACT AREAS TO PARTIES.......................................... 205 Contract Areas and Parties...................................................................... 206 Exhibit "A" Sample................................................................................. 207 EXHIBIT "B" FORM OF LEASE ..................................................................... 209 Paid Up Oil and Gas Lease Sample......................................................... 210 EXHIBIT "C" ACCOUNT PROCEDURE JOINT OPERATIONS.................... 213 I. General Provisions ...................................................................... 215 II. Direct Charges ............................................................................. 217 III. Overhead ..................................................................................... 225 IV. Pricing of Joint Account Material Purchases, Transfers and Dispositions ........................................................... 231 V. Inventories.......................................................................................... 237 EXHIBIT "D" INSURANCE............................................................................. 239 Form 1.................................................................................................... 240 Form 2.................................................................................................... 241 Commentary ........................................................................................... 243 EXHIBIT "E" GAS BALANCING AGREEMENT........................................... 245 Commentary ........................................................................................... 246 Sample.................................................................................................... 257 EXHIBIT "F" NON-DISCRIMINATION AND CERTIFICATE OF NON-SEGREGATED FACILITIES.................................. 263 Sample.................................................................................................... 264 Commentary ........................................................................................... 268 EXHIBIT "G" TAX PARTNERSHIP AGREEMENTS..................................... 269 Commentary ........................................................................................... 270 Tax Partnership Provisions...................................................................... 272 "G-1" Fair Market Value of Property Contributed to Tax Partnership................................................................ 275 Use of Tax Partnership............................................................................ 276 Model American Petroleum Institute Tax Partnership Provisions Form............................................................ 278 COMMENTARY .............................................................................................. 283 v 1989 JOINT OPERATING AGREEMENT WITH COMMENTARY * by Andrew B. Derman INTRODUCTION To facilitate the annual drilling of thousands of wells within the United States, the oil industry has relied on form agreements. The American Association of Petroleum Landmen (A.A.P.L.) has, since 1956, provided industry with standardized Joint Operating Agreements. The 1956 form was revised in 1977, 1982 and again in 1989. The forms have, generally, been effective in establishing procedures and obligations which have resulted in the drilling of tens of thousands of wells with minimal litigation. This Manual reviews each of the provisions of the Joint Operating Agreement and provides a discussion of that provision with selective comments on how the provision might be strengthened or amended. In addition, this Manual reviews exhibits that are customarily attached to the Joint Operating Agreement. Article XVI. is reserved for additional provisions. I have suggested a number of additional provisions which amend and/or supplement the Joint Operating Agreement. We live in a dynamic age where rules should be modified to fit the times. The A.A.P.L. Form Joint Operating Agreement has served the industry well, but as the oil industry evolves so must the form. This Manual seeks to educate the reader as to what the Joint Operating Agreement provides and to offer suggestions on how it can be improved. * Chief Counsel, Exploration and International, Oryx Energy Company; B.A., New York University; J.D., Temple University Law School. I want to acknowledge my wonderfully talented secretary, Julie Whitmire. During the lengthy preparation process, Julie's positive attitude and eye for perfection substantially contributed to the success of this project. I would also like to acknowledge my wife, Lynn Derman, who has always assisted me in attaining a healthy balance between my work and personal endeavors. 1 A.A.P.L. FORM 610 - 1989 MODEL FORM OPERATING AGREEMENT OPERATING AGREEMENT DATED * * * * , 19 , * * * * OPERATOR * * * * CONTRACT AREA COUNTY OR PARISH OF , STATE OF 2 Cover Page -- JOA Date: The date inserted should be consistent with the date included in Article XVI., lines 1 and 2, page 18. As a word of caution, this date should be earlier than the date provided in Article VI.A. If not, it is questionable whether the Operator is obligated to drill the Initial Well. If the Joint Operating Agreement (JOA) is attached to a farmout agreement or an exploration agreement and will become effective at some future date, the date provisions should be modified accordingly. For example, if the JOA is attached as an exhibit to a farmout and is to be effective after payout and conversion, the date provisions might read, "To be effective if and when Farmor and Farmee become joint owners in any of the Farmout Lands covered by the Farmout Agreement dated , 19 and attached hereto." Operator: This is the same person named in the body of the JOA. Be certain to use the proper corporate or partnership name. Contract This is a brief description of lands covered by the JOA. For example Area: NW of Section 16, Township 6 North -- Range 8 East. Be certain that the Contract Area description is identical to that described in Exhibit "A." If the description is long and detailed, describe the Contract Area on an Exhibit and include the following reference, "as described on Exhibit 'A' attached hereto." The parties should carefully consider the size of the Contract Area. A Contract Area that is overly expansive may well contractually bind the parties to jointly develop property years after the Initial Well is drilled. This can be troublesome where the Contract Area includes unleased acreage. In this situation, an area of mutual interest provision should be included in Article XVI. (See Article XVI.M. for an example.) An expansive Contract Area combined with the selection of Option No. 1 of Article XIII. can unintentionally create contractual relationships which will endure for decades. A party may find that a nine year old JOA controls operations on a new play on acreage that has never been drilled. Conversely, a Contract Area that is too small may cause difficulties where the exploration or development program includes acreage that is not within the Contract Area. If a lessee or a mineral owner refuses to expand the Contract Area or execute another JOA which encompasses this additional acreage, the party desirous of drilling has neither the benefit of a procedure that governs the proposal of a well nor the benefit of the non-consent penalty provisions. 3
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