Joint Operation Agreements (‘JOAs’)

The exploration, development and production of hydrocarbons is a high-risk, costly business, with projects often running into the billions of dollars. Rather than take on such risks (which can include a combination of financial, political, technical and geological risks) on an individual basis, upstream oil and gas exploration and production companies (‘O&G Companies’) typically allocate and manage this risk by forming a consortium of similar upstream companies who share that risk on a joint venture basis. Under this risk allocation model, no single company bears all the risks for one project on its own. When a company spreads itself across several projects at the same time, it can often achieve the same economies of scale with less risk.

There are two basic mechanisms that O&G Companies use to form a joint venture. The primary mechanism used in the upstream oil and gas business is the unincorporated joint venture, which is essentially a contractual joint venture using a joint operating agreement (‘JOA’). This is the most common mechanism used in the industry since it is easier and faster to establish from a logistical, legal and tax perspective. The other mechanism is a joint venture company (‘JVC') with limited liability. The JVC, rather than the individual shareholders, holds the O&G concession in its name. The relationship of the shareholders is governed by the incorporation documents and a shareholders’ agreement. These are typically bespoke documents that are drafted based upon the requirements of the jurisdiction of incorporation and the country of operation.

The JOA is the most significant contract used in the upstream business by O&G Companies. It sets out the fundamental and overarching relationship among joint venture parties from the initial exploration to the ultimate production of hydrocarbons. It appoints an operator to carry out the operations and designates the remaining companies as non-operators. The purpose of a JOA is to:

• provide a decision-making process amongst the companies;
• provide for the conduct and funding of operations to perform the obligations under the granting instrument; and
• allocate benefits, costs and liabilities amongst the companies based on their respective shares in the consortium.

O&G Companies acquire petroleum rights from governments who issue them granting instruments such as production sharing contracts, risk service agreements, petroleum leases or licenses, or concession agreements. Governments grant such rights on the basis that the consortium parties are jointly and severally liable to the government who can enforce the entirety of the concession terms and obligations against any one of them individually. JOAs are designed to manage this risk by reallocating and limiting the joint and several liability amongst the parties. It does this by providing that the parties’ liabilities are apportioned amongst themselves according to predetermined shares. The JOA allocates the risk of third-party claims on a similar basis. This underlying principle means that each party must meet its share of obligations at all times for the JOA to effectively work. This underlying rationale affects significant terms in a JOA, including how the consortium allocates liability, approves work programs and budgets, manages cash calls, triggers defaults and determines transfer rights.

The global petroleum industry has developed a number of model contracts, including model JOAs, through its various business organizations that reflect widely accepted industry practice.¹ These model contracts eliminate the need to draft a bespoke agreement every time parties negotiate a JOA, while providing assurance to the parties that they have incorporated customary industry practice, or trade usage, into their agreement.

Industry organizations such as the American Association of Petroleum Landmen, the American Petroleum Institute, the Canadian Association of Petroleum Landmen and Oil & Gas UK have developed model JOAs for their particular regions or countries. However, the most widely used and accepted JOA in the international petroleum industry is the one published by the Association of International Petroleum Negotiators (‘AIPN’),² which is based upon customary industry practice in the international O&G upstream sector.

The AIPN has published four versions of its Model JOA in the years 1990, 1995, 2002 and 2012 and is presently updating a fifth version. Since its inception, the AIPN Model JOA has become the starting point for international O&G Companies to form unincorporated joint ventures and is often used with minimal modification by the parties. It is the model JOA most often referred to and relied upon in the ICC awards described in this article.

JOA Disputes

The international petroleum business invests in large, complex, capital-intensive projects that have long life spans. Circumstances, economics, governments and parties invariably change in these international oil and gas projects, which can often lead to a dispute. International arbitration is usually selected as the dispute resolution mechanism in the industry’s international JOAs, many of which are administered under the ICC Arbitration Rules.

The international energy sector, along with its associated construction projects, make up the largest portfolio of international commercial and investment disputes in the world, which are shown in the statistics of major arbitral institutions. In the years 2011 to 2018, between 12.5% and 19% of the ICC’s annual caseload derived from energy-related arbitrations.³ At ICSID, the energy sector comprising oil, gas, mining, electric power & other energy accounted for a 41% share of the ICSID Convention and Additional Facility Rules registered cases in 2018. Previous years’ figures show similar numbers.⁴ At the ICDR, energy disputes regularly rank as the highest in amount in dispute.⁵

Given the significance of JOAs in the upstream business, a major source of commercial disputes in the industry concern its JOAs. In order to determine the scope and nature of these disputes, the authors undertook an extensive research project sponsored by the AIPN in which they reviewed more than 250 court cases and more than a dozen international arbitral awards that dealt with JOA disputes. Part of that research included a review of previously unpublished arbitral awards, which are the subject of this article. This was accomplished with the support and co-operation of the ICC International Court of Arbitration, for which the authors are grateful. The ICC arbitral awards discussed in this article dealt with many of the same issues arising from JOAs found in the published court cases.

ICC Awards on JOA Disputes

The reviewed ICC awards were rendered between 2002 and 2014, involving parties from Africa, the Americas, Central Europe and East Asia. Those ICC awards dealt with the following issues:

1. Approval of Work Program and Budget
2. Accounting Procedure
3. Transfer and Pre-Emption Rights
4. Scope of Operator’s Duties/Authority
5. Limitation of Liability and Indemnities
6. Default and Forfeiture

These arbitral awards are analyzed under each of the issues listed above. A description of the issue is first provided, followed with a brief account of the points addressed in the relevant award. Some of these awards dealt with a number of the listed issues and as a result are discussed under several of the issue headings.

1. Approval of Work Program and Budget

International JOAs require the operator to present a Work Program and Budget on a regular basis to the operating committee, which is comprised of representatives from each of the joint venture parties, for approval. This is typically done on an annual basis in international JOAs. Work Programs and Budgets detail the work to be undertaken for the period in question and the estimated cost of that work. JOAs set out details of the level of approval required to be achieved in the operating committee for the Work Program and Budget to be adopted. Different levels of approval may be specified for different types of activity.

Even though operators have a fair degree of discretion in carrying out their job under industry JOAs, the other parties to an international JOA will insist on maintaining control over capital and operating expenditure decisions to protect their investment, manage their financial risk and to limit their liability. That includes control over the costs, timing and quality in contracts awarded for the acquisition of equipment and facilities for the joint account. This is reflected in the approval process in international industry JOAs.

Disputes tend to arise in relation to the levels of approval required for various items, whether the requisite approval was obtained, precisely what was approved and the consequences of not achieving the requisite approval.

Case No. 1 arose from a dispute between the operator (Claimant) and two other non-operator parties to a JOA (Respondents). The parties to the dispute were also parties to a Production Sharing Contract under which they were granted rights by the host state to explore, produce and develop the block. The dispute related to i) whether due process had been applied in the approval of certain drilling work and the budget for that work; and ii) whether cash calls made by the operator exceeded the approved budget. One of the non-operators settled its dispute with the operator shortly after the arbitration was commenced and withdrew from the arbitration, so the award only dealt with the dispute between the operator and one of the non-operators.

The due process issues related to whether the correct approval mechanism had been followed for revising a Work Program and Budget. They arose when the operator wanted to conduct additional drilling work not covered by the Work Program and Budget that was in place during the course of a drilling campaign. They were complicated by the interrelationship between the Production Sharing Contract and the JOA and the fact that the JOA contained provisions allowing for a shorter approval mechanism (24 hours rather than 15 days) in circumstances where a drilling rig was on location.

The Production Sharing Contract set minimum work obligations that were required to be completed to avoid the state being entitled to terminate the Production Sharing Contract and forfeit any guarantees to the host government. The additional drilling that was the subject of the dispute related to that minimum work obligation.

In making its decision, the tribunal considered whether: i) the drilling vessel was ‘on location’, such that a shorter notice period for a vote could be given by the operator; ii) the non-operator had contemporaneously objected to the validity of the voting procedure; and iii) sufficient financial and technical information had been provided to the non-operator so that it could make an informed decision in respect of the vote.

The determination of whether the 24-hour approval mechanism applied turned on whether the drillship was on location. The JOA did not contain a definition of on location and no expert evidence was provided to the tribunal of what on location should be understood to mean. The tribunal held that on location meant within the Contract Area (as argued by the operator) and not at the well about to be drilled (as argued by the non-operator). The tribunal noted that the non-operator’s narrow interpretation was not commercially sensible as it would result in the drilling vessel standing by in the Contract Area until the longer voting notice period (15 days) had expired, incurring significant standby charges. The approval vote was therefore not invalid as a result of the operator giving the shorter notice period (24 hours) for the vote.

The tribunal determined this issue on a construction of the JOA with the express objectives of the PSC in mind. One of those objectives was that Work Programs and Budgets should be carried out with the goal of avoiding waste. Waiting for 15 days to approve work when the drillship was on a high daily rate was not consistent with that objective. Consequently, the tribunal determined that the 24-hour approval mechanism had been correctly applied and the revised budget approved under the JOA.

The tribunal noted that the non-operator had not contemporaneously protested the manner in which the relevant Work Programs and Budgets were voted upon. The non-operator’s view of the soundness of the drilling program did not lead to a breach of due process by the operator if the decisions in relation to the drilling program were taken in accordance with the JOA procedure, with the non-operator’s knowledge and participation, regardless of the fact that the non-operator’s views did not prevail because its minority participating interest was outvoted. In light of the above, the votes in question had been validly called and the correct voting procedure followed. As a result, the operator was entitled to make the cash calls upon the non-operator as they had been properly approved.

The issue of whether the cash calls made by the operator exceeded the budget and whether it was therefore entitled to issue and collect the above approved budget is addressed in the next section. There was an additional issue arising from the operator’s claim that the non-operator had failed to pay its cash calls and was thus in default, which is addressed in section 6 (Default and Forfeiture) below.

2. Accounting Procedure

The parties to a JOA share the costs of the work undertaken in exploring for and ultimately producing hydrocarbons from the area in question. Given the operator’s role in managing the work, the costs of the work are handled by the operator with the other participants contributing their share of those costs under the accounting mechanisms of the JOA. The detailed provisions dealing with the types of cost that can be charged to the joint account, how it is to be shared by the participants and how each of the participants will make its contributions to those costs through cash calls or invoices are set out in the Accounting Procedure, which is typically an exhibit to the JOA.

Disputes can arise on a number of issues relating to the Accounting Procedure. They can be closely connected to other areas of dispute such as the approval of Work Programs and Budgets, by which the costs to be shared may have been approved, and Default and Forfeiture, which as described at section 6 below, are the potential consequences of a participant not paying its share.

Case No. 2 dealt with whether an operator could charge to the joint account Profit-Sharing Expenses that were imposed solely on it by the government. The non-operators (Claimants) and the operator (Respondent) were all parties to a JOA. Claimants sought repayment of the sums paid in respect of the Profit-Sharing Expenses that the operator had charged to the joint account.

Each party was separately accountable for income tax. The JOA specifically provided that the income tax of the operator was not a cost of operation and so could not be allocated to the non-operators. Each party was also accountable separately for their own Profit-Sharing Expenses. A company was required to pay the Profit-Sharing Expenses if it had more than a specified number of employees in the country in question. Only the operator hit that threshold. The non-operators did not.

The issue first arose following an audit conducted by the non-operators. The audit discovered that the operator was charging the Profit-Sharing Expenses. The non-operators raised exceptions in relation to the Profit-Sharing Expenses and other costs charged. The operator reversed the charge for Profit-Sharing Expenses in exchange for the non-operators withdrawing their objections. The operator then charged Profit-Sharing Expenses to the non-operators without prior notice in subsequent cash calls. Although the non-operators objected to the inclusion of the Profit-Sharing Expenses, they paid the cash calls to avoid possible default. Subsequently, the operator included the Profit-Sharing Expenses as a line item in an annual Work Program and Budget, which the non-operators refused to approve.

The Accounting Procedure in dispute described what costs relating to the operator’s employees could be charged to the joint account. The operator argued that Profit-Sharing Expenses fell within the costs that could be charged pursuant to the relevant paragraph of the Accounting Procedure. The non-operators argued that they were excluded both by the words of the relevant paragraph itself and by the other provisions of the JOA.

The JOA and the Accounting Procedure were based on the AIPN Model JOA and its model Accounting Procedure. The sole arbitrator concluded that the industry standard forms did not address charges like the Profit-Sharing Expenses. Neither side was able to give an example of a joint venture (based on the AIPN Model JOA or otherwise) in which the operator was entitled to charge costs like the Profit-Sharing Expenses to the other parties.

The arbitrator decided that the operator was not entitled to charge the Profit-Sharing Expenses to the joint account for the following reasons:

• The burden lay on the operator to show that the Profit-Sharing Expenses fell within the employee costs included within the relevant paragraph of the Accounting Procedure. It had failed to do that.
• The Profit-Sharing Expenses were calculated based on the operator’s taxable income and it had little, if any, link to the block in question.
• It was not possible to devise an accurate or equitable method of allocation for the Profit-Sharing Expenses. Even if this standard could be met, a method had not in fact been devised in this case.
• The JOA did not provide an express foundation for charging the Profit-Sharing Expenses. In addition, the governing law of the JOA did not permit the juridical creation of new contractual terms for policy or teleological reasons.

As a result, the arbitrator ordered the Operator to credit the joint account in respect of the Profit-Sharing Expenses charged to it and to pay interest.

In Case No. 1 described above, the tribunal unanimously found that the revised Work Program and Budget in respect of the additional drilling work had been approved, and went on to consider whether the operator was entitled to charge the other JOA parties cash calls that exceeded the approved budget. The tribunal was unable to reach a unanimous decision on this issue.

The Respondent (non-operator) challenged the Claimant’s (operator) claim for the cash calls on the basis that the operator had not established that the costs included in them had been properly approved in a work program, budget or otherwise and so, under the Accounting Procedure, the operator was not entitled to make cash calls for them.

The operator’s position was that the costs included in the cash call related not directly to the costs of the drilling but to the Respondent’s share of geological and geophysical costs, social commitment and training, project management and overheads. It accepted that the costs exceeded the amounts included in the previously approved Work Program and Budget but contended that the amounts in the Work Program and Budget were estimates and that the sums claimed were the actual costs of the joint operations in respect of which the non-operator was required to pay its participating interest share.

Applying the IBA Rules on the Taking of Evidence in International Arbitration, the tribunal noted that the operator bore the burden of proving its claim on the balance of probabilities. The majority of the tribunal determined that the burden fell on the operator to prove that the sums claimed represented the actual costs of joint operations (to the extent that they exceeded the approved budget) and how they related to the approved Work Program and Budget or were otherwise approved under the JOA. They found that the operator presented no argument or evidence indicating whether, how and when the difference between the approved budget and the related cash calls was dealt with pursuant to the contractual procedure, or represented the actual costs of joint operations. The majority of the tribunal therefore concluded that the operator had failed to discharge that burden. Consequently, its claim for sums in excess of the approved Work Program and Budget failed.

The dissenting arbitrator’s view was that the conclusion reached by the majority was not consistent with a number of provisions of the JOA because the effect was to impose a draconian 100% liability on the operator for any cost overrun. He noted that the non-operator had not requested an audit of the cost which he noted was the mechanism provided by the JOA (in particular, the Accounting Procedure) to protect the non-operators from being required to bear costs that had not been incurred or did not relate to joint operations. He proposed that an award should be made on a provisional basis and that the non-operator should be given the opportunity to audit the costs claimed. A final award could then be made after incorporating adjustments to the costs claimed identified in the audit.

The tribunal concluded that the cash calls were validly made pursuant to the JOA and that the non-operator was liable to the operator for its participating interest share of such portions of the cash calls that were part of the approved budget, but not the portions in excess of the approved budget.⁵

3. Transfer and Pre-Emption Rights

International JOAs typically provide that a party can freely transfer its interest to another party, subject to restrictions under the governing law of the JOA and the approval of the government, which may be required under the granting instrument for the concession.

Industry JOAs often place additional contractual restrictions on a party’s ability to transfer its interest in the JOA. Typical transfer restrictions that are widely accepted in the industry address issues such as: i) the qualifications of the transferee; ii) minimum interest thresholds; and iii) the process for obtaining government approval.

Pre-emption rights are additional to these standard restrictions and can be grounds for a dispute amongst the parties. Pre-emption rights are typically only included in a JOA by using express language that the parties have agreed upon.

The basic concept behind a pre-emption right is that a transferor must offer the interest being transferred to the non-transferring parties in the JOA before it can transfer its interest in the JOA to a third party. If the other JOA parties do not exercise their pre-emptive right to take up the transferor’s interests on the same terms being offered by the third party within a specified time, the transferor can then proceed with its sale and transfer its interest to that third party.

There are essentially two kinds of pre-emption mechanisms. The first is a preferential (or matching) right. The second mechanism is a right of first refusal (or first negotiation). The basic difference between these two mechanisms is the timing when the transferor must offer the pre-emptive right to the non-transferring parties and the process for setting the price and terms.

In a preferential right, the transferor notifies the non-transferring parties in the JOA of the commercial terms it has finalized with a transferee. The non-transferring parties then have a specified time to match those terms. If the non-transferring parties elect to do so, they have a priority right to step into the proposed sale of the transferor's interest instead of the original transferee.

Under a right of first refusal, a transferor starts the pre-emptive process before it seeks out a third-party buyer by giving notice to the other parties of its intention to sell its interest. The non-transferring parties then have an exclusive right to negotiate the purchase of the transferor’s interests for a defined period of time. If they are unable to agree upon terms, the transferor is then free to seek a transferee outside the JOA parties.

In addition to one of the above pre-emption mechanisms, JOA parties need to also agree upon on whether their pre-emption rights apply to an asset transfer or a share transfer (i.e. a change of control) or both. An asset transfer is when a JOA party transfers its direct ownership interest (or participating interest) in a JOA and its accompanying interest in the granting instrument. A change in control is the direct or indirect change in the ownership of the voting rights of a JOA party, typically through the sale of its or its parent company’s shares.

Case No. 3 concerned a dispute that arose where two parties to a JOA each alleged that a change in control in relation to the other party triggered a pre-emption right and, because in each case the procedure set down by the JOA had not been followed, a breach of the JOA. Both parties sought declarations from the tribunal and an order for specific performance requiring the participating interest of the other party to be transferred to it. The pre-emption clause in this JOA was identical to the clause in the 1990 AIPN Model JOA, which read:

Any transfer of all or a portion of a Participating Interest whether directly, or indirectly by assignment, merger, consolidation, or sale of stock, or other conveyance, other than with or to an Affiliate, shall be subject to the following procedure (...).

Both parties agreed that this pre-emption clause applied to a change of control (i.e. a share transfer). However, they disagreed on how far up the corporate chain the pre-emptive right extended.

Company A (Claimant) argued that, since all preferential rights provisions operate to restrict alienation of the property to which they refer, they should be strictly construed under familiar principles of contract interpretation and that the provision was not intended to apply to changes in ownership in parent companies higher up the corporate chain. On that basis, the pre-emption clause limited the indirect share transfers to sales of the stock of the Party by which the participating interest in question was held.

Company B (Respondent) argued that the provision was not to be so narrowly drawn and that the intention of the clause was to reach transfers of participating interests as broadly as possible. Instead, the relevant purpose of the clause, especially acute in international oil exploration, was to know and have some control over the identity of the partners with which one shares the risk of the enterprise. This, therefore, extended the pre-emptive right beyond a single purpose entity which does no more than nominally hold title to the participating interest, and onto a parent corporation which decisively controls the behavior of the named Party.

For Company A, the transaction in question was that nearly all of the shares in its direct parent company were sold. The original owner of the shares took the view that the restrictions on the transfer of ownership interest only applied in respect of the entity that was a party to the JOA. As this transaction was higher up the chain of ownership, it took the view that pre-emption rights did not apply and so did not give notice of the proposed transaction to Company B.

At around the same time, the corporate group that owned Company B went through a restructuring so that Company B was separated from its other O&G assets and Company B was offered for sale. Given the change of ownership of Company B through the restructuring, a notice under the pre-emption provisions of the JOA was given to the parties to the JOA. Company B informed Company A of its proposed sale but informed Company A that, because of its failure to give a pre-emption notice in respect of the transaction relating to it, it was prevented from exercising pre-emption rights in relation to the proposed sale of Company B.

The tribunal concluded that the pre-emption clause was intended to allow consensual comfort among the parties to a JOA concerning the key characteristics they each bring to the venture. Consequently, it would come into play when a participating interest was being transferred in a way that varied the qualitative identity, if not the nominal identity, of the venturers who have staked their enterprise on one another. As a result, the tribunal found that the pre-emption clause applied to both transactions. However, for other reasons, it concluded that both Company A’s claim and Company B’s counterclaim failed.

In relation to Company A’s claim against Company B, the tribunal determined that the governing law of the JOA prevented Company A from making a claim against Company B because of its previous breach of the same provision on which its claim relied. On Company B’s counterclaim against Company A, the tribunal found on the facts that Company B had not asserted its rights at the time of the transaction but had acquiesced in the transaction. Consequently, it was prevented from asserting its rights in the arbitration.

4. Scope of Operator’s Duties/Authority

As the operator conducts the work on the participants’ behalf, JOAs define the scope of the operator’s duties and its authority to act and assume liabilities for them. These provisions work with the approval processes set out in the JOAs for Work Programs and Budgets and other mechanisms designed to give control and oversight to the operating committee over the steps taken by the operator.

Disputes can arise in relation to the precise scope of what the operator is able to do without the approval of the operating committee and on what the operating committee has, in fact, approved. In some circumstances, disputes arise where there is a disagreement among the participants so that the requisite approval of the operating committee cannot be obtained for certain work to be done and the operator or other participants are of the view that it is imperative that such work is undertaken. In these cases, the questions concern whether the operator has the authority to act notwithstanding the lack of formal approval.

Case No. 4 concerned a dispute that arose between a non-operator (Claimant) and the operator (Respondent) of a Production Sharing Agreement and its JOA. The operator had previously agreed to include the host government’s national oil company (‘NOC’) in the JOA and that the NOC would hold a similar participating interest in the Production Sharing Agreement and JOA respectively. The operator further agreed to carry the NOC’s share of the costs of financing the exploration and exploitation activities (‘Petroleum Costs’) and for those costs to be reimbursed from the NOC’s future share of production. When the non-operator acquired a portion of the operator’s interest in the block, it assumed an obligation to pay an equivalent proportion of the NOC’s share of the Petroleum Costs, which it did through an Advance Account managed by the operator. The dispute related to the order in which those Petroleum Costs would be reimbursed to the non-operator and the operator.

The non-operator contended that it was entitled to recover all the Petroleum Costs that it had advanced for itself and for the NOC through the Advance Account and, consequently, it was entitled to its own share of Cost Oil under the Production Sharing Agreement as well as a proportion of the NOC’s Cost Oil. It argued that the operator was required to reimburse the Petroleum Costs advanced on behalf of the NOC in an agreed order of priority and that the operator was failing to do that. In particular, it contended that exploitation costs were to be recovered first, followed by development costs and then exploration costs. For each of these categories, the costs were to be reimbursed on a first in, first out basis.

As a result of the operator’s failure to respect the specified order, the non-operator claimed that the operator had acted in breach of contract or its duty as agent and fiduciary and that, as a result, it had suffered loss and damage.

There were a number of relevant contracts to the issue. The Claimant (non-operator) had commenced: i) an arbitration under an assignment agreement by which it had acquired its participating interest from the operator; and ii) an arbitration under the JOA. This arbitration was commenced under the assignment agreement. The award principally concerned jurisdictional issues because this arbitration had been suspended pending a final award in the JOA arbitration. However, it is apparent from the award that, in the JOA arbitration, the non-operator alleged breaches of contract and of agency and fiduciary duties in respect of the approach taken by the operator to the reimbursements of costs as operator. None of the non-operator’s claims in the JOA arbitration succeeded and it withdrew its remaining claims in this arbitration.

In Case No. 5, a dispute arose concerning the authority and obligations of the operator under a JOA that was based on the AIPN Model JOA. At the material time, a subsidiary of an international oil company (‘IOC’) was the operator (Respondent) and the non-operator (Claimant) was the NOC of the state in which the block in question was located. The Claimant had originally been the operator, but the role was transferred because it did not have sufficient offshore experience to carry out the project effectively.

The dispute concerned steps taken by the IOC operator in relation to the award and management of a contract for the construction of a gas pipeline to bring gas onshore. The non-operator alleged that the operator, in breach of its obligations under the JOA, had: i) conducted an uncompetitive bidding process for the award of the pipeline contract; ii) not claimed a penalty for late completion of the work by the contractor; and iii) amended the pipeline contract after it was awarded which caused the non-operator to incur additional costs. During the arbitration, the non-operator added new claims that the operator had acted in wilful misconduct by awarding: i) additional work to the contractor without following the tender process; and ii) work to a different contractor without the non-operator’s involvement.

All of the non-operator’s claims failed on the facts. The tribunal concluded that the operator had followed the bidding process required by the JOA and that the non-operator had been fully aware of, participated in and approved the decisions relating to the steps taken in relation to the contractors.

In reaching its conclusions, the tribunal considered the following issues that were raised by the parties:

• Limitation of liability. The operator raised the exculpatory/indemnity clause as a blanket defence, which the tribunal rejected. More details on this issue are provided in the next section.
• Time bar. The operator contended that the claims were subject to the limitation period specified by the governing law of the JOA and that, in addition, the Accounting Procedure of the JOA required any payment to be disputed within 24 months. The tribunal found that neither the statutory limitation period nor the 24-month requirement prevented the claims from being made. In relation to the 24-month period, the tribunal concluded that the requirement to dispute a payment within the period applied to a procedural challenge to an invoice, as opposed to more fundamental questions of the parties’ contractual relationship. In this case, the tribunal concluded that the issues in dispute represented more fundamental questions relating to the parties’ relationship.
• Special relationship. The non-operator argued that the operator owed it a special duty of care because of its role of operator. The tribunal found that, under the applicable law, the partners had formed an ordinary partnership which imposed duties of good faith and care. However, these duties applied equally to all of the parties to the JOA, not just to the operator.

Case No. 6 dealt with an operator that allegedly failed to perform its obligations to manage the work program and contribute its share of costs. Companies A and B (Claimants), and Companies C and D (Respondents) were all parties to a Joint Development Agreement with a number of other parties. The Joint Development Agreement concerned two oil and gas exploration blocks and was very similar to an industry JOA.

Companies A and B represented foreign investors in the blocks and Companies C and D were controlled by a local partner. Foreign investors were permitted by the law of the host state to only hold a 50% interest in the blocks. The local partner (C and D) was the operator and responsible for the day-to-day management of the work relating to the blocks.

Companies A and B’s complaints regarding Companies C and D’s mismanagement of the project under the Joint Development Agreement focused on: i) a lack of cooperation from Companies C and D, including a refusal to provide daily reports, seismic test results and financial statements; ii) Company D’s failure to maintain the concession rights leading to Company A having to honour a guarantee given to a bank; iii) a refusal on the part of Companies C and D to accept technical advice on drilling, to allow representatives of Company B to observe drilling work and to conduct a proper tender process for drilling work which resulted in an unsuitable contractor being selected; and iv) a failure by Company D to achieve drilling targets.

The tribunal found that Companies C and D were in breach of some of their obligations under the Joint Development Agreement with regard to their performance of the Joint Development Agreement and the management of the project. On the facts, Companies C and D had received a number of notifications of violations from the Ministry of Oil and Gas of obligations under the subsurface contracts which it had not passed on to Companies A and B. The violations eventually led to the Ministry terminating the subsurface contracts.

The tribunal made the following decisions with regards to the issues raised by the parties:

• Companies C and D had misused fund. The tribunal determined that the scope of the obligation under the Joint Development Agreement on Companies C and D was only to limit the use of the funds and did not extend to impose a standard on the efficient use of the funds. Consequently, it found that there had not been any breach of this obligation.
• Intentional bad faith actions by Respondent. The tribunal found that there had been a breach in relation to the failure to register the pledge of subsoil right but, otherwise, there had been no breaches of the obligations under the Joint Development Agreement.
• Company C usurped control of Company D. The tribunal determined that as a matter of fact Companies C and D did not usurp management control of Company D.
• Company C failed to fund 50% of exploration cost. The tribunal found that the Joint Development Agreement did not contain a binding obligation to share additional costs equally and there had been no subsequent binding agreement.

The tribunal therefore concluded that Companies A and B succeeded only under one of the heads of damages claimed, which was the loss caused by losing the security right of pledge over the subsoil use right.

5. Limitation of Liability and Indemnities

An adjunct issue to the scope of an operator’s authority is the contractual limitation that JOAs typically provide to an operator with regards to its liability in carrying out its role and the indemnities that non-operators’ provide to the operator.

It is common industry practice to limit the operator’s liability in JOAs. A key expectation of any operator is that it will not be exposed to an open-ended legal liability when it acts in the capacity of an operator. This principle is usually justified by an operator to its non-operators as being consistent with the principle that an operator will neither lose nor gain while carrying out its responsibilities as an operator.

There are typically two components to such a provision in a JOA. The first is a statement that the operator will not be responsible for any loss or liability (except for its share) resulting from the operator performing (or failing to perform) its duties and functions as an operator under the JOA. This protection is usually all encompassing and is extended to losses or liabilities caused by the fault or negligence (and often the gross negligence) of the operator. This is often referred to as an exculpatory or exemption clause.

At a minimum, the exculpatory clause will relieve the operator of any disproportionate liability related to its conduct of operations. However, depending on the specific wording of the clause and the governing law that is applied, the exculpatory clause may or may not relieve the operator of liability for breach of contract.

The second component is a clause where the parties (including the operator) undertake to indemnify the operator for any such loss or liability for which the operator might otherwise be responsible. Through this combination of disclaimed responsibility and indemnity coverage, the operator is protected from full exposure to catastrophic liabilities that sometime arise in O&G operations that results in it only being liable for its share or participating interest in the JOA.

There are sound commercial reasons for JOA parties to provide such protection to an operator. These clauses are designed to protect an operator from being solely exposed to potential large-scale liabilities that may arise from carrying out its operational responsibilities, and to thus attract the most qualified operator.

It is customary in the international O&G industry for operator liability provisions to establish a high threshold that must be met before the operator is liable for the consequences of its activities performed (or not performed) in its capacity as operator. Hence, the standard of gross negligence or willful misconduct is often applied in such clauses. If the protection is extended to cover the gross negligence of the operator, there is typically a carve-out on what operations will fall inside or outside this exception.

There are other limitations on the extent of operator protection that reasonable commercial parties expect such clauses to contractually provide. The first limitation is the kinds of parties that are covered in the indemnity. It is commonly accepted in the industry that exculpatory clauses are meant to limit the liability of the operator to the other JOA parties in relation to claims made by third parties.

The second limitation is whether this clause is intended to shield an Operator from a breach of its duties owed to non-operators under the JOA. Operators sometimes use this clause as a blanket defence when things go wrong and its actions (or lack of) are disputed. In contrast, non-operators typically take the position that such a clause is not intended to allow an operator to carry out its administrative, planning, budgeting, contracting or accounting obligations in a grossly negligent fashion.

The third limitation is the kind of operations covered. An exculpatory/indemnity clause is meant to cover approved joint operations for that particular JOA. The question then becomes whether a particular activity or expenditure was properly approved as a joint operation under the JOA. This could involve examining the fact matrix to determine such matters as: i) what operations were formally approved; ii) whether certain expenditures were contemplated, expected or justifiably incurred by the operator; iii) whether the non-operators were aware of and condoned such expenditures; or iv) whether the operator properly responded to unplanned events or accidents.

Case No. 5 (described above) dealt with the interpretation of an exculpatory/indemnity clause in a JOA that was based on Article 4.6 of the AIPN Model JOA, which in this case read:

(A) Except as set out in this Article 4.6, the Party designated as Operator shall bear no cost, expense or liability resulting from performing the duties and functions of the Operator. Nothing in this Article shall, however, be deemed to relieve the Party designated as Operator from any cost, expense or liability for its Participating Interest share of Joint Operations.

(B) The Parties shall be liable in proportion to their Participating Interests for all Covered Liabilities (as hereinafter defined) and shall jointly and severally defend and indemnify Indemnities (as hereinafter defined) from any and all Covered Liabilities less those amounts which are attributable to Operator's participating interests EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), WILLFUL MISCONDUCT, STRICT LIABILITY OR OTHER LEGAL FAULT OF ANY INDEMNITEE.

The operator raised the above exculpatory/indemnity clause as a blanket defence and argued that, in the absence of fraud or gross negligence (which were excluded by the applicable civil code), it was only responsible for its share of costs and was not liable to the other parties for any other costs whatsoever, including for its breach of contract.

The tribunal held that Article 4.6 in that JOA only applied to third party claims, that it was not designed or intended to exclude liability for breach of contract as between the parties and that therefore the Respondent's limitation of liability defence based upon Article 4.6 failed. The tribunal came to that conclusion for the following reasons:

• Article 4.6 in its entirety must be considered to define and delineate the exclusion of liability that the parties intended.
• The language in Article 4.6 is, on its face, expansive. It does not appear to limit the exclusion of the Operator's liability to third party claims, but instead, appears to exclude any liability that arises from actions the Operator takes in the performance of its role, which could be read, in isolation, to shield the Operator from claims raised by the non-operating parties.
• However, Article 4.6(A) states that ‘[n]othing in this Article shall ... be deemed to relieve [the Operator] from any cost, expense or liability for its Participating Interest share of Joint Operations’. This language supports a reading that Article 4.6, in reality, is about claims raised by third parties against the joint operation.
• The use of neutral, even disassociated, terms such as ‘person’ and ‘entity’ suggests that the provision does not include the parties to the JOA (who are consistently referred as ‘Parties’), but is instead meant to refer to non-parties, i.e., third parties to the contract.
• It would not be a natural reading of the indemnity provision that the Parties to JOA agreed to ‘indemnify’ the Operator against their own claims.

6. Default and Forfeiture

The participants’ agreement to share in the costs of work undertaken on the joint area is considered fundamental in a JOA. It is important for the efficient implementation of the work that the required funds from the parties are available at all times. Consequently, JOAs contain a powerful mechanism to ensure that cash contributions are made by participants when requested. The failure of a party to comply with this payment request on time is considered a default under the agreement, which may lead to the implementation of a series of remedies. The purpose of the JOA default provision is to provide certainty and stability for the financial contributions that are required throughout the life of a petroleum project.

The default procedure provides for a notice to be given to a defaulting party and for sanctions to be applied if the defaulting party does not cure the default within the period allowed. The initial sanctions include being deprived of its voting rights, losing the right to receive its share of the hydrocarbons produced or the revenue achieved and, ultimately, the potential of forfeiting its participating interest. The defaulting party’s entitlements then pass to the non-defaulting parties and any proceeds of sale are applied to the amount in default.

Since the ongoing costs of operations must be met regardless of one party’s unwillingness to pay its share, non-defaulting parties are required under the JOA to bear the defaulting party’s share of costs on a pro-rata basis. Any failure by a non-defaulting party to meet the additional payment obligations which have been generated by the notice of default will constitute a separate default by that party.

The ultimate remedy of forfeiture of a defaulting party’s interest has been considered a harsh, but necessary, remedy in the industry to ensure the risk allocation provisions of the JOA work, while meeting the consortium’s obligations to the government under the granting instrument. However, the forfeiture remedy has both practical and legal challenges. The principal concern around the forfeiture remedy has been whether a court or arbitral tribunal might consider it to be a penalty and possibly unenforceable by the non-defaulting parties against the defaulting party. As a result, the industry developed a number of other remedies for non-defaulting parties to apply in addition to the forfeiture remedy, which were developed over time in the AIPN Model JOAs. These included optional provisions for a buyout of, a withering interest applied to or a security interest on the defaulting party’s interest in the JOA (all of which have potential shortcomings). These additional remedies are meant to reduce the risk of an adverse intervention by the courts or an arbitral tribunal by moderating the potential impact of the forfeiture remedy.

In order to ensure the continuity of operations, JOAs usually prohibit the right of a defaulting party to offset any amounts that might be due to it from any of the non-defaulting parties in order to reduce the amount in default. This restriction typically also applies to claims that a defaulting party might have against another party, including the operator. This no offset provision is based on the frequently cited industry principle that a party must ‘pay now, argue later’. As a result, industry JOAs usually contain a ‘no right of set-off’ clause, which is reflected in all versions of the AIPN Model JOA. Despite these restrictions, defaulting parties often use such counterclaims to justify their non payment of cash calls.

Since the consequences of the default procedure can be potentially severe to a defaulting party, disputes arise when it is applied as a result of the defaulting party taking steps to avoid losing its participating interest and being deprived of its other rights. The grounds on which these disputes arise frequently include challenges to whether the operator was entitled to seek the contribution requested and whether the correct procedures were followed in issuing the default notice. Relief is also sought by the defaulting party on legal grounds by seeking to argue that the default procedure is a penalty or disproportionately harsh and so is unenforceable under the governing law of the JOA or, where the JOA is governed by the law of certain common law countries, to seek the equitable remedy of relief from forfeiture.

In published ICC Case No. 11663,⁷ there were a number of related agreements including a Shared Management Agreement, a Participation Agreement, a Production Sharing Agreement and a JOA. Three parties (an operator and two non-operators) were parties to the Shared Management Agreement and the Participation Agreement. In addition, they were also parties to a JOA with the NOC of the host country. This arbitration was commenced by the two non-operators (Claimants) against the operator (Respondent) under the arbitration agreements in the Shared Management Agreement and JOA alleging breach of the Shared Management Agreement for failing to deliver letters of credit and for breach of both agreements by failing to make timely payments of cash calls.

The Shared Management Agreement (which was essentially a JOA for the three paying parties) provided for the sharing of costs and expenses and required that if a party was in default for more than 60 days after receiving a default notice, it had to forfeit and assign its participating interest to the non-defaulting party upon the request of that party. The operator consistently failed to pay its share of cash calls. As a result, the two non-operators served it with a default notice and demanded that it assign its interest to them. By the time of the final hearing in the arbitration, the operator admitted that it was in breach but sought relief from forfeiture. The two non-operators sought specific performance of the obligation on the operator to transfer its participating interest to them.

The tribunal found that it was a fundamental principle of the Shared Management Agreement that each party must pay its share of cost and expenses under such an agreement and issued a declaration that the non-paying party had forfeited its participating interest in the project. They found that this was consistent with standard practice in the oil and gas industry, as demonstrated by the 1995 AIPN Model JOA, which contained a forfeiture clause similar to what was in the Shared Management Agreement.⁸

In addition, the tribunal found that the management committee had the right to remove the operator and replace it with another party if it was in material breach of any of the parties’ agreements. In this case, the non-paying party (Respondent) was also the operator and failed to provide a timely letter of credit to the ministry.

The tribunal concluded that it had the authority to grant the equitable remedy of relief from forfeiture pursuant to the arbitration agreement. However, it declined to do so. It found that the Operator had been in persistent default under the agreements whereas relief from forfeiture was typically granted sparingly in cases ‘where the party in default has been guilty of a single breach, which may have resulted from inadvertence, and in respect of which a prompt tender of performance is made’. Consequently, it granted the non-operators’ request for specific performance of the assignment of the operator’s interest to them. The tribunal also awarded damages and interest to them for the unpaid cash calls.

Case No. 1 also dealt with a demand of payment of unpaid cash calls under the default provisions of a JOA. The operator (Claimant) put the non-operator (Respondent) on notice of its default in failing to pay two cash calls for the remaining well under a minimum work commitment. The operator maintained that, during the continuance of the default, pursuant to Article 8.6 of the JOA, the non-operator:

• had no right to vote on matters submitted to the Operating Committee;
• would be bound by any decision of the Operating Committee and excluded from the Management Committee; and
• would not have access to data or other information relating to Joint Operations.

The basis of the operator’s claim was that the non-operator owed the amount of the cash calls plus interest because it had defaulted on the payment of the cash calls when issued by the operator. The majority of the tribunal rejected the operator’s claim because these two cash calls were outside an approved budget, and found that any budget put forth by the operator at the time of drilling the remaining well was not subjected to the appropriate procedures required by the JOA but instead some kind of informal, pell-mell scramble at the end from which the operator appears to say that the tribunal can infer approval was given without any regard to the JOA at all.

The majority of the tribunal reached this conclusion while noting in the award that the JOA Parties were:

• obliged to carry out the Minimum Work Commitment by drilling three wells in Phase I by a set date (which the remaining well under dispute was the third well they were obligated to drill);
• not contractually entitled to choose to spend only the Minimum Financial Commitment; and
• not contractually entitled to defer the Minimum Work Commitment to Phase II, and could only do so with the regulatory authority's consent, which had not been given.

As described above, the dissenting arbitrator maintained that the majority’s decision was not consistent with a number of provisions of the JOA because the effect was to impose 100% liability on the operator for any cost overrun.

The result of the majority decision was that the default claim disappeared. The issue of the potential forfeiture of the defaulting party’s interest in the concession never arose because all the parties withdrew from the concession, which was the result of not finding commercial reserves after completing the minimum work commitment.

Case No. 7 concerned a dispute between one of the non-operators (Claimant) and the operator (Respondent), under a JOA based upon the AIPN Model JOA. The dispute related to the non-operator’s failure to pay a cash call when it was due and whether it was in default, which would result in the operator being entitled to claim the forfeiture of the non-operator’s participating interest. The non-operator raised a number of defences and sought relief from forfeiture.

This arbitration was the second arbitration between the operator and non-operator relating to the non-payment of a cash call under the same JOA and project. In the first arbitration, the non-operator was ordered to pay the relevant cash call within 30 days of a partial award and it did so.

The operator then issued a second cash call to the non-operator and, three weeks later, delivered a default notice to the non-operator stating that it was in default for failing to pay the second cash call. Two weeks later, the operator delivered a forfeiture notice to the non-operator requiring it to withdraw from the JOA since it had still not paid the cash call. The operator further stated that the non-operator’s participating interest was forfeited and deemed to have been transferred to the non-defaulting parties to the JOA. The non-operator responded by sending a cheque to the operator for the second cash call eleven days after the forfeiture notice, which was still within 30 days after the default notice. That cheque was rejected by the operator on the grounds that the non-operator had already forfeited its participating interest.

The operator relied on a provision in the JOA (an Expedited Forfeiture Procedure), which stated that, where there had been a prior default by a party and a second default occurred within a year of the last day of the default period for the first default, the defaulting party was required to remedy its default within 15 days of the default notice (rather than the 30 day remedy period normally permitted if there had not been a prior default within a year).

The non-operator commenced the second arbitration challenging the operator’s right to rely on the expedited forfeiture procedure and to issue the forfeiture notice.

In its award, the tribunal found the following:

• A bedrock principle of the JOA was that the operator shall neither gain nor suffer a loss as a result of being the operator in its conduct of joint operations.
• A fundamental purpose of the JOA was that each party was required to pay all amounts due as and when required.
• The JOA imposed a strict regime of sanctions to ensure timely payment of operating expenses incurred by the operator.
• All payments made to the operator under the JOA were without prejudice and that the non-operator was protected by detailed audit and refund procedures.
• The non-operator has an unconditional obligation to timely pay all expenses incurred by the operator with full reservation of its rights of challenge. ‘Pay now, complain later’ accurately described this procedure.

The tribunal concluded that the second cash call had been validly made and that the non-operator was in default for failing to pay it. However, the award in the first arbitration was not clear as to whether the non-operator had been in default in relation to the first cash call. Given this, the tribunal found that the operator had not established to the level of certainty required that the non-operator had been in default in relation to the first cash call and so could not conclude that the expedited forfeiture mechanism applied. Consequently, the tribunal determined that the non-operator had cured the default within the period required (which was within 30 days rather than 15 days) and the operator was, therefore, not entitled to declare a forfeiture.

Conclusion

There are only a few jurisdictions, such as the United States, England, Canada and Australia, that have a developed and sophisticated O&G jurisprudence. In contrast, most jurisdictions in which international O&G operations are conducted have no or very little such jurisprudence. In addition, the agreements used in the international O&G business are often quite different than those used in the domestic O&G business of the jurisdictions mentioned above. This makes any reference to O&G cases from well developed O&G law jurisdictions limited in understanding how international commercial O&G agreements work, what they mean and how any dispute arising from them may be resolved.

Since most agreements, including JOAs, in the international O&G industry provide for international arbitration as their dispute resolution mechanism (whose awards are not regularly published for confidentiality reasons), the ICC awards reviewed in this article provide, for the first time, an insight into how tribunals have grappled with and determined issues that arise in international JOAs. The issues disputed in these awards are ones that frequently arise and will be recognized by those familiar with international JOAs.

These arbitration awards show what tribunals have typically taken into consideration in reaching their conclusions on international JOA disputes. Their starting point was the fact matrix and the language of the contract. However, disputing parties always have different interpretations of the same language because of some ambiguity, unexpected event or unique circumstance, which often leaves this initial inquiry short in being able to make a definitive conclusion.

Some of the tribunals considered case law from the jurisdiction of the law governing the contract, but those were only court cases relating to general principles of contract interpretation, rather than any domestic O&G case law. Instead, most of the tribunals turned to customary industry practice (or trade usage) to determine how these agreements were applied and interpreted. This approach is supported by both the ICC Rules⁹ and the UNCITRAL ad hoc arbitration rules.¹⁰

The primary source of determining such business practices in the O&G industry that the tribunals relied upon were the industry’s model contracts. In particular, these tribunals referenced the model contracts developed and published by the AIPN, which they considered the main source for confirming business practices in the international O&G business.

Finally, these tribunals then took into consideration the specific choice of law in the contract, its general principles of contract interpretation and any general requirements under such law, such as matters of public policy. The impact of a particular governing law on the interpretation of a JOA is not addressed in this article since it was not included in the redacted versions of the awards provided to the authors.

Despite this limitation, these ICC awards will be helpful to counsel, their clients and arbitral tribunals in considering the merits of their own international JOA disputes; and for the long term, the industry in updating its model JOAs.

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