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Focus: Room to move in joint operating agreements

5 December 2016

In brief: The Western Australian Supreme Court of Appeal has handed down its decision in Apache v Santos, allowing the appeal by Apache and overturning the first instance decision. The Appeal Court's decision has important implications for the interpretation of joint operating agreements and the ability of parties to undertake development activities outside the operation of such agreements at their own expense. Partner Igor Bogdanich (view CV) and Law Clerk Erin Molony report.

 
 

How does it affect you?

  • The decision has implications for the interpretation of joint venture/operating agreements, particularly in relation to operators and managers conducting their own 'internal work' related to joint venture activities.
  • In particular, the decision clarifies the scope for parties to engage in investigatory and/or initial development activities outside of the operation of the joint operating agreement, if done at their own expense without prejudice to the other parties.
  • Such activities may prejudice the other parties if they involve contracting for equipment or services where there is a limited market in the supply of such equipment or services and the contracting might make such equipment or services unavailable to the joint venture.
  • Parties should turn their minds to whether they plan to guard against or protect their ability to undertake such activities or, indeed, clarify that such activities may be undertaken.
  • Parties should be mindful that a clause which seeks to limit the operations that can be conducted under the joint operating agreement to operations expressly provided for in the agreement, may be interpreted narrowly.

Background

Apache Oil Australia Pty Ltd v Santos Offshore Pty Ltd [2016] WASCA 213 (Apache v Santos) concerned a dispute arising from an offshore petroleum joint venture between Santos Offshore Pty Ltd and three other entities (Apache Oil, Apache East Spar and Apache Kersail) (the Apache parties). Santos Offshore is wholly owned by Santos Ltd and the Apache parties are wholly owned by Apache Energy Ltd.

In 2010, under a Sale and Purchase Agreement (SOA), the Apache parties purchased a 55 per cent interest in a retention lease owned by Santos Offshore. A petroleum production licence was subsequently granted to the parties in 2011.

The parties entered into a Joint Operating Agreement (JOA) to establish their respective rights and obligations with regard to operations under the title. Apache Oil was appointed as Operator. The JOA provided that that no operations were to be conducted under the JOA except as Joint Operations or Exclusive Operations. Joint Operations were defined as those operations or activities carried out by the Operator under the JOA, the costs of which were chargeable to all parties. Exclusive Operations were defined as those operations and activities carried out under the JOA, the costs of which are chargeable to the account of fewer than all of the parties. A moratorium was imposed upon issuing an Exclusive Operations notice for three years.

Under the JOA, the Operator was responsible for the conduct of all Joint Operations under the supervision of the Operating Committee. The JOA also provided for removal of the Operator where the Operator committed a material breach of the JOA and failed to remedy that breach within 30 days.

Santos Offshore alleged that Apache Energy, acting as agent for Apache Oil, breached the JOA by, at the expense of the Apache parties, completing front-end engineering design in relation to the well, undertaking evaluation and investigation into subsea infrastructure and entering into contracts with certain suppliers for the procurement of equipment (the activities). Santos Offshore issued a material breach notice, to which Apache Oil issued a notice of dispute. Subsequently, Santos Offshore advised Apache Oil that it had not remedied the breaches within 30 days and stated its intention to remove Apache Oil as Operator.

Apache Oil brought an application in the Western Australian Supreme Court seeking a declaration that Santos Offshore could not remove Apache Oil as Operator. Santos Offshore counterclaimed, seeking a declaration that Apache Oil had committed breaches of the JOA and that it was entitled to remove Apache Oil as Operator.

Santos Offshore argued that Apache Oil’s activities were not authorised under the JOA, as no other operations could be conducted under the agreement other than Joint Operations and Exclusive Operations. Santos Offshore alleged that Apache Oil's breaches constituted material breaches and therefore entitled Santos Offshore to remove Apache Oil as Operator under the JOA.

The primary decision

The trial judge found that on proper construction of the JOA, no party could take any ‘material step with respect to the development or production of gas from the title’ except as a Joint Operation or an Exclusive Operation.

The trial judge, also found that the unauthorised development activities carried out by Apache Oil constituted material breaches of the JOA and determined that Santos Offshore was entitled to remove Apache Oil as the Operator. Apache Oil appealed the decision.

The appeal

All three judges allowed Apache Oil’s appeal, finding that the trial judge had erred in his findings regarding the proper construction of the JOA.

The Court of Appeal split as to whether the clause providing that no operations were to be conducted under the JOA, other than Joint Operations and Excusive Operations, was a prohibition. Appeal Justice Mitchell held that the clause was not in the nature of a prohibition, but was rather an agreement that any operations under the JOA were to be Joint Operations or Exclusive Operations conducted in accordance with the JOA.

Justices Newnes and Murphy found the question unnecessary to decide in light of their finding that, upon proper construction of the clause, any prohibition did not prevent any participant from ‘undertaking, at its own expense, the kind of work and activities undertaken’ by the Apache parties. Justices Newnes and Murphy read the relevant clause in the context of the purpose of the JOA and conjunctively with the clause governing the powers and duties of the Operating Committee. Their Honours determined that any prohibition was directed to ‘operations or activities which could prejudice or interfere with the functions of the Operating Committee’, concluding that the activities undertaken did not jeopardise the title, involve the use of joint property nor confer a timing advantage on Apache Oil.

All three judges also considered the alternative grounds of appeal, namely whether the purported breaches were committed by Apache Oil in its capacity as Operator and whether the alleged breaches were 'material' in the relevant sense. Justices Newnes and Murphy found that Apache Energy was acting as an agent for the Apache parties, not solely on behalf of Apache Oil either in its capacity as a participant or Operator under the JOA. Appeal Justice Mitchell focused instead on the contractual language of the JOA and whether the relevant terms imposed obligations on Apache Oil in its capacity as Operator or as a participant. In relation to the final ground of appeal, all three judges found that the breaches alleged by Santos Offshore were not 'material'.

Practical learnings from Apache v Santos

The following key points from the Apache v Santos decision should be kept in mind when drafting or reviewing joint operating agreements:

  • Parties should consider the intended scope of the JOA and whether they anticipate the agreement to govern work undertaken in preparation for proposals to the operating committee. 
  • Parties should also turn their minds to whether they intend the JOA to govern investigatory work and/or initial development operations conducted by a party at their own expense.
  • When drafting a prohibition clause, the terms should be directed to one or more party and should expressly state how such parties must act. Failure to do so may result in the clause being construed as simply identifying the scope of the operations to which the JOA applies.
  • When construing such clauses, preference will be given to a construction that is commercially sound, allowing parties to undertake investigatory work, at their own expense, to determine the viability of any proposed project. This may or may not include work capable of being the subject of an operation provided for under the JOA.

Next steps

The Court of Appeal's decision in Apache v Santos currently stands as good authority.

The decision highlights the need for parties to a proposed joint venture/operating agreement to carefully draft the terms of such agreements, to accurately reflect the intended scope of its operation in relation to activities carried out concerning the title area. Parties to JOAs already on foot should diligently review their contractual arrangements and consider whether, in light of the Apache v Santos decision, they accurately reflect the intention of the parties.

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