A year dominated by the story of low oil prices is drawing to a close amid predictions that the pressures on upstream oil and gas companies’ financial positions may well intensify through 2016. For those who may be concerned about the financial health of their joint venture partners, we offer below a quick guide to taking stock of where you stand under your Joint Operating Agreements (JOAs) to put you in the best position to deal with any emerging problems.
Know what the JOA says about default
Most JOAs contain an unqualified and absolute obligation on a party to pay all cash calls, pre-funding and invoice requests. But check if a partner is in trouble, it may try to dispute the validity of payment obligations – most JOAs depend on a ‘pay now argue later’ formulation – but it’s worth checking.
If the operator is in trouble
Check that the JOA allows a non-operator to issue a default notice and ask for all joint account statements. The JOA should require the operator to provide periodic information on funding the joint account to evidence that non-operators and the operator are funding their participating shares.
The operator is not responsible for a shortfall
Do not suppose the operator’s functions extend to funding any default – they will almost certainly not. The non-defaulting parties will be liable for the defaulting party’s share in proportion to their respective shares and non-payment of the additional share will be a default event itself. The operator may be able to borrow funds instead – this may be a more attractive means of funding any immediate work commitments, so talk to the operator.
Know the short-term remedies
The defaulting party will cease to have voting rights – and a non-defaulting party’s rights at OPCOM will increase proportionately. Other entitlements will be lost as well: the right to information, the right to transfer an interest or withdraw. Again, check the JOA. The prohibition on transfer should be at the non-defaulting party’s discretion – there may be a willing buyer and the advantage of a quick sale.
What happens to the petroleum?
Rights over petroleum entitlements will be lost as well. Check what the operator’s obligations are – usually to sell the defaulting party’s petroleum on the best terms available to offset against the shortfall. Non-defaulting parties will want transparency on this and no sweetheart deals with the operator’s affiliates.
What happens next?
Here’s where JOAs differ in approach, so it’s important to know the process. Options include compulsory withdrawal, interest sales, mortgage security enforcement and forfeiture. The process for enforcing additional remedies will be spelt out in the JOA. Timing, and the role and exposure of the non-defaulting parties will differ depending on the form of the sequestration sanction.
Mortgage security enforcement
This avoids the uncertainties with forfeiture and is potentially attractive. The non-defaulting parties have a secured interest – and can rank ahead of unsecured creditors. But it can be problematic in some respects, multiple charges need to be registered and commercial lenders to the defaulting party may have some priority.
Interest sales … what needs to be passed over
Know what deductions can be made from the sale price beyond the amount in default. It is easy to justify all associated costs of the sale, marketing, legal and so on. However, any deduction that cannot be easily justified (such as fixed percentage deduction) may look like a penalty – and that can be problematic.
A slippery slope
Forfeiture – i.e. distribution of the defaulting party’s interest to the others. Fine in principle, but it only works if all the non-defaulting parties are willing to assume an additional burden. If others won’t do this, the situation can rapidly worsen – with other parties withdrawing and the handback or surrender of the concession. This can be off-putting to buyers – have the sellers got good title?
The ultimate sanction … perhaps not
Forfeiture comes with baggage – how effective is it? Not commercially justifiable – so perhaps a penalty? Or an unfair preference over unsecured creditors, such that a private contract defeats the law of insolvency? Not straightforward and plenty of scope for mischief by those in default.
If you would like to discuss any of the issues raised above, please do not hesitate to get in touch with the author or any of your other regular contacts in the Dentons oil and gas team.