Enforceability of Default Provisions under Joint Operating Agreements

By Pereira, Eduardo | Houston Journal of International Law, Spring 2019 | Go to article overview

Enforceability of Default Provisions under Joint Operating Agreements


Pereira, Eduardo, Houston Journal of International Law


ABSTRACT

Default provisions are commonly included in joint operating agreements (JOAs) in the context of petroleum operations. Among other contractual provisions, default provisions memorialize the commitment among the parties to share cost and underscore the consequences of any failure to do so. However, transnational petroleum contracts and their default provisions might not be consistently enforceable across jurisdictions, depending heavily on factors including the precise terms of the provision as well as the jurisdiction's adherence to civil or common law systems. Despite the fact that the usefulness of a default provision hinges on its enforceability, this issue remains largely unexamined in the context of international petroleum transactions under a number of common and civil law jurisdictions. This article explores the reasons behind Operators' choice to include a default provision in a JOA, the issues arising out of the possible unenforceability of such provisions across jurisdictions, and finally, the suite of remedies available for default that extend beyond forfeiture, including buyouts, liens, transfer-of-interest rights, or withdrawal.

I.     INTRODUCTION

II.    ENFORCEABILITY OF THE DEFAULT PROVISION

       A. Context Behind the Default Provision

          1. Default Rationale
          2. Default Procedures
          3. Default Definition
          4. Default Timing
          5. Pay Now, Argue Later?
          6. Remedies Available?
          7. Industry Practices

       B. Common Law Perspective
       C. Civil Law Perspective

III.   CONCLUSION

APPENDIX A

I. INTRODUCTION (1)

A joint operating agreement (JOA) is based on the principle of shared risk and cost. (2) Hence, one of the most important issues that the JOA addresses is the parties' financial obligations within the consortium. The preservation of financial resources under the JOA allows the consortium to perform its joint operations. (3) Conversely, a member's failure to meet those obligations might put the viability of the JOA at risk even though a JOA party could legally/contractually challenge certain obligations and/or payments that are inconsistent with the JOA terms or applicable law. (4)

In the context of petroleum operations, the aim of the default provision is to provide certainty and stability for the financial contributions that are required throughout the life of the specific project. (5) Thus, it is crucial for the JOA to bear a provision stipulating the so-called situation of "default" (default provision). This is a common approach in the petroleum industry, (6) but the precise definition of default and the implementation of such a provision might vary between different JOAs and Model Forms available in the industry. (7)

However, regardless of the Model Form used, the two main critical issues for the default provision are the commercial rationale for using such a provision and its enforceability. (8) On one hand, the default provision is meant to be used in a phase when the given assets or project has commercial value. (9) This is why the likelihood of a member's default varies, depending on the stage of joint operations, and the associated costs. (10)

On the other hand, a default provision (specifically its remedies) might not be enforceable during a phase with "commercial value" (i.e., after a commercial discovery and prior to the decommissioning stage). (11) This paper will analyze the second concern, which refers to the enforceability of the default provision.

II. ENFORCEABILITY OF THE DEFAULT PROVISION

Whereas a few decades ago, the term default would be completely absent from the JOA, a large variety of JOA Model Forms now bear sophisticated provisions that define default and stipulate the remedies that will apply upon its occurrence. (12) Each type of remedy bears its own features (both advantages and weaknesses). (13) Despite the chosen remedy, however, a default provision should have a commercial rationale to be used (i. …

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