No gain no loss - but what about liability for an Operator under a Joint Operating Agreement?

The no gain no loss principle is well anchored in the international practice of oil field operation. Consistent with that, Joint Operating Agreements (JOAs) typically contain very wide exclusions on the Operator's liability. In what circumstances might the non-operating parties be able to engage the Operator's liability for its acts or omissions?

The operator's obligations

JOAs are the cornerstone of exploration, development and commercial production of hydrocarbons. Extraction of hydrocarbons is capital-intensive with long lead times for return on investment. It is therefore rare for any given interest to be exploited by one commercial entity alone. Investment and risk is usually shared among a number of parties. One of the participants (typically the party with the largest interest) is appointed as Operator to manage all operational and commercial activity relating to the field, under the supervision and direction of all other parties through the Operating Committee.

Operatorship is founded on the "no gain no loss" principle. The role is not a remunerated one and the Operator is not to profit from its role. However, neither should the Operator end up worse off as a result of performing its role. Generally speaking, the parties (including the Operator, albeit in its capacity as a co-venturer) are liable for the costs of all activities carried out by the Operator, in proportion to their respective interest.

The Operator is in charge of the performance of all "joint operations", being all operations and activities relating to the interest, including exploration, appraisal, development, production and decommissioning, as well as activities connected to the joint operations, such as obtaining necessary permits or representing the parties in engagement with the regulator or government.

If the participants are not satisfied with the Operator's performance, the JOA will ordinarily provide for the possibility of taking action, including that:

• the parties may take decisions and give directions to the Operator through the Operating Committee; and
• in cases of a persistent breach or breaches, the parties may decide to remove the Operator, usually by a majority vote of the parties excluding the Operator.

But what happens when the participants have suffered loss as a result of the Operator's acts or omissions? Can they engage the Operator's liability and obtain redress?

The short answer is "only in limited circumstances". As mentioned above, JOAs typically contain very wide exclusions on the Operator's liability. In most cases, the Operator will only be liable in the event of gross negligence or wilful misconduct of senior personnel, which is difficult to establish. Even then, the Operator's liability is often subject to further monetary or other limitations, such as loss relating to joint property (as opposed to loss suffered by the other parties independently). There may however be instances where the Operator's acts or omissions might engage its liability even in the presence of such contractual limitations of liability.

The operator as a fiduciary

What happens if the Operator tries to use its position to its advantage or is putting its own interests first? For example, the Operator alone has the right to negotiate with the regulator or government and third parties; it may have other interests in that country and may accept terms in negotiations or enter into arrangements which are not in the best interests of all parties, in order to obtain advantages for its other operations. While this is a clear breach of the no gain no loss principle, what remedies do non-operators have?

In some cases, JOAs might contain an express duty on the Operator to act in the best interests of the co-venturers. In such cases, it might be possible to establish a breach of that duty and engage the Operator's liability thereunder. Alternatively, it may be possible to argue that the Operator owes fiduciary duties to the non-operators. Fiduciary duties will arise if the parties are in a partnership or agency relationship. If that is the case, the Operator would be under an obligation to provide full and frank disclosure of any personal interest and not to use its position to acquire a benefit for itself. A finding that the Operator acts as a fiduciary would be significant not just in terms of liability but also remedies. In particular, it would be possible to seek an account of profits made by the Operator in breach of its duties, and not just compensatory damages for actual loss suffered by the other parties (which loss itself may in any event be subject to contractual limitations as mentioned above).

The question has previously been considered in other common law jurisdictions. Under Texan law, for example, the law will impose fiduciary duties if the parties to a JOA are also joint venture partners. Until recently, the prevalent view was that the position is similar under English law, often however explained on the basis of agency law (i.e. the Operator acting as agent of all other parties). A big stumbling block with this however is that most JOAs (for example the model JOAs of the Association of International Petroleum Negotiators (AIPN) or Oil & Gas UK) will include a provision that the agreement does not create a partnership or more broadly that the parties shall not be fiduciaries save for certain limited circumstances, as expressly stated in the document. Consequently, no fiduciary duties would arise.

The point was recently considered by the English High Court in the case of TAQA -v- RockRose, albeit not extensively. Without deciding on the point, HHJ Pelling QC cast doubt over whether it is correct to have recourse to agency concepts in this area, given the detailed description of the Operator's duties in the JOAs. However, the clear implication in the judgment is that, in the absence of a "no partnership" clause, fiduciary duties would arise. In HHJ Pelling QC's words, "the parties have expressly agreed that their relationship is not a partnership and thus does not give rise to the sort of fiduciary duties that would arise in such circumstances".

The judgment in TAQA -v- RockRose does therefore leave the door open for a finding of fiduciary duties where such a provision is not present. However, in our experience, this is unlikely to be the case in most well drafted JOAs.

Relational contracts and the duty of good faith

Unless specifically provided for in a contract, in general English law does not recognise an implied duty of good faith. One exception to this is relational contracts. There is no strict definition of what a relational contract is, although they are usually long-term contracts that require a level of cooperation between the parties. A key ingredient is that the parties repose trust and confidence in one another.

In TAQA -v- RockRose, the Court considered whether a JOA is a relational contract. The Court took the view that JOAs are arguably relational contracts; however, it was not necessary to decide the point on that case. TAQA -v- RockRose concerned removal of the Operator through one of the mechanisms provided for in the JOA. The Court found that, on the wording of the particular clause in the JOA in question, it was an unqualified absolute right and there was no scope to imply good faith in the exercise of that right. This is in line with previous case law that a duty of good faith will not be implied in a relational contract if it contains specific express terms preventing such an implication.

In Bates -v- Post Office it was also argued that a duty of good faith in any event only requires a party to act honestly. The Court rejected that argument: "the parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people".

There is therefore scope to argue in future cases that a JOA is a relational contract which imposes a duty of good faith on the Operator, breach of which may engage the Operator's liability. However, as noted above, the case law makes it clear that this will not be possible in the presence of express provisions preventing such an implication.

In certain jurisdictions, JOAs are sometimes governed by local law when the national oil company (or the state) is a party to it. This is the case for example in a number of civil law African countries, such as The Republic of the Congo, Mauritania, Senegal or Tunisia. The position on good faith in relation to these JOAs often differs from the position under JOAs governed by English law. In our experience, in such cases, independent oil companies sometimes enter into a separate JOA or a JOA side letter, often governed by English or Texan law.

Conclusion

Although possible in principle, in our experience any well-drafted JOA will contain a "no partnership" provision and therefore no fiduciary duties would arise. However, TAQA -v- Rockrose has made it clear that there might be instances where it is possible to imply a duty of good faith on the basis of relational contracts and engage the Operator's liability for breach of that duty.