Nicol Thompson Kramer and James Parrot 2017-12-07 15:53:11
In the recent bust of the oil and gas industry, companies were left scrambling to recover unpaid operating costs from working interest owners who were filing bankruptcy or simply going under. In some situations, recovery was simply not possible. However, identifying and exercising rights to recover early can increase the chance of getting paid, or may at least limit losses. Below are some of the remedies typically available for non-payment in joint operating relationships. Joint Operating Agreements Joint operating agreements (JOAs) are contracts used to allocate rights and obligations among multiple companies holding rights to operate an oil and gas property. JOAs identify one company as the “operator,” who is responsible for actual drilling, exploration and operation of the property. Non-operators are the companies who own part of the rights to operate the property, but do not conduct the operations. Non-operators may elect to “participate” in a well and receive a proportionate share of the well’s revenue in exchange for their agreement to pay their proportionate share of costs; or they can be carried, meaning participating operators will cover their proportionate share of the costs in exchange for the right to be repaid for the carried cost, plus a penalty. Most JOAs follow the forms published by American Association of Professional Landmen (AAPL). Terms can vary, but under most JOAs the parties grant each other mutual liens to secure their respective performance, especially payment of operational costs. The liens cover the real property leasehold interests and also provide security interests in personal property and fixtures used in operations. Additionally, JOAs grant parties the right to file statutory liens, but as long as it is properly perfected, the lien granted under the JOA is usually more durable. JOAs customarily allow operators to deduct the non-operators’ share of costs from their share of revenues and require non-operators to pay up front for anticipated costs of major operations, such as drilling or workovers (known as “cash calls”). However, problems arise when properties operate at a loss. To protect their rights to require proportionate payment of costs, parties to a JOA should ensure at the time of signing the JOA that a memorandum of the JOA is recorded in every county in which the real property is located and the security interest is filed in compliance with UCC requirements. Recording the lien is necessary to perfect its priority with respect to third parties (especially important in the event of a bankruptcy), and to exercise rights to foreclose on the lien when necessary. If the lien is not perfected, parties to the JOA may also lose their position as a secured creditor. While it is best to memorialize the JOA with a writing signed by every party, newer JOAs may grant parties the right to unilaterally record liens. Modern JOAs typically grant parties the right to foreclose on the liens by power of sale (some older JOAs do not). The Wyoming Supreme Court has held that an operator can foreclose on liens granted by a JOA by selling the interest in accordance with the statutes dealing with foreclosure of real property mortgages. Andrau v. Michigan Wisconsin Pipe Line Co., 712 P.2d 372 (Wyo. 1986). Thus, a party to a JOA can foreclose on a non-paying working interest owner pursuant to the power of sale foreclosure procedures in Wyo. Stat. §§34-4-101, et seq. This process involves notice to the defaulting party, publication of notice for four consecutive weeks, and a sale on the courthouse steps. However, the power of sale process cannot be invoked unless the lien has been recorded and no other proceeding has been commenced to recover on the debt. Wyo. Stat. §34- 4-103(a). While power of sale foreclosure is efficient, the remedy has a key limitation. In a distressed market, there is a significant risk that the oil and gas property has lost its value and may, in fact, have a net negative value. In such case, foreclosure is not an attractive option, as any purchaser at the sale would acquire the liabilities for abandonment. If the property sells for less than the debt owed, the non-defaulting party must file suit to recover the deficiency. JOAs may also provide that an operator can obtain contribution from other non-operators. Any and all of the non-defaulting parties who have paid a defaulting party’s share can recover from the defaulting party by foreclosure, further liens, or filing suit. In the end, however, the liens under the JOA are only as good as the value of the property and a judgment is only as good as the company’s assets. It will likely be difficult to recover on a judgment if the defaulting company is in financial distress. Therefore, the keys to increasing the likelihood of recovery are: 1) ensuring the parties grant mutual liens under the JOA, 2) ensuring those liens are properly recorded and perfected, and 3) acting quickly against a defaulting party in the event of non-payment. WOGCC Alternative While JOAs may offer useful tools for collecting from non-paying working interest owners, many oil and gas companies are involved in wells without JOAs. The options available in these situations depend largely on whether the party trying to collect is an operator or a non-operator. When a non-operator does not pay cash calls for a well that is expected to be profitable, operators may choose to seek relief from the Wyoming Oil and Gas Conservation Commission (WOGCC). The operator may ask the WOGCC to enter a pooling order covering the well with a specific finding that the non-paying party is a non-consenting owner. Wyo. Stat. Ann. § 30-5-109(g). This could entitle the operator to recover up to 300% of the non-paying party’s share of the well’s costs. Id. If the WOGCC has already entered a pooling order for the well, the operator can request that a new order be entered changing the non-paying party’s status from consenting to non-consenting. For a well that is performing sub-optimally, the 300% non-consent penalty will not help the operator. Breach of Contract If the non-paying party signed an election to participate in the well (albeit, not a JOA), the operator could pursue a breach of contract claim against the non-paying party. Wyoming has not addressed whether a typical well election and authorization for expenditure (AFE), without a JOA, establishes a contract. However, courts in other states have concluded that an election and AFE, on their own, can establish a contract. Bill Barrett Corp. v. YMC Royalty Co., Civil Action No. 15-cv-02177-RBJ-KLM, 2016 U.S. Dist. LEXIS 177987, at 1 (D. Colo. Dec. 23, 2016); St. George Coal Co., Inc. v. G3 Operating LLC, Halcon Resources Corp, et al, No. CV 13-106-GFBMM, 2015 WL 881509, at1-2 (Mar. 2, 2015). Once an operator obtains a judgment against a non-operator, the operator may be able to execute the judgment with liens on the non-operator’s interests in not only the subject well, but in other wells. Conclusion JOAs offer several options to increase the chances of recovery as long as the appropriate steps are taken to secure those options early in the relationship. The water is murkier when there is no JOA, but there are options. As the industry starts to recover, companies should be conscious of these lessons when venturing out in the next boom. Nicol Thompson Kramer is an attorney with Beatty & Wozniak, P.C. and has been in private practice in Casper for over 15 years. Nicol’s practice focuses on oil and gas and natural resources, along with real estate, trusts, estates, and business planning. She is a Wyoming native and was raised in the energy industry. She is licensed in both Wyoming and Colorado and has a wide variety of oil and gas experience, including surface use agreements and disputes, contracts, severance and ad valorem taxation, royalties, environmental regulatory permitting and compliance, title curative work, land use law, and water law. Nicol received her bachelor’s degree in accounting from the University of Wyoming in 1997 and her Juris Doctorate in 2002. James Parrot strives for business-oriented solutions that maximize operators’ abilities to complete projects and close deals quickly, efficiently, and securely. He started in the oil and gas industry as a landman and traveled through Wyoming obtaining leases, examining mineral title, negotiating and drafting joint operating agreements, and performing due diligence for acquisitions, divestitures, and oil and gas financing. Today, he focuses on oil and gas regulatory and transactional matters, and represents numerous companies in front of the Wyoming Oil and Gas Conservation Commission and other state and federal agencies in the Rocky Mountain Region. He has obtained approval for hundreds of spacing and pooling matters, prevailed in dozens of contested hearings, negotiated with regulators on challenging environmental mitigation and remediation matters, established enhanced oil and gas recovery units, resolved high-risk suspense funds, and represented operators and industry groups in rulemaking and legislation proceedings.
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