May 4, 2017

Joint Operating Agreements | Onyeka Obidi

(10 years ago *gasp*, I wrote this essay - which may or may not be terrible - on JOAs back in Aberdeen. Back then, I was chomping at the bits to be done with my Masters and working in the oil field. Alas... anyway, I was trawling through essays written back then, way back then and I came across this one. I chuckled to myself as I read through it, and then I decided to put it up and see what the public might make of it. Without tweaking a word or editing - so forgive all typos and structural problems - here's my short essay on JOAs) J

Oil exploration, no matter how rewarding it is on the chance of said exploration being successful, is fraught with extremely high risks, costs and liabilities. In order for oil companies, especially international oil companies to go about exploring, developing and producing hydrocarbon reserves, it is crucial and more advantageous for said companies to pool their resources together thereby minimizing the risks, high costs and liabilities that go hand in hand with petroleum exploration as well as realizing maximum rewards. This is especially crucial due to the fact that these companies will be based in different countries all over the world thus increasing said risks and liabilities.

There are different ways via which oil companies could form a joint venture through which this could be achieved and the most common of these ventures is the Joint Operating Agreement.[1] This agreement is viewed as being very beneficial to international oil companies due to various reasons and the aim of this essay is to describe the key features of this arrangement as well as highlight its advantages as opposed to other agreements or types of joint ventures. This will be achieved by stating what a Joint Operating Agreement is and then describing its key traits and benefits ergo, explaining why international oil companies prefer to enter into such arrangements.

A Joint Operating Agreement[2] is a contractual agreement between two or more parties establishing and setting out the terms of a joint venture between them under which petroleum exploration, development and production operations will be conducted.[3] It is the common means by which businesses come together as a joint venture in their search for and production of oil and gas both within the United Kingdom Continental Shelf and internationally. This agreement is regarded as very important and necessary especially with reference to international oil companies as the oil and gas industry is a high-risk, high-cost enterprise with a heavy frontloading of costs.[4]

The JOA is known for its remarkable features which distinguishes it from other forms of joint ventures. Firstly, the JOA is not a legal entity. This agreement is purely contractual without the involvement of any legal entity[5] as the parties to the contract decide among themselves the manner in which their joint objectives will be achieved.[6] As stated by J. Ellison and E. Kling[7], ‘there exists neither a single body of the United Kingdom law nor a distinct legal entity dedicated to the formation and operation of joint ventures, neither is there a dedicated body of law.’ This therefore means that the parties engaged in this agreement can, in their discretion, agree on how issues like funding, management etc. can be tackled, amongst other things.

Secondly, the co-venturers have no authority to bind one another[8] i.e. an operator or manager is interposed between the parties of the agreement and the operation itself hence leaving them with no authority to bind one another as agents.[9] Also, the co-venturers attempt to create several liabilities.[10] This is in the sense that there is a lack of mutual liability between the parties as each co-venturer will be liable for his own acts and omissions in the course of the arrangement.

Again, co-venturers take the fruits of the venture separately and in kind[11] i.e. each party has the right to take its share of petroleum in kind and dispense of it separately in its own business. This is regarded as a very important feature as it distinguishes the JOA from other forms of joint venture particularly legal and/or corporate partnership. This shall be tackled further-on in the essay.

These are but a few of the key features which the JOA possesses, and this includes that of co-venturers having the power to hold their assets in common. Regardless of how beneficial they may seem, one cannot help but wonder why international oil companies choose to enter into these agreements as opposed to the other ways via which a joint venture could be established. This is due to the fact that these other arrangements also achieve the same purpose of uniting different parties from all over the world in their common goal of making profit yet reducing risks and costs. An example of these forms of joint venture is the joint venture company. This is an arrangement set up for the purpose of said joint venture as well as acting as the company’s shareholder. It is regarded as the most popular legal structure for joint ventures and is viewed as a separate legal personality from the shareholders. This inevitably exposes the company to the financial and commercial risks involved in the joint venture thereby protecting them from losses, were the joint venture to fail[12].

Another form of a joint venture is the partnership joint venture. Under the Partnership Act 1980[13], a partnership is defined as ‘the relation which subsists between persons carrying on a business in common with a view of profit.’ According to Kling and Ellison, the establishment of a partnership gives rise to a vehicle that can be used for the creation and operation of a jointly owned business.[14] In this instance, theoretically[15], a partnership offers the parties an independent identity i.e. the firm operates under a name that is different from its partners and ‘may open a separate bank account, may sue or be sued in its own name and may not appear to be affected by the comings and goings of partners’[16]. This form of joint venture is described by some[17] as ‘the most suitable form to use in instances where the parties wish to establish a collaborative structure without the administrative formalities and the accounting transparency of a corporate vehicle.’

As indicated above, there are different ways via which international oil companies can go about the oil exploration, development and producing business, however these companies have a preference for joint operating agreements regardless of how suitable the other agreements may seem. This is as a result of a large number of reasons. Firstly, unlike other types of joint ventures, the JOA structure offers total tax transparency[18]. This is due to the fact that there is an absence of a joint entity thus the parties to the contract are able to deal with the tax on their own profit in accordance with their own circumstances, as well as plan his/her own tax affairs individually without interference from another party. According to Styles[19], ‘the unincorporated joint venture has been favoured by the oil industry over other possible models such as legal partnership or incorporation because of the tax advantages it provides…which is possible under the JOA’. This is in sharp contrast with the partnership venture.

Further, international oil companies, particularly those holding smaller interests will benefit more from a JOA as this arrangement possesses the unique ‘pass mark trait’. The pass mark is the ‘percentage interest share of votes which must be obtained before the Operating Committee may make a binding decision[20].’ The importance of this trait lies in the fact that parties with large interests inadvertently hold the dominant position if a low pass mark is given and this leads to those possessing lesser interests to lose out on the making of important decisions during negotiation. Thus, the pass mark is hardly ever less than 50 percent as it will inevitably lead to a large interest holder being dominant. 70 percent is suggested as a common level[21], although the outcome of agreeing on the exact pass mark depends on the degree of trust the parties have in each other as well as their contractual strengths[22]. This lays in sharp contrast to the corporate partnership whereby unanimity is of the essence in all major decisions. There can be no negotiations between parties as to a majority of votes. Rather, there has to be a unanimous agreement and this could lead to time-wasting in decision making as parties might reach a stalemate if a unanimous vote is not achieved as quickly and efficiently as possible. As for the joint venture companies, especially under the United Kingdom legislation, ‘the holder of a 75 percent interest can ensure the passing of a special resolution…and anyone holding more than 50 percent will be able to pass ordinary resolutions.’[23] This suggests that a large interest holder could invariably possess the power to make ordinary or even ‘special’ resolutions regardless of whether other parties agree with his decision or not.

Again, the JOA has the advantage of its formation being relatively easy as well as its mode of operation being informal[24]. With regards to the former, there is a lack of an independent vehicle or body of law prescribing formalities that need to be observed thus these arrangements can be set in place economically and without any unnecessary fuss. This is in contrast to the formation of a joint venture company as its formation is dictated by the Companies Act 1985 thus rendering it more complex, time consuming and lastly, costly. Regarding the latter, the mode of operation in a contractual joint venture is relatively flexible as there is no joint venture vehicle in which the parties have an equity interest unlike the joint venture companies and partnership which are legal entities thus the dictates of the aforementioned Act require a ‘more formal administrative framework especially in respect of board meetings, general meetings or directors’ duties.’[25]

Another reason international oil companies choose to enter into a JOA is due to the distinctive clauses the arrangement is party to i.e. the sole risk and non-consent clause. With reference to the former, if one fails to obtain the pass-mark, one could still go ahead with his decision. As incompatible as this may seem to the idea of a joint venture, it can be seen as a form of giving every member a chance regardless of whether a pass mark is obtained or not. This is also evident in the latter (non-consent), whereby the members who do not intend to participate in a decision agreed upon by the majority does not do so. This gives everyone a chance to engage in their own dealings and an opportunity buy themselves back into the engagements they opted out of regardless of how large the premium could be.

With regards to ways in which joint ventures could be terminated, JOAs are easier to terminate as they are prescribed solely by contract and typically address a specific business project hence they can end the arrangement if decided upon together or once the project is over. This is unlike other forms of joint ventures like a partnership whereby statutory rules have to observed before termination can take place e.g. the Insolvency Act 1986 regarding liquidation and the Partnership Act 1980 on issues of dissolution[26].

The biggest bone of contention lies within the thin line between a partnership joint venture and the JOA. Members of the JOA are adamant about their agreement not being mistaken for a partnership. This is due to a number of reasons: tax benefits shall be lost if the agreement is mistaken for a partnership, and minimisation of liability amongst the parties to a JOA unlike those in a partnership. Again, under the JOA, each party has the right to take and dispose of separately its share of the petroleum gained. This clearly emphasises that the common enterprise of the joint venture is limited to the exploration and production of the oil and gas which the parties hold in common[27]. This is different from a partnership whereby there is joint disposal of the product for mutual profit. This is also similar to profit-making by the parties in a partnership. As stated in the aforementioned Act[28], a partnership constitutes of the sharing of profit by its parties and the mode of taking separate profits in the JOA might be regarded as not being so indistinguishable from the way profit is shared in a partnership. Although it has been expressly stated that ‘it is not the purpose or intention of this Agreement to create, nor shall the same be construed as creating, any…partnership’,[29] the courts are of the opinion that regardless of the express denial of any formation of a partnership by the JOA, ‘if a partnership exists…no concealment of name, nor verbal equivalent for the ordinary phrases of profit or loss…will prevent the substance from and reality of the transaction being adjudged to be a partnership.’[30] This has led to the argument by G Lewis[31] that a JOA ‘does not involve the sharing of gross returns,’ however ‘each participant is entitled to and bound to take in kind its share of the crude or the gas which is produced’ as well as being able to ‘sell its share for its own account’. Hence, ‘these arrangements do not amount to a sharing of profits which the Partnership Act definition requires and in effect the participants share the expenses of the production, but sell the products separately.’

From all that has been stated above, one sees that a JOA is extremely vital to ‘such powerful players as international oil companies’ regardless of the slight confusion that could arise due to arguments as to whether it is viewed as a partnership or not. The courts are even deemed to be fairly reluctant to argue against what has been expressly stated in a contract except if blatantly disregarded. Although other joint ventures are important in their own ways, the JOA trumps them all as it covers virtually all bases that international oil companies might view tentatively. Therefore, it is not surprising in the least for one to be of the opinion that international oil companies choose to enter into these arrangements.

[1] Also known as a Contractual Joint Venture
[2] Hereby referred to as a JOA
[3] T Winsor and S Tyne, Taylor and Winsor on Joint Operating Agreements (1992), p xix
[4] Styles
[5] Stephen Sayer ‘Negotiating and Structuring International Joint Venture Agreements’ Vol 5 of the Dundee University CPML web journal:
[6] J Ellison and E Kling, Joint Ventures in Europe (1997) p 315
[7] supra
[8] G M D Bean, ‘Fiduciary Obligations and Joint Ventures: the collaborative fiduciary relationship,’ (1995) p 8
[9] J D Merrals, “Mining & Petroleum Joint Ventures in Australia: Some basic concepts,” (1998) p 909
[10] Ibid G M D Bean
[11] Ibid J D Merrals
[12] Ibid Stephen Sayer ‘Negotiating and Structuring International Joint Venture Agreements’
[13] Section 1
[14] Ibid Ellison & Kling pg 329
[15] theoretical because in practice the law does not regard its members as being independent in English law and even if it was recognised the members themselves are still party to unlimited liability.
[16] Ibid Ellison & Kling
[17] Ibid Stephen Sayer ‘Negotiating and Structuring International Joint Venture Agreements’
[18] Ibid Ellison and Kling p 317
[19] Styles
[20] Styles
[21] supra
[22] supra
[23] Dundee
[24] Ibid Ellison and Kling pp 315-16
[25] supra
[26] Ellison and Kling p 317
[27] Stephen Sayer ‘Negotiating and Structuring International Joint Venture Agreements’
[28] Partnership Act 1980 Section 1
[29] UKOOA 20th Round Draft Joint JOA, cl 21.2.1
[30] Adam v Newbigging (1888) 13 App Cas 308 at 315
[31] G Lewis, Comment: the Joint Operating Agreement: Partnership or Not? (1986) 4 JENRL 80-84

Onyeka Obidi
Legal Counsel & Writer

Ed's Note - This article was first published here

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