25 September, 2015
In brief
In the first decision of its kind in Australia,1 the Supreme Court of WA has ruled on a non-operator’s power to remove a joint venture operator for material breach.
The Court held that the Operator committed material breaches of the joint operating agreement by taking steps to develop a discovery of offshore petroleum in advance of operating committee approval.
The decision is instructive for all joint venture participants in clarifying the nature of the joint venture relationship and the boundaries within which operators must act.
Summary of facts
A Santos entity (as non-operator) and 3 Apache2 entities (one of which as Operator) are parties to an offshore petroleum joint venture (Spar JV), in 45% and 55% shares respectively. The Spar JV is governed by a joint operating agreement dated 27 August 2010 that was adapted from the 2002 AIPN Model JOA (JOA).3
In late 2010, with the agreement of all parties, the Operator drilled the Spar-2 well which is to be the Spar JV’s first production well. The Spar-2 well will be tied back to existing infrastructure for processing and liquids storage and handling on Varanus Island.
In a separate agreement, the participants agreed that they would not propose any work or expenditure as an Exclusive Operation under the Spar JOA (ie sole risk) before 27 August 2013. However, in 2011 – 2013, the Operator carried out the development of the Spar-2 well regardless (and without Operating Committee approval), purportedly to its own account, including by:
- completing Front End Engineering and Design (FEED),
- identifying, tendering and evaluating long lead items, and
- awarding contracts for major items of equipment.
In late 2012, Apache costed the development of the Spar-2 well at US $82m4 in total (not including drilling costs in the order of AU $67m5). By September 2013, the development was well advanced, with over AU $30m spent or committed.6
Santos gave notice that the Operator had committed material breaches, including by carrying out the development without Operating Committee approval. Santos requested that the Operator take steps to cure its breaches, failing which Santos would remove Apache as Operator under the JOA. Apache denied any breach and commenced proceedings to restrain Santos from removing it as Operator.
Prior to commencing proceedings, Apache presented the work and expenditure to the Operating Committee for approval (including of the retrospective steps). By this stage, Apache was no longer prevented from proposing the development as an Exclusive Operation, but the development proposal would have to be rejected by the Operating Committee before it could do so.
Apache’s conduct left Santos in a difficult position: approve the proposed (but already partially undertaken) development without any meaningful capacity to shape the development concept or reject the proposal and risk the project being advanced by Apache exclusively. Santos (and, with it, the Operating Committee) approved the development in November 2013, and it became a Joint Operation.
Contractual provisions
Under the JOA:
- all rights and interests in and under the Title, all joint property, and any production from the Title Area are owned by the parties in accordance with their respective participating interests (ie 45/55),7
- the Operator has the exclusive charge of, and shall conduct, all Joint Operations as agent on behalf of the parties under the overall supervision and control of the Operating Committee,8
- the respective participating interests of Santos and Apache (45/55) mean that Operating Committee resolutions could only pass with unanimous approval,
- no operations may be conducted except as Joint Operations or Exclusive Operations. Exclusive Operations are operations by fewer than all parties, that may be pursued only in limited circumstances, in which only those participating share the cost and proceeds (a share in petroleum thereby produced),9 and
- non-operators can remove the Operator for ‘material breach’, after giving notice and affording an opportunity to cure.10
Apache’s contentions and their resolution
Apache resisted Santos’ proposed removal of it as Operator by arguing, among other things, that:
- As a matter of construction, the JOA did not prohibit the steps Apache took without Operating Committee approval (the JOA only expressly prohibited ‘operations’ and that term, Apache argued, only applied to physical steps taken within the Title Area, not any other activities directed towards development which do not affect or impinge on the Title Area).The Court rejected Apache’s distinction between ‘operations’ and ‘activities’, finding that both were within the scope of the JOA.
- Any breaches were not ‘material’ breaches because Santos did not suffer any damage. The Court focused on the materiality of the breach, rather than the materiality of the obligation and found that a material breach is one that substantially adversely affects the interests of the other party, with “the word 'material' … to be attributed the meaning of 'important' and to connote 'significance'”.11 Here, the breaches were material because their effect on Santos was significant, in that they deprived Santos of the benefit of the provisions of the JOA that entitled it to have input into budgets, contract awards and timing of the development.12
- Santos had waived its entitlement to remove by approving the development in November 2013. Apache’s case was that in voting to approve the development in November 2013, Santos had elected to have Apache, as Operator, implement the development, rather than remove Apache as Operator for material breach, those two sets of rights being inconsistent. The Court found that there was no inconsistency in Santos choosing to progress the development of the Spar-2 well and, at the same time, maintaining that Apache was liable to be removed as Operator for its prior material breach.13 Also, the JOA provided for no waiver except in writing and, in voting to approve the development, Santos expressly reserved its rights regarding breaches of the JOA.14
Key insights
The Court recognised that the Operator’s duties and powers under the JOA are fundamentally subject to the supervision of the Operating Committee.15 It is critical to the proper functioning of the joint venture that the Operator act in the interests of the joint venture (as directed by the Operating Committee), not preferring its own interests or those of its corporate group.
The JOA comprehensively regulates matters within its scope. There is no implied term that an Operator may act without the authority of the Operating Committee16and the JOA cannot be circumvented by the Operator permitting others (including the individual participants, as licensees of the Title) to undertake activities which, if undertaken by the Operator, would be subject to the supervision and approval requirements of the JOA.17
It is no answer that the steps taken were consistent with a regulator-approved Field Development Plan and the conditions of the Title, nor that they would result in the timely development of the gas field. Those factors did not entitle the Operator to ignore the constraints under the JOA.18
Different views as to timing and other aspects of a development are very common among offshore oil and gas joint venture participants. This JOA provided that the proper forum for resolution of these differences is the Operating Committee and, failing that, any applicable deadlock breaking mechanisms.
Unilateral acts by an Operator to accelerate a work program, or perform actions outside an approved work program, without Operating Committee approval, put at risk more than the cost of such actions. The Operator is exposed to a finding of breach, which may entail adverse publicity, removal and, subject to the operator’s indemnity, a damages claim.
This case did not involve a claim for damages for breach, and so the Court was not called upon to construe the operator’s indemnity in the context of the material breaches found to be committed by the Operator. Wilful misconduct is often excluded from operator indemnities and a court may well conclude that an operator undertaking a work program that had been rejected by the operating committee constitutes wilful misconduct, lifting the operator’s indemnity and exposing the operator to a claim for substantial damages.
Endnotes
- Apache Oil Australia P/L & Ors v Santos Offshore P/L [2015] WASC 318 (Apache v Santos), which is accessible here. There is a New Zealand precedent: Greymouth Petroleum Acquisition Company Ltd v Ngatoro Energy Ltd (2003) CP 162-02.
- These interests were sold by Apache Corporation in mid-2015 and are now subsidiaries of Quadrant Energy.
- The Spar JV and this JOA were also the subject of an earlier decision of the WA Supreme Court, relating to the construction and application of pre-emption rights engaged by Apache Corporation’s divestment of its Australian business (establishing Quadrant Energy): Santos Offshore P/L v Apache Oil Australia P/L & Ors [2015] WASC 242, which is accessible here. See our commentary on that decision here.
- Apache v Santos at [115] – [117].
- Apache v Santos at [15].
- Apache v Santos at [143], [145] and [146].
- Apache v Santos at [22].
- Apache v Santos at [23].
- Apache v Santos at [35].
- Apache v Santos at [37]. Given that the Spar JV is, in effect, a two-party JV, any removal of Apache as operator for material breach means that Santos will be substituted as operator and Apache will remain as non-operator party.
- Following a line of authorities culminating in the Victorian Court of Appeal decision of Androvitsaneas v Members First Broker Network P/L [2013] VSCA 212 at [89]: Apache v Santos at [199].
- Apache v Santos at [202] – [204].
- Applying the test for election set out in Sargent v ASL Developments Ltd [1974] HCA 40; (1974) 131 CLR 634 at 641 & 646: Apache v Santos at [212] – [215].
- Apache v Santos at [216] – [217].
- Apache v Santos at [195], [202].
- At least in taking any ‘material step with respect to the development or production of gas from the Title’: Apache v Santos at [220].
- Apache v Santos at [195].
- Apache v Santos at [184].
For further information, please contact:
Mal Cooke, Partner, Herbert Smith Freehills
mal.cooke@hsf.com
