Does the operator in a Joint Operating Agreement owe a fiduciary duty to non-operators?

TABLE OF CONTENT

LIST OF ABBREVIATIONS

CHAPTER 1 INTRODUCTION
1.0 INTRODUCTION

CHAPTER 2 MEANING OF FIDUCIARY DUTIES
2.1: What is a fiduciary duty?
2.2: Importance of fiduciary duties
2.3 Fiduciary duties in joint ventures

CHAPTER 3 THE MODEL FORM AGREEMENTS
3.1 An analysis of the Model Form Agreements
3.2 Model Forms and parties’ duties

CHAPTER 4 CASE LAW DECISIONS
4.1 Cases where the courts find in favour of fiduciary duties
4.2 Cases where the courts agree with the Model Forms

CHAPTER 5 CONCLUSION
5.1 CONCLUSION

REFERENCES:
BOOKS:
ARTICLES
CASES
MODEL AGREEMENTS
INTERNET

LIST OF ABBREVIATIONS

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CHAPTER 1
INTRODUCTION

1.0 INTRODUCTION

In order to facilitate the drilling of thousands of wells within the United States annually, the oil industry has over the years relied on Model Form agreements as a guide for negotiating Joint Operating Agreements. The American Association of Professional Landmen (AAPL), has, over the decades (since 1956) formulated standardized Joint Operating Agreements. The first of such forms drafted in 1956 was revised in 1997, 1982 and 1989.^[1]

The 1989 Model Form was an improvement over the previous Model Forms. This form substantially influenced the Association of International Petroleum Negotiators (AIPN) in formulating the 1990, 1995 and 2002 Model Form Joint Operating Agreements.^[2] The AIPN Model Form is currently utilized worldwide even though some of its provisions have been under criticisms.

Since Joint Operating Agreements form the backbone of the Oil and Gas industry, the importance of fiduciary duties of the operator cannot be overemphasized. The operator is usually entrusted with the task of managing the finances of the oil field operations;^[3] hence it is important for non-operators to see that in instances of mismanagement of funds entrusted to the operator, fiduciary duties can be invoked against the operator in a court of law.

As we shall see in this paper, the Model forms have sought to exempt the operator from being liable as a fiduciary , thereby limiting, or exempting the operators from liability arising from damages, costs, losses, expenses and liabilities arising out of, or resulting from the performance or failure to perform, even if caused by a pre-existing defect, or the negligence (whether sole, joint or concurrent), willful misconduct, gross negligence, strict liability and other legal fault of the Operator.^[4]

This paper will firstly consider the meaning, importance and creation of fiduciary duties in law. Then the US Model Form Agreements will be analyzed. Since the Model Form Agreements originated from the USA, it is then vital to consider how the courts within the USA jurisdictions have viewed or interpreted the duty of the operator in a Joint Operating Agreement( i.e., do the courts view the operator as a fiduciary or not).

The research findings will demonstrate that the courts in the USA have in some cases interpreted the model forms in a way favourable to the protection of non-operators investment despite operator friendly language found in the Model Forms. Recently, however, as we shall see, in some cases, the courts are less willing to read beyond the contractual language.

CHAPTER 2
MEANING OF FIDUCIARY DUTIES

2.1: What is a fiduciary duty?

A fiduciary duty is a form of legal relationship that involves trust or confidence between two or more parties; in most instances, a fiduciary or trustee on one hand and a principal or beneficiary on the other hand. One party thus acts in a fiduciary capacity to another party, where funds are remitted to the former for investment purposes for example.^[5] To be a fiduciary means agreeing to act on behalf of another person in exercising power or discretion where such discretion may affect the interest of the other person.

A fiduciary duty can be said to command the highest standard of care at Common Law and Equity. A fiduciary, therefore, must not put his or her personal interest before the duty and must not unduly profit from his or her position as a fiduciary, except with the consent of the principal.^[6]

Generally, fiduciary duties arise from general law and not from the agreement between the parties. The terms of the parties’ agreement could, however, affect the extent of the fiduciary duties which could arise in a particular scenario or case.^[7]

If it can be demonstrated that the relationship between the operator and non-operator is that of agency, then it is easier to invoke fiduciary obligations based on case law decisions deeming an agent to be a fiduciary.^[8]

2.2: Importance of fiduciary duties

Why do companies struggle to avoid fiduciary duties? Why are interested parties eager to assert it? And why are courts reluctant to uphold it in some cases? These are the questions put forward for consideration in this paper.

It is worth noting as a starting point, that a fiduciary duty alters the position of the parties in a Joint Operating Agreement in many ways. We shall consider two of such important factors.

Firstly, a fiduciary duty holds the operator in a high standard of disclosure and conduct. Secondly, a wilful breach of the duty will expose the operator to certain punitive damages.^[9]

Fiduciary duties impose a standard of sincerity and honesty on the operator. This high expectation of standards makes it easier for co-venturers to make a claim in court in instances where the operator conceals information or fails to disclose unpleasant facts.^[10]

The importance of the duty to disclose can clearly be illustrated if we compare a claim relating to a breach of fiduciary duty to a claim of fraud. In the fraud case, the plaintiff has to determine or prove that an omission or misrepresentation was of a material nature; that the defendant indeed intended the plaintiff to rely upon the disclosure and that reliance on such information was reasonable.^[11] Fiduciary cases on the other hand, do not require such limits and conditions to pursue a successful claim.

On the issue of punitive damages, wilful violation of a duty or gross recklessness exposes a fiduciary to likely claims for damages. This, and the reason mentioned above, amongst other factors, probably explains why proposals to treat operators as fiduciaries are vehemently resisted in the oil and gas industry in the United States and other parts of the world. Simply put, operators are not kin on measures that can add to the cost of doing business.^[12]

Where the operator holds property as a trustee on behalf of the non-operators or enters into a contract as their agent, it will be bound by fiduciary obligations with respect to the particular contract or property; this is so because the relationship of trustee and beneficiary as well as agent and principal give rise to fiduciary duties.^[13]

2.3 Fiduciary duties in joint ventures

Since a Joint Operating agreement is a form of a joint venture contractual relationship, it is pertinent to discuss how the courts view fiduciaries in a traditional joint venture agreement.

It is worth observing that Joint ventures and mining partnership cases tend to treat operators as fiduciaries. Indeed, it has been suggested that fiduciary principles are normally applicable to joint endeavours.^[14]

Generally, a joint venture requires three basic elements to be valid as a joint venture. These are as follows: an agreement to partake in profits and losses, a community of interest and some degree of co-operation or control.^[15] Control implies some mutually agreed right of management or control of the enterprise.^[16] The burden of proving the joint venture naturally lies with the plaintiff, with virtually all jurisdictions applying the preponderance of evidence standard of proof.^[17] Some courts do require proof indicating that the parties did intend to form a joint venture, even though intent is not among the three basic elements of a joint venture. Besides, the relevant intent to be required will have to support the existence of the three elements.^[18]

Parties may enter into or form a joint venture expressly. Disputes do arise, however, in instances where the parties did not address the issue of their legal status in the joint venture. The courts, in such cases, have traditionally found that parties who enter contractual relationship which satisfies the elements of a joint venture do owe a fiduciary relationship to each other.^[19]

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^[1] Andrew, B.D., Amadeo .I., the 1989 AAPL Model Form Operating Agreement: Why are we not using it?

www.landmen.org/landmanarchive/archive/DermanJOA(1).doc. ( last visited on 25/06/09).

^[2] Ibid.

^[3] See Article 4.2 AIPN Model Form Joint Operating Agreement (2002).

^[4] See Article 4.6(A) AIPN Model Form Joint Operating Agreement (2002).

^[5] legal-dictionary.thefreedictionary.com/fiduciary+duty-Cached – Similar (last visited on 20/06/09).

^[6] Bristol and Western Building Society v. Mathew, Chancery 1 @ 18(1998).

^[7] Brownstead on the Law of Agency, p. 156, (15th ed), ( London, Uk; Sweet & Maxwell, 1985).

^[8] Ibid.

^[9] McArthur, J.B., the restatement (first) of the Oilfield Operator’s Fiduciary Duty, 45 (3) Natural Res. Journ., p. 587-776 (2005).

^[10] Dime Bo Petroleum Corporation v La Land and Exploration Company, 717 F. Supp 717, D., Colorado (1989).

^[11] Naftalis v Rankin 542 S.W. 2d 893,898, Texas Civ. App. (1976).

^[12] Supra, note 4.

^[13] Taylor, M., Tyne, S., Taylor and Winsor on Joint Operating Agreement, p. 9 (2nd ed) (London, UK: Longman Group UK Ltd, 1992).

^[14] Williams, H.R., the fiduciary principle in the law of oil and gas, 13, Institute on oil and gas law & tax., 201, 203 (1962).

^[15] Williams R.P., Meyer, C.J., Williams and Meyers oil and gas law, p. 524 (eds. Patrick, H.M., Bruce M.K., 2004).

^[16] Ibid, p. 519.

^[17] Weiner v Fleishman, 816 P2d, 892,898, California (1991).

^[18] Hendrix, P., Stanton L.T., the standard of care in the operation of oil and gas properties. Does the operator owe a fiduciary duty to non-operators?, 44, Inst. on oil gas law and tax., 10-8 (1993).

^[19] Bolivar v R & H oil and gas co., 789 F. Supp. 1374,1379, S.D, Mississippi (1991).