The 1989 AAPL Model Form Operating Agreement: why are you not using it?

The 1989 AAPL Model Form Operating Agreement:why are you not using it? Andrew B. Derman & Isabel Amadeo Thompson & Knight LLP 1700 Pacific Avenue •Suite 3300 Dallas, Texas 75201 214.969.1700

Introduction • Oil Industry relies on form agreements • AAPL standardized forms: 1956, 1977, 1982, & 1989 • 1989 Form superior to its predecessors yet not universally accepted – Why? • Provisions of 1989 Form used worldwide but not onshore – Ironic!

The Debate: Investors vs. Operator • Is special protection required for Investors? • Parties to a JOA can negotiate and establish their rights and duties • 1989 Form  standardized “form”; a basis • Advantages of using form  reduce negotiation and drafting costs, comprehensively well written, efficient interpretation, among others

The 1989 AAPL Model Form Operating Agreement:why are you not using it? Review of 1989 Form

Definitions – Article I • Several definitions added • Elimination of ambiguity and conflict • “Affiliate” should be defined • If drilling a horizontal well  the definition of “deepen” must be expanded

Exhibits – Article II • Various Exhibits • Improved Exhibit A (identification of contract area) phone numbers of parties for notice purposes and burdens on production

Interest of Parties in Costs & Production – Article III.B • Production as allocated in Exhibit A • Revenues and Royalties not pooled • 1989 Form  clarifies that parties should share burdens up to the amount provided for in the blank and individually shoulder all excess burdens

Subsequently Created Interests – Article III.C • 1989 Form includes definition of subsequently created interests • Critical to fully disclose existing burdens in Exhibit A otherwise they are deemed as subsequently created interests

Titles – Article IV.A • 1989 Form improvement – Title examination if requested by a majority in interest of the drilling parties or by Operator vs. 1982 Form that requires all of the parties’ consent • Copies of drilling title opinions only to parties that pay for them

Loss or Failure of Title – Article IV.B • Owner’s of wellbore interests not considered a party to JOA unless otherwise specified in Exhibit A • If a lease is lost due to failure of title & no new lease secured within 90 days  Exhibit A adjusted

Designation and Responsibilities of Operator – Article V.A • Standard of care of Operator expanded • Negligent Operator liable for its percentage interest only

Resignation or Removal of Operator – Article V.B • Operator may resign at any time providing proper notice • Inclusion of removal standard • Good Cause Removal • Successor Operator  affirmative vote of 2 or more parties owning a majority interest

New Provision • Insolvent or bankrupt Operator = deemed to have resigned • No action of non-operators needed, only selection of new Operator • Bankruptcy Court may prevent removal of Operator  interim operating committee

Rights & Duties of Operator – Article V.D • Timely pay expenses • Keep Contract Area free of liens • Operator not a fiduciary • Non-operators greater ability to monitor the project

Initial Well – Article VI.A • Drilling of initial well obligatory • Horizontal wells not addressed

Subsequent Operations – Article VI.B • New language clarifies procedure • Non-consenting parties may now participate in deepening or sidetracking operations • Party proposing a subsequent operations must provide proper notice

Operations By Less Than All Parties – Article VI.B.2(B) • New provision  if well not drilled to its objective due to reasons other than mechanical problems or impenetrable substances  non-consenting parties entitled to participate

Reworking or Plugging Back – Article VI.B.2 • 100% penalty replaced by a blank • Parties will seek for higher penalties

Deepening – Article VI.B.4 • Detailed provision added • Non-consenting parties can participate in deepening

Sidetracking – Article VI.B.5 • Provision added similar to deepening provision

Order of Preference of Operations – Article VI.B.6 • New procedure to elect between conflicting proposals • Majority interest prevails & in event of tie initial proposal prevails

Paying Wells – Article VI.B.8 • New provision provides certainty • Consent of all parties needed to operate a commercial well

Completion of Wells; Reworking & Plugging Back – Article VI.C • Casting point expanded: AFE • Procedure for conflicting completion proposals incorporated • AFEs are estimates of costs not firm commitments

Other Operations – Article VI.D • 1989 Form improves efficiency of production operations • Certain work can be undertaken with written consent of any party or parties owning at least ___% of the interest

Abandonment of Wells – Article VI.E • Satisfactory proof of financial capability needed to take over a well • Costs of plugging, abandoning exceed salvage value  abandoning parties have to pay the party taking over the well

Termination of Operations – Article VI.F • Operations can be terminated prematurely if a determined percentage of the parties wish to do so • For the operations to end no need for it to be “impractical”

Taking Production in Kind – Article VI.G • Each party owns a share of production in accordance with its proportionate interest in the Contract Area • For antitrust & tax reasons  Operator only able to buy or sell the non-operator’s oil for a limited period of time

Operator Notification • Parties have to advise Operator their gas marketing arrangements, except for price • Split stream gas deliveries pursuant to gas balancing agreements

Liability of Parties – Article VII.A • Several not joint • Explicit disclaim to any intent to create a partnership • Duty to deal in good faith with each other

Liens & Security Interests – Article VII.B • Lien covers real property & present and future acquired personal property & fixtures • Each non-operator grants Operator a lien on its oil and gas rights and a security interest on its share of production

Defaults & Remedies – Article VII.D • Defaulting party automatically has certain rights suspended • Non-defaulting parties can sue to recover at joint account expense

Surrender of Leases – Article VIII.A • Surrender of lease requires consent of all parties to JOA • Failure to respond within designated time = consent to receive surrendered interest. Caution!

Renewal or Extension of Leases – Article VII.B • Now renewals, replacements & extensions of leases are addressed • BUT intent to eliminate 1982 Form’s ambiguity not that clear

Assignment; Maintenance of Uniform Interest – Article VIII.D • Transfer of ownership not recognized until 30 days after satisfactory notice has been received • Transferor liable for all costs incurred prior to assignment

Preferential Right to Purchase – Article VIII.F • Now an optional provision • If box is not checked  preferential right not applicable • Does “sell” include farmout? • Do mergers & corporate restructurings trigger preferential rights?

Claims & Lawsuits – Article X • Operator is authorized to settle claims arising from operations if the amounts do not exceed a specified amount

Notice – Article XII • Oral notices need to be confirmed immediately in writing • Responsive notices deemed delivered when deposited in mail

Miscellaneous – Article XV • New article • Addresses execution, successors and assigns counterparts and severability

Conclusions • 1989 Form incorporates many improvements over the 1982 Form • 1989 Form has yet not attained universal acceptance • 1989 Form is an improvement

The 1989 AAPL Model Form Operating Agreement: why are you not using it?