Oil and gas: Voting to next exploration phase

In the recent case of Adamantine Energy (Kenya) Limited v Bowleven (Kenya) Limited [2016] EWHC 130 (Comm), the English High Court considered whether the parties to a sale and purchase agreement (SPA) concerning interests in Kenya had validly voted concerning moving into the next exploration stage. In deciding the vote was invalid, the High Court considered that where there was no realistic prospect of completing the minimum work obligations in the underlying production sharing contract (PSC) on time, and where an application for extension of the existing exploration phase was pending, the vote served no contractual purpose or was premature.

While this decision ultimately fell on the specific drafting of the PSC and SPA in dispute, it provides insight into an important issue concerning votes to enter into subsequent exploration phases under PSCs.

Facts

Adamantine Energy (Kenya) Limited (Adamantine) entered into a PSC with the Kenyan government in respect of largely unexplored land in Northern Kenya. The PSC provided for an initial exploration period (IEP), during which Adamantine was obliged to carry out minimum work obligations. It also provided for an option to proceed to a first additional exploration period (1AEP) at the end of the IEP provided the minimum work obligations in the IEP had been fulfilled. In order to exercise this option, Clause 2(3) of the PSC required Adamantine to make an application to the government no later than one month prior to the expiry of the IEP.

Under the SPA, Adamantine assigned 50% of the participating interest in the PSC to Bowleven (Kenya) Limited (Bowleven) in return for Bowleven’s agreement to ‘carry’ the minimum cost under the PSC of each of the exploration phases. The SPA contained a ‘drill or drop’ provision at Clause 8, providing that there should be a management committee meeting “not later than three (3) months before expiry of [the IEP]” at which Bowleven and Adamantine vote on whether to proceed into 1AEP. In the event that one party voted to proceed while the other voted not to proceed, the withdrawing party was obliged to assign its participating interest to the other at no extra cost. The relevant clause stated:

“8. DRILL OR DROP

8.1 Not later than three (3) months before expiry of each Exploration Period (or any extension thereof pursuant to Clause 2.5 of the PSC), [Adamantine] and [Bowleven] shall hold a meeting of the Management Committee pursuant to Clause 5 of the JOA at which the Parties shall discuss, in good faith, and then vote on whether they jointly wish to proceed into the next Exploration Period and also the portion of the Contract Area to be surrendered pursuant to Clause 3 of the PSC.

8.2 If the Parties agree to proceed into the First Additional Exploration Period or the Second Additional Exploration Period (as applicable), [Adamantine] shall give notice to the Government, on behalf of the Parties, of their intention to do so pursuant to Clause 2.3 or 2.4, respectively, of the PSC and [Bowleven] shall, not less than one (1) month prior to the expiry of the then current Exploration Period, deliver to [Adamantine] (i) a Bank Guarantee for fifty percent (50%) of the value of the Phase 2 Work Programme or Phase 3 Work Programme, as applicable (as set out in column 3 of Schedule A); and (ii) a PSC PCG Guarantee for the remaining fifty percent (50%) in value of such applicable Work Programme.
…
8.4 If either Party votes against proceeding into the next Exploration Period, but the other Party votes to proceed, the other Party may require, at any time thereafter before the expiry of the then current Exploration Period, the first Party to assign its fifty percent (50%) Participating Interest in the PSC for nil consideration...”

The Phase 1, Phase 2 and Phase 3 Work Programmes referred to were defined in Schedule A of the SPA and corresponded, so far as material, with the minimum work obligations undertaken to the Government in the PSC for the IEP, 1AEP and 2AEP respectively.

As the IEP was due to expire on 26 May 2015, three months prior to that expiry was 25 February 2015. However, delays to the completion of minimum work obligations meant that the obligations would not be complete by 26 May 2015. This led to a formal application by the parties for an extension of the IEP.

On 25 February 2015, the parties met, Adamantine voted to proceed to 1AEP, and Bowleven also voted to proceed but on the condition that the extension to the IEP is granted. Adamantine did not accept the conditional vote, treated it as a “no” vote, and sought a High Court order that Bowleven transfer its 50% participating interest to them.

Decision

The High Court decided that what happened on 25 February 2015 was not a valid ‘drill or drop’ vote under the SPA, and that Bowleven therefore did not have to transfer its interests under the PSC.

The High Court considered that the starting point in construing Clause 8 of the SPA is that the vote that it contemplates is a vote on whether to invoke rights under Clause 2(3) of the PSC. Although the wording of Clause 8.1 involves a vote on “whether [the parties]…wish to proceed into the next Exploration Period”, this is not simply a decision on whether to proceed into a further exploration period in principle or in the abstract. Exploration Period (capitalised) was a defined term in the SPA, which gave the words the same meaning as in the PSC. In the PSC “Exploration Period” was defined by reference to the IEP, 1AEP and 2AEP. The decision required by Clause 8 of the SPA was therefore whether to enter into 1AEP, as defined in the PSC, by invoking the rights under Clause 2(3) of the PSC. This conclusion was reinforced by the terms of Clause 8.2 of the SPA which linked the voting decision required by Clause 8.1 to the invocation of rights under the PSC.

In this context the High Court reasoned:

• What is contemplated as being required by Clause 8 is not, therefore, simply a vote on whether to invoke such rights under Clause 2(3) of the PSC as may exist at some indefinite point in the future. It is a vote on whether to invoke such rights as may exist under Clause 2(3) of the PSC three months later by giving a notice two months later.
• It follows that there can be no requirement for a Clause 8 vote at a time when there is known to be no realistic possibility of invoking rights under Clause 2(3) of the PSC arising three months later, due to minimum work commitments not being completed.
• As a fact, both parties knew that there was no realistic prospect of completing the IEP seismic data acquisition required under the minimum work commitments of the PSC by 26 May 2015 and therefore there was no realistic possibility of invoking rights under Clause 2(3), unless the requested extension were to the IEP granted.
• It follows that what happened on 25 February 2015 was not a vote contemplated under Clause 8, as there was no realistic Clause 2(3) right to invoke.

The High Court accepted that “[t] he position would be different if there had been a real possibility of the minimum work obligation being completed by 26 May 2015, such that a notice one month earlier might give rise to a right to move into the 1AEP pursuant to the Clause 2(3) notice. If such a possibility had been in prospect on 25 February 2015, Adamantine would have been entitled to a drill or drop decision so as to be able to make the forward planning arrangements during the following three months for that contingent eventuality. But if, as was the case, there was no such realistic possibility, there was no contingent eventuality of an effective Clause 2(3) notice to be considered”.

In reaching the conclusion that the vote was not valid, the High Court considered it relevant that any different interpretation would have created odd commercial consequences. For example, if the Government had not granted an extension, there would have been no 1AEP to move into, and no purpose to a vote, whereas if an extension was granted, it would have been possible to have the ‘drill or drop’ vote at a later point in time once more technical information was available to aid in making a decision.

Comment

Whilst the facts of Adamantine v Bowleven may seem special or even unique, the circumstances considered by the High Court are remarkably common in the oil and gas industry where extensions to periods to carry out minimum work commitments are regular occurrences.

Although the High Court appeared to take support for its approach from the commercial sense of Bowleven’s construction of the SPA, Bowleven primarily benefited from the drafting of an SPA that clearly placed the parties’ obligations to vote on moving into the next PSC period in the express context of rights existing under the PSC. This linking of the drafting of the SPA with the PSC allowed the High Court to establish the natural and ordinary meaning of the parties’ respective rights under the SPA from the suite of relevant contractual documents. In this respect, the decision of the High Court might serve as useful guidance to drafters of such provisions on the importance of aligning provisions in transactional documents.

Interestingly, the AIPN (2012) Model International Joint Operating Agreement (JOA) requires any proposal to extend the Exploration Period or move to a new Exploration Period to be brought before the Operating Committee (but does not provide for a specific time period for a vote) and the Oil & Gas UK Model JOA requires that the “Operator shall convene a special meeting” not less than ninety days prior to the latest day upon which notice may be given to continue or extend the licence. The AIPN Model International JOA and Oil & Gas UK Model JOA both use language that link the extension in question to the underlying licence of PSC/Contract. It may be arguable, by analogy, that the holding of such meetings and votes under such JOAs also requires the existence of a realistic prospect of a further/extended term being available.

Please click here for a copy of the judgment.