Oil & Gas: JOAs, budget overruns and operator pension deficits

In Marathon Oil UK LLC v Centrica Resources Limited, TAQA Bratani Limited and TAQA Bratani LNS Limited [2018] EWHC 322 (Comm), the Commercial Court considered whether an operator was entitled to charge joint venture participants for pension fund shortfalls where the other participants had not approved the remedial plan concerning such shortages as part of a work programme and budget. In a decision that is likely to have profound, and global, implications, the Commercial Court found that the operator was entitled to recover sums properly incurred to close the pension shortfall from other joint venture participants. The reasoning of the Commercial Court might also be said to apply to any work that an operator has carried out that exceeds the original approved budget.

Facts

Marathon Oil UK LLC (“Marathon”), Centrica Resources Limited, TAQA Bratani Limited and TAQA Bratani LNS Limited are, and were, parties to a joint operating agreement (“JOA”) and a unitisation and unit operating agreement (“UUOA”) for operations in the Brae fields in the North Sea. Marathon (the “Operator” and/or the “Claimant”) was designated as the operator.

The terms of the JOA and UUOA were materially similar, namely:

“…

5.2 In accordance with approved programmes and budgets and under the overall supervision and direction of the Operating Committee, and subject to this Agreement, Operator shall have exclusive charge of and shall conduct all operations under this Agreement either by itself or by its duly authorized agents or by independent Contractors engaged by it.

5.3 Subject to the provisions of any approved operating programme and budget the number of employees of Operator employed in connection with operations hereunder shall be determined by Operator. The Operator shall determine the selection of such employees, their hours of work and their remuneration, and all such employees shall be employees of Operator exclusively.

5.4 In the conduct of operations, Operator shall:

(a) use its best efforts to conduct diligently all operations in accordance with practices generally followed by the petroleum industry, to conform to good oil field and engineering practices and accepted conservation principles and to perform such operations in an efficient and economic manner. All operations shall be conducted in accordance with the provisions of the Licence and all applicable laws and regulations;
…

(g) pay all costs and expenses incurred by it in its operations hereunder promptly and when due and payable;

…

(j) obtain and maintain, in respect of the Joint Operations and the Joint Property, all insurance required under the Licence or any applicable law and such other insurance as the Operating Committee may from time to time determine, provided that, in respect of such other insurance, any [p]articipant may elect not to participate provided such [p]articipant gives notice to that effect to the other [p]articipants and does nothing which may interfere with the Operator’s negotiations for such insurance for the other [p]articipants. The cost of insurance in which all the [p]articipants are participating shall be for the Joint Account and the cost of insurance in which less than all the [p]articipants are participating shall be charged to such [p]articipants in the proportion that each such [p]articipant’s Participating Interest bears to the sum of the Participating Interests of such Participants. The Operator shall, in respect of any such insurances:

1. promptly inform the [p]articipants participating therein when it is taken out and supply them with copies of the relevant policies when the same are issued;
2. arrange for the [p]articipants participating therein, according to their respective Participating Interests, to be named as co-insureds on the relevant policies with waivers of subrogation in favour of the Parties; and
3. duly file all claims and take all necessary and proper steps to collect any proceeds and, if all the [p]articipants are participating therein, credit them to the Joint Account or, if less than all the [p]articipants are participating therein, credit them to the participating [p]articipants.

…

(l) prepare and furnish to the Operating Committee such reports, statements, data and information as may be prescribed from time to time by the Operating Committee concerning [all operations conducted in accordance with the Agreement by or on behalf of any party with a Participating Interest];

…

5.5 (a) Without prejudice to Article 5.5(b) [which dealt with emergency expenditure] the Operator is authorised to make such expenditures, incur such Commitments for expenditure and take such actions as may be authorised by the Operating Committee in accordance with the provisions of this Agreement.

…

6.1 To provide for the orderly supervision and direction of [all operations conducted in accordance with the Agreement by or on behalf of any party with a Participating Interest], there shall be set up an Operating Committee composed of representatives of each [p]articipant. In exercising such supervision and direction, each representative on the Operating Committee shall act solely on behalf of the Party whom he represents and not on behalf of the participants as an entity. The powers and duties of the Operating Committee shall include:

(a) determination of all general policies, procedures and methods of [operations];

(b) consideration, revision and approval of all proposed operating programmes, budgets …;

…

7.2 On or before the 15th day of December of each year, the Operating Committee shall agree upon and adopt an operating programme and budget for the 12 month period beginning on the 1st day of January of the following year and for such further periods as the Operating Committee deems appropriate, which shall include as a minimum the work required to be performed under the Licence in respect of the Contract Area during such budget periods and the requirements of [the] Operator having regard to previously approved programmes and budgets and its obligations hereunder. At the time of agreeing upon and adopting an operating programme and budget, the Operating Committee shall provisionally consider, but not act upon or adopt, an operating programme for the calendar year next succeeding the period covered by such approved operating programme and budget.

…

7.10 Ongoing Liability
Following completion of Decommissioning, the [p]articipants shall remain liable for any residual liability (including in respect of remedial work) which arises at law or is otherwise imposed by regulatory authority unless and until the [p]articipants enter into a separate agreement as contemplated by in Article 2.3.

…

7.11 Expenditure Overruns
The Operator shall use reasonable endeavours not to exceed the approved Decommissioning Budget but shall be entitled without prior approval of the Operating Committee to incur expenditure:

a) in excess of an approved AFE [Authorisation for expenditure] up to the lesser of ten per cent (10%) of the amount of the approved AFE and ten million Pounds (£10,000,000); and

b) subject to (a) above, in excess of an approved Decommissioning Budget up to ten per cent (10%) of the amount of the approved Budget.

Whenever it appears to the Operator that the over-expenditure for any item will exceed the amount authorised under this Article 7.11.4 the Operator shall revise the appropriate AFE and/or Budget and will seek the prior approval of the Operating Committee to incur the additional expenditure prior to entering into any further commitment, such approval not to be unreasonably withheld or delayed where the over-expenditure is necessary to comply with the Decommissioning Programme approved by the Secretary of State.
…

10.1 All costs and expenses of all operations under this Agreement in or in respect of the Contract Area or the Licence, including the handling, treating, storing and transporting, whether within or outside the Contract Area, of Petroleum produced from the Contract Area, and all costs and expenses properly incurred by the Operator in its performance of the relevant provisions of the Decommissioning Security Agreement except for costs and expenses which are solely attributable or relevant to a Party, shall be borne by the [p]articipants in proportion to their respective Participating Interests from time to time except as herein otherwise specifically provided. Furthermore, the costs of all assets, including materials and equipment acquired for the Joint Account of the [p]articipants shall be for the account of the [p]articipants in accordance with their Participating Interests from time to time, and, similarly, liabilities shall be borne in such proportions.

10.2 All costs and expenses of whatsoever kind that are incurred in the conduct of operations under this Agreement shall be determined and settled in the manner provided for in the Accounting Procedures hereto attached and marked Exhibit A, which is hereby made part of this Agreement, and Operator shall keep its records of costs and expenses in accordance with such Accounting Procedure. In the event of conflict between the main body of this Agreement and the said Accounting Procedure, the provisions of the main body of this Agreement shall prevail.
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Covenant and Relationship of the Parties

18.1 Subject to the responsibility delegated hereunder to the Operator and the Operating Committee, each Party covenants and undertakes with each other Party that it will comply with all provisions and requirements of the Licence and the applicable laws and regulations and will do all such acts within its control as may be necessary to maintain the Licence in force and effect.

18.2 The rights, duties, obligations and liabilities of the Parties shall be several and not joint or collective, and each Party shall be responsible only for its obligations as set out herein, it being the express purpose and intention of the Parties that this Agreement shall not be construed as creating any partnership or association or as (except as expressly stated) authorising any Party to act as agent, servant or employee for any other Party for any purpose whatsoever.”

Exhibit “A” to the JOA was entitled “ACCOUNTING PROCEDURE”. The Exhibit began with this statement:

“The purpose of this Accounting Procedure is to establish equitable methods for determining charges and credits applicable to [all operations conducted in accordance with the Agreement by or on behalf of any party with a Participating Interest] under the Agreement and to provide that Operator neither gains nor loses by reason of the fact it acts as Operator. In the event of a conflict between the provisions of this Accounting Procedure and the provisions of the Agreement, the provisions of the Agreement shall control.”

The question between the parties concerned the costs of staff employed by the Operator (in practice through an affiliate) in connection with the operations. More specifically the question is whether the Participants were liable to meet a share of a proportion of deficit recovery charges (“DRCs”) in respect of a defined benefit pension scheme (the “Scheme”) of which some of those employees were beneficiaries.

The reference to a ‘share’ was the share of the costs of operations for which Participants were, between them, responsible. A proportion only was involved because the Scheme included some employees who did not work on operations in the Brae fields, and some who worked on operations there for some periods and on other unrelated tasks for other periods.

The Participants argued that they had no liability as a matter of contract under the JOA and UUOA. The Participants accepted that the Operator was entitled to select employees and their hours of work and their remuneration (including benefits such as pension provision). However, they argued that the Operator’s ability to recharge the cost was, and remained, subject to the provisions for approved operating programmes and budgets and the direction of the Operating Committee. They argued that Clause 5.5(a), 6.1(e), and 7 made it clear that the Operator is not entitled to incur any expenditure in the nature of remuneration without the approval of the Operating Committee as part of a work programme and budget found in the business management plan (“BMP”).

The Participants argued that the Operators approach that it was entitled to such costs, even when outside the agreed budget, involved their signing a “blank cheque”.

They also contended that the Operator owed fiduciary, as well as contractual, duties and its breach of both relieved the Participants of liability.

Decision

In rejecting the Participants’ arguments and finding in favour of the Operator the Commercial Court decided that the scheme of the JOA and UUOA was:

(a) The Operator had charge of and was required to conduct all operations: see Clause 5.2.

(b) The Operator was to pay all costs and expenses incurred by it in its operations under the Agreement: see Clause 5.4(g).

(c) Subject to the provisions of any approved operating programme and budget the number of employees of the Operator employed in connection with operations was to be determined by the Operator: see Clause 5.3.

(d) The Operator was to determine remuneration (and thus the pension arrangements that would form part of that remuneration): see Clause 5.3.

(e) The Operator was to conduct all operations in accordance with approved programmes and budgets and under the overall supervision and direction of the Operating Committee: see Clause 5.2.

(f) The Operator was authorised to make such expenditures, incur such Commitments for expenditure and take such actions as may be authorised by the Operating Committee: see Clause 5.5(a).

(g) The Operating Committee was responsible for the orderly supervision and direction of operations: see Clause 6.1.

(h) This would include: (a) determination of all general policies, procedures and methods of operations; and (b) consideration, revision and approval of all proposed operating programmes and budgets: see Clause 6.1(a).

(i) An operating programme and budget was to “include as a minimum the work required to be performed under the Licence in respect of the Contract Area during such budget period and the requirements of Operator having regard to previously approved programmes and budgets and its obligations”: see Clause 7.2.

(j) All costs and expenses of all operations under the Agreements in or in respect of the Contract Area or the Licence were to be borne by the Participants in proportion to their respective Participating Interests: see Clause 10.1.

(k) The Operator was to prepare and furnish to the Operating Committee reports, statements, data and information: see Clause 5.4(l).

(l) All costs and expenses of whatsover kind that are incurred in the conduct of operations were to be determined and settled in the manner provided in the Accounting Procedure: see Clause 10.2.

(m) The purpose of the Accounting Procedure was to establish equitable methods for determining charges and credits applicable to operations under the Agreement and to provide that the Operator neither gained nor lost by reason of the fact it acted as Operator: see Exhibit “A”.

(n) The Accounting Procedures envisaged that often estimation might be involved: see Exhibit “A”.

The relevant employees were properly taken on or deployed to enable operations. The operations were those envisaged by the Operating Committee in the operating programmes. Taking on or deploying employees involved remuneration that included pension arrangements.

Against this background, the Commercial Court decided that the authorisation of the Operating Committee that first engaged the liability of participants (including the Participants) came when the operations were approved, rather than when later budgets were approved year by year.

The approval of a budget at the point when payments under the pension arrangements were required in a particular year represented approval of the amounts that were payable in respect of a liability that had already been authorised. As a consequence, the Participants were in breach of their obligations where they refused to approve budgets on the basis of a contention that they had no liability for the cost of the pension arrangements.

The pension arrangements of the relevant staff came with a cost. That cost is, and was, not fixed, and cannot be. Its inclusion in a budget can only ever be as an estimate at the time, and it is important to appreciate the nature of a budget. In relation to the Participants’ argument that they were being asked to give the Operator a ‘blank cheque’, their position would not be materially different if the Participants had employed the employees themselves to do the work on operations they wanted undertaken.

The alternative proposition that the Operator was alone responsible for some part of the pension costs attributable to employees’ work on authorised operations was, the Commercial Court considered, wholly at odds with the arrangements that the parties agreed. The fact that the Operator had to work to budgets, to business management plans and under the overall supervision and direction of the Operating Committee did not involve it in underwriting expenditure over budget of this sort.

The Commercial Court specifically rejected the Participants’ argument that a right to recover would require a clause along the lines of the arrangements for insurance under Clause 5.4(j). That Clause simply involved one method, but not the only method, of requiring costs to be shared. It dealt with a subject that had greater optionality. It did not leave arrangements in a place where the Operator would be left with a cost because others who had taken the benefit then chose not to pay the costs that resulted. The Participants’ argument that it is material that there is no provision corresponding to Clause 7.10 for DRCs also failed.

The Commercial Court emphasised that its decision was not to say that there were no restraints on the Operator. The outcome in law in the case could have been quite different if there was a material dispute over whether the employees were required, or whether they were properly selected for employment, or as to the propriety of the Operator agreeing the pension arrangements it did.

In relation to the issue of fiduciary duties, the Commercial Court decided that the Operator’s actions would not amount to a breach of such duties – so it need not decide whether it was, in law, a fiduciary. The Commercial Court, however, expressed its doubts on the issue.

Comment

The ‘no loss, no gain’ principle of operatorship is contained in most joint operating agreements and regularly referenced in disputes concerning operator reimbursement. In this case, the Commercial Court was clearly swayed by the fact that it considered the “Participants enjoyed the benefit of the employment” of the staff in question and it would be wrong to require the associated costs/liabilities to fall to the operator. The exception to this was that if the operator was in breach of its obligations under the JOA to the Participants in relation to the costs claimed it might not be able to recover such costs.

Interestingly, the text of the Commercial Court’s decision suggests that the relevant JOA and UUOA only expressly dealt with authorised cost overruns in the context of decommissioning budgets. It follows that the JOA and UUOA did not contain the clauses found in many JOAs, including the AIPN Model Form and Oil & Gas UK Model Form, which specifically authorise limited cost overruns by the operator for the budget as a whole and/or specified line items of the budget. As such, the Commercial Court was not required to ask whether recovery of such cost overruns by the operator was limited to the extent permitted by such clauses in the absence of additional approval.

That said, the Commercial Court decision will add to the debate about the circumstances in which an operator is entitled to recover costs in excess of an approved budget. In the context of pension fund liabilities, the consequences are potentially significant. The Operator in this case is far from alone in finding itself with a pension deficit. Other operators will doubtless be considering whether to adopt the same approach and prepare plans to recover pension shortfalls from joint venture partners.

Conversely, non-operators will wish to consider whether the absence of the usual provisions dealing with operator cost overruns in the JOA/UUOA in this case means that the decision of the Commercial Court is limited in its application to the facts of the case.

When it comes to drafting joint operating agreements, non-operators might also wish to consider whether pension liabilities should be specifically addressed in accounting procedures. The issue might be more important where the operator is an established oil company with a final salary pension scheme (or similar).

Finally, although the facts of the case relate to the pension liability for staff of an operator, the decision would be equally applicable to almost any cost-overrun concerning JOAs on the same terms. For example, if the Operator had employed a drilling unit or other vessel to carry out works approved by the Operating Committee, and the cost of operations exceeded the approved budget through no fault of the operator, it is difficult to immediately see how the conclusion would have been different. It was the reasoning of the Commercial Court that on the terms of the JOA/UUOA in dispute that once work was authorised, on terms authorised or terms specified to be agreed by the operator, Participants were liable for the cost consequences of such work – even where this was more than set out in the relevant work programme and budget.