Paul Yale Gray Reed & McGraw The AAPL Operating Agreement and the Deadbeat Non-Operator

© Gray Reed & McGraw, P.C.  Introduction

A Brief Overview of History and Use of Operating Agreements in the Upstream Exploration and Production Sector A Brief Overview of History and Use of Operating Agreements in the Upstream Exploration and Production Sector  Why operating agreements?  What happens if there is no written JOA?  Advantages of a written JOA  The Operator’s Lien  Development of the AAPL 610 Form  Mid 1980s Oil Price Crash and the 1989 Form

Problems With AAPL Forms Prior to 1989 in Enforcing Operator’s Lien Problems With AAPL Forms Prior to 1989 in Enforcing Operator’s Lien  Evolution of bankruptcy laws had made unrecorded lien and security interests less valuable  Operator’s lien in prior JOA forms was typically unrecorded  Recording JOAs is cumbersome  Amarex, Inc. v. El Paso Natural Gas (772 P2d 905 (1987) held that recorded memos of JOAS would suffice  Hence the “Recording Supplement” feature of the 1989 JOA form.

Unique Features of the 1989 AAPL Model Form JOA in Dealing with the Non-paying, Non-operator Unique Features of the 1989 AAPL Model Form JOA in Dealing with the Non-paying, Non-operator  Proceeds: Are they or are they not covered by mineral liens? In Texas, Colorado, and North Dakota—arguably not. Abella v. Knight Tools is a Texas case often cited to the contrary S.W. 2d 847 (Tx. App. Houston, 1 st Dist.1997, no writ). Abella v. Knight Tools is a Texas case often cited to the contrary S.W. 2d 847 (Tx. App. Houston, 1 st Dist.1997, no writ). Colorado Supreme Court has specifically held that proceeds of oil and gas sales are not subject to mineral lien claims under the Colorado statute. Chambers v. Nation, 178 Colo. 124, 497 P.2d 5 (1972) Colorado Supreme Court has specifically held that proceeds of oil and gas sales are not subject to mineral lien claims under the Colorado statute. Chambers v. Nation, 178 Colo. 124, 497 P.2d 5 (1972) Okahoma, Louisiana—yes, by statute. Okahoma, Louisiana—yes, by statute. But why take a chance? But why take a chance?

Unique Features of the 1989 AAPL Model Form JOA in Dealing with the Non-paying, Non-operator Unique Features of the 1989 AAPL Model Form JOA in Dealing with the Non-paying, Non-operator  So what do you do if a Non-Operator doesn’t pay its bills?  Answer: Blitzkrieg ! Advance Payment Advance Payment Suspension of Rights Suspension of Rights Deemed Non-Consent Deemed Non-Consent

Advance Payment Advance Payment  Cash call may be made as early as first of month of proceeding operation for next month’s estimated costs  Advance payments due within 15 days of request  If payment is not received in 15 days, Notice of Default may be sent.  If 30 day Notice of Default fault period runs with no response, then Operator may cash all remaining well costs (not just next 30 days) plus any other expenses which might become due from Non- operator anywhere in contract area

Suspension of Rights Suspension of Rights  If Non-operator does not respond within 30 days of Noticed of Default, then all rights of the defaulting party are suspended under the JOA  No longer entitled to well information  Can no longer participate in any operation  Default amounts can be set off against production proceeds otherwise due the Non- Operator

Deemed Non-Consent Deemed Non-Consent  Notice of Non-Consent Election can be sent immediately following the expiration of the 30 day cure period after a Notice of Default  Non-operator is then deemed non-consent and is subject to sole risk penalties  Once Notice of Non-Consent, election is irreversible even if payment is subsequently tendered

Attorneys Fees, Late Payment Interest, Interest, Court Costs, and Consequential Damages Attorneys Fees, Late Payment Interest, Interest, Court Costs, and Consequential Damages  Attorneys fees, court costs and late payment interest all chargeable against defaulting party if suit for damages ensues  Plus—consequential damages  Examples of consequential damages?

Conclusion: Best Practices in Avoiding Issues with the Non-paying, Non-Operators Conclusion: Best Practices in Avoiding Issues with the Non-paying, Non-Operators 1.Have a written JOA, always 2.Get JOA signed up front 3.Cash call as early as possible; follow up & don’t forget other paying participants if default 4.Record JOA Supplement 5.Use the 2015 AAPL 610 Form (should be out soon), or 1989 Form with horizontal modifications in the interim. 6.Consider special modifications to the agreement Cash call 100% of well costs up front Cash call 100% of well costs up front Special penalty in deemed non-consent situation Special penalty in deemed non-consent situation

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