1 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

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 2 Introduction Oil Industry relies on form agreements Oil Industry relies on form agreements AAPL standardized forms: 1956, 1977, 1982, & 1989 AAPL standardized forms: 1956, 1977, 1982, & Form superior to its predecessors yet not universally accepted – Why? 1989 Form superior to its predecessors yet not universally accepted – Why? Provisions of 1989 Form used worldwide but not onshore – Ironic! Provisions of 1989 Form used worldwide but not onshore – Ironic!

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 3 The Debate: Investors vs. Operator Is special protection required for Investors? Is special protection required for Investors? Parties to a JOA can negotiate and establish their rights and duties Parties to a JOA can negotiate and establish their rights and duties 1989 Form  standardized “form”; a basis 1989 Form  standardized “form”; a basis Advantages of using form  reduce negotiation and drafting costs, comprehensively well written, efficient interpretation, among others Advantages of using form  reduce negotiation and drafting costs, comprehensively well written, efficient interpretation, among others

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

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

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 6 Exhibits – Article II Various Exhibits Various Exhibits Improved Exhibit A (identification of contract area) phone numbers of parties for notice purposes and burdens on production Improved Exhibit A (identification of contract area) phone numbers of parties for notice purposes and burdens on production

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 7 Interest of Parties in Costs & Production – Article III.B Production as allocated in Exhibit A Production as allocated in Exhibit A Revenues and Royalties not pooled 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 1989 Form  clarifies that parties should share burdens up to the amount provided for in the blank and individually shoulder all excess burdens

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 8 Subsequently Created Interests – Article III.C 1989 Form includes definition of subsequently created interests 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 Critical to fully disclose existing burdens in Exhibit A otherwise they are deemed as subsequently created interests

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 9 Titles – Article IV.A 1989 Form improvement – Title examination if requested by a majority in interest of the drilling parties or by Operator vs Form that requires all of the parties’ consent 1989 Form improvement – Title examination if requested by a majority in interest of the drilling parties or by Operator vs Form that requires all of the parties’ consent Copies of drilling title opinions only to parties that pay for them Copies of drilling title opinions only to parties that pay for them

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 10 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 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 If a lease is lost due to failure of title & no new lease secured within 90 days  Exhibit A adjusted

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 11 Designation and Responsibilities of Operator – Article V.A Standard of care of Operator expanded Standard of care of Operator expanded Negligent Operator liable for its percentage interest only Negligent Operator liable for its percentage interest only

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 12 Resignation or Removal of Operator – Article V.B Operator may resign at any time providing proper notice Operator may resign at any time providing proper notice Inclusion of removal standard Inclusion of removal standard Good Cause Removal Good Cause Removal Successor Operator  affirmative vote of 2 or more parties owning a majority interest Successor Operator  affirmative vote of 2 or more parties owning a majority interest

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 13 New Provision Insolvent or bankrupt Operator = deemed to have resigned Insolvent or bankrupt Operator = deemed to have resigned No action of non-operators needed, only selection of new Operator No action of non-operators needed, only selection of new Operator Bankruptcy Court may prevent removal of Operator  interim operating committee Bankruptcy Court may prevent removal of Operator  interim operating committee

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 14 Rights & Duties of Operator – Article V.D Timely pay expenses Timely pay expenses Keep Contract Area free of liens Keep Contract Area free of liens Operator not a fiduciary Operator not a fiduciary Non-operators greater ability to monitor the project Non-operators greater ability to monitor the project

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 15 Initial Well – Article VI.A Drilling of initial well obligatory Drilling of initial well obligatory Horizontal wells not addressed Horizontal wells not addressed

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 16 Subsequent Operations – Article VI.B New language clarifies procedure New language clarifies procedure Non-consenting parties may now participate in deepening or sidetracking operations Non-consenting parties may now participate in deepening or sidetracking operations Party proposing a subsequent operations must provide proper notice Party proposing a subsequent operations must provide proper notice

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 17 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 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

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 18 Reworking or Plugging Back – Article VI.B.2 100% penalty replaced by a blank 100% penalty replaced by a blank Parties will seek for higher penalties Parties will seek for higher penalties

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 19 Deepening – Article VI.B.4 Detailed provision added Detailed provision added Non-consenting parties can participate in deepening Non-consenting parties can participate in deepening

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 20 Sidetracking – Article VI.B.5 Provision added similar to deepening provision Provision added similar to deepening provision

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 21 Order of Preference of Operations – Article VI.B.6 New procedure to elect between conflicting proposals New procedure to elect between conflicting proposals Majority interest prevails & in event of tie initial proposal prevails Majority interest prevails & in event of tie initial proposal prevails

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 22 Paying Wells – Article VI.B.8 New provision provides certainty New provision provides certainty Consent of all parties needed to operate a commercial well Consent of all parties needed to operate a commercial well

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 23 Completion of Wells; Reworking & Plugging Back – Article VI.C Casting point expanded: AFE Casting point expanded: AFE Procedure for conflicting completion proposals incorporated Procedure for conflicting completion proposals incorporated AFEs are estimates of costs not firm commitments AFEs are estimates of costs not firm commitments

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 24 Other Operations – Article VI.D 1989 Form improves efficiency of production operations 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 Certain work can be undertaken with written consent of any party or parties owning at least ___% of the interest

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 25 Abandonment of Wells – Article VI.E Abandonment of Wells – Article VI.E Satisfactory proof of financial capability needed to take over a well 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 Costs of plugging, abandoning exceed salvage value  abandoning parties have to pay the party taking over the well

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 26 Termination of Operations – Article VI.F Operations can be terminated prematurely if a determined percentage of the parties wish to do so 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” For the operations to end no need for it to be “impractical”

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 27 Taking Production in Kind – Article VI.G Each party owns a share of production in accordance with its proportionate interest in the Contract Area 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 For antitrust & tax reasons  Operator only able to buy or sell the non-operator’s oil for a limited period of time

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 28 Operator Notification Parties have to advise Operator their gas marketing arrangements, except for price Parties have to advise Operator their gas marketing arrangements, except for price Split stream gas deliveries pursuant to gas balancing agreements Split stream gas deliveries pursuant to gas balancing agreements

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 29 Liability of Parties – Article VII.A Several not joint Several not joint Explicit disclaim to any intent to create a partnership Explicit disclaim to any intent to create a partnership Duty to deal in good faith with each other Duty to deal in good faith with each other

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 30 Liens & Security Interests – Article VII.B Lien covers real property & present and future acquired personal property & fixtures 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 Each non-operator grants Operator a lien on its oil and gas rights and a security interest on its share of production

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 31 Defaults & Remedies – Article VII.D Defaulting party automatically has certain rights suspended Defaulting party automatically has certain rights suspended Non-defaulting parties can sue to recover at joint account expense Non-defaulting parties can sue to recover at joint account expense

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 32 Surrender of Leases – Article VIII.A Surrender of lease requires consent of all parties to JOA Surrender of lease requires consent of all parties to JOA Failure to respond within designated time = consent to receive surrendered interest. Caution! Failure to respond within designated time = consent to receive surrendered interest. Caution!

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 33 Renewal or Extension of Leases – Article VII.B Now renewals, replacements & extensions of leases are addressed Now renewals, replacements & extensions of leases are addressed BUT intent to eliminate 1982 Form’s ambiguity not that clear BUT intent to eliminate 1982 Form’s ambiguity not that clear

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 34 Assignment; Maintenance of Uniform Interest – Article VIII.D Transfer of ownership not recognized until 30 days after satisfactory notice has been received Transfer of ownership not recognized until 30 days after satisfactory notice has been received Transferor liable for all costs incurred prior to assignment Transferor liable for all costs incurred prior to assignment

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 35 Preferential Right to Purchase – Article VIII.F Now an optional provision Now an optional provision If box is not checked  preferential right not applicable If box is not checked  preferential right not applicable Does “sell” include farmout? Does “sell” include farmout? Do mergers & corporate restructurings trigger preferential rights? Do mergers & corporate restructurings trigger preferential rights?

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 36 Claims & Lawsuits – Article X Operator is authorized to settle claims arising from operations if the amounts do not exceed a specified amount Operator is authorized to settle claims arising from operations if the amounts do not exceed a specified amount

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 37 Notice – Article XII Oral notices need to be confirmed immediately in writing Oral notices need to be confirmed immediately in writing Responsive notices deemed delivered when deposited in mail Responsive notices deemed delivered when deposited in mail

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 38 Miscellaneous – Article XV New article New article Addresses execution, successors and assigns counterparts and severability Addresses execution, successors and assigns counterparts and severability

The 1989 AAPL Model Form Operating Agreement: why are you not using it? 39 Conclusions 1989 Form incorporates many improvements over the 1982 Form 1989 Form incorporates many improvements over the 1982 Form 1989 Form has yet not attained universal acceptance 1989 Form has yet not attained universal acceptance 1989 Form is an improvement 1989 Form is an improvement