Enforceability Of The JOA Forfeiture Mechanism Under Brazilian Law

Keywords: freedom of contract, oil and gas industry, Association of International Petroleum Negotiators, AIPN

Basic Concepts and Principles

As a general rule, Brazilian law adopts the principle of freedom of contract. Contracting parties are authorized to determine the specific terms and conditions that will be applicable to their contractual relationship, to the extent such terms and conditions are not forbidden by law and do not affront the public order. Moreover, the contracting parties are committed to act in accordance with the principles of probity and good faith, tightly connected with the pacta sunt servanda principle (Latin for "agreements must be kept"), as provided for in article 422 of the Brazilian Civil Code.

In the specific context of the oil and gas industry, a party's freedom to choose with whom and on what terms to contract becomes particularly important given the significant investment of time and money intrinsic in exploration and production joint ventures. Because the joint operations cannot stop simply due to lack of funds, the parties will normally need to be as clear and specific as possible in their Joint Operating Agreements ("JOA") in order to discourage and manage any party's payment default.

The importance of this is reflected by the forfeiture mechanism included in the "default clause" of the Association of International Petroleum Negotiators ("AIPN") Model Form JOA. According to the JOA, a defaulting party would be forced to forfeit its participating interest under the JOA to the other parties, without any compensation, if it fails to timely pay its cash obligations to the joint venture.1 Specifically, the clause states:

If a Defaulting Party fails to fully remedy all its defaults by the thirtieth (30th) Day following the date of the Default Notice, then, without prejudice to any other rights available to each non-defaulting Party to recover its portion of the Total Amount in Default, each non-defaulting Party shall have the option, exercisable at any time thereafter during the Default Period, to require that the Defaulting Party completely withdraw from this Agreement and the Contract.2

However, application of the forfeiture mechanism is subject to debate in Brazil, particularly when considering the importance given to the principles of fairness and the protection against unjust enrichment in the Brazil legal system (and civil law countries alike). Opponents of the mechanism assert that property should not be...