What Price Default?

This article considers the efficacy of the withering interest forfeiture remedy under a joint operating agreement ("JOA") as a reaction to a party's unremedied default and whether the interest sale option is a preferable remedy.

This article references the model form JOAs issued by the AIPN (2012), the AMPLA (2011) and OGUK (2009).

Remedies for default

The default remedies under a JOA apply principally to the failure of a party to pay when due its proportionate share of a cash call or invoice request (depending on how the JOA deals with demands by the operator for funding the costs of joint operations).

The two essential components of the default remedies under the JOA are that the default is made good by the non-defaulting parties (so that the continuation of joint operations is not jeopardised) and that the defaulting party will be required to make good the default amount. Ultimately, this second component could result in the loss by the defaulting party of its interests in the concession and the JOA.

In the first instance the JOA will typically prescribe a series of steps which disenfranchise the defaulting party: that party will be excluded from voting under the JOA and will be denied the ability to transfer or withdraw from its interests under the JOA. Thereafter the JOA's default remedies focus their attention on attaching the economic interests of the defaulting party, in the interest of recouping the payments made by the non-defaulting parties to make good the defaulting party's default. If the project is producing petroleum, then the defaulting party's entitlements will be sequestered by the non-defaulting parties.

The ultimate intended purpose of the JOA's default remedies is to ensure that the non-defaulting parties are fully recompensed for the amounts which they have had to expend in order to make good the default amount. The ostensible purpose of the JOA's default remedies is not to punish the defaulting party for its default (although this could of course be an inevitable consequence).

The most accurate way of achieving the intended purpose of the default remedy is to see the amount to be recompensed being repaid in cash by the defaulting party to the non-defaulting parties. Cash compensation, paid on a full indemnity basis, should give a perfect reconciliation and no room for argument as to whether the non-defaulting parties have been over-compensated or under-compensated. In recognition of this, the JOA typically reflects that the default amount constitutes a debt which is due and owing from the defaulting party to the non-defaulting parties.

This sounds simple enough but the reality is that if the defaulting party lacked the necessary cash resources to pay its share of the cash call or invoice request then, in all probability, that defaulting party will also lack the cash resources necessary to repay the resultant debt. Thus it becomes necessary for the non-defaulting parties to look to any other assets or interests of the defaulting party in order to recover the default amount.

The last level of recourse for the non-defaulting parties is to take over the interests of the defaulting party in the petroleum project itself. Those project interests are represented by the presence of the defaulting party in the concession and the JOA.

At this point two options present themselves for consideration: (i) the forfeiture remedy, whereby the defaulting party's entitlements as party to the concession and the JOA will be transferred to the non-defaulting parties in satisfaction of the default amount; and (ii) the sale of the defaulting party's project interests to the non-defaulting parties (or to third parties) in consideration of the payment of a price which is set at a fair market value (with any surplus beyond the default amount being returned to the defaulting party).

Forfeiture

Historically the principal concern regarding the operation of the forfeiture remedy has revolved around whether the remedy might be determined by a court to be a penalty and so potentially unenforceable by the non-defaulting parties against the defaulting party. This is based on the principle that under the rules of equity a provision will be unenforceable if it is imposed in terrorem (i.e. where it is intended to enforce the performance of a contract by a defaulting party rather than to compensate the non-defaulting party for a breach of contract).

Applicable English law has suggested that a penalty might be inferred where a sum stipulated for payment (which, in the context of a JOA, could be read as the interest to be surrendered by the defaulting party) is "extravagant and unconscionable...