As the global energy industry faces the most serious crisis in its history, caused by an invisible virus, the pressure of the energy transition due to climate change, and a global oil price war, there are many exploration and production (E&P) companies that substantially adjust their capital and operating budgets (Capex and Opex), while carefully evaluating the financial positions of their partners, the listing of their shares in the different stock exchange markets, the reports of their external auditors and the credit ratings they receive from independent entities.
In front of with this hard situation it is possible that in a sector in which risks and investments are pooled and where sole risk, especially exploratory ones, is very rare, it could be affected by the difficult situations of its partners, which can undoubtedly complicate the course of operations. Let’s recall that the oil companies gathered in a consortium agreement, joint venture or, more properly, a Joint Operating Agreement (JOA), are governed under joint and several liability before the State that receives the investment, while amongst them there is just a several or proportionate liability relationship, according to their respective percentage of participation.
One of the members of the consortium will always be the Operator; that is, the company in charge of the activities, the fulfillment of the minimum commitments assumed with the host State, but not responsible of financing said tasks, since it is governed under one of the guiding principles of this industry, which is that Operator no gain, no loss for being the Operator; although of course it is compensated for the expenses that it may have as a consequence of the exercise of said functions through an item in the operating budget called overhead, which constitutes a fixed annual amount that is not subject to audits.
In turn, the Operator gathers the contributions of all the partners in a so-called joint account, which must be kept separate from its own accounts, as well as from the accounts of other consortiums it operates, under the no-commingling of funds principle.
Considering the above, we can affirm that although a JOA does not constitute a legal entity other than the members that compose it and that its legal nature is not corporate, but contractual, it could be considered a tax person and also an accounting person, different of the companies that subscribes it; since it has its own accounting, as a result of the contributions of its members, income from hydrocarbon sales, payment of taxes and royalties, payment to suppliers and contractors, as well as a tax identification number in many countries.
In several countries, it is also necessary for the JOA to register with the governing authority for hydrocarbons and energy, usually a Ministry, a Super-intendency or the corresponding national oil company.
In this way, before the State, the financial solvency of each of the members of the JOA is not periodically revealed, it is assumed, since it becomes a requirement to be fulfilled from the signing of the petroleum contract or the obtaining of the respective concession, through the granting of the corresponding bank letters of credit, renewable at each change of phase, which entails the assumption of new minimum commitments duly quantified and/or the joint and several guarantee of the parent company, normally without time or amount limitation.
In any case, for the host State of the investment, there will always be the possibility of executing the bank guarantees or even the parent company guarantees in case of non-compliance with the minimum commitments, with the particularity of being able to execute it jointly and severally, usually and in a practical way before its closest interlocutor, which is the Operator.
It is the Operator who under the JOA will have to exercise, where appropriate, the action for recovery against the other JOA members; However, what happens if one of the members of the joint venture becomes insolvent? and what happens if it is the Operator which is the insolvent?
The bankruptcy filing of a JOA member (whether operator or non-operator) can lead to substantial problems for the other members. For example, during bankruptcy proceedings, other partners are usually prevented from exercising their contractual rights and remedies under their agreements (including JOAs) with the bankrupt.
In such a situation, normally anticipated by a default, the other non-defaulting members may not be able to recover the payments made proportionally in replacement of the defaulting member, although they may take the corresponding part of the production in compensation for such extraordinary and disproportionate payments of their percentage of participation; considering the temporality of that situation.
However, in the concessional regimes under which the consortium is obliged to sell all production to the State, establishing the subsequent payment to each of its members according to their participation, the corresponding money will go directly to said member’s accounts, not to the joint account; which will further complicate its recovery, if such a member is in bankruptcy.
In other words, while the bankruptcy of the defaulting member of the JOA occurs, it remains part of the consortium, although without the right to vote or receive information on operations and activities, and the other members would be forced to assume their obligations, given joint and several liability vis-à-vis the State and, by extension, vis-à-vis suppliers, suppliers and even customers, especially common buyers or, even worse, to the only and obligately one, such as the State; with the added difficulty or damage of not being able to recover the extraordinary contribution they are making, as well as the accrued interest.
This can lead non-defaulting members many times to be at an uncomfortable crossroads, given by the duty of compliance with third parties to the consortium, and maintaining a situation of non-compliance of one of its members; thus, unbalancing said relationship.
On the other hand, if it is the Operator who falls into bankruptcy, one of the assessed reasons for its removal would be met, as established in the 2012 AIPN JOA model, and the other members would have to choose another operator among them, who must assume control of the joint account, as well as the dialogue with the State and the other third parties involved in the operation. But first obtaining the corresponding State’s approvals for the change of the Operator.
In this sense, it is appropriate to review the JOAs that are executed, since the palliative alternatives included in the 2002 and 2012 models of the AIPN differs and taking into account that the negotiation of each one is also different due to their circumstances, such as: host country of the investment, members, initial Operator, onshore or offshore block, concessional regime with the State, changes of control that the parties have had, applicable law (Civil Law or Common Law), etc. In addition to the current situation of the block, if it is to say, if it is in exploration or is already in the development or production phase, we would even dare to say that before a next phase of decommissioning, this matter must also be considered.
Among these measures are:
- Once an uninterrupted default period has been reached, which is normally set to three months, the defaulting member must sell its participation to the other parties in a proportional manner, unless otherwise agreed between them. The price results from a formula that is established in the JOA itself and will depend on the phase of the concession and that will take into account the debt and interests owed to the nondefaulting members.
- Free transfer of the percentage of defaulting member’s participation to the other compliant members, also proportionally unless agreed otherwise, through powers of attorney previously granted and that are executed when a series of established conditions occurs. This solution is not exempt of controversy, since under arguments of excessive onerousness, illegitimate enrichment and abuse by non-defaulting members, the matter has come to disputes between the members of a consortium, who have found themselves faced with the reality of the application of a clause that was intended to be a deterrent at the time of their agreement and which ultimately became an expulsion clause for the defaulting member.
- To reach an agreement with the bankruptcy administrator and depending on the jurisdiction where the bankruptcy is applied, to create a trust account or segregated account to face the costs contained in the current budget, while the affected company is cleaned and a buyer outside the consortium, also bearing in mind the preemptive or first refusal rights that the members may have.
The abovementioned options are some of the most used alternatives in JOAs from a practical perspective, which could serve as a guide for the particularized analysis of which we can feel that they will present some risk, both to prevent it and to try to solve it.
Madrid, April 2, 2020
Notice: The foregoing article is authored by Martín Añez Rea and has been reposted by Javier Zambrano for informational and educational purposes. No copyright infringement intended. All rights reserved in favor of the author.
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