2014 Fall Newsletter - How and When an Operator Can Avoid Owing Fiduciary Duties to Working Interest Holders
How and When an Operator Can Avoid Owing Fiduciary Duties to Working Interest Holders
By Ben Allen
Operators of oil and gas exploration and development projects have many incentives to avoid owing fiduciary duties to working interest holders. From a legal standpoint, fiduciary duties require the operator to act with the utmost loyalty and good faith and to subordinate its interests to working interest owners when those interests conflict. From a practical standpoint, fiduciary duties can force operators to perform an accounting of finances for their projects to working interest holders on demand. They also lower the threshold for working interest holders to second guess and challenge operators’ economic decisions, such as whether to explore or drill, whether to obtain financing, and when to plug and abandon. In an industry where information is uncertain and hindsight is 20/20, fiduciary duties can create a basis for liability to the disgruntled working interest holder. An operator knowledgeable of when and how these fiduciary duties can be waived can better manage this risk, or at least know where the risk is unavoidable.
A joint operating agreement (“JOA”) defines the operator and working interest owners’ relationship, but whether the JOA creates a ‘special relationship’ is the ultimate question courts ask to determine whether operators owe a fiduciary duty to working interest holders.
The American Association of Professional Landmen (“AAPL”) has promulgated four Joint Operating Agreement forms over the years—in 1956, 1977, 1982, and 1989. The most recent form contains the following clause relating to operator liability to working interest owners:
Operator shall conduct its activities under this agreement as a reasonable prudent operator, in a good and workmanlike manner, with due diligence and dispatch, in accordance with good oilfield practice, and compliance with applicable law and regulations, but in no event shall it have any liability as Operator to other parties for losses sustained or liabilities incurred except as may result from gross negligence or willful misconduct.
AAPL Form JOA, Art. (V)(A) (1989).
Jurisdictions construing this language, and language like it, to determine the operator’s responsibilities to working interest holders fall into roughly four categories: (1) those that never recognize fiduciary duties; (2) those that recognize fiduciary duties in some circumstances but also give the parties the right to disclaim them in the JOA; (3) those that determine the existence of a fiduciary relationship on a case by case basis; and (4) those that construe JOA’s as joint ventures and therefore always recognize a fiduciary relationship.
No Fiduciary Duty
First, Oklahoma, Arkansas, and Louisiana recognize no fiduciary duty is implied between operators and working interest holders. 52 Okl. St. § 902 (passed in 2012 and overturning prior case law recognizing fiduciary duties); Ark. St. Ann. § 15-72-207(a) (mineral lessee does not owe fiduciary duty to mineral interest owners); Clovelly Oil. Co., LLC v. Midstates Pet. Co., LLC, No 2012-C-2055, 2013 WL 1115296, *9 (La. 2013) (recognizing no fiduciary duty because the JOA does not create a partnership unless the contract expressly so provides).
Freedom to Contract Jurisdictions
The second type of jurisdiction favors freedom of the parties to contract their agreement, and will allow operators to disclaim fiduciary liability with clear contract language, such as the language appearing in the 1989 AAPL Form JOA.
For example, North Dakota law provides that “[i]n the case of joint ventures to develop oil and gas properties, the law is well established that the determination of the existence and extent of such [fiduciary] duties is controlled by the terms of the agreement between the parties.” Grynberg v. Dome Petrol. Corp., 599 N.W.2d 261, 268 (N.D. 1999).
In Texas, an exculpatory clause relieved the operator from liability for any act taken in its capacity ‘“as Operator’ under the JOA (except for gross negligence or willful misconduct”) (citing Caddo Oil Co. v. O’Brien, 908 F.2d 13, 17 (5th Cir. 1990) (expressly holding that a disclaimer of liability except for cases of willful conduct precludes a claim for breach of fiduciary duty under Louisiana law)). It also appears that Texas may not recognize even implied fiduciary duties between operators and working interest holders. “[U]nder Texas law, ‘evidence of a joint operating arrangement to develop a particular lease [in and of itself] will not support a finding of a broader relationship,’ such as a partnership or joint venture.” Norman v. Apache Corp., 19 F.3d 1017, 1024 (5th Cir. 1994) (quoting Rankin v. Naftalis, 557 S.W.2d 940, 946 (Tex. 1977)).
Some jurisdictions however, like Wyoming, clearly recognize a fiduciary duty between operator and working interest holders in certain circumstances but still allow operators to disclaim liability—even where there is a fiduciary relationship—by contractually authorizing particular acts. Andrau v. Michigan Wisconsin Pipe Line Co., 712 P.2d 372, 376 (Wyo. 1986) (“Parties are permitted to limit their fiduciary duties by contract provisions specifically authorizing particular acts.”). In Andrau, the Court held an operator could not be liable for foreclosing on a non-operator’s interest to satisfy debts for drilling costs because the JOA specifically gave the operator the right of foreclosure. Id. at 376-377. However, a JOA could just as easily include a term providing that the operator has the absolute discretion to decline or elect to produce, explore, or contract with third parties, which in a jurisdiction like Wyoming, could have the effect of disclaiming many of the commonly litigated potential fiduciary obligations operators face.
Facts and Circumstances Jurisdictions
The third type of jurisdiction typically views the existence of a fiduciary relationship between the operator and working interest holders as a factual inquiry based upon the facts and circumstances surrounding the transaction. The Tenth Circuit, construing Colorado law, applies a facts-and-circumstances analysis to determine whether an operator owes fiduciary duties to a working interest owner, with the notable caveat that “an agency relationship may be specifically disavowed in the contract itself.” Dime Box Pet. Corp. v. Louisiana Land and Explor. Co., 717 F.Supp. 717, 722, affirmed, 938 F.2d 1144 (10th Cir.). Despite the opinion’s freedom of contract sounding language, however, the Tenth Circuit only commits to holding that there is no joint venture and therefore no fiduciary duties where “experienced and sophisticated parties with equal bargaining power have fully negotiated a contract which specifically disavows a joint undertaking.” Id. Absent facts and circumstances meeting this high threshold, courts applying Colorado law would likely leave to a jury whether a joint venture existed to create a fiduciary duty. Id. at 722 (“Whether a joint venture exists is a question of fact for the fact-finder to determine from the facts and circumstances in evidence”). The Tenth Circuit appears to have extended the facts and circumstances analysis to operator and working interest holders' relationships under Utah law as well. Cascade Energy and Metals Corp.,896 F.2d 1557, 1569 (10th Cir. 1990) (applying Utah law and upholding district court’s factual finding of fiduciary duty under joint operating agreement).
Jurisdictions Where Operators Always Owe Fiduciary Duties
Lastly, some jurisdictions hold that JOA’s are joint ventures, a particular breed of partnership, and therefore that all members of the JOA owe each other fiduciary duties. For example, the Supreme Court of Kansas held that a JOA creates a fiduciary relationship between operators and working interest holders even where language in the JOA expressly disclaimed a fiduciary relationship. See First Nat’l Bank & Trust Co. v. Sidwell Corp., 678 P.2d 118, 124 (Kan. 1984). Likewise, in Michigan, all parties to contracts for the development of oil and gas wells are joint venturers and owe a fiduciary duty to one another as a matter of law. Schmude Oil Co. v. Omar Operating Co., 458 N.W.2d 659, 665 (Mich. 1990).
Although this area of the law has yet to be developed in many states, there are a few clear drafting strategies. For facts-and-circumstances jurisdictions, operators will be able to protect themselves by documenting the equality of the parties’ bargaining power (where possible), and in jurisdictions like Wyoming, operators will be able to insulate themselves from claims relating to actions they can anticipate and specifically authorize in the JOA. Fortunately, these approaches can be used in tandem to minimize the operator’s potential exposure as a fiduciary. The good news is that outside of jurisdictions holding that every JOA creates a fiduciary relationship, operators will usually be able to avoid being fiduciaries to their working interest holders with some careful drafting and planning.
Ben Allen is an associate at Johnson, Trent, West & Taylor, LLP who specializes in commercial and products liability litigation.