Should There Be Obligations of Good Faith in Resources Joint Ventures?

Recently the UK offshore petroleum body, Oil and Gas UK, established a Commercial Code of Practice designed to ensure its members “take the steps necessary to secure that the maximum value of economically recoverable petroleum is recovered”.

A supplement to this Code is a negotiations best practice document which includes an obligation for openness and transparency, including, where appropriate, an open book sharing of analyses dealing with costs, risks and economics. There is no punishment for failing to comply with these requirements, other than a shaming process which may lead to companies being more discerning about with whom they want to do business.

A specific recommendation for best practice negotiations is that the parties engage in initial framing workshops to seek alignment on specific objectives, deliverables and timelines. I agree wholeheartedly with this approach. Normally what happens is that the M&A people negotiate terms to buy in, then the resultant joint venture is treated as a formality where the lawyers take a standard precedent and insert names and the voting threshold.

To be fair, large companies are acquainted intimately with standard forms and will only make minor adjustments to fit the situation. A smaller company is usually so eager to complete the deal it does not press for any changes, and if it does will be told it has to trust the larger partner to do the right thing. Even with the best will in the world, subsequent changes in culture and personnel will often lead to issues and a dysfunctional joint venture.

Recently, I have conducted a number of these framing workshops and the parties were astonished how far apart they were in their respective aspirations and views of the capabilities of the other party. We were able to tailor the JV arrangements appropriately. It is reasonable to assume that the time invested at the beginning would be a fraction of the time and expense of any later litigation or arbitration that might be avoided in this way.

This development begs the question whether principles of openness and transparency should be extended to the inclusion of express or implied obligations of good faith, and maybe even the imposition of a fiduciary duty on an operator.   

As a general proposition, there is no implied duty of good faith in a joint venture agreement, which ultimately is a contract like any other and does not create any particular fiduciary obligations, except perhaps where a party is in a vulnerable position. Thus an unincorporated joint venture is not a special type of contract where the parties create a relationship where they agree to put the collective interests ahead of their personal interests.

The corollary of this is that when negotiating a JV agreement, if the parties want duties of good faith, then they should be expressly included. This should be contrasted with an incorporated joint venture where directors will have a statutory duty to act in the best interests of the company. Similar principles apply where the parties enter into a partnership agreement.

Indeed, my experience in the drafting of JV templates for resources projects is that major international companies will do everything possible to negate obligations of good faith or fiduciary obligations. These standard agreements have been drafted carefully by major players so that the obligations, particularly of an operator, are expressed very precisely in the agreement; nothing more, nothing less.

Often a small company is granted a tenement and then at some point farms out to a larger company, which would take over operatorship. There is no way the larger company would agree to any ongoing obligations of good faith towards the junior party. For example, if a junior party is a single purpose company its employees spend their working days concentrating on how to develop that asset, whereas a multinational has a seriatum of projects and it may be years before it turns its attention to developing this opportunity. It would be inappropriate to suggest that the timing of the project should take into account the needs of a smaller non-operating partner.

To take this concept further, in resources joint ventures the scope of the joint venture is restricted to activities on the specific tenement. This recognises that resource companies are competitors and will have different portfolio interests; in fact a participant may have other interests in adjoining blocks that it wants to develop first.

This level of competition is common in LNG joint ventures where major companies produce LNG together, but then are competing across the world for market share. Another example is the long running Pohokura dispute in New Zealand, where one of the joint venture parties wanted to maximise gas production but the other two parties wanted to limit production to avoid flooding the market and to keep prices buoyant for their other sales.

Even the development of infrastructure to deliver product from the tenement to market must be the subject of a separate agreement. As the parties market and sell their respective shares of product separately, in theory each could build its own infrastructure. However, commercial reality usually dictates that they co-operate. In the absence of a statutory third party access regime, if one party does build infrastructure it is under no obligation to provide access to its JV partners to use spare capacity on reasonable terms. Again this happened in the Pohokura dispute where one party built its own pipeline but the Operator refused to connect it unless that party agreed to the production limits mentioned above.

Undoubtedly, some progressive judges will take the view that there is inequality of bargaining power between the JV partners, even when a small company which farms out to a larger one has achieved its objective, and in the process  achieves a carry on operational costs and a great boost to its credibility and share price. Usually the original tenement holder has been actively trying to bring in a partner with deep pockets for some time and it will be happy to get agreements signed as quickly as possible. It must be assumed that the smaller company is an industry player with the benefit of sophisticated legal advice, and could hardly be considered to be vulnerable.

It also seems quite absurd to suggest that a judge with no commercial experience should be able to ignore the express words of the agreement and try to place himself of herself in the shoes of the parties. We have been down this path previously where activist judges tried to rewrite pre-emption clauses to give effect to the intent of the parties, but this created so many disputes and uncertainties that that the UK authorities effectively outlawed pre-emptive rights in the North Sea. Another example is the decision in the Orbit Valve case (arising out of the Piper Alpha disaster) where the Court decided that it was “implausible that the parties meant to of a party agreeing to release the other from liability for negligence or assuming liability for the consequence of the others negligence” when that is exactly what the  “knock for knock” clause was intended to do.  

In my view, it is highly undesirable to introduce obligations of good faith in resources joint ventures because I believe this would create far more problems than it will solve.

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