In the oil and gas regulatory environment, operators are familiar with the following increasingly common pattern. As part of the process of pooling the working interests in a drilling and spacing unit (“DSU”), an operator sends AFEs and election letters to working interest owners and other parties with interests in the DSU. A non-operator signs and returns its election letter, in which it agrees to participate by paying its proportionate share of the drilling, completion, and equipping costs associated with a particular well. The operator obtains regulatory approval pooling all interests in the DSU and granting the operator the right to recover costs against nonparticipating working interest owners. The operator then sends an invoice to the consenting non-operator, who does not pay. In some cases, the operator discovers that the non-operator’s interest was sold to a third party shortly after the non-operator returned its signed election letter; in other cases, the non-operator simply fails to pay.
The scenario raises questions of whether certain parties are signing election letters only to strengthen the value of their interest in a well and DSU before ultimately selling their interests. However, it is difficult for operators to recover against nonpaying parties and particularly those nonpaying parties who have sold their interests. The following article provides a brief summary of the enforcement mechanisms available to an operator to recover unpaid JIBs.
Joint Operating Agreements
Although becoming more uncommon now, a joint operating agreement (JOA), properly executed between the parties, can include some powerful standard and custom provisions that may deter delinquency and allow more efficient recovery. Generally, the JOA will grant the parties reciprocal liens on leasehold and other property then owned or later acquired in the contract area. So long as the lien has been perfected and notice was provided as required by applicable law, each party has a power of sale over any property subject to the lien. Wyoming case law, for example, has held that parties can take action on JOA power of sale provisions via the procedures outlined in the state’s real property foreclosure statutes. In addition, after proper notice of default, JOAs may provide operators with the ability to require advance payment (cash calls) from defaulting parties for costs including those required for drilling and completing a well. A JOA may also impose hefty interest payments that begin accruing days after the defaulting party’s receipt of invoices. While operating under the terms of a JOA offers these protections when developing a contract area, JOAs are sometimes unattractive for other reasons and parties are not required to sign a JOA. In the absence of a JOA, the following other remedies may apply.
Obtaining a Statutory Lien
Another option for the operator is to take advantage of the lien statutes that Rocky Mountain states apply to oil and gas development. Some election letters will specifically provide that participating parties are subject to a lien on their interest in the well. Colorado, North Dakota, and Wyoming provide that parties providing labor and equipment for oil and gas operations, as well as operators in oil and gas properties, may be able to take advantage of state lien statutes under C.R.S. § 38-24-101, et seq.; NDCC §§ 35-24-01, et seq.; and Wyo. Stat. Ann. §§ 29-3-101, et seq. While these liens may attach to the leasehold and properties within the subject area, states differ as to whether they attach to proceeds of production. Generally, within six months from the time that services or materials were provided, these statutes require that liens be perfected by recording in the office of the county clerk and recorder a lien statement containing the amounts due, a description of the property, and other required information. In general, lien statutes are strictly construed according to the particular statutory language and operators should obtain an attorney’s assistance when filing liens.
Statutory Pooling
Even after a defaulting party agreed to participate and a pooling and cost recovery order was obtained, if an operator can show that the party has failed or refused to pay, operators may petition the state oil and gas commission to have the defaulting party deemed nonconsent. Some nonpaying parties may agree to be treated as a nonconsenting party despite electing to participate in the costs of drilling and completing a well, expecting operators to “net” their unpaid JIBs. Such a “supplementary” cost recovery order could be sought in conjunction with other remedies, such as the filing of a lien. Recording a lien statement and a declaration that a party is being treated as a nonconsenting interest for failure to pay JIBs will also put future purchasers on notice of a lien against the party’s interests.
Although a state commission like Wyoming’s Oil and Gas Conservation Commission has the authority to determine the “proper cost” in the event of a dispute over costs, beyond authorizing statutory cost recovery, its enforcement mechanism over unpaid JIBs is limited. Contract disputes are beyond the scope of their rules and regulations and must be addressed through the courts.
Lawsuits
Perhaps the most time-consuming and expensive remedy is filing a lawsuit. Colorado and Montana courts have held that signed election letters and AFEs have formed contracts; thus, a breach of contract claim, among other potential causes of action, could be appropriate for participating parties that have failed to pay JIBs. In addition, Wyoming’s new Chancery Court may offer operators a faster way to resolve JIB disputes through litigation.
Conclusion
Hundreds of thousands of dollars in costs are potentially at stake when parties are unable or unwilling to pay their invoices on development operations. However, there are a number of options available to the operator. The summary of options provided above are not mutually exclusive, and a combination of such remedies could be advantageous in the right circumstances.
Please contact Craig Rowland, Jill Fulcher, Nicol Kramer, or Jake Haseman if you have any questions or would like additional information.