Nearly every day a different E&P company makes an announcement that indicates the company is facing financial distress, insolvency or bankruptcy.  Many of these companies are Operators under Joint Operating Agreements and with each announcement there are likely Non-Operators concerned about the impact these events will have on their non-operated working interests.  Non-Operators should understand their JOA rights and options when their Operator becomes distressed.

Article V.B.3. of the 1989 Model Form Operating Agreement provides that if an Operator “becomes insolvent, bankrupt or is placed in receivership, it shall be deemed to have resigned without any action by Non-Operators, except the selection of a successor.”

If an Operator becomes insolvent, but has not yet filed for bankruptcy protection, it may be prudent for the Non-Operators to act quickly to replace the Operator.  Even though the JOA provides that an Operator shall be deemed to have resigned when it files for bankruptcy, any deemed resignation and replacement of a bankrupt Operator may arguably be barred by the automatic stay or otherwise be unenforceable in bankruptcy.  Non-Operators attempting to replace an insolvent (but not yet bankrupt) Operator will need to be confident that they have conclusive, factual evidence of the Operator’s insolvency that will withstand any legal challenge the Operator makes against the replacement.

Non-Operators whose properties are operated by a distressed Operator, but who do not believe they have clear evidence of the Operator’s insolvency have an additional option for removing the Operator.  Article V.B.1 of the JOA provides that Non-Operators owning a majority interest based on ownership of the properties subject to the JOA may remove an Operator for “good cause.”  Good cause includes the inability of the Operator to meet the reasonable prudent operator standard of the JOA or the material failure or inability of Operator to perform its obligations under the JOA.  Non-Operators pursuing this route should closely examine applicable case law interpreting good cause under the JOA to determine if the underlying facts relating to the Operator’s distress are sufficient to justify removal. Additionally, the JOA provides notice and cure periods in connection with removal with which the Non-Operators must comply.

In light of distress in the oil patch, a Non-Operator should monitor its Operator closely, keep track of instances where the Operator’s financial distress causes the Operator to fail to perform its obligations under the JOA, and be ready to move quickly if the Non-Operator has grounds and the desire to replace its Operator.  In the event an Operator does file bankruptcy, the Non-Operator should contact qualified bankruptcy counsel immediately to ensure that the Non-Operator does not take any action that violates the automatic stay and to determine the best course of action to protect its interests.