On 1 December 2016, the Western Australian Court of Appeal delivered its decision in Apache Oil Australia Pty Ltd v Santos Offshore Pty Ltd WASCA 213. This concerned whether Apache Oil Australia Pty Ltd (Apache, but now Quadrant Oil Australia Pty Ltd) was in “material breach” of the joint operating agreement for the Spar Joint Venture (JOA) and able to be removed as operator by Santos Offshore Pty Ltd (Santos). In issue were certain works undertaken by Apache at its own expense that advanced the project, without the approval of Santos.
At trial, Chaney J found that Apache was in “material breach” of the JOA and Santos was entitled to remove Apache as operator for that reason. This decision has now been overturned by the Court of Appeal. The Court of Appeal found unanimously that Apache’s actions were not prohibited by the JOA and did not prejudice Santos in any material way.
Under the JOA, Apache was able to be removed as operator if “in its capacity as Operator” it committed a “material breach” of the JOA which was not remedied. A key clause of the JOA provided that “[n]o operations may be conducted under this Agreement” except as “Joint Operations” or “Exclusive Operations” (Claimed Prohibition).
Santos rejected a work program and budget proposed by Apache for the Joint Venture in 2012. Nevertheless, at its own expense Apache undertook the following work in 2012 and 2013:
- front-end engineering design for one of the Spar wells;
- evaluation and investigation into items of subsea infrastructure with long lead times for use in proposed tie back work; and
- entry into contracts for the procurement of certain long lead time equipment (but not its installation),
The Work was not done as a “Joint Operation” or “Exclusive Operation” under the JOA, did not involve the use of joint property under the JOA and was not charged to Santos on the joint account until Santos subsequently approved the field development plan and associated work program and budget (while expressly reserving its rights). Santos also subsequently paid the associated cash call.
Santos considered the Work to be a material breach of the Claimed Prohibition by Apache (among other breaches) and claimed the right to remove Apache as operator.
At trial, Chaney J found that Apache had materially breached the JOA and was able to be removed as operator by Santos on the following bases:
- the Claimed Prohibition extended to activities and operations directed towards the development of the project, and not merely to “physical steps” taken within the title area;
- the Claimed Prohibition referred to activities or operations which were capable of being “Joint Operations” or “Exclusive Operations”;
- therefore, the Claimed Prohibition precluded Apache from taking any step within the scope of the JOA without the approval of the operating committee;
- the clear commercial purpose of the JOA would be defeated if the parties were at liberty to embark upon activities outside of the operation of the JOA with respect to the project;
- something is “material” if it substantially affects the interests of the party, is “important” or is of “significance”;
- overall control of the development by the operating committee was fundamental to the JOA; and
- the JOA gave Santos significant input into budgets, contract awards and timing.
The judge found that Apache was motivated to avoid the delays in development which would result from strict adherence to the requirements of the JOA.
In essence, Apache appealed on the following grounds (on all of which it succeeded):
- the Claimed Prohibition did not in fact prohibit a party carrying out some activities at its own risk and expense, without operating committee approval;
- Chaney J didn’t properly consider whether Apache’s conduct was “in its capacity as Operator”, or whether it was merely acting as a party to the Joint Venture; and
- if there were breaches, they were not “material”.
On the first point, the Court found that the Work did not interfere with or prejudice the operating committee in relation to the development of the project. The parties to the JOA individually, and not simply the operator, bind themselves to the JOA framework. Santos’ argument was stretching the words of the Claimed Prohibition – while “Joint Operations” and “Exclusive Operations” could include some of the Work, it does not automatically follow that any such work done outside of that process is forbidden.
Apache succeeded on the second point in light of the finding on the first point. Further, Chaney J had gone so far as to find that whether Apache carried out the relevant activity as operator or as a participant in the joint venture was “of no moment”, with which the Court of Appeal did not agree.
On the third point, it was telling that Santos accepted that it sought no remedy with respect to some of the impugned Work. Further, the evidence indicated that the only real ‘input’ Santos could have had would have been to add to the list of entities invited to tender for the Work. Santos gave no evidence at all about any claimed adverse impact on it of the alleged breaches.
The dispute between Apache and Santos with respect to the Work has a history running back several years, and it remains to be seen whether this decision of the Court of Appeal brings the matter to a close. Understandably, little is revealed in the judgements about the likely commercial motivators of each of Apache and Santos in adopting their respective positions. At the very least, Apache appeared to want the project to develop faster than Santos did. There are some lessons to be learned, by both operators and non-operators. Courts may take a different view as to what constitutes a ‘commercial’ interpretation of a joint operating agreement, and what is ‘material’ in light of the context.
For non-operators that wish to ensure involvement in all decisions regarding the project, the joint operating agreement should contain an express prohibition on the parties undertaking any activity on the project without the approval of the operating committee. Non-operators will be running a risk if they rely on the fact that operating committee approval is required for certain activity as implying that other activity is prohibited. If a party wishes to contend that there is an adverse impact of certain conduct, it must be able to produce persuasive evidence of that adverse impact.
For operators, a degree of flexibility is clearly desirable and prohibitions on conduct are best avoided. However, if there is a commonly understood commercial intention with the operation of a joint venture, it is always best for it to be clearly documented.