Allocation of Interest to Non-Breaching Parties Under Breach of Contract Remedies Contained in the AIPN Model JOA and the AIPN Model SBA

Allocation of Interest to Non-Breaching Parties Under Breach of Contract Remedies Contained in the AIPN Model JOA and the AIPN Model SBA

Frank Alexander Jr, Dentons Canada LLP

Frank Alexander Jr at Dentons Canada provides an in-depth analysis of Association of International Petroleum Negotiators rules surrounding the rates of interest due under breach of contract damages claims in the global petroleum industry.

Frank Alexander

EXECUTIVE SUMMARY

Applicable breach of contract remedies under the AIPN 2012 Model International Joint Operating Agreement (AIPN Model JOA), and the AIPN Model Form International Study and Bid Group Agreement (AIPN Model SBA), do not provide a non-breaching party wishing to obtain a portion of the breaching party’s interest in the applicable government petroleum contract (GPC) (and, in the case of the AIPN Model SBA, any associated JOA) with the right to stipulate the percentage of the breaching party’s interest that such non-breaching party shall agree to receive. A non-breaching party exercising such a remedy by notice would do so not knowing (unless it made binding arrangements with the other parties outside the applicable contract) what percentage of the breaching party’s interest it might end up having to accept and pay for. Such a non-breaching party would be required to accept and pay for a range of percentages between the “minimum percentage” (defined immediately below) and 100 per cent of the breaching party’s interest. This regardless of the maximum percentage of the breaching party’s interest that such non-breaching party might actually wish to receive – which might even be less than such minimum interest.

Such minimum interest would be a percentage of the breaching party’s interest equal to a fraction, the numerator of which is such non-breaching party’s participating interest and the denominator of which is the aggregate of:

  • the participating interest of such non-breaching party; and
  • the respective participating interests of each other non-breaching party.

Most importantly, such a non-breaching party giving notice would become exposed to the risk that it would end up being obligated to accept 100 per cent of the breaching party’s interest – along with the obligation to pay 100 per cent of the applicable amount due to the breaching party in return for such interest, and also to pay 100 per cent of the cost of operations, going forward, associated with such interest. Once again, this is regardless of the maximum percentage of the interest that such non-breaching party might actually wish to receive.

The contractual mechanisms in the AIPN Model JOA, and the AIPN Model SBA, respectively, for the allocation of the breaching party’s interest to the non-breaching parties wishing to obtain a portion of the breaching party’s interest may, however, be amended. This in order to provide each non-breaching party giving such notice with the right to stipulate the percentage, up to applicable limits, of the breaching party’s interest such non-breaching party would be obligated to receive, and to pay for. The nature of such an amendment is described below (under “Amendment of contractual mechanisms for the allocation of the breaching party’s interest to the electing non-breaching parties”).

REMEDIES UNDER ARTICLE 8.4 OF THE AIPN MODEL JOA

Under the breach of contract remedy under alternative 1 (detailed below) of article 8.4.F.1 (buy-out option) of the AIPN Model JOA, a non-breaching party giving notice of the exercise of such remedy would not have a right to stipulate a percentage of the breaching party’s interest that it would wish to receive in an amount less than the minimum percentage. This regardless of the percentage of the breaching party’s interest that such non-breaching party may actually wish to receive. (Please see article 8.4.F.1 of the AIPN Model JOA below.)

According to article 8.4.F.1, either of

  • alternative 1: each non-defaulting party; or
  • alternative 2: a majority in interest of the non-defaulting parties (after excluding affiliates of the defaulting party)
     

may, but shall not be obligated to, exercise such Buy-Out Option by notice to the Defaulting Party and each other non-defaulting Party (the Buy-Out Notice). The Defaulting Party shall be deemed to have proposed to sell and assign, effective on the date of the Buy-Out Notice, its entire Participating Interest to the non-defaulting Parties having exercised the Buy-Out Option (each, an Acquiring Party). Any other non-defaulting Party that gives an Option Notice within thirty (30) Days after the Buy-Out Option is first exercised by an Acquiring Party shall also become an Acquiring Party. Any non-defaulting Party that fails to exercise its Buy-Out Option during such thirty (30) Day period shall be deemed to have elected not to become an Acquiring Party, and its Buy-Out Option with respect to the Defaulting Party shall terminate. Each Acquiring Party shall be deemed to have proposed to acquire a proportion of the Participating Interest of the Defaulting Party equal to the ratio of such Acquiring Party’s Participating Interest to the total Participating Interests of all Acquiring Parties and pay such proportion of the Buy-Out Price, unless they otherwise agree.

If a non-defaulting party giving such notice was unable to cause all other non-defaulting parties to join such non-defaulting party in the notice, or was otherwise unable to obtain, outside the JOA, applicable binding commitments from all other non-defaulting parties regarding whether or not they would subsequently give their own notice under article 8.4.F.1, then such non-defaulting party would be exposed to the risk that it would become obligated to receive, and to pay for, 100 per cent of the interest of the defaulting party – along with the obligation, going forward, to pay for 100 per cent of the cost of operations (including associated liabilities) associated with such interest. Once again, this regardless of the maximum percentage of the defaulting party’s interest that such non-defaulting party may actually wish to receive.

Even if alternative 2 for article 8.4.F.1 were selected, a non-defaulting party giving such notice would have the same issues in regard to any other non-defaulting Parties that were not part of the “majority in interest of the non-defaulting Parties” giving such notice.

Similar issues apply to the breach of contract remedies described in articles 8.4.D.1/8.4.E and 8.4.D.3/8.4.G.1 of the AIPN Model JOA.

REMEDY UNDER ARTICLE 12.1 OF THE AIPN MODEL SBA

Article 12.1 of the AIPN Model SBA provides the following:

Except as otherwise provided in this Agreement, each Party undertakes that it shall refrain from submitting, and shall cause its Affiliates to refrain from submitting, any bid or application covering any part of the Study Area either alone, with, or through an Affiliate, or any third parties. Each Party undertakes that it shall refrain from negotiating and entering into, and shall cause its Affiliates to refrain from negotiating and entering into, any other agreement before the Application Date with any entity or person under which the Party or Affiliate may acquire any interest in any government contract covering all or any part of the Study Area. Subject to acceptance by the other Parties and without prejudice to any other remedies that aggrieved Parties may have, if a Party or its Affiliates acquires an interest in violation of this undertaking, that Party shall immediately notify the other Parties and shall, upon request from any Party, assign or cause to be assigned, on a pro-rata basis, all of the interest so acquired, to the other Parties for the same consideration paid by the Party or its Affiliate to the entity from whom that interest was acquired

Although the breach of contract remedy under article 12.1 of the AIPN Model SBA is not clearly drafted, it would appear that a non-breaching party giving an applicable notice would find itself in essentially the same position as would a non-defaulting party giving an applicable notice under alternative 1 of article 8.4.F.1 (buy-out option) of the AIPN Model JOA.

AMENDMENT OF CONTRACTUAL MECHANISMS FOR THE ALLOCATION OF THE BREACHING PARTY’S INTEREST TO THE ELECTING NON-BREACHING PARTIES

The contractual mechanisms for the allocation of the breaching party’s interest, as contained in article 8.4.F.1 of AIPN Model JOA, and article 12.1 of the AIPN Model SBA, may be amended in order to permit a non-breaching party to stipulate the percentage of the breaching party’s interest that such non-breaching party would be obligated to accept, and to pay for, in accordance with the following principles.

Firstly, each non-breaching party would give notice of its election to receive a percentage of the breaching party’s interest equal to or less than the percentage equal to a fraction, the numerator of which is such non-breaching party’s participating interest and the denominator of which is the aggregate of:

  • the participating interest of the such non-breaching party; and
  • the respective participating interests of the other non-breaching party or non-breaching parties, if any.

Each non-breaching party so electing to receive any percentage of the breaching party’s interest shall be an “electing non-breaching party”. The interest so elected to be received by an electing non-breaching party shall constitute its “initial committed percentage interest”.

If each non-breaching party elects to receive the full percentage of the breaching party’s interest available to it under section 4.2, then each such electing non-breaching party’s initial committed percentage interest shall also be such electing non-breaching party’s “final committed percentage interest”, which it shall be obligated to receive and to pay for.

Secondly, if any non-breaching party elects to receive a percentage of the breaching party’s interest that is less than the full percentage of such interest available to such non-breaching party under section 4.2, then the amount by which the aggregate of the initial committed percentage interests of the respective electing non-breaching parties is less than one shall constitute the “unsubscribed interest”. In any case where there is an unsubscribed interest then each electing non-breaching party, if any, that has elected to receive from the breaching party the full percentage of the breaching party’s interest available to such electing non-breaching party under section 4.2 shall have the right to elect to receive an additional percentage of the breaching party’s interest equal to or less than the product of the unsubscribed interest multiplied by a fraction, the numerator of which is such electing non-breaching party’s participating interest and the denominator of which is the aggregate of the:

  • the participating interest of such electing non-breaching party; and
  • the respective participating interests of each other electing non-breaching party, if any that has elected to receive from the breaching party the full percentage of the breaching party’s interest available to such electing non-breaching party under section 4.2.

Each such electing non-breaching party wishing to exercise such right shall notify the breaching party and each other non-breaching party of the additional percentage of the breaching party’s interest, if any, that it elects to take in accordance with such right, and the sum of any such additional percentage of the breaching party’s interest and its initial committed percentage interest shall constitute its “revised initial committed percentage interest”.

Thirdly, if, subsequent to any application of section 4.4, there would continue to be an unsubscribed interest (because each of the applicable electing non-breaching parties that elected to receive the full percentage of the breaching party’s interest available to it under section 4.2 did not elect, in turn, to receive the full amount of additional percentage of the breaching party’s interest available to it under section 4.4), then the procedure described in section 4.4 would be repeated, mutatis mutandis, and, if applicable, repeated thereafter, mutatis mutandis, until either:

  • there was no further unsubscribed interest; or
  • no applicable electing non-breaching party elected to receive an additional percentage of the breaching party’s interest;

at which time each applicable initial committed percentage interest and revised initial committed percentage interest would become a final committed percentage interest, which the applicable electing non-breaching party would be obligated to receive and to pay for. If desired, provision may also be made, in the case of the AIPN Model JOA, for any exercise of the applicable remedy that did not result in the non-breaching parties electing to take 100 per cent of the interest of the breaching party to be null and void. At least that way a non-defaulting party exercising the applicable remedy by notice would be in control of the percentage of the defaulting party’s interest that such non-defaulting party would be exposed to having the obligation to accept, and to pay for.

  • The above would also have to be supplemented with provisions addressing the following:
  • any minimum interest requirements under the applicable GPC (and, in regard to the AIPN Model SBA, under any applicable JOA);
  • any required approvals and/or waivers under the applicable GPC that pertain to transfers of interest (and, in regard to the AIPN Model SBA, under any applicable JOA);
  • deadlines for applicable notices; and
  • in regard to the AIPN Model SBA:

1.issues that might pertain to the breaching party obtaining any required consents necessary in order to permit the breaching party to disclose applicable information to the non-breaching parties in order to permit them to decide whether or not to exercise their breach of contract remedy; and

2.audit, expert determination and/or arbitration applicable to amounts claimed by the breaching party that would become the subject of a reimbursement obligation by each electing non-beaching party.

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