07 December 2016

Apache v Santos: scope for participants to undertake activities in joint ventures

This article was written by Ian Gordon, Tim Edwards and Tom Fotheringham.

On 1 December 2016, the WA Court of Appeal handed down its decision in Apache Oil Australia Pty Ltd (now known as Quadrant Oil Australia Pty Ltd) v Santos Offshore Pty Ltd [2016] WASCA 213, finding in favour of the Apache parties and overturning Justice Chaney’s first instance decision in Apache Oil Australia Pty Ltd v Santos Offshore Pty Ltd [2015] WASC 318.

The decision of the WA Court of Appeal is significant because it demonstrates the following:

  • there is likely to be some room under a joint operating agreement for a party (acting in the capacity of a participant rather than as operator) to undertake and fund activities that are neither joint operations nor exclusive operations, without operating committee approval;
  • the activities that may be undertaken by a participant in this capacity are potentially quite broad (eg front-end engineering and design, investigating and evaluating subsea infrastructure and entering into contracts for long lead items), but they must not interfere with nor prejudice joint operations for the appraisal, development and/or maintenance of the relevant titles;
  • the distinction between a participant conducting activities in its capacity as operator and in its capacity as a participant is sometimes unclear; and
  • if you are wishing to limit the scope for a party to conduct activities in its capacity as a participant, it is likely that you will need to supplement the “standard” AIPN-based joint operating agreement language (which the Court of Appeal found in this case did not have the effect of prohibiting the relevant activities).

Background to the decision

In 2010, Apache Oil Australia Pty Ltd (Apache Oil), Apache East Spar Pty Ltd and Apache Kersail Pty Ltd (together, the 'Apache Parties') acquired an interest in the Spar gas field off the coast of Western Australia from Santos Offshore Pty Ltd (Santos). The joint operating agreement (JOA) entered into at the time of the acquisition confirmed that the Apache Parties and Santos held (respectively) 55% and 45% interests in the joint venture (Spar JV) and appointed Apache Oil as Operator.

In 2011, the Apache Parties proposed the drilling of an appraisal well within the relevant title area (Spar-2 well). This proposal was included in the 2012 Work Program and Budget submitted by the Apache Parties to the operating committee, which was rejected by Santos, primarily because it was not comfortable with the development proposal (which involved tying back the Spar-2 well to the adjacent Halyard development and Varanus Island gas processing facilities).

Despite this, the Apache Parties proceeded to take a number of steps in relation to the development of the Spar-2 well, including completing front-end engineering design, undertaking evaluation and investigation into certain items of subsea infrastructure, and entering into contracts for the procurement of other long lead time items, all without operating committee approval. These actions were undertaken at the Apache Parties’ own expense (at least until Santos had finally approved the program and budget in 2013 as noted below) and the Apache Parties did not make use of joint property. For the reasons set out below, the actions were not conducted as Exclusive Operations.

In 2013, Apache Oil prepared a new Work Program and Budget, which was broadly similar to the 2012 Work Program and Budget that Santos had rejected and included the costs that the Apache Parties had incurred in undertaking the steps set out above. Although Santos approved the 2013 Work Program and Budget, it nevertheless:

  • claimed that Apache Oil, as Operator, had committed a material breach of clause 7.1(A) of the JOA by undertaking the activities referred to above; and
  • sought to remove Apache Oil as the Operator of the Spar JV pursuant to a provision of the JOA which allowed the removal of the Operator if the Operator (acting in that capacity) committed a “material breach” of the JOA.

Clause 7.1(A) of the JOA provided that “no operations may be conducted under this Agreement except as Joint Operations … or as Exclusive Operations”. “Joint Operation” was defined as an operation or activity carried out by the Operator pursuant to the JOA, the costs of which would be charged to all parties, while “Exclusive Operation” was defined as an operation carried out pursuant to the JOA and charged only to certain parties.

The JOA also provided that an Exclusive Operation could only be proposed if the operation was first proposed as a Joint Operation and not accepted, and an Exclusive Operations notice could only be issued after 27 August 2013 (which was after the Apache Parties had taken the relevant actions).

The Apache Parties commenced proceedings in the Supreme Court of WA, seeking a declaration that Santos could not remove Apache Oil as the Operator for the alleged breaches.

Trial judge’s findings

At first instance, Chaney J found that clause 7.1(A) was a prohibition that captured not only physical steps within the area of the relevant production licence, but also activities and operations for the development of the Spar project. His Honour found that the reference in clause 7.1(A) to operations “conducted under this Agreement” was a reference to activities that fell within the scope of the JOA or that could be the subject of a Joint Operation or Exclusive Operation. The activities undertaken by the Apache Parties were activities that fell within the scope of the JOA, and therefore in breach of clause 7.1(A). His Honour deemed this to be a material breach, because it deprived Santos of the benefit of certain oversight, input and control over the activities relating to the development, such that Santos was entitled to remove Apache Oil as Operator.

Grounds of appeal

On appeal, the Apache Parties raised three grounds of appeal, arguing that Chaney J erred in:

  • finding that clause 7.1(A) prohibited the Apache Parties from undertaking the relevant activities;
  • failing to consider whether any material breach was committed by Apache Oil in its capacity as Operator; and
  • finding that the breaches were “material breaches”.

Decision of the Court of Appeal

In a joint judgment, Newnes and Murphy JJA found in favour of the Apache Parties on all three grounds. Mitchell JA delivered a separate judgment, also finding in favour of the Apache Parties, but for different reasons.

Based on their view of the construction of clause 7.1(A), Newnes and Murphy JJA found that any prohibition in clause 7.1(A) was “directed to operations or activities which could prejudice or interfere with the functions of the Operating Committee in authorising, reviewing and supervising Joint Operations”. For example, drilling a well in the title area, or doing something that would jeopardise the maintenance of the title could be a breach. However, in this case, none of the activities undertaken by the Apache Parties were of this nature. While the activities in question could have been undertaken as a Joint Operation or an Exclusive Operation, their Honours held that clause 7.1(A) did not prevent these activities from being undertaken by a party outside of an established Joint Operation or Exclusive Operation.

Mitchell JA agreed with the argument of the Apache Parties that clause 7.1(A) was not a prohibition at all, with the clause only being intended to define the scope of operations that could be conducted under the JOA and not prohibiting conduct otherwise undertaken by parties at their own expense.

In relation to the second ground of appeal, Newnes and Murphy JJA found that, on the facts, Apache Energy Ltd (which was the Apache party that took the relevant actions such as entering into contracts) had acted as agent for the Apache Parties as JV participants, not as agent for Apache Oil in its capacity as Operator. As such, the right under the JOA to remove Apache Oil as Operator did not arise because, even if there was a breach, the breach was not committed by Apache Oil in its capacity as Operator. Given his finding that no prohibition existed, Mitchell JA did not find it necessary to answer this question.

For completeness, Newnes and Murphy JJA also considered the issue of materiality of the alleged breach, in light of the consequences for Santos of the actions undertaken by the Apache Parties. Their Honours found that the alleged breaches of the JOA did not have any significant consequences for Santos. The only missed opportunity for Santos to provide input was the ability to add an entity to the list of entities invited to tender for contracts. As such, even if the actions had constituted a breach of the JOA by Apache Oil in its capacity as Operator, the right to remove Apache Oil from the position of Operator would not have been available to Santos because the breaches were not material. Mitchell JA agreed with Newnes and Murphy JJA on this point.

Accordingly, the appeal was allowed, and Santos is not entitled to remove Apache Oil from its position as Operator of the Spar JV for material breach of the JOA.

See the full judgment in Apache Oil Australia Pty Ltd (now known as Quadrant Oil Australia Pty Ltd) v Santos Offshore Pty Ltd [2016] WASCA 213 here.

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