- Record all recordable interests
- Recordable interests are leases, deeds, assignments of working interests, royalty interests, and memorandum of contracts2 that affect real property.
- Though the more recent model form AAPL joint operating agreements (1989 & 2015) contain language specifically developed to protect operators from non-operator bankruptcies and vice versa, a memorandum of such JOA needs to be recorded in the real property records.In addition, a financing statement can be recorded as well.
- Risk: Whose lien is first?If possible, it’s desirable to confirm that the memorandum of JOA / Exploration and Development Agreement is in first position vis a vis the operator’s lender’s lien or obtain a written and recordable agreement that the lender’s lien is subordinated.
- Risk: Unrecorded interests may be set aside in bankruptcy under the broad powers granted to debtors and trustees under the Bankruptcy Code.
- Confirm that the operator is paying its vendors and service providers
- The operator is required to pay field expenses as such become due.
- Non-operators are particularly vulnerable in this area, thus they must use all reasonable efforts to ensure that cash calls, etc. are actually paid to the contractors3 providing the services and not utilized by the operator for other purposes.
- Escrowing funds would be ideal but might not be practical in all circumstances.In any case, a non-operator should demand proof of payment from the operator in situations where the operator appears to be financially distressed.
- Risk: Failure of operator to fully or timely pay contractors allows such contractors to file mechanics and materialman liens4 and/or mineral liens5 against the entire lease, not just the operator’s property.
- Risk: Enforcement and foreclosure of the lien against a non-operating working interest’s property will depend on whether JIBs were paid as well as when such JIBs were paid.
- Don’t Sit Back and Rely on the Operator – Actively Monitor Activities
- Payments due to non-operating working interests – this property belongs to the working interest owner.
- Make sure the operator is paying any and all funds due under the JOA to you as a working interest owner and a royalty owner, as applicable.
- Confirm where the operator maintains these funds (watch out for sweeps of operator’s bank account by a secured lender).
- Risk: If the operator has insufficient cash to pay working interest owners or royalty owners, the operator may have converted your funds to its use.
- Risk: An operator who has fallen behind in making these payments could leave you with nothing more than a general unsecured claim in a future bankruptcy case.
1 Based on an article written by John Melko, an energy industry focused bankruptcy partner in Foley’s Houston office, entitled “An ounce of protection is worth a bbl of cure” which was printed in the April 2008 edition of OIL & GAS FINANCIAL JOURNAL.
2 Often, parties do not want to file the actual operating agreement or exploration and development agreement. Instead, a memorandum of such contract is filed in the real property records of the applicable counties.
3 Contractors includes other services providers and vendors.
4 Statutory mechanics and materialman have broad rights to file mechanics and materialman liens (“M&M Liens”) in most states, giving such contractors extensive lien rights against the property where the work was performed.
5 In oil and gas producing states, in addition to M&M Liens, contractors who provide services/sell goods at the well site also are entitled to file separate statutory liens called “mineral liens” against the property where the work was performed.