Court of Appeal construes Farm-Out Agreement by reference to associated Joint Operating Agreement

03/11/20

On Friday 30 October, the Court of Appeal handed down judgment in Apache North Sea Limited v Euroil Exploration Limited [2020] EWCA Civ 1397. The dispute concerned the construction of payment provisions in a Farm-Out Agreement (“FOA”) and required consideration of the relationship between the terms of the FOA and those of the associated Joint Operating Agreement (“JOA”) in the light of an inconsistency clause.

In return for a share in the production licence and participation in the JOA, under the FOA, Euroil had agreed to pay Apache “Earn In Costs” defined in part as a percentage contribution towards the “costs incurred” in drilling an exploratory “Earn-In Well”.

As Operator under the relevant JOA, Apache later chose to use the WilPhoenix, a drilling rig which was on long-term hire to it. Euroil objected to Apache’s demand for a contribution to the high rig rates which were almost three times the rates for which equivalent rigs could be hired to drill the well. Euroil relied on the terms of the JOA which, while permitting the Operator to use equipment from its own resources, required the Operator to charge costs to the Joint Account in accordance with the Accounting Procedure. This in turn allowed the Operator to charge for its own equipment at rates commensurate with the cost of ownership but limited those charges to market rates.

Numerous provisions in the FOA required various matters to be done “in accordance with the JOA” but the definition of Earn-In Costs itself contained no reference to the JOA. Apache relied on an inconsistency clause in the FOA arguing that the terms of the FOA superseded all the terms of the JOA when it came to the price payable under the FOA and claiming a contribution towards the expenses it had actually incurred in relation to the WilPhoenix.

At first instance, HHJ Pelling QC dismissed Apache’s claim, finding no relevant conflict between the FOA and the JOA. The FOA had modified the percentage contribution required of Euroil to the costs of drilling the Earn-In Well so that it paid a larger contribution than reflected its percentage interest under the JOA but left “costs incurred” to be determined under the JOA. Properly construed, the FOA and the JOA were not inconsistent and worked together as a cohesive whole.

The Court of Appeal granted Apache permission to appeal. Apache argued that there was a fundamental difference between the terms of a multilateral JOA which regulated charges to be made by an Operator to a Joint Account and the FOA which was a bilateral contract of sale governing its right to a price as seller to which the Joint Account was irrelevant.

While acknowledging the initial attraction of Apache’s submissions, and observing that the FOA could have been drafted more clearly, the Court of Appeal accepted Euroil’s analysis. The Earn-In Well was to be drilled by the Operator under the JOA. The various references to the JOA in the FOA each confirmed that the parties had intended “costs incurred” to refer to “costs incurred” by Apache as Operator and not in a personal capacity. Although Apache may be seen to suffer a loss as supplier of the rig, the Accounting Procedure produced a fair and equitable result ensuring that it was compensated fairly for the value of what it had supplied. The result was consistent with the principle embodied in the JOA that, in that capacity, the Operator should neither gain nor suffer a loss as a result of acting as Operator.

The first instance judgment is here.

The Court of Appeal judgment is here.