Joint Operating Agreements. Peter Roberts
the non-participating parties against any residual loss or liability to which they are exposed as a consequence of the exclusive operation.
The non-participating parties might take the view that, while that participating party could be sufficiently creditworthy to meet its share of the costs of the joint operations, it is not sufficiently creditworthy when exposed to the increased financial profile presented by the exclusive operation. The non-participating parties will also be aware that they do not have a say in defining or controlling the extent of the risks which are undertaken within the exclusive operation. Because their indemnity is unsecured the non-participating parties could therefore require the provision of collateral support by the participating party as a condition of the permitted performance of the exclusive operation, but this is only a compellable right if the JOA is drafted to provide for it.
A policy of insurance that is provided by the participating party in respect of risks associated with the exclusive operation would operate as a form of collateral support in respect of the indemnity if the non-participating parties were also endorsed on the policy as co-insureds.
(d)Forms of collateral support
Collateral support can come in a variety of forms, and the most appropriate form must be selected for the particular commercial circumstances.
•Parent company guarantees – a parent company guarantee is a form of corporate guarantee given by an entity (often, but not always, the parent company of a party) in respect of certain contractual commitments of the guaranteed party. A parent company guarantee can present difficulties in application, since in practice it is unlikely to be honoured on demand and without question by the parent company, and further enforcement action by the beneficiary might be necessary. There is no industry-wide standard or model form parent company guarantee document, and so the terms of a guarantee will need to be negotiated. That said, most guarantees tend to follow a relatively formulaic structure.
A guarantee is a contract in its own right, and requires all the legal characteristics of a contract in order to be enforceable (and, additionally, is subject to the particular requirement of being in writing if it is to be effective under English law). A guarantee is usually written so that it can only be called upon by the named beneficiary in order to remedy a breach of an underlying contractual obligation, and not so that it can be applied electively by the guarantor in order to make good a default of the guaranteed party.
The guarantor promises to be responsible for the debt or default of the guaranteed party, and the guarantor’s liability under the terms of the guarantee will not ordinarily come into existence unless and until the guaranteed party fails to perform the underlying contractual obligation. Thus, the obligation of the guarantor to the beneficiary under the guarantee can be said to be secondary and not primary. The commitment of a guarantor in respect of a party might be set out in the body of the JOA (and that guarantor would be an additional signatory to the JOA), so that the guarantor gives a directly enforceable commitment to each party that is intended to be a beneficiary of that commitment. Alternatively, the guarantee commitment could be stated in a separate document, outwith the JOA.
•Bank guarantees – short-term liquidity concerns in respect of a party might be addressed by the issue of a form of guarantee by a bank or other financial institution. Bank guarantees take various forms and the associated nomenclature is often applied imprecisely. A demand guarantee (also called a ‘performance bond’) is essentially an unconditional undertaking by a bank to pay a specified amount to a named beneficiary, sometimes with reference to an underlying obligation but often with no reference to the need to evidence any default under that underlying obligation. For this reason a demand guarantee can be construed as a primary obligation, and is truly abstract and not a guarantee at all in the strict sense. The bank will be obliged to honour a demand guarantee in accordance with its terms, making payment on demand if so stipulated, without the application of any conditions.
The defences to a demand for payment that would ordinarily apply to a guarantor under a parent company guarantee will not apply in respect of a demand guarantee, and so a demand guarantee is less attractive to a guarantor. Standby letters of credit fulfil a similar function to demand guarantees, although they employ a different vernacular in their operative provisions because they are a form of documentary credit.
•Letters of comfort – it could be that a form of collateral undertaking referred to, or generally known as, a letter of comfort is issued in respect of a party’s JOA commitments. There is no settled form for a letter of comfort. Typically it takes the appearance of a letter issued to a nominated recipient by a person (commonly, but not exclusively, the parent company of the party to the JOA) wherein the issuer makes some or all of the following declarations to the recipient in respect of the party: that the issuer is aware of the obligations which the party has undertaken under the JOA; that it is the policy of the issuer to ensure that the party will be able to perform its obligations under the JOA at all times; or that the issuer intends to maintain its shareholding in the party as an affiliated party (at least for a certain duration) or will notify a prospective change in the level of that shareholding.
The essential issue to note here is the extent to which a letter of comfort casts the issuer in the role of a guarantor in favour of the recipient of the letter of comfort. This may be expressly disclaimed within the terms of the letter of comfort but, more commonly, this is left unsaid and will need to be addressed further. The extent of the commitment offered by the issuer will be critical where the recipient of the letter of comfort later seeks to enforce it against the issuer in the manner of enforcement of a conventional guarantee. Whether the letter of comfort can be so enforced will depend on whether it can be shown to have contractual force, creating an enforceable covenant against the issuer.
In the hands of the recipient, the letter of comfort could be taken to mean something more than simply an expression of good intention. It should be beyond doubt that any express covenants given by the issuer in the letter of comfort (for example to maintain a shareholding for a period of time or to notify changes of interest) are intended to create legally binding obligations that are enforceable against the issuer by the recipient. That is as far as the liability of the issuer may go (with the extent of the issuer’s liability for breach to be assessed as a matter of quantum). To amplify those obligations into a full guarantee (or similar) in respect of the party and the JOA may well take the letter of comfort beyond what was intended.
•Step-in rights – an alternative form of protection for a party is the possible existence of a step-in right, contained in a separate step-in agreement or direct agreement. In theory at least, where a step-in right exists in respect of a commercial contract, then in the event of a party’s failure to make payment when due, another party could step in to the defaulting party’s position in order to operate the defaulting party’s interests and to commandeer the revenues that would ordinarily be received by the defaulting party.
To structure an effective step-in right would require agreement and documentation beforehand between the parties and any relevant regulatory authority whose sanction may be required to allow such a step-in right to operate. Step-in rights, at least as described above, typically do not exist in the context of JOAs. The forfeiture remedy under the JOA (see 18.7) is effectively a form of step-in right in favour of each of the non-defaulting parties (subject to compliance with the conditions of the forfeiture remedy).
•Escrow arrangements – a party might be required to fund a defined bank account (to which the other parties have access, and called variously an escrow account or a locked-box account) with certain monies that the other parties can then draw down in the event of a default or a defined credit event affecting a party. The mechanism in the JOA for remediation of a default whereby the proceeds of sale of the defaulting party’s petroleum are held in escrow (see 18.4) represents a similar sort of arrangement. A similar arrangement could also apply in respect of the deposit of cash consideration paid to a farming-out party under a farm-out agreement (see Appendix 1).