The Court of Appeal has dismissed an appeal by Apache finding that a Farm-Out Agreement should be interpreted by reference to the terms of the Joint Operating Agreement, rather than as an entirely separate contract.
Apache entered into a farm-out agreement with Euroil in 2015 pursuant to which it sold Euroil a minority interest in a UK Continental Shelf seaward production license (the FOA). As part of the transaction:
Euroil was required to pay the costs of drilling an exploration well by way of consideration for the transfer (the Earn In Costs).
Euroil acceded to the joint operating agreement (JOA) which regulated the relationship between the joint venture partners.
Apache, as Operator, leased the “WilPhoenix” semi-submersible rig to drill the exploration well. Drilling began on December 19, 2017 and continued until February 3, 2018. The daily rate for leasing the rig (USD 382,404 per day) was substantially higher than the market rate at the time (US$130,000 per day).
The well was discovered to be dry and the operation was terminated. The total cost of rig hire was £3,280,482.46. Apache claimed these costs from Euroil. Euroil refused to pay and contended that Apache was only entitled to a sum equivalent to the market rate for the lease of the rig pursuant to the basis of the terms of the JOA (and appended Accounting Procedure). Clause 3.2.4 of the JOA stated that “the cost of services, equipment and/or facilities…shall not exceed rates currently prevailing for like services”.
At first instance, the court found that the FOA and the JOA should be read together and that accordingly the total costs recoverable by Apache were capped at the JOA market rate (no more than £1,114,480.68). According to HHJ Pelling QC, as the term “total costs” was not defined in the FOA the parties must have intended for the mechanisms in the JOA to determine the total costs payable.
Apache appealed arguing that:
a) The FOA and the JOA were entirely separate contracts and should not have been read in conjunction. The FOA was a bilateral sale contract whilst the JOA was a multilateral joint venture contract. Under the FOA Apache wore a “seller” hat and under the JOA it wore a different “operator” hat.
b) The inconsistency clause in the FOA meant that the JOA was superseded by the FOA.
c) The judgment would be “a significant development for the oil and gas industry, given that joint operating agreements are attached routinely to farm-out agreements by way of appendix”.
d) Under the FOA, Euroil had agreed to pay 26.25 per cent of the total costs “whensoever incurred”. There was no limitation of this amount to current market rates and the judge had erred in failing to address the unambiguous words of “whensoever incurred”.
e) If the parties intended a market cap to apply, it would have been expressly provided for in the FOA.
The Court of Appeal upheld the dismissal finding that the contracts should not be read separately and that Apache’s recoverable sum was capped at market rates. Carr LJ gave the leading judgment with which Lewison LJ and Peter Jackson LJ concurred. The Court gave four principal reasons for its decision:
a) It was wrong in principle to treat the Agreement and the JOA “as entirely separate contracts, with Apache wearing different hats in each”, the Agreement and JOA should be construed as a “cohesive whole”. This is because the terms of the JOA were negotiated before the execution of the Agreement and the terms of the Agreement deemed the JOA to be in full force. Hence, construing the two documents separately would “not reflect the true nature of the parties’ dealings at the time”.
b) The Agreement contained several references to the JOA. This suggests that the contracts were complementary.
c) The parties issued invoices and payments under the Agreement in accordance with the mechanism set out in the JOA. This process was therefore inconsistent with the argument that both contracts were entirely separate. Ultimately, this was a decisive factor.
d) For Apache’s argument to succeed the court would have effectively have had to find that Euroil agreed to an uncapped exposure to costs under the Agreement, even though it had no meaningful control over those costs. This would be commercially absurd.
Although the Court stressed that it was dealing with the contracts before it (which were not model form) and that it was not setting a “general precedent” that all farm-out agreements would be construed by reference to any appended joint operating agreement, the decision is significant in demonstrating the approach the English courts are likely to take when one contract sits alongside another. In any sector where complex multi-party relationships and layers of contracts exist, this case demonstrates the importance of clear and concise drafting. Where, for example, parties intend contracts to be construed independently, wording to this effect should be included. Equally, if one party wishes costs to be capped at a certain level, it is advised to set that out in the body of the contract and more generally to ensure that terms as to consideration are drafted in clear, unambiguous language.