Recent events in the oil and gas industry highlight its ever-present risks: the well-related “mudflow disaster” in Indonesia in 2006; the oil leak and fire at the Montara Oil Field in the Timor Sea in 2009; and most recently the Deepwater Horizon oil spill in the Gulf of Mexico in April 2010.

Such incidents, and more minor incidents which have not attracted such intense media scrutiny, are constant reminders of the need to ‘get it right’ when pre-empting risk. This includes, if a Joint Operating Agreement (JOA) applies, getting risk allocation ‘right’. This applies both for operators and non-operators.

Standard models

There are various standardmodels which are used for JOAs. One of the most regularly used is the JOA standard provided by the Association of International Petroleum Negotiators (AIPN). While a less-experienced party may be tempted to "tick the boxes" in terms of risk allocation using such models, the incidents outlined above make it increasingly vital for each party to step back and carefully consider the losses for which it wishes to exclude its liability, and what its potential exposure may be.

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As operators bear the burden of the day-to-day operations of joint ventures, JOAs typically release the operator from liability and provide that the non-operating participants indemnify the operator for loss or damage which arises through the performance of its functions as operator.

However, such clauses regularly contain carve-outs which render the operator liable – and accordingly remove liability from non-operators – if loss or damage is caused where the conduct of the operator's senior supervisory personnel constitutes ‘gross negligence’ or ‘wilful misconduct’. Generally the operator will also exclude liability for ‘consequential loss’.

Negotiation

As a party to a JOA, great care should be taken when negotiating and drafting clauses excluding or limiting liability for ‘wilful misconduct’, ‘gross negligence’ and ‘consequential loss’. Understanding these terms and how they can be varied in the JOA is important as it determines how the operator and non-operators divide such liability.

In amending the scope of these terms in the JOA, parties shift the ‘negotiation lines’. For example, for non-operators, in a JOA based on the standard AIPN model, it is more beneficial for the definitions of “gross negligence” and “wilful misconduct” to be as broad as possible, while operators would benefit from narrow definitions.

However, like many legal questions, the definitions of these terms present a dilemma. Australian case law provides only an ambiguous meaning and application of these phrases.

The solution?

It is all in the drafting. Parties cannot rely on the fact that a generic term will be interpreted in their favour. Unless vagueness is intended for strategic reasons, the better approach is to express in as much detail as possible what each term means, and when it will apply.