Can unapproved expenditure be back-charged to other joint venture participants?

Joint Venture (JV) participants who undertake unapproved activities (at their sole risk), may be able to back charge expenditure incurred by that participant to the other joint participants at a later date [1].

Apache Northwest (Apache) and Santos (Bol) Pty Ltd (Santos) are JV participants in a processing facility on Varanus Island (ESJV) whose gas is drawn from the John Brookes gas field off the coast of Western Australia. The ESJV is governed by a Joint Operating Agreement (JOA). Apache was named as the Operator due to its interest in the ESJV being greater than Santos’ interest.

The dispute between the parties concerned a project named the Varanus Island Compression Project (VICP) which Apache had partially implemented to install compression equipment at the inlet point of the ESJV processing facility. Its purpose was to boost the pressure of gas to a suitable operating pressure.

Timeline

A brief chronology of relevant events is set out below:

  • 2003: The Operating Committee (comprised of one person from each JV participant in the ESJV) approved a development program which stated: “if there is insufficient aquifer support, compression can be installed onshore Varanus Island to maximise reserves recovery.” The breakdown of costs did not include any amount for inlet compression.
  • 2012: Apache sent an Authority for Expenditure (AFE) to Santos in relation to two inlet compressors and an additional export compressor to be installed on Varanus Island. Santos declined the AFE and Apache responded it would perform the work on a ‘sole risk basis’. Apache undertook various activities for the VICP at its ‘sole risk’.
  • 2013: Apache proposed to Santos a work program and budget for 2014, the major expenditure of which related to the VICP. An Operating Committee meeting was held and Santos abstained from voting on the basis that the program and budget were invalid.
  • 2014/2015: Apache issued cash calls to Santos for the VICP, which Santos paid under protest (to avoid being treated as a defaulting party under a separate clause of the JOA).

The legal question

The primary legal issue in this case was whether, on proper construction of the JOA, a JV participant could include past expenditure incurred by that participant in either a program or budget, without prior approval of the Operating Committee [2]. If this was permitted, the participant whom incurred the expense could then raise an AFE and pursue the money from the other participants.

The key issue

The primary legal issue in this case was whether, on proper construction of the JOA, a JV participant could include past expenditure incurred by that participant in either a program or budget, without prior approval of the Operating Committee.

The key issue was the interpretation of the following expressions contained in the JOA:

  • ‘proposed program and budget’; and,
  • ‘proposed production program and budget for the next year’,

and whether these words could include expenses already incurred by Apache, (who argued they were incurred as part of the proposed ‘Joint Operation’).

In determining this point, Chaney J referred to the JOA’s accounting procedure contained at Appendix B of the JOA. His Honour identified a clause in this procedure which contemplated the sale by a party of fixed assets it owns to the joint venture for the purpose of ‘Joint Operations’ [3]. He recognised that, for this provision to be effective, the selling party must first have incurred the expense of the acquisition of the asset.

Consequently the party proposing the sale of the existing fixed asset to the JOA parties must have the expenses of the sale of that asset included in a proposed budget[4]. His Honour determined this was analogous to Apache incurring the VICP expenses and then proposing those expenses as a ‘Joint Operation’ to Santos. For that reason, he ruled including past expenditure in the JOA’s proposed program and budget was permissible.

Could this outcome be avoided?

There are a number of important considerations when drafting a JV agreement to avoid the unexpected back charge of costs from one JV participant to other JV participants (if that is what the party intends). Proper drafting of the JOA (or similar JV agreement) is critical.
The Courts will give an objective construction to commercial agreements, giving effect to the text, content, subject matter and purpose of its provisions [5]. As such it is recommended that parties give consideration to the following:

  • the inclusion of an express prohibition in the JOA clarifying that if a participant takes steps at its ‘sole risk’, costs incurred cannot be back charged to other participants at a future time;
  • amending any provisions similar to the accounting procedure featured in Appendix B of the Apache/Santos JOA which allow inferences to be drawn enabling expenses to be back charged;
  • consider the definition of ‘default’ in JOA (and perhaps amend to avoid a JV participant having to answer cash calls it disputes); and,
  • provide for a procedure for dispute resolution (in the event an issue cannot be resolved within the JV), which enables the JV to continue.

References

[1] Santos (Bol) Pty Ltd v Apache Northwest Pty Ltd [2016] WASC 225.
[2] [133]
[3] [141]
[4] Ibid.
[5] Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451, 461 – 462; Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165, 179.

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