North Dakota Joint Operating Agreements (JOAs) in a Bankruptcy Case
By David L Ganje Esq.
Joint operating agreements (JOAs) form the contractual relationship among the parties in oil and gas drilling and operating ventures. JOAs establish how profits, losses, and liabilities will be shared. These agreements are generally considered executory contracts, and not executed contracts. This means that each of the parties signing a JOA have agreed to future performance on matters yet to be completed at the time of signing. JOAs are complicated contracts. Putting them into a bankruptcy case multiplies the issues.
A JOA is so technical that I did not review it in the bankruptcy courses that I taught; it has too many facets to be absorbed in a general course. Nevertheless, when a party is confronted by a bankruptcy filing involving a JOA, inaction is not the watchword. As Winston Churchill said, “I never worry about action, but only inaction.” The law serves the vigilant, not those who sleep upon their rights.
The classification of JOAs as executory contracts has implications when a party files for bankruptcy. The bankruptcy code allows the bankrupt party two possible outcomes. First, the bankrupt party can assume the entire JOA as is. Alternatively, the party can elect to reject the contract all together. These options are mutually exclusive, as the bankrupt party is not able to reject only the unfavorable portions of the JOA. The bankrupt party must either assume or reject the JOA in whole with what I call a real estate exception (which I will address later in this article). Either direction continues until the bankrupt party chooses to either assume or reject the JOA. Under the bankruptcy code, two other curious matters come into the picture. One, a JOA may never be enforceable as a contract if a debtor party so elects. And two, a bankruptcy court has the legal authority to cram down a JOA on the parties.
If the bankrupt party choses to assume the JOA, the bankrupt party, or so-called debtor, must first cure all existing contractual defaults. The non-bankrupt party can also seek financial assurances from the debtor to ensure that the debtor will have the means of providing future performance of the JOA.
Because JOAs cover a multitude of contractual issues, it is possible that some portions of the JOA are considered executory contracts, thus subject to assumption or rejection by the bankrupt party, while other portions (such as my so-called “real estate exception”) are not. While this seems trivial, the implications have an impact if a party files for bankruptcy. Because some clauses of a JOA may be subject to assumption or rejection, and others not, it is possible that a portion of the JOA will still be enforceable by a creditor after the debtor files bankruptcy. North Dakota Courts have yet to rule on JOAs in a bankruptcy context. Relevant case law, however, suggests that many of the clauses of a typical JOA would fall within what I have called the real estate exception.
When drafting a JOA, a way of reducing risk is to state what constitutes “adequate assurances.” Well-drafted JOAs describe what a debtor would have to do in order to assume its rights under the JOA after bankruptcy is filed. Stipulating a time table for adequate assurances, assessing the possibility of an escrow account and determining what is and what is not considered an “adequate financial assurance” will minimize headaches. A separate method for reducing risk is to ensure that the contract terms fall under a real estate exception; these exceptions are not able to be rejected in bankruptcy proceedings. Well-drafted JOAs should state when clauses in the JOA “touch and concern the land.”
Understanding Joint Operating Agreement drafting and negotiating, although technical, will assist in reducing legal challenges. While JOAs are widely considered executory contracts, and subject to assumption or rejection should a party file bankruptcy, portions of the JOA are likely considered real property interests — making rejection of those terms not a viable legal option.
David Ganje practices law in the area of natural resources, environmental and commercial law in South Dakota and North Dakota. His website is Lexenergy.net
