14.17 Due to the significant costs in exploring and developing oil and gas projects, sponsors normally seek to share investment risks by teaming up with other oil companies, trading companies, and utilities to sponsor the development of the project. In the context of upstream projects, in particular, it is fairly common for each sponsor to invest in the project through a wholly owned subsidiary that, together with wholly owned subsidiaries of the other sponsors, will form an unincorporated joint venture to develop the project.
14.18 The motivation for adopting such an approach stems from a number of reasons, including:
14.19 Alternatively, it is also quite common for sponsors to invest in a downstream project by incorporating a project company. The relative rights and responsibilities of each sponsor with respect to the project and the project company will then be governed pursuant to a shareholders’ agreement. The decision to utilize a project company structure is often driven by a number of factors—namely, minimizing tax exposure, limiting liability, and limiting bankruptcy concerns, to name a few. Incorporating a project company, rather than utilizing an unincorporated joint venture, may often be a condition from the lenders in order to secure adequate funding as well.
14.20 The participants in the unincorporated joint venture will govern arrangements between themselves through a joint operating agreement (a ‘JOA’) (as opposed to a shareholders’ agreement adopted where the project vehicle is an incorporated project company). Pursuant to the JOA, the unincorporated joint venture participants are treated as ‘tenants in common’, each having an undivided interest in the licence or contractual arrangements with the host government, the project assets, and any hydrocarbons produced, in each case, in proportion to their participating interest in the unincorporated joint venture.
14.21 A JOA will appoint one participant as the operator who will lead the construction and operation of the project, including the scheduling and loading of the hydrocarbons produced. The operator will take instructions from an operating committee which usually consists of one representative from each participant. Each representative will typically have a voting right on the operating committee that is proportionate to its participating interest in the unincorporated joint venture.
(p. 393) 14.22 The operator leads the development of the project and enters into contractual commitments as agent on behalf of the participants. In order to cover the costs of such commitments, the operator will make cash calls on each participant in proportion to each participant’s participating interest in the project. Each participant is severally responsible for its share of the cash call, and, if a participant does not fund its share, its right to receive any production will (after delivery of certain notices and expiration of certain cure periods) be suspended and, typically, if the non-payment remains unremedied, then the defaulting participant’s interests in the JOA could be bought out, or sold, by the other participants on a discounted basis.
14.23 In order to ensure that the operator has the necessary funds to continue to implement the project though, the other participants are typically also obliged to meet a proportionate share of any unpaid cash call to the extent there is a non-payment from a defaulting participant. Failure to pay such additional amounts may also ripen into a default on the part of such other participants too. Cash calls paid on behalf of a defaulting participant will be reimbursable by the defaulting participant which can be recovered through an increased share of hydrocarbons being allocated to the non-defaulting participants as well as having a direct claim against the defaulting participant and, ultimately, the right to enforce the sale of, or to buy out, the defaulting participant’s interest.
14.24 JOAs also include provisions relating to assignments (including by way of security) and changes of control. Typically, assignments will only be permitted with the consent of each participant and will also be subject to a corresponding assignment of interests under the applicable framework agreement or licence as well, which also gives the host government a consent right over all proposed assignments (including by way of security). Each participant will usually also grant pre-emption rights to the other participants in connection with a direct sale of a participant’s interests in the project or in the event of a change in control of a participant (so that it ceases to be owned by the original sponsor). It is also not an uncommon feature in the oil and gas sector for participants to grant their co-participants a charge, or other similar security, over their interests in the JOA and the unincorporated joint venture (including the underlying licence or framework agreement). Such a charge will rank in priority to other security interests, if any, granted in favour of a participant’s lenders and this can give rise to complexities in developing a deed of priority to govern the competing security interests and claims that a participant and a lender may have against the particular participant.