Oil and gas joint venture parties not bound by good faith or rationality when discharging operator

The parties owned oil and gas field blocks through an unincorporated joint venture governed by joint operating agreements.  The defendant acted as operator of the field blocks.  The claimants invoked a change of operator clause in the agreements, which stated that the “Operator may be discharged… by the Operating Committee giving not less than ninety (90) days notice to it” provided that the non-operating parties approved the discharge by unanimous vote.  The claimants’ intention was to substitute the first and second claimants as operator; and the first and second claimants had agreed to indemnify the third and fourth claimants for any transition costs exceeding a certain cap. 

A dispute arose as to the validity and effect of the notices of discharge.  The defendant alleged that the right to discharge was qualified by duties of good faith and rationality, either through interpretation of the agreements (the interpretation issue) or implication of terms based on: (i) a Socimer/Braganza contractual discretion (the Braganza issue); or (ii) the agreements being Yam Seng relational contracts (the Yam Seng issue).  

No qualification as a matter of interpretation 

On its proper interpretation, the court found that the right to discharge the operator was unqualified.  Relevant factors included:

• the use of clear and unambiguous language: the right to discharge was a binary decision involving no evaluatory or adjudicatory exercise;  
• the parties’ drafting convention evidenced through other clauses in the agreements:  where a right was intended to be unqualified, it was simply described as a right, without stating that it was unqualified.  Conversely, as seen in other clauses, the parties could and would have expressly included a qualification if that was their intention; and
• the parties’ common understanding of the nature of the relationship: there was no partnership or quasi-partnership.  Where interests ceased to be aligned, the parties were free to act in their individual best interests.

Braganza issue: reluctance to imply a duty of rationality in commercial context

The court reiterated prior case law on the basic test for implication of terms.  It noted that particular care is required when considering implying terms into a sophisticated and professionally drawn and negotiated agreement between well-resourced parties (such as in this case).  Where an issue had been left unresolved, it was much more likely to be the result of choice rather than error.  Where detailed, professionally-drawn contracts exist, it is more difficult to imply terms because there is a strong inference that the parties have given careful consideration to all the terms by which they agree to be bound (following UTB LLC v Sheffield United Ltd [2019] 2322 (Ch)).

In Braganza v BP Shipping [2015] 1 WLR 1661, the Supreme Court approved the Court of Appeal’s statement in Socimer International Bank Ltd (In liquidation) v Standard Bank London Ltd [2008] EWCA Civ that “…a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality”. 

However, on the present facts, it was not necessary to imply any duty of rationality or good faith either in order to give business efficacy to the joint operating agreements or in order to give effect to what was so obvious that it went without saying.  Prior case law established that Braganza duties had no application to unqualified termination provisions in expertly drafted, complex commercial agreements between sophisticated commercial parties.  Here, the right to discharge the joint venture operator was assimilated to the right to terminate a contract. 

Braganza and commercial contracts

More generally, the court expressed doubt over the application of Braganza to absolute rights in commercial contracts. Absolute rights conferred by professionally drawn or standard form contracts – including but not limited to absolute rights to terminate relationships and roles within relationships – were an everyday feature of contracts that govern commercial relationships.  Extending Braganza to such provisions would be an unwarranted interference in the freedom of parties to contract on the terms they choose, at any rate where there was no fiduciary relationship.

Yam Seng issue: not all relational contracts include implied duty of good faith

In Yam Seng Pte v International Trade Corp [2013] EWHC 111 (QB), a duty of good faith was implied into a “relational contract”, the definition of which included “a contract governing a long term relationship to which the parties make a substantial commitment”. Examples included some joint venture agreements, franchise agreements and long-term distributorship agreements.

Here, the court treated the joint operating agreements as being, at least arguably, relational contracts within the meaning of Yam Seng.  However, not all relational contracts would attract an implied duty to act in good faith, as the basic test for implication of terms still applied. 

The court held that it was not necessary to imply a duty to act in good faith obligation in relation to the exercise of the right to discharge the operator.  On its true interpretation, the right in question was absolute and unqualified.  As the parties had legislated on the terms of the relationship, it was not necessary to imply such a term in this case.

Braganza duty would have involved a review both of process and outcome

Despite the fact that the court had rejected the proposed implied duties, it considered the content of a hypothetical implied Braganza duty and applied it to the facts, on the parties’ request. 

The court commented that where a Braganza duty is implied, both the decision-making process and the substantive decision itself would come under review:

• First, did the decision-maker take into account something that it should not have, or fail to take into account something that it should have?
• Second, was the decision that was reached so unreasonable that no reasonable decision-maker, occupying the position of the maker of the decision under challenge, could have reached it?

The court added that each claimant would be considered separately; that the weight given to any particular factor was a matter for the decision-maker; and that where a mixture of material and immaterial factors had been taken into consideration, the court should ask whether the party concerned would still have made the same decision by reference to the material factors.

After considering evidence as to each claimant’s motivations, the court concluded that, even assuming that its decision on the implication of terms was incorrect, the claimants did not breach any implied qualification.  Even aside from the first and second claimants’ wider commercial best interests in taking over operation of the fields, each claimant had considered the discharge to be in their best interests based on genuine concerns about the risks of the defendant continuing as operator.  The fact that the first and second claimants had agreed to indemnify the third and fourth claimants for any transition costs over a costs cap did not invalidate the decision.  The claimants’ decision to discharge the defendant as operator was therefore upheld.   

Comment

Good faith-type arguments have been raised in a number of first instance cases, based on the Yam Seng and Socimer/Braganza decisions on good faith in relational contracts and implied duties of rationality.  The developing case law in this area and the fact-specific nature of disputes provide multiple angles for challenging a contractual counterparty’s actions, although ultimately such challenges have tended to fail in the context of detailed commercial contracts.  As Professor Ed Peel has said, the good faith cat is now out of the bag. 

On a practical level, this case shows the value of having contemporaneous evidence of the reasons for exercising contractual rights.  Decision-makers should be aware that their beliefs and motivations may come under close scrutiny.

Further information

For more information please contact Amy Edwards, amy.edwards@allenovery.com.