Mosburg 1-30-99-3a

AREA OF MUTUAL INTEREST PROVISIONS

By Lewis G. Mosburg, Jr.

Part One: Introduction

Including or objecting to an "AMI" clause is something which the explorationist must consider in connection with a number of the contracts he negotiates. The Area of Mutual Interest provision is quite common in Joint Operating Agreements and Farmouts;¹ and AMIs are the rule rather than the exception in Seismic Options and Exploration Agreements.²

Although the Area of Mutual Interest provision is most commonly encountered in the type of contracts just mentioned, any agreement for the processing of acreage can (and possibly should) include an AMI clause. Occasionally, AMIs can be seen as independent, "stand alone" agreements; and the same reasons discussed in a later part of this series that dictate including an AMI in a Farmout, Joint Operating Agreement, or Seismic Option could be equally applicable to a Support Agreement.

Special consideration must be given the treatment of subsequently acquired leases in Farmout Agreements. Any "Lease Exhibit" identifying the "Farmout Leases" can list only those leases currently owned by the Farmor. However, either the Farmor or the Farmee may subsequently acquire additional Leases within the "Farmout Area." What will be the rights of the nonacquiring party as to such subsequentlyacquired Leases?

The subsequentlyacquired Lease problem involves three different situations:

Leases acquired by the Farmor during the Farmout Agreement's "earning period";
Extensions and Renewals of Farmout Leases;
Other Leases acquired in (or in the vicinity of) the Farmout Area by either party, often as a result of the additional information secured by the drilling of the Earning Well.

Even when the parties have determined that each should generally be free to acquire Leases solely for its own account, Leases acquired by the Farmor during the earning period to round out its Lease Block will usually be committed to the Farmout Agreement. Whether or not the Farmee will be required to directly pay any part of the cost of acquiring these Leases will be a matter of negotiation between the Farmor and the Farmee. However, these Leases which the Farmor acquires currently, without finding it necessary to wait for the results of the drilling, normally will not remain the sole property of the Farmor, even though there is to be no general right to share in subsequentlyacquired Leases.³

As is true of the "rounding out" Leases, both the Farmor and the Farmee are normally given the right to share in extensions and renewals of Farmout Leases, irrespective of which party renews those Leases;⁴ similarly, Joint Operating Agreements normally call for the opportunity to share in extensions or renewals of the agreements' "Joint Leases."⁵ Here, though, the nonacquiring party will be expected to bear its proportionate part of the cost of extension or renewal.⁶

Whether subsequentlyacquired Leases that do not fall in these "rounding out" or extension/renewal categories are to be subject to any such rights is a subject for negotiation between the parties as to whether or not a general Area of Mutual Interest provision is to be included in the agreement. Hopefully, there will be such negotiations; and the contract will clearly specify that an AMI is – or is not – to exist between the parties to the agreement.

However, what if the agreement is silent? The courts have split over this issue. Some courts hold that a fiduciary relationship exists among the parties which prohibits one party acquiring leases strictly for its own benefit. Others reach the opposite result, either on the basis that no such fiduciary relationship exists, or that its impact does not extend to "forcing" an AMI arrangement among the parties.⁷

Coming Next: "Advantages and Disadvantages of Forming an Area of Mutual Interest"

¹"Quite common" doesn't mean that you will see the AMI provision in fifty percent or more of these agreements. (In our next article, we'll discuss when you would want to use an AMI and when you would like to avoid it.) However, it's certainly to be expected that including an AMI will at least be considered when JOAs or Farmouts are being negotiated.

²Seismic Options and Exploration Agreements, to be successful, call for a high degree of cooperation between companies that work well together. For this type of an arrangement to work, an AMI normally is called for.

For further information about Seismic Options and Exploration Agreements, see Lewis Mosburg's five-part article on "The Use of Seismic Options and Exploration Agreements as Exploration Tools," and Fred Davis' "From the Trenches: Seismic Options: Come On, Let Me Have a Peek" both contained elsewhere in this Newsletter.

³It is not equally well established as a matter of industry practice that the Farmor will share in Leases acquired by the Farmee during the Farmout period; and it is unusual for the Farmor to have a right to acquire an interest in Leases already owned within the Farmout Area by the Farmee. Still, the parties will often decide to "pool" their rights by entering into a Working Interest Area (Joint Operating) agreement in conjunction with their Farmout.

For more information about Working Interest Areas, see Lewis Mosburg's Internet Oil & Gas Primer on JOINT OPERATING AGREEMENTS, contained elsewhere in this Newsletter.

⁴A party to a Farmout has been known, in the past, to "top lease" a Farmout Lease owned by his "partner" in the Farmout venture. (This has not, historically, improved his Farmout relationship!)

The Model Form Operating Agreements of the American Association of Petroleum Landmen provide for such an opportunity to share: see Lewis Mosburg's Internet Oil & Gas Primer on JOINT OPERATING AGREEMENTS, op. cit. n. 3.

⁶Occasionally in a Farmout, either the Farmor or the Farmee will be obligated to "use his best efforts" to secure the extension or renewal of a "short fuse" Farmout Lease at its own expense.

⁷At issue is the concept that an operating agreement creates a "joint venture" among the parties, with a fiduciary relationship being created through this joint venture arrangement. For an excellent discussion, see Williams & Meyers, Oil & Gas Law, §§437 – 437.1.

For a key case permitting a Non-Operator to share in acquisitions by the Operator where no such sharing was dictated by the express language of the operating agreement, see Schmude Oil Co. v. Omar Operating Co., 184 Mich.App. 574 (1990).

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