With energy prices trending up and the U.S. economy on the rebound despite the COVID-19 pandemic, some oil and gas companies will move quickly to take advantage of this upswing in the business cycle. As business picks up, now is the time to take stock of lessons learned from a downturn by putting in place practices and procedures to ensure that contracts are getting the attention they deserve both during formation and implementation. These practices can fall by the wayside when business is moving quickly, and the going is good, which comes back to haunt companies when the business cycle inevitably enters another downturn and litigation picks up. Dedicating more time and attention to contract formation and implementation – including review by legal counsel – can help to avoid the many pitfalls that companies encounter in relying too heavily on draft contracts provided by counterparties or on outdated off-the-shelf forms that may not fit the current situation.
Don’t leave anything open to interpretation
The biggest problem we see with any contract, including oil and gas contracts, is ambiguity. Oil and gas businesses, in particular, have their own language and shorthand for deals, and the parties may believe there is an understanding as to the intent of contract language, even if it is not precise. Problems emerge when business deals go sideways during a downturn, and suddenly one party is looking for an out while the other is reading the contract for enforcement. Consequently, it is critical that contracts precisely define the contract term, performance metrics and termination rights.
Uncertainty can also be created by the lax enforcement of contracts. Too often, once a contract is signed, it goes in a drawer, and nobody pulls it out until a dispute arises. Failure to properly implement and monitor contract performance risks waiver of contractual rights if a dispute later arises. Conversely, significant financial liability can accrue for years based on penalty or bonus provisions that neither side pays attention to while business is good. Companies should put in place proper procedures for the appropriate department, whether accounting, land or legal, to systematically monitor contract performance.
Don’t ignore boilerplate clauses
Provisions that are generally viewed as “boilerplate” can have significant consequences when disputes arise. Oftentimes, important provisions are missing altogether or do not reflect what was intended. For example, when moving quickly, parties tend to pay little attention to dispute resolution, forum and venue selection, insurance requirements, termination rights, available remedies and attorney fee-shifting, all of which can shape the path of litigation if it becomes necessary. Litigation will quickly become uneconomical if a party is required to litigate in a far-off forum with no ability to recover its attorneys’ fees even if it wins. Legal fees can pile up quickly and can easily wipe out a damages award.
The lesson of 2020
The biggest contract takeaway from 2020 is simple: Pay attention to your force majeure clauses. Whether or not those clauses covered a pandemic became critically important during 2020. Going forward, the scope of these provisions will receive much greater attention and could be a hot-button issue during contract negotiation. You should assess the risk of force majeure events and whether your company would want to excuse or enforce performance and then shape the force majeure clause accordingly. A full explanation of force majeure is beyond the scope of this article, but at a minimum, companies should be strategic in how these provisions are crafted going forward.
A bullet-proof force majeure clause may be out of reach in some contract negotiations, as may other contract protections such as obligation-free exits. But these are good starting points in negotiations as you decide how to balance risks and opportunities and, regardless of how the negotiations turn out, paying attention to these details will allow you to go into a deal with eyes wide open.
The oil and gas business attracts people who are comfortable with risk. As lawyers, our mindset is to be risk-averse, and so our lens for reviewing a contract is to assume that anything that can go wrong will go wrong. Spending a little time and money on the front-end to focus on contract formation and implementation can go a long way toward avoiding significant and unexpected financial consequences. Having an attorney review your contracts may be the most cost-effective insurance you can buy for your oil and gas business.
Benjamin J. Larson and James J. Killean are directors at Ireland Stapleton (Denver, Colo.) who counsel oil and gas businesses on a number of legal matters related to their day-to-day operations. They may be reached at [email protected] and [email protected].