Apache North Sea Ltd v Euroil Exploration Ltd & Anor

An oil and gas farm-out agreement and an associated joint operating agreement may be construed as a single contractual package without being merged. Where the farm-out agreement makes AFEs, invoices and payment subject to the joint operating agreement, its accounting procedure may govern the amount recoverable, not merely the timing or mechanics of payment. A provision capping charges for operator-supplied leased or hired equipment at prevailing market rates can therefore limit recoverable drilling costs. Words such as whensoever incurred do not necessarily exclude that cap. An inconsistency clause applies only where the instruments objectively conflict. The construction remains dependent on the precise wording of the bespoke agreements.

Apache North Sea Limited entered into a farm-out agreement with Euroil Exploration Limited concerning interests in UK Continental Shelf licences. Euroil agreed to pay specified proportions of the costs of drilling an earn-in well. Edison S.P.A., Euroil’s parent, guaranteed its payment obligations. The associated Val D’Isere Joint Operating Agreement contained an accounting procedure limiting charges for operator-supplied hired equipment to prevailing market rates.

The High Court held that the recoverable drilling costs were capped by market rates and dismissed Apache’s claim: 2019 EWHC 3241 (COMM). Apache appealed, arguing that the farm-out agreement required payment of its actual costs and prevailed over the joint operating agreement. The central issue was how the two agreements interacted and whether the accounting procedure governed the amount payable.

1. Appeal dismissed. The Court of Appeal, in the judgment of Carr LJ agreed with by Peter Jackson and Lewison LJJ, upheld the dismissal of Apache’s claim. The agreements were bespoke, so the conclusion was contract-specific and did not establish a general industry-wide rule.
2. Contractual construction. The court applied the objective and unitary approach described in Arnold v Britton and others [2015] UKSC 36, Rainy Sky SA v Kookmin Bank [2011] UKSC 50 and Wood v Capita Insurance Services Ltd [2017] UKSC 24. The language had to be read with the agreement as a whole, its purpose and relevant commercial context. Clear language was not to be rewritten merely because it produced an imprudent bargain.
3. Interaction of the agreements. The farm-out agreement and the joint operating agreement formed part of one contractual package. References in the farm-out agreement to AFEs, invoices and payment in accordance with the relevant JOA showed that the agreements were to be read together. Clause 3.1 concerned both the mechanics and the amount of payment. The words whensoever incurred established when costs could be recovered but did not exclude a limitation on the amount recoverable.
4. Market-rate cap. Drilling was a joint operation and its costs had to be charged to the Joint Account under the Accounting Procedure. Paragraph 3.2.4 of Schedule 1 therefore applied. Charges for equipment leased or hired by the operator could not exceed rates prevailing for like equipment supplied by unaffiliated third parties. Euroil’s 26.25% liability under the farm-out agreement was measured by those capped costs.
5. Inconsistency clause. Applying Pagnan SpA v Tradax Ocean Transportation SA [1983] All ER 565 and Alexander v West Bromwich Mortgage Company Limited [2016] EWCA Civ 496, a conflict required more than qualification or modification. The provisions had to contradict each other or be incapable of sensible and fair operation together. There was no such conflict.
6. The respondent’s alternative defence was not allowed to be advanced for the first time on appeal because it raised significant new factual issues and no good reason for the omission was shown. Permission to appeal the costs order was refused. The trial judge’s costs discretion had not exceeded the generous ambit within which reasonable disagreement was possible.

1. Court of Appeal (Civil Division): Appeal dismissed. Permission to appeal the costs order was refused.
2. High Court of Justice, Commercial Court: HHJ Pelling QC dismissed Apache’s claim, holding that recoverable drilling costs were capped by market rates: 2019 EWHC 3241 (COMM).