Having conducted a number of oil and gas arbitrations before the American Arbitration Association (AAA), this article is intended to provide some thoughts on the process for those who may become involved in such proceedings. While this article references the AAA, these recommendations are offered for consideration regardless of the forum. As with all litigation, there are unlimited issues that could be addressed in an article such as this and it would be impossible to meaningfully cover more than a select few.
Sophisticated oil and gas companies typically have agreements requiring that all disputes arising out of those agreements should be addressed in arbitration. The preference for arbitration has often been driven by the presumed efficiencies of the arbitration process. Further, oil and gas companies tend to agree that the unique and specialized nature of the industry makes the resolution of a dispute better situated in a process conducted by an arbitrator having actual knowledge and expertise in oil and gas. Thus, the controlling arbitration provisions in many oil and gas agreements have specified that an arbitration be conducted before the AAA.
Know which rules apply
Oil and gas agreements are commonly no different from other extensively negotiated and exhaustively drafted commercial agreements in that they often include a boilerplate arbitration provision. While not intended as criticism, business lawyers charged on both sides with closing a substantial commercial oil and gas deal may often overlook, or be unfamiliar with, the practical realities of litigation when it comes to the drafting of an arbitration provision. Business lawyers for good reason are well-versed and focused on the discrete commercial terms and conditions unique to the oil and gas industry and the pending deal. To get that deal done, they may have focused substantial attention on the specific business terms yet resort to the easy “cut and paste” insertion of a boilerplate arbitration provision. Thus, after a dispute has arisen, the parties could be stuck with a boilerplate arbitration provision that was not meaningfully negotiated or considered.
It is not uncommon then for farm-out or operating agreements to include boilerplate arbitration provisions such as the following:
The Parties agree that any controversy or dispute arising out of or involving this Agreement will be addressed before the American Arbitration Association in accordance with the rules then followed by the AAA and to be held in Pittsburgh. The losing party shall reimburse the winning party for all of its legal fees and for all other costs associated with the arbitration.
With such a generalized provision, the first issue is, what rules actually apply? Of the AAA’s available rules, the only ones that are really applicable are the Commercial Arbitration Rules (the “Commercial Rules”). In fact, Commercial Rule R-1(a) states that in those domestic commercial disputes where the applicable rules are not specified in an arbitration provision, the AAA’s Commercial Rules shall apply.
The AAA will apply its “Large, Complex Commercial Dispute” procedures for any claim in excess of $500,000. Conversely, the AAA’s “Expedited Procedures” will apply when the claims are less than $75,000. These rules are available on the AAA’s website (www.adr.org) for comparison. The parties can always agree on what rules should apply to a particular case and inform the AAA accordingly. In addition, it is important to note that the parties can also modify the applicable rules by written agreement before an arbitrator is appointed. Once an arbitrator has been appointed, the Commercial Rules cannot be modified without his or her consent. See Commercial Rule R-1(a).
Carefully select a qualified arbitrator
The AAA has a “National Roster” of distinguished and qualified individuals who have expressed an interest in serving as an arbitrator for all types of disputes. It is beyond dispute that the oil and gas sector is unique with terminology, practices, financial modeling and expectations that may not be thoroughly appreciated and readily understood by those who have not had firsthand experience in the sector. For obvious reasons then, a qualified arbitrator who understands the economics of the industry as well as the language and intent of such agreements as a farm-out or an operating agreement, or the evolving law on post-production deductions, is crucial. Concerns have arisen that some seeking to serve as arbitrators have overstated their actual oil and gas experience in order to be considered.
This is not to say that many are not qualified and capable arbitrators. Rather, caution is given that oil and gas clients and their attorneys should not be surprised that an initial roster of proposed arbitrators may be disappointing. Regrettably, there is a perception that some may have chosen to insert the key words “oil and gas” in their biographical work experience descriptions in order that the AAA will identify and include them in the initial proposed roster for an oil and gas arbitration. Of course, parties should also be prepared to receive an initial roster from the AAA that will include some very qualified oil and gas candidates.
If an initial roster is provided by the AAA with perceived deficiencies in the qualifications and/or experience of the candidates, it will become necessary for the parties and their attorneys to work with one another to address the problem. Experience has shown that the AAA is receptive when the parties jointly request a new roster and/or provide additional criteria for the inclusion of additional candidates. For those who may be inexperienced with the AAA, there is no requirement that you must choose from a dissatisfactory roster of AAA candidates. If the parties desire to have an eminently qualified and well-versed individual who is not on the AAA roster serve as the arbitrator, they can insist that the AAA abide by that decision. Upon such an election, the AAA will continue to administer the case and the chosen arbitrator will have to provide the AAA’s required conflict disclosures and take the required oath. Reaching an early agreement on a qualified and respected oil and gas attorney to handle the dispute should be a relatively easy matter.
Managing discovery in arbitration
Commercial Rule R-22(a) provides that the arbitrator “shall manage any necessary exchange of information among the parties with a view to achieving an efficient and economical resolution of the dispute.” In the context of an oil and gas case, an exchange of documents under Commercial Rule-22(b) is typically the efficient and cost-effective way to proceed. Because there are typically no depositions, some parties seek additional discovery in the form of “limited” interrogatories and often try to persuade the arbitrator that they will “narrow” the issues for the hearing. This is rarely the case.
Sophisticated oil and gas companies often have been parties to a subject agreement for many years and presumably know all of the pertinent facts arising out of their business relationship at issue in the dispute. Unless there is a truly compelling need or unique circumstances, parties should not plan on additional forms of traditional discovery in arbitration.
Recovering the full measure of damages
One area that warrants careful consideration is the necessary steps to properly claim and recover the full measure of damages. As an example, consider an arbitration where the claimant is a working interest holder in a natural gas well and claims that the respondent operator has improperly deducted gathering fees and marketing fees from the sale of the gas. In such situations, the operator typically issues a distribution statement to the working interest holder several months following the sale. Thus, a statement received in June will only reflect net distributions from sales through the preceding April.
If the working interest owner claims in the arbitration that the operator has taken improper deductions, the working interest owner will not have an up-to-date damage calculation because of the time lag in the issuance of the distribution statements. This facet of the oil and gas industry highlights the discussion above concerning the importance of appointing a truly qualified oil and gas arbitrator who understands this about the business.
Because the AAA typically requires the parties to exchange their exhibits, including damage summaries, approximately 30 days before the hearing, the working interest owner will not have up-to-date distribution statements to bring its damages claim current through the date of the hearing. Accordingly, after offering evidence as to why the nature or amount of the deductions was improper, the claimant working interest owner should be prepared to explain to the arbitrator why the damage claim is not current or “final” and why the claimant must be allowed to supplement the damage calculation upon receipt of the subsequent distribution statements from the operator.
It is therefore recommended that in such situations where the calculation of total damages will be subject to a time lag, claimants and their attorneys must inform the arbitrator during the hearing (and in a written submission filed with the AAA for extra measure) that they desire to leave the record of the proceedings open under Commercial Rule R-39 if necessary to supplement the calculation of damages. If the parties are to submit post-hearing submissions of proposed findings of fact, etc., the claimant can use the submission to further add to its damages with the appropriate supporting documentation.
This may not entirely protect the claimant’s full claim for damages after the record has closed. This is because the arbitrator typically will have thirty days to issue an award after the record has been closed. See, Commercial Rule R-45. During those thirty days, the calculation of the claimant’s damages could continue to grow from the continued deductions taken from the ongoing production and sale of the gas from the well. Yet, after the record has been closed, the claimant will not have a formal process to supplement the calculation of those additional damages.
If the arbitrator ultimately holds that the deductions were improper, the claimant and its attorney should be given fair opportunity to supplement the claim for damages with the additional deduction amounts that were disclosed in distribution statements that were unavailable during the hearing or in time for the post-hearing submissions. It is for this very reason that a claimant and its attorney should make it clear before, during and after the hearing that they seek an interim, and not a final, award under Commercial Rule R-47(b).
It is further recommended that claimants and their attorneys in an oil and gas case involving claims of improper deductions should offer to submit a detailed proposed order for the arbitrator to understand the continuing potential accumulation of damages from the ongoing production. Thus, under Commercial Rule R-47(a), a claimant and its counsel should submit a proposed order initially directing specific performance from the operator and/or precluding the challenged deductions after the date of the award. The proposed order should also provide for continuing jurisdiction by the arbitrator to receive additional evidence of the claimant’s deduction damages under Commercial Rule R-47(b).
Upon submission of a calculation of the most up-to-date damages, the final award can then be issued under Commercial Rule R-47(c). Indeed, for those agreements that also provide for an award of attorneys’ fees such as in our example above, any party seeking to make such a claim may want to follow a procedure such as this because they will: (a) not know who was the “winning” party until after an interim award has been issued; and (b) the total attorneys’ fees incurred will not be known or quantified until after the hearings have concluded. A structured interim award process provides a procedural mechanism for the submission of attorneys’ fees claims to the arbitrator to be included in the final award.
Dan McLane is a trial lawyer with Eckert Seamans’ Energy Group who has extensive experience representing a wide variety of corporations in complex commercial litigation.