OEUK Decommissioning Security Agreements – Default Provisions

It is crucial to the operation of the arrangements set out in decommissioning security agreements (“DSA”) that parties post the required security within the timelines set out in the DSA as well as comply with their other obligations under the DSA. To enforce this requirement (and in common with many types of contracts), DSAs will include default provisions to cover various circumstances which may impact on the amount of availability of the security provided under the contract.

The consequences of default when such circumstances arise differ depending on the specific terms of the provisions. In this article, we focus on the default provisions set out in the OEUK template PRT and Non-PRT Decommissioning Security Agreements (the “OEUK DSA”)[1].

Default under the OEUK DSA by a Licensee

Under the OEUK DSA, a default event is described in clause 8.1 as arising when a Licensee:

(i) fails to comply with particular provisions in respect of the Provisional Amount, Additional Amount or Alternative Provision;

(ii)  fails to pay an invoice issued under the DSA when it falls due;

(iii) receives a notice of default from the Operator under the joint operating agreement (“JOA”) for the relevant field(s);  

(iv) becomes insolvent;

(v) fails to pay the relevant Trustee the Provision Amount or provide replacement Alternative Provision within a certain time when requested by the Operator in circumstances where the issuer of any Alternative Provision becomes insolvent;

(iv) fails to pay the relevant Trustee the Provision Amount or provide replacement Alternative Provision within a certain time when requested by the Operator in circumstances where the issuer of any Alternative Provision ceases to be a “Qualifying Surety”;

(vii) fails to pay the relevant Trustee the Provision Amount or provide replacement Alternative Provision within a certain time when requested by the Operator in circumstances where the issuer of any Alternative Provision, in the case of a guarantee ceases to be the ultimate holding company/Affiliate of the Licensee;

(viii) fails to enter into a Trust Deed within a certain time following notice from the Operator;

(ix) fails to renew or replace any Alternative Provision as required under the OEUK DSA or to make payment to the relevant Trustee within a certain time of notice from the Operator

(x) (optional under the OEUK DSA) fails to make payment to the relevant Trustee where, if applicable, there has been a material adverse change in any fact or matter on which Counsel’s Opinion expressly relies (in the reasonable opinion of the Operator); and

(xi) being a sole Licensee, fails to carry out its obligations to submit and/or undertake any part of a Statutory Decommissioning Programme within any time limit stipulated by the Secretary of State pursuant to the Act.

The focus is on ensuring that the full amount of security is posted in a timely manner, and will ultimately be available to meet decommissioning costs if required, in accordance with the terms of the DSA.  A failure to do so may arise not only where a Licensee fails to make its own security posting, but also where the security provided becomes defective for any reason (for example, where difficulties arise with the issuer of any Alternative Provision (which may be in the form of a parent company guarantee, bond or letter of credit)).  If that does not happen, the process for addressing a default is intended to allow the non-defaulting parties to step in quickly (in some instances, having allowed the defaulting party a period to remedy the failing) to ensure that the default is remedied or that alternative measures are put in place. 

In that context, it is notable that a default under the relevant JOA is a cross-default under the DSA, reflecting the close interaction of the two agreements. Similarly, and underlining the importance of ensuring adequate decommissioning security is in place, a default under the DSA will be a cross-default under the JOA.  That means that a party which fails to post security in accordance with the DSA can very quickly lose all of its rights to participate in the management of the underlying asset (for example, being excluded from operating committee meetings and denied any information pertaining to ongoing operations) and ultimately its participating interest share in the operations. In some ways, many of these events of default can be considered as early warning signs – i.e. if a party is in default of its payment obligations under the JOA, it may be indicative that there are wider solvency issues and therefore there may be a need to take steps to protect the security.

Default process

Where a Default occurs, clause 8.2 provides that each Licensee undertakes to promptly notify the Operator and Trustee “as soon as it becomes aware” of any Default. Responsibility for identifying and taking steps to address any failure falling within the list set out in clause 8.1 is therefore not only the responsibility of the Operator but rather of all of the parties to the DSA. 

When a Default is identified by or notified to the Operator, the Operator is required to serve a Default Notice on the Trustee to take steps to realise any Authorised Investments and/or any Alternative Provision made by or relating to the Licensee – this has the consequence of converting any Alternative Provision to cash, to be held on trust by the Trustee.

Optional wording is then contained in Clause 8.3 of the OEUK template, providing mechanisms by which the non-defaulting parties under the DSA are then required to meet any shortfall in the security amount posted by or held for the defaulting Licensee (whether that shortfall arises because of a failure by the defaulting Licensee to post security as required, or because of issues that have arisen with any Alternative Provision of that defaulting Licensee). Under these optional provisions, the Defaulting Licensee can remedy the Default at any time prior to the forfeiture or transfer of its License Interest (as per the default provisions set out in the JOA) by meeting in full all debts that have arisen as a result of the Default, including posting such security as is required and paying interest to the non-defaulting parties that have ‘stepped in’ to meet the outstanding amounts in the interim.

Where the Default is not remedied and the Defaulting Licensee’s License Interest is forfeited/transferred under the JOA, clause 8.4 sets out a process by which the Defaulting Licensee’s security amount as held by the Trustee is allocated to the trust accounts of each of the non-defaulting Licensees, in proportion to their interest share, and the non-defaulting Licensees are required to make up any shortfall. In that instance, the Defaulting Licensee is then indemnified by the non-defaulting Licensees in relation to decommissioning costs up to the amount that is transferred to that non-defaulting Licensee’s trust from the Defaulting Licensee’s trust.  If there is a shortfall when it comes to the actual costs of decommissioning, the Defaulting Licensee is required to meet its share of costs over and above the amount secured from its trust – although in practice, depending on the circumstances of the default and subsequent forfeiture, there must be a reasonable likelihood that it will not be able to meet any claim for such a shortfall.

Default under the OEUK DSA by the Operator

The OEUK DSA also sets out provisions covering circumstances where it is the Operator that is found to be in Default. Under clause 8.5, if an Operator fails to carry out any of its obligations under the OEUK DSA in any material respect, the failure shall constitute a breach under the JOA justifying removal of the Operator. In that instance, one of the other Licensees may take over the obligations of the Operator, or in the event the Operator is the sole Licensee, the Second Tier Participants may be permitted to appoint an Operator in the circumstances.

In extreme circumstances, clause 8.6 provides for circumstances where the Operator fails to carry out its obligation under the OEUK DSA, the Operator is the sole Licensee, there are no Second Tier Participants (or none willing to take on the role of Operator), and another entity is the recipient of a section 29 Notice (i.e. a notice from the Secretary of State confirming that such entity has a duty to carry out a Statutory Decommissioning Programme).  In that (likely rare scenario) then a novation may be entered under which the entity with the decommissioning obligation accepts and assumes all of the rights and obligations of the Operator.

Consequences of Default Provisions

The default provisions in the DSA are designed to ensure that each of the parties posts each year the full amount of security that has been calculated in accordance with the DSA as being required such that all stakeholders (including those not directly party to the DSA itself) obtain comfort that relevant decommissioning costs will be met at the relevant time. A failure to do so has very serious potential consequences, both under the DSA and the JOA.  The sums likely to be involved make it important that non-defaulting Licensees are able to move quickly to protect their interests and ensure that adequate decommissioning security is in place.   The importance of these arrangements is underlined by the cross-default arrangements between the OEUK DSA and the OEUK template JOA – giving a direct route to forfeiture by a Defaulting Licensee of its interest in the underlying assets if it does not provide adequate insurance in accordance with the time and other requirements of the DSA. 

For parties entering into the OEUK DSA, it is worth considering in practical terms how the default provisions under the OEUK DSA play out in practice when working alongside the provisions under the JOA, particularly those relating to forfeiture/transfer of interest and default, to ensure that the necessary processes are streamlined and complimentary, and do not create a greater burden on the non-defaulting Licensees than is necessary to achieve the overall aim.

Next Steps

Future Law-Now articles in this series will consider how other jurisdictions are addressing the question of how the costs of decommissioning are met.