Introduction

In a dispute arising in connection with a sale and purchase agreement for an interest under a Production Sharing Contract in the Congo, an English court (the Queen's Bench Division of the High Court of Justice) was asked to consider the meaning of “commencement of drilling.” The Court found that “commencement of drilling” occurs when the drill penetrated the seabed, that it was the natural meaning of the phrase, and that there was no reason to adopt a wider interpretation that encompassed the drilling operation as a whole and commenced with its preparations. In this article we summarise the case, and the Court’s findings.

Facts

Both Vitol E & P Limited (the “Claimant”) and Africa Oil and Gas Corporation (the “Defendant”), were involved in a Production Sharing Contract (the “PSC”) with the Republic of Congo. The parties to the PSC were granted a Research Permit (the “Permit”) for an offshore area known as “Marine XI” which could be extended to run for up to three consecutive exploration periods on the condition that at least one “Commitment Well” was drilled in the area in the preceding exploration period.

A Commitment Well had already been drilled within the second exploration period which ran from 1 April 2011 to 30 March 2013 and all the parties to the PSC were agreed that they should apply to renew the Permit for a third exploration period. However, certain parties to the PSC proposed to drill an additional well (the “Well”), known as a “Discretionary Well.” The Claimant was opposed to the Well but on 10 April 2012, a majority of the PSC members voted to include it in the work programme and budget ( the “WP&B”). The Well was confirmed as part of the approved 2012 WP&B at a further meeting held on 9 June 2012. As the Well was a committed budgeted item, the parties to the PSC would be liable for its cost whether it was completed within the budget period or not.

Around this time, the Claimant was approached by New Age (African Global Energy) Ltd (“New Age”), which was interested in acquiring the Claimant’s interest in the Marine XI area. Under the terms of the proposed sale between the Claimant and New Age, New Age would pay part of the consideration up front at the time of the transfer of shares, and then either (i) bear the Claimant’s share of the costs relating to the Well, or (ii) if the Well were to be removed from the WP&B or the drilling of the Well was not commenced before the expiry of the second exploration period, a deferred consideration payment.

However, the other parties to the PSC had pre-emption rights entitling them to purchase the shares from the party that wished to sell on the same terms as agreed with the proposed third party buyer, in this case, New Age. The Defendant decided to exercise this right and buy the shares from the Claimant. Under the agreement executed on 24 January 2013, the Defendant thus agreed to pay $12.6m at the time of transfer and then either (i) bear the Claimant’s $7.2m share of the costs relating to the Well, or (ii) if the Well were to be removed from the WP&B or the drilling of the Well was not commenced before the expiry of the second exploration period, a deferred consideration payment of $7.4m (the “Deferred Consideration”). Meanwhile, on 14 January 2013, the second exploration period was extended by the Congolese Minister for Hydrocarbons to run until 30 June 2013.

In April 2013, a drilling rig became available. A letter of award was issued on 14 May 2013 and a contract pursuant to the letter was agreed on 22 May 2013 under which the contractor was to transport the rig from Rio de Janeiro to the Republic of Congo. These agreements were therefore entered into prior to the expiration of the extended second exploration period. However, the rig did not arrive until 3 July 2013, after the end of the second exploration period, and the Well was not spudded until 20 July 2013.

The question before the Court

Thus, for the purposes of determining if the Claimant was entitled to the Deferred Consideration under the Agreement, and consequently if the Defendant was liable for the Claimant’s share of the costs of the Well under the PSC, the question before the court was whether the “commencement of drilling” occurred at the time when the initial agreements were entered into with the contractor or at the time when the drill actually broke through the seabed.

The decision

The Court held that “commencement of drilling” meant the physical penetration of the seabed and that, since this did not occur before 30 June 2013, the Defendant must pay the Deferred Consideration.

Reasons given

Citing Arnold v Britton^[1] in support of the proposition that generally words in a contract should be given their natural meaning and determining that the use of the word “drilling” in another clause of the contract did not indicate that the phrase should be given a wide interpretation.

Though they are not binding authority in the English courts, the Defendant presented some US cases in which preparatory acts such as bringing timber to build a derrick on to the land in anticipation of drilling were deemed to be commencing drilling, to the Court. However, the Court, like the US Federal Tax Court which examined this line of cases in a 2012 decision, distinguished them on the basis that the majority of contracts in those cases concerned leases where the term referred to “operations for drilling”, which is broader wording and may therefore encompass preparatory steps. The Court noted that there is a need for clarity and certainty where such a substantial payment is at issue and that including preparations was more susceptible to uncertainty than defining commencement as from spudding.

The Court found that adopting a broader interpretation of the phrase “commencement of drilling” did not serve the underlying commercial purpose of the contractual term and that it was not unfair to adopt a narrower interpretation and limit the protection offered by the clause to the Defendant. The parties had already agreed to restrict the protection by specifying a cut-off point, either when the Well was removed from the WP&B or when drilling began. Furthermore, it was particularly difficult to see how it could be deemed unfair when the Defendant still benefitted from significant protection under the clause and the narrow interpretation produced a workable result that was neither commercially absurd nor objectively unreasonable. The Defendant’s argument that the protection should be made available if it is known that there will be a drilling of the Well also failed because: first, this rationale is not made explicit in the relevant clause itself; and second, because this would mean that commencement would have to be interpreted as the passing of some “point of no return” from which liability for the Well is incurred, but the Defendant’s case was not put to the Court in this way, instead it relied on the fact of mobilisation of the rig as signalling commencement.