Marathon Oil UK LLC v Centrica Resources Ltd & Ors

This case concerns the contractual arrangements between the parties under two joint operating agreements (“the Agreements”) for operations in the Brae fields in the North Sea. The first is dated 25 January 1980 and carries the title “Joint Operating Agreement”. The second is dated 19 September 1990 and entitled “Unitisation and Unit Operating Agreement”.

The Claimant (“the Operator”) was designated as the operator. The Defendants (“the Participants”) comprise some of the participants in the ventures.

The question between the parties concerns the costs of staff employed by the Operator (in practice through an affiliate) in connection with the operations. More specifically the question is whether the Participants are liable to meet a share of a proportion of deficit recovery charges (“DRCs”) in respect of a defined benefit pension scheme (“the Scheme”) of which some of those employees were beneficiaries.

The reference to a share is to the share of the costs of operations for which Participants were, between them, responsible. A proportion only is involved because the Scheme included some employees who did not work on operations in the Brae fields, and some who worked on operations there for some periods and on other unrelated tasks for other periods.

The Participants say that they have no such liability as a matter of contract. In the same connection, they also contend that the Operator owes fiduciary as well as contractual duties and is in breach of both in a way that relieves the Participants of liability.

There is no material dispute that the employees were required for the operations, or other than properly selected for employment, or as to any other aspect of the costs associated with their employment.

Following the trial, work has continued on the quantum aspects of the case. In the event the parties requested that I confine this judgment to questions of liability only at this stage.

The parties were content to treat the Agreements as materially identical. I shall focus on the JOA, as they did.

Clause 5 of the JOA provided:

“…

5.2

In accordance with approved programmes and budgets and under the overall supervision and direction of the Operating Committee, and subject to this Agreement, Operator shall have exclusive charge of and shall conduct all operations under this Agreement either by itself or by its duly authorized agents or by independent Contractors engaged by it.

5.3

Subject to the provisions of any approved operating programme and budget the number of employees of Operator employed in connection with operations hereunder shall be determined by Operator. The Operator shall determine the selection of such employees, their hours of work and their remuneration, and all such employees shall be employees of Operator exclusively.

5.4

In the conduct of operations, Operator shall:

(a)

use its best efforts to conduct diligently all operations in accordance with practices generally followed by the petroleum industry, to conform to good oil field and engineering practices and accepted conservation principles and to perform such operations in an efficient and economic manner. All operations shall be conducted in accordance with the provisions of the Licence and all applicable laws and regulations;

…

(g)

pay all costs and expenses incurred by it in its operations hereunder promptly and when due and payable;

…

(j)

obtain and maintain, in respect of the Joint Operations and the Joint Property, all insurance required under the Licence or any applicable law and such other insurance as the Operating Committee may from time to time determine, provided that, in respect of such other insurance, any [p]articipant may elect not to participate provided such [p]articipant gives notice to that effect to the other [p]articipants and does nothing which may interfere with the Operator’s negotiations for such insurance for the other [p]articipants. The cost of insurance in which all the [p]articipants are participating shall be for the Joint Account and the cost of insurance in which less than all the [p]articipants are participating shall be charged to such [p]articipants in the proportion that each such [p]articipant’s Participating Interest bears to the sum of the Participating Interests of such Participants. The Operator shall, in respect of any such insurances:-

(1)

promptly inform the [p]articipants participating therein when it is taken out and supply them with copies of the relevant policies when the same are issued;

(2)

arrange for the [p]articipants participating therein, according to their respective Participating Interests, to be named as co-insureds on the relevant policies with waivers of subrogation in favour of the Parties; and

(3)

duly file all claims and take all necessary and proper steps to collect any proceeds and, if all the [p]articipants are participating therein, credit them to the Joint Account or, if less than all the [p]articipants are participating therein, credit them to the participating [p]articipants.

…

(l)

prepare and furnish to the Operating Committee such reports,

statements, data and information as may be prescribed from time to time by the Operating Committee concerning [all operations conducted in accordance with the Agreement by or on behalf of any party with a Participating Interest];

…”

5.5

(a) Without prejudice to Article 5.5(b) [which dealt with emergency expenditure] the Operator is authorised to make such expenditures, incur such Commitments for expenditure and take such actions as may be authorised by the Operating Committee in accordance with the provisions of this Agreement.

…

6.1

To provide for the orderly supervision and direction of [all operations conducted in accordance with the Agreement by or on behalf of any party with a Participating Interest], there shall be set up an Operating Committee composed of representatives of each [p]articipant. In exercising such supervision and direction, each representative on the Operating Committee shall act solely on behalf of the Party whom he represents and not on behalf of the participants as an entity. The powers and duties of the Operating Committee shall include:

(a)

determination of all general policies, procedures and methods of [operations];

(b)

consideration, revision and approval of all proposed operating programmes, budgets …;

…

7.2

On or before the 15^th day of December of each year, the Operating Committee shall agree upon and adopt an operating programme and budget for the 12 month period beginning on the 1^st day of January of the following year and for such further periods as the Operating Committee deems appropriate, which shall include as a minimum the work required to be performed under the Licence in respect of the Contract Area during such budget periods and the requirements of [the] Operator having regard to previously approved programmes and budgets and its obligations hereunder. At the time of agreeing upon and adopting an operating programme and budget, the Operating Committee shall provisionally consider, but not act upon or adopt, an operating programme for the calendar year next succeeding the period covered by such approved operating programme and budget.

…

7.10

Ongoing Liability

Following completion of Decommissioning, the [p]articipants shall remain liable for any residual liability (including in respect of remedial work) which arises at law or is otherwise imposed by regulatory authority unless and until the [p]articipants enter into a separate agreement as contemplated by in Article 2.3.

…

7.11

Expenditure Overruns

The Operator shall use reasonable endeavours not to exceed the approved Decommissioning Budget but shall be entitled without prior approval of the Operating Committee to incur expenditure:

(a)

in excess of an approved AFE [Authorisation for expenditure] up to the lesser of ten per cent (10%) of the amount of the approved AFE and ten million Pounds (£10,000,000); and

(b)

subject to (a) above, in excess of an approved Decommissioning Budget up to ten per cent (10%) of the amount of the approved Budget.

Whenever it appears to the Operator that the over-expenditure for any item will exceed the amount authorised under this Article 7.11.4 the Operator shall revise the appropriate AFE and/or Budget and will seek the prior approval of the Operating Committee to incur the additional expenditure prior to entering into any further commitment, such approval not to be unreasonably withheld or delayed where the over-expenditure is necessary to comply with the Decommissioning Programme approved by the Secretary of State.

…

10.1

All costs and expenses of all operations under this Agreement in or in respect of the Contract Area or the Licence, including the handling, treating, storing and transporting, whether within or outside the Contract Area, of Petroleum produced from the Contract Area, and all costs and expenses properly incurred by the Operator in its performance of the relevant provisions of the Decommissioning Security Agreement except for costs and expenses which are solely attributable or relevant to a Party, shall be borne by the [p]articipants in proportion to their respective Participating Interests from time to time except as herein otherwise specifically provided. Furthermore, the costs of all assets, including materials and equipment acquired for the Joint Account of the [p]articipants shall be for the account of the [p]articipants in accordance with their Participating Interests from time to time, and, similarly, liabilities shall be borne in such proportions.

10.2

All costs and expenses of whatsoever kind that are incurred in the conduct of operations under this Agreement shall be determined and settled in the manner provided for in the Accounting Procedures hereto attached and marked Exhibit A, which is hereby made part of this Agreement, and Operator shall keep its records of costs and expenses in accordance with such Accounting Procedure. In the event of conflict between the main body of this Agreement and the said Accounting Procedure, the provisions of the main body of this Agreement shall prevail.

…

COVENANT AND RELATIONSHIP OF THE PARTIES

18.1

Subject to the responsibility delegated hereunder to the Operator and the Operating Committee, each Party covenants and undertakes with each other Party that it will comply with all provisions and requirements of the Licence and the applicable laws and regulations and will do all such acts within its control as may be necessary to maintain the Licence in force and effect.

18.2

The rights, duties, obligations and liabilities of the Parties shall be several and not joint or collective, and each Party shall be responsible only for its obligations as set out herein, it being the express purpose and intention of the Parties that this Agreement shall not be construed as creating any partnership or association or as (except as expressly stated) authorising any Party to act as agent, servant or employee for any other Party for any purpose whatsoever.”

Exhibit “A” to the JOA was entitled “ACCOUNTING PROCEDURE”. Material extracts from this appear at the end of this judgment. The Exhibit began with this statement:

“The purpose of this Accounting Procedure is to establish equitable methods for determining charges and credits applicable to [all operations conducted in accordance with the Agreement by or on behalf of any party with a Participating Interest] under the Agreement and to provide that Operator neither gains nor loses by reason of the fact it acts as Operator. In the event of a conflict between the provisions of this Accounting Procedure and the provisions of the Agreement, the provisions of the Agreement shall control.”

The percentage share of the DRCs allocated to the Participants has been revised, downwards, by the Operator since these proceedings were commenced. The Participants contend that this development itself defeats the claim and shows it be premature. They argue that liability is conditional on a determination of the percentage.

In my view this preliminary argument has no merit. The argument does not challenge the fact that the original determination of the percentage would satisfy the condition for liability. That is sufficient to answer the suggestion that the claim is not properly constituted or is premature.

Having heard evidence on how it came about, the downward revision is in my judgment to be seen as a concession properly and responsibly made by the Operator. Any question whether the downward revision is itself sufficient can be considered within the proceedings.

Where appropriate the court will decide the final figure. In a case such as the present the Commercial Court should in any event be prepared to make declarations as to the methodology required by a contract where it cannot itself set a figure. Again, the suggestion that proceedings of the current nature are in some way invalidated or premature is wrong.

The downward revision is also accompanied by the possibility that previous payments by the Participants (at a time before the Participants challenged the inclusion of DRCs) include an element of overpayment. Where the Participants are as a result entitled to an adjustment in their favour it will again be necessary to identify the correct figure or the methodology required to arrive at it.

The Participants accused Mr Larry Seidel of Marathon Oil Corporation, who gave evidence at trial, of bad faith, including in withholding information from them, over his involvement with the original percentage share allocation and the downward revision. Having seen him give his evidence in response to these accusations I find the allegations unfounded.

In my view Mr Seidel has throughout been trying to resolve the matter and to do so fairly in the circumstances in which he found himself. As a witness I found his evidence worthy of trust, and reassuringly not defensive. In his second witness statement, he showed he recognised the nature of the exercise to arrive at a share of a proportion of DRCs, when he said that he did “not know that the deficit can be indisputably analysed down to a member by member, year by year basis”. In oral evidence he added even of the actuaries that it “would be something that [they] perhaps could do, perhaps could not do. I don’t know.”

The Participants accept that the Operator is entitled to select employees and their hours of work and their remuneration (including benefits such as pension provision). However they argue that the Operator’s ability to recharge the cost is subject to the provisions for approved operating programmes and budgets and the direction of the Operating Committee. In this connection, “as a general proposition”, argue the Participants, the Participants cannot be obliged to agree or give approval to a business management plan (“BMP”), in which operating programmes and budgets are found.

I respectfully consider that this argument does not fully appreciate the way in which the Agreements worked. Decisions of the Operator, the supervision and direction of the Operating Committee, and the use of operating programmes and budgets were all part of a single scheme which can be sufficiently understood from the Clauses set out above and the provisions of Exhibit “A”.

So far as material, this scheme was in my judgment as follows:

In the present case the relevant employees were properly taken on or deployed to enable operations. The operations were those envisaged by the Operating Committee in the operating programmes. Taking on or deploying employees involved remuneration that included pension arrangements. The authorisation of the Operating Committee that first engaged the liability of participants (including the Participants) came when the operations were approved, rather than when later budgets were approved year by year.

The Participants accept that remuneration in the context of Clause 5.3 includes pension benefits and that Clause 5.3 permits the Operator to fix the remuneration of its employees. However they say that it does not follow that the Operator is entitled to seek reimbursement from the Participants of a share of that remuneration, “in the absence of a specific authorisation from Operating Committee”. They say that Clause 5.5(a), 6.1(e), and 7 make it clear that the Operator is not entitled to incur any expenditure in the nature of remuneration without the approval of the Operating Committee as part of a BMP. In my judgment the authorisation in fact comes with the authorisation of operations.

The approval of a budget at the point when payments under the pension arrangements were required in a particular year represented approval of the amounts that were payable in respect of a liability that had already been authorised. That is why the Operator is correct in its contention that the Participants are in breach of their obligations where they refuse to approve budgets on the basis of a contention that they have no liability for the cost of the pension arrangements.

There is no suggestion that the pension arrangements of the employees in question were improperly agreed with them. Those arrangements came with a cost. That cost is not fixed, and cannot be. Its inclusion in a budget can only ever be as an estimate at the time, and it is important to appreciate the nature of a budget. In fact in their written closing submissions the Participants were themselves to recognise what Mr Paul Newman QC, their Leading Counsel, termed “the temporal disconnect between the accrual of pension contributions and the disclosure of [DRCs]”.

The Participants say that this involves their signing a “blank cheque”, but the position would not be materially different if the Participants had employed the employees themselves to do the work on operations they wanted undertaken.

The alternative proposition that the Operator was alone responsible for some part of the pension costs attributable to employees’ work on authorised operations is wholly at odds with the arrangements that the parties agreed. The fact that the Operator had to work to budgets, to business management plans and under the overall supervision and direction of an operating committee did not involve it in underwriting expenditure over budget of this sort.

Yet the Participants argue that the Operating Committee’s “authorising the Brae Operations in the knowledge of the pension costs and the possibility of a deficit arising does not necessarily imply that the Operating Committee must have authorised those costs to be rechargeable to [the Participants], perhaps many years later.” This argument would leave the Participants free to choose to leave the Operator alone to meet a deficit, known to be possible as a result of authorised operations. This is, with respect, uncommercial, and unsurprisingly the Agreements do not provide for it.

The Participants press that if the Operator “had wanted to negotiate the right to recharge pension deficit contributions, it should have required a contingency or specific indemnity as part of the BMP for the year in which the benefits accrued”. On the view I take of the way in which the Agreements work, on their true construction, this would not be required. But on the Participants’ case the Participants would be able simply to refuse a contingency or specific indemnity if sought when “the benefits accrued”. It would be remarkable if that was what the Agreements allowed, and it is not.

Nor can I accept the Participants’ argument that a right to recover would require a clause along the lines of the arrangements for insurance under Clause 5.4(j). That Clause simply involved one method, but not the only method, of requiring costs to be shared. It dealt with a subject that had greater optionality. It did not leave arrangements in a place where the Operator would be left with a cost because others who had taken the benefit then chose not to pay the costs that resulted.

The Participants’ argument that it is material that there is no provision corresponding to Clause 7.10 for DRCs also fails, in my view. The major context of that Clause is Decommissioning. The same is broadly true of Clause 7.11.4. It is commercially inconceivable that the absence of a Clause 7.10 or 7.11.4 equivalent to deal with DRCs should lead to the conclusion that participants are not liable to contribute to the true remuneration cost of employees unless they later approve them, and can leave that cost to the Operator alone, where there is room to deal with that cost under the other Clauses discussed.

None of this is to say that there were no restraints on the Operator. The outcome in law in the case could be quite different if there was a material dispute over whether the employees were required, or whether they were properly selected for employment, or as to the propriety of the Operator agreeing the pension arrangements it did.

In fact another restraint to mention is the commercial restraint that lay in the fact that a company within the group of which the Operator was a member was, like the Participants (ie the Defendants), a participant and so liable for a percentage share of the costs of operations including the DRCs.

Mr Newman QC additionally argued that the trustees of the Scheme had what he described as a unilateral right to set employer contributions under the Scheme. However that does not mean that that right would be abused.

In his forceful closing written argument Mr Newman QC argued in these terms:

“… why is it any more commercial to impose an unknown, uncontrollable and unlimited liability for [the] unforeseen risks [of “future pension deficit contributions”] on the [Participants]? The position is that neither [the Operator] not [the Participants] wish to bear the risk, but why should the contract be construed so as to require [the Participants] to bear the risk, with the impossible accounting consequences identified …. In the real world, [Mr David Wolfson QC, Leading Counsel for the Opertaor]’s impasse [where the matters are left with the Participants “refusing to take on the future undetermined liabilities, with [the Operator] exposed to those liabilities”] would be broken by negotiation and agreement between [the Operator] and [the Participants] about how to deal with future liabilities: [the Particpants] may argue that the volatility of the Scheme’s funding should be reduced (by closing the [defined benefit] scheme and switching employees to a [defined contribution] scheme or a group personal pension arrangement); [the Operator] may argue that that would be a false economy, as a [defined benefit] scheme is vital to the recruitment and retention of key staff; but the point is that this would be dealt with by negotiation and agreement, perhaps leading to the amendment of the Agreements.”

I quote this passage in order to offer an answer to a question it asks and to seek to bring out a feature of a point it makes. First a reason why it is unsurprising to find the contract bearing a true construction “so as to require [the Participants] to bear the risk” is because the Participants have enjoyed the benefit of the employment. Second the referenced “negotiation and agreement between [the Operator] and [the Participants] about how to deal with future liabilities” “perhaps leading to the amendment of the Agreements” is always open to the Operator and the Participants, but the reason is because the Participants, on the Agreements as they stand, have a share of the future liabilities with which the negotiations would be concerned.

In closing Mr Newman QC also argued that an obligation on the Participants to contribute to the Scheme in the way I have held would be impossible for a company to account for, and that made the interpretation of the Agreements uncommercial. For this argument he relied on the accounting bases FRS 17 and 87 and pointed to the data needed to report on these bases. This is in my view a wrong approach. If an obligation has been agreed then, with the assistance of auditors, the party who has agreed that obligation must ensure that it is does what is necessary to comply with the attendant accounting requirements.

The Operator admits that where the Agreements conferred a contractual discretion on it, it was under an implied duty to exercise its discretion honestly and in good faith. The Participants agree but also argue that the Operator was in the position of a fiduciary and for that alternative reason, or on the basis of the admitted contractual duty, owed a duty to act in good faith “such good faith importing the requirement of fair and open dealing”.

I do not need to set out an examination of the detail of the claims to a broader base for an obligation of good faith than that admitted by the Operator. I was not impressed with the arguments made for that broader base, but need not express a final view simply because on the evidence at trial there is in my judgment no foundation in the allegation that there was any lack of good faith on the part of the Operator.

The heart of the Participants’ complaint concerns alleged failures by the Operator to warn the Operating Committee or the Participants in three areas. First, of the Scheme’s benefit structure. Second, of the potential future deficit liabilities. And third, of “the alleged fact (denied by [the Participants]) that the authorisation of the Brae operations/ employees and/or the making of deficit payments between 2003 and 2015 constituted authorisation of the deficit payments sought in this claim”.

The Agreements date from 1980 and 1990. The Participants (or their predecessors) were aware of the existence of the Scheme by 2003 and that it was a defined benefit scheme by 2004. They were aware that the Scheme was non-contributory and of its accrual rate. Lump sum payments into the Scheme were agreed by the parties in 2007 and 2008.

Mr Newman QC and Ms Emily Campbell’s opening written submissions outline the history of the developing statutory basis for the liability of employers in relation to deficiencies in pension scheme assets as follows. The statutory liability of employers in the event of winding up was introduced with effect from 29 June 1992 (s58B Social Security Act 1975 and now s75 Pensions Act 1995). A minimum funding requirement in relation to continuing pension schemes was introduced with effect from 6 April 1997 (Part 1 Pensions Act 1995). A statutory liability to fund schemes on a scheme specific funding basis was introduced from 30 December 2005 (Part 3 Pensions Act 2004).

It is clear from the above that the Participants have long been aware of the essentials, and that the long history has included developments newly affecting the Operator and the Participants alike. The Participants have in fact made payments towards the Scheme deficit in more recent years, though now say they are entitled to claim these back (in full, and not simply where there has been overpayment). The problem today, and one equally faced by the Operator and affiliates, and many other companies, is that the continuing burden where there is a defined benefit scheme is very considerable.

The evidence available at the trial has the feel of being far from complete. The Participants did not call as witnesses some of those who might have been able to throw most light on events; and by contrast a witness they did call - Ms Laura Wiseman - was plainly honest but unaware of much of the history of the matter.

I have little insight into what narrative was added or questions were asked over the years, for example. Such evidence as there is in fact shows the provision of some information in the first two alleged areas of failure. I am moreover far from satisfied that the Participants, as commercial parties in this specialised field of endeavour, did not appreciate that employees could come with remuneration that included defined benefit scheme pension arrangements, with attendant liabilities.

It is said by the Participants that the Scheme’s benefit structure was “unusually generous” and this feature was not disclosed. I do not consider this characterisation to be made out, viewed both in the context and at the relevant times.

In the course of a cross examination by Mr Conall Patton (junior Counsel for the Operator) which stood out for its accuracy and concision, Mr William Reid gave evidence as a joint venture auditor that a defined benefit scheme would have been the norm in the oil and gas sector in the 1980s and 1990s. I accept the evidence of Mr John Andrew of the Operator (a conscientious witness) that he and his colleagues felt at the time that the Scheme was on balance fairly typical. Mr Philip Kemp of the first of the Participants, Centrica Resources Limited, accepted that he must have appreciated that there was the risk of a deficit in the Scheme.

I accept Mr Jonathan Punter’s expert evidence that the generosity of the Scheme was not exceptional in the context of the oil and gas industry. As does Mr Punter, I note the evidence of Ms Laura Nolen that consideration was given by the employer in 2009 to reduce the generosity of Scheme benefits but competitive pressures and the limited lifespan of the Brae oil fields led to a choice not to make changes.

I draw attention to the fact that the last of the three alleged areas of failure is no more than an alleged failure to warn about what the Agreements meant or a position or argument that the Operator would or might take. In none of the three alleged areas of failure, and confirmed by hearing the witness evidence, do I find any lack of good faith on the Operator’s part in what was and was not provided.

In their opening submissions the Participants said that what they asked of me was to consider all the circumstances (including their state of knowledge) and decide whether a reasonable observer would conclude that they or the Operating Committee had given their authorisation and consent to the expenditure on the Scheme. Given that invitation I have looked at the matter in that way. My decision is that a reasonable observer would so conclude.

Leaving aside the question of any past overpayments by the Participants (or predecessors in title) where there was an error that should be corrected, the counterclaim raised by the Participants cannot succeed in light of the findings I have reached. I will deal with any question of correction of error in respect of any past overpayments when and if I am asked deal with quantum.

I should however refer to the fact that the counterclaim included an allegation that recovery of past payments could be made on the basis of mistake. In this connection it was said that the Participants would not have made payments in the past on “an unqualified basis” “if they had known … that they were, by doing so, effectively writing a blank cheque to [the Operator] as regards possible future deficit payments” to the Scheme. The Participants are entitled, it was said, to recovery of past payments “so as - in effect – to reverse the mistake under which they were acting.” I should make clear now that the Participants did not make out the foundations necessary in law for a credible claim in mistake of this nature.

In my judgment there is no question but that, alongside the other costs of employees in connection with the operations, the Participants are liable to meet a share of a proportion of DRCs in respect of the Scheme of which those employees were beneficiaries.

Although tried over a short period of 4 days, very many different points were touched on by one or other party, very extensive trial bundles were provided, the evidence ranged over many years, and the points that seemed to be at the forefront of one or other party’s argument, especially legal argument, changed. I have in this judgment sought to deal with the issues that I understand will be material to the parties. I have also sought to respect the request that I confine this judgment to questions of liability.

Statements of Expenditure

Advances

Payments by [p]articipants

Adjustments

Audits

Amendments or Revisions

Other Expenditures

The wells to be drilled and other works to be undertaken.

A properly itemized estimate in sterling of all costs and expenditures to be incurred under the programme, sub-divided into main classifications and phased by quarter for the budget year and by year thereafter.

An unitemized estimate for general and miscellaneous expenditures.

An estimate of the timing and value of commitments under each main classification of cost, phased by quarter for the budget year and by year thereafter.

An estimate of the amount of each currency in which the total budget cost is to be paid, phased by quarter for the budget year and by year thereafter.

An estimate of Joint Account warehouse stock movement.

In respect of a development programme and budget:

As appropriate, estimates of date of commencement of production, rates of production, and total production by quarters through the next full calendar year.

Such other information as the Operating Committee may require.