High Court provides clarity on 'commencement of drilling' for contractual purposes

The clarification is important, because the term is commonly used as a trigger for payment or other obligations in oil and gas exploration contracts, according to energy disputes expert Richard Dickman of Pinsent Masons, the law firm behind Out-Law.com.

The court upheld a claim for $7.4 million by Vitol Exploration and Production Ltd (Vitol) under a sale and purchase agreement between the company and Africa Oil and Gas Corporation (AGOC). The dispute turned on whether drilling had commenced as of 30 June 2013; at which point the rig had been mobilised but 'spudding', which refers to the initial turning of the drill bit into the seabed, had not yet taken place.

"Although the decision seems obvious, there was limited English authority on the meaning of the term and the US cases relied on by AOGC tended to support a wider interpretation," Dickman said.

"The judge therefore had to carry out a rigorous application of the principles of interpretation of contracts articulated in a number of English cases, most recently the Supreme Court decision in Arnold v Britton, ultimately applying the natural and ordinary meaning of the term 'commencement of drilling'. That meaning was not displaced by reference to the 'factual matrix'," he said.

The dispute arose in conjunction with 'research permits' issued by the Republic of Congo to various oil and gas exploration and production companies covering an offshore area known as 'Marine XI'. Research permits were granted by the republic for up to three consecutive 'exploration periods', but in order for a second or third exploration period to be granted the beneficiaries of the permit had to have drilled at least one well in the preceding period.

Both Vitol and AOGC were beneficiaries of one of these research permits along with a number of other companies, with whom they entered into a joint operating agreement (JOA). AOGC later purchased Vitol's interest in the JOA for a deferred consideration, payable if drilling of the well was "not commenced before the date of expiry of the second exploration period". The second exploration period ended on 30 June 2013 but, due to a delay in the arrival of the necessary equipment, spudding did not take place until 20 July.

Although he was referred to a number of earlier cases covering construction of contracts by lawyers for both Vitol and AOGC, Judge Waksman QC said that he only had to look at the Arnold v Britton case as the most recent decision of the UK's highest court on the point. In that case, judgment on which was handed down in June 2015, the Supreme Court said that what was relevant was "the meaning of the relevant words ... in their documentary, factual and commercial context". That meaning had to be assessed with reference to "the natural and ordinary meaning of the clause", among other factors, the Supreme Court said.

"I first consider whether there is a 'natural' interpretation of the words 'commencement of drilling'," Judge Waksman QC said in his judgment. "I find that there is and it is the physical penetration of the seabed i.e. spudding. This is to be distinguished from preparations for drilling."

"Drilling is itself not a momentary process and so it is perfectly sensible to speak of when drilling starts, in the spudding sense, and when it stops. That is the sense in which one would define drilling the road or the drilling of one's teeth by a dentist. I further find that 'commencement' naturally means the beginning of drilling, not the beginning of preparations for drilling," he said.

The judge said that the underlying commercial purpose of the agreement between Vitol and AOGC was also relevant.

"The parties, objectively, clearly agreed that this protection [against AOGC's liabilities for Vitol's costs] would not last indefinitely and that there had to be a point at which it could clearly be ascertained whether it was still in place or not. Hence the conditions of the removal of the well ... or the commencement of drilling," he said.