Document:

Bayshore Exploration L.L.C.
 	
            20501 Katy Freeway, Suite 216
 

	
             
 	
            Katy, Texas 77450
 

	
             
 	
            Phone (281) 646-1919
 

	
             
 	
            Fax (281) 647-9448
 

	
             
 	
            bayshoreexpl@sbcglobal.net
 

 

March 8, 2006

 

Paxton Energy, Inc.

2533 North Carson Street

Suite 6232

Carson City, Nevada 89706

 

	
             
 	
            RE:
 	
            Lease Acquisition Agreement
 

	
             
 	
            3,200 acres, more or less
 

	
             
 	
            La Salle County, Texas
 

 

Gentlemen:

 

This letter is written to evidence the agreement between Bayshore Exploration L.L.C. (“Bayshore”) and Paxton Energy, Inc., (“Paxton”) pertaining to the acquisition and development of certain oil and gas leases and oil and gas lease options located in La Salle County, Texas. 

 

Bayshore is in the process of acquiring certain oil and gas leases and/or oil and gas lease options on 3,200 acres (“the subject acreage”), more or less, for the purpose of oil and gas exploration and production. The subject acreage is outlined on the attached land plat and described as follows, to wit:

 

Tract One - 640 acres, more or less, being all of the H. & G.N.R.R. Survey No. 121, A-260, La Salle County, Texas.

 

Tract Two - 640 acres, more or less, being all of the A. Sullivan Survey No. 140, A-1084, La Salle County, Texas.

 

Tract Three- 640 acres, more or less, being all of P. Johnston Survey No. 150, A-1042, La Salle County, Texas.

 

Tract Four- 640 acres, more or less, being all of the H. & G.N.R.R. Survey No. 139, A-267, La Salle County, Texas.

 

Tract Five - 640 acres, more or less, being all of the C. Sullivan Survey 122, A-1082, La Salle County, Texas.

 

Paxton desires to participate for a 50% working interest ownership in the acquisition and development of the subject acreage and hereby agrees to the following terms and conditions:

 

• Page2                                          
                                          
                                          
          March 16, 2006

 

1.            Paxton agrees to pay to Bayshore, on or before March 20, 2006, the sum of $305,000.00 U.S. dollars which represents Paxton’s share (50%) of the lease and lease option acquisition costs. In the event Paxton does not pay Bayshore the sum of $305,000.00 U.S. dollars on or before March 20, 2006, then this letter agreement and all of its terms and conditions will become null and void.

 

2.            Bayshore agrees to make its best effort to acquire said leases and lease options on the subject acreage within 90 days of the date of this letter agreement.

 

3.            In the event that Bayshore is unable to acquire all the subject tracts Paxton’s deposit shall be applied at the pro-rata cost base and the balance returned to Paxton.

 

4.            Bayshore also agrees, upon acquisition of said leases and lease options on the subject acreage, to assign Paxton a 50% working interest ownership in the acquired leases and lease options.

 

5.            Within ninety days of this agreement, Paxton shall have an option to increase its leasehold working interest in the subject acreage to seventy-five percent on the same costs, terms and conditions as provided herein.

 

6.            Bayshore and Paxton agree to enter into a mutually acceptable Joint Operating Agreement to cover oil and gas exploration and production operations on the subject acreage naming Bayshore as operator.

 

7.            This agreement is the entire agreement between Bayshore and Paxton pertaining to the lease acquisition and options of the subject acreage. Any changes to this agreement must be agreed to in writing by both parties.

 

If the foregoing is your understanding of our agreement, please acknowledge your acceptance by signing in the space provided below and returning one fully executed agreement to Bayshore along with your check in the amount of $305,000.00 U.S. dollars on or before March 20, 2006.

 

Sincerely, 

 

BAYSHORE EXPLORATION L.L.C.

 

/s/ Jamin Swantner

 

Jamin Swantner

President

Attachment: Land Plat

 

AGREED to and ACCEPTED this 15th day

of March, 2006.

 

PAXTON ENERGY, INC.

 

By: /s/Robert Freiheit

          Robert Freiheit, CEO

ATTACHMENTBayshore Exploration L.L.C.

20501 Katy Freeway, Suite 216

Katy, Texas  77450

Phone (281) 646-1919

Fax (281) 647-9448

bayshoreexpl@sbcglobal.net

 

Paxton Energy, Inc.

2533 North Carson Street

Suite 6232

Carson City, Nevada  89706

 

EXPLORATION AGREEMENT

 

THIS AGREEMENT is made and entered into this 1st day of March, 2006 by and between BAYSHORE EXPLORATION LLC. (“Bayshore”), a Texas limited liability company and PAXTON ENERGY, INC. (“Paxton”), a Nevada corporation (collectively referred to in this Agreement as the “Parties”).

In consideration of the covenants contained in this Agreement, the Parties agree as follows:

 

ARTICLE I

PURPOSE OF THE AGREEMENT

 

1.1 The Parties hereby join together for the purpose of developing the existing Cooke Ranch Prospect acreage (8,884 acres) and acquiring additional prospective oil and gas properties on which to explore for, develop and produce oil and gas thereon in accordance with the terms and provisions of this Agreement.

 

ARTICLE II

DEFINITIONS

 

2.1 “Area of Mutual Interest” (“AMI”) is the area outlined with the bold outline on Exhibit “A” and Exhibit “B” attached hereto and located in La Salle County, Texas.

 

2.2 “Excluded Interest” shall have the same meaning as set forth in Article 6.1.

 

2.3 “Oil and Gas Interest” shall refer to oil and gas leases, and contractual rights thereto such as farm-out agreements, participation agreements, assignments and back-in agreements covering and relating to oil and gas, or either of them.

 

2.4 “Oil and Gas” shall include not only hydrocarbons, but also other minerals to the extent the lease or other instrument affecting or relating to oil and gas or either of them also affects or relates to other minerals. 

 

2.5 “Operating Agreement” shall mean the Joint Operating Agreement attached hereto as Exhibit “C”.

 

 

	
            Page 2
 	
            March 1, 2006
 

 

 

2.6 “Original Acquiring Party” is the party who is subject to this agreement that first acquires an Oil and Gas Interest in the AMI.

 

ARTICLE III

EXHIBITS

The following exhibits are attached hereto and made a part hereof for all purposes:

3.1 Exhibit “A” and Exhibit “B” describe and outline the Area of Mutual Interest of the Parties.

3.2 Exhibit “C” is the form of Operating Agreement that the Parties are executing contemporaneously with the execution of this Agreement to govern oil and gas exploration, development and operations on the jointly acquired properties. 

3.3 Exhibit “D” is the certain Purchase Agreement dated December 30, 2005 between the parties for the purchase of additional working and leasehold interest by Paxton in the Cooke Ranch 8884 acre project. 

ARTICLE IV

EXPANSION OF THE AREA OF MUTUAL INTEREST

4.1 The AMI shall automatically be expanded under the following terms and conditions:

In the event a test well in search of hydrocarbons is drilled within 5,280 feet of the boundary of the AMI and encounters formations which indicate hydrocarbons the AMI shall automatically be expanded to include an area of 640 acres, as near as reasonably possible in the shape of a square around such well with such well to be located as near as reasonably possible in the center of such area. Only the Parties participating in said test well mentioned above shall have the right to participate in the expansion of the AMI.

In the event geophysical operations are conducted within the AMI or such data is purchased, and a party elects not to participate in such expense, then that party shall not be entitled to access or ownership of such data.

ARTICLE V

PRESENT STATUS OF OPERATIONS 

WITHIN THE AMI

 

5.1 Within the AMI the Parties have drilled two wells. The Cooke No. 3 Well has been completed in the Escondido Formation as an oil well. Bayshore, et al, owns 91.5% working interest and Paxton owns 8.5% working interest in the well. The Cartwright No. 1 Well has been drilled and is in the process of being completed in the Escondido formation. Bayshore, et al, owns 88.25% working interest and Paxton owns 11.75% working interest in the well with the right for Paxton to acquire an additional 20% working interest pursuant to an agreement dated December 30, 2005 attached hereto as Exhibit “D”. Under the terms of the purchase agreement Paxton will also own a 31.75% leasehold interest in the 8884 

 

	
            Page 3
 	
            March 1, 2006
 

 

 

acre Cooke Ranch project. In addition, the Parties are evaluating the subject acreage for additional drilling locations. 

ARTICLE VI

ACQUISITION OF OIL AND GAS INTEREST 

WITHIN THE AMI

6.1 If any of the Parties acquire any Oil and Gas Interest within the AMI during the term of this Agreement, the party acquiring such Oil and Gas Interest (the “original acquiring party”) shall give the other parties written notice, with supporting documentation of the interest acquired and the actual cost, terms and conditions of such acquisition within fifteen (15) days of the actual date of acquisition. Each of the Parties receiving such written notice shall have thirty (30) days (or forty-eight [48] hours if there is drilling rig on the property covered by the Oil and Gas Interest) after receipt of written notice of such acquisition, to acquire a share of the Oil and Gas Interest. Such election shall be made by delivering by Express Mail to the original acquiring party its share of the actual acquisition costs as determined by this Agreement and agreeing to be bound by the
terms and conditions of the acquisition. Failure to respond within the specified period shall conclusively be deemed to be an election not to acquire an interest in the Oil and Gas Interest so offered and as to such party, the Oil and Gas Interest will be excluded from the AMI (referred to hereafter as the “Excluded Interest”). Each party shall be entitled to acquire in the acquisition, the proportion that such party’s interest as set forth in the Operating Agreement bears to the total interest of the parties electing to participate in the acquisition and shall deliver to the original acquiring party its proportionate share of the actual cost of the acquisition at the time the election is made. Any acreage so acquired within the AMI that Paxton elects to participate in for its proportionate share shall be subject to a 75% Net Revenue Interest (NRI). The terms of the Area of Mutual Interest shall run concurrent with this Agreement.

 

6.2 In the event any party elects not to acquire its proportionate share of any Oil and Gas Interest offered to it pursuant to paragraph 6.1 of this Agreement, such party agrees that:

 

(i). It shall hereafter not be entitled to the benefits of Paragraph 6.1 of this Agreement as to any Oil and Gas Interest acquired by the participating parties.

 

(ii). It will not acquire or attempt to acquire through itself or any of its representatives, officers or directors, any Oil and Gas Interest within the Excluded Interest for a period of three (3) calendar years after the date of its election not to acquire the Oil and Gas Interest offered to it by the original acquiring party.

 

ARTICLE VII

ASSIGNMENTS

 

7.1 Within forty-five (45) days after a party’s election hereunder to acquire a portion of an Oil and Gas Interest, the original acquiring party shall assign to all parties who elect to acquire a portion of an Oil and Gas Interest the interest so acquired.

 

 

	
            Page 4
 	
            March 1, 2006
 

 

 

ARTICLE VIII

OPERATIONS OF THE OIL AND GAS INTERESTS

ACQUIRED BY ALL OF THE PARTIES

 

8.1 The Oil and Gas Interests and the properties covered thereby shall be operated by the parties in accordance with the terms and provisions of the Operating Agreement attached hereto as Exhibit “C” when such Oil and Gas Interest is owned by all of the parties in the proportion set forth in Exhibit “A” to such Operating Agreement. The location and timing of the initial well to be drilled under the terms of the Operating Agreement will be determined by the Operator.

 

ARTICLE IX

OPERATIONS OF THE OIL AND GAS INTERESTS

IN THE EVENT OF AN ELECTION BY LESS THAN

ALL PARTIES TO ACQUIRE OIL AND GAS INTEREST

 

9.1 In the event an Oil and Gas Interest becomes an Excluded Interest, the property covered thereby shall be deleted from the Operating Agreement attached hereto as Exhibit “C”, and the parties acquiring such interest shall enter into successor operating agreement on the same terms and conditions as the Operating Agreement attached hereto as Exhibit “C”, except the Operating Agreement shall be limited to and cover only the Excluded Interest and the ownership interest of the party shall be revised to reflect their ownership of the Excluded Interest covered by the successor operating agreement.

 

ARTICLE X

TERM OF THIS AGREEMENT

 

10.1 This Agreement shall be effective as of March 1, 2006 and shall continue for a period of three (3) years or a period of six (6) months after the termination of the last expiring leasehold interest acquired pursuant to the terms of this Agreement, whichever is the later date.

 

ARTICLE XI

GENERAL

 

11.1 The Parties agree to execute such additional agreements and documents as may be necessary to effectuate the intentions of this Agreement.

 

11.2 Unless otherwise specified in this Agreement, notice of the parties shall be deemed sufficiently given, if sent by first class mail or facsimile document transfer addressed to the party to be notified, at the address stated herein, and shall be deemed to have been received within seventy-two (72) hours of posting or at the time set forth on the facsimile document transfer transmission statement, as the case may be; provided that if the time period for receipt expires on Saturday, Sunday, or a legal holiday, the time for receipt shall be deemed to be the next ensuing business day.

 

11.3 This Agreement. shall be construed in accordance with and governed by the 

 

	
            Page 5
 	
            March 1, 2006
 

 

 

laws of the State of Texas, shall be binding upon and shall inure to the benefit of the Parties and shall extend to and be binding upon their respective successors and assigns.

 

11.4 This Agreement shall supersede all prior oral and written agreements between the Parties in connection with the AMI matter hereof.

 

11.5 This Agreement may not be altered except in writing signed by all Parties. In addition the Parties agree not to enter into any new agreement or agreements concerning the matters set forth herein unless such agreement or agreements are evidenced by a written document signed by all of the Parties.

 

11.6 The section headings are inserted for convenience only and shall not control the meaning or construction of any provisions of this Agreement.

 

11.7 In the event of a conflict between the terms of this Agreement and any Exhibit attached hereto, this Agreement shall control.

 

EXECUTED THIS 17th day of April, 2006 but effective as of March 1, 2006. 

 

BAYSHORE EXPLORATION L.L.C.

By: 

 

	
             
 	
            /s/ Jamin Swantner
 

 

Jamin Swantner, President

 

PAXTON ENERGY, INC.

By: 

 

	
             
 	
            /s/ Robert Freiheit
 

 

Robert Freiheit, CEO

 

 

EXHIBIT “A”

To Exploration Agreement

 

 

EXHIBIT “B”

To Exploration Agreement

 

 

 

EXHIBIT “C”

To Exploration Agreement

 

 

OPERATING AGREEMENT

 

DATED 

MARCH 1, 2006

	
            OPERATOR
 	
            BAYSHORE EXPLORATION L.L.C
 

 

	
            CONTRACT AREA
 	
            COOKE RANCH FIELD
 

	
             
 	
            COOKE RANCH PROSPECT
 

 

 

COUNTY OF LA SALLE, STATE OF TEXAS

 

 

 

 

 

 

 

COPYRIGHT 1989 – ALL RIGHTS RESERVED

AMERICAN ASSOCIATION OF PETROLEUM

LANDMEN, 4100 FOSSIL CREEK BLVD.

FORT WORTH, TEXAS, 76137, APPROVED FORM.

A.A.P.L. NO. 610 – 1989

 

EXHIBIT “C”

To Participation Agreement

 

 

OPERATING AGREEMENT

 

DATED 

MARCH 1, 2006

	
            OPERATOR
 	
            BAYSHORE EXPLORATION L.L.C
 

 

	
            CONTRACT AREA
 	
            COOKE RANCH FIELD
 

	
             
 	
            COOKE RANCH PROSPECT
 

 

 

COUNTY OF LA SALLE, STATE OF TEXAS

 

 

 

 

 

 

 

COPYRIGHT 1989 – ALL RIGHTS RESERVED

AMERICAN ASSOCIATION OF PETROLEUM

LANDMEN, 4100 FOSSIL CREEK BLVD.

FORT WORTH, TEXAS, 76137, APPROVED FORM.

A.A.P.L. NO. 610 – 1989

 

TABLE OF CONTENTS

Title

	
            I. DEFINITIONS
 	
            1
 

	
            II. EXHIBITS
 	
            1
 

	
            III. INTERESTS OP PARTIES
 	
            .2
 

	
             
 	
            A. OIL AND GAS INTERESTS
 	
            2
 

	
             
 	
            B. INTERESTS OF PARTIES IN COSTS AND PRODUCTION
 	
            2
 

	
             
 	
            C. SUBSEQUENTLY CREATED INTERESTS
 	
            2
 

	
            IV. TITLES
 	
            2
 

	
             
 	
            A. TITLE EXAMINATION
 	
            2
 

	
             
 	
            B. LOSS OR FAILURE OF TITLE
 	
            3
 

	
             
 	
            1. Failure of Tide
 	
            3
 

	
             
 	
            2. Loss by Non-Payment or Erroneous Payment of Amount Due
 	
            3
 

	
             
 	
            3. Other Losses
 	
            3
 

	
             
 	
            4. Curing
 	
            3
 

	
            V. OPERATOR
 	
            4
 

	
             
 	
            A. DESIGNATION AND RESPONSIBILITIES OP OPERATOR
 	
            4
 

	
             
 	
            B. RESIGNATION OR REMOVAL OF OPERATOR AN SELECTION OF SUCCESSOR
 	
            4
 

	
             
 	
            1. Resignation or Removal of Operator
 	
            4
 

	
             
 	
            2. Selection of Successor Operator
 	
            4
 

	
             
 	
            3. Effect of Bankruptcy
 	
            4
 

	
             
 	
            C. EMPLOYEES AND CONTRACTORS
 	
            4
 

	
             
 	
            D. RIGHTS AND DUTIES OF OPERATOR
 	
            4
 

	
             
 	
            1. Competitive Rates and Use of Affiliates
 	
            4
 

	
             
 	
            2. Discharge of Joint Account Obligations
 	
            4
 

	
             
 	
            3. Protection from Liens
 	
            4
 

	
             
 	
            4. Custody of Funds
 	
            5
 

	
             
 	
            5. Access to Contract Area and Records
 	
            5
 

	
             
 	
            6. Filing and Furnishing Governmental Reports
 	
            5
 

	
             
 	
            7. Drilling and Testing Operations
 	
            5
 

	
             
 	
            8. Cost Estimates
 	
            5
 

	
             
 	
            9. Insurance
 	
            5
 

	
            VI. DRILLING AND DEVELOPMENT
 	
            5
 

	
             
 	
            A. INITIAL WELL
 	
            5
 

	
             
 	
            B. SUBSEQUENT OPERATIONS
 	
            5
 

	
             
 	
            1. Proposed
 	
            5
 

	
             
 	
            2. Operations by Less Than All Parties
 	
            6
 

 

i

 

	
             
 	
            3. Stand-By Costs
 	
            7
 

	
             
 	
            4. Deepening
 	
            8
 

	
             
 	
            5. Sidetracking
 	
            8
 

	
             
 	
            6. Order of Preference of Operations
 	
            8
 

	
             
 	
            7. Conformity to Spacing Pattern
 	
            9
 

	
             
 	
            8. Paying Wells
 	
            9
 

	
            C. COMPLETION OF WELLS; REWORKING AND PLUGGING BACK
 	
            9
 

	
             
 	
            1. Completion
 	
            9
 

	
             
 	
            2. Rework, Recomplete or Plug Back
 	
            9
 

	
            D. OTHER OPERATIONS
 	
            9
 

	
            E. ABANDONMENT OF WELLS
 	
            9
 

	
             
 	
            1. Abandonment of Dry Holes
 	
            9
 

	
             
 	
            2. Abandonment of Wells That Have Produced
 	
            10
 

	
             
 	
            3. Abandonment of Non-Consent Operations
 	
            10
 

	
            F. TERMINATION OF OPERATIONS
 	
            10
 

	
            G. TAKING PRODUCTION IN KIND
 	
            10
 

	
             
 	
            (Option 1) Gas Balancing Agreement
 	
            10
 

	
             
 	
            (Option 2) No Gas Balancing Agreement
 	
            11
 

	
            VII. EXPENDITURES AND LIABILITY OF PART
 	
            11
 

	
             
 	
            A. LIABILITY OF PARTIES
 	
            11
 

	
             
 	
            B. LIENS AND SECURITY INTERESTS
 	
            11
 

	
             
 	
            C. ADVANCES
 	
            12
 

	
             
 	
            D. DEFAULTS AND REMEDIES
 	
            12
 

	
             
 	
            1. Suspension of Rights
 	
            13
 

	
             
 	
            2. Suit for Damages
 	
            13
 

	
             
 	
            3. Deemed Non-Consent
 	
            13
 

	
             
 	
            4. Advance Payment
 	
            13
 

	
             
 	
            5. Costs and Attorneys’ Fees
 	
            13
 

	
             
 	
            E. RENTALS, SHUT-IN WELL PAYMENTS AND MINIMUM ROYALTIES
 	
            13
 

	
             
 	
            F. TAXES
 	
            13
 

	
            VIII. ACQUISITION, MAINTENANCE OR TRANSFER OF INTEREST
 	
            14
 

	
             
 	
            A. SURRENDER OF LEASES
 	
            14
 

	
             
 	
            B. RENEWAL OR EXTENSION OF LEASES
 	
            14
 

	
             
 	
            C. ACREAGE OR CASH CONSTIRUBTIONS
 	
            14
 

	
             
 	
            D. ASSIGNMENT; MAINTENANCE OF UNIFORM INTEREST
 	
            15
 

	
             
 	
            E. WAIVER OF RIGHTS TO PARTITION
 	
            15
 

	
             
 	
            F. PREFERENTIAL RIGHT TO PURCHASE
 	
            15
 

 

ii

 

	
            IX. INTERNAL REVENUE CODE ELECTION
 	
            15
 

	
            X. CLAIMS AND LAWSUITS
 	
            15
 

	
            XI. FORCE MAJEURE
 	
            16
 

	
            XII. NOTICES
 	
            16
 

	
            XIII. TERM OF AGREEMENT
 	
            16
 

	
            XIV. COMPLIANCE WITH LAWS AND REGULATIONS
 	
            16
 

	
             
 	
            A. LAWS, REGULATIONS AND ORDERS
 	
            16
 

	
             
 	
            B. GOVERNING LAW
 	
            16
 

	
             
 	
            C. REGULATORY AGENCIES
 	
            16
 

	
            XV. MISCELLANEOUS
 	
            17
 

	
             
 	
            A. EXECUTION
 	
            17
 

	
             
 	
            B. SUCCESSORS AND ASSIGNS
 	
            17
 

	
             
 	
            C. COUNTERPARTS
 	
            17
 

	
             
 	
            D SEVERABILITY
 	
            17
 

	
            XVI. OTHER PROVISIONS
 	
            17
 

 

 

iii

 

OPERATING AGREEMENT

 

THIS AGREEMENT, entered into by and between Bayshore Exploration L.L.C., hereinafter designated and referred to as “Operator,” and the signatory party or parties other than Operator, sometimes hereinafter referred to individually as “Non-Operator,” and collectively as “Non-Operators.”

 

WITNESSETH:

 

WHEREAS, the parties to this agreement are owners of Oil and Gas Leases and/or Oil and Gas Interests in the land identified in Exhibit “A,” and the parties hereto have reached an agreement to explore and develop these Leases and/or Oil and Gas Interests for the production of Oil and Gas to the extent and as hereinafter provided,

 

	
             
 	
            NOW, THEREFORE, it is agreed as follows:
 

 

ARTICLE I.

DEFINITIONS

 

As used in this agreement, the following words and terms shall have the meanings here ascribed to them:

 

A. The term “AFE” shall mean an Authority for Expenditure prepared by a party to this agreement for the purpose of estimating the costs to be incurred in conducting an operation hereunder.

 

B. The term “Completion” or “Complete” shall mean a single operation intended to complete a well as a producer of Oil and Gas in one or more Zones, including, but not limited to, the setting of production casing, perforating, well stimulation and production testing conducted in such operation.

 

C. The term “Contract Area” shall mean all of the lands, Oil and Gas Leases and/or Oil and Gas Interests intended to be developed and operated for Oil and Gas purposes under this agreement. Such lands, Oil and Gas Leases and Oil and Gas Interests are described in Exhibit “A.”

 

D. The term “Deepen” shall mean a single operation whereby a well is drilled to an objective Zone below the deepest Zone in which the well was previously drilled, or below the Deepest Zone proposed in the associated AFE, whichever is the lesser.

 

E. The terms “Drilling Party” and “Consenting Party” shall mean a party who agrees to join in and pay its share of the cost of any operation conducted under the provisions of this agreement.

 

F. The term “Drilling Unit” shall mean the area fixed for the drilling of one well by order or rule of any state or federal body having authority. If a Drilling Unit is not fixed by any such rule or order, a Drilling Unit shall be the drilling unit as established by the pattern of drilling in the Contract Area unless fixed by express agreement of the Drilling Parties.

 

G. The term “Drillsite” shall mean the Oil and Gas Lease or Oil and Gas Interest on which a proposed well is to be located.

 

H. The term “Initial Well” shall mean the well required to be drilled by the parties hereto as provided in Article VI.A.

 

I. The term “Non-Consent Well” shall mean a well in which less than all parties have conducted an operation as provided in Article VI.B.2.

 

J. The terms “Non-Drilling Party” and “Non-Consenting Party” shall mean a party who elects not to participate in a proposed operation.

 

1

 

 

K. The term “Oil and Gas” shall mean oil, gas, casinghead gas, gas condensate, and/or all other liquid or gaseous hydrocarbons and other marketable substances produced therewith, unless an intent to limit the inclusiveness of this term is specifically stated.

 

L. The term “Oil and Gas Interests” or “Interests” shall mean unleased fee and mineral interests in Oil and Gas in tracts of land lying within the Contract Area which are owned by parties to this agreement.

 

M. The terms “Oil and Gas Lease,” “Lease” and “Leasehold” shall mean the oil and gas leases or interests therein covering tracts of land lying within the Contract Area which are owned by the parties to this agreement.

 

N. The term “Plug Back” shall mean a single operation whereby a deeper Zone is abandoned in order to attempt a Completion in a shallower Zone.

 

O. The term “Recompletion” or “Recomplete” shall mean an operation whereby a Completion in one Zone is abandoned in order to attempt a Completion in a different Zone within the existing wellbore.

 

P. The term “Rework” shall mean an operation conducted in the wellbore of a well after it is Completed to secure, restore, or improve production in a Zone which is currently open to production in the wellbore. Such operations include, but are not limited to, well stimulation operations but exclude any routine repair or maintenance work or drilling, Sidetracking, Deepening, Completing, Recompleting, or Plugging Back of a well.

 

Q. The term “Sidetrack” shall mean the directional control and intentional deviation of a well from vertical so as to change the bottom hole location unless done to straighten the hole or drill around junk in the hole to overcome other mechanical difficulties.

 

R. The term “Zone” shall mean a stratum of earth containing or thought to contain a common accumulation of Oil and Gas separately producible from any other common accumulation of Oil and Gas.

 

Unless the context otherwise clearly indicates, words used in the singular include the plural, the word “person” includes natural and artificial persons, the plural includes the singular, and any gender includes the masculine, feminine, and neuter.

 

ARTICLE II.

 

EXHIBITS

 

The following exhibits, as indicated below and attached hereto, are incorporated in and made a part hereof:

 

	
             
 	
            X
 	
            A.
 	
            Exhibit “A,” shall include the following information:
 

 

	
             
 	
            (1) Description of lands subject to this agreement,
 

	
             
 	
            (2) [Deleted text]
 

 

	
             
 	
            (3) Parties to agreement with addresses and telephone numbers for notice purposes,
 

 

	
             
 	
            (4) Percentages or fractional interests of parties to this agreement,
 

 

	
             
 	
            (5) [Deleted text]
 

 

	
             
 	
            (6) [Deleted text]
 

 

	
             
 	
            B.
 	
            Exhibit “B,” Form of Lease.
 

 

 

2

 

	
             
 	
            X
 	
            C.
 	
            Exhibit “C,” Accounting Procedure.
 

 

	
             
 	
            X
 	
            D.
 	
            Exhibit “D,” Insurance.
 

 

	
             
 	
            X
 	
            E.
 	
            Exhibit “E,” Gas Balancing Agreement.
 

 

	
             
 	
            X
 	
            F.
 	
            Exhibit “F” Non-Discrimination and Certification of Non-Segregated Facilities.
 

 

	
             
 	
            G.
 	
            Exhibit “G,” Tax Partnership.
 

 

	
             
 	
            H.
 	
            Other:
 

 

If any provision of any exhibit, except Exhibits “E,” “F” and “G,” is inconsistent with any provision contained in the body of this agreement, the provisions in the body of this agreement shall prevail.

 

ARTICLE III.

INTERESTS OF PARTIES

 

A. [DELETED TEXT]

 

B. Interests of Parties in Costs and Production:

 

Unless changed by other provisions, all costs and liabilities incurred in operations under this agreement shall be borne and paid, and all equipment and materials acquired in operations on the Contract Area shall be owned, by the parties as their interests are set forth in Exhibit “A.”  In the same manner, the parties shall also own all production of Oil and Gas from the Contract Area subject, however, to the payment of royalties and other burdens on production as described hereafter.

 

Regardless of which party has contributed any Oil and Gas Lease or Oil and Gas Interest on which royalty or other burdens may be payable and except as otherwise expressly provided in this agreement, each party shall pay or deliver, or cause to be paid or delivered, all burdens on its share of the production from the Contract Area up to, but not in excess of 25% and shall indemnify, defend and hold the other parties free from any liability therefor. Except as otherwise expressly provided in this agreement, if any party has contributed hereto any Lease or Interest which is burdened with any royalty, overriding royalty, production payment or other burden on production in excess of the amounts stipulated above, such party so burdened shall assume and alone bear all such excess obligations and shall indemnify, defend and hold the other parties hereto harmless from any and all claims
attributable to such excess burden. However, so long as the Drilling Unit for the productive Zone(s) is identical with the Contract Area, each party shall pay or deliver, or cause to be paid or delivered, all burdens on production from the Contract Area due under the terms of the Oil and Gas Lease(s) which such party has contributed to this agreement, and shall indemnify, defend and hold the other parties free from any liability therefor.

 

No party shall ever be responsible, on a price basis higher than the price received by such party, to any other party’s lessor or royalty owner, and if such other party’s lessor or royalty owner should demand and receive settlement on a higher price basis, the party contributing the affected Lease shall bear the additional royalty burden attributable to such higher price.

 

Nothing contained in this Article III.B. shall be deemed an assignment or cross-assignment of interests covered hereby, and in the event two or more parties contribute to this agreement jointly owned Leases, the parties’ undivided interests in said Leaseholds shall be deemed separate leasehold interests for the purposes of this agreement.

 

C. Subsequently Created Interests:

 

If any party has contributed hereto a Lease or Interest that is burdened with an assignment of production given as security for the payment of money, or if, after the date of this agreement, any party creates 

 

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an overriding royalty, production payment, net profits interest, assignment of production or other burden payable out of production attributable to its working interest hereunder, such burden shall be deemed a “Subsequently Created Interest.”  Further, if any party has contributed hereto a Lease or Interest burdened with an overriding royalty, production payment, net profits interests, or other burden payable out of production created prior to the date of this agreement, and such burden is not shown on Exhibit “A,” such burden also shall be deemed a Subsequently Created Interest to the extent such burden causes the burdens on such party’s Lease or Interest to exceed the amount stipulated in Article III.B. above.

 

The party whose interest is burdened with the Subsequently Created Interest (the “Burdened Party”) shall assume and alone bear, pay and discharge the Subsequently Created Interest and shall indemnify, defend and hold harmless the other parties from and against any liability therefor. Further, if the Burdened Party fails to pay, when due, its share of expenses chargeable hereunder, all provisions of Article VII.B. shall be enforceable against the Subsequently Created Interest in the same manner as they are enforceable against the working interest of the Burdened Party. If the Burdened Party is required under this agreement to assign or relinquish to any other party, or parties, all or a portion of its working interest and/or the production attributable thereto, said other party, or parties, shall receive said assignment and/or production free and clear of said Subsequently
Created Interest, and the Burdened Party shall indemnify, defend and hold harmless said other party, or parties, from any and all claims and demands for payment asserted by owners of the Subsequently Created Interest.

 

ARTICLE IV.

TITLES

 

A. Title Examination:

 

Title examination shall be made on the Drillsite of any proposed well prior to commencement of drilling operations and, if a majority in interest of the Drilling Parties so request or Operator so elects, title examination shall be made on the entire Drilling Unit, or maximum anticipated Drilling Unit, of the well.  The opinion will include the ownership of the working interest, minerals, royalty, overriding royalty and production payments under the applicable Leases. Each party contributing Leases and/or Oil and Gas Interests to be included in the Drillsite or Drilling Unit, if appropriate, shall furnish to Operator all abstracts (including federal lease status reports), title opinions, title papers and curative material in its possession free of charge. All such information not in the possession of or made available to Operator by the parties, but necessary for the examination of the
title, shall be obtained by Operator. Operator shall cause title to be examined by attorneys on its staff or by outside attorneys. Copies of all title opinions shall be furnished to each Drilling Party. Costs incurred by Operator in procuring abstracts, fees paid outside attorneys for title examination (including preliminary, supplemental, shut-in royalty opinions and division order title opinions) and other direct charges as provided in Exhibit “C” shall be borne by the Drilling Parties in the proportion that the interest of each Drilling Party bears to the total interest of all Drilling Parties as such interests appear in Exhibit “A.”  [Deleted Text]

 

Each party shall be responsible for securing curative matter and pooling amendments or agreements required in connection with Leases or Oil and Gas Interests contributed by such party. Operator shall be responsible for the preparation and recording of pooling designations or declarations and communitization agreements as well as the conduct of hearings before governmental agencies for the securing of spacing or pooling orders or any other orders necessary or appropriate to the conduct of operations hereunder. This shall not prevent any party from appearing on its own behalf at such hearings.

 

Costs incurred by Operator, including fees paid to outside attorneys, which are associated with hearings before governmental agencies, and which costs are necessary and proper for the activities contemplated under this agreement, shall be direct charges to the joint account and shall not be covered by the administrative overhead charges as provided in Exhibit “C.”  Operator shall make no charge for services rendered by its staff attorneys or other personnel in the performance of the above functions.

 

No well shall be drilled on the Contract Area until after (1) the title to the Drillsite or Drilling Unit, if appropriate, has been examined as above provided, and (2) the title has been approved by the examining attorney or title has been accepted by all of the Drilling Parties in such well.

 

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B. Loss or Failure of Title:

 

	
             
 	
            1. [Deleted text]
 

 

	
             
 	
            2. [Deleted text]
 

 

3. Other Losses: All losses of Leases or Interests committed to this agreement, [Deleted Text] shall be joint losses and shall be borne by all parties in proportion to their interests shown on Exhibit “A.”  This shall include but not be limited to the loss of any Lease or Interest through failure to develop or because express or implied covenants have not been performed (other than performance which requires only the payment of money), and the loss of any Lease by expiration at the end of its primary term if it is not renewed or extended. There shall be no readjustment of interests in the remaining portion of the Contract Area on account of any joint loss.

 

4. Curing Title: In the event of a Failure of Title under Article IV.B.1.or a loss of title [deleted text], any Lease or Interest acquired by any party hereto (other than the party whose interest has failed [deleted text] covering all or a portion of the interest that has failed or was lost shall be offered at cost to the party whose interest has failed or was lost, and the provisions of Article VIII.B. shall not apply to such acquisition.

 

ARTICLE V.

OPERATOR

 

A. Designation and Responsibilities of Operator:

 

Bayshore Exploration LLC shall be the Operator of the Contract Area, and shall conduct and direct and have full control of all operations on the Contract Area as permitted and required by, and within the limits of this agreement. In its performance of services hereunder for the Non-Operators, Operator shall be an independent contractor not subject to the control or direction of the Non-Operators except as to the type of operation to be undertaken in accordance with the election procedures contained in this agreement. Operator shall not be deemed, or hold itself out as, the agent of the Non-Operators with authority to bind them to any obligation or liability assumed or incurred by Operator as to any third party. Operator shall conduct its activities under this agreement as a reasonable prudent operator, in a good and workmanlike manner, with due diligence and dispatch, in accordance with
good oilfield practice, and in compliance with applicable law and regulation, but in no event shall it have any liability as Operator to the other parties for losses sustained or liabilities incurred except such as may result from gross negligence or willful misconduct.

 

B. Resignation or Removal of Operator and Selection of Successor:

 

1. Resignation or Removal of Operator: Operator may resign at any time by giving written notice thereof to Non-Operators. If Operator terminates its legal existence, no longer owns an interest hereunder in the Contract Area, or is no longer capable of serving as Operator, Operator shall be deemed to have resigned without any action by Non-Operators, except the selection of a successor. Operator may be removed only for good cause by the affirmative vote of Non-Operators owning a majority interest based on ownership as shown on Exhibit “A” remaining after excluding the voting interest of Operator; such vote shall not be deemed effective until a written notice has been delivered to the Operator by a Non-Operator detailing the alleged default and Operator has failed to cure the default within thirty (30) days from its receipt of the notice or, if the default concerns an operation
then being conducted, within forty-eight (48) hours of its receipt of the notice. For purposes hereof, “good cause” shall mean not only gross negligence or willful misconduct but also the material breach of or inability to meet the standards of operation contained in Article V.A. or material failure or inability to perform its obligations under this agreement.

 

Subject to Article VII.D.1., such resignation or removal shall not become effective until 7:00 o’clock A.M. on the first day of the calendar month following the expiration of ninety (90) days after the giving of notice of resignation by Operator or action by the Non-Operators to remove Operator, unless a successor Operator has been selected and assumes the duties of Operator at an earlier date. Operator, after effective date of resignation or removal, shall be bound by the terms hereof as a Non-Operator. A change of a corporate name 

 

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or structure of Operator or transfer of Operator’s interest to any single subsidiary, parent or successor corporation shall not be the basis for removal of Operator.

 

2. Selection of Successor Operator: Upon the resignation or removal of Operator under any provision of this agreement, a successor Operator shall be selected by the parties. The successor Operator shall be selected from the parties owning an interest in the Contract Area at the time such successor Operator is selected. The successor Operator shall be selected by the affirmative vote of two (2) or more parties owning a majority interest based on ownership as shown on Exhibit “A”; provided, however, if an Operator which has been removed or is deemed to have resigned fails to vote or votes only to succeed itself, the successor Operator shall be selected by the affirmative vote of the party or parties owning a majority interest based on ownership as shown on Exhibit “A” remaining after excluding the voting interest of the Operator that was removed or resigned. The former
Operator shall promptly deliver to the successor Operator all records and data relating to the operations conducted by the former Operator to the extent such records and data are not already in the possession of the successor operator. Any cost of obtaining or copying the former Operator’s records and data shall be charged to the joint account.

 

3. Effect of Bankruptcy: If Operator becomes insolvent, bankrupt or is placed in receivership, it shall be deemed to have resigned without any action by Non-Operators, except the selection of a successor. If a petition for relief under the federal bankruptcy laws is filed by or against Operator, and the removal of Operator is prevented by the federal bankruptcy court, all Non-Operators and Operator shall comprise an interim operating committee to serve until Operator has elected to reject or assume this agreement pursuant to the Bankruptcy Code, and an election to reject this agreement by Operator as a debtor in possession, or by a trustee in bankruptcy, shall be deemed a resignation as Operator without any action by Non-Operators, except the selection of a successor. During the period of time the operating committee controls operations, all actions shall require the approval of two (2)
or more parties owning a majority interest based on ownership as shown on Exhibit “A.”  In the event there are only two (2) parties to this agreement, during the period of time the operating committee controls operations, a third party acceptable to Operator, Non-Operator and the federal bankruptcy court shall be selected as a member of the operating committee, and all actions shall require the approval of two (2) members of the operating committee without regard for their interest in the Contract Area based on Exhibit “A.”

 

C. Employees and Contractors:

 

The number of employees or contractors used by Operator in conducting operations hereunder, their selection, and the hours of labor and the compensation for services performed shall be determined by Operator, and all such employees or contractors shall be the employees or contractors of Operator.

 

D. Rights and Duties of Operator:

 

1. Competitive Rates and Use of Affiliates: All wells drilled on the Contract Area shall be drilled on a competitive contract basis at the usual rates prevailing in the area. If it so desires, Operator may employ its own tools and equipment in the drilling of wells, but its charges therefor shall not exceed the prevailing rates in the area and the rate of such charges shall be agreed upon by the parties in writing before drilling operations are commenced, and such work shall be performed by Operator under the same terms and conditions as are customary and usual in the area in contracts of independent contractors who are doing work of a similar nature. All work performed or materials supplied by affiliates or related parties of Operator shall be performed or supplied at competitive rates, pursuant to written agreement, and in accordance with customs and standards prevailing in the industry.

 

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2. Discharge of Joint Account Obligations: Except as herein otherwise specifically provided, Operator shall promptly pay and discharge expenses incurred in the development and operation of the Contract Area pursuant to this agreement and shall charge each of the parties hereto with their respective proportionate shares upon the expense basis provided in Exhibit “C.”  Operator shall keep an accurate record of the joint account hereunder, showing expenses incurred and charges and credits made and received.

 

3. Protection from Liens: Operator shall pay, or cause to be paid, as and when they become due and payable, all accounts of contractors and suppliers and wages and salaries for services rendered or performed, and for materials supplied on, to or in respect of the Contract Area or any operations for the joint account thereof, and shall keep the Contract Area free from liens and encumbrances resulting therefrom except for those resulting from a bona fide dispute as to services rendered or materials supplied.

 

4. Custody of Funds: Operator shall hold for the account of the Non-Operators any funds of the Non-Operators advanced or paid to the Operator, either for the conduct of operations hereunder or as a result of the sale of production from the Contract Area, and such funds shall remain the funds of the Non-Operators on whose account they are advanced or paid until used for their intended purpose or otherwise delivered to the Non-Operators or applied toward the payment of debts as provided in Article VII.B. Nothing in this paragraph shall be construed to establish a fiduciary relationship between Operator and Non-Operators for any purpose other than to account for Non-Operator funds as herein specifically provided. Nothing in this paragraph shall require the maintenance by Operator of separate accounts for the funds of Non-Operators unless the parties otherwise specifically agree.

 

5. Access to Contract Area and Records: Operator shall, except as otherwise provided herein, permit each Non-Operator or its duly authorized representative, at the Non-Operator’s sole risk and cost, full and free access at all reasonable times to all operations of every kind and character being conducted for the joint account on the Contract Area and to the records of operations conducted thereon or production therefrom, including Operator’s books and records relating thereto. Such access rights shall not be exercised in a manner interfering with Operator’s conduct of an operation hereunder and shall not obligate Operator to furnish any geologic or geophysical data of an interpretive nature unless the cost of preparation of such interpretive data was charged to the joint account. Operator will furnish to each Non-Operator upon request copies of any and all reports and
information obtained by Operator in connection with production and related items, including, without limitation, meter and chart reports, production purchaser statements, run tickets and monthly gauge reports, but excluding purchase contracts and pricing information to the extent not applicable to the production of the Non-Operator seeking the information. Any audit of Operator’s records relating to amounts expended and the appropriateness of such expenditures shall be conducted in accordance with the audit protocol specified in Exhibit “C.”

 

6. Filing and Furnishing Governmental Reports: Operator will file, and upon written request promptly furnish copies to each requesting Non-Operator not in default of its payment obligations, all operational notices, reports or applications required to be filed by local, State, Federal or Indian agencies or authorities having jurisdiction over operations hereunder. Each Non-Operator shall provide to Operator on a timely basis all information necessary to Operator to make such filings.

 

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               7. Drilling and Testing Operations: The following provisions shall apply to each well drilled hereunder, including but not limited to the Initial Well:

 

 (a) Operator will promptly advise Non-Operators of the date on which the well is spudded, or the date on which drilling operations are commenced.

 

 (b) Operator will send to Non-Operators such reports, test results and notices regarding the progress of operations on the well as the Non-Operators shall reasonably request, including, but not limited to, daily drilling reports, completion reports, and well logs.

 

 (c) Operator shall adequately test all Zones encountered which may reasonably be expected to be capable of producing Oil and Gas in paying quantities as a result of examination of the electric log or any other logs or cores or tests conducted hereunder.

 

8. Cost Estimates: Upon request of any Consenting Party, Operator shall furnish estimates of current and cumulative costs incurred for the joint account at reasonable intervals during the conduct of any operation pursuant to this agreement. Operator shall not be held liable for errors in such estimates so long as the estimates are made in good faith.

 

9. Insurance: At all times while operations are conducted hereunder, Operator shall comply with the workers compensation law of the state where the operations are being conducted; provided, however, that Operator may be a self-insurer for liability under said compensation laws in which event the only charge that shall be made to the joint account shall be as provided in Exhibit “C.”  Operator shall also carry or provide insurance for the benefit of the joint account of the parties as outlined in Exhibit “D” attached hereto and made a part hereof. Operator shall require all contractors engaged in work on or for the Contract Area to comply with the workers compensation law of the state where the operations are being conducted and to maintain such other insurance as Operator may require.

 

In the event automobile liability insurance is specified in said Exhibit “D,” or subsequently receives the approval of the parties, no direct charge shall be made by Operator for premiums paid for such insurance for Operator’s automotive equipment.

 

ARTICLE VI.

DRILLING AND DEVELOPMENT

 

A. [Deleted Text] 

 

B. Subsequent Operations:

 

1. Proposed Operations: If any party hereto should desire to drill any well on the Contract Area other than the Initial Well, or if any party should desire to Rework, Sidetrack, Deepen, Recomplete or Plug Back a dry hole or a well no longer capable of producing in paying quantities in which such party has not otherwise relinquished its interest in the proposed objective Zone under this agreement, the party desiring to drill, Rework, Sidetrack, Deepen, Recomplete or Plug Back such a well shall give written notice of the proposed operation to the parties who have not otherwise relinquished their interest in such objective Zone under this agreement and to all other parties in the case of a proposal for Sidetracking or Deepening, specifying the work to be performed, the location, proposed depth, objective Zone and the estimated cost of the operation. The parties to whom such a notice is
delivered shall have thirty [deleted text] days after receipt of the notice within which to notify the party proposing to do the work whether they elect to participate in the cost of the proposed operation. If a drilling rig is on location, notice of a proposal to Rework, Sidetrack, Recomplete, Plug Back or Deepen may be given by telephone and the response period shall be limited to forty-eight (48) hours, exclusive of Saturday, Sunday and legal holidays. Failure of a party to whom such notice is delivered to reply within the period above fixed shall constitute an election by that party not to participate in the cost of the proposed operation. Any proposal by a party to conduct an operation conflicting with the operation initially proposed shall be delivered to all parties within the time and in the manner provided in Article VI.B.6.

 

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If all parties to whom such notice is delivered elect to participate in such a proposed operation, the parties shall be contractually committed to participate therein provided such operations are commenced within the time period hereafter set forth, and Operator shall, no later than ninety (90) days after expiration of the notice period of thirty [deleted text] days (or as promptly as practicable after the expiration of the forty-eight (48) hour period when a drilling rig is on location, as the case may be), actually commence the proposed operation and thereafter complete it with due diligence at the risk and expense of the parties participating therein; provided, however, said commencement date may be extended upon written notice of same by Operator to the other parties, for a period of up to thirty (30) additional days if, in the sole opinion of Operator, such additional time is
reasonably necessary to obtain permits from governmental authorities, surface rights (including rights-of-way) or appropriate drilling equipment, or to complete title examination or curative matter required for title approval or acceptance. If the actual operation has not been commenced within the time provided (including any extension thereof as specifically permitted herein or in the force majeure provisions of Article XI) and if any party hereto still desires to conduct said operation, written notice proposing same must be resubmitted to the other parties in accordance herewith as if no prior proposal had been made. Those parties that did not participate in the drilling of a well for which a proposal to Deepen or Sidetrack is made hereunder shall, if such parties desire to participate in the proposed Deepening or Sidetracking operation, reimburse the Drilling Parties in accordance with Article VI.B.4. in the event of a Deepening operation and in accordance with Article VI.B.5. in
the event of a Sidetracking operation.

 

	
             
 	
            2. Operations by Less Than All Parties:
 

 

 (a) Determination of Participation. If any party to whom such notice is delivered as provided in Article VI.B.1. or VI.C.1. (Option No. 2) elects not to participate in the proposed operation, then, in order to be entitled to the benefits of this Article, the party or parties giving the notice and such other parties as shall elect to participate in the operation shall, no later than ninety [deleted text] days after the expiration of the notice period of thirty [deleted text] days (or as promptly as practicable after the expiration of the forty-eight (48) hour period when a drilling rig is on location, as the case may be) actually commence the proposed operation and complete it with due diligence. Operator shall perform all work for the account of the Consenting Parties; provided, however, if no drilling rig or other equipment is on location, and if Operator is a Non-Consenting Party, the
Consenting Parties shall either: (i) request Operator to perform the work required by such proposed operation for the account of the Consenting Parties, or (ii) designate one of the Consenting Parties as Operator to perform such work. The rights and duties granted to and imposed upon the Operator under this agreement are granted to and imposed upon the party designated as Operator for an operation in which the original Operator is a Non-Consenting Party. Consenting Parties, when conducting operations on the Contract Area pursuant to this Article VI.B.2., shall comply with all terms and conditions of this agreement.

 

If less than all parties approve any proposed operation, the proposing party, immediately after the expiration of the applicable notice period, shall advise all Parties of the total interest of the parties approving such operation and its recommendation as to whether the Consenting Parties should proceed with the operation as proposed. Each Consenting Party, within forty-eight (48) hours (exclusive of Saturday, Sunday, and legal holidays) after delivery of such notice, shall advise the proposing party of its desire to (i) limit participation to such party’s interest as shown on Exhibit “A” or (ii) carry only its proportionate part (determined by dividing such party’s interest in the Contract Area by the interests of all Consenting Parties in the Contract Area) of Non-Consenting Parties’ interests, or (iii) carry its proportionate part (determined as provided in
(ii)) of Non-Consenting Parties’ interests together with all or a portion of its proportionate part of any Non-Consenting Parties’ interests that any Consenting Party did not elect to take. Any interest of Non-Consenting Parties that is not carried by a Consenting Party shall be deemed to be carried by the party proposing the operation if such party does not withdraw its proposal. Failure to advise the proposing party within the time required shall be deemed an election under (i). In the event a drilling rig is on location, notice may be given by telephone, and the time permitted for such a response shall not exceed a total of forty-eight (48) hours (exclusive of Saturday, Sunday and legal holidays). The proposing party, at its election, may withdraw such proposal if there is less than 100% participation and shall notify all parties of such decision within ten (10) days, or within twenty-four (24) hours if a drilling rig is on location, following expiration of the applicable
response period. If 100% subscription to the proposed operation is obtained, the proposing party shall promptly notify the Consenting Parties of their proportionate interests in the operation and the party serving as Operator shall commence such operation within the period provided in Article VI.B.1., subject to the same extension right as provided therein.

 

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            (b)  [Deleted text]
 

 

 (c) Reworking, Recompleting or Plugging Back. An election not to participate in the drilling, Sidetracking or Deepening of a well shall be deemed an election not to participate in any Reworking or Plugging Back operation proposed in such a well, or portion thereof, to which the initial non-consent election applied that is conducted at any time prior to full recovery by the Consenting Parties of the Non-Consenting Party’s recoupment amount. Similarly, an election not to participate in the Completing or Recompleting of a well shall be deemed an election not to participate in any Reworking operation proposed in such a well, or portion thereof, to which the initial non-consent election applied that is conducted at any time prior to full recovery by the Consenting Parties of the Non-Consenting Party’s recoupment amount. Any such Reworking, Recompleting or Plugging Back operation
conducted during the recoupment period shall be deemed part of the cost of operation of said well and there shall be added to the sums to be recouped by the Consenting Parties _______% of that portion of the costs of the Reworking, Recompleting or Plugging Back operation which would have been chargeable to such Non-Consenting Party had it participated therein. If such a Reworking, Recompleting or Plugging Back operation is proposed during such recoupment period, the provisions of this Article VI.B. shall be applicable as between said Consenting Parties in said well.

 

	
             
 	
            (d) [Deleted Text]
 

 

3. Stand-By Costs: When a well which has been drilled or Deepened has reached its authorized depth and all tests have been completed and the results thereof furnished to the parties, or when operations on the well have been otherwise terminated pursuant to Article VI.F., stand-by costs incurred pending response to a party’s notice proposing a Reworking, Sidetracking, Deepening, Recompleting, Plugging Back or Completing operation in such a well (including the period required under Article VI.B.6. to resolve competing proposals) shall be charged and borne as part of the drilling or Deepening operation just completed. Stand-by costs subsequent to all parties responding, or expiration of the response time permitted, whichever first occurs, and prior to agreement as to the participating interests of all Consenting Parties pursuant to the terms of the second grammatical paragraph of
Article VI.B.2. (a), shall be charged to and borne as part of the proposed operation, but if the proposal is subsequently withdrawn because of insufficient participation, such stand-by costs shall be allocated between the Consenting Parties in the proportion each Consenting Party’s interest as shown on Exhibit “A” bears to the total interest as shown on Exhibit “A” of all Consenting Parties.

 

In the event that notice for a Sidetracking operation is given while the drilling rig to be utilized is on location, any party may request and receive up to five (5) additional days after expiration of the forty-eight hour response period specified in Article VI.B.1. within which to respond by paying for all stand-by costs and other costs incurred during such extended response period; Operator may require such party to pay the estimated stand-by time in advance as a condition to extending the response period. If more than one party elects to take such additional time to respond to the notice, standby costs shall be allocated between the parties taking additional time to respond on a day-to-day basis in the proportion each electing party’s interest as shown on Exhibit “A” bears to the total interest as shown on Exhibit “A” of all the electing parties.

 

	
             
 	
            4. [Deleted Text]
 

 

5. Sidetracking: Any party having the right to participate in a proposed Sidetracking operation that does not own an interest in the affected wellbore at the time of the notice shall, upon electing to participate, tender to the wellbore owners its proportionate share (equal to its interest in the Sidetracking operation) of the value of that portion of the existing wellbore to be utilized as follows:

 

 (a) If the proposal is for Sidetracking an existing dry hole, reimbursement shall be on the basis of the actual costs incurred in the initial drilling of the well down to the depth at which the Sidetracking operation is initiated.

 

 (b) If the proposal is for Sidetracking a well which has previously produced, reimbursement shall be on the basis of such party’s proportionate share of drilling and equipping costs incurred in the initial drilling of the well down to the depth at which the Sidetracking operation is conducted, calculated in the manner described in 

 

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Article VI.B.4(b) above. Such party’s proportionate share of the cost of the well’s salvable materials and equipment down to the depth at which the Sidetracking operation is initiated shall be determined in accordance with the provisions of Exhibit “C.”

 

6. Order of Preference of Operations. Except as otherwise specifically provided in this agreement, if any party desires to propose the conduct of an operation that conflicts with a proposal that has been made by a party under this Article VI, such party shall have fifteen (15) days from delivery of the initial proposal, in the case of a proposal to drill a well or to perform an operation on a well where no drilling rig is on location, or twenty-four (24) hours, exclusive of Saturday, Sunday and legal holidays, from delivery of the initial proposal, if a drilling rig is on location for the well on which such operation is to be conducted, to deliver to all parties entitled to participate in the proposed operation such party’s alternative proposal, such alternate proposal to contain the same information required to be included in the initial proposal. Each party receiving such
proposals shall elect by delivery of notice to Operator within five (5) days after expiration of the proposal period, or within twenty-four (24) hours (exclusive of Saturday, Sunday and legal holidays) if a drilling rig is on location for the well that is the subject of the proposals, to participate in one of the competing proposals. Any party not electing within the time required shall be deemed not to have voted. The proposal receiving the vote of parties owning the largest aggregate percentage interest of the parties voting shall have priority over all other competing proposals; in the case of a tie vote, the initial proposal shall prevail. Operator shall deliver notice of such result to all parties entitled to participate in the operation within five (5) days after expiration of the election period (or within twenty-four (24) hours, exclusive of Saturday, Sunday and legal holidays, if a drilling rig is on location). Each party shall then have two (2) days (or twenty-four (24)
hours if a rig is on location) from receipt of such notice to elect by delivery of notice to Operator to participate in such operation or to relinquish interest in the affected well pursuant to the provisions of Article VI.B.2.; failure by a party to deliver notice within such period shall be deemed an election not to participate in the prevailing proposal.

 

7. Conformity to Spacing Pattern. Notwithstanding the provisions of this Article VI.B.2., it is agreed that no wells shall be proposed to be drilled to or Completed in or produced from a Zone from which a well located elsewhere on the Contract Area is producing, unless such well conforms to the then-existing well spacing pattern for such Zone.

 

8. Paying Wells. No party shall conduct any Reworking, Deepening, Plugging Back, Completion, Recompletion, or Sidetracking operation under this agreement with respect to any well then capable of producing in paying quantities except with the consent of all parties that have not relinquished interests in the well at the time of such operation.

 

C. Completion of Wells; Reworking and Plugging Back:

 

1. Completion: Without the consent of all parties, no well shall be drilled, Deepened or Sidetracked, except any well drilled, Deepened or Sidetracked pursuant to the provisions of Article VI.B.2. of this agreement. Consent to the drilling, Deepening or Sidetracking shall include:

 

Option No. 1: All necessary expenditures for the drilling, Deepening or Sidetracking, testing, Completing and equipping of the well, including necessary tankage and/or surface facilities.

 

xx          Option No. 2: All necessary expenditures for the drilling, Deepening or Sidetracking and testing of the well. When such well has reached its authorized depth, and all logs, cores and other tests have been completed, and the results thereof furnished to the parties, Operator shall give immediate notice to the Non-Operators having the right to participate in a Completion attempt whether or not Operator recommends attempting to Complete the well, together with Operator’s AFE for Completion costs if not previously provided. The parties receiving such notice shall have forty-eight (48) hours (exclusive of Saturday, Sunday and legal holidays) in which to elect by delivery of notice to Operator to participate in a recommended Completion attempt or to make a Completion proposal with an accompanying AFE. Operator shall deliver any
such Completion proposal, or any Completion proposal conflicting with Operator’s proposal, to the other parties entitled to participate in such Completion in accordance with the procedures specified in Article VI.B.6. Election to participate in a Completion attempt shall include consent to all necessary expenditures for the Completing and equipping of such well, including necessary tankage and/or surface facilities but excluding any stimulation 

 

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operation not contained on the Completion AFE. Failure of any party receiving such notice to reply within the period above fixed shall constitute an election by that party not to participate in the cost of the Completion attempt; provided, that Article VI.B.6. shall control in the case of conflicting Completion proposals. If one or more, but less than all of the parties, elect to attempt a Completion, the provision of Article VI.B.2. hereof (the phrase “Reworking, Sidetracking, Deepening, Recompleting or Plugging Back” as contained in Article VI.B.2. shall be deemed to include “Completing”) shall apply to the operations thereafter conducted by less than all parties; provided, however, that Article VI.B.2. shall apply separately to each separate Completion or Recompletion attempt undertaken hereunder, and an election to become a Non-Consenting Party as to one Completion or Recompletion
attempt shall not prevent a party from becoming a Consenting Party in subsequent Completion or Recompletion attempts regardless whether the Consenting Parties as to earlier Completions or Recompletion have recouped their costs pursuant to Article VI.B.2.; provided further, that any recoupment of costs by a Consenting Party shall be made solely from the production attributable to the Zone in which the Completion attempt is made. Election by a previous Non-Consenting party to participate in a subsequent Completion or Recompletion attempt shall require such party to pay its proportionate share of the cost of salvable materials and equipment installed in the well pursuant to the previous Completion or Recompletion attempt, insofar and only insofar as such materials and equipment benefit the Zone in which such party participates in a Completion attempt.

 

2. Rework, Recomplete or Plug Back: No well shall be Reworked, Recompleted or Plugged Back except a well Reworked, Recompleted, or Plugged Back pursuant to the provisions of Article VI.B.2. of this agreement. Consent to the Reworking, Recompleting or Plugging Back of a well shall include all necessary expenditures in conducting such operations and Completing and equipping of said well, including necessary tankage and/or surface facilities.

 

D. Other Operations:

 

Operator shall not undertake any single project reasonably estimated to require an expenditure in excess of Twenty Five Thousand Dollars ($25,000.00) except in connection with the drilling, Sidetracking, Reworking, Deepening, Completing, Recompleting or Plugging Back of a well that has been previously authorized by or pursuant to this agreement; provided, however, that, in case of explosion, fire, flood or other sudden emergency, whether of the same or different nature, Operator may take such steps and incur such expenses as in its opinion are required to deal with the emergency to safeguard life and property but Operator, as promptly as possible, shall report the emergency to the other parties. If Operator prepares an AFE for its own use, Operator shall furnish any Non-Operator so requesting an information copy thereof for any single project costing in excess of Ten Thousand Dollars
($10,000.00). Any party who has not relinquished its interest in a well shall have the right to propose that

Operator perform repair work or undertake the installation of artificial lift equipment or ancillary production facilities such as salt water disposal wells or to conduct additional work with respect to a well drilled hereunder or other similar project (but not including the installation of gathering lines or other transportation or marketing facilities, the installation of which shall be governed by separate agreement between the parties) reasonably estimated to require an expenditure in excess of the amount first set forth above in this Article VI.D. (except in connection with an operation required to be proposed under Articles VI.B.1. or VI.C.1. Option No. 2, which shall be governed exclusively be those Articles). Operator shall deliver such proposal to all parties entitled to participate therein. If within thirty (30) days thereof Operator secures the written consent of any party or parties owning at
least 51% of the interests of the parties entitled to participate in such operation, each party having the right to participate in such project shall be bound by the terms of such proposal and shall be obligated to pay its proportionate share of the costs of the proposed project as if it had consented to such project pursuant to the terms of the proposal.

 

E. Abandonment of Wells:

 

1. Abandonment of Dry Holes: Except for any well drilled or Deepened pursuant to Article VI.B.2., any well which has been drilled or Deepened under the terms of this agreement and is proposed to be completed as a dry hole shall not be plugged and abandoned without the consent of all parties. Should Operator, after diligent effort, be unable to contact any party, or should any party fail to reply within forty-eight (48) hours (exclusive of Saturday, Sunday and legal holidays) after delivery of notice of the proposal to plug and abandon such well, 

 

12

 

such party shall be deemed to have consented to the proposed abandonment. All such wells shall be plugged and abandoned in accordance with applicable regulations and at the cost, risk and expense of the parties who participated in the cost of drilling or Deepening such well. Any party who objects to plugging and abandoning such well by notice delivered to Operator within forty-eight (48) hours (exclusive of Saturday, Sunday and legal holidays) after delivery of notice of the proposed plugging shall take over the well as of the end of such forty-eight (48) hour notice period and conduct further operations in search of Oil and/or Gas subject to the provisions of Article VI.B.; failure of such party to provide proof reasonably satisfactory to Operator of its financial capability to conduct such operations or to take over the well within such period or thereafter to conduct operations on such well or plug and
abandon such well shall entitle Operator to retain or take possession of the well and plug and abandon the well.

 

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The party taking over the well shall indemnify Operator (if Operator is an abandoning party) and the other abandoning parties against liability for any further operations conducted on such well except for the costs of plugging and abandoning the well and restoring the surface, for which the abandoning parties shall remain proportionately liable.

 

2. Abandonment of Wells That Have Produced: Except for any well in which a Non-Consent operation has been conducted hereunder for which the Consenting Parties have not been fully reimbursed as herein provided, any well which has been completed as a producer shall not be plugged and abandoned without the consent of all parties. If all parties consent to such abandonment, the well shall be plugged and abandoned in accordance with applicable regulations and at the cost, risk and expense of all the parties hereto. Failure of a party to reply within sixty (60) days of delivery of notice of proposed abandonment shall be deemed an election to consent to the proposal. If, within sixty (60) days after delivery of notice of the proposed abandonment of any well, all parties do not agree to the abandonment of such well, those wishing to continue its operation from the Zone then open to production
shall be obligated to take over the well as of the expiration of the applicable notice period and shall indemnify Operator (if Operator is an abandoning party) and the other abandoning parties against liability for any further operations on the well conducted by such parties. Failure of such party or parties to provide proof reasonably satisfactory to Operator of their financial capability to conduct such operations or to take over the well within the required period or thereafter to conduct operations on such well shall entitle operator to retain or take possession of such well and plug and abandon the well.

 

Parties taking over a well as provided herein shall tender to each of the other parties its proportionate share of the value of the well’s salvable material and equipment, determined in accordance with the provisions of Exhibit “C,” less the estimated cost of salvaging and the estimated cost of plugging and abandoning and restoring the surface; provided, however, that in the event the estimated plugging and abandoning and surface restoration costs and the estimated cost of salvaging are higher than the value of the well’s salvable material and equipment, each of the abandoning parties shall tender to the parties continuing operations their proportionate shares of the estimated excess cost. Each abandoning party shall assign to the non-abandoning parties, without warranty, express or implied, as to title or as to quantity, or fitness for use of the equipment and
material, all of its interest in the wellbore of the well and related equipment, together with its interest in the Leasehold insofar and only insofar as such Leasehold covers the right to obtain production from that wellbore in the Zone then open to production. If the interest of the abandoning party is or includes and Oil and Gas Interest, such party shall execute and deliver to the non-abandoning party or parties an oil and gas lease, limited to the wellbore and the Zone then open to production, for a term of one (1) year and so long thereafter as Oil and/or Gas is produced from the Zone covered thereby, such lease to be on the form attached as Exhibit “B.”  The assignments or leases so limited shall encompass the Drilling Unit upon which the well is located. The payments by, and the assignments or leases to, the assignees shall be in a ratio based upon the relationship of their respective percentage of participation in the Contract Area to the aggregate of the percentages
of participation in the Contract Area of all assignees. There shall be no readjustment of interests in the remaining portions of the Contract Area.

 

Thereafter, abandoning parties shall have no further responsibility, liability, or interest in the operation of or production from the well in the Zone then open other than the royalties retained in any lease made under the terms of this Article. Upon request, Operator shall continue to operate the assigned well for the account of the non-abandoning parties at the rates and charges contemplated by this agreement, plus any additional cost and charges which may arise as the result of the separate ownership of the assigned well. Upon proposed abandonment of the producing Zone assigned or leased, the assignor or lessor shall then have the option to repurchase its prior interest in the well (using the same valuation formula) and participate in further operations therein subject to the provisions hereof.

 

3. Abandonment of Non-Consent Operations: The provisions of Article VI.E.1. or VI.E.2. above shall be applicable as between Consenting Parties in the event of the proposed abandonment of any well excepted from said Articles; provided, however, no well shall be permanently plugged and abandoned unless and until all parties having the right to conduct further operations therein have been notified of the proposed abandonment and afforded the opportunity to elect to take over the well in accordance with the provisions of this Article VI.E.; 

 

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and provided further, that Non-Consenting Parties who own an interest in a portion of the well shall pay their proportionate shares of abandonment and surface restoration cost for such well as provided in Article VI.B.2.(b).

 

F. Termination of Operations:

 

Upon the commencement of an operation for the drilling, Reworking, Sidetracking, Plugging Back, Deepening, testing, Completion or plugging of a well, including but not limited to the Initial Well, such operation shall not be terminated without consent of parties bearing 80% of the costs of such operation; provided, however, that in the event granite or other practically impenetrable substance or condition in the hole is encountered which renders further operations impractical, Operator may discontinue operations and give notice of such condition in the manner provided in Article VI.B.1, and the provisions of Article VI.B. or VI.E. shall thereafter apply to such operation, as appropriate.

 

G. Taking Production in Kind:

 

	
             
 	
            X
 	
            Option No. 1: Gas Balancing Agreement Attached
 

 

Each party shall take in kind or separately dispose of its proportionate share of all Oil and Gas produced from the Contract Area, exclusive of production which may be used in development and producing operations and in preparing and treating Oil and Gas for marketing purposes and production unavoidably lost. Any extra expenditure incurred in the taking in kind or separate disposition by any party of its proportionate share of the production shall be borne by such party. Any party taking its share of production in kind shall be required to pay for only its proportionate share of such part of Operator’s surface facilities which it uses.

 

Each party shall execute such division orders and contracts as may be necessary for the sale of its interest in production from the Contract Area, and, except as provided in Article VII.B., shall be entitled to receive payment directly from the purchaser thereof for its share of all production.

 

	
             
 	
            * Operator will make its best effort to sell all gas for the joint account.
 

 

15

 

If any party fails to make the arrangements necessary to take in kind or separately dispose of its proportionate share of the Oil produced from the Contract Area, Operator shall have the right, subject to the revocation at will by the party owning it, but not the obligation, to purchase such Oil or sell it to others at any time and from time to time, for the account of the non-taking party. Any such purchase or sale by Operator may be terminated by Operator upon at least ten (10) days written notice to the owner of said production and shall be subject always to the right of the owner of the production upon at least ten (10) days written notice to Operator to exercise at any time its right to take in kind, or separately dispose of, its share of all Oil not previously delivered to a purchaser. Any purchase or sale by Operator of any other party’s share of Oil shall be only for such
reasonable periods of time as are consistent with the minimum needs of the industry under the particular circumstances, but in no event for a period in excess of one (1) year.

 

Any such sale by Operator shall be in a manner commercially reasonable under the circumstances but Operator shall have no duty to share any existing market or to obtain a price equal to that received under any existing market. The sale or delivery by Operator of a non-taking party’s share of Oil under the terms of any existing contract of Operator shall not give the non-taking party any interest in or make the non-taking party a party to said contract. No purchase shall be made by Operator without first giving the non-taking party at least ten (10) days written notice of such intended purchase and the price to be paid or the pricing basis to be used.

 

All parties shall give timely written notice to Operator of their Gas marketing arrangements for the following month, excluding price, and shall notify Operator immediately in the event of a change in such arrangements. Operator shall maintain records of all marketing arrangements, and of volumes actually sold or transported, which records shall be made available to Non-Operators upon reasonable request.

 

In the event one or more parties’ separate disposition of its share of the Gas causes split-stream deliveries to separate pipelines and/or deliveries which on a day-to-day basis for any reason are not exactly equal to a party’s respective proportion-ate share of total Gas sales to be allocated to it, the balancing or accounting between the parties shall be in accordance with any Gas balancing agreement between the parties hereto, whether such an agreement is attached as Exhibit “E” or is a separate agreement. Operator shall give notice to all parties of the first sales of Gas from any well under this agreement.

 

	
             
 	
            Option No. 2: No Gas Balancing Agreement:
 

 

Each party shall take in kind or separately dispose of its proportionate share of all Oil and Gas produced from the Contract Area, exclusive of production which may be used in development and producing operations and in preparing and treating Oil and Gas for marketing purposes and production unavoidably lost. Any extra expenditures incurred in the taking in kind or separate disposition by any party of its proportionate share of the production shall be borne by such party. Any party taking its share of production in kind shall be required to pay for only its proportionate share of such part of Operator’s surface facilities which it uses.

 

Each party shall execute such division orders and contracts as may be necessary for the sale of its interest in production from the Contract Area, and, except as provided in Article VII.B., shall be entitled to receive payment directly from the purchaser thereof for its share of all production.

 

If any party fails to make the arrangements necessary to take in kind or separately dispose of its proportionate share of the Oil and/or Gas produced from the Contract Area, Operator shall have the right, subject to the revocation at will by the party owning it, but not the obligation, to purchase such Oil and/or Gas or sell it to others at any time and from time to time, for the account of the non-taking party. Any such purchase or sale by Operator may be terminated by Operator upon at least ten (10) days written notice to the owner of said production and shall be subject always to the right of the owner of the production upon at least ten (10) days written notice to Operator to exercise its right to take in kind, or separately dispose of, its share of all Oil and/or Gas not previously delivered to a purchaser; provided, however, that the effective date of any such revocation may be
deferred at Operator’s election for a period not to exceed ninety (90) days if Operator has committed such production to a purchase contract having a term extending beyond such ten (10) -day period. Any purchase or sale by Operator of any other party’s share of Oil and/or Gas shall be only for such reasonable 

 

16

 

periods of time as are consistent with the minimum needs of the industry under the particular circumstances, but in no event for a period in excess of one (1) year.

 

Any such sale by Operator shall be in a manner commercially reasonable under the circumstances, but Operator shall have no duty to share any existing market or transportation arrangement or to obtain a price or transportation fee equal to that received under any existing market or transportation arrangement. The sale or delivery by Operator of a non-taking party’s share of production under the terms of any existing contract of Operator shall not give the non-taking party any interest in or make the non-taking party a party to said contract. No purchase of Oil and Gas and no sale of Gas shall be made by Operator without first giving the non-taking party ten days written notice of such intended purchase or sale and the price to be paid or the pricing basis to be used. Operator shall give notice to all parties of the first sale of Gas from any well under this Agreement.

 

All parties shall give timely written notice to Operator of their Gas marketing arrangements for the following month, excluding price, and shall notify Operator immediately in the event of a change in such arrangements. Operator shall maintain records of all marketing arrangements, and of volumes actually sold or transported, which records shall be made available to Non-Operators upon reasonable request.

 

ARTICLE VII.

EXPENDITURES AND LIABILITY OF PARTIES

 

A. Liability of Parties:

 

The liability of the parties shall be several, not joint or collective. Each party shall be responsible only for its obligations, and shall be liable only for its proportionate share of the costs of developing and operating the Contract Area. Accordingly, the liens granted among the parties in Article VII.B. are given to secure only the debts of each severally, and no party shall have any liability to third parties hereunder to satisfy the default of any other party in the payment of any expense or obligation hereunder. It is not the intention of the parties to create, nor shall this agreement be construed as creating, a mining or other partnership, joint venture, agency relationship or association, or to render the parties liable as partners, co-venturers, or principals. In their relations with each other under this agreement, the parties shall not be considered fiduciaries or to have
established a confidential relationship but rather shall be free to act on an arm’s-length basis in accordance with their own respective self-interest, subject, however, to the obligation of the parties to act in good faith in their dealings with each other with respect to activities hereunder.

 

B. Liens and Security Interests:

 

Each party grants to the other parties hereto a lien upon any interest it now owns or hereafter acquires in Oil and Gas Leases and Oil and Gas Interests in the Contract Area, and a security interest and/or purchase money security interest in any interest it now owns or hereafter acquires in the personal property and fixtures on or used or obtained for use in connection therewith, to secure performance of all of its obligations under this agreement including but not limited to payment of expense, interest and fees, the proper disbursement of all monies paid hereunder, the assignment or relinquishment of interest in Oil 

and Gas Leases as required hereunder, and the proper performance of operations hereunder. Such lien and security interest granted by each party hereto shall include such party’s leasehold interests, working interests, operating rights, and royalty and overriding royalty interests in the Contract Area now owned or hereafter acquired and in lands pooled or unitized therewith or otherwise becoming subject to this agreement, the Oil and Gas when extracted therefrom and equipment situated thereon or used or obtained for use in connection therewith (including, without limitation, all wells, tools, and tubular goods), and accounts (including, without limitation, accounts arising from gas imbalances or from the sale of Oil and/or Gas at the wellhead), contract rights, inventory and general intangibles relating thereto or arising therefrom, and all proceeds and products of the foregoing.

 

To perfect the lien and security agreement provided herein, each party hereto shall execute and acknowledge the recording supplement and/or any financing statement prepared and submitted by any party hereto in conjunction herewith or at any time following execution hereof, and Operator is authorized to file this agreement or the recording supplement executed herewith as a lien or mortgage in the applicable real estate 

 

17

 

records and as a financing statement with the proper officer under the Uniform Commercial Code in the state in which the Contract Area is situated and such other states as Operator shall deem appropriate to perfect the security interest granted hereunder. Any party may file this agreement, the recording supplement executed herewith, or such other documents as it deems necessary as a lien or mortgage in the applicable real estate records and/or a financing statement with the proper officer under the Uniform Commercial Code.

 

Each party represents and warrants to the other parties hereto that the lien and security interest granted by such party to the other parties shall be a first and prior lien, and each party hereby agrees to maintain the priority of said lien and security interest against all persons acquiring an interest in Oil and Gas Leases and Interests covered by this agreement by, through or under such party. All parties acquiring an interest in Oil and Gas Leases and Oil and Gas Interests covered by this agreement, whether by assignment, merger, mortgage, operation of law, or otherwise, shall be deemed to have taken subject to the lien and security interest granted by this Article VII.B. as to all obligations attributable to such interest hereunder whether or not such obligations arise before or after such interest is acquired.

 

To the extent that parties have a security interest under the Uniform Commercial Code of the state in which the Contract Area is situated, they shall be entitled to exercise the rights and remedies of a secured party under the Code.The bringing of a suit and the obtaining of judgment by a party for the secured indebtedness shall not be deemed an election of remedies or otherwise affect the lien rights or security interest as security for the payment thereof. In addition, upon default by any party in the payment of its share of expenses, interests or fees, or upon the improper use of funds by the Operator, the other parties shall have the right, without prejudice to other rights or remedies, to collect from the purchaser the proceeds from the sale of such defaulting party’s share of Oil and Gas until the amount owed by such party, plus interest as provided in “Exhibit C,”
has been received, and shall have the right to offset the amount owed against the proceeds from the sale of such defaulting party’s share of Oil and Gas. All purchasers of production may rely on a notification of default from the non-defaulting party or parties stating the amount due as a result of the default, and all parties waive any recourse available against purchasers for releasing production proceeds as provided in this paragraph.

 

	
             
 	
            [Deleted text]
 

 

If any party does not perform all of its obligations hereunder, and the failure to perform subjects such party to foreclosure or execution proceedings pursuant to the provisions of this agreement, to the extent allowed by governing law, the defaulting party waives any available right of redemption from and after the date of judgment, any required valuation or appraisement of the mortgaged or secured property prior to sale, any available right to stay execution or to require a marshaling of assets and any required bond in the event a receiver is appointed. In addition, to the extent permitted by applicable law, each party hereby grants to the other parties a power of sale as to any property that is subject to the lien and security rights granted hereunder, such power to be exercised in the manner provided by applicable law or otherwise in a commercially reasonable manner and upon reasonable notice.

 

Each party agrees that the other parties shall be entitled to utilize the provisions of Oil and Gas lien law or other lien law of any state in which the Contract Area is situated to enforce the obligations of each party hereunder. Without limiting the generality of the foregoing, to the extent permitted by applicable law, Non-Operators agree that Operator may invoke or utilize the mechanics’ or materialmen’s lien law of the state in which the Contract Area is situated in order to secure the payment to Operator of any sum due hereunder for services performed or materials supplied by Operator.

 

C. Advances:

 

Operator, at its election, shall have the right from time to time to demand and receive from one or more of the other parties payment in advance of their respective shares of the estimated amount of the expense to be incurred in operations hereunder during the next succeeding month, which right may be exercised only by submission to each such party of an itemized statement of such estimated expense, together with an invoice for its share thereof. Each such statement and invoice for the payment in advance of estimated expense shall be submitted on or before the 20th day of the next preceding month. Each party shall pay to Operator its proportionate share of such estimate within fifteen (15) days after such estimate and invoice is received. If any 

 

18

 

party fails to pay its share of said estimate within said time, the amount due shall bear interest as provided in Exhibit “C” until paid. Proper adjustment shall be made monthly between advances and actual expense to the end that each party shall bear and pay its proportionate share of actual expenses incurred, and no more.

 

D. Defaults and Remedies:

 

If any party fails to discharge any financial obligation under this agreement, including without limitation the failure to make any advance under the preceding Article VII.C. or any other provision of this agreement, within the period required for such payment hereunder, then in addition to the remedies provided in Article VII.B. or elsewhere in this agreement, the remedies specified below shall be applicable. For purposes of this Article VII.D., all notices and elections shall be delivered only by Operator, except that Operator shall deliver any such notice and election requested by a non-defaulting Non-Operator, and when Operator is the party in default, the applicable notices and elections can be delivered by any Non-Operator. Election of any one or more of the following remedies shall not preclude the subsequent use of any other remedy specified below or otherwise available to a
non-defaulting party.

 

1. Suspension of Rights: Any party may deliver to the party in default a Notice of Default, which shall specify the default, specify the action to be taken to cure the default, and specify that failure to take such action will result in the exercise of one or more of the remedies provided in this Article. If the default is not cured within thirty (30) days of the delivery of such Notice of Default, all of the rights of the defaulting party granted by this agreement may upon notice be suspended until the default is cured, without prejudice to the right of the non-defaulting party or parties to continue to enforce the obligations of the defaulting party previously accrued or thereafter accruing under this agreement. If Operator is the party in default, the Non-Operators shall have in addition the right, by vote of Non-Operators owning a majority in interest in the Contract Area after
excluding the voting interest of Operator, to appoint a new Operator effective immediately. The rights of a defaulting party that may be suspended hereunder at the election of the non-defaulting parties shall include, without limitation, the right to receive information as to any operation conducted hereunder during the period of such default, the right to elect to participate in an operation proposed under Article VI.B. of this agreement, the right to participate in an operation being

conducted under this agreement even if the party has previously elected to participate in such operation, and the right to receive proceeds of production from any well subject to this agreement.

 

2. Suit for Damages: Non-defaulting parties or Operator for the benefit of non-defaulting parties may sue (at joint account expense) to collect the amounts in default, plus interest accruing on the amounts recovered from the date of default until the date of collection at the rate specified in Exhibit “C” attached hereto. Nothing herein shall prevent any party from suing any defaulting party to collect consequential damages accruing to such party as a result of the default.

 

3. Deemed Non-Consent: The non-defaulting party may deliver a written Notice of Non-Consent Election to the defaulting party at any time after the expiration of the thirty-day cure period following delivery of the Notice of Default, in which event if the billing is for the drilling a new well or the Plugging Back, Sidetracking, Reworking or Deepening of a well which is to be or has been plugged as a dry hole, or for the Completion or Recompletion of any well, the defaulting party will be conclusively deemed to have elected not to participate in the operation and to be a Non-Consenting Party with respect thereto under Article VI.B. or VI.C., as the case may be, to the extent of the costs unpaid by such party, notwithstanding any election to participate theretofore made. If election is made to proceed under this provision, then the non-defaulting parties may not elect to sue for the unpaid
amount pursuant to Article VII.D.2.

 

Until the delivery of such Notice of Non-Consent Election to the defaulting party, such party shall have the right to cure its default by paying its unpaid share of costs plus interest at the rate set forth in Exhibit “C,” provided, however, such payment shall not prejudice the rights of the non-defaulting parties to pursue remedies for damages incurred by the non-defaulting parties as a result of the default. Any interest relinquished pursuant to this Article VII.D.3. shall be offered to the non-defaulting parties in proportion to their interests, and the non-defaulting parties electing to participate in the ownership of such interest shall be required to contribute their shares of the defaulted amount upon their election to participate therein.

 

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4. Advance Payment: If a default is not cured within thirty (30) days of the delivery of a Notice of Default, Operator, or Non-Operators if Operator is the defaulting party, may thereafter require advance payment from the defaulting party of such defaulting party’s anticipated share of any item of expense for which Operator, or Non-Operators, as the case may be, would be entitled to reimbursement under any provision of this agreement, whether or not such expense was the subject of the previous default. Such right includes, but is not limited to, the right to require advance payment for the estimated costs of drilling a well or Completion of a well as to which an election to participate in drilling or Completion has been made. If the defaulting party fails to pay the required advance payment, the non-defaulting parties may pursue any of the remedies provided in the Article VII.D. or
any other default remedy provided elsewhere in this agreement. Any excess of funds advanced remaining when the operation is completed and all costs have been paid shall be promptly returned to the advancing party.

 

5. Costs and Attorneys’ Fees: In the event any party is required to bring legal proceedings to enforce any financial obligation of a party hereunder, the prevailing party in such action shall be entitled to recover all court costs, costs of collection, and a reasonable attorney’s fee, which the lien provided for herein shall also secure.

 

E. Rentals, Shut-in Well Payments and Minimum Royalties:

 

Rentals, shut-in well payments and minimum royalties which may be required under the terms of any lease shall be paid by the party or parties who subjected such lease to this agreement at its or their expense. In the event two or more parties own and have contributed interests in the same lease to this agreement, such parties may designate one of such parties to make said payments for and on behalf of all such parties. Any party may request, and shall be entitled to receive, proper evidence of all such payments. In the event of failure to make proper payment of any rental, shut-in well payment or minimum royalty through mistake or oversight where such payment is required to continue the lease in force, any loss which results from such non-payment shall be borne in accordance with the provisions of Article IV.B.2.

 

Operator shall notify Non-Operators of the anticipated completion of a shut-in well, or the shutting in or return to production of a producing well, at least five (5) days (excluding Saturday, Sunday, and legal holidays) prior to taking such action, or at the earliest opportunity permitted by circumstances, but assumes no liability for failure to do so. In the event of failure by Operator to so notify Non-Operators, the loss of any lease contributed hereto by Non-Operators for failure to make timely payments of any shut-in well payment shall be borne jointly by the parties hereto under the provisions of Article IV.B.3.

 

F. Taxes:

 

Beginning with the first calendar year after the effective date hereof, Operator shall render for ad valorem taxation all property subject to this agreement which by law should be rendered for such taxes, and it shall pay all such taxes assessed thereon before they become delinquent. Prior to the rendition date, each Non-Operator shall furnish Operator information as to burdens (to include, but not be limited to, royalties, overriding royalties and production payments) on Leases and Oil and Gas Interests contributed by such Non-Operator. If the assessed valuation of any Lease is reduced by reason of its being subject to outstanding excess royalties, overriding royalties or production payments, the reduction in ad valorem taxes resulting therefrom shall inure to the benefit of the owner or owners of such Lease, and Operator shall adjust the charge to such owner or owners so as to reflect
the benefit of such reduction. If the ad valorem taxes are based in whole or in part upon separate valuations of each party’s working interest, then notwithstanding anything to the contrary herein, charges to the joint account shall be made and paid by the parties hereto in accordance with the tax value generated by each party’s working interest. Operator shall bill the other parties for their proportionate shares of all tax payments in the manner provided in Exhibit “C.”

 

If Operator considers any tax assessment improper, Operator may, at its discretion, protest within the time and manner prescribed by law, and prosecute the protest to a final determination, unless all parties agree to abandon the protest prior to final determination. During the pendency of administrative or judicial proceedings, Operator may elect to pay, under protest, all such taxes and any interest and penalty. When any such protested assessment shall have been finally determined, Operator shall pay the tax for the joint account, 

 

20

 

together with any interest and penalty accrued, and the total cost shall then be assessed against the parties, and be paid by them, as provided in Exhibit “C.”

 

Each party shall pay or cause to be paid all production, severance, excise, gathering and other taxes imposed upon or with respect to the production or handling of such party’s share of Oil and Gas produced under the terms of this agreement.

 

ARTICLE VIII.

ACQUISITION, MAINTENANCE OR TRANSFER OF INTEREST

 

A. Surrender of Leases:

 

The Leases covered by this agreement, insofar as they embrace acreage in the Contract Area, shall not be surrendered in whole or in part unless all parties consent thereto.

 

However, should any party desire to surrender its interest in any Lease or in any portion thereof, such party shall give written notice of the proposed surrender to all parties, and the parties to whom such notice is delivered shall have thirty (30) days after delivery of the notice within which to notify the party proposing the surrender whether they elect to consent thereto. Failure of a party to whom such notice is delivered to reply within said 30-day period shall constitute a consent to the surrender of the Leases described in the notice. If all parties do not agree or consent thereto, the party desiring to surrender shall assign, without express or implied warranty of title, all of its interest in such Lease, or portion thereof, and any well, material and equipment which may be located thereon and any rights in production thereafter secured, to the parties not consenting to such
surrender. If the interest of the assigning party is or includes an Oil and Gas Interest, the assigning party shall execute and deliver to the party or parties not consenting to such surrender an oil and gas lease covering such Oil and Gas Interest for a term of one (1) year and so long thereafter as Oil and/or Gas is produced from the land covered thereby, such lease to be on the form attached hereto as Exhibit “B.”  Upon such assignment or lease, the assigning party shall be relieved from all obligations thereafter accruing, but not theretofore accrued, with respect to the interest assigned or leased and the operation of any well attributable thereto, and the assigning party shall have no further interest in the assigned or leased premises and its equipment and production other than the royalties retained in any lease made under the terms of this Article. The party assignee or lessee shall pay to the party assignor or lessor the reasonable salvage value of the
latter’s interest in any well’s salvable materials and equipment attributable to the assigned or leased acreage. The value of all salvable materials and equipment shall be determined in accordance with the provisions of Exhibit “C,” less the estimated cost of salvaging and the estimated cost of plugging and abandoning and restoring the surface. If such value is less than such costs, then the party assignor or lessor shall pay to the party assignee or lessee the amount of such deficit. If the assignment or lease is in favor of more than one party, the interest shall be shared by such parties in the proportions that the interest of each bears to the total interest of all such parties. If the interest of the parties to whom the assignment is to be made varies according to depth, then the interest assigned shall similarly reflect such variances.

 

Any assignment, lease or surrender made under this provision shall not reduce or change the assignor’s, lessor’s or surrendering party’s interest as it was immediately before the assignment, lease or surrender in the balance of the Contract Area; and the acreage assigned, leased or surrendered, and subsequent operations thereon, shall not thereafter be subject to the terms and provisions of this agreement but shall be deemed subject to an Operating Agreement in the form of this agreement.

 

B. Renewal or Extension of Leases:

 

If any party secures a renewal or replacement of an Oil and Gas Lease or Interest subject to this agreement, then all other parties shall be notified promptly upon such acquisition or, in the case of a replacement Lease taken before expiration of an existing Lease, promptly upon expiration of the existing Lease. The parties notified shall have the right for a period of thirty (30) days following delivery of such notice in which to elect to participate in the ownership of the renewal or replacement Lease, insofar as such Lease affects lands within the Contract Area, by paying to the party who acquired it their proportionate shares of the acquisition cost allocated to that part of such Lease within the Contract Area, which shall be in proportion to the interest held at 

 

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that time by the parties in the Contract Area. Each party who participates in the purchase of a renewal or replacement Lease shall be given an assignment of its proportionate interest therein by the acquiring party.

 

If some, but less than all, of the parties elect to participate in the purchase of a renewal or replacement Lease, it shall be owned by the parties who elect to participate therein, in a ratio based upon the relationship of their respective percentage of participation in the Contract Area to the aggregate of the percentages of participation in the Contract Area of all parties participating in the purchase of such renewal or replacement Lease. The acquisition of a renewal or replacement Lease by any or all of the parties hereto shall not cause a readjustment of the interests of the parties stated in Exhibit “A,” but any renewal or replacement Lease in which less than all parties elect to participate shall not be subject to this agreement but shall be deemed subject to a separate Operating Agreement in the form of this agreement.

 

If the interests of the parties in the Contract Area vary according to depth, then their right to participate proportionately in renewal or replacement Leases and their right to receive an assignment of interest shall also reflect such depth variances.

 

The provisions of this Article shall apply to renewal or replacement Leases whether they are for the entire interest covered by the expiring Lease or cover only a portion of its area or an interest therein. Any renewal or replacement Lease taken before the expiration of its predecessor Lease, or taken or contracted for or becoming effective within six (6) months after the expiration of the existing Lease, shall be subject to this provision so long as this agreement is in effect at the time of such acquisition or at the time the renewal or replacement Lease becomes effective; but any Lease taken or contracted for more than six (6) months after the expiration of an existing Lease shall not be deemed a renewal or replacement Lease and shall not be subject to the provisions of this agreement.

 

	
             
 	
            The provisions in this Article shall also be applicable to extensions of Oil and Gas Leases.
 

 

C. Acreage or Cash Contributions:

 

While this agreement is in force, if any party contracts for a contribution of cash towards the drilling of a well or any other operation on the Contract Area, such contribution shall be paid to the party who conducted the drilling or other operation and shall be applied by it against the cost of such drilling or other operation. If the contribution be in the form of acreage, the party to whom the contribution is made shall promptly tender an assignment of the acreage, without warranty of title, to the Drilling Parties in the

proportions said Drilling Parties shared the cost of drilling the well. Such acreage shall become a separate Contract Area and, to the extent possible, be governed by provisions identical to this agreement. Each party shall promptly notify all other parties of any acreage or cash contributions it may obtain in support of any well or any other operation on the Contract Area. The above provisions shall also be applicable to optional rights to earn acreage outside the Contract Area which are in support of well drilled inside Contract Area.

 

If any party contracts for any consideration relating to disposition of such party’s share of substances produced hereunder, such consideration shall not be deemed a contribution as contemplated in this Article VIII.C.

 

D. Assignment; Maintenance of Uniform Interest:

 

For the purpose of maintaining uniformity of ownership in the Contract Area in the Oil and Gas Leases, Oil and Gas Interests, wells, equipment and production covered by this agreement no party shall sell, encumber, transfer or make other disposition of its interest in the Oil and Gas Leases and Oil and Gas Interests embraced within the Contract Area or in wells, equipment and production unless such disposition covers either:

 

1.           the entire interest of the party in all Oil and Gas Leases, Oil and Gas Interests, wells, equipment and production; or

 

2.           an equal undivided percent of the party’s present interest in all Oil and Gas Leases, Oil and Gas Interests, wells, equipment and production in the Contract Area.

 

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Every sale, encumbrance, transfer or other disposition made by any party shall be made expressly subject to this agreement and shall be made without prejudice to the right of the other parties, and any transferee of an ownership interest in any Oil and Gas Lease or Interest shall be deemed a party to this agreement as to the interest conveyed from and after the effective date of the transfer of ownership; provided, however, that the other parties shall not be required to recognize any such sale, encumbrance, transfer or other disposition for any purpose hereunder until thirty (30) days after they have received a copy of the instrument of transfer or other satisfactory evidence thereof in writing from the transferor or transferee. No assignment or other disposition of interest by a party shall relieve such party of obligations previously incurred by such party hereunder with respect to
the interest transferred, including without limitation the obligation of a party to pay all costs attributable to an operation conducted hereunder in which such party has agreed to participate prior to making such assignment, and the lien and security interest granted by Article VII.B. shall continue to burden the interest transferred to secure payment of any such obligations.

 

If, at any time the interest of any party is divided among and owned by four or more co-owners, Operator, at its discretion, may require such co-owners to appoint a single trustee or agent with full authority to receive notices, approve expenditures, receive billings for and approve and pay such party’s share of the joint expenses, and to deal generally with, and with power to bind, the co-owners of such party’s interest within the scope of the operations embraced in this agreement; however, all such co-owners shall have the right to enter into and execute all contracts or agreements for the disposition of their respective shares of the Oil and Gas produced from the Contract Area and they shall have the right to receive, separately, payment of the sale proceeds thereof.

 

E. Waiver of Rights to Partition:

 

If permitted by the laws of the state or states in which the property covered hereby is located, each party hereto owning an undivided interest in the Contract Area waives any and all rights it may have to partition and have set aside to it in severalty its undivided interest therein.

 

F. [Deleted text]

 

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ARTICLE IX.

INTERNAL REVENUE CODE ELECTION

 

If, for federal income tax purposes, this agreement and the operations hereunder are regarded as a partnership, and if the parties have not otherwise agreed to form a tax partnership pursuant to Exhibit “G” or other agreement between them, each party thereby affected elects to be excluded from the application of all of the provisions of Subchapter “K,” Chapter 1, Subtitle “A,” of the Internal Revenue Code of 1986, as amended (“Code”), as permitted and authorized by Section 761 of the Code and the regulations promulgated thereunder. Operator is authorized and directed to execute on behalf of each party hereby affected such evidence of this election as may be required by the Secretary of the Treasury of the United States or the Federal Internal Revenue Service, including specifically, but not by way of limitation, all of the returns, statements, and
the data required by Treasury Regulation §1.761. Should there be any requirement that each party hereby affected give further evidence of this election, each such party shall execute such documents and furnish such other evidence as may be required by the Federal Internal Revenue Service or as may be necessary to evidence this election. No such party shall give any notices or take any other action inconsistent with the election made hereby. If any present or future income tax laws of the state or states in which the Contract Area is located or any future income tax laws of the United States contain provisions similar to those in Subchapter “K,” Chapter 1, Subtitle “A,” of the Code, under which an election similar to that provided by Section 761 of the Code is permitted, each party hereby affected shall make such election as may be permitted or required by such laws. In making the foregoing election, each such party states that the income derived by such party
from operations hereunder can be adequately determined without the computation of partnership taxable income.

 

ARTICLE X.

CLAIMS AND LAWSUITS

 

Operator may settle any single uninsured third party damage claim or suit arising from operations hereunder if the expenditure does not exceed Ten Thousand Dollars ($10,000.00) and if the payment is in complete settlement of such claim or suit. If the amount required for settlement exceeds the above amount, the parties hereto shall assume and take over the further handling of the claim or suit, unless such authority is delegated to Operator. All costs and expenses of handling settling, or otherwise discharging such claim or suit shall be at the joint expense of the parties participating in the operation from which the claim or suit arises. If a claim is made against any party or if any party is sued on account of any matter arising from operations hereunder over which such individual has no control because of the rights given Operator by this agreement, such party shall immediately
notify all other parties, and the claim or suit shall be treated as any other claim or suit involving operations hereunder.  

 

ARTICLE XI.

FORCE MAJEURE

 

If any party is rendered unable, wholly or in part, by force majeure to carry out its obligations under this agreement, other than the obligation to indemnify or make money payments or furnish security, that party shall give to all other parties prompt written notice of the force majeure with reasonably full particulars concerning it; thereupon, the obligations of the party giving the notice, so far as they are affected by the force majeure, shall be suspended during, but no longer than, the continuance of the force majeure. The term “force majeure,” as here employed, shall mean an act of God, strike, lockout, or other industrial disturbance, act of the public enemy, war, blockade, public riot, lightening, fire, storm, flood or other act of nature, explosion, governmental action, governmental delay, restraint or inaction, unavailability of equipment, and any other cause,
whether of the kind specifically enumerated above or otherwise, which is not reasonably within the control of the party claiming suspension.

 

The affected party shall use all reasonable diligence to remove the force majeure situation as quickly as practicable. The requirement that any force majeure shall be remedied with all reasonable dispatch shall not require the settlement of strikes, lockouts, or other labor difficulty by the party involved, contrary to its wishes; how all such difficulties shall be handled shall be entirely within the discretion of the party concerned.

 

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ARTICLE XII.

NOTICES

 

All notices authorized or required between the parties by any of the provisions of this agreement, unless otherwise specifically provided, shall be in writing and delivered in person or by United States mail, courier service, telegram, telex, telecopier or any other form of facsimile, postage or charges prepaid, and addressed to such parties at the addresses listed on Exhibit “A.”  All telephone or oral notices permitted by this agreement shall be confirmed immediately thereafter by written notice. The originating notice given under any provision hereof shall be deemed delivered only when received by the party to whom such notice is directed, and the time for such party to deliver any notice in response thereto shall run from the date the originating notice is received. “Receipt” for purposes of this agreement with respect to written notice delivered hereunder shall
be actual delivery of the notice to the address of the party to be notified specified in accordance with this agreement, or to the telecopy, facsimile or telex machine of such party. The second or any responsive notice shall be deemed delivered when deposited in the United States mail or at the office of the courier or telegraph service, or upon transmittal by telex, telecopy or facsimile, or when personally delivered to the party to be notified, provided, that when response is required within 24 or 48 hours, such response shall be given orally or by telephone, telex, telecopy or other facsimile within such period. Each party shall have the right to change its address at any time, and from time to time, by giving written notice thereof to all other parties. If a party is not available to receive notice orally or by telephone when a party attempts to deliver a notice required to be delivered within 24 or 48 hours, the notice may be delivered in writing by any other method specified
herein and shall be deemed delivered in the same manner provided above for any responsive notice.

 

ARTICLE XIII.

TERM OF AGREEMENT

 

This agreement shall remain in full force and effect as to the Oil and Gas Leases and/or Oil and Gas Interests subject hereto for the period of time selected below; provided, however, no party hereto shall ever be construed as having any right, title or interest in or to any Lease or Oil and Gas Interest contributed by any other party beyond the term of this agreement.

 

(           Option No. 1: So long as any of the Oil and Gas Leases subject to this agreement remain or are continued in force as to any part of the Contract Area, whether by production, extension, renewal or otherwise.

 

Option No. 2: In the event the well described in Article VI.A., or any subsequent well drilled under any provision of this agreement, results in the Completion of a well as a well capable of production of Oil and/or Gas in paying quantities, this agreement shall continue in force so long as any such well is capable of production, and for an additional period of _______days thereafter; provided, however, if, prior to the expiration of such additional period, one or more of the parties hereto are engaged in drilling, Reworking, Deepening, Sidetracking, Plugging Back, testing or attempting to Complete or Re-complete a well or wells hereunder, this agreement shall continue in force until such operations have been completed and if production results therefrom, this agreement shall continue in force as provided herein. In the event the well described in Article VI.A., or any subsequent well
drilled hereunder, results in a dry hole, and no other well is capable of producing Oil and/or Gas from the Contract Area, this agreement shall terminate unless drilling, Deepening, Sidetracking, Completing, Re-completing, Plugging Back or Reworking operations are commenced within __________ days from the date of abandonment of said well. “Abandonment” for such purposes shall mean either (i) a decision by all parties not to conduct any further operations on the well or (ii) the elapse of 180 days from the conduct of any operations on the well, whichever first occurs.

 

The termination of this agreement shall not relieve any party hereto from any expense, liability or other obligation or any remedy therefor which has accrued or attached prior to the date of such termination.

 

Upon termination of this agreement and the satisfaction of all obligations hereunder, in the event a memorandum of this Operating Agreement has been filed of record, Operator is authorized to file of record in all necessary recording offices a notice of termination, and each party hereto agrees to execute such a notice of 

 

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termination as to Operator’s interest, upon request of Operator, if Operator has satisfied all its financial obligations.

 

ARTICLE XIV.

COMPLIANCE WITH LAWS AND REGULATIONS

 

A. Laws, Regulations and Orders:

 

This agreement shall be subject to the applicable laws of the state in which the Contract Area is located, to the valid rules, regulations, and orders of any duly constituted regulatory body of said state; and to all other applicable federal, state, and local laws, ordinances, rules, regulations and orders.

 

B. Governing Law:

 

This agreement and all matters pertaining hereto, including but not limited to matters of performance, non-performance, breach, remedies, procedures, rights, duties, and interpretation or construction, shall be governed and determined by the law of the state in which the Contract Area is located. If the Contract Area is in two or more states, the law of the state of Texas shall govern.

 

C. Regulatory Agencies:

 

Nothing herein contained shall grant, or be construed to grant, Operator the right or authority to waive or release any rights, privileges, or obligations which Non-Operators may have under federal or state laws or under rules, regulations or orders promulgated under such laws in reference to oil, gas and mineral operations, including the location, operation, or production of wells, on tracts offsetting or adjacent to the Contract Area.

 

With respect to the operations hereunder, Non-Operators agree to release Operator from any and all losses, damages, injuries, claims and causes of action arising out of, incident to or resulting directly or indirectly from Operator’s interpretation or application of rules, rulings, regulations or orders of the Department of Energy or Federal Energy Regulatory Commission or predecessor or successor agencies to the extent such interpretation or application was made in good faith and does not constitute gross negligence. Each Non-Operator further agrees to reimburse Operator for such Non-Operator’s share of production or any refund, fine, levy or other governmental sanction that Operator may be required to pay as a result of such an incorrect interpretation or application, together with interest and penalties thereon owing by Operator as a result of such incorrect interpretation
or application.

 

ARTICLE XV.

MISCELLANEOUS

 

A. Execution:

 

This agreement shall be binding upon each Non-Operator when this agreement or a counterpart thereof has been executed by such Non-Operator and Operator notwithstanding that this agreement is not then or thereafter executed by all of the parties to which it is tendered or which are listed on Exhibit “A” as owning an interest in the Contract Area or which own, in fact, an interest in the Contract Area. Operator may, however, by written notice to all Non-Operators who have become bound by this agreement as aforesaid, given at any time prior to the actual spud date of the Initial Well but in no event later than five days prior to the date specified in Article VI.A. for commencement of the Initial Well, terminate this agreement if Operator in its sole discretion determines that there is insufficient participation to justify commencement of drilling operations. In the event of such a
termination by Operator, all further obligations of the parties hereunder shall cease as of such termination. In the event any Non-Operator has advanced or prepaid any share of drilling or other costs hereunder, all sums so advanced shall be returned to such Non-Operator without interest. In the event Operator proceeds with drilling operations for the Initial Well without the execution hereof by all persons listed on Exhibit “A” as having a current working interest in such well, Operator shall indemnify Non-Operators with respect to all costs incurred for the Initial Well which would have been charged to such person under this agreement if such 

 

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person had executed the same and Operator shall receive all revenues which would have been received by such person under this agreement if such person had executed the same.

 

B. Successors and Assigns:

 

This agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, devisees, legal representatives, successors and assigns, and the terms hereof shall be deemed to run with the Leases or Interests included within the Contract Area.

 

C. Counterparts:

 

This instrument may be executed in any number of counterparts, each of which shall be considered an original for all purposes.

 

D. Severability:

 

For the purposes of assuming or rejecting this agreement as an executory contract pursuant to federal bankruptcy laws, this agreement shall not be severable, but rather must be assumed or rejected in its entirety, and the failure of any party to this agreement to comply with all of its financial obligations provided herein shall be a material default.

 

ARTICLE XVI.

OTHER PROVISIONS

 

A. PREPAYMENT OF DRILLING WELL DRY HOLE COSTS

 

Notwithstanding any provision contained herein to the contrary, prior to the commencement of drilling operations on any well proposed pursuant to the terms and conditions of this Agreement, each Participating Party shall remit to the Operator its proportionate share of the estimate dry hole expenses required for actual drilling operations with respect to the proposed well and as set forth on an AFE submitted by Operator. In the event that any Participating Party fails to remit its proportionate share of said estimated dry hole expenses with fifteen (15) days from its receipt of the AFE for the proposed well, then in such event it shall be irrevocably deemed to have relinquished and forfeited all of its right, title and interest in and to the proposed well, leases, lands and/or oil and gas interests, together with the applicable production unit, held by the drilling of the proposed well. If said well is a
dry hole, or completed pursuant to this Agreement and subsequently abandoned pursuant to this Agreement, a Participating Party that fails to remit its proportionate share of the dry hole cost pursuant to this Article XVI.A., shall be deemed to have relinquished all of its right, title and interest in and to the leases, lands and/or other Oil and Gas Interests held or that would have been held by the well if said well had not been abandoned.

 

B. COMPLETION OF A DRILLING WELL

 

Notwithstanding any provision contained herein to the contrary, consent to the drilling or deepening of any well in the Contract Area shall not be deemed consent to the running and setting of a production string of casing therein or to a completion attempt thereof.

 

After the drilling or deepening of such a well to the depth or formation previously agreed upon and after appropriate tests have been made, Operator shall give immediate notice as provided for in this Agreement, to be confirmed in writing to all parties participating in the drilling or deepening of such well, setting forth Operator’s recommendations with respect to such attempted completion, each such party shall within forty-eight (48) hours after receipt of such notice notify the Operator as to whether or not such party elects to participate in such completion attempt Failure to so notify Operator, within said forty-eight (48) hour period shall be deemed an election not to participate. In the event that any participating party fails to remit its proportionate share of said completion cost within fifteen (15) days from its receipt of notification and the AFE for the proposed completion, then in such
event ft shall be irrevocable deemed to have relinquished and forfeited all of its right, title and interest in and to the proposed well, leases, lands and/or other Oil and Gas Interest so held by the drilling of the proposed well. Should all parties hereto elect to so participate, Operator shall conduct such operations for the 

 

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joint account of all such parties. Should less than all parties elect to so participate, then such completion operations shall be conducted under the provision of Article XVI.C. hereof, as an operation by less than all parties. Should no party elect to attempt such completion or should the completion attempt initially result in a dry hole regardless of whether all of the parties participate in such attempt, Operator shall plug and abandon the well at the joint cost of all parties who participated in the completion attempt on the well.

 

C. RELINQUISHMENT OF INTEREST FOR NON-PARTICIPATION

 

Notwithstanding any provision contained herein to the contrary, in the event any party to this Agreement elects to non-consent as to the drilling of any well and if such well is drilled within the time and to the depths stated in the notice of such well, then in such event the entire cost and risk of conducting such operations shall be borne by the consenting parties in the proportions that their respective interest shown on Exhibit “A” bear to the total interest of all consenting parties. If such an operation results in a dry hole, the consenting parties shall plug and abandon the well at their sole cost, risk and expense. If any well drilled, completed, reworked, deepened or plugged back under the provisions of this paragraph results in a producer of oil and/or gas in paying quantities, the Operator for the consenting parties shall complete and equip the well to produce at their sole cost and
risk. Upon commencement of operations for the drilling, completing, reworking, deepening or plugging back and any well by consenting parties in accordance with the provision of this Article, each party electing not to participate in such operations; i.e., a Non-Consenting Party shall be deemed to have relinquished to the consenting parties, and the consenting parties shall own and be entitled to receive, in proportion to their respective interests, all of such Non-Consenting Party’s interest in and to the wellbore, machinery and equipment used in connection therewith, proceeds or production therefrom and proration unit or production unit attributable therewith, as to all depths in the well and all production therefrom.

 

Any Non-Consenting Party agrees to furnish the Consenting Parties an assignment assigning its interest in the leases and the well as provided for above within fifteen (15) days of its relinquishment of interest as provided for in this Agreement.

 

D. LIMITATION ON WELL PROPOSALS

 

Notwithstanding anything in this Agreement to the contrary, not more than one (1) well may be proposed for drilling, reworking, deepening, sidetracking or plugging back at any single time, and until a period of not less than forty-five (45) days from the date the preceding operation has been completed, no subsequent operation may be proposed under this Agreement: unless unanimous consent of all the Parties is acquired for said proposed operation. Only a Party not in default or who is not a non-participating Party may propose the drilling, completing, recompleting, reworking, deepening, sidetracking or plugging back or any other operation in a well.

 

E. PREBILLING

 

Notwithstanding any terms of Article VII.C. hereof to the contrary, the Operator shall have the right to request in advance from Non-Operators for their share of the estimated costs of drilling any well hereunder and completing same as a dry and abandoned well (“Dry Hole Costs”) as reflected by the applicable AFE thereto, regardless of whether such operation will be completed in the next succeeding month. Likewise, if a well is proposed for completion, Operator shall have the right to request an advance from Non-Operators for their share of the costs of completing any well hereunder as a commercial producer (“Completion Costs”) as reflected by the applicable AFE thereto (regardless of whether such operation will be completed in the next succeeding month).

 

Should a Non-Operator fail to pay within fifteen (15) days of receipt of an invoice its share of an estimate for (a) the Dry Hole Costs, or (b) Completion Costs and within two (2) days of a verbal notice following the above-referenced written fifteen (15) day notice, then notwithstanding anything contained in Article VII.C. to the contrary such Non-Operator shall be deemed to have elected not to participate in such operation under the terms of Article XVI.C. hereof, or Article XVI.A., whichever is applicable.

 

F. PAYMENT OF REVENUE BY OPERATOR TO NON-OPERATORS

 

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The Operator shall be designated as agent for Non-Operators to receive and disburse proceeds from the sale of any oil, gas or other hydrocarbons produced from the Contract Area pursuant to the terms hereof. Operator will use its best efforts to make such disbursement. Should Operator consider it necessary, Non-Operators agree that Operator may deduct from any such proceeds Non-Operator’s share of the cost incurred by Operator under the terms of the Joint Operating Agreement, and Operator agrees to promptly account to Non-Operators’ proportionate share of the costs incurred. If at any time the monies received by Operator attributable to the sale of Non-Operators’ interest in the production is not sufficient to offset the monies due Operator by Non-Operators for Non-Operators’ share of the costs incurred under the Operating Agreement, then Non-Operators agree to pay Operator said amount as
provided for in the Agreement.

 

G. RIGHT OF OPERATOR TO NET OUT NON-OPERATORS

 

Notwithstanding any provision contained herein to the contrary, as additional security for all sums owing or which become owning to Operator hereunder on account of any expense hereunder, each Party grants to the other parties a security interest in and a contractual right of off set in and to all money, proceeds form sale of production and property of Non-Operator now or at any time hereunder coming within Operator’s custody or control. In the event Non-Operator fails to make timely payment within the time period as provided in this Agreement, Operator will advise Non-Operator of default via certified mail, return receipt requested, and Non-Operator will thereafter have ten (10) business days after receipt of such notice of default within which to remit payment thereof. Failure to remit the delinquent sum within the period set forth above shall entitle Operator to exercise a contractual right of
offset as to all money proceeds from sale of production and property of Non-Operator now or at any time thereafter coming within the Operator care, custody or control. For so long as such delinquency exists, Operator may apply all proceeds against the outstanding indebtedness (or eliminate, as the case may be) any such outstanding indebtedness and give Non-Operator appropriate credit therefore. Any such amount so applied shall first be applied to outstanding interests, if any, and then to the underlying debt.

 

Subject to the provisions of Article VII.B. each Non-Operator grants to the Operator a lien upon all of the rights, titles and interest of such granting party, whether now existing or hereafter acquired, in and to (a) the oil, gas and other minerals in, on and under the Contract Area; (b) any oil, gas and mineral leases covering the Contract Area or any portion thereof; and (c) any oil and gas interest within the Contract Area. In addition, each Non-Operator grants to the Operator a security interest in and to all of such granting party’s rights, titles, interest, claims, general intangibles, proceeds and products thereof, whether now existing or hereafter acquired, in and to (a) all oil, gas and other minerals produced from the Contract Area when produced; (b) all accounts receivable accruing or arising as a result of the sale of such oil, gas and other minerals once produced and (d) all oil or gas
swells and other surface and subsurface equipment and facilities of any kind or character located in the Contract Area and the cash or other proceeds realized form the sale thereof (collectively, “the Property Collateral”). Some of the personal Property Collateral is or will become fixtures on the Contract Area, and the interest of each party in and to the oil, gas and other minerals when extracted from the Contract Area and the accounts receivable accruing or arising as the result of the sale thereof shall be financed at the wellhead of the well or wells located on the Contract Area. This Agreement shall constitute a non-standard form financing statement under the terms of the Uniform Commercial Code of the state in which the Contract Area is locate and, as such, may be filed for record in the records of any county in which Contract Area is located and/or with the Secretary of State.

 

H. LEGAL FEES FOR DELINQUENCY IN PAYMENT

 

Should any Non-Operator fail to timely pay its proportionate party of any amounts owed under this Agreement, Operator’s rights shall include the right to charge such Non-Operator for any legal expense and attorney’s fees incurred in connection with collecting such amount. Similarly, if Operator fails to timely pay its proportionate party of any amounts owed under this Agreement, Non-Operators shall have the right to charge Operator for any legal expense and attorney’s fees incurred in connection with the collecting of such amount.

 

In the event a party disputes in good faith the existence of a default on his part that is subject of a notice of default, as set forth in Article XVI.H, such party may avoid the imposition of the remedies of such default contained in this Agreement by paying the disputed amount into an account at a bank requiring the signatures of both such parties and the Operator (or, if the Operator is the party in default, a Non-Operator designated by 

 

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the Non-Operators) in order to release such funds. Such funds shall be released to the party entitled thereto upon the resolution of the issue raised by the objecting party.

 

SUBSEQUENTLY CREATED BURDENS

 

If, subsequent to the date hereof, any party should create an overriding royalty, production payment or other burden against its working interest production, no other party’s interest shall be burdened by such newly created interest and. furthermore, if such party should not participate in an operation under any provision hereof so that the participating parties become entitled to receive such Non-Consenting Party’s proceeds from the sale of production from such well, the party creating such burden shall hold harmless the other parties hereto from and against any obligations created by such burden and if the party holding the newly created interest does not voluntarily acknowledge the fact that its interest terminates under the non-consent provisions hereof, the non-consenting party shall pay all amounts due under such burden so the participating parties receive an amount equal to all proceeds
from the sale of production from such well subject only to reduction for production taxes, royalty, overriding royalty and other interests of record on the date hereof or disclosed on Exhibit “A”; hereto, payable out of or measure by production from such well. A subsequently created inters shall terminate if the party creating the same elects or is deemed to have elected to not participate in a subsequent operation. Such subsequently created interest shall terminate effective upon same date as the effective date of the assignment from the non-consenting party to the consenting parties.

 

J. SUPPLEMENTAL DIRECT CHARGES TO THE JOINT ACCOUNT

 

Notwithstanding anything to the contrary contained in this Agreement, or the Accounting Procedure (Exhibit “C”) attached hereto, the following items pertaining to the Contract Area shall not be considered as administrative overhead, and the Operator shall be entitled to make a direct charge against the joint account therefore:

 

1. Fees for legal services, costs and expenses in connection with the preparation and presentation of evidence and exhibits at hearing before any governmental agency having jurisdiction over the Contract Area; provided, if Operator determines that such costs for any one item or project may exceed $10,000, consent or the Non-Operators shall be required.

 

2. In the event Operator receives one hundred percent (100%) payment for proceeds of production attributable to the Contract Area, and Operator disburses royalties, then in such event Operator shall be entitled to charge the joint account with the actual cost of the necessary title opinions, division order title opinions, or other due diligence that Operator deems necessary.

 

3. Fees for professional consulting services in connection with the preparation and presentation of tax information returns as may be necessary to enable the Contract Area participants to report such information for income tax purposes.

 

4. The direct costs of professional services and contract services of personnel (Including but not limited to engineers, geologists, geophysicists and land personnel) directly connected with, assigned projects associated with or directly benefiting or engaged in the operation of the Contract Area.

 

	
             
 	
            IN WITNESS WHEREOF, this agreement shall be effective as of the 1ST day of March, 2006
 

 

 

	
            ATTEST OR WITNESS:
 	
            OPERATOR
 

 

	
             
 	
            BAYSHORE EXPLORATION LLC
 

 

 

	
             
 	
            By __________________________
 

	
             
 	
            Jamin Swantner
 

	
             
 	
            Type or print name
 

 

30

 

 

	
             
 	
            Title:
 	
            President
 

 

	
             
 	
            Date _________________________
 

 

	
             
 	
            Tax ID or S.S. No.:  1-76-0540526
 

 

 

NON-OPERATORS

 

	
             
 	
            Paxton Energy, Inc.
 

 

	
             
 	
            By
 

	
             
 	
            Robert Freiheit, CEO
 

	
             
 	
            Type or print name
 

 

 

	
             
 	
            Title:
 	
            President
 

 

	
             
 	
            Date _________________________
 

 

	
             
 	
            Tax ID or S.S. No. ______________
 

 

ACKNOWLEDGMENTS

 

Note: The following forms of acknowledgment are the short forms approved by the Uniform Law on Notarial Acts. The validity and effect of these forms in any state will depend upon the statutes of that state.

 

 

Individual acknowledgment:

 

State of _______________)

 

______________________) ss.

 

County of _____________)

	
             
 	
            This instrument was acknowledged before me on
 

 

______________________________________ by ____________________________________________

 

 

	
            (Seal, if any)
 	
            _______________________________________
 

 

	
             
 	
            Title (and Rank) _________________________
 

 

	
             
 	
            My commission expires: __________________
 

 

 

Acknowledgment in representative capacity:

 

Individual acknowledgment:

 

31

 

 

State of _______________)

 

______________________) ss.

 

County of _____________)

	
             
 	
            This instrument was acknowledged before me on
 

 

______________________________________ by ____________________________________________

 

 

	
            (Seal, if any)
 	
            _______________________________________
 

 

	
             
 	
            Title (and Rank) _________________________
 

 

	
             
 	
            My commission expires: __________________
 

 

 

32

 

EXHIBIT “A”

 

Attached to and made a part of that certain Joint Operating Agreement dated March 1, 2006, between Bayshore Exploration LLC, as operator, and Paxton Energy, Inc., as non-operator, pertaining to the Cooke Ranch Prospect located in La Salle County, Texas.

 

DESCRIPTION OF LANDS SUBJECT TO THIS AGREEMENT:

 

See Attached Letter Agreement ‘AMI”

 

PARTIES ADDRESSES AND TELEPHONE NUMBERS FOR NOTIFICATION:

 

Bayshore Exploration LLC

20501 Katy Freeway

Suite 216

Katy, Texas 77450

(281) 646-1919 Telephone

(281) 647-9448 Fax

EMail: bayshoreexpl@sbcglobal.net

 

Paxton Energy, Inc.

2533 North Carson Street

Suite 6232

Carson City, Nevada 89706

(604) 215 3834 Telephone

(916) 797-0207 Telephone

(604) 215-3831 Fax

(916) 791-0289 Fax

EMail: KJM@paxtonenergyinc.com

 

WORKING INTEREST PERCENTAGES OF THE PARTIES:

 

EXHIBIT “A”- EXISTING COOKE RANCH PROSPECT ACREAGE

Bayshore Exploration LLC 68.25% - 91.5% WI

Paxton Energy, Inc 8.5 - 31.75% WI

 

EXHIBIT “B” - NEW ACREAGE ACQUIRED WITHIN AMI

Bayshore Exploration LLC 50% WI

Paxton Energy, Inc 50% WI

 

EXHIBIT “C”

 

Attached to and made a part of that certain Joint Operating Agreement dated March 1st, 2006, between Bayshore Exploration LLC, as operator, and Paxton Energy, Inc., as non-operator, Cooke Ranch Prospect, La Salle County, Texas.

 

	
            Exhibits to Operating Agreement
 	
            -1-
 

 

EXHIBIT C

 

ACCOUNTING PROCEDURE

JOINT OPERATIONS

 

I. GENERAL PROVISIONS

 

	
            1.
 	
            Definitions
 

“Joint Property” shall mean the real and personal property subject to the agreement to which this Accounting Procedure is attached.

 

“Joint Operations’ shall mean all operations necessary or proper for the development, operation, protection and maintenance of the Joint Property.

 

“Joint Account” shall mean the account showing the charges paid and credits received in the conduct of the Joint Operations and which are to be shared by the Parties.

 

“Operator” shall mean the party designated to conduct the Joint Operations, “Non-Operators” shall mean the Parties to this agreement other than the Operator

 

“Parties” shall mean Operator and Non-Operators.

 

“First Level Supervisors” shall mean those employees whose primary function in Joint Operations is the direct supervision of other employees and/or contract labor directly employed on the Joint Property in a field operating capacity.

 

“Technical Employees” shall mean those employees having special and specific engineering, geological or other professional skills, and whose primary function in Joint Operations is the handling of specific operating conditions and problems for the benefit of the Joint Property.

 

“Personal Expenses” shall mean travel and other reasonable reimbursable expenses of Operator’s employees. 

 

“Material” shall mean personal property, equipment or supplies acquired or held for use on the Joint Property.

 

“Controllable Material” shall mean Material which at the time is so classified in the Material Classification Manual as most recently recommended by the Council of Petroleum Accountants Societies.

 

	
            2.
 	
            Statement and Billings
 

 

Operator shall bill Non-Operators on or before the last day of each month for their proportionate share of the Joint Account for the preceding month. Such bills will be accompanied by statements which identify the authority for expenditure, lease or facility, and all charges and credits summarized by appropriate classifications of investment and expense except that items of Controllable Material and unusual charges and credits shall be separately identified and fully described in detail.

 

	
            Exhibits to Operating Agreement
 	
            -2-
 

 

	
            3.
 	
            Advances and Payments by Non-Operators
 

 

A.           Unless otherwise provided for in the agreement, the Operator may require the Non-Operators to advance their share of estimated cash outlay for the succeeding month’s operation within fifteen (15) days after receipt of the billing or by the first day of the month for which the advance is required, whichever is later, Operator shall adjust each monthly billing to reflect advances received from the Non-Operators.

 

B.            Each Non-Operator shall pay its proportion of all bills within fifteen (15) days after receipt. If payment is not made within such time, the unpaid balance shall bear interest monthly at the prime rate in effect at ___________ on the first day of the month in which delinquency occurs plus 1% or the maximum contract rate permitted by the applicable usury laws in the state in which the Joint Property is located, whichever is the lesser, plus attorney’s fees, court costs, and other costs in connection with the collection of unpaid amounts.

 

	
            4.
 	
            Adjustments
 

 

Payment of any such bills shall not prejudice the right of any Non-Operator to protest or question the correctness thereof:  provided, however, all bills and statements rendered to Non-Operators by Operator during any calendar year shall conclusively be presumed to be true and correct after twenty-four (24) months following the end of any such calendar year, unless within the said twenty-four (24) month period a Non-Operator takes written exception thereto and makes claim on Operator for adjustment. No adjustment favorable to Operator shall be made unless it is made within the same prescribed period. The provisions of this paragraph shall not prevent adjustments resulting from a physical inventory of Controllable Material as provided for in Section V.

 

	
            5
 	
            Audits
 

 

A.           Non-Operator, upon notice in writing to Operator and all other Non-Operators, shall have the right to audit Operator’s accounts and records relating to the Joint Account for any calendar year within the twenty-four (24) month period following the end of such calendar year provided, however, the making of an audit shall not extend the time for the taking of written exception to and the adjustments of accounts as provided for in Paragraph 4 of this Section I. Where there are two or more Non-Operators, the Non-Operators shall make every reasonable effort to conduct a joint audit in a manner which will result in a minimum of inconvenience to the Operator. Operator shall bear no portion of the Non-Operators’ audit cost incurred under this paragraph unless agreed to by the Operator. The audits shall not be conducted
more than once each year without prior approval of Operator, except upon the resignation or removal of the Operator, and shall be made at the expense of those Non-Operators approving such audit.

 

B.           The Operator shall reply in writing to an audit report within 150 days after receipt of such report.

 

	
            6.
 	
            Approval By Non-Operators
 

 

Where an approval or other agreement of the Parties or Non-Operators is expressly required under other sections of this Accounting Procedure and if the agreement to which this Accounting Procedure is attached contains no contrary provisions in regard thereto. Operator shall notify all Non-Operators of the Operator’s proposal, and the agreement or approval of a majority in interest of the Non-Operators shall be controlling on all Non-Operators.

II DIRECT CHARGES

 

Operator shall charge the Joint Account with the following items:

 

	
             
 	
            1.
 	
            Ecological and Environmental
 

 

 

	
            Exhibits to Operating Agreement
 	
            -3-
 

 

Costs incurred for the benefit of the Joint Property as a result of governmental or regulatory requirements to satisfy environmental considerations applicable to the Joint Operations. Such costs may include surveys of an ecological or archaeological nature and pollution control procedures as required by applicable laws and regulations.

 

	
             
 	
            2.
 	
            Rentals and Royalties
 

 

Lease rentals and royalties paid by Operator for the Joint Operations.

 

	
             
 	
            3.
 	
            Labor
 

 

	
             
 	
            A.
 	
            (1) Salaries and wages of Operator’s field employees directly employed on the
 

	
             
 	
            Joint Property in the conduct of Joint Operations.
 

 

(2) Salaries of First Level Supervisors in the field.

 

(3) Salaries and wages of Technical Employees directly employed on the Joint Properly if such charges are excluded from the overhead rates.

 

(4) Salaries and wages of Technical Employees either temporarily or permanently assigned to and directly employed in the operation of the Joint Property if such charges are excluded from the overhead rates.

 

B.      Operator’s cost of holiday, vacation, sickness and disability benefits and other customary allowances paid to employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. Such costs under this Paragraph 3B may be charged on a “when and as paid basis” or by “percentage assessment” on the amount of salaries and wages chargeable to the Joint Account under Paragraph 3A of this Section II. If percentage assessment is used, the rate shall be based on the Operator’s cost experience.

 

C.      Expenditures or contributions made pursuant to assessments imposed by governmental authority which are applicable to Operator’s costs chargeable to the Joint Account under Paragraphs BA and 38 of this Section II.

 

D.     Personal Expenses of those employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II.

 

	
             
 	
            4.
 	
            Employee Benefits
 

 

Operator’s current costs of established plan for employees’ group life insurance, hospitalization, pension, retirement, stock purchase, thrift, bonus, and other benefit plans of a like nature, applicable to Operator’s labor cost chargeable to the Joint Account under Paragraphs 3A and 3B of this Section II shall be Operator’s actual cost not to exceed the percent most recently recommended by the Council of Petroleum Accountants Societies.

 

	
             
 	
            5.
 	
            Material
 

 

Material purchased or furnished by Operator for use on the Joint Property as provided under Section IV. Only such Material shall be purchased for or transferred to the Joint Property as may be required for immediate use and is reasonably practical and consistent with efficient and economical operations. The accumulation of surplus stocks shall be avoided.

 

	
             
 	
            6.
 	
            Transportation
 

 

Transportation of employees and Material necessary for the Joint Operations but subject to the following limitations:

 

	
            Exhibits to Operating Agreement
 	
            -4-
 

 

A.     If Material is moved to the Joint Property from the Operator’s warehouse or other properties, no charge shall be made to the Joint Account for a distance greater than the distance from the nearest reliable supply store where like material is normally available or railway receiving point nearest the Joint Property unless agreed to by the Parties.

 

B.      If surplus Material is moved to Operator’s warehouse or other storage point, no charge shall be made to the Joint Ac count for a distance greater than the distance to the nearest reliable supply store where like material is normally available, or railway receiving point nearest the Joint Property unless agreed to by the Parties. No charge shall be made to the Joint Account for moving Material to other properties belonging to Operator, unless agreed to by the Parties.

 

C.      In the application of subparagraphs A and B above, the option to equalize or charge actual trucking cost is available when the actual charge is $400 or less excluding accessorial charges. The $400 will be adjusted to the amount most recently recommended by the Council of Petroleum Accountants Societies.

 

	
             
 	
            7.
 	
            Services
 

 

The cost of contract services, equipment and utilities provided by outside sources, except services excluded by Paragraph 10 of Section II and Paragraph i, ii, and iii, of Section II The cost of professional consultant services and contract ser vices of technical personnel directly engaged on the Joint Property if such charges are excluded from the overhead rates. The cost of professional consultant services or contract services of technical personnel not directly engaged on the Joint Property shall not be charged to the Joint Account unless previously agreed to by the Parties.

 

	
             
 	
            8.
 	
            Equipment and Facilities Furnished By Operator
 

 

A.     Operator shall charge the Joint Account for use of Operator owned equipment and facilities at rates commensurate with costs of ownership and operation. Such rates shall include costs of maintenance, repairs, other operating expense, insurance, taxes, depreciation, and interest on (18%) per annum. Such rates shall not exceed average commercial rates currently prevailing in the immediate area of the Joint Property.

 

B.      In lieu of charges in paragraph 8A above, Operator may elect to use average commercial rates prevailing in the immediate area of the Joint Property less 20%. For automotive equipment, Operator may elect to use rates published by the Petroleum Motor Transport Association.

 

	
             
 	
            9.
 	
            Damages and Losses to Joint Property
 

 

All costs or expenses necessary for the repair or replacement of Joint Property made necessary because of damages or losses incurred by fire, flood, storm, theft, accident, or other cause, except those resulting from Operator’s gross negligence or willful misconduct. Operator shall furnish Non-Operator written notice of damages or losses incurred as soon as practicable after a report thereof has been received by Operator.

 

	
             
 	
            10.
 	
            Legal Expense
 

 

Expense of handling, investigating and settling litigation or claims, discharging of liens, payment of judgments and amounts paid for settlement of claims incurred in or resulting from operations under the agreement or necessary to protect or recover the Joint Property, except that no charge for services of Operator’s legal staff or fees or expense of outside attorneys shall be made unless previously agreed to by the Parties. All other legal expense is considered to be covered by the overhead provisions of Section III unless otherwise agreed to by the Parties, except as provided in Section I, Paragraph 3.

 

	
            Exhibits to Operating Agreement
 	
            -5-
 

 

	
             
 	
            11.
 	
            Taxes
 

 

All taxes of every kind and nature assessed or levied upon or in connection with the Joint Property, the operation thereof, or the production therefrom, and which taxes have been paid by the Operator for the benefit of the Parties. If the ad valorem taxes are based in whole or in part upon separate valuations of each party’s working interest, then notwithstanding anything to the contrary herein, charges to the Joint Account shall be made and paid by the Parties hereto in accordance with the tax value generated by each party’s working interest.

 

	
             
 	
            12.
 	
            Insurance
 

 

Net premiums paid for insurance required to be carried for the Joint Operations for the protection of the Parties. In the event Joint Operations are conducted in a state in which Operator may act as self-insurer for Worker’s Compensation and/ or Employers Liability under the respective state’s laws, Operator may, at its election, include the risk under its self- insurance program and in that event, Operator shall include a charge at Operator’s cost not to exceed manual rates.

 

	
             
 	
            13.
 	
            Abandonment and Reclamation
 

 

Costs incurred for abandonment of the Joint Property, including costs required by governmental or other regulatory authority.

 

	
             
 	
            14.
 	
            Communications
 

 

Cost of acquiring, leasing, installing, operating, repairing and maintaining communication systems, including radio and microwave facilities directly serving the Joint Property. In the event communication facilities/systems serving the Joint Property are Operator owned, charges to the Joint Account shall be made as provided in Paragraph 8 of this Section II.

 

	
             
 	
            15.
 	
            Other Expenditures
 

 

Any other expenditure not covered or dealt with in the foregoing provisions of this Section II, or in Section III and which is of direct benefit to the Joint Property and is incurred by the Operator in the necessary and proper conduct of the Joint Operations.

 

III. OVERHEAD

 

	
             
 	
            1.
 	
            Overhead - Drilling and Producing Operations
 

 

i         As compensation for administrative, supervision, office services and warehousing costs, Operator shall charge drilling and producing operations on either:

 

(XX) Fixed Rate Basis, Paragraph 1A, or

	
             
 	
            (  ) Percentage Basis, Paragraph 1B
 

 

Unless otherwise agreed to by the Parties, such charge shall be in lieu of costs and expenses of all offices and salaries or wages plus applicable burdens and expenses of all personnel, except those directly chargeable under Paragraph 3A. Section II. The cost and expense of services from outside sources in connection with matters of taxation, traffic, accounting or matters before or involving governmental agencies shall be considered as included in the overhead rates provided for in the above selected Paragraph of this Section III unless such cost and expense are agreed to by the Parties as a direct charge to the Joint Account.

 

ii.      The salaries, wages and Personal Expenses of Technical Employees and/or the cost of professional consultant services and contract services of technical personnel directly employed on the Joint Property:

 

	
            Exhibits to Operating Agreement
 	
            -6-
 

 

	
             
 	
            (  ) shall be covered by the overhead rates, or
 

(XX) shall not be covered by the overhead rates.

 

iii.     The salaries, wages and Personal Expenses of Technical Employees and/or costs of professional consultant services and contract services of technical personnel either temporarily or permanently assigned to and directly employed in the operation of the Joint Property:

 

	
             
 	
            (  ) shall be covered by the overhead rates, or
 

(XX) shall not be covered by the overhead rates.

 

	
             
 	
            A.
 	
            Overhead — Fixed Rate Basis
 

 

	
             
 	
            (1)
 	
            Operator shall charge the Joint Account at the following rates per well per month:
 

 

	
             
 	
            Drilling Well Rate $
 	
            6,000.00
 

(Prorated for less than a full month)

Producing Well Rate $600.00

 

	
             
 	
            (2)
 	
            Application of Overhead - Fixed Rate Basis shall be as follows:
 

 

	
             
 	
            (a)
 	
            Drilling Well Rate
 

 

(1) Charges for drilling wells shall begin on the date the well is spudded and terminate on the date the drilling rig, completion rig, or other units used in completion of the well is released, whichever is later, except that no charge shall be made during suspension of drilling or completion operations for fifteen (15) or more consecutive calendar days.

 

(2) Charges for wells undergoing any type of workover or recompletion for a period of five (5) consecutive work days or more shall be made at the drilling well rate. Such charges shall be applied for the period from date workover operations, with rig or other units used in workover, commence through date of rig or other unit release, except that no charge shall be made during suspension of operations for fifteen (15) or more consecutive calendar days.

 

	
             
 	
            (b)
 	
            Producing Well Rates
 

 

(1)    An active well either produced or injected into for any portion of the month shall be considered as a one- well charge for the entire month.

 

(2)    Each active completion in a multi-completed well in which production is not commingled down hole shall be considered as a one-well charge providing each completion is considered a separate well by the governing regulatory authority.

 

(3)    An inactive gas well shut in because of overproduction or failure of purchaser to take the production shall be considered as a-one-well charge providing the gas well is directly connected to a permanent sales outlet.

 

(4)    A one-well charge shall be made for the month in which plugging and abandonment operations are completed on any well. This one-well charge shall be made whether or not the well has produced except when drilling well rate applies.

 

(5)    All other inactive wells (including but not limited to inactive wells covered by unit allowable, lease allow able. transferred allowable, etc.) shall not qualify for an overhead charge.

 

(3)     The well rates shall be adjusted as of the first day of April each year following the effective date of the agreement to which this Accounting Procedure is attached. The 

 

	
            Exhibits to Operating Agreement
 	
            -7-
 

 

adjustment shall be computed by multiplying the rate currently in use by the percentage increase or decrease in the average weekly earnings of Crude Petroleum and Gas Production Workers for the last calendar year compared to the calendar year preceding as shown by the index of average weekly earnings of Crude Petroleum and Gas Production Workers as published by the United States Department of Labor. Bureau of Labor Statistics, or the equivalent Canadian index as published by Statistics Canada, as applicable. The adjusted rates shall be the rates currently in use, plus or minus the computed adjustment.

 

B. Overhead — Percentage Basis

 

	
             
 	
            (1)
 	
            Operator shall charge the Joint Account at the following rates:
 

 

(a) Development

 

N/A Percent (____%) of the cost of development of the Joint Property exclusive of costs provided under Paragraph 10 of Section I and all salvage credits.

 

(b) Operating

 

N/A Percent (____%) of the cost of operating the Joint Property exclusive of costs provided under Paragraphs 2 and 10 of Section II, all salvage credits, the value of injected substances purchased for secondary recovery and all taxes and assessments which are levied, assessed and paid upon the mineral interest in and to the Joint Property.

 

	
             
 	
            (2)
 	
            Application of Overhead - Percentage Basis shall be as follows:
 

 

For the purpose of determining charges on a percentage basis under Paragraph lB of this Section III, development shall include all costs in connection with drilling, redrilling, deepening, or any remedial operations on any or all wells involving the use of drilling rig and crew capable of drilling to the producing interval on the Joint Property; also, preliminary expenditures necessary in preparation for drilling and expenditures incurred in abandoning when the well is not completed as a producer, and original cost of construction or installation of fixed assets, the expansion of fixed assets and any other project clearly discernible as a fixed asset, except Major Construction as defined in Paragraph 2 of this Section III. All other costs shall be considered as operating.

 

2. Overhead - Major Construction

 

To compensate Operator for overhead costs incurred in the construction and installation of fixed assets, the expansion of fixed assets, and any other project clearly discernible as a fixed asset required for the development and operation of the Joint Property, Operator shall either negotiate a rate prior to the beginning of construction, or shall charge the Joint Account for overhead based on the following rates for any Major Construction project in excess of $ ____________:

 

	
             
 	
            A.
 	
            4% of first $100,000 or total cost if less, plus
 

 

	
             
 	
            B.
 	
            3% of costs in excess of $100,000 but less than $1,000,000, plus
 

 

	
             
 	
            C.
 	
            1 % of costs in excess of $1,000,000.
 

 

 

	
            Exhibits to Operating Agreement
 	
            -8-
 

 

Total cost shall mean the gross cost of any one project. For the purpose of this paragraph, the component parts of a single project shall not be treated separately and the cost of drilling and workover wells and artificial lift equipment shall be excluded.

 

	
             
 	
            3.
 	
            Catastrophe Overhead
 

 

To compensate Operator for overhead costs incurred in the event of expenditures resulting from a single occurrence due to oil spill, blowout, explosion, fire, storm, hurricane, or other catastrophes as agreed to by the Parties, which are necessary to restore the Joint Property to the equivalent condition that existed prior to the event causing the expenditures, Operator shall either negotiate a rate prior to charging the Joint Account or shall charge the Joint Account for overhead based on the following rates:

 

	
             
 	
            A.
 	
            4% of total costs through $100,000; plus
 

	
             
 	
            B.
 	
            3% of total costs in excess of $100,000 but less than $1,000,000; plus
 

	
             
 	
            C.
 	
            1% of total costs in excess of $1,000,000.
 

 

Expenditures subject to the overheads above will not be reduced by insurance recoveries, and no other overhead provisions of this Section III shall apply.

 

	
             
 	
            4.
 	
            Amendment of Rates
 

 

The overhead rates provided for in this Section III may be amended from time to time only by mutual agreement between the Parties hereto if, in practice, the rates are found to be insufficient or excessive.

 

IV. PRICING OF JOINT ACCOUNT MATERIAL PURCHASES.TRANSFERS AND DISPOSITIONS

 

Operator is responsible for Joint Account Material and shall make proper and timely charges and credits for all Material movements affecting the Joint Property. Operator shall provide all Material for use on the Joint Property; however, at Operator’s option, such Material may be supplied by the Non-Operator. Operator shall make timely disposition of idle and/or surplus Material, such disposal being made either through sale to Operator or Non-Operator, division in kind, or sale to outsiders. Operator may purchase, but shall be under no obligation to purchase, interest of Non-Operators in surplus condition A or B Material. The disposal of surplus Controllable Material not purchased by the Operator shall be agreed to by the Parties.

 

	
             
 	
            1.
 	
            Purchases
 

 

Material purchased shall be charged at the price paid by Operator after deduction of all discounts received. In case of Material found to be defective or returned to vendor for any other reasons, credit shall be passed to the Joint Account when adjustment has been received by the Operator.

 

	
             
 	
            2.
 	
            Transfers and Dispositions
 

 

Material furnished to the Joint Property and Material transferred from the Joint Property or disposed of by the Operator, unless otherwise agreed to by the Parties, shall be priced on the following basis exclusive of cash discounts:

 

	
             
 	
            A.
 	
            New Material (Condition A)
 

 

	
             
 	
            (1) Tubular Goods Other than Line Pipe
 

 

(a) Tubular goods, sized 23/8 inches OD and larger, except line pipe, shall be priced at Eastern mill published carload base prices effective as of date of 

 

	
            Exhibits to Operating Agreement
 	
            -9-
 

 

movement plus transportation cost using the 80,000 pound carload weight basis to the railway receiving point nearest the Joint Property for which published rail rates for tubular goods exist. If the 80.000 pound rail rate is not offered, the 70,000 pound or 90,000 pound rail rate may be used. Freight charges for tubing will be calculated from Lorain, Ohio and casing from Youngstown, Ohio.

 

(b) For grades which are special to one mill only, prices shall be computed at the mill base of that mill plus transportation cost from that mill to the railway receiving point nearest the Joint Property as provided above in Paragraph 2.A.(1)(a). For transportation cost from points other than Eastern mills, the 30.000 pound Oil Field Haulers Association interstate truck rate shall be used.

 

(c) Special end finish tubular goods shall be priced at the lowest published out-of-stock price, f.o.b. Houston, Texas, plus transportation cost, using Oil Field Haulers Association interstate 30,000 pound truck rate, to the railway receiving point nearest the Joint Property.

 

(d) Macaroni tubing (size less than 23/8 inch OD) shall be priced at the lowest published out-of-stock prices f.o.b. the supplier plus transportation costs, using the Oil Field Haulers Association interstate truck rate per weight of tubing transferred, to the railway receiving point nearest the Joint Property.

 

(2) Line Pipe

 

(a) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) 30,000 pounds or more shall be priced under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio.

 

(b) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) less than 30,000 pounds shall be priced at Eastern mill published carload base prices effective as of date of shipment, plus 20 percent, plus transportation costs based on freight rates as set forth under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio.

 

(c) Line pipe 24 inch OD and over and 3/4 inch wall and larger shall be priced f.o.b. the point of manufacture at current new published prices plus transportation cost to the railway receiving point nearest the Joint Property.

 

(d) Line pipe, including fabricated line pipe, drive pipe and conduit not listed on published price lists shall be priced at quoted prices plus freight to the railway receiving point nearest the Joint Property or at prices agreed to by the Parties.

 

(3) Other Material shall be priced at the current new price, in effect at date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property.

 

(4) Unused new Material, except tubular goods, moved from the Joint Property shall be priced at the current new price, in effect on date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. Unused new tubulars will be priced as provided above in Paragraph 2 A (1) and (2).

 

B. Good Used Material (Condition B)

 

	
            Exhibits to Operating Agreement
 	
            -10-
 

 

Material in sound and serviceable condition and suitable for reuse without reconditioning:

 

(1) Material moved to the Joint Property

 

At seventy-five percent (75%) of current new price, as determined by Paragraph A.

 

(2) Material used on and moved from the Joint Property

 

(a) At seventy-five percent (75%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as new Material or

 

(b) At sixty-five percent (65%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as used Material.

 

(3) Material not used on and moved from the Joint Property

 

At seventy-five percent (75%) of current new price as determined by Paragraph A.

 

The cost of reconditioning, if any, shall be absorbed by the transferring property.

 

C. Other Used Material

 

(1) Condition C

 

Material which is not in sound and serviceable condition and not suitable for its original function until after reconditioning shall be priced at fifty percent (50%) of current new price as determined by Paragraph A. The cost of reconditioning shall be charged to the receiving property, provided Condition C value plus cost of reconditioning does not exceed Condition B value.

 

(2) Condition D

 

Material, excluding junk, no longer suitable for its original purpose but usable for some other purpose shall be priced on a basis commensurate with its use. Operator may dispose of Condition D Material under procedures normally used by Operator without prior approval of Non-Operators.

 

(a) Casing, tubing, or drill pipe used as line pipe shall be priced as Grade A and B seamless line pipe of com parable size and weight. Used casing, tubing or drill pipe utilized as line pipe shall be priced at used line pipe prices.

 

(b) Casing, tubing or drill pipe used as higher pressure service lines than standard line pipe, e.g. power oil lines, shall be priced under normal pricing procedures for casing, tubing, or drill pipe. Upset tubular goods shall be priced on a non upset basis.

 

(3) Condition E

 

Junk shall be priced at prevailing prices. Operator may dispose of Condition E Material under procedures normally utilized by Operator without prior approval of Non-Operators.

 

D. Obsolete Material

 

	
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Material which is serviceable and usable for its original function but condition and/or value of such Material is not equivalent to that which would justify a price as provided above may be specially priced as agreed to by the Parties. Such price should result in the Joint Account being charged with the value of the service rendered by such Material.

 

E. Pricing Conditions

 

(1) Loading or unloading costs may be charged to the Joint Account at the rate of twenty-five cents (25cents) per hundred weight on all tubular goods movements, in lieu of actual loading or unloading costs sustained at the stocking point. The above rate shall be adjusted as of the first day of April each year following January 1, 1985 by the same percentage increase or decrease used to adjust overhead rates in Section III, Paragraph l.A(3). Each year, the rate calculated shall be rounded to the nearest cent and shall be the rate in effect until the first day of April next year. Such rate shall be published each year by the Council of Petroleum Accountants Societies.

 

(2) Material involving erection costs shall be charged at applicable percentage of the current knocked-down price of new Material.

 

3. Premium Prices

 

Whenever Material is not readily obtainable at published or listed prices because of national emergencies, strikes or other unusual causes over which the Operator has no control, the Operator may charge the Joint Account for the required Material at the Operator’s actual cost incurred in providing such Material, in making it suitable for use, and in moving it to the Joint Property: provided notice in writing is furnished to Non-Operators of the proposed charge prior to billing Non-Operators for such Material. Each Non-Operator shall have the right, by so electing and notifying Operator within ten days after receiving notice from Operator, to furnish in kind all or part of his share of such Material suitable for use and acceptable to Operator.

 

4. Warranty of Material Furnished By Operator

 

Operator does not warrant the Material furnished. In case of defective Material, credit shall not be passed to the Joint Account until adjustment has been received by Operator from the manufacturers or their agents.

 

V. INVENTORIES

 

The Operator shall maintain detailed records of Controllable Material.

 

	
             
 	
            1.
 	
            Periodic Inventories, Notice and Representation
 

 

At reasonable intervals, inventories shall be taken by Operator of the Joint Account Controllable Material. Written notice of intention to take inventory shall be given by Operator at least thirty (30) days before any inventory is to begin so that Non-Operators may be represented when any inventory is taken. Failure of Non-Operators to be represented at an inventory shall bind Non-Operators to accept the inventory taken by Operator.

 

	
             
 	
            2.
 	
            Reconciliation and Adjustment of Inventories
 

 

Adjustments to the Joint Account resulting from the reconciliation of a physical inventory shall be made within six months following the taking of the inventory; Inventory adjustments shall be made by Operator to the Joint Account for overages and shortages, but, Operator shall be held accountable only for shortages due to lack of reasonable diligence.

 

	
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3. Special inventories

 

Special inventories may be taken whenever there is any sale, change of interest, or change of Operator in the Joint Property. It shall be the duty of the party selling to notify all other Parties as quickly as possible after the transfer of interest takes place. In such cases, both the seller and the purchaser shall be governed by such inventory. In cases involving a change of Operator, all Parties shall be governed by such inventory.

 

4. Expense of Conducting Inventories

 

A. The expense of conducting periodic inventories shall not be charged to the Joint Account unless agreed to by the Parties.

 

B. The expense of conducting special inventories shall be charged to the Parties requesting such inventories, except inventories required due to change of Operator shall be charged to the Joint Account.

EXHIBIT “D”

 

INSURANCE

 

A      At all times during the conduct operations hereunder, Operator shall maintain in force the following minimum insurance at the expense of and benefit of the joint account. Any party may, at its own expense, acquire such additional insurance as it may deem necessary to protect its own interest against claim losses, damages or destruction to property arising out of operations hereunder.

 

	
            I.
 	
            Coverage A:  Workman’s Compensation - Statutory Benefits
 

 

	
             
 	
            Coverage B:
 	
            Employer’s Liability - $1,000,000 limit covering employees of Operator
 

 

	
            II.
 	
            Commercial General Liability Insurance:
 

 

	
             
 	
            $1,000,000
 	
            Per Occurrence Limit
 

	
             
 	
            $2,000,000
 	
            General Aggregate
 

 

	
            III
 	
            Operator’s Extra Expense Indemnity Insurance (Well Control Insurance):
 

 

	
             
 	
            $5,000,000 (100% WI)
 	
            Any one occurrence - During Drilling & Completion Stages
 

 

IV. Business Auto Insurance:

 

$1,000,000.00 combined single limit per occurrence.

 

V. Excess Liability:

 

	
             
 	
            $5,000,000
 	
            Bodily Injury and Property Damage - Policy Limit
 

 

B.      Operator shall request all contractors performing work under this agreement to carry the following Insurance.

 

	
            I.
 	
            Coverage A: Workman’s Compensation - Statutory Benefits
 

 

	
             
 	
            Coverage B: Employers Liability - $500,000 limit covering employees of Operator
 

 

	
            II.
 	
            Commercial General Liability Insurance:
 

 

	
             
 	
            $500,000
 	
            Per Occurrence Limit
 

	
             
 	
            $1,000,000
 	
            General Aggregate
 

 

	
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            III.
 	
            Business Auto Insurance:
 

 

	
             
 	
            $500,000 combined single limit per occurrence.
 

 

	
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EXHIBIT “E”

GAS BALANCING AGREEMENT (“AGREEMENT”)

ATTACHED TO AND MADE PART OF THAT CERTAIN

OPERATING AGREEMENT DATED ______________________________

BY AND BETWEEN BAYSHORE EXPLORATION, L.L.C.

AND _________________________________________________ (OPERATING AGREEMENT

RELATING TO THE _______________________________________________________ AREA,

LA SALLE IN THE STATE OF TEXAS

I. DEFINITIONS

The foliating definitions shall apply to this Agreement:

1.01 “Arm’s Length Agreement” shall mean any gas sales agreement with an unaffiliated purchaser or any gas sales agreement with an affiliated purchaser wheat the sales price and delivery conditions under such agreement are representative of prices and delivery conditions existing under other similar agreements in the area betweens unaffiliated parties at the same time for natural gas of comparable quality and quantity.

1.02 “Balancing Area” shall mean (select one):

o  each well subject to the Operating Agreement that produces Gas or is allocated a share of Gas production. If a single well is completed in two or more producing intervals, each producing interval (rum which the Gas production is not commingled in the wellbore shall be entitled to a separate well.

x  all of the acreage and depths subject to the Operating Agreement.

o  __________________________________________________________________________________

 

1.03 “Full Share of Current Production” shall mean the Percentage Interest of each Party in the Gas actually produced from the Balancing Area during each month.

1.04 “Gas” shall mean a hydrocarbons produced or producible from the Balancing Ares, whether from well classified as an oil well or gas well by the regulatory agency having jurisdiction in such matters, which are or may be made available for sale or separate disposition by else Parties, excluding rail, condensate and ocher liquids recovered by held equipment operated for the joint account. “Gas” does not include gas used in joint operations, such as for fuel, recycling or reinjection or which is vented or lost prior to its sale or delivery from the Balancing Area.

1.05 “Makeup Gas” shall mean any Gas taken by an Underproduced Party from the Balancing Area in excess of its Full Share of Current Production whether pursuant to Section 3.3 or Section 4.1 hereof.

1.06 “Mcf” shall mean one thousand cubic feet. A cubic foot of Gas shall mean the volume of gas contained in one cubic fool of space at a standard pressure base and at a standard temperature base.

1.07 “MMBtu” shall mean one million British Thermal Units. A British Thermal Unit shall mean the quantity of heat required to raise one pound avoirdupois of pure water from 58.5 degrees Fahrenheit to 59.5 degrees Fahrenheit at a constant pressure of 14.73 pounds per square inch absolute.

1.08 ‘‘Operator’’ shall mean the individual car entity designated under the terms of the Operating Agreement or, in the event this Agreement is not employed in connection with an operating agreement, the individual or entity designated as the operator of the well(s) located in the Balancing Area.

1.09 “Overproduced Party” shall mean any Party having taken a greater quantity of Gas from the Balancing Area than the Percentage Interest of such Party in the cumulative quantity of all Gas produced from the Balancing Area.

1.10 “Overproduction” shall mean the cumulative quantity of Gas taken by a Party in excess of its Percentage Interest in the cumulative quantity of all Gas produced from the Balancing Area.

 

	
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1.11 “Party” shall mean those individuals or entities subject to this Agreement, and their respective heirs, successors, transferees and assigns.

1.12 “Percentage Interest” shall mean the percentage of each Party in the Gas produced from the Balancing Area pursuant to the Operating Agreement covering the Balancing Area.

1.13 ‘‘Royalty’’ shall mean payments on production of Gas from the Balancing Area to all owners of royalties, overriding royalties, production payments or similar interests.

1.14 “Underproduced Party” shall mean any Party having taken a lesser quantity of Gas from the Balancing Area than the Percentage Interest of such Party in the cumulative quantity of all (gas produced from the Balancing Area.

1.15 “Underproduction” shall means the deficiency between the cumulative quantity of Gas taken by a Party and its Percentage Interest in the cumulative quantity of all Gas produced from the Balancing Area.

1.16 o (Optional) “Winter Period” shall mean the month(s) of ___________________________________________ calendar year and the month(s) of ___________________________________________ in the succeeding calendar year.

2. BALANCING AREA

2.1 If this Agreement covers more than one Balancing Area, it shall be applied as if each Balancing Area were covered by separate but identical agreements. Al balancing hereunder shall be on the basis of Gas taken from the Balancing Area measured in (Alternative 1) o Mcfs or (Alternative 2) x MMBrus.

2.2 In the event that all or part of the Gas deliverable from a Balancing Area is or becomes subject to one or more maximum lawful prices, any Gas not subject to price controls shall be considered as produced from a single Balancing Area and Gas subject to each maximum lawful price category shall be considered produced from a separate Balancing Area.

3. RIGHT OF PARTIES TO TAKE GAS

3.1 Each Party desiring to take Gas will notify the Operator, or cause the Operator to be notified or the volumes nominated, the name of the transporting pipeline and the pipeline contract number (if available) and meter station relating to such delivery, sufficiently in advance fro the Operator, acting with reasonable diligence, to meet all nomination and other requirements. Operator is authorized to deliver the volumes so nominated and confirmed (if confirmation is required) to the transporting pipeline in accordance with the terms of this Agreement.

3.2 Each Party shall ma a reasonable, good faith effortto take its Full Share of Current Production each month, to the extent that such production is required to maintain leases in effect, to protect the producing capacity of a well or reservoir, to preserve correlative rights, or to maintain oil production.

3.3 When a Party fails for any reason to rake its Full Share of Current Production (as such Share may be reduced by the right of the other Parties to make up far Underproduction as provided herein), the other Parties shall be entitled to take any Gas which such Party fails to take. To the extent practicable, such Gas shall be made available initially to each Underproduced Party in the proportion that its Percentage Interest in the Balancing Area bears to the total Percentage Interests of all Underproduced Parties desiring to take such Gas. If all such Gas is not taken by the Underproduced Parties, the portion not taken shall then be made available to the other Parties in the proportion that their respective Percentage Interests in the Balancing Area bear to the total Percentage Interests of such Parties.

3.4 All Gas taken by a Party in accordance with the provisions of this Agreement, regardless of whether such Party is underproduced or overproduced, shall be regarded as Gas taken for its own account with title thereto being in such raking Party.

3.5 Notwithstanding the provisions of Section 3.3 hereof, no Overprroduced Party shall be entitled in any month to take any Gas in excess of three hundred percent (300%) of its Percentage Interest of the Balancing Area’s then-current Maximum Monthly Availability; provided, however, that this limitation shall not apply to the extent that it would preclude production that is required to main rain leases in effect, to protect the producing capacity of a well or reservoir, to preserve correlative rights, or to maintain oil production. “Maximum Monthly Availability” shall mean the maximum average monthly rate of production at which Gas can be delivered from the Balancing Area, as determined by the Operator, considering the maximum efficient well rate for each well within the 

 

	
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Balancing Area, the maximum allowable(s) set by the appropriate regulatory agency, mode of operation, production facility capabilities and pipeline pressures.

3.6 In the event that a Party fails to make arrangements to take its Full Share of Current Production required to be produced to maintain leases in effect, to protect the producing capacity of a well or reservoir, to preserve correlative rights, or to maintain oil production, the Operator nay sell any part of such Party’s Full Share of Current Production that such Party fails to take for the account of such Party and render to such Party, on a current basis, the full proceeds of the sale, less any reasonable marketing, compression, treating, gathering or transportation costs incurred directly in connection with the sale of such Full Share of Current Production. In making the sale contemplated herein, the Operator shall be obligated only to obtain such price and conditions for the sale as are reasonable under the circumstances and shall not be obligated to share any of its markets. Any such sale by
Operator under the terms hereof shall be only for such reasonable periods of time as are consistent with the minimum needs of the industry under the particular circumstances. But in no event for a period in excess of one year. Notwithstanding the provisions of Article 3.4 hereof, Gas sold by Operator for a Party under the provisions hereof shall be deemed to be Gas taken for the account of such Party.

4.  IN-KIND BALANCING

4.1 Effective the first day of any calendar month following at least sixty (60) days prior written notice to the Operator, any Underproduced Party may begin taking, in addition to its Full Share of Current Production and any Makeup Gas taken pursuant ito Section 3.3 of this Agreement, a share of current production determined by multiplying Fifty percent (50%) of the Full Shares of Current Production of all Overproduced Parties by a fraction, the numerator of which is the Percentage Interest of such Underproduced Party and the denominator of which is the total of the Percentage Interests of all Underproduced Parties desiring to take Makeup Gas. In no event will an Overproduced Party be required to provide more than Fifty percent (50%) of its Full Share of Current Production for Makeup Gas. The Operator will promptly notify all Overproduced Parties of the election of an Underproduced Party to begin taking Makeup Gas.

4.2 o (Optional — Seasonal Limitation on Makeup — Option 1) Notwithstanding the provisions of Section 4.1. the average monthly amount of Makeup Gas taken by an Underproduced Party during the Winter Period pursuant to Section 4 shall not exceed the average monthly amount of Makeup Gas taken by such Underproduced Party during the _______________________________________ (__________) months immediately preceding the Winter Period.

4.2 o (Optional — Seasonal Limitation on Makeup – Option 2) Notwithstanding the provisions of Section 4.1, no Overproduced Party will be required to provide more than ________________________ percent (______%) of its Full Share of Current Production for Makeup Gas during the Winter Period.

4.3 x (Optional) Notwithstanding any other provision of this Agreement, at such time and for so long as Operator, or (insofar as concerns production by the Operator) any Underproduced Party, determines in good faith that an Overproduced Party may be required to make available for Makeup Gas, upon the demand of the Operator or any Underproduced Party, up to Fifty percent (50%) of such Overproduced Party’s full Share of Current Production.

5. STATEMENT OF GAS BALANCES

5.1 The Operator will maintain appropriate accounting on a monthly and cumulative basis of the volumes of Gas that each Party is entitled to receive and the volumes of Gas actually taken or sold for each Party’s account. Within forty-five (45) days after the month of production, the Operator will furnish a statement for such month showing (1) each Party’s Full Share of the volume taken by each Party and that Party’s Ful Share of Current Production, (4) the Overproduction or Underproduction of each Party, and (5) other data as recommended by the provisions of the Council of Petroleum Accountants Societies Bulletin No. 24, as amended or supplemented hereafter. Each Party taking Gas will promptly provide in the Operator any data required by the Operator for preparation of the statements required hereunder.

5.2 If any Party fails to provide the data required herein for four (4) consecutive production months, the Operator, or where the Operator has failed to provide data, another Party, may audit the production and Gas sales and transportation volumes of the non0reporting Party to provide the required data. Such audit shall be conducted only after reasonable notice and during normal business hours in the office of the Party whose records are being audited. All costs associated with such audit will be charged to the account of the Party failing to provide the required data.

6. PAYMENTS ON PRODUCTION

 

	
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6.1 Each Party taking Gas shall pay or cause to be paid all production and severance taxes due on all volumes of Gas actually taken by such Party.

6.2 o (Alternative 1 – Entitlements) Each Party shall pay or cause to be paid all Royalty due with respect to Royalty owners to whom it is accountable as if such Party were taking its Full Share of Current Production, and only its Full Share of Current Production.

6.2.1 o (Optional — For use only with Section 6.2 – Alternative 1 — Entitlement) Upon written request of a Party taking less than its Full Share of Current Production in a given month (“Current Underproducer”), any Party taking more than its Full Share of Current Production in such month (“Current Overproducer”) will pay to such Current Underproduceran amount each month equal to the Royalty percentage of the proceeds received by the Current Overproducer for that portion of the Current Underproducer’s Full Share of Current Production taken by the Current Overproducer; provided, however, that such payment will not exceed the Royalty percentage that is common to all Royalty burdens in the Balancing Area. Payments made pursuant to this Section 6.2.1 will be deemed payments to the Underproduced Party’s Roylty owners for
purposes of Section 7.5.

6.2 x (Alternative 2 — Sales) Each Party shall pay or cause to be paid Royalty due with respect to Royalty owners to whom it is accountable based on the volume of Gas actually taken for its account.

6.3 In the event that any governmental authority requires that Royalty payments be made on any other basis than that provided for in his Section 6, each Party agrees to make such Royalty payments accordingly, commencing on the effective date required by such governmental authority, and the method provided for herein shall be thereby superseded.

7. CASH SETTLEMENTS

7.1 Upon the earlier of the plugging and abandonment of the last producing interval in the Balancing Area, the termination of the Operating Agreement or any pooling or unit agreement covering the Balancing Area, or at any time no Gas is taken from the Balancing Area for a period of twelve (12) consecutive months, any Party may give written notice calling for cash settlement of the Gas production imbalances among the Parties. Such notice shall be given to all Parties in the Balancing Area.

7.2 Within sixty (60) days after the notice calling for cash settlement under Section 7.1, the Operator will distribute to each Party a Final Gas Settlement Statement detailing the quantity of Overproduction owed by each Overproducec Party to each Underproduced Party and identifying the month to which such Overproduction is attributed, pursuant to the methodology set out in Section 7.4.

7.3 o (Alternative 1 — Direct Party-to-Party Settlement) Within sixty (60) days after receipt of the Final Gas Settle Statement, each Overproduced Party will pay to each Underproduced entitled to settlement the appropriate cash settlement accompanied by appropriate accounting detail. At the time of payment, the Overproduced Party will notify the Operator of the Gas imbalance settled by the Overproduced Party’s payment.

7.3 x (Alternative 2 — Settlement Through Operator) Within sixty (60) days after receipt of the final Gas Settlement, each Overproduced Party will send its cash settlement, accompanied by appropriate accounting detail, to the Operator. The Operator will distribute the monies so received, along with any settlement owed by the Operator as an Overproduced Party, to each Underproduced Party to whom settlement is due within ninety (90) days after issuance of the Final Gas Settlement Statement. In the event that any Overproduced Party fails to pay any settlement due hereunder, the Operator may turn over responsibility for the collection of such settlement to the Party to whom it is owed, and the Operator will have no further responsibility with regard to such settlement.

7.3.1 o (Optional — For use only with Section 7.3, Alternative 2 — Settlement Throuth Operator)Any Party shall have the right at any time upon thirty (30) days prior written notice to all other Parties to demand that any settlements due such Party for Overproduction be paid direct to such Party by the Overproduced Party, rather than being paid through the Operator. In the event that so Overproduced Party pays the Operator any sums due to an Underproduced Parties at any time after thirty (30) days following the receipt of the notice provided for herein, the Overproduced Party will continue to be liable to such Underproduced Party foe any sums to be paid, until payment is actually received by the Underproduced Party.

7.4 o (Alternative 1 — Historical Sales Basis) The amount of she cash settlement will be based on the proceeds received by the Overproduced Party under an Arms length Agreement for the volume of Gas taken from time to time by the Overproduced Party in excess of the Overproduced Party’s Full Share of Current 

 

	
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Production. Any Makeup Gas taken by the Underproduced Party prior to monetary settlement hereunder will be applied to offset Overproduction chronologically in the order of accrual.

7.4 x (Alternative 2 — Most Recent Sails Basis) The amount of the cash settlement will be based on the proceeds received by the Overproduced Party under an Arm’s Length Agreement for the volume of Gas that constituted Overproduction by the Overproduced Party from the Balancing Area. For the purpose of implementing the cash settlement provision of the Section 7, an Overproduced Party will not be considered to have produced any of an Underproduced Party’s share of Gas until the Overproduced Party has produced cumulatively all of its Percentage Interest share of the Gas ultimately produced from the Balancing Area.

7.5 The valued used for calculating the cash settlement under Section 7.4 will include all proceeds received for the sale of the Gas by the Overproduced Party calculated at the Balancing Area, after deducting any production or severance taxes paid and any Royalty actually paid by the Overproduced Party to an Underproduced Party’s Royalty owner(s), to the extent said payments amounted to a discharge of said Underproduced Party’s Royalty obligation, as well as any reasonable marketing, compression, treating, gathering or transportation costs incurred directly in connection with the sale of the Overproduction.

7.5.1 x (Optional — For Valuation Under Percentage of Proceeds Contracts) For Overproduction sold under a gas purchase contract providing for payment based on a percentage of the proceeds obtained by the purchaser upon resale of residue gas and liquid hydrocarbons extracted at a gas processing plant, the values used for calculating cash settlement will include proceeds received by the Overproduced Party for both the liquid hydrocarbons and the reside gas attributable to the Overproduction.

7.5.2 o (Optional – Valuation for Processed Gas – Option 1) For Overproduction processed for the account of the Overproduced Party as a gas processing plant for the extraction of liquid hydrocarbons, the full quantity of the Overproduction will be valued for purposes of cash settlement at the prices received by the Overproduced Party for the sale of the reside gas attributable to the Overproduction without regard to proceeds attributable to liquid hydrocarbons which may have been extracted from the Overproduction.

7.5.2 o (Option – Valuation for Processed Gas – Option 2) For Overproduction processed for the account of the Overproduced Party at a gas processing plant for the extraction of liquid hydrocarbons, the values used for calculating cash settlement will include the proceeds received by the Overproduced Party for the sale of the liquid hydrocarbons extracted from the Overproduction, less the actual reasonable costs incurred by the Overproduced Party to process the Overproduction and to transport, fractionate and handle the liquid hydrocarbons extracted therefrom prior to sale.

7.6 To the extent the Overproduced Party did not sell all Overproduction under an Arm’s Length Agreement, the cash settlement will be based on the weighted average price received by the Overproduced Party for any gas sold from the Balancing Area under Arm’s Length Agreements during the months to which such Overproduction is attributed. In the event that no sales under Arm’s Length Agreements were made during any such month, the cash settlement for such month will be based on the spot sales prices published for the applicable geographic area during such month in a mutually acceptable pricing bulletin.

7.7 Interest compounded at the rate of zero percent (0 %) per annum or the maximum lawful rate of interest applicable to the Balancing Area, whichever is less, will accrue for all amounts due under Section 7.1, beginning the first day following the date payment is due pursuant to Section 7.3. Such interest shall be borne by the Operator or any Overproduced Party in the proportion that their respective delays beyond the deadlines set out in Sections 7.2 and 7 3 contributed to the accrual of the interest.

7.8 In lieu of the cash settlement required by Section 7.3, an Overproduced Party may deliver to the Underproduced Party an offer to settle its Overproduction in-kind and at such cares, quantities, times and sources as may be agreed upon by the Underproduced Party. If the Parties see are unable to agree upon the manner in which such in-kind settlement gas will be furnished within sixty (60) days after the Overproduced Party’s offer to settle in kind, which period nay be extended by agreement of said Parties, the Overproduced Party shall make a. cash settlement as provided in Section 7.3. The making of an in-kind settlement offer under this Section 7.8 will not delay the accrual of interest on the cash settlement should the Parties fail to reach agreement on an in-kind settlement.

7.9 o (Optional — For Balancing Areas Subject to Federal Price Regulation) That portion of any monies collected by an Overproduced Party for Overproduction which is subject to refund by orders of the Federal Energy Regulatory Commission or other governmental authority may be withheld by the Overproduced Party until such prices are fully approved by such governmental authority, unless the Underproduced Party furnishes 

 

	
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a corporate undertaking, acceptable to the Overproduced Party, agreeing to hold the Overproduced Party harmless from financial loss due to refund orders by such governmental authority.

7.10 o (Optional — Interim Cash Balancing) At any time during the term of this Agreement, any Overproduced Party may, in its sole discretion, make cash settlement (s) with the Underproduced Parties covering all or part of its outstanding Gas imbalance, provided that such settlements must be made with all Underproduced Parties proportionately based on the relative imbalances of the Underproduced Parties, and provided further that such settlements may not be made more often than once every twenty-four (24) months, Such settlements will be calculated in the same manner provided above for final cash settlements. The Overproduced Party will provide Operator a detailed accounting of any such cash settlement within thirty (30) days after the settlement is made.

8. [deleted text]

9. OPERATING COSTS

Nothing in this Agreement shall change or affect any Party’s obligation to pay its proportionate share of all costs and liabilities incurred in operations on or in connection with the Balancing Area, as its share thereof is set forth in the Operating Agreement, irrespective of whether any Party is at any time selling and using Gas or whether such sales or use are in proportion so its Percentage Interest in the Balancing Area.

10. LIQUIDS

The Parties shall share proportionately in and own all liquid hydrocarbons recovered with Gas by field equipment operated for the joint account in accordance with their Percentage Interests in the Balancing Area.

11. AUDIT RIGHTS

Notwithstanding any provision in this Agreement or any other agreement between the Parties hereto, and further notwithstanding any termination or cancellation of this Agreement, for a period of two (2) years from the end of the calendar year in which any information to be furnished under Section 3 or 7 hereof is supplied, any Party shall have the right to audit the records of any other Party regarding quantity, including but not limited to information regarding Bru-content. Any Underproduced Party shall have the right for a period of two (2) years from the end of the calendar year in which any cash settlement is received pursuant to Section 7 to audit the records of any Overproduced Party as to all matters concerning values, including but not limited to information regarding prices and disposition of Gas from the Balancing Area. Any such audit shall be conducted at the expense of the Party or Parties
desiring such audit, and shall be conducted, after reasonable notice, during normal business hours in the office of the Party whose records are being audited. Each Party hereto agrees to maintain records as to the volumes and prices of Gas sold each month and the volumes of Gas used in its own operations, along with the Royalty paid on any such Gas sued by a Party in its own operations. The audit rights provided for in this Section 11 shall be in addition to those provided for in Section 5.2 of this Agreement.

12. MISCELLANEOUS

12.1 As between the Parties, in the event of any conflict between the provisions of this Agreement and the provisions of any gas sales contract, or in the event of any conflict between the provisions of this Agreement and the provisions of the Operating Agreement, the provisions of this Agreement shall govern.

12.2 Each Party agrees to defend, indemnify and hold harmless all other Parties from and against any and all liability for any claims, which may be asserted by any third party which now or hereafter stands in a contractual relationship with such indemnifying Party and which arise out of the operation of this Agreement or any activities of such indemnifying Party under the provisions of this Agreement, and does further agree to save the other Parties harmless from all judgments or damages sustained and costs incurred in connection therewith.

12.3 Except as otherwise provided in this Agreement, Operator is authorized to administer the provisions of this Agreement, but shall have no liability to the other Parties for losses sustained or liability incurred which arise out of or in connection with the performance of Operator’s duties hereunder, except such as may result from Operator’s gross negligence or willful misconduct. Operator shall not be liable to any Underproduced Party for the failure of any Overproduced Party (other than Operator) to pay any amounts owed pursuant to the terms hereof.

12.4 This Agreement shall remain in full force and effect for as long as the Operating Agreement shall remain in force and effect as to the Balancing Area, and thereafter until the Gas accounts between the Parties are settled in full and shall to the benefit of and be binding up on the Parties hereto, and their respective heirs, successors, legal representatives and assign, if any. The Parties hereto agree to give notice of the existence of this 

 

	
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Agreement to any successor in interest of any such Party and to provide that any such successor shall be bound by this Agreement, and shall further make any transfer of any interest subject to the Operating Agreement, or any part thereof, subject to the terms of this Agreement.

12.5 Unless the consent clearly indicates otherwise, words used in the singular include the plural, the plural includes the singular, and the neuter gender includes the masculine and the feminine.

12.6 In the event that any “Optional” provision of this Agreement is not adopted by the Parties to this Agreement by a typed, printed or handwritten indication, such provision shall not form a part of this Agreement, and no inference shall be made concerning the intent of the Parties in such event. In the event that any “Alternative” provision of this Agreement is not so adopted by the Parties, Alterative 1 in each such instance shall be deemed to have been adopted by the Parties as a result of any such omission. In those cases where it is indicated that an Optional provision may be used only if a specific Alternative is selected: (i) an election to include said Optional provision shall not be effective unless the Alternative in question is selected; and (ii) the election to include said Optional provision must be expressly indicated hereon, it being understood that the selection of an
Alternative either expressly or by default as provided herein shall not, in and of itself, constitute an election to include an associated Optional provision.

12.7 This Agreement shall bind the Parties in accordance with the provisions hereof, and nothing herein shall be construed or interpreted as creating any rights in any person or entity not a signatory hereto, or as being a stipulation infavor of any such person or entity.

12.8 If contemporaneously with this Agreement becoming effective, or thereafter, any Party requests that any other Party execute an appropriate memorandum or notice of this Agreement in order to give third parties notice of record of same and submits same for execution in recordable form, such memorandum or notice shall be duly executed by the Party to which such request is made and delivered promptly thereafter to the Party making the request. Upon receipt, the Party making the request shall cause the memorandum or notice to be duly recorded in the appropriate real property or other records affecting the Balancing Area.

12.9 In she event Internal Revenue Service regulations require a uniform method of computing taxable income by all Parties, each Party agrees to compute and report income to the Internal Revenue Service (select one) o as if such Party were taking its Full Share of Current Production during each relevant tax period in accordance with such regulations, insofar as same relate to entitlement method tax computations; or x based an the quantity of Gas taken for its account in accordance with such regulations, insofar as same relate in sales method tax computations.

13. ASSIGNMENT AND RIGHTS UPON ASSIGNMENT

13.1 Subject to the provisions of Sections 13.2 (if elected) and 13.3 hereof, and notwithstanding anything in this Agreement or in the Operating Agreement to the contrary, if any Party assigns (including any sale, exchange or other transfer) any of its working interest in the Balancing Areas when such Party is an Underproduced or Overproduced Party, the assignment or other act of transfer shall, insofar as the Parties hereto are concerned, include all interest of the assigning or transferring Party in the Gas, all rights to receive or obligations to provide or take Makeup Gas and all rights to receive or obligations to make any monetary payment which may ultimately be due hereunder, as applicable. Operator and each of the other Parties hereto shall thereafter treat the assignment accordingly, and the assigning or transferring Party shall look solely to its assignee or other transferee for any interest in
the Gas or monetary payment that such Party may have or to which it may be entitled, and shall cause its assignee or other transferee to assume its obligations hereunder.

13.2 o (Optional — Cash Settlement Upon Assignment) Notwithstanding anything in this Agreement (including but not limited to the provisions of Section 13.1 hereof) or in the Operating Agreement to the contrary, and subject to the provisions of Section 13.3 hereof, in the event an Overproduced Party intends to sell, assign. exchange or otherwise transfer any of its interest in a Balancing Area, such Overproduced Party shall notify in writing the other working interest owners who are Parties hereto in such Balancing Area of such fact at least ________________ (_____) days prior to closing the transaction. Thereafter, any Underproduced Party may demand from such Overproduced Party in writing, within ______________ (______) days after receipt of the Overproduced Party’s notice, a cash settlement of its Underproduction from the Balancing Area. The
Operator shall be notified of any such demand and of any cash settlement pursuant to this Section 13, and the Overproduction and Underproduction of each Party shall be adjusted accordingly. Any cash settlement pursuant to this Section 13 shall be paid by the Overproduced Party on or before the earlier to occur (i) of sixty (60) days after the Overproduced Party’s sale, assignment, exchange or transfer of its interest in the Balancing Area for any amounts not paid. Provided, however, if any Underproduced Party does not so demand such cash 

 

	
            Exhibits to Operating Agreement
 	
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settlement of its Underproduction from the Balancing Area, such Underproduced Party shall look exclusively to the assignee or other successor in interest of the Overproduced Party giving notice hereunder for the satisfaction of such Underproduced Party’s Underproduction in accordance with the provisions of Section 13.1 hereof.

13.3 The provisions of this Section 13 shall not be applicable in the event any Party mortgages its interest or disposes of its interest by merger, reorganization, consolidation or sale of substantially all of its assets to a subsidiary or parent company, or to any company in which any parent or subsidiary of such Party owns a majority of the stock of such company.

14. OTHER PROVISIONS

 

 

	
            Exhibits to Operating Agreement
 	
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EXHIBIT “F”

 

Attached to and made a part of that certain Joint Operating Agreement dated March 1, 2006

 

NON-DISCRIMINATIONA AND CERTIFICATION OF NON-SEGREGATED FASCILITIES

 

In the performance of this agreement, Operator agrees to comply fully with the misdiscrimination provisions of Section 202 (1) to (7) inclusive of Executive Order No. 11246, as amended. Operator further agrees to comply with the provisions of Executive Order No. 11701, which is incorporated herein by reference.

 

 

	
            Exhibits to Operating Agreement
 	
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EXHIBIT “D”

To Exploration Agreement

 

 

	
            Bayshore Exploration L.L.C.
 	
            20501 Katy Freeway, Suite 216
 

	
             
 	
            Katy, Texas 77450
 

	
             
 	
            Phone (281) 646-1919
 

	
             
 	
            Fax (281) 647-9448
 

	
             
 	
            bayshoreexpl@sbcglobal.net
 

 

December 30, 2005

 

Paxton Energy, Inc.

2533 North Carson Street

Suite 6232

Carson City, Nevada 89706

 

	
             
 	
            RE:
 	
            Purchase Agreement — 20% Working Interest
 

	
             
 	
            Alamo Operating Company, L.C. — Cartwright No. 1 Well
 

	
             
 	
            Cooke Ranch Prospect — La Salle County, Texas
 

 

Gentlemen:

 

This letter is written to evidence the agreement between Bayshore Exploration L.L.C. (“Bayshore”) and Paxton Energy, Inc. (“Paxton”) pertaining to the Alamo Operating Company, L.C. — Cartwright No. 1 Well located in the C. Sullivan Survey No. 226, A -1076, La Salle County, Texas. Bayshore is the owner and holder of a 20% working interest, subject to a 75% net revenue interest, in the Alamo Operating Company, L.C. — Cartwright No. 1 Well. Paxton desires to purchase said 20% working interest from Bayshore with the following terms and conditions:

 

	
             
 	
            1.
 	
            On or before the expiration of 120 days from the date of this Letter Agreement, Paxton agrees to pay to Bayshore the sum of $237,800.00 U.S. dollars which represents the total purchase price for said 20% working interest.
 

 

	
             
 	
            2.
 	
            On or before the expiration of 120 days from the date of this Letter Agreement, Paxton agrees to pay to Bayshore the sum of $176,800.00 U.S. dollars which represents the total purchase price of 20% of the leasehold and working interest in and to 8,840 acres (“the subject acreage”), more or less, which is illustrated in bold outline on the attached land plat as Exhibit “A” hereto. The purchase of said 20% leasehold interest by Paxton from Bayshore will increase Paxton’s leasehold interest in the subject acreage to a 31.75% leasehold interest.
 

 

	
             
 	
            3.
 	
            Upon receipt of the above mentioned sums paid to Bayshore by Paxton in a timely manner as set out above, Bayshore agrees to assign to Paxton a 20% working interest in the Alamo Operating Company, L.C.-Cartwright No. 1 Well (75% NRI). Paxton shall also have the option to participate for said 20% working interest in subsequent well(s) drilled on the subject acreage under the terms of a mutually acceptable Joint Operating Agreement, naming Bayshore as operator.
 

 

	
             
 	
            4.
 	
            The purchase of said 20% working interest in the Alamo Operating Company, L.C.-Cartwright No. 1 Well by Paxton from Bayshore will increase Paxton’s working interest in the subject acreage to a 31.75% working interest.
 

 

	
             
 	
            5.
 	
            This Letter Agreement is the entire agreement between the parties hereto pertaining to the purchase of a 20% working interest in the Alamo Operating Company, L.C.-Cartwright No. 1 Well and supersedes all prior oral and written agreements. Any changes to this agreement must be agreed to in writing between both parties.
 

 

 

	
             
 	
            6.
 	
            The parties agree to execute such additional agreements and documents as may be necessary to effectuate the intentions of this Agreement.
 

 

	
             
 	
            7.
 	
            This Letter Agreement, shall be construed in accordance with and governed by the laws of the State of Texas, shall be binding upon and shall inure to the benefit of the parties hereto and shall extend to and be binding upon their respective successors and assigns.
 

 

If the foregoing is your understanding of our agreement, please acknowledge your acceptance by signing in the space provided below and returning one fully executed copy of this Letter Agreement to Bayshore at your earliest convenience.

 

Sincerely,

 

BAYSHORE EXPLORATION L.L.C.

 

/s/ Jamin Swantner

 

Jamin Swantner

President

 

PAXTON ENERGY, INC.

 

/s/ Robert Freiheit

 

Robert Freiheit, CEO

 

Attachment: Exhibit “A” — Land Plat

 

EXHIBIT “A”

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