existential questionWe begin with an existential question:

“The philosophy behind all of the model form agreements is that aggressive drilling under the JOA should be promoted and rewarded.

Agree or disagree?

That was an issue in Talisman Energy v. Matrix Petroleum.  It was not resolved, but the decision is worth your attention because the court enjoined the operator from drilling and proposing wells pending trial on the merits.

The parties were drilling wells in LaSalle County, Texas, under a 1954 Model Form JOA. Section 15 (which the court refers to as Section ”16”; see V.D of the later forms) allows the operator to use its own equipment and tools only on a competitive basis, if it does not exceed prevailing rates, and after an agreement in writing with the non-operators. Evidence was presented that Talisman was exceeding the prevailing market rate and was not confirming the arrangement with Matrix prior to operations.

A procedural hurdle

Procedural wrangling prevented the court from answering our existential question. Talisman’s expert landman, and the source of the statement, was going to show certain customs and usages in the model form and how it is intended to work.

An expert can testify about, for example, the common understanding of “commencement of operations”. But the court viewed the testimony as being offered not to explain the meaning of an industry term, but rather to aid the trial court in construing sections 5 and 8 of the agreement.  A court doesn’t need an expert to help it construe an agreement. That’s what the judge is for. The testimony was not considered.

What about irreparable harm?

Lawyers: The decision discusses why there was irreparable injury and why it didn’t matter that Matrix wasn’t seeking a permanent injunction.

INTERMISSION

We’re usually done by now. Appropriate for an old-timey but still-breathing JOA are old-timey but timeless tunes. Today we have one with roots from 1860, and one originating in 1720 (you can look it up!).

If you elect to participate in a subsequent operation, you may now …

Consider the existential question

I conducted a random and unscientific survey of industry professionals (to-wit, people with whom I have lunch and drink whiskey, often not at the same time). The result: Some agreed with the statement, most did not.

These alternative “philosophies” behind the model form were presented:

  • The JOA is an “outline for honorable men to follow in the development of oil and gas properties.”
  • The purpose … or the “philosophy”, is to control the Operator to a certain extent and to ensure that WI owners understand and agree to costs and when and how payments are to be made.
  • The efficient utilization and maximization of leasehold opportunities, along with effective production management should be the goal. Profit maximization and reasonable adherence to the prudent operator’s implied covenant to develop should govern the drilling philosophy.
  • One of the reasons … [is] … to protect minority owners, to keep the major participants from expensing them out of the Agreement by not orderly and timely proposing drilling, completing and evaluating opportunities and risks … .
  • The goal is to have prudent operations in all respects – financial, engineering, geologic, etc.
  • The reason … is to provide those who elect to participate in the drilling of wells necessary to efficiently drain the reservoir with a proper return for assuming the risk and burden of those partners who elect not to participate.
  • If they choose to do so, the parties can negotiate terms that clearly provide for an active drilling program as their primary objective.
  • If you wanted “aggressive development” the non-consent penalty would be [more than] 300%.  Or there would be no non-consent … .  If the drafters truly wanted to reward “aggressive drilling”, the non-consent would have never been proposed.
  • In contrast to a JOA, it could be argued that “aggressive drilling be promoted and rewarded” is the intent of an Oklahoma Forced Pooling Order [and that] such an Order is designed to punish anyone who does not aggressively drill or expend capital … by taking away subsequent interests.

But I also heard from who agree (including the expert, who stands by his opinion):

  • The generation that came up in the 1950’s, ‘60’s and ‘70’s, plus committee members of the AAPL JOA task force who worked on the 1989 Model Form, asserted their “philosophy” that aggressive drilling is to be promoted and rewarded. That philosophy prevailed. Hence, the non-consent option.
  • Article VI (Drilling & Development) sets forth the conditions for which one party can take on the risk of drilling with or without the participation of all parties. Oklahoma’s forced pooling statute revolves around the JOA. (A contrary view of Oklahoma forced pooling?)
  • The pro-development bias is explained by the fact that any party, no matter how small its interest, can propose a well and force all other parties to either join or go non-consent, subject to the penalty.
  • The alternative is to either 1) carry the non- consenting party  under common law co-tenancy (in which case there is no “penalty”; only recovery of costs), or  2) vote on operations, as with international, offshore, and onshore field wide unitization/secondary recovery.
  • Unlike international or offshore arrangements, in the model forms there are no provisions for voting mechanisms, project teams, committees, and forced collaboration prior to a drilling proposal. Any party can move forward by AFE’ing the others and allowing them to invoke the non-consent penalty.  That reflects the aggressive drilling philosophy.
  • The form certainly doesn’t discourage aggressive drilling. That is reflected in the non-consent option.

Why the discord? 

It’s no surprise. The “disagreers” tend to be smaller operators and non-ops (my eating buddies). The “agreers” tend to be larger, with bigger budgets.  The “small guys” tend to want to rein in the “big guys” and make them go about development in an orderly fashion with maximum collaboration. The big guys tend to favor agreements that allow them drill away; said less charitably, to force operations on the others at-will.

Who says the oil business is monolithic?

Rally Possum May 7 - June 12, 2016
Rally Possum RIP. May 7 – June 12, 2016

Co-author Nathan Cox *

Good morning class. Welcome to an advanced course on what can go wrong with the Model Form just when you need it.

FIRST CASE

Do you know where to file your UCC financing statement?

Operator wants to perfect both a mineral lien and a financing statement against Non-operator, a Delaware Corporation. The property is in Texas. The mineral lien, of course, will be filed in the county where the property is located. Where to file the UCC financing statement? With the Secretary of State of Texas, the state where the property is located, or in Delaware, the state where Non-op is registered?

See Article VII B of the 1989 Model Form Operating Agreement:

“To perfect the lien and security agreement provided herein….Operator is authorized to file this agreement or the recording supplement executed herewith as a lien or mortgage in the applicable real estate records and as a financing statement in the applicable real estate records and as a financing statement with the proper officer under the [UCC] in the state in which the Contract Area is situated and such other states as Operator shall deem appropriate…. ” (our emphasis)

So, you file with the Texas SOS?  Not so fast.

The Uniform Commercial Code itself requires that a financing statement be filed in the proper office (usually the Secretary of State) in the jurisdiction where the entity is organized. One arrives at that conclusion by a circuitous route through UCC Sections 9-501, 9-301 and 9-307.

The 2016 revision repeats the 1989 language, so this problem, if that’s what it is, will be around for a while.

So do this

Record the financing statement both in the state where the lands are located and the state where the debtor is organized. Otherwise, the debtor could make a mess of your foreclosure efforts.

SECOND CASE 

When can you recover attorney’s fees under the Model Form? See Article VII.D.5 of the 1989 form (far different from the 1982 form): “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…”

The answer, according to the U. S. Bankruptcy Court for the Western District of Texas, in In re, WEB LP et alis when you obtain a monetary award, but not when you obtain injunctive relief.

WBH, LP was the operator; USED was a non-operator. WBH failed to pay vendors who filed lien affidavits. USED obtained injunctive relief in state court to remove WBH as operator. WBH filed for bankruptcy and the bankruptcy court adopted the state court injunction. Eventually, the court ordered the sale of the assets to Castlelake, WBH’s lender.  The order of sale provided that the debtors assets were subject to any valid senior liens asserted by USED under the JOA.  USED’s proof of claim totaled $500,000 in attorney fees for the injunction action. The court reasoned that the word in the document was “financial” obligations, which an injunction was not. No attorney’s fees for USED.

EULOGY FOR THE RALLY POSSUM

Our treasured marsupial was with us for a mere 36 days; a life too short but yet so full of memories, beginning a half-inning after he was carried off the Alex Box outfield in a trash bag. Overcoming a nine-run deficit against Arkansas, sweeping Tennessee, taking 3 of 5 from No. 1 Florida, thwarting the Cowbells and the Brainiacs. Done in by sloppy fielding and poor clutch hitting, he has shrugged off the mortal coil, much like a freshman would the “take” sign. But our good Possum is not really gone.  He is with his Higher Power, and we who have faith are solid in our conviction that one day we will be reunited with him in a glorious homecoming in that Heaven that he would call Omaha. That is, if he could talk. But he can’t talk because he’s a possum and he’s dead, so we have to imagine that’s what he would say. (Unless he was “talking” through that lady’s balloon hat at the Super Regional.) Nevertheless, his death is our inspiration to a greater cause, like going 1st-to-3rd on a single to right field.

Let’s hope our journey with Mr. RP does not parallel this musical interlude. May his rallying powers return on September 3.

* Nathan is a 2L at Baylor Law School, U.C. Davis undergrad, clerking at Gray Reed for the summer.

Co-author Alexandra Crawley

In Elm Ridge Exploration Co., LLC v. Engle we are reminded of a little-used provision in the 1989 Model Form Operating Agreement. Article VI.D.1 allows the operator to use its own equipment, but his charges may not exceed prevailing rates in the area, and the rates must be agreed to in writing before drilling commences.

Breach of the JOA?

A New Mexico Operator sued the majority working interest owner/non-operator for recovery of well costs. The AFE for the well specified a 24-hour rig.  The majority owner alleged that Operator breached the Operating Agreement by drilling the well with a more expensive daylight rig of Operator’s affiliate, instead of a 24-hour rig. He claimed that the excess cost of the daylight rig should reduce the amount he owed for his share of well costs.  Use of the daylight rig was without the majority owner’s consent. A 24-hour rig would have cost less to operate than the daylight rig.

Operator argued that the BLM drilling permit would have expired had it waited, leading to an even costlier re-permitting process to finish drilling the well and that by not waiting, Operator saved money.

The Testimony

Operator testified that they were lucky to get the rig they did because another rig was not available. However, he also testified that the permits were satisfied when the Operator spudded some time between October and January, and that an Application for Permit to Drill (“APD”) that was extended to November 2008 meant that Operator had until then to spud the well. Nevertheless, he went ahead and spudded the well in August 2008.

In testimony likely to negatively impact his chances for career advancement, Operator’s district superintendent testified that an APD deadline no longer matters once surface pipe has been set to 250 to 300 feet or, at the very least, the well has been spudded by setting a conductor pipe. Possibly seeking another reason to dust off his resume, he then testified that Operator would initially use smaller rigs (like the one used) on deep wells to put pipe down to 250 or 300 feet to “hold [the] wells, or get them where the permits would be good,” and they could come back later, when a larger rig was available, to finish drilling.  The court noted that 24–hour rigs were available by the beginning of 2009.

The Result

The jury found, and the appellate court agreed, that a reasonably prudent operator would have used the less expensive rig and reduced the defendant’s share of costs by the amount attributable to the breach. Operator was not entitled to judgment for the more expensive rig. The permit would not have been jeopardized by waiting for a less expensive rig. Problem for the non-operator:  Operator was entitled to foreclose because other costs the non-operator failed to pay were justified.

Enough About Extravagance 

My wife and I drink “affordable” wine during the week. That way, when we drink good wine on the weekend we appreciate it more. And so it is with music. Today’s musical interlude is not one but two of the most vapid, lame and treacly musical offerings ever. Quaff a little Phantom 309 and Teen Angel and  you will be blown away by just about any tune you will ever hear from this moment forward.  Don’t laugh. Patches is next.

Scriveners, when you add those “Other Provisions” in Article XVI of your model from JOA’s, are you sure that the document remains internally consistent, that no “Other Provision” conflicts with the form?

… Are you mindful of which of two related contracts will govern if there is a conflict in provisions? Did you choose the correct one?

Purchasers under a Purchase and Sale Agreement, do you fully understand the effect of the prevailing-contract provision in the underlying agreements?

In XH LLC v. Cabot Oil & Gas Corp., a PSA and a joint operating agreement between the parties’ predecessors were executed at the same time, for the same purpose, and in the course of the same transaction. One can tell from the language quoted by the court that the JOA was an AAPL Model Form 610. The question was whether Cabot’s acquisition of an overriding royalty interest was governed by the AMI provisions in the JOA.

Under the PSA, any lease subsequently acquired by either party within any of five separately-designated AMI’s established in the JOA would be subject to the AMI provision of the JOA.

The JOA’s subsequently-created-interest provision said, in effect:

III.C: Any override (and other interests not important here) created after the date of the agreement would be deemed a Subsequently Created Interest and the burden would be borne by the creating party alone.

JOA Article XVI, Other Provisions, said, in effect:

XVI.A: The JOA will be subject to the terms of the Purchase Agreement. In the event of any conflict between the two, the Purchase Agreement shall prevail.

XVI.G: Subsequently Created Interests shall be subject to this Agreement to the effect that:

If any party were to create an overriding royalty interest (and other interests not important here) after the effective date, such Subsequently Created Interest would be specifically subject to the terms and provisions of the JOA. Three scenarios were described, under all of which the party creating the interest would be responsible for it alone.

XVI.H: Article XVI trumps any other term of the JOA.

XVI.N established the five AMI’s, and gave each non-acquiring party the right to acquire their proportionate interest in any override (and other interests not important here) acquired by any other party.

XH’s View

Article XVI.N obligated Cabot to offer XH the right to purchase a proportionate share of the override. The two provisions were harmonious. The override was not subject to the JOA when Cabot acquired it and as a result was subject to the AMI provisions of the JOA.

Cabot’s View

Jane, you ignorant slut, the Purchase Agreement AMI conflicted with the JOA AMI provision and the Purchase Agreement trumped.

The Result

Cabot wins. The two provisions could not be harmonized. The PSA AMI was limited in scope to subsequently acquired leases, whereas the JOA AMI was broader and included overrides and other interests. Nothing in either agreement said that the JOA was to supplement the PSA. Thus, the override was not governed by the JOA’s AMI.

Musical Analogue

In the case of a song, which should prevail, the original or the cover? Here, you can choose between West Baton Rouge Parish’s own Slim Harpo or The World’s Greatest Rock ‘n Roll Band. The original trumps.

MDU Barnett Ltd. P’ship v. Chesapeake Exploration Ltd. P’ship is at least three things:

  • The culmination of an unhappy relationship between an operator and non-operators.
  • What happens when joint owners’ interests are not aligned.
  • Predictable, given Texas law and the relationship of parties under the model form JOA.

In 2005 Chesapeake and Conglomerate Gas entered into an Exploration and Development Agreement involving Barnett Shale properties. A separate 1982 AAPL Model Form 610 Operating Agreement governed each exploration and development area.

Chesapeake was designated as the  operator, which gave it exclusive control over leasing, drilling and operations. Under the E&D Agreement, Chesapeake was to provide drilling reports, logs, cores, tests and all information gathered from the wellbore. After termination of the E&D Agreement  – on March 1, 2008 – each separate operating agreement governed.

Conglomerate assigned wellbore interests to Oro in June 2008. Oro then conveyed the interests to the plaintiffs, who bought with the intent to sell. In order to do so, the plaintiffs sought development information and acreage maps, which Chesapeake wouldn’t give.  Plaintiffs sued. The claims and their fate:

Negligence and Negligent Misrepresentation – Dismissed 

Plaintiffs claimed that Chesapeake negligently deprived them of well information and financial payments. If the injury flowed from the economic loss to the subject of the contract itself, rather than as a result of the breach of a duty created by law (a tort, for example), the action sounds in contract alone. Here, the alleged economic damages arose from the defendant’s failure to perform under the contract.  This is the economic loss rule in action.

There were allegations of misrepresentation of the viability of the E&D agreement. The complaint stated that they justifiably relied on the representations, which led to damages. This conclusory allegation was insufficient to support a claim for negligent representation.

Fraud – Dismissed

The claim was that Chesapeake fraudulently provided inaccurate or incomplete data wellbore data. The plaintiffs failed to allege fraudulent intent, and the pleading did not meet the heightened pleading requirement in federal court for fraud. The plaintiffs must do more than state that the statements were knowingly false when made or made with reckless disregard of the truth. The allegation in the complaint was not enough to show that the discrepancy was intentional or reckless.

Breach of Fiduciary Duties – Dismissed

  • Trustee/agency relationship: Texas law does not recognize trustee type relationships in operating agreements.
  • Joint venture: An operating agreement giving mutual right of control to both parties may create a joint venture. However, these agreements gave sole operating rights to Chesapeake.
  • Informal fiduciary relationship: Such a claim requires a preexisting relationship between the parties. There was none in this case.

Equitable Accounting – Dismissed

The plaintiffs pled no facts showing that the revenue calculations under the contractual accounting mechanisms were of sufficient complexity to merit equitable relief.

Gross Negligence and Willful Misconduct – Dismissed

This was made, no doubt, to avoid the model form’s exculpatory clause. I’ve reported twice before on the difference between the 1982 and 1989 forms. The exculpatory clause is more favorable to the operator in the 1982 form.

Breach of Contract – The Plaintiff Stays Alive

The assertion was that Chesapeake violated several provisions of the E&D Agreement and the operating agreements, which caused the plaintiffs to suffer out-of-pocket, expectation, and impairment of vendibility damages. The E&D Agreement had terminated by the time MDU bought the properties. The court did not agree with plaintiff’s argument that the operating agreement’s incorporation language preserved the E&D Agreement. The operating agreements incorporated all of the E&D Agreement, including its March 1, 2008 termination date. Under the operating agreements, Chesapeake owed no duty to disclose development plans and acreage maps.

Unlike General Custer, the plaintiffs were not totally poured out. They stated a plausible claim for breach of contract relating to delayed look-back elections, erroneous JIBs, underpayments of proceeds, and improper production charges. These claims survived. Damages would be limited to expectancy damages in the form of financial underpayments of monies owed and overcharges of production costs.

Special thanks to Alexandria Moore, Baylor Law 2L and Gray Reed summer intern.

Our musical interlude is about the Barnett Shale, kind of.

Co-author Andrew Neal

Non-operators have had a lot in common with Br’er Rabbit ever since 2006, when the Texas Supreme Court surprised the industry in Seagull Energy E & P, Inc. v. Eland Energy, Inc. Their tar baby is the ruling that, absent a release from the operator a working interest under a JOA who assigns his interest to a third party remains automatically liable for costs not paid by his successor. Indian Oil Company, LLC v. Bishop Petroleum, Inc. is a step to clarify the extent of the automatic liability prescribed in Seagull.

Bishop, operator and working interest owner, and Trotter, non-operating working interest owner, signed a 1989 Model Form 610 JOA. Trotter assigned his interest to Indian Oil in 2002 and informed Bishop about the assignment. In 2007 the well ceased to produce. Indian Oil and the other working owners approved an AFE for a workover costing $1.6 million to restore production. The workover was unsuccessful and the well was plugged at a cost of $243,300. When Indian Oil refused to pay, Bishop sued Trotter claiming under Seagull that he was automatically liable for all costs not paid by Indian Oil.

The 1989 model form states, “[N]o assignment or other disposition of interest by a party shall relieve such party of obligations previously incurred by such party.” Trotter was held liable for costs which he “previously incurred” prior to assigning his interest in the well to Indian Oil in 2002, such as his pro rata share of P&A costs, but not for costs of reworking operations approved by Indian Oil and not by Trotter. In other words, under the 1989 model form, a working interest owner will not be held liable for expenses which he did not agree to pay.

Indian Oil isn’t a roadmap for all disputes over the automatic liability prescribed in Seagull, but it does establish some relief for former working interest owners. 

Takeaways

  •  Working interest owners who assign their interests continue to be automatically liable for unpaid costs that they agreed to pay.
  • Texas courts appear to be reluctant to force working interest owners who sold theirinterests to pay for costs approved after they sell their interest in the well.

Maybe now this plea from a former owner won’t be so desperate.

Lawyers and landmen are taught that a document affecting real or immovable property not recorded in the public records means nothing to a stranger. Like O. J.’s quest for the real killer, lower premiums after the Patient Protection and Affordable Care Act, and the present I would have given my wife except I forgot our anniversary, treat it like it never happened. Freeman v. Block “T” Operating LLC tells us – too late to save our healthcare system and the sanctity of my wedding vows – that’s not always the case.

The Facts

Kurios assigned 2.5% of 8/8ths overrides in wells in Acadia and Jefferson Davis Parishes (the percentage was different on one well but that doesn’t matter here). The assignments were not recorded. Kurios then conveyed to Block T a 20% working interest and a 14% NRI. These assignments were recorded.

After Block “T” acquired and recorded its interests, the plaintiffs-override owners recorded their assignments. Block “T” assumed operations and payment of proceeds from production, and the plaintiffs demanded payment.

Plaintiffs then sued Block T, operator and partial working interest owner, for payment. Block T asserted the public records doctrine (codified in Louisiana Civil Code Art. 3338) as a defense. According to the court, the public records doctrine did not apply.

The Rationale

The gist of the ruling is that “The recorded documents indicate that the net revenue interest owners received only a portion of the leasehold interest of each well. The retained leasehold, the assignments demonstrate, was sufficient so as to create the overriding royalty interest in the percentages claimed by the plaintiffs.”

The plaintiffs’ position was that the working interest assignment to Block “T” and others was based on a portion of the overall NRI, and that adding the landowners royalty and the working interest assignments together would demonstrate that Kurios retained a sufficient leasehold interest that permitted it to convey the override to the plaintiffs. This, the court said, was apparent on the public record.

The court found that Block “T”, as the operator of the wells and the party responsible for properly distributing revenues from the properties, was the appropriate party to be cast in judgment for payment of the overrides.

It’s not as Weird as You First Imagine

At first blush, this is perplexing because it appears that Block T, upon receiving a leasehold assignment, was required to “do the math” to figure out who to pay and how much to pay them. This is especially so in light of this comment in the opinion: “The primary focus of the public records doctrine is the protection of third persons against unrecorded interests”.  But focusing on the court’s approach reveals that Block T’s liability was as the operator charged with paying proceeds properly, and not as the recipient of an assignment without notice of existing overrides.

Here is the musical dilemma faced by Block T.  You gotta love the way Garth Hudson plays the organ.

By Travis Booher

History tells us that the young friends of Virginia O’Hanlon broke the news to her that there was no Santa Claus. When she quizzed her father about Santa’s existence, Dad’s fatherly advice was to ask the local newspaper.  “If you see it in The Sun, it’s so.” You know the rest of that story.

Another mysterious claus(e), the Maintenance of Uniform Interest provision (the “MUI”), exists in your Joint Operating Agreements. (VIII D of A.A.P.L. Form 610 – Model Form Operating Agreement 1989). The MUI has been referred to as “probably the most violated” and “least enforced” provision of the JOA.  (See Michael E. Curry, A Look at the Maintenance of Uniform Interest Provision in Joint Operating Agreements, State Bar of Tex., 24th Annual Advanced Oil, Gas and Energy Resources Law Course, 2006).  Although seldom discussed, and litigated even less, the MUI exists.

The purpose is to maintain “uniformity of ownership” over the Contract Area. In a nutshell, the MUI prohibits the transfer of an interest covered by a JOA unless such a conveyance includes (i) all of the parties’ interest (e.g., “all of my right, title and interest”) or (ii) a uniform, undivided interest in the Contract Area (e.g. “an undivided 1/2 of my interest in the entire Contract Area”)

The are several rationales for the MUI: (i) protection of the original JOA parties from unwanted third parties, (ii) the inability or cost associated with metering individual wells, and (iii) consistency in voting rights. A standard JOA provides no mechanism for counting votes when ownership is not uniform over the Contract Area. As a result, any breach of the MUI may not be discovered until a voting event arises under the JOA. If, however, a vote is required, a lack of uniformity in ownership will most definitely create an issue.

The scenario for a breach of the MUI is quite common. For example, assume you own a 12.5% working interest in lands covered by a JOA; producing wells are located in the Contract Area. In keeping with the holiday spirit, and in a moment of generosity (or pressure from your beloved), you convey a 5% interest in the #2 Well to your son as a Christmas gift. Although generous and thoughtful, such a conveyance would be a breach of the MUI clause, and it is unlikely the restriction ever crossed your mind as you were enjoying your egg nog. Imagine the same scenario if you sell only specific depths, or certain acreage, or only a couple of leases in the Contract Area.  What if the sale was an arms-length trade for which you were paid good money?

The next time you are considering trading an interest in your producing properties, careful review the MUI clause to avoid a breach (and a potential lawsuit). Similar to Virginia’s mysterious Claus, if the MUI clause is in your JOA, it should not be doubted or ignored. Yes, working interest owner, there is a MUI in your JOA.

A holiday greeting:  http://www.youtube.com/watch?v=rEyV8gnC4aQ

It’s deju vu all over again in Chesapeake Operating, Inc. v. Sanchez Oil & Gas Corp. More accurately, it is a variation of Reeder v. Wood County Energy, LLC, et al. applied to Louisiana operations. For the impact of the exculpatory clause protecting the operator from liability in the 1989 Model Form JOA, see my post (co-authored by Marty Averill), “Operator Not Liable for Breach of 1989 Model Form Operating-Agreement, Part Two”. 

This one is a bit different.  Chesapeake and Sanchez entered into a JOA to operate leases in Louisiana. Chesapeake sued Sanchez for failing to pay its proportionate share of drilling and completion costs. Sanchez asserted the defense that Chesapeake had breached the  JOA in, as the court put it, “several ways”,  and did not perform its work in a good and workmanlike manner.

The key issue was the scope of the exculpatory clause, and whether Sanchez was required to prove that Chesapeake acted with gross negligence when it breached the JOA. The clause mirrors Article V.A of the 1977 and 1982 Model Form JOA’s (I assume one of those forms was at issue, but the court didn’t say):

 Chesapeake  . . .  shall be the Operator  . . .  and shall conduct and direct and have full control of all operations on the Contract Area . . .  . It shall conduct all such operations in a good and workmanlike manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except such as may result from gross negligence or willful misconduct.

Sanchez argued that the clause only applied to claims that Chesapeake had not conducted the operations in a good and workmanlike manner; Chesapeake responded that the exculpatory clause also applied to allegations that it breached the JOA.

The court noted that the Fifth Circuit construed an identical clause in Stine v. Marathon Oil Company, and held that protection of the exculpatory clause extended to breaches of the JOA and that the operator was not liable unless its actions were grossly negligent or willful. The court also noted that three Texas appellate courts had reached the opposite conclusion, holding that the clause only applied to claims that the operator failed to act as a reasonably prudent operator.

The court stated that clause would apply to Sanchez’s defenses if Stine controlled but would not apply if the Texas appellate decisions controlled. The court stated that it could only rely on the appellate decisions if they “comprised unanimous or near-unanimous holdings from several—preferably a majority—of the intermediate appellate courts of the state in question.”Here, although the appellate courts were unanimous, they were not a majority of the Texas appellate courts. Thus, the court deemed itself bound to follow Stine.

The clause applied to Sanchez’s affirmative defenses. Because Sanchez had not presented evidence that Chesapeake’s breaches resulted from gross negligence or intentional misconduct, the court dismissed Sanchez’s defenses.

Big and Important Caveat: Chesapeake is a Texas case ostensibly applying Louisiana law. It is not from a Louisiana court.  The parties agreed that Louisiana and Texas law would be identical, so the court looked to Texas cases. I’m sure there are Louisiana non-operators who would (and will) take issue with this result.