Co-author Alexandra Crawley

Oh, how a simple Favored-Nations clause in an oil and gas lease can get complicated, with large financial consequences! In BP America Production Company v. Zaffirini, BP paid Solis a $1,300 per acre bonus for a lease covering 30% of the mineral estate and agreed that if paid a more favorable bonus or royalty term with any other co-owner in the same mineral estate, BP would pay lessor Solis according to the more favorable terms.

BP later obtained the Zaffirini lease covering the remaining 70% of the mineral estate and paid $1,750 per acre for a paid-up bonus and for lessor’s consent for BP to assign to a third party. Also, if BP’s title examination later revealed a greater number of net mineral acres, then BP would pay the difference on the basis of $1,300 and $450 per net mineral acre (for a total of $1,750). The Zaffirini lease included the same Favored-Nations clause.

 Upon executing the Zaffirini lease, BP paid the $450 per acre difference to Solis (the $1,750 bonus in the Zaffirini lease minus the $1,300 bonus in the Solis lease). After BP paid Solis, Zaffirini demanded that BP pay another $450 per acre as bonus under her Favored-Nations clause, claiming their bonus was only $1,300 per acre and that the additional $450 was a consent-to-assign fee, separate and distinct from the bonus. Zaffirini stated the “plain language of the lease expressly called for such segregation.”

The trial court agreed with Zaffirini, awarded over $2 million in damages and $600,000 in attorney’s fees to Zaffirini, and declared that the disputed $450 per acre was not bonus and even so, Solis was entitled to retain the additional payment to her.

The appellate court reversed. The Zaffirini lease was unambiguous and the parties’ intent, expressed in the lease, was that the bonus was to be $1,750 per acre. A determining factor was the prior negotiations of the parties, wherein BP specifically rejected several proposals from Zaffirini requesting a paid up bonus of $1,300 per acre and $450 per acre for lessor’s consent-to-assign. 

 Takeaways:

  • Perhaps this dispute could have been avoided had someone taken a little more time to examine their documents before signing. Scriveners, here is a way to do that: Write the language, put the document away for a day or so, get back to it while keeping in mind the purpose of the provision. Is it still as clear as it was the first time? If not, fix it.
  • For provisions in a lease, or any contract for that matter, which could be subject to more than one interpretation, specifically define meanings and implications in the document itself.
  • As we often see in lease disputes, home town justice prevailed at the trial court, to be corrected on appeal.
  • Each side argued the agreement was unambiguous and should be decided in their favor. Unless the court was going to award a trophy to everebody for showing up, that just can’t be.

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.

There is a “Rorschach” way to examine your thinking about the controversy over fossil fuels and global warming. 

Psychologists use the Rorschach test to examine a person’s personality characteristics and emotional functioning. It’s been employed to detect  underlying thought disorder, especially disorganized thinking as evidenced by disorganized speech.  Try this on yourself.

Here is a photograph (from an English artist flying over Leon County, Texas, as reported in The Guardian).

Tell me what you see: The highest and best use of this land, … happy royalty owners and economic prosperity, … a nudge toward independence from people who want to kill us, … a step to a cleaner environment? 

Or: Stark and relentless environmental devastation, … a preview of the ghastly future of fossil fuels, … fracking, … the invisible hand of Dick Chaney and the Koch brothers?

If you are in the first category, you would probably agree with this, from the Associated Press, on the environmental costs of ethanol, or this, about  the good news of increased use of recycled water in fracking.

If not, then you would likely gravitate toward this one from the Los Angeles Times on the perils of climate change. (The same L A Times who refuses to publish letters to the editor questioning global warming.)

Or Al Gore’s Wall Street Journal warning about the inevitable and fast approaching carbon asset bubble.

Incidentally, I’ve confirmed what I suspected. Wells in the picture were drilled mostly in the 70’s and 80’s.  Modern fields tend to appear nothing like this because of the ability, with horizontal drilling, to drill a number of wells from a single pad, thereby reducing the drilling footprint.    

A musical interlude that best combines confused thinking and good piano playing.

Co-author Brooke Sizer

Vestiges of the early Haynesville Shale land rush remain.

Imagine: The lease is about to expire. Lessee (Mecom) offers lessor (Henderson) $90 per acre for an extension, telling him, “I could extend for two more years without consent so I’m giving you free money.” He explains his intention to drill more Cotton Valley wells on the Bossier Parish property. Henderson agrees to the $90, plus a royalty increase to 20%. Two months later Mecom sells the lease and other acreage to Petrohawk for $6,750 per acre.

Mecom’s work isn’t done. He couldn’t assign the lease without Henderson’s permission. After his sale Mecom flies to Shreveport to meet with Henderson and explains that the assignment was “just a chance to make money”, and offers to pay off his mortgage on the ranch, which he does. Henderson sues.

No misrepresentation – read your lease

In Henderson v. Windrush Operating Co., LLC, et al, Henderson claimed that the defendants (Mecom and the original lessee, Gaylord) deceived him about the terms of the lease and about their development intentions. But,

“A party who signs a written instrument is presumed to know its contents and cannot avoid its obligations by contending that he did not read it, that he did not understand it or that the other party failed to explain it to him.”

At trial Henderson was shown the continuous operations provision and agreed that the language “seems to say” that operations could extend the lease beyond its primary term.

The lease language supported Mecom’s statement that the lease could be extended. While the exact nature of the extension wasn’t disclosed during the discussion, a lessor is responsible for knowing what his lease says, said the court.

The court didn’t buy the trial court’s finding of an “ulterior motive” supporting Henderson’s claim that he was lied to about Mecom’s future intentions, citing the abrupt spike in land prices after the extension was negotiated.

No relation of confidence – I’m not the friend you thought I was

A ”relation of confidence” exists in Louisiana where there is a longstanding and close relationship between the parties due to numerous transactions. Courts have found this relationship in a family relationship, a 25-year long business relationship, and between spouses. Henderson only met Gaylord in 2005 and Mecom in 2007. The court concluded that the relationship here was not extensive and was limited to intermittent social and business interactions.

That Henderson assisted Mecom in obtaining leases from Henderson’s neighbors, Mecom gave Henderson a $10,000 Christmas present because “it was the right thing to do”, and they discussed going into the saltwater disposal business together, wasn’t enough to convince the court.

Takeaways

Lessee: In a fraud suit brought by the former local police chief, don’t expect to win at trial.

Lessor: Read your lease! Don’t rely on the unctuous words from your “friend”, the silky-smooth lessee.

Bonus observation: Congrats to Mecom III, who in this case and his Petrohawk deal fared better than any of his daddy’s Saints teams ever did.

Ever the schoolyard bully, the EPA has been pushing its agenda against the will of the states, at least until the principal intervenes.

A minority (that’s the Republicans) report by the U. S. Senate Committee on the Environment & Public Works asserts that the EPA is in violation of “cooperative federalism”, in which the EPA would set national standards on an emissions rule and allow states to administer the regulation in the most cost effective way. The rationale is that states and localities are better suited than the feds to design and implement compliance strategies.

The report says the agency has failed to consult with states or has coerced states to adapt stringent regulation that come at a huge cost to the state’s citizens and economy.

The report focuses on “sue and settle” agreements the EPA makes with environmental activist organizations in which the agency, after being sued by an environmental group, enters into a consent decree allowing regulations to move forward without comment from the states or regulated industries.

The bully doesn’t always get its way.

Alt v. EPA was about the EPA’s assertion of regulatory authority over stormwater runoff from Ms. Alt’s farmyard. She challenged the EPA’s findings that she had violated the Clean Water Act. The case was about the discharge of “particles, dust and feathers” from Ms. Alts’ poultry farm into a federal waterway. Inother words, when it rained, chicken poo-poo ran into “Mudlick Run”.

The EPA found that Ms. Alt was in violation of the Clean Water Act and threatened a civil action in which she could be subject to penalties of up to $37,500 per day. The question was whether Ms Alt’s activity was exempt from liability under the agricultural storm water exception to the definition of a “point source”.

I’ll skip the legal analysis and get to the larger point: According to the court,“it appears to be a central assumption of the EPA’s position that the agricultural stormwater discharge exemption had no meaning whatsoever from the time the exemption was added to the statute until 1987 until the EPA promulgated its new regulations in 2003.”

In rejecting the EPA and ruling for Ms. Alt, the court concluded that “common sense it the most fundamental guide to statutory construction.”

In Iowa League of Cities. v. EPA, the federal 8th Circuit ruled that the agency was pushing a new interpretation of its wastewater treatment rules in letters sent to cities in Iowa in order to prohibit selected internal techniques for treating wastewater during high-flow storm events.

If you would rather not read the opnion, I refer you to the NCPA’s Energy and Environment  newaletter by Sterling Burnett, from which I plagiarize joyfully. The ruling says that what goes on within the plant is not within the EPA’s purview as long as the effluents leaving the plant meet pollution limits. If the EPA wants to regulate an activity, it must go through the rule making process, not simply give opinions. The EPA can’t contradict its own rules.

Makes sense to me.

Co-author Brooke Sizer

The Bureau of Land Management released a new Instructional Memorandum 2013-151, clarifying the re-evaluation of bonds required for operations on federal lands. The purpose was to clearly define the terms and conditions now set out in the regulation governing the subject: 43 CFR § 3104.5(b). Here is a brief summary of the IM: 

The amount of any bond may be increased whenever it is determined that the operator poses a risk due to certain factors:

  • a history of previous violations,
  • a notice from the Service that there are uncollected royalties due,
  • the total cost of plugging existing wells and reclaiming lands exceeds the present bond amount based on the estimates determined by the authorized officer, or
  • other factors not specifically enumerated.

The increase in the bond amount may be to any level specified by the BLM’s authorized officer, but in no circumstances can it exceed:

  • the total of the estimated costs of plugging and reclamation,
  • the amount of uncollected royalties due to the Service, plus
  • the amount of monies owed to the lessor due to outstanding violations.

When Can There Be an Increase?

Re-evaluations of all bonds shall take place at least once every five years, or sooner if warranted in situations such as transfer of title, submission of an application to drill, failure to timely plug and abandon.

What Will Trigger an Increase?

The IM now sets the basis for adequacy reviews performed by the BLM field officers. A point system will examine the well status, compliance history, and reclamation stewardship and each criterion will be assigned a number of points based on the risk it creates. One example: each shut-in/shut-down of operations in the last three years will be credited as 50 points.

The total number of points will determine whether a bond increase will be issued. Less than 100 points accrue means no bond increase. If more than 100 points are accrued, the bond will be increased. The points are calculated at $500 each.

Can I Avoid an Increase?

It is possible in certain situations for the BLM’s Authorized Officer to override a bond increase. The primary situations envisioned by an override are:

  • the operator conducts all operations in a prudent and timely manner and has a history of compliance,
  • average daily oil production per well over the past 12 months is greater than five barrels, but daily gas production per well over the same period averages less than 30 MCF from marginal wells,
  • average daily gas production per well over the past 12 months is greater than 30 MCF, but daily oil production per well over the same period averages less than five barrels from marginal wells.

Happy Witchy Halloween

Even if you aren’t the actual plaintiff in a lawsuit you can still be personally liable for breach of a covenant not to sue. It’s easy! Sign a release in your individual capacity, cause an entity you control to bring a lawsuit, and then financially support the suit. And you can share the liability with your friends who signed with you!  That’s the takeaway in Dallas Gas Partners, LP, et al v. Prospect Energy Corporation.

Muse, Nelson and others formed Dallas Gas Partners, LP (DGP), which got into a feud with Prospect Energy over an agreement to finance the purchase of Gas Solutions. In a transaction to resolve the dispute, the parties executed three documents:

  • DGP’s limited partners signed a “Unanimous Written Consent of the Partners,” approving assignment of the contract to purchase Gas Solutions.
  • Muse, Nelson, Weiss, and Prospect signed a “LLC Membership Interest Purchase Agreement” which included a “Mutual Release” by which each signatory agreed to release all claims arising out of the agreement, and a covenant not to “institute, maintain, or prosecute any action, claim, suit, proceeding or cause of action” relating to the agreement. The agreement provided for recovery of “actual damages”.
  • The DGP partners also signed a “Consent and Agreement of Limited Partners”, by which they consented to the assignment of the right to purchase Gas Solutions and the transfer of the membership interests to Prospect. Each limited partner ratified the Mutual Release.

DGP sued Prospect alleging many bad deeds. Prospect counterclaimed and sued DGP, its general partner, Muse, Nelson, and Weiss for breach of the covenant not to sue.

Prospect prevailed. The court found that Muse, Nelson, and Weiss signed the LLC Purchase Agreement in their individual capacities and were therefore bound by the Mutual Release. Muse, Nelson, and Weiss received “‘significant consideration” in the transaction. There was “uncontroverted evidence” that Muse, Nelson, and Weiss caused and funded the filing of both lawsuits.”

Muse and Nelson argued that, even assuming they were bound personally by the LLC Membership Interest Purchase Agreement, there was no breach because they didn’t personally sue Prospect; DGP did.

But in that agreement the three individuals transferred their individual interests to Prospect. And they signed the Consent and Agreement of Limited Partners as partners.

Focusing on the phrase “institute, maintain or prosecute any action, claim, suit . . . to enforce any of” the released claims the court decided that even though they weren’t the actual plaintiff, the individuals caused the suit to be filed, prosecuted it, and funded it.

The word ‘maintain,’ must be given meaning, the court said, relying on the definition from Merriam-Webster: “to support or provide for.” Based on this definition, Muse and Nelson, as signatories of the agreement, could “maintain”’ a lawsuit by providing financial support. Muse and Nelson violated the mutual release and covenant not to sue by personally funding the suit.

Prospect’s only damages were its attorneys’ fees, which the court awarded as “actual damages”.

Lou Reed RIP. (Ignore the graphics; the song is great)

As another college football weekend approaches, let’s talk whiskey.  All work and no play might save Jack’s liver from decaying into a bile-filled mass of diseased tissue, but the oil man needs a break from the burden of termination clauses, stolen trade secrets, and – as revealed by Yoko and Shawn – desecration of Mother Earth by those toxic gas wells he’s been drilling.

Cheer up, Jack! I’ve reported before on my search. (Perhaps you took the quiz?) Round two is really the neo-Sazerac, and our candidates, all in Dallas, tweak the traditional ingredients to great and tasty effect.

Princi Italia

Alternative ingredient: Black Sambuca instead of Absinthe. It’s lower in alcohol and hence more subtle and smooth than Pernod or Absinthe, with less of an alcoholic jolt. They’ll do it with Woodward Reserve Bourbon if you like. Don’t take them up on the offer – too sweet IMO. Aaron Neville and Linda Ronstadt in a glass.

Hibiscus

Alternative ingredients: Where do I start? Grant, the very excellent mixologist, uses Whistle Pig, a 100 proof rye, and Bitter Truth Aromatic Bitters, 80 proof (higher in alcohol than Pernod or Absinthe). The absinthe is misted, rather than rinsed around the inside of the glass. Very cool. The bitters lingers for an aftertaste that’s as soothing as Eric Clapton channeling Elmore James.

A nice, not harsh, alcohol bite. Talking Heads in a glass.

Bonus drink that has no name: Five 50-proof or less Italian Amaro herbal liqueurs, the names of which I don’t know, with a spritz of something called Bittermen’s orange cream citrate, and who-knows-what-else. It’s an aromatic drink that is complex and … I have no idea … Exotic and incomprehensible? King Sunny Ade in a glass.

The Standard Pour

“Neo” in that they mist the absinthe in the glass and then flame it, giving it a kind of caramelized flavor. A tiny bit too much simple syrup IMO.

The Meters in a glass, with a Barrence Whitfield and the Savages chaser.

Enjoy!

The fellow on the right is after your lease. The result in Cabot Oil & Gas Corporation v. Healey, LP was so bad for the lessee I’m going directly to …

The Takeaways

Landmen: First, when offered a lease with automatic termination language, run away like you’re chased by an Obamacare Navigator who hasn’t undergone a background check, especially when termination is triggered by something as immaterial as failing to share data. I don’t care how much your geologist says that’s where all the hydrocarbons are. 

Second, for all those times you will ignore the first suggestion, redouble your lease administration processes so that burdensome and out-of-the-ordinary lease requirements are not overlooked. I have litigated these provisions.  Protecting your assets from a catastrophe is a matter of having both good processes and good people.

Landowners: If you are in the middle of the play, especially if you have big acreage, see “Second”.  Used in good faith, data-sharing, automatic termination and similar clauses protect you from operators who might otherwise ignore legitimate concerns. 

The Lease

Three oil and gas leases required the lessee to deliver to the lessor daily drilling reports, copies of all logs, monthly production reports for the life of the well, copies of all reports and forms filed with the Railroad Commission, locations, dates of completion and abandonment, and copies of title opinions.

Any breach of the lease “ … shall be grounds for cancellation of this lease …”.

The Lawsuit

Cabot and its predecessor, Enduring Resources, drilled 21 wells without providing all the required information. Healey contacted Cabot, suggested that the leases had been breached, and requested to be treated as a working interest owner. In response, Cabot provided a “sizable amount” of data in accordance with the data-sharing provision.

Healey sought a declaratory judgment that the leases had terminated, that Healey was an unleased co-tenant in the wells, and for an accounting. The jury found that Healey had effectively terminated the lease due to Cabot’s breach. The court signed a judgment declaring that the leases were terminated, the amount of production expense for each well, and determining Healy’s ownership percentage in each of the units and awarded Healey attorney fees.

If you don’t go to trial for a living, you may stop reading now

A declaratory-judgment action is not the proper procedural vehicle for determining whether the lease had been terminated, and the court so ruled. The proper procedure is trespass-to-try-title. But Cabot didn’t preserve the error because it had not filed special exceptions to Healey’s petition.

What you say in a hearing months before trial can haunt you. At a continuance hearing Cabot said it needed to conduct discovery from Enduring on the reasonable and necessary expenses for the wells. Months later, at a limine hearing, the lawyers explained that they had been told to “take a hike”, and didn’t try harder (letters rogatory, depo notices, etc). Thus, there was no evidence of those expenses.

The court discussed Rule 1006 (summaries of voluminous records) and Rule 803(6) (the business records exception to hearsay).

Challenges to the jury questions on substantial compliance, waiver, and quasi-estoppel are worth a look.

Co-author Travis Booher

How is a producer to deal with a demanding and formidable lessor’s insistence on stringent surface protection? How about demands from environmental groups and government entities? One way might be to educate himself and his fellow stakeholders.

One group at the forefront of education efforts is Texas A&M University-Kingsville’s Caesar Kleberg Wildlife Research Institute . The Institute promotes voluntary conservation practices in oil and gas development.  Specifically, it provides information to producers about native grass reseeding efforts. Texas Parks and Wildlife  also provides wildlife-friendly education materials.

Why is this important? Historically, “South Texas” meant brush country, big deer, quail, and late-night border town revelry. I was in south Texas last week, marveling at the development arising from Eagle Ford Shale oil production. Today, “South Texas” is as much about oil derricks, over-travelled roads, “no vacancy” signs, and savvy lessors with significant mineral interests presenting sophisticated and demanding lease provisions (we’re talking about surface use; let’s not even mention royalty and pooling clauses).

Larger rural tracts resulting in greater bargaining power for the mineral owner drive more stringent requirements for surface reclamation. Landowners devote significant effort and attention to their surface. In addition to addressing locations and damages for roads, pads, pits and pipelines, leases often also require reseeding and planting of grasses after production is obtained. Drilling closer to populated areas drives the same interest by governments and environmental groups. (To our knowledge this isn’t prevalent in the Eagle Ford but is an issue elsewhere.)

There is another reason: South Texas is a significant wildlife habitat, and landowners and environmental groups hoping to support the environment, while also enjoying the economic rewards of mineral development, request reseeding with native grasses. To the landowner it’s easy – native grasses encourage vibrant wildlife and support wildlife habitat. It’s not quite “Keep Austin Weird”; it’s more like “Keep South Texas Native”. Satisfying these requirements can be burdensome and costly, and requires knowledge and effort, but it can be good for producers, landowners, hunters, environmentalists and nature lovers in general.

The Big Picture

Landowner and community happiness can often be found in creative surface-use protections. Not coincidentally, producers’ frustrations often lie in the same spot.  Reseeding with native grasses and similar efforts can turn the producer’s frustration into happiness – at least until the royalty and continuous operations clauses kick in.

For another article on this subject, see the July/August 2013 AAPL Landman magazine.