By David Leonard and Julie Palmer

BP’s woes from the Deepwater Horizon disaster in the Gulf continue. The federal Fifth Circuit in In re: Deepwater Horizon, withdrew an opinion of a three-judge panel and certified questions for consideration by the Supreme Court of Texas. Resolution of this dispute could significantly impact insurance law in Texas, which would demand energy companies to immediately and carefully review their insurance programs.

Transocean paid substantial premiums to insure its worldwide drilling program. It is these insurance policies that BP—a self-insured corporation by its own design—would like to exhaust in order to offset its massive losses arising from the Deepwater Horizon disaster.

The BP and Transocean Drilling Contract

BP executed a drilling contract with Transocean for activities on the Macondo well in the Gulf of Mexico. The drilling contract required, among other things, that (i) Transocean maintain certain minimum insurance coverage for the benefit of BP and (ii) BP be named as an additional insured in each of Transocean’s insurance policies.

Transocean’s Insurance Policies

Transocean contracted with its insurers to obtain at least $700 million of additional general liability coverage related to its drilling activities. The policies broadly define an “Insured” to not only include Transocean, but also any entity with whom Transocean entered into an agreement to assume tort liability.

The Disaster

Following the Deepwater Horizon explosion in April 2010, BP sought coverage from Transocean’s insurers as an additional insured under Transocean’s policies. Transocean and its insurers disagreed and filed suit against BP in the U. S. District Court for the Eastern District of Louisiana seeking a declaration that BP did not qualify as an additional insured. The district court ruled that BP could not access Transocean’s policies because Transocean was only required to name BP as an additional insured as to the risks Transocean assumed in the indemnities provisions of the drilling contract which did not include oil pollution risks.

Fifth Circuit Punts

On BP’s appeal, a panel of the Fifth Circuit issued an opinion reversing the trial court, holding that Transocean’s policies covered BP as an additional insured.

Questions for the Texas Court

The Fifth Circuit’s en banc decision withdrew the panel’s opinion and certified two questions to the Supreme Court of Texas.

First: Which document governs the scope of BP’s coverage as an additional insured: Transocean’s umbrella insurance policies or the indemnity clauses in the drilling contract? This question will likely trigger an examination of the Supreme Court of Texas’ seminal decision in Evanston Ins. Co. v. ATOFINA Petrochems., Inc., which held that in determining the scope of an additional insured’s rights under a liability policy procured by its contractor, the court must look not to the indemnity agreement in the service contract but rather to the umbrella insurance policy itself.

Second: If the indemnity clauses govern the scope of BP’s coverage as an additional insured, the Texas court must then address a question related to the additional insured provision of the drilling contract. Resolution of this question would bring into play the sophisticated insured exception and the doctrine of contra proferentem (ambiguities in an insurance policy are strictly interpreted against the insurer).

The answers to these questions could significantly impact insurance law in Texas. Stay tuned.

The prospect generator’s worst nightmare is presented in Southwestern Energy Production Co. v. Berry-Helfand and Muncey. I will over-simplify the facts: Hefland and Muncey toil for years generating James Lime prospects in a five-county area in East Texas. They show it. Dry holes are drilled. More data is generated. They show it many times again.  Parties who are shown the data don’t like the prospects. Those parties enter into AMIs with non-recipients that include some of Helfands’ sweet spots. Their objectives, though, are the Travis Peak and Cotton Valley. The son of Hefland’s new partner is involved with Southwestern (Sepco), who is shown the prospect. Sepco enters into a confidentiality agreement, gets more data, and declines to participate. Sepco buys acreage in two counties, drills Travis Peak wells with others, and participates in over 80 James Lime wells, all of which are successful and all of which are clustered in an area of Hefland’s sweet spots. Revenues from the wells exceed $382M by the time of trial.

The Lawsuit

Helfand sues “everybody” (as in 12 defendants) for “everything”. The jury concludes that Helfand’s study was a trade secret and found against Sepco for trade secret misappropriation, statutory theft of a trade secret, breach of fiduciary duty, fraud, and breach of contract. Damages, disgorgement and fees total more than $30M. Sepco appeals.

Breach of Fiduciary Duty

Sepco owed no fiduciary duty because the parties dealt at arms’ length, the agreement expressly defined and limited to Sepco’s obligations of confidentiality, and there was no formal or informal relationship creating a duty of trust and confidence. Jury reversed.

Fraud

The fraud claim was based on several emails over the course of many years. Sepco, at the time it sent the emails, had no interest in the James Lime, but acquired an interest later. There was no evidence that Sepco’s statement that it was not interested in the prospects was false when made or that Helfand relied on it. Jury reversed.

The court noted that mere failure to perform a contract is not evidence of fraud.

To win on fraud by concealment there must be a duty to disclose. Sepco owed no such duty to Helfand.

Misappropriation

As with most trade secret misappropriation cases, this one rested on circumstantial evidence. There were no wells on the prospects before the presentation to Sepco, and later there were 80 wells; Sepco couldn’t show the paper trail one would expect if it had generated the prospects based on its own engineering; Sepco’s leasing and drilling activity corresponded directly with Helfand’s sweet spots; Sepco couldn’t produce a body of independent research comparable to Helfand’s. The court: It was “not unreasonable” for the jury to conclude that Sepco’s success was a product of information it obtained through misappropriation. The jury had the right to consider the circumstantial evidence, determine credibility of the witnesses, and make reasonable inferences from the evidence. Jury affirmed.

Theft of Trade Secrets

The court found that Sepco returned all of its materials to Helfand and that it did not deprive her of a “trade secret” as that word is defined in the Penal Code, nor was there evidence of intent to deprive her of a trade secret. Jury reversed.

Breach of Contract

Sepco breached its three obligations under the confidentiality agreement: to use the confidential information solely to evaluate prospects it was shown, not to disclose the information to third parties, and not to acquire any leases without giving Hefland the right of first refusal. Jury affirmed.

Issues For Lawyers

The court discussed issues such as limitations, jury instructions, trade secret damages, and the use of prior pleadings, all of which will be of interest to trial lawyers.

The Result

$30M+ verdict and judgment reduced to $11M. The disgorgement award was reversed.

The Takeways

More to come. This post is already too long.

 The jury forcefully answered the question posed by this musical  interlude.

Les Miles encourages Vidal Alexander to subscribe to Energy and the Law.

Occasionally in my litigation experience I’m reminded of time-honored rules of law.  Often I’m pleased, sometimes I’m not. So it was, I assume, for the parties in Midnight rilling, LLC v. Triche et al .The Rules

In Louisiana law, operations and production of minerals sufficient to interrupt prescription of a mineral servitude for nonuse within a unit can interrupt the running of prescription on all tracts within the unit.

But there is a catch.  Drilling and production do not interrupt prescription of a servitude encumbering the surface location if the operations are for the sole and exclusive purpose of discovering and producing minerals from property not subject to the servitude.

Parol evidence cannot be used to prove title to any mineral right, nor to prove any claim for or any interest in the revenues from a mineral right. In Midnight Drilling, whether a well was produced on a unit basis could not be proved by parol evidence. The claim failed because it was not supported by a writing.

The Facts

Triche owned two tracts of land in Terrebonne Parish, separated by the Intracoastal Waterway. Cole’s mineral servitude covered both tracts. Neither party had mineral rights under the canal. The Cole # 2 well had been operated as a lease well, apparently on leases granted by Triche and Cole covering both tracts. The problem for Cole was that, although the surface location was on the North tract, the bottomhole was on the South tract.

Triche asserted that 10 years had elapsed since creation of the original servitudes during which no operations for the benefit of the servitude tract were conducted. Cole asserted that both servitudes had been preserved by production and/or operations, arguing that the parties to the lease acted in such a manner that the Cole #2 well was produced on a unit basis.

Cole’s evidence was insufficient as a matter of law. Whether a well is produced on a unit basis cannot be proved by parol evidence outside of the lease. Invoking the parol evidence rule, the court found that a voluntary unit was not established for the North tract, nor were there operations on the Cole #2 well such that prescription was suspended from accruing on the Cole’s mineral servitude for the North tract.

The Point

Non-unit well operations and production must occur on the actual land burdened with the servitude in order to interrupt prescription. The surface location of the Cole # 2 well did not determine whether the operations or production associated with the well constituted an exercise of the mineral servitude.

It’s that special time of the year: football season. I dedicate this musical interlude to our Aggie friends who will be visiting Baton Rouge in November.

In the Book of Revelation, the really scary guys were the four horsemen. Now, as then, some would have you believe that the end times are upon us. This time it is because of fracking. Is it really? Absent from many discussions about oil and gas drilling are fairness and objectivity. In their place are the modern horsepersons of the anti-drilling movement. There are many, but let’s focus on four today:

Hysteria

The coddled Artists Against Fracking is at it again, this time with a video entitled Don’t Frack My Mother. Aside from the lamely Dylanesque structure (Daddy John would be ashamed), note the embedded misinformation, one example being the discredited fracking-caused fireball from the water faucet.

Listen to the video and then see the commentary from fuelfix.com revealing its shortcomings.

And acidizing is a new, untested, flora- and fauna-threatening scheme to poison the earth.   Here’s my offer:  A free ticket to Al Gore’s next speaking engagement to anyone who can find an engineer alive who remembers when acidizing was NOT used in the oil patch.  Even in California, where this story began.

Sloth

Graphics can be a lazy way to convey information. Money Magazine depicts a direct and short route for frac fluids to migrate from the shale to the fresh water acquifer.  And then ther is theheadline. The Los Angles Times summarizes a poll reflecting  Californians’ supposed “unease” with fracking in a misleading headline which, I believe you would agree, that conclusion is not supported by the accompanying graphic. Do the math.  Here is a report on these two examples of lazy journalism.

This one would fit prevarication if the articles weren’t from seemingly non-idealogical publications.

The Ad Hominem

In the spirit of equal treatment, here is one from Energy In Depth, an industry friendly news source, criticizing anti-drilling activist Bill McKibbben.  This one would fit prevarication if we were focusing on Mr. McKibben.

According to Gas2, Texans (and by extension, all producing states) are   “mental midget teabillies” and “mentally deficient”, and everyone who voted for Rick Perry is an “idiot”. (Come on, not everyone who voted for him is an idiot).  This one is a two-category winner, fitting nicely under prevarication.

Prevarication

Friends of the Earth stretches the truth in demanding a new State Department study of the Keystone XL Pipeline.

And there is the Austin Chronicle article featuring outrageous statements from populist former Texas Land Commissioner Jim Hightower, and a critique from Forbes.com 

The perfect musical interlude.

Comparative Title Analysis in Texas, North Dakota and Montana co-authored by Katie English and Taylor Lamb

The Title Question

Harold Smith, the owner of Blackacre, and his wife, Wendy Smith, execute a deed covering all of their interest in Blackacre to Tiger Drilling. The deed reserves to Harold and Wendy a 50% mineral interest. Does the third party mineral reservation in the deed reserve an interest to Wendy?

We refer to the mineral reservation to Wendy as a “third party reservation” because Wendy did not own an interest in Blackacre and is considered a stranger (or third party) to the deed. Some states, like Texas, follow the common law rule that such third party reservations are invalid, while other states, like North Dakota and Montana, will look to the grantor’s intent.

Texas: No Third Party Mineral Reservations

In Texas, Wendy is out of luck. (For purposes of our Texas discussion, this was Harold’s separate property.) Texas courts hold that mineral reservations to third parties are ineffective. Even a mineral reservation to the grantor’s spouse will not pass title to that third-party spouse.

North Dakota: Look to Intent and Possibly the Spousal Relationship to Grantor

In North Dakota, Wendy gets the mineral interest since it was Harold’s intent to reserve it to her. However, if Harold made the reservation to Ned the neighbor instead of Wendy, the answer would not be as clear. In addition to the grantor’s intent, whether a third party will receive the reserved mineral interest might also depend on whether or not the third party is the grantor’s spouse. In Stetson v. Nelson, 118 N.W.2d 685 (N.D. 1962), the North Dakota Supreme Court followed the common law rule that an attempted third party reservation was inoperative as to the third party. However, in Malloy v. Boettcher, 334 N.W.2d 8 (N.D. 1983), the Court did not apply Stetson where the third party reservation was to the grantor’s wife. Instead, it looked to the grantor’s intent to determine that the reservation was effective. However, there is some question as to whether Stetson or Malloy would apply where the reservation is made to third party who is not the grantor’s spouse (such as Ned the neighbor), and for all cases of third party reservations, North Dakota Mineral Title Standard 3-06 requires clarification of the intent of the parties by stipulation of interest or quiet title action.

Montana: Only Look to Intent

In Montana, like North Dakota, Wendy gets the mineral interest since it was Harold’s intent. Also, if Harold reserved the interest to Ned the neighbor instead of Wendy, Ned would acquire the mineral interest. In Montana, the effectiveness of third party mineral reservations is purely a question of the grantor’s intent.

Co-author Michael Kelsheimer

Are your landmen independent contractors? Are they employees? What do they look like to the government?

Why should you care about these questions? Because your government cares. When independent contractors do not report all of their income, or take questionable deductions to reduce their earnings, Uncle Sam is deprived of income, FICA, and FUTA taxes. Unable to raise taxes on their own, the IRS and Department of Labor are squeezing tax dollars from any place they can. The “misclassification” of independent contractors is a pot of gold.

New investigators have been hired. Fines are up 500%. The IRS has sophisticated new software programs that monitor businesses fitting the misclassification profile: Large numbers of 1099-type payments to individuals in excess of threshold amounts, and 1099’s to the same individuals year after year. To make matters worse, government agencies have started to cooperate and share data on potential violators.

But wait, there’s more!

Assuming the IRS finds you before you turn yourself in or the DOL finds you, they will assess the employer’s half of back payroll taxes, penalties and interest, possibly the “contractor’s” half of back payroll taxes, and the amount that “contractor” should have withheld. In some cases, this number approaches 40% of the amount paid to each “contractor” over the last three years. Do the math. The liability could add up quickly.

But wait, there’s more!

It might not end with the IRS. You could be handed off to the DOL, who will ask for time sheets for those “contractors” who have now been re-classified as employees. You treated them as contractors, so you won’t have time sheets, so DOL will interview them and ask about the overtime they worked, say in the last three years. With a free pass to answer and no time records to dispute them, some witnesses will say just about anything and DOL will then assess for overtime.

If you are in Texas, the Texas Workforce Commission may audit for unemployment benefits due to terminated “contractors” who should have been treated as employees.

But wait, there’s more! 

Once bitten by the IRS and DOL, your more entrepreneurial competitors might decide to turn in everybody else they believe uses the same approach. For this treachery they will receive up to 15% of the government’s recovery.

What to do?

There are at least two options: (1) take steps to reduce the appearance of landmen as employees ; or (2) If you believe you have a problem, re-characterize landmen as employees and take advantage of the very favorable settlement program now offered by the government and thereby reduce your liability by as much as 95%.

Study your treatment of landmen to determine which method is right for you. Don’t wait around; the settlement program does not have a definite end date.

Co-author Brooke Sizer

PanAmerican Operating Inc. v. Maud Smith Estate highlights the perils of working through independent landmen:  maintaining enough control to be sure the work is done as you like it, but also wanting authority to disavow his actions should you desire. 

PanAmerican hired an independent contractor, Wormser, to obtain oil and gas leases from mineral owners, including Maud Smith. Wormser contacted Elder, Ms. Smith’s attorney, and negotiated a lease. After executing and mailing the lease to PanAmerican and attempting for seven months to get paid, Ms. Smith sued for breach of contract.

PanAmerican claimed the lease was invalid because Wormser did not have authority to bind the company. The trial and appellate courts found that Wormser had apparent authority, which bound PanAmerican, and that PanAmerican ratified the lease.

Agent or Not an Agent – The Factors

Evidence that the independent contractor had apparent authority:

• Used a “@panampo.com” e-mail address,

• Had a cubicle in the PanAmerican offices,

• Used a company telephone line,

• The founder and president of PanAmerican knew he was negotiating the lease,

• In reports he was required to submit to PanAmerican, the landman described all of his efforts to secure the lease,

• His e-mails used words such as “we,” “our,” “they,” and “our attorney”.

PanAmerican argued that it had done nothing to give Maud Smith reason to rely on the landman’s authority. The court found that the formal business relationship between PanAmerican and Wormser, with no limitation of Wormser’s power known to the third party, presented a reasonable inference that Wormser was authorized to execute leases on PanAmerican’s behalf.

The Real Story?

The medieval morality play goes like this: Man begins in innocence, Man falls into temptation, Man repents and is saved. The court apparently thought PanAmerican didn’t stick around for the third act. It failed to timely repudiate the lease when the opportunity presented itself. Instead, it did nothing until the price of oil made honoring the lease uneconomical.

Intent to ratify will be inferred if there is an acceptance of benefits while having full knowledge of any act that would make the lease voidable. PanAmerican retained the benefit of the lease while it waited to see if economics would make honoring the lease favorable.

How to Avoid The Predicament

See the factors above for how to maintain separation between the independent landman and his client. No single factor will carry the day one way or another. And there are surely others, depending on the situation.

And remember, this case was about apparent authority. The principal has the duty to give notice to third parties of the agent’s limitations when the agent is dealing on behalf of the principal. If your landman has limited authority, make certain that the parties he deals with know that.

J J Cale – RIP.

Ross et al v. Enervest Operating, L.L.C. et al has several teachable moments for Louisiana royalty owners. 

“Nice to Meet You” is Not a Demand

Under the Louisiana Mineral Code, a lessee is entitled to written notice from the lessor that royalties are due. The court concluded that such a notice must be more than a notification that the royalty owner had purchased the land. An “introductory letter” that doesn’t indicate that the lessor is requesting royalties or that any royalties were past due is insufficient. It was helpful to the equities of the case that the lessee in charge of royalty payments paid royalties immediately after receiving notice that the monies were past due.

Is it a Royalty or a Rental?

Ross also differentiates between the Mineral Code definitions of a “rental” – money or other property given to maintain a mineral lease in the absence of drilling or mining operations or production of minerals, and “royalty” – any interest in production from or attributable to land subject to a mineral lease that is payable to the lessor. A payment for production is a royalty, no matter if the value paid never exceeds an annual minimum payment required. In Ross, the annual payment was a royalty because the amount was tied to the amount of gas production. Had the payment been a rental, a breach of the lessee’s duty could have resulted in forfeiture of the lease.

The Lessee’s Duty of Good Faith Has Limits 

The decision also addressed lessees’ duty to perform their obligations in good faith. The court concluded that the party responsible for royalty payments does not have the obligation to pursue knowledge of lessors’ change of address and/or ownership in the property upon which monies were due. The plaintiffs were in a much better position to be aware of address and/or ownership changes regarding property they owned.  Lessees everywhere will appreciate the court’s rejection of the assertion that lessees’ duty included investigation of the conveyance records of the parish where the property is located.

 Ancient Agreements Count

Ross also discussed the effect of amendments in 1921 and 1935 to a 1916 oil and gas lease. Space doesn’t permit discussion of that aspect of the decision, except to say that you will be bound by the lease language agreed by your predecessors 78 years ago, despite the efforts of your very capable lawyer to contort it into something else. 

Ross is rather long on facts. If you have an interest in these issues I recommend you read the decision itself.

Thanks to Katie Beard, our summer intern and SMU law student, for her capable assistance.

Why Lou Brock?  He knew how to steal a base, and he’s from Morehouse Parish, where this case originated.

Co-author Travis Booher.

All legislation is not good legislation. The good news is that some of it fails. Such is the case with H.B. 2590 passed by the 2013 Texas legislature but vetoed by the Governor. We mention it because it will be back in the next session.

The Bill, “An act relating to the foreclosure sale of property subject to an oil or gas lease”, addresses the age old problem of foreclosure of property subject to an oil and gas lease.

Any oil and gas lease acquired after a deed of trust is subordinate to the deed of trust. Title examiners require a subordination agreement from the lender in order to prevent termination of the lease in the event a foreclosure occurs. H.B. 2590 provided that an oil and gas lease on land that has been foreclosed would remain effective after the foreclosure sale ifthe lease was valid, and was:

  • executed and recorded in the real property records of the county before the security interest was recorded; or
  • executed and recorded in the real property records of the county after the security interest was recorded but before the foreclosure sale.

The Bill was drafted with urban drillers in mind, and would be useful where an urban unit includes thousands of home lots.

But there were hidden perils:

  • The Bill required the lessee to “indemnify the purchaser and any mortgagee of the foreclosed real property from actual damages resulting from the lessee’s operations conducted pursuant to the oil or gas lease”.
  • The Bill provided that foreclosure sale “terminates and extinguishes the lessee’s right to use the surface … “.

Supporters argued that if property is foreclosed and there is no subordination agreement the lease would be lost anyway! Correct, and as a result the Bill had great practical application.

Critics disagreed with increased indemnification liability, and were unsettled about the wording of the surface provision. (We call them “critics” and not “opponents” because the Bill was discovered by many industry insiders only after it had passed with no opposition. The sponsors denied any monkey business.)

The Bill created more questions than it answered. For instance, it was writen as if the surface owner always owns 100% of the minerals, and not only portion. This is uncommon in rural acreage. Also, the loss of surface rights could be contrary to the mineral estate’s dominance in tracts covered by more than one lease (where the foreclosure would be of less than 100% of the minerals).

In any event, the Bill died. Expect it to be re-introduced in the next session. If so, it will not escape scrutiny and may not have the opportunity to meet our new governor.

Comparative Title Analysis in Texas, North Dakota and Montana. Co-authored by Katie English and Taylor Lamb

The Title Question

Your title examiner often encounters a conveyance to an individual “as Trustee” with no Trust specified in the instrument. For example, the Mineral Deed conveys all right, title and interest in Blackacre to “Harold Smith, Trustee,” but the Mineral Deed does not identify the trust or disclose the names of the beneficiaries. These unidentified trusts are commonly referred to as “blind trusts,” and not all states treat these the same way.

Texas

In Texas an examiner “may presume the authority to convey, transfer or encumber the title to the property.” See Texas Mineral Title Standard 9.20. Thus, in Texas, if “Harold Smith, Trustee” appeared in a subsequent conveyance purporting to convey Blackacre to a third party, the examiner may treat this as an effective conveyance. If “Harold Smith, Trustee” never reappeared in the chain of title, record title of Blackacre would be held by “Harold Smith, Trustee.”

North Dakota

In North Dakota, identifications such as “‘trustee’ . . . without further identification of the beneficiary by name or the nature of the trust, are merely descriptive and the person is deemed to be acting in an individual capacity.” See North Dakota Title Standard 10-06. Thus, unlike in Texas, the Mineral Deed would not convey Blackacre to a blind trust with Harold Smith as Trustee. Instead, “Harold Smith” in his individual capacity would hold Blackacre.

However, because Standard 10-06 applies to both grantees and grantors, if “Harold Smith, Trustee” reappeared to convey Blackacre, the Examiner would be able to credit this second conveyance because the grantor’s “Trustee” title would be viewed as merely surplus. Thus, the result is the same here as it would be in Texas, although through different means.

Montana

In Montana any conveyance to an individual as “‘trustee’ . . . must be considered as though . . . the word ‘trustee’, or ‘as trustee’, or any equivalent fiduciary expression had not been used in connection with the grantee’s name.” See MCA 70-21-307. In other words, Montana follows the same approach as North Dakota.

The Takeaway

Instruments with identical language can have different meanings, depending on the state. If you are operating in a new state don’t assume the law there is the same as the law you are used to.