Co-authored by Marty Averill

If you are a non-operator under the 1989 Model Form Operating Agreement, pay close attention to Reeder v. Wood County Energy, LLC, et al.  The Texas Supreme Court ruled that the operator is not liable to non-operators for breach of the agreement except in the cases of gross negligence or willful misconduct.

 This is a departure from Texas decisions which historically have held that the exculpatory language at the heart of the case extends only to claims that the operator failed to act as a reasonable prudent operator in connection with operations, but not for breaches of the JOA.

 The Decision

 The question before the court: What is the standard for resolution of a breach of contract claim against the operator? Article V.A.1. requires the operator to “ . . . conduct its activities under this agreement as a reasonable prudent operator, in a good workmanlike manner, with due diligence and in accordance with good oil field practice, …”. So far so good. But then comes the exculpatory clause: “. . . 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.”

 The difference between the forms is, “its activities under this agreement …” (‘89 form) and “… all such operations …” (’77 and ’82 forms). The court concluded that there is a substantial difference between those terms.

 The Litigation

 The parties were not getting along on major operations decisions. Reeder, the operator, sued Wood County Energy (in which he was a 45% partner) and the other non-operators alleging that as operator he had the exclusive right of possession of certain well bores and for other claims. The defendants counterclaimed that he illegally produced oil, fraudulently reported oil from one formation as being produced from another, and failed to sustain production in the quantities required by the JOA. All parties alleged conversion, violations of the Texas Thief Liability Act, and a host of other misdeeds.

 The jury found that Reeder breached his duties as operator. The non-operators were awarded damages and a declaration that Reeder owned no interest in the two formations at issue. The Court of Appeals agreed, but the Supreme Court reversed.

 The Takeaway

 It will be more difficult for non-operators under te 1989 form to recover against the operator for any claim, including breach of the contract, unless the non-operator can prove that the operator is guilty of gross negligence or willfulness conduct. Those are difficult burdens to meet.

 The court also discussed the legal sufficiency of the evidence necessary to support a jury verdict for gross negligence or willful conduct.

Stay tuned for a more thorough analysis of the case, including how the court could have resolved it in favor of the non-operators, why that result might have been better for the industry, how the ruling can be addressed when negotiating future agreements, and the sufficiency of evidence in this kind of  case.

A Quiz:

I don’t always read blogs, but when I do, I prefer Energy and the Law.

“Sazerac”: (a) The bar in the Roosevelt Hotel in New Orleans, (b) A wholly-owned subsidiary of the oil field company with the blue trucks, (c) Cyrano, the French guy with the big nose, (d) A drink comprising rye whiskey, simple syrup, Absinthe or Herbsaint or Pernod, Angostura bitters, and Peychaud’s bitters, (e) a and d.

After attending a party in Baton Rouge, we decamped to a local restaurant, LeCreole, for a nightcap. Having been raised in those environs, I’m no stranger to the local culture. Why not a Sazerac? So I ordered one, and it was good, and at that moment my quest began: To find the perfect Sazerac. Invented before the Civil War in New Orleans, the Sazerac is one of the oldest cocktails in America – kind of like an Old Fashioned without the mulled fruit.

The basics: Rye, I would say, is less distinctive than bourbon or Tennessee whiskey, so it benefits from additional ingredients. Too much Absinthe/Herbsaint/Pernod – all made from the herb anise – and the drink tastes like cough syrup; too much simple syrup and it’s treacly, without the bite necessary for an honest drink.

Disclaimer: Cocktails are like art and music – appreciation is subjective, and everyone is entitled to his opinion. But bad taste has its limits. I refuse to imitate my college frat brother who tried in vain to convince me that Grand Funk Railroad was as talented as the Stones. What follows is an effort to enlighten those who might want to venture off the beaten path mixology–wise. Here are the first four candidates (in no particular order):

Galatoire’s (Second block of Bourbon Street, N.O. – stand just inside the front door in your slacks and jacket on a Saturday afternoon and watch the “revelers” stumble up and down Bourbon Street. Quite entertaining) Leans more toward the whiskey. Traditional, meaning the balance was just where it needed to be.

Hermes (At the entrance to Antoine’s Restaurant in the French Quarter): A lot like Galatoire’s, which means classic. Just what you would expect from a New Orleans bar.

Le Creole (way out Highland Road in Baton Rouge) Heavy on the simple syrup. Just right on the Herbsaint. The treat here was how much the waiter and bartender enjoyed their work, down to tossing the glass in the air to shake out the Pernod. True art.

Di Giulio Brothers (neighborhood restaurant on Perkins Road in B. R. – good food): A bit heavy on the whiskey. Not quite cold enough. Traditionally served neat, the barkeep has to get the glass very cold before pouring.

To be continued. A journey as important as this one is never complete.

http://www.youtube.com/watch?v=6EFPU221kPc

Answer to the quiz: e, of course.

“Who cares about the law. It’s time for some football in Tiger Town.” Les Miles

My, how times change!  In a suit that brings the chaos, frenzy, and all-embracing madness of 2008 Haynesville leasing activity into focus, Hall Ponderosa LLC vs. Petrohawk Properties L.P. held that reformation of an oil and gas lease because of mutual error was not available to a lessor who was negligent in executing the agreement.

In an environment the court described as a “land rush”, Petrohawk was eager to acquire leases, but only on tracts at least 100 acres in size. Hall Ponderosa, owner of Stella Plantation, was eager to receive a big check (Nothing wrong with that). Stella Plantation is located in Section 14 and Section 13 in Red River Parish. Hall Ponderosa believed that Section 14 was 170 acres and Section 13 was 30 acres. The lessor’s representatives, an experienced landman and a petroleum engineer, were not newbies. The negotiations were hurried (15 days passed between the first phone call and execution).

A little law is necessary at this point. Louisiana courts employ the “four corners doctrine” in construing oil and gas leases. When the words of a contract are clear and explicit and lead to no absurd consequences, no further interpretation may be made in search of the parties’ intent. The reason is obvious: It’s all about certainty and stability of titles and other instruments involving land. A stranger knows the “real deal” from the four corners of the document.

The trial court reformed the lease and awarded $1,971,030 in damages (131.42 acres at $15,000 per acre, the price for the original lease).

More law: Reformation in Louisiana requires clear and convincing evidence (demonstrating that the existence of a disputed fact is highly probable, that is, much more probable than its nonexistence). The court of appeals found that there was not clear and convincing evidence that Petrohawk intended to include the Section 13 property in the lease.

Here is how the court of appeals reported the events before the lease was signed:

• The lessor never mentioned to Petrohawk that they owned property in Section 13;

• The Petrohawk landman didn’t look at Section 13;

• Section 13 was never offered to Petrohawk to be leased.

• Old surveys of Section 13 were available to the lessor.

And after:

• Errors in the original lease were cleaned up and Section 13 was not mentioned;

• The lessors surveyed Section 13 and realized for the first time that it had 144 acres.

• Four months later one of the representatives advised Petrohawk that the lessor had acreage in Section 13 that was available to lease;

• Four months after that, the lessor told Petrohawk that the Section 13 acreage had was mistakenly left out of the property description.

One lessor representative said he didn’t read the lease before signing it. Good luck with that one. In Louisiana (as in every other state I am aware of) one who signs an instrument without reading it has no complaint.

There is another, oft-repeated lesson here: When the trial court action is on the home-town lessor’s dance floor, the celebration will be at the expense of the out-of-state lessee with the deep pockets.

Petro-Hunt L.L.C. vs. Wapiti Energy L.L.C. causes one to think about the effect of a gas imbalances on a producing property acquisition and the importance of so-called “boilerplate” in the purchase agreement. It is also the saga of a bad day at the plate for the seller.

Let’s say I sold you an interest in gas wells which, after closing, turn out to be over-produced. You bought another interest in the same field from mighty Exxon in a more-or-less simultaneous transaction. Those interests were under-produced.

I refuse to settle up as required by our purchase agreement. My response to your suit for damages is that the overproduced and under-produced interests that you acquired wash each other out. Whatever value you lost from me, you will get back from Exxon. By not considering your value received from the other guy, you failed to mitigate. I win – home run! Not so fast, said the court. The under-production you might recover from the Exxon interest has no bearing on your claim against me. My over-production diminished the value of the asset you purchased from me, the purchase price of which was based upon there being no over- or under-production. Strike one.

Next pitch: I say your damages are determined by the value of each over-produced MCF at the time it accrued, set off by the value of each under-produced MCF at the time it accrued. At least a single? Wrong again. The value of your loss was determined on the date of the sale of my interest to you. Strike two.

I’m in a hole at 0 and 2, but maybe I can dribble out an infield hit. Your attorney’s fees award was 75% of your damage recovery. The court should have reduced the fees, I say.  The Texas Supreme Court recognizes a number of factors that go into an award of attorney’s fees.  The amount of fees must bear some reasonable relationship to the amount in controversy, but that factor alone is not determinative. The mere fact that attorney’s fees meet or exceed the amount of damages does not automatically establish that the fees are unreasonable.  Strike three; the futility is complete. You’re feeling like JustinVerlander and I’m looking like Reggie Jackson.*

The ‘boilerplate” that was important in this decision was the survival of warranties and representations after closing and the further assurances clause. Hunt’s representation that there were no gas production imbalances survived closing. And the parties provided for a post-closing final settlement statement. The amount of the imbalances had not been determined at that time. Wapiti relied on the further assurances provision to require Hunt to honor its representation months later when the imbalance was determined.

*Why Reggie? Mr. October leads all batters in the history of major league baseball in strikeouts.  http://www.youtube.com/watch?v=70I4xRbsT4Q

I promise this will be the last post in a while on covenants running with the land. I think we all get it by now (This topic was discussed in my August 1 post).

The Result

A Joint Operating Agreement referenced in documents that is in a party’s chain of title and is, by its terms, binding on “ . . . the parties hereto and to their respective heirs, devisees, representatives, successors and assigns.” will bind that party, according to TransTexas Gas Corp. v. Forcenergy Onshore, Inc. That language establishes the agreement as a covenant running with the land.

What makes this rather mundane decision (mundane to you and me, probably not so to the parties) worthy of your attention is the focus on the JOA, letter agreements and a complicated series of assignments (of deep rights, shallow rights and other, deeper rights) at various times among a number of parties, most of which were entered into over 20 years ago.

The lesson

Keep your land files and records complete, accurate and in good order. Sometimes those who follow behind the original players are going to be put to the task of recreating a transaction, or the history of the parties’ performance of a transaction. The party without good land records is at a serious disadvantage.

A more obvious lesson

Don’t ask for relief in one suit by relying on the existence of a contract to which you are a party and then in another suit, deny that the contract burdens your interest. You can seldom have it both ways.

The Case

Trans Texas and Forcenergy owned interests in the same lease, and disagreed over the applicability of a non-consent provision of a JOA entered into by their assignors. TransTexas did not consent to Forcenergy’s drilling proposals, resulting in relinquishment of the working interest until 400% of costs had been recovered by the consenting parties. Trans Texas sued to determine if the non-consent relinquishment provisions applied. TransTexas’ argument was that the JOA wasn’t in its chain of title and therefore its interest was not subject to the JOA. The JOA and the letter agreement by the parties’ predecessors were mentioned in earlier assignments that were recorded in the official public records, establishing constructive notice of their contents. Also, TransTexas judicially admitted that the agreement applied to its interest by suing for a TRO in an earlier case in reliance on the JOA.

And there is something for the bankruptcy clients and their lawyers: TransTexas’s rejection of the JOA in bankruptcy had no effect on Forcenergy’s ownership of relinquished interests because relinquished interests are excluded from the debtor’s estate under the Bankruptcy Code.

 

Highland Capital Mgmt., L.P. et al v. Ryder Scott Co. shows how far a plaintiff will reach to find deep pockets to pay for a bad investment. Here, the plaintiffs went after the reservoir engineers who made reserve estimates and to a purchaser who acquired notes after the plaintiff acquired theirs. There was a question about whether the engineers aided the brokers in the sale of the notes and whether proved reserve estimates constituted material representations. This was an appeal of a summary judgment, so nothing has been proven. Reversals of summary judgments are all about whether there are fact questions left for a jury to decide and not whether assertions have been proven.

Highland held unsecured interests in notes issued by Seven Seas, an oil and gas exploration company. Because the notes were sold and traded on the public markets they were subject to SEC regulations defining what an issuer can report as “proved reserves”. Highland’s purchase was based on estimates prepared by Ryder Scott, the reservoir-evaluation consulting firm. Seven Seas later issued secured notes to Chesapeake Energy. It was discovered that the proved reserves were much lower than originally believed. Seven Seas could no longer pay the interest and went into bankruptcy. Highland sued Ryder Scott and Chesapeake alleging fraud, negligent misrepresentation, and violations of the Texas Securities Act.

The court dismissed Highland’s claims for fraud and negligent misrepresentation. Highland failed to show evidence of either out-of-pocket damages or benefit-of-the-bargain damages, said the court.  There was no evidence of wrongdoing by Chesapeake, who purchased senior notes after Highland purchased its subordinated notes. The claim was that when buying the notes Chesapeake relied on the reserve reports which it knew were false and thus knew that the value of Highland’s interests would be destroyed by Chesapeake’s purchase. This was alleged as a conspiracy between Seven Seas and Chesapeake to decrease the value of Highland’s notes. For good reason (how about the absence of a motive?) the court didn’t buy that argument.

The court also dismissed the claim that Chesapeake aided and abetted Ryder Scott’s (alleged) securities fraud. To aid and abet, a person must have “general awareness” of its role in a securities violation, or render “substantial assistance”, or either intend to deceive the plaintiff or act with reckless disregard for the truth of the primary violator’s representations. Chesapeake testified that it had no knowledge that the reserve reports were false. Highland’s expert testified that Chesapeake should have known of the falsity, but “should have known” isn’t enough to constitute aiding and abetting, said the court.

A question remained whether the securities brokers (who weren’t parties to the litigation) were “sellers” under the TSA, so Ryder Scott could potentially be secondarily liable for aiding the brokers. There was also a fact question whether Ryder Scott’s estimates were material misrepresentations, despite strong cautionary language in the prospectus. The case was remanded to the trial court to determine those issues.  It appears that Highland will rely on the reckless disregard element to establish its case. 

 

 

Louisiana Governor Bobby Jindal signed into law two bills significantly revising Louisiana’s oilfield cleanup statute, La. R. S 30:29. The new law affects the procedures for remediating oil field pollution and resolving oilfield contamination claims.  The purupose is to expedite the remediation process and the resolution of claims.

For the highlights that were important to the Louisiana Oil and Gas Association, I refer to the analysis of Donald Briggs, president of LOGA, as reported by the American Oil & Gas Reporter in its July issue:

  • In an effort to accelerate remediation, parties can assume responsibility for environmental damage according to a regulatory standard without admitting liability for private damages.
  • Once a party claims responsibility, the Department of Natural Resources will structure a feasible cleanup plan.
  • Cleanup plans will be subject to review by the DNR, secretary of the Department of Environmental Quality, and the commissioner of agriculture.
  • Both the remediation plans and the agencies’ comments are admissible in court.
  • No employee, contractor, nor representative of the state is allowed to engage in any ex parte communications with department employees  while plans are being designed.
  • Any party that admits responsibility waives the right to enforce contractual rights to indemnification for punitive damages caused by the responsible party.

Other features of the new law are meaningful (as a lawyer, I gravitate toward the procedural stuff):

  • A defendant can request an early dismissal from a suit. There will be an evidentiary hearing at which the plaintiff can provide evidence of the defendant’s liability. The defendant will have an opportunity to rebut. The defendant could be brought back into the suit if evidence is discovered later in the proceeding.
  • A plaintiff can interrupt prescription by delivering a notice of intent to investigate to the DNR. Certain information must be included in the notice.

To say this musical interlude is relevant to today’s topic is a stretch. But what if the aforesaid Gov. Jindal becomes one heartbeat away from the presidency?  Other than that, it’s here because I like it.

This non-oil and gas case should be of interest to startups and those of you who run “lean and mean” operation.  Thanks to Jerry Murray at Goldin Peiser & Peiser, LLP for bringing it to my attention.

You file the paperwork to set up a corporation so that your personal assets are shielded from assault by unprincipled plaintiff’s lawyers and their predatory lawsuits. You then get so busy searching for the next Daisy Bradford No. 3 that you ignore those pesky notices from the Secretary of State and the Comptroller.  In the meantime, your ambitious enterprise runs into a few hicccups. True to form, the bottom-feeding plaintiff and his lawyer – who must be as dumb as he is shameless – sues you personally even though even he should know that you have a corporation and are protected.

Surprise!  That lawyer and his client might know somethign you don’t.  Suntide Sandpit, Inc. v. H & Sand and Gravel, Inc. says that in Texas you could be personally liable if those letters you ignored were requests that you pay the corporate franchise tax and file annual reports.

Each officer and director of a Texas corporation whose charter has been forfeited for the failure to provide a report or pay a tax or penalty are liable for each debt of the corporation created or incurred after the date on which the report, tax or penalty is due and before the corporate privileges are revived. There are exceptions: For example, a director who objected or had no knowledge of the debt is not liable; personal liability attaches only to those directors and officers of the corporation at the time the debt is created or incurred; and the liabilities do not attach to tort judgments based on negligence; and reinstatement of the charter within 90 days is retroactive.

The entity in this case wasn’t in the oil business; however, charter forfeiture is not uncommon for corporations whose shareholders are too busy producing oil and not busy enough tending to their mundane corporate housekeeping obligations. There is potential exposure.

In this case, the directors and officers had no personal liability, but that was for reasons peculiar to this case, and the result was from an appeals court, which means after the directors lost at the trial court and incurred a gusher of legal fees.

 

Question: Can a landowner enforce a right of first refusal bargained for by his predecessor? Answer: It depends. (Note to self: Why do you always say that in your posts?  Because, as Texas Rangers’ manager Ron Washington might say, “That’s the way the law go”.)  The answer in MPH Production Co. v. Smith et al, was yes, he can. But that’s not always the result.

The Horans owned land in Harrison County, Texas. In 1979, they sold their mineral rights in the property, but reserved a first right of refusal – the opportunity to purchase the rights on the same terms as any future prospective buyer. Two years later the Horans sold their interest in the surface to the Smiths.

Many years and many conveyances later, MPH purchased the minerals without first giving the Smiths the opportunity to match the offer. The Smiths attempted to enforce the right of first refusal and to purchase the minerals from MPH. MPH refused and the Smiths sued.

The issue was whether the first right of refusal was a covenant running with the land. If the right of the Horans – the original reserving party – to buy back the minerals was connected to the land, then the Smiths acquired the right when they acquired the surface.

The Law

In Texas, a covenant runs with land when:

(1) it touches and concerns the land,

(2) it relates to a thing in existence or specifically binds the parties and their assigns,

(3) it is intended by the original parties to run with the land,

(4) the successor to the burden has notice, and

(5) the parties are in privity of estate when the covenant was established.

Rights that do not run with land are personal to the parties to the agreement in which the rights were creted, and subsequent owners cannot enforce them.

The Law and This Case

The answer to the question depended on the intent of the parties in the 1979 deed, which did not state explicitly that the obligations of the grantees (MPH’s predecessors) would bind subsequent owners. Without this express reservation, the court had to rely on Texas case law implying restrictions by law. The court found that the Horans and the Smiths were in privity of estate, so that the Horans’ right of refusal was included in the “bundle” of rights transferred to the Smiths in the 1981 Deed. Thus, the answer to the question ws that the right of first refusal was a covenant running with the land.

The Takeaway:

If you are a party to a deed, say what you mean.  Courts look to the language of the agreement to divine the parties’ intent. If you want a reservation – or any other right or obligation – to be a covenant to run with the land, make your intent clear. Some lawyers would suggest that the parties specify that the rights apply to the grantor/ee, and their successors and assigns. Or that the deed say that it is the parties’ intention that this reservation be a covenant running with the land.

If you are buying minerals and see a right of first refusal in the chain of title, be mindful of this case.

BY CHANCE DECKER

Here in the south, we know all bourbon is whisky, but not all whisky is bourbon. In El Paso Marketing, LP and Enterprise Pipeline LLC v. Wolf Hollow I, L.P., the Texas Supreme Court held that all natural gas is power, but not all power is natural gas.

The Dispute

This case was about a gas transportation and supply contract. Wolf Hollow (owner of a gas-fired power plant and buyer of gas) sued Enterprise (owner of the pipeline supplying gas to the plant) and El Paso (who managed the plant’s fuel supply). The problem was service interruptions and delivery of substandard gas. Wolf Hollow sought reimbursement for the cost of replacement power it bought to supply its customers while the plant was shut down. Wolf Hollow claimed the costs were Uniform Commercial Code “cover” damages. El Paso claimed the replacement power costs were consequential damages, waived by Wolf Hollow under the supply agreement.

The Ruling

The Texas Supreme Court sided with El Paso on the “cover” issue. The replacement power was not “cover” under the U.C.C.

The Rule

The UCC says that when a supplier fails to meet its delivery obligations, the buyer can “cover” by “making in good faith . . . any reasonable purchase of . . . goods in substitution for those due from the seller.” Under the U.C.C., consequential damages do not include cover damages. Thus, when a supplier breaches its delivery obligations, a buyer can “cover” and sue for damages even when the contract waives consequential damages.

The Rationale

Wolf Hollow claimed that by purchasing replacement power it discharged its delivery obligations to its customers just as if it had purchased replacement gas. El Paso argued the replacement was “substantially different” from the gas due under the agreement, and thus not “cover.” The court agreed with El Paso. The power Wolf Hollow bought was not a replacement for gas due under the contract; it was a replacement for the electricity Wolf Hollow was to produce from the gas. The gas was power, but the power was not gas.

Thankfully for Wolf Hollow, the agreement allowed Wolf Hollow to sue for the cost of replacement power if certain conditions were met even though the power was not U.C.C. “cover”.  The Court remanded the case to determine if those conditions had been met.

The Takeaway – You Need an Alternative Damage Clause

What does the case mean? No, not that you need a stiff drink. It shows the importance of  having a detailed alternative damage clause in your gas transportation and supply contract. When a supplier can’t meet its delivery obligations, it’s usually because of supply disruptions. That means replacement gas will be hard to find. If your contract contains a consequential damage waiver – and most do – you can’t buy replacement power or gas that is substantially different from the gas due under your contract and collect cover damages unless your contract contains an alternative damages clause. Without one, you may need a shot of bourbon yourself. I recommend Garrison Brothers from the Texas Hill Country.