Chesapeake Operating Inc.

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.

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.