622 Southwestern Energy Prod. Co. v. Berry-Helfand, 491 S.W.3d 699 (Tex. 2016)

Monday, June 19th, 2017

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.

Southwestern Energy Prod. Co. v. Berry-Helfand, 491 S.W.3d 699 (Tex. 2016) (Misappropriation of prospect analysis as trade secret) examines the proper remedy, damages, and proof of damages when a trade secret oil and gas prospect is misappropriated. In this case, the evidence presented for trade-secret misappropriation damages was held legally insufficient to support the entire jury award, and the case was reversed and remanded for new trial. Toby Berry–Helfand (“Engineer”) worked for seven years analyzing data across five counties in East Texas to identify very specific “sweet spots” for drilling and producing from the James Lime reservoir with multiple stacked pays. In 2004, Engineer obtained leases covering 6,300 acres in two specific sweet spots called the Pearson and Pearson Northeast prospects in Nacogdoches County to generate interest in the drill-ready prospects and the broader James Lime play. In February 2005, Engineer pitched the deal to Southwestern Energy Production Co. (“SEPCO”).

Before Engineer disclosed any information, SEPCO executed a confidentiality and noncompete agreement that required SEPCO to maintain the information’s confidentiality, to use it solely to evaluate the Pearson prospects for purchase from or development with Engineer, and to not compete with Engineer in a specified area of mutual interest for one year. Engineer then provided detailed information about the Pearson prospects and identified sweet-spot prospects throughout the play. “At the time of the presentation, SEPCO had not acquired any mineral leases with James Lime as the primary drilling objective, had never drilled a James Lime well, and had been dissuaded from pursuing James Lime ventures by an internal study conducted in 2003, had declined to participate in a James Lime play with [a third party] in 2003, and had zero horizontal wells.” SEPCO never extended an offer to Engineer. Engineer then closed a deal with Petrohawk Properties, L.P. (“Petrohawk”) on the Pearson prospects specifically and a broader deal across three counties. “By the fall of 2010, SEPCO had acquired 1,888 leases and drilled more than 140 wells—88 of them James Lime horizontal wells—in areas clustered around the sweet spots [Engineer] had identified.” Almost all of SEPCO’s leases were in the sweet spots, all of the wells produced, and those wells generated an undisputed $381.5 million in production revenue. The jury found that SEPCO misused proprietary information acquired under the Confidentiality Agreement, and liability was not contested on this appeal.

The principal evidence on damages was the contemporaneous Petrohawk agreement, Engineer’s testimony, and expert testimony by Engineer’s Expert. SEPCO did not call an expert witness, but instead attacked Engineer’s evidence and the Expert’s methodology. Under the Petrohawk agreement, Engineer received $1.8 million for the Pearson prospects, an overriding royalty interest, a 6.25% back-in after payout, monthly consulting fees, and a similar arrangement across three counties. “Hundreds and hundreds” of leases were acquired by Petrohawk. The overriding royalty was generally about 3%, but it was a sliding scale royalty, subject to expansion or reduction based on existing lease burdens, with more than one trigger point. The overriding royalty could have ranged from zero to about 6.75%. Engineer testified that she received an average of 3% on her Petrohawk leases, and although she did not testify that such terms were “reasonable and customary” or provide an average for all of the leases, the court accepted that testimony as some evidence of the prices past purchasers or licensees of the trade secret may have paid.” There was also some evidence that some of the SEPCO wells had a net revenue interest greater than 75%, which would support at least some overriding royalty under the Petrohawk agreement’s scheme of a sliding scale royalty. Expert also testified that the Petrohawk deal would be “a customary and reasonable type of compensation that someone would receive for identifying a prospect.”

The Expert opined as to a damages number considerably larger than the number the jury awarded. The critical issue in the case was the 3% “average” overriding royalty that Expert assumed in his calculations based on Engineer’s testimony about her experience with the Petrohawk leases.

The jury apparently did something similar. The jury found SEPCO’s “profits” to be $381.5 million (which corresponds to the evidence of past production revenue) and a 3% overriding royalty applied to that number equals $11.455 million, which was the number the jury awarded for past damages. The jury awarded $-0- for future damages and $-0- for exemplary damages. The trial court ordered a post-verdict accounting and awarded an additional $23.89 million in equitable disgorgement of profits, and awarded $4.6 million in attorney’s fees and interest.

There are multiple ways to prove damages for misappropriation of a trade secret, including value of plaintiff’s lost profits, defendant’s actual profits, value another would have paid, development costs saved by defendant, and reasonable royalty. For claims arising after September 1, 2013, there is an applicable statute. The parties disputed the reliability of the Expert’s damages calculation.

The court noted that “the Petrohawk agreement actually employs a sliding-scale overriding royalty tied to the total royalty burden, and analogous agreements in the record similarly bear payout terms tied to the total royalty burden.” Consequently, the sliding scale in the Petrohawk agreement zeroes out at a specified threshold. The court noted that failure to take the sliding-scale overriding royalty into consideration in calculating a reasonable royalty for Engineer’s trade secret was a critical misstep, because when there is objective evidence from which more certainty can be gleaned, it is incumbent on the plaintiff to produce that evidence.

The court further noted that because the actual overriding royalty interest on the SEPCO wells could have been determined, using the average overriding royalty received under the Petrohawk agreement was not probative. The court remanded because there was evidence to support damages, but less than the full amount awarded.

Because the court remanded for a new trial, it declined to address or rule upon a number of other issues. Perhaps most importantly, the appellate court had held disgorgement of profits was not available, but the Texas Supreme Court said: “[W]e have not expressly limited the [equitable disgorgement of profits] remedy to fiduciary relationships nor foreclosed equitable relief for breach of trust in other types of confidential relationships.”

The significance of the case is the guidance given on the measure of damages, the role of expert testimony, and the burden of proof in recovering for a lost prospect. The case was tried on theories of breach of contract, breach of fiduciary duty, theft, and fraud.