710 Dimock Operating Co. v. Sutherland Energy Co., LLC , No. 07-16-00230-CV, 2018 WL 2074643 (Tex. App.—Amarillo Apr. 24, 2018, pet. denied)

Monday, July 8th, 2019

Richard F. Brown

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

Dimock Operating Co. v. Sutherland Energy Co., LLC, No. 07-16-00230-CV, 2018 WL 2074643 (Tex. App.—Amarillo Apr. 24, 2018, pet. denied) (mem. op.) (Calculation of payout under FOA) held that land and seismic costs were properly included in “capital costs” for purposes of calculating payout under a farmout agreement. Farmor and Farmee entered into a Seismic Exploration and Farmout Agreement (“FOA”) with two primary aims: (1) to drill a replacement well, and (2) to explore and develop the surrounding fifteen-section area. The FOA provided “[w]hen the Farmee’s cumulative revenue equals two (2) times the Farmee’s capital cost the Initial Earning Well will have reached ‘project payout.’” The FOA also provided that:

The Farmee’s capital cost is defined as cost incurred by Farmee for land and seismic for the Hamrick Area 3D Shoot (defined in Exhibit B), a fifty thousand dollar ($50,000) prospect fee, and cost for drilling, testing, completing, and equipping, the Initial Earning Well.

There was a form joint operating agreement (“JOA”) attached to the FOA that included a typical limitation on expenditure provision of $25,000. That is, Farmee, as Operator, was required to seek the approval of Farmor, as Nonoperator, for projects over $25,000. The FOA provided that:

The Operating Agreement shall be subject to this Agreement so that in the event of any conflict between the Operating Agreement and this Agreement, this Agreement shall be the governing Agreement.

Farmee conducted no seismic prior to drilling the replacement well, but did thereafter conduct extensive seismic exploration in the surrounding area. Farmor contended “project payout” occurred when revenue from the replacement well exceeded 200% of Farmee’s costs in drilling and completing that well and therefore “project payout” had occurred. Farmee contended that seismic and land costs should be included in “capital costs” for purposes of calculating project payout and therefore “project payout” had not occurred. The issue on appeal was whether “project payout” included land and seismic costs. Whether project payout had or had not occurred was not considered, and the court did not consider whether specific expenditures were proper.

The Court upheld a summary judgment for a declaration that the plain language of the FOA defined Farmee’s capital costs as “costs incurred by . . . [Farmee] for land and seismic for the Hamrick Area 3D Shoot . . ., a fifty thousand dollar ($50,000) prospect fee, and cost for drilling, testing, completing, and equipping, the Initial Earning Well.” That is, capital costs included (1) land and seismic, (2) the prospect fee, and (3) well costs. The court held that this language in the FOA clearly means that costs incurred for both land and seismic operations constitute “capital costs,” and are therefore applicable in calculating project payout.

The Court held that the limitation in the JOA (that was signed at the same time as the FOA) was not controlling. The Court concluded that it did not matter whether the JOA was or was not “effective,” because the FOA gave the Farmee complete discretion over seismic operations and the FOA provided that the JOA was “subject to” the FOA.

The court rejected Farmor’s claim that “land” and “seismic” are ambiguous.

As used in the [FOA], the term “land” is unambiguous and broad. As such, it is not limited to surface acreage or surface rights, but includes mineral interests and mineral rights. Similarly, the term “seismic” is unambiguous and broad, such that it includes everything necessary to obtain the seismic information the parties sought in the [FOA].

This is a contract construction case, but it is of importance that “subject to” is given considerable weight in interpreting two agreements, and the words “land” and “seismic” are construed broadly and as unambiguous.