Face Challenges Confidently

344 Tawes v. Barnes

Tuesday, September 1st, 2015

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
Tawes v. Barnes, 340 S.W.3d 419 (Tex. 2011) held that a lessor of lands included within a Joint Operating Agreement (“JOA”) had no right to sue under the JOA, either as a third-party beneficiary of the JOA or by virtue of having privity of estate. Two adjacent tracts of land were leased by landowners Barnes and Baker. Thereafter, the Barnes Lease and Baker Lease were pooled into a single unit. The working interest owners in the unit entered into a Working Interest Unit Agreement (“WIUA”) and an attached JOA. Moose, one of the non-operators and one of the lessees under the Baker Lease, proposed drilling two additional wells in the pooled unit under the terms of the JOA. The operator, who was the lessee under the Barnes Lease, elected to go non-consent. Moose, Tawes, and various other non-operators who owned the lessee’s interest under the Baker Lease, drilled the wells. Moose acted as operator for the consenting parties in drilling the wells. Tawes and another company later acquired Moose’s working interest in the Baker Lease and the wells in a foreclosure sale. At issue in this case was Tawes’ liability, as a consenting party, for the payment of royalty to Barnes under the provisions of the WIUA and JOA.
The JOA provided in Article VI.B2 that “[t]he entire cost and risk of conducting such operations shall be borne by the Consenting Parties in the proportions they have elected to bear . . . .” In a subsequent portion of Article VI, the JOA provided that “[d]uring the period of time Consenting Parties are entitled to receive Non-Consenting Party’s share of production, or the proceeds therefrom, Consenting Parties shall be responsible for the payment of all production, severance, excise, gathering and other taxes, and all royalty, overriding royalty and other burdens applicable to Non-Consenting Party’s share of production . . . .” The Court called this the “Royalty Provision” for identification.
The JOA in this case was similar to most JOAs because it allocated all costs and expenses, along with the sharing of revenue, in accordance with an allocation based on the interests owned by the working interest owners. However, the Royalty Provision recited that “Consenting Parties shall be responsible for the payment of . . . all royalty,” and that language was arguably consistent with either joint or several liability for royalty payments as between and among the Consenting Parties.
Barnes asserted that Tawes, as a Consenting Party, was liable for all royalty owed to her, and she asserted that she had standing to sue under the Royalty Provision as a third-party beneficiary of the JOA. Alternatively, Barnes argued that she could recover against Tawes for the payment of royalty because they were in privity of estate. The lower courts found Tawes to be liable and to be responsible for “all royalty.”
The Texas Supreme Court considered the following certified question as one of three questions submitted:

Certified Question One: Does Barnes have any right [to] enforce the [Dominion- Moose Agreements]-the WIUA and JOA-between Dominion, Moose . . . and the Moose Assignees, including Tawes, to recover unpaid royalties, between the date of first production and February 2002, of Baker-Barnes Nos. 1 & 2 wells under what we have called the “Royalty Provision” of the JOA, either as a third-party beneficiary of the WIUA and JOA or by virtue of having privity of estate with Tawes?

Answering the foregoing question, the Texas Supreme Court first held that Barnes was not a third-party beneficiary. “A third party may enforce a contract it did not sign when the parties to the contract entered the agreement with the clear and express intention of directly benefitting the third party. When the contract confers only an indirect, incidental benefit, a third party cannot enforce the contract.” The language of the contract must be clear, and the intent of the contracting parties controls. “Traditionally, Texas courts have maintained a presumption against third-party beneficiary agreements.” “Therefore, in the absence of a clear and unequivocal expression of the contracting parties’ intent to directly benefit a third party, courts will not confer third-party beneficiary status by implication.”
Here, Dominion and Moose did not express a clear intent to directly benefit Barnes, and any benefit received by her was merely incidental. “JOAs are ‘contract[s] typical to the oil and gas industry whose function is to designate an operator, describe the scope of the operator’s authority, provide for the allocation of costs and production among the parties to the agreement, and provide for recourse among the parties if one or more default in their obligations.’” The court deduced “from the oil and gas industry’s customary purpose of using JOAs, and from the plain language of the JOA at issue here, that neither Dominion nor Moose included the JOA Royalty Provision with the intention of directly benefitting any lessor of a Baker Unit lease.” “We do not find it determinative that the 1982 version of the AAPL’s Model Form JOA used here does not expressly waive third-party liability like the contract at issue in MCI . . . . Instead, the controlling factor is the absence of any sufficiently clear and unequivocal language demonstrating an intent to directly benefit Barnes or any other would-be beneficiary of the contract.”  
Accordingly, Barnes was not a third-party beneficiary to the JOA.
Barnes argued that even if she was not a third-party beneficiary, she could recover against Tawes for the payment of royalty because they were in privity of estate. “Liability to . . . [a] lessor for the payment of rent or the performance of other lease covenants may arise from either privity of contract or privity of estate.” Barnes asserted that Tawes came into privity of estate with her when Tawes undertook the obligation to pay royalty under the Barnes Lease. This argument is apparently based on the reasoning that the original lessee had to pay royalty to Barnes, Moose agreed to pay the royalty owed by the original lessee pursuant to the JOA, Tawes acquired Moose’s interest, and, therefore, Tawes must pay Barnes.
“[W]hen privity of estate exists between an assignee of an oil and gas lessee’s entire leasehold interest and the original oil and gas lessor, the assignee must pay the lessor’s royalties as required by the oil and gas lease.” However, Tawes’ interest in the Barnes Lease was derived from the JOA and WIUA, and Tawes’ interest in the Baker-Barnes Wells No. 1 and No. 2 became possessory when the operator of the Barnes Lease went non-consent. Article III.B of the JOA expressly provided that “[n]othing contained in this [contract] shall be deemed an assignment or cross-assignment of interests covered hereby.”  Moreover, the JOA provided the methodology used to calculate the period of time the consenting parties are granted temporary ownership of non-consenting parties’ share of production. This time period is of a limited duration, and the non-consenting parties’ share of production will revert back to the non- consenting parties at the end of the time period. “Therefore, the terms of the Dominion-Moose Agreements make clear that by opting to go non-consent as to the Baker-Barnes Wells No. 1 and No. 2, Dominion did not assign its interest as Barnes’s lessee to Tawes or any other consenting party.” Instead, Dominion retained a reversionary interest in the non-consent wells. Tawes, as a consenting party, received no permanent interest in the Barnes Lease. Accordingly, privity of estate did not exist between Barnes and Tawes.
In response to the Fifth Circuit’s first certified question, the Texas Supreme Court held that Barnes had no right to enforce the Dominion-Moose Agreements, either as a third-party beneficiary or by virtue of having privity of estate. The other two certified questions were only applicable in the event that Barnes could enforce the Dominion-Moose Agreements. Accordingly, because Barnes could not enforce the Agreements, the Texas Supreme Court did not address the following two certified questions:

Certified  Question  Two:      If Barnes may enforce the [Dominion–Moose Agreements], does the WIUA prevent Barnes from recovering from Tawes?

. . .

Certified Question Three:   If Tawes, as a Consenting Party, is responsible for royalties under the JOA, does the JOA Royalty Provision change the agreement within the JOA such that Tawes is responsible for all of Barnes'[s] unpaid royalty jointly and severally, or does the JOA limit Tawes'[s] liability for unpaid royalty to the extent of his interest in the two wells at issue between the date of first production and February 2002?

This case is significant because it does not open the door for lessors to assert that they are third party beneficiaries under this common form of JOA. There are many terms and provisions in a typical JOA that arguably could tie back to implied or express lease covenants. While there is no doubt that no one in the industry has actually intended that result, except in the most unusual of documents, if the Texas Supreme Court had read that intent into this form JOA, then the unintended consequence of the use of the forms would have been to significantly increase the risk of liability for working interest owners.