Face Challenges Confidently

035 Huggs, Inc. v. LPC Energy, Inc.

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 some significance to you.
Huggs, Inc. v. LPC Energy, Inc., 889 F.2d 649 (5th Cir. 1989), concerns the duty of the operator to the nonoperator when a well ceases to produce. The lease was past the expiration of the primary term and held by production. The well ceased production, and the time to resume operations expired, apparently before the operator knew production had ceased. The expired acreage was leased by another party, and a producing well was drilled on the same acreage.
The parties’ participation agreement provided in paragraph XI:

In the event [operator] elects not to maintain any lease within a proposed unit in effect by payment of delay rentals or drilling operations or to renew or extend to such lease then on or before 60 days of the earliest lease expiration or delay rental date on any lease on any unit, [operator] shall relinquish and assign, free of liens and encumbrances, to [nonoperator] all of such leases within such unit area and any leases therein and any wells drilled or caused to be drilled thereon shall no longer be subject to this agreement.

The parties’ joint operating agreement provided in paragraph 2(c):

If any lease or interest subject to this agreement be lost through failure to develop or because express or implied covenants have not been performed, or if any lease be permitted to expire at the end of its primary term and not be renewed or extended, the loss shall not be considered a failure of title and all such losses shall be joint losses and shall be borne by all parties in the proportion to their interests and there shall be no readjustment of interest in the remaining portion of the Unit Area.

The issue was whether the operator could escape liability by characterizing the event as a joint loss. Held: The operator is liable. If the two provisions were contradictory, the participation agreement would control. They are not contradictory because the meaning of the two agreements is that, if the nonoperator under paragraph XI also agreed to let the lease go, then the loss would be a joint loss under paragraph 2(c). Nonoperator never got the chance to agree. Operator’s failure to give nonoperator the required notice under paragraph XI (because of its own negligence in not knowing production had ceased), does not excuse operator. Nonoperator and overriding royalty owner recovered lost profits and lost royalties for the loss of the lease.
The significance of the case is that the form of “reassignment clause” illustrated by paragraph XI in the participation agreement in this case is a fairly common industry provision. It may show up in farmout agreements, participation agreements, area of mutual interest agreements, reservations of overriding royalty, joint operating agreements, sales contracts, and in other agreements.  The “reassignment clause” is frequently overlooked or given little consideration when a well is to be abandoned. Presumably, this is because “everyone knows” the property is worthless. If “everyone” is wrong, this case shows that the liability can be significant.