Face Challenges Confidently

164 ExxonMobile Corporation v. Valence Operating Company

Tuesday, September 1st, 2015

Richard F. Brown

 
ExxonMobil Corporation v. Valence Operating Company, 174 S.W.3d 303 (Tex. App.— Houston [1st Dist.] 2005, pet. filed), holds the operator liable for substantial damages for breach of the uniform maintenance of interest (“MOI”) provision of the parties’ joint operating agreement (“JOA”). The MOI provision was the typical  form  JOA  provision  found  in Article VIII.B. of the JOA, except that it deleted the references to “uniform”. It provided:
 
E.  Maintenance of Uniform Interest:
 
For the purpose of maintaining uniformity of ownership in the oil and gas leasehold interests covered by this agreement, and Notwithstanding any other provisions to the contrary, no party shall sell, encumber, transfer or make other disposition of its interest in the leases embraced within the Contract Area and in wells, equipment and production unless such disposition covers either:
 

  1. the entire interest of the party in all leases and equipment and production; or
  2. an equal undivided interest in all leases and equipment and production in the Contract Area.

 
Every such sale encumbrance, transfer or other disposition made by any party shall be made expressly subject to this agreement, and shall be made without prejudice to the rights of the other parties.
 
Three producing wells were drilled through the higher Cotton Valley Sand formation in Unit 16 and into the lower Cotton Valley Lime, but it was known that there were behind-the-pipe reserves in the higher Cotton Valley Sand. The majority owner and operator, ExxonMobil, then farmed out the higher Cotton Valley Sand formation to farmees, who proposed and drilled five wells. Not knowing that the farmees had any relationship with Unit 16, Valence made no response to the first two well proposals from the farmees, and Valence was therefore deemed to have elected to go non-consent on those two wells. Valence participated in the last three wells proposed by the farmees “under protest.” Valence sued ExxonMobil to recover the non-consent penalties, the additional costs incurred to drill and complete new wells in the Cotton Valley Sand (rather than produce the zone through the existing wells), and for attorneys’ fees. Valence recovered $523,432 for the non-consent penalties, $310,867 for the extra costs, and $166,250 in attorneys’ fees, together with prejudgment interest, in a judgment which was affirmed.
 
The court rejected ExxonMobil’s argument that the deletion of the reference to “uniform” indicated an intention not to require the maintenance of uniform interests. The court reasoned that the deletion merely recognized the reality that ExxonMobil owned 81.8% and Valence owned 18.2%, which was not “uniform.” The whole MOI provision would be meaningless if the provision was not intended to maintain the parties’ respective interests in the lease. The court also rejected ExxonMobil’s argument that the MOI provision was not triggered because by its language, it was only applicable to transfers “of its interest in the leases embraced within the Contract Area and in wells . . . .” That is, ExxonMobil argued it did not transfer any interest in wells, and therefore the MOI provision was inapplicable. “When ExxonMobil transferred its entire interest in land in the Cotton Valley Sand portion of the Unit 16 oil and gas lease, it executed a conveyance of realty that transferred its interest in wells, equipment, and production appertaining to the Cotton Valley Sand formation.”  This conclusion was based on the language in the farmout, which provided that ExxonMobil agreed to convey “all of our present right, title and interest (herein referred to as ‘interests in land’)” in a segregated portion of Unit 16.
 
To prove damages for the extra expense incurred in drilling the new wells, Valence presented evidence showing the difference between the new well costs and the theoretical dual completion costs for the existing wells. The judgment awarded Valance $310,867, which was the difference (for the three existing Cotton Valley Lime wells) multiplied by Valence’s 18.2% interest. The court affirmed this judgment as consequential damages for breach of contract. By farming out and retaining an overriding royalty, ExxonMobil relieved itself of the costs of exploiting the gas in the Cotton Valley Sand formation while creating farmees who had no interest in minimizing the number of wells or in using existing wellbores. By severing its interest from Valence’s, rather than maintaining it, ExxonMobil breached the JOA and caused Valence to incur the extra costs.
 
The issue on non-consent penalties was limited to the first two wells and Valence’s failure to elect to participate.
 
Valence acknowledges that its non-consent damages were limited to the two wells in which it did not participate (16-4 and 16-5), multiplied by its 18.2% interest times the actual cost of drilling a well, multiplied by 200% (the 300% penalty minus 100% of the actual cost of drilling).
 
The court affirmed the judgment of $523,432 against ExxonMobil because the failure to consent cannot result in any contractual penalties unless it is triggered by the required notice of operations. ExxonMobil gave no notice, and it was not enough that the farmees gave notice of their proposal to drill new wells into the Cotton Valley Sand formation.
 
Such “notice” from strangers to the JOA, coming after the farmout agreement had already been executed, entirely failed to satisfy the purpose of the notice requirement, namely, that Valence be given the opportunity to consent, or not, to a proposal made by a party to the JOA who had agreed to all its terms and conditions—not by strangers to the JOA with different interests.
 
The significance of the case is that it confirms the powerful effect of the uniform maintenance of interest clause found in almost all printed form operating agreements. Although this clause is frequently deleted by the parties, this case demonstrates the significance of the provision when included in the final agreement.