370 Long v. Rim Operating, Inc.

Richard F. Brown

 
The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.
 
Long v. RIM Operating, Inc. held a blackout provision in a JOA to be enforceable. Article VI.B.2. of the 1982 American Association of Petroleum Landmen Model Form Operating Agreement 610-1982 (“JOA”) places parties to the agreement on notice of the cost and risk sharing associated with any agreed upon future oil and gas operations. It provides that when an operational expenditure is approved by consenting owners, any non-consenting owners are deemed to have relinquished their right to any production proceeds from the well until the non- consenting owner’s full share of the cost (plus an additional percentage, in this case, 200% or 500% of costs, depending on the type of costs), plus interest, has been recouped over time. The 1982 Model Form JOA also incorporates Article XV, titled “other provisions,” which permits the parties to establish additional agreement terms. In this case, the original working interest owners included Article XV.K, which provides in part:
 

Notwithstanding anything to the contrary herein contained, it is understood and agreed that the non-consent provisions of Article VI.B.2. shall not be applicable to any well or operation which is necessary to perpetuate an expiring lease or to earn an interest in a lease . . . . Any well drilling or other operation which is necessary to perpetuate or earn a lease or interest therein shall be deemed to be a “required well” or “required operation.” As to any required well . . . proposed by any party hereto in which any other party hereto elects not to participate, the non- participating party shall release and relinquish forever proportionately to the participating parties all of non-participating party’s interest in and to the lease . . . which would be perpetuated by such required well or required operation. The interest in such relinquished leases shall be assigned by the non-participating party to the participating parties . . . .

While the general Article VI.B.2. provision subjected the non-consenting party to a temporary forfeiture of interest, plus penalty, the more specific Article XV.K provision required a permanent relinquishment and reassignment of the non-consenting party’s interest (commonly called a blackout provision in the industry).
 
In 2006, when the single well holding all the leases on the unit in effect ceased to produce due to parted rods, the operator, RIM Operating, Inc. (“RIM”), submitted an Authorization for Expenditure (“AFE”) to all working interest owners proposing to repair the well together with a cover letter suggesting that replacement might be required. The majority of working interest owners consented to the AFE; however, Long failed to respond, resulting in his effective non- consent to the repair expenses. After an unsuccessful attempt to repair the well, RIM drilled a replacement  well  and  eventually  reestablished  production.     RIM  forwarded  to  Long  an assignment of his interest to the consenting owners which again was met with Long’s failure to respond. RIM filed this declaratory judgment action against Long.
 
Long challenged the enforceability of Article XV.K on multiple grounds. Long first argued that Article XV.K violated the statute of frauds because on the day the agreement was executed, “the parties conditionally agreed to convey real property interests in the future but did so without knowing what interests they could be required to assign or to whom those assignments would be made.” In Texas, for an agreement to satisfy the statute of frauds, the property to be conveyed must be “adequately described by providing the means . . . by which it may be identified with reasonable certainty.”
 
In overruling Long’s statute of frauds challenge, the court found that by looking to the JOA in its entirety, not just Article XV.K, the potential property to be assigned as well as the possible assignors and assignees could be identified with reasonable certainty. Specifically, the contract area was adequately defined in the JOA and the existing leases were listed on an exhibit. Additionally, the court relied upon Westland Oil Development Corp. v. Gulf Oil Corp., which raised similar issues in the context of an Area of Mutual Interest Agreement (“AMI Agreement”). Although the AMI Agreement “did not specifically identify what interest would be assigned” due to the uncertainty associated with any future dealing, the Texas Supreme Court ruled that the assignment provision did not violate the statute of frauds. Here, the court found that “Article XV.K was limited to the JOA’s contract area,” which had been sufficiently described within other sections of the JOA and, therefore, did not violate the statute of frauds.
 
Long also contended that Article XV.K created an unenforceable penalty by requiring permanent forfeiture of his working interest based upon his non-consent. The Texas Supreme Court has approved Article VI.B.2 non-consent penalties, not as liquidated damages, but rather as incentives “for the risk takers . . . for agreeing to participate in new wells.” Here, if the well was not repaired, the owners’ leases and interests would expire. This presented Long and the other working interest owners with a basic decision to make: either “participate in operations to keep the leases in force or not” and watch the leases expire. Had the other working interest owners similarly elected to go non-consent, the leases would have terminated, and “Long would be in the same position he is in now.” However, the participating interest owners decided to “accept the financial risk of keeping the leases intact” by paying for the repair and eventual drilling of a replacement well. Ultimately, the court found that because the consenting owners assumed the risk while Long chose to avoid such risk, he was in no different position than if the lease had expired; therefore, “Article XV.K is not an unenforceable penalty or forfeiture.”
 
There were also interesting standing and jurisdictional issues in the case. RIM was apparently a contract operator owning no interest in the contract area and was the sole plaintiff in this declaratory judgment action. The court held that owning an interest was not necessary to give RIM standing, because RIM as operator had an interest in determining the identity and proportionate shares of the working interest owners. The relief sought was not inappropriate, because RIM did not seek specific performance of a contract (the JOA), but only a declaration of Long’s interest.   The working interest owners were not necessary parties, but only permissive parties. “[T]heir presence was unnecessary for the trial court to determine whether JOA Article XV.K required Long to assign his interest to them.”
 
Westland Oil Development Corp. v. Gulf Oil Corp. previously established that the JOA form nonconsent provisions were enforceable. The significance of this case is the holding that a blackout provision added to the form JOA in Article XV is enforceable. Adding a blackout provision in Article XV is a very common industry practice. However, it should be noted that this particular provision was very carefully drafted in contrast to the typical addendum which is often very abbreviated. It was also central to the holding that this blackout provision only applied to interests which would otherwise be lost if the parties did nothing. It is common in the industry to use blackout provisions more aggressively to incentivize participation, or penalize nonparticipation, depending on your perspective. The reasoning used in this case may not support a more aggressive blackout provision.