163 Valence Operating Company v. Dorsett

Richard F. Brown

 
Valence Operating Company v. Dorsett, 164 S.W.3d 656 (Tex. 2005), construes the notice and non-consent provisions applicable to subsequent operations under the A.A.P.L. Form 610–1977 Model Form Operating Agreement (“JOA”), as primarily determined by the notice provision found in Article VI.B.(1) of the JOA. The key holding in the case is that the JOA permits the operator to commence work before the expiration of the thirty-day notice period required for subsequent operations. The notice is given to other owners so they may elect to consent to subsequent operations or elect to go non-consent. Valence, as operator, proposed drilling a series of wells over time under various notices, and none of them gave thirty days notice prior to the commencement of operations. Dorsett argued that the non-consent provisions were inapplicable because of the failure of Valence to give notice thirty days prior to the commencement of operations as required by the JOA, and therefore Dorsett was entitled to recover the leasehold interests Dorsett lost over a period of ten years by going non-consent. Valence argued that the operator could commence operations at any time, and that Article VI.B.(1) requires only that the operator allow the non-operator thirty days to elect to participate, regardless of the timing of the commencement of operations.
 
The JOA provided that the operator “shall, within sixty (60) days after the expiration of the notice period of thirty (30) days . . . actually commence work on the proposed operation and complete it with due diligence.” The court agreed with Valence that “the provision’s purpose is not to prohibit the early commencement of work, but to ensure that work is not unreasonably delayed after the consent deadline.” The court based its opinion on the plain language of the JOA and the conclusion that early commencement could be beneficial (e.g. by offsetting a draining well) and that the entire risk of early commencement falls on the operator, with no apparent consequences to the other working interest owners.
 
Dorsett also claimed that the non-consent provisions were an unenforceable liquidated damages provision. The court construed the non-consent provisions as a reward to the consenting parties for undertaking a defined risk, rather than a liquidated damages clause. The court expressly disapproved prior authority treating the non-consent penalty as a liquidated damages provision. The court reasoned that to construe the provision otherwise would mean that no one would consent, because there would be no incentive to do so. The concurring opinion also noted that the “non-consent penalty” is industry vernacular and does not appear in the JOA, but “those in the oil industry widely use and rely on clauses like the one here, and certainly consider them enforceable.”
 
The significance of the case is that it confirms (at least under the language in the 1977 M.F.O.A) a fairly common industry practice. If the operator knows that the participating parties will go forward, regardless of whether some of the owners go non-consent, then the operator frequently commences the operation before all the elections are in. The only real issue is the expense and revenue sharing ratios. If Dorsett’s theory prevailed, many, many property rights over extended periods of time would be subject to challenge.