Face Challenges Confidently

286 XTO Energy Inc. v. Smith Prod. Inc.

Wednesday, September 2nd, 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.
XTO Energy Inc. v. Smith Production Inc., 282 S.W.3d 672 (Tex. App.—Houston [14th Dist.] 2009, pet. granted), holds that a non-consent election under a 1982 A.A.P.L. form JOA as to subsequent drilling operations is final when made. Pursuant to two joint operating agreements based on the American Association of Petroleum Landmen  Model  Form  Operating Agreement 610-1982 (“JOA”), the operator gave written notice to the non-operators of its proposal to drill four new wells. The JOA gave the non-operators thirty days to elect to participate or go “non-consent.” One of the non-operators (“Non-Consenting Party”) gave notice to the operator that it was electing not to participate in drilling the wells. Then, within the thirty- day election period provided in the JOA, the Non-Consenting Party sent the operator a letter stating that it was electing to participate, that it was revoking its prior notification to the contrary, and that the election not to participate had been sent in error. Notwithstanding the second notice, the operator continued to treat the non-operator as a non-consenting party under the JOA. The Non-Consenting Party brought suit against the operator for breach of contract.
In a matter of first impression, the court concluded “that, under the unambiguous language of the agreements, such a party may not change its election after it gives notice of its election to the proposing party.”
Article VI.B of the JOA in this case generally tracks the form of the 1982 Model Form Operating Agreement and provides the procedures the parties to the JOA must follow when a new well is proposed.  Article VI.B provides in part:
B. Subsequent Operations:

  1. Proposed Operations: Should any party hereto desire to drill any well on the Contract Area other than the [initial well], . . . the party desiring to drill . . . such a well shall give the other parties written notice . . . . The parties receiving such a notice shall have thirty (30) days after receipt of the notice within which to notify the party wishing to do the work whether they elect to participate in the cost of the proposed operation . . . . Failure of a party receiving such notice to reply within the period above fixed shall constitute an election by that party not to participate in the cost of the proposed operation . . . .

If the Consenting Parties comply with the requirements of Article VI.B.2. by drilling the well as proposed, then the interest of any Non-Consenting Party is subject to the Non-Consent penalties included in the JOA, which in this case included a 400% penalty on drilling costs.
The JOA is silent as to whether the Non-Consenting Party may, or may not, change its election. The Non-Consenting Party argued that the JOA was unambiguous and allowed the Non-Consenting  Party  to  change  its  election  within  thirty  days  of  receiving  the  notice. Alternatively, the Non-Consenting Party argued that the JOA was ambiguous. The court disagreed with the Non-Consenting Party’s arguments and held that “allowing such a change in election would conflict with the intent of the parties as expressed in the unambiguous language of Article VI.B.”
In reaching its conclusion, the court used the “four corners” approach to ascertain the intentions of the parties. In applying this approach, the court examined the two JOAs “in their entirety in an effort to harmonize and give effect to all of their provisions so that none will be rendered meaningless.” The court found the timing of the procedures set forth in Article VI is consistent with intent not to allow changes to elections by the receiving parties. Article VI of the JOA requires the proposing party to notify the Consenting Parties of any Non-Consenting Party “immediately after” the expiration of the notice period and also requires that proposed operations must be commenced within ninety days after the expiration of the notice period. “Construing Article VI to not allow changes in elections by the receiving parties is consistent with” these provisions of the JOA.
The timing of required events under Article VI of the JOAs, accompanied by the time sensitive nature of drilling operations (i.e., the proposing party must make financial arrangements, begin drilling within ninety days of the expiration of the notice period, and pursue operations with due diligence), led the court to conclude that the operator’s construction of the JOA was the “only reasonable construction of the language at issue.” In this case, all of the non- operators made their election before the Non-Consenting Party changed its election, but that was not a factor the court deemed relevant. The court expressly held that the notice period provided in the JOA expired as to the Non-Consenting Party when the Non-Consenting Party gave notice of its election.
The significance of the case is the holding that, under a very common form of JOA, an election to go “non-consent” as to subsequent drilling operations is final when made and cannot thereafter be revoked. Such an election cannot be revoked even if the revocation is within the thirty days originally given under the form JOA to the non-operator to make an election, or even if the general notice period is still open because some other non-operator has not yet elected.