Joint Operations: Trends In JOA Operator/Non-Operator Disputes. The Exculpatory Clause. By Jana L. Grauberger LISKOW & LEWIS Houston, Texas

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1 Joint Operations: Trends In JOA Operator/Non-Operator Disputes By Jana L. Grauberger LISKOW & LEWIS Houston, Texas I. Introduction Follow the career path of many seasoned oil and gas litigation attorneys and the evolution of energy litigation will reveal itself to you. Decades of landowner royalty and development disputes, interspersed with the 1980s take-or-pay disputes (some of which took twenty years to reach final resolution) and class action royalty litigation initiated in the 1990s, has given way, in the 21st century, to less royalty-related litigation and more inter-company disputes under joint operating agreements (JOAs) and other similar agreements. Significant and evolving jurisprudence concerning the extent of protection afforded the operator under American Association of Petroleum Landmen (A.A.P.L.) Model Form JOAs may be one reason operator/nonoperator disputes are on the rise. Recent court decisions have restricted the scope of the exculpatory clause limiting operator liability to situations of gross negligence or willful misconduct to operations activities such as drilling and extraction. Even more recent decisions support operator removal based upon a material breach of the parties JOA or failure of the operator to perform its JOA obligations a standard that requires no showing of gross negligence or willful misconduct. This article examines recent case law interpreting the scope of the exculpatory clause and operator removal provisions, particularly as issues involving these JOA terms have arisen in a series of joint interest account disputes. 1 1 This article is an extension of a similar paper published in 2007 by the Rocky Mountain Mineral Law Institute. See Jana L. Grauberger II. The Exculpatory Clause A. Pertinent Model Form Operating Agreement Provisions The standard language of model form operating agreements requires the operator to act as a reasonably prudent operator and limits operator liability to non-operators to situations of gross negligence or willful misconduct. It also provides for removal of the operator under circumstances where the operator fails to carry out its duties under the JOA: ARTICLE V. OPERATOR A. Designation and Responsibilities of Operator: shall be the Operator on the Contract Area, and shall conduct and direct and have full control of all operations on the Contract Area as permitted and required by, and within the limits of this agreement.... Operator shall conduct its activities under this agreement as a reasonably prudent operator, in a good and workmanlike manner, with due diligence and dispatch, in accordance with good oilfield practices, and in compliance with applicable law and regulation, but in no event shall it have any liability as Operator to the other parties for losses sustained or liabilities incurred except such as may result from gross negligence or willful misconduct. B. Resignation or Removal of Operator and Selection of Successor: & Doug Tymkiw, Has the Operator's Protection Been "Plutoed"?: Joint Interest Disputes Between Operators and Non-Operators, 53 ROCKY MTN. MIN. L. INST (2007).

2 Resignation or Removal of Operator: Operator may resign at any time by giving written notice thereof to Non- Operators. If Operator terminates its legal existence, no longer owns an interest hereunder in the Contract Area, or is no longer capable of serving as Operator, Operator shall be deemed to have resigned without any action by Non-Operators, except the selection of a successor. Operator may be removed only for good cause by the affirmative vote of Non- Operators owning a majority interest based on ownership as shown on Exhibit A remaining after excluding the voting interest of Operator.... For purposes hereof, good cause shall mean not only gross negligence or willful misconduct but also the material breach of or inability to meet the standards of operation contained in Article V.A. or material failure or inability to perform its obligations under this agreement. 2 The above-quoted language comes from the A.A.P.L. Form Model Form. The 1977 and the 1982 versions of Form 610 contain similar exculpatory clause language. Interestingly, the original 1956 Form 610 s exculpatory clause provides that the operator has no liability to the other parties to the agreement for losses sustained, or liabilities incurred, except as may result from the operator s gross negligence or from operator s breach of the provisions of the agreement. 3 Much of the recent jurisprudence involving disputes between operators and nonoperators tracks the 1956 Form 610 exculpatory clause language more closely than the later versions of the Form 610, 2 A.A.P.L. Form , Model Form Operating Agreement, art. V.A. & V.B.1 (emphasis added). 3 A.A.P.L. Form , Model Form Operating Agreement 5 (emphasis added). even though the JOAs at issue are on those later A.A.P.L. Model Forms. B. Historical Judicial Interpretation of the Exculpatory Clause In a 1992 decision, Stine v. Marathon Oil Co., 4 the Fifth Circuit made an Erie 5 guess as to Texas law and interpreted the scope of the exculpatory clause in the 1977 A.A.P.L. Form 610 Model Form Operating Agreement broadly, holding that the language in Article V.A. of the JOA applied to all good faith actions undertaken by the operator pursuant to the JOA, including performance of its contractual administrative and accounting duties: This protection extends to Marathon s various administrative and accounting duties, including the recovery of costs under the authority of the JOA. It is clear to us that the protection of the exculpatory clause extends not only to acts unique to the operator, as the district court expressed it, but also to any acts done under authority of the JOA as Operator. This protection clearly extends to breaches of the JOA. It also reaches other acts including acts performed as Operator under the authority of the JOA (except for gross negligence or willful misconduct). 6 In Stine, a jury verdict resulted in a judgment against the operator, Marathon, for breach of contract for not delivering operation of two wells to its co-owner, Stine, prior to plugging and abandoning the wells, for not furnishing information required by the parties JOA to be shared between co F.2d 254, 261 (5th Cir. 1992). 5 The Erie doctrine is [t]he principle that a federal court exercising diversity jurisdiction over a case that does not involve a federal question must apply the substantive law of the state where the court sits. BLACK S LAW DICTIONARY 581 (8th ed. 2004) F.2d at 261.

3 owners, and for not timely completing certain wells in exploratory areas. 7 The jury also determined that Marathon had tortiously interfered with Stine s gas sales contract with a third party by causing the third party to withhold payments to Stine for gas due to the fact that Stine was in arrears on operating expenses due Marathon under the JOA, which was a remedy that the JOA provided to Marathon under such circumstances. Finding actual malice as to the tortious interference claim, the jury awarded $5 million in punitive damages. 8 The Fifth Circuit reversed the jury verdict and remanded for a new trial as to the breach of contract claims based upon the failure of the district court to require a showing of gross negligence or willful misconduct on the part of Marathon as it determined was required by the exculpatory clause for all acts taken by Marathon in its capacity as operator. 9 The court also reversed the jury verdict finding tortious interference, which resulted in the punitive damages award also being overruled. Stine s claim was that Marathon tortiously interfered with its gas sales contract by sending notices to the buyer instructing it to continue to pay gas sales proceeds to it, instead of Stine, when it knew or should have known that Stine s debt of outstanding operating expenses due Marathon as operator had already been satisfied. The Fifth Circuit determined that Marathon s actions in sending the notices were done in its capacity as operator and, as a result, the exculpatory clause applied and required a showing of gross negligence or willful misconduct. 10 The jury had received no such instruction, but had found actual malice in awarding punitive damages. However, the court did not decide whether such finding was sufficient to satisfy the exculpatory clause requirements due to a 7 at at at at 261. lack of causation between termination of the gas sales contract by Stine and the notices sent by Marathon. 11 Stine, along with other judicial decisions interpreting the exculpatory clause expansively, resulted in a sense of broad protection for operators from claims by nonoperators be they claims related to operational activities or, at least in some instances, other types of activities such as the accounting or administrative duties set forth in the JOA. 12 C. Texas Courts Take a Different View Eight years after Stine came Abraxas Petroleum Corp. v. Hornburg. 13 In Abraxas Petroleum Corp., a Texas court of appeals concluded that the exculpatory clause requirement that there be a showing of gross negligence or willful misconduct on the part of the operator was limited to claims involving the operator s physical activities and did not apply to performance of 11 at See, e.g., Palace Exploration Co. v. Petroleum Dev. Co., 374 F.3d 951 (10th Cir. 2004) (applying gross negligence/willful misconduct standard in JOA dispute and affirming summary judgment in favor of operator); Dime Box Petroleum Corp. v. Louisiana Land & Exploration Co., 938 F.2d 1144 (10th Cir. 1991) (applying gross negligence/willful misconduct standard and finding no operator liability for alleged excessive charges for pipe and deceptive billing); Parejo Ltd v. Getty Oil Co., Nos. CV F EDP, CV F EDP, 1991 WL (E.D. Ca. May 28, 1991) (applying gross negligence/willful misconduct standard of A.A.P.L. Form Model Form Operating Agreement and finding no proof that operator s conduct rose to this level or that operator committed any breach of the parties agreement) S.W.3d 741 (Tex. App. El Paso 2000, no pet.).

4 contractual obligations or administrative actions. 14 Abraxas became operator of four wells in an area that had been in continuous production for approximately 40 years. Shortly after becoming operator, well production declined severely, and several co-owners became disenchanted with Abraxas as operator. 15 Eventually, the co-owners sued Abraxas alleging negligence, gross negligence, willful misconduct, breach of contract, and waste. 16 On appeal, a principal issue was whether the exculpatory clause protected Abraxas from sending the co-owners an unjustified Authorization for Expense letter ( AFE ). The AFE gave the co-owners notice of $44,000 in "workover" operations necessary to regain production in the four wells. 17 If the co-owners failed to agree to the work proposed by the AFE, they would be subject to the JOA's non-consent penalties, which allowed Abraxas to recover 300% of the non-consenting co-owners proportionate share of the workover costs before the coowners would again be entitled to the proceeds of their share of production from the wells. The AFE was determined to be unjustified because the work proposed was really in the nature of routine repair work to be done by the operator and billed to the coowners through the joint interest account without any necessity of an AFE that would require the co-owners to decide whether or not to subject themselves to non-consent 14 at 759. Professor Ernest Smith questioned the more expansive Stine-type interpretation of exculpatory clause language well before the Abraxas Petroleum Corp. decision. See Ernest E. Smith, The Future Course of Oil and Gas Jurisprudence: Joint Operating Agreement Jurisprudence, 33 WASHBURN L.J. 834, (1994) S.W.3d at at at 747. penalties. 18 In addition, the amount of work to be done on each well did not trigger the $30,000 threshold for the sending of an AFE. 19 The appellate court rejected Abraxas argument that the fact that the jury failed to make a finding of gross negligence or willful misconduct precluded liability for breach of contract in sending the unjustified AFE. The court first noted that the exculpatory clause s location in the JOA, in a section dealing with operations in the contract area, was an indication that the parties did not intend for it to apply to any and all claims related to the JOA: More significantly, the operator s limitation of liability is linked directly to imposition of the duty to act as a reasonably prudent operator, which strictly concerns the manner in which the operator conducts drilling operations on the lease. Accordingly, we conclude that the exculpatory clause is limited to claims based upon an allegation that Abraxas failed to act as a reasonably prudent operator and does not apply to a claim that it breached the JOA. 20 Notably, in its decision, the Abraxas Petroleum Corp. court did not discuss or even cite to Stine or any of the other authorities relied upon by the Fifth Circuit in Stine. Shortly after Abraxas Petroleum Corp., in Cone v. Fagadau Energy Corp., 21 a different Texas appellate court rejected the notion that a showing of operator gross negligence or willful misconduct was required in order to prevail on claims based upon breach of contract and accounting issues. Again, although the applicable substantive law in 18 at at at S.W.3d 147, 155 (Tex. App. Eastland 2001, no pet.).

5 Stine was Texas law, the court did not address the Fifth Circuit case in its decision. Cone, a working interest owner, disputed charges made to his account by the operator, Fagadau Energy Corporation ( FEC ) as production expenses. 22 Apparently, Cone believed the charges to be improperly assessed since they related to a water flood program used to increase unit production that he had voted against, but that all the other owners had approved. 23 After FEC sued Cone to determined liability for the unpaid charges, Cone counterclaimed against FEC. 24 Following a trial court ruling in favor of the operator, Cone appealed. One issue before the court of appeals was whether the A.A.P.L. Form Model Form Operating Agreement limited causes of action against the operator to violations of the JOA based upon actions of gross negligence or willful misconduct. The trial court had struck Cone s pleadings to the extent they sought to hold FEC liable for any loss he sustained absent a showing of gross negligence or willful misconduct on FEC s part. 25 In reliance upon Abraxas Petroleum Corp., the appellate court held that the trial erred in its ruling on this point. 26 The court based its determination on the location of the exculpatory clause in the JOA where it immediately followed the provision requiring an operator to conduct operations in a good and workmanlike manner: Cone s complaints did not allege the failure of FEC to operate in a good and workmanlike manner. Rather, Cone s complaints alleged breaches of specific terms of the agreement and are in the nature of an accounting.... The gross negligence/willful 22 at at at 155. misconduct requirement applies to any and all claims that the operator failed to conduct operations in a good and workmanlike manner. 27 Because the record reflected that, in spite of its ruling granting FEC s special exception, the trial court had considered all of Cone s breach of contract arguments, the court of appeals found this error harmless. 28 The appellate court considered various points of error raised by Cone concerning charges he was assessed under the JOA by FEC, and affirmed the trial court s ruling that Cone could be charged his attributable portion of FEC s actual costs for the purchase of water for use in the flooding operations, even though he had not consented to such operations. 29 This ruling was based on the COPAS 30 attachment to the JOA, which provided that materials purchased for operations were to be charged at the price paid for them by the Operator. 31 Following Abraxas Petroleum Corp. and Cone, a third Texas appellate court addressed the scope of applicability of the JOA exculpatory clause in IP Petroleum Co., Inc. v. Wevanco Energy, L.L.C. 32 However, unlike those cases, IP Petroleum Co. involved operational activities claims against an operator for allegedly failing to drill deeply enough to test a specific formation and the court of appeals did require a showing of gross negligence or at The Council of Petroleum Accountants Societies (COPAS), a national organization since 1961, has issued a succession of accounting forms which serve as the primary source of oil and gas accounting standards in the industry. Armstrong Petroleum Corp. v. Tri-Valley Oil & Gas Co., 11 Cal. Rptr. 3d 412, 417 (Cal. Ct. App. 2004) S.W.3d at S.W.3d 888 (Tex. App. Houston [1st Dist] 2003, pet. denied).

6 willful misconduct in order to hold the operator liable. 33 The court emphasized that the non-operators claims for damages involved physical activity, and not claims based upon breach of contract: Here, the basis of the plaintiffs claims is alleged misconduct arising from the manner in which IP, as operator, conducted drilling operations on the lease. Unlike in Cone and Abraxas, the plaintiffs alleged that IP failed to conduct operations in a good and workmanlike manner and failed to act as a reasonably prudent operator.... Accordingly, the exculpatory clauses in the JOA applied, and the plaintiffs had to establish that IP was grossly negligent or acted with willful misconduct when it breached the contract. 34 The court of appeals found that the acts complained of by the plaintiff working interest owners no written drilling plan, getting stuck during drilling operations, failure to run a drill stem test, failure to communicate certain information to the working interest owners, misleading the working interest owners about plans to deepen a well, etc. might be sufficient to prove negligence, but did not rise to the level of gross negligence or willful misconduct. 35 As a result, the jury verdict, which had awarded $4 million in lost profits on a wildcat well, plus $1.5 million in attorney fees, was reversed at at at at 894, 900. A wildcat well is a speculative well that does not offer a reasonable expectation of profit to a reasonably prudent operator under the same or similar facts and circumstances. at 891 n.2 (quoting Sun Exploration & Prod. Co. v. Jackson, 715 S.W.2d 199, 202 (Tex. App. Houston [1st Dist.] 1986), rev d in part on other grounds, 783 S.W.2d 202 III. Recent Cases Involving Joint Interest Account Abuse Claims In recent years, a number of cases in various jurisdictions have involved claims by non-operators against operators for alleged accounting abuses and mismanagement of the joint interest account. The types of claims made vary widely and include untimely billings, 37 delays in paying expenses, 38 delays in making payments due interest owners, 39 excessive drilling and operations costs, 40 double billings, 41 improper assessment of charges against the joint account, 42 failing to supply information requested by non-operators, 43 (Tex. 1989)). Other commentators have also addressed recent jurisprudence involving exculpatory clauses. See, e.g., Jonathan A. Hunter & Cheryl M. Kornick, Operator Liability in the 21st Century: Is Being in Charge Still Worth It?, 51 ROCKY MT. MIN. L. INST (2005); John R. Reeves & J. Matthew Thompson, The Development of the Model Form Operating Agreement: An Interpretative Accounting, 54 OKLA. L. REV. 211 (2001); Wilson Woods, Comment, The Effect of Exculpatory Clauses in Joint Operating Agreements: What Protections Do Operators Really Have in the Oil Patch?, 38 TEX. TECH. L. REV. 211 (2005). 37 R & R Res. Corp. v. Echelon Oil & Gas, L.L.C., No CV, 2006 WL 66458, at *6 (Tex. App. Austin Jan. 10, 2006, no pet. h.) Shell Rocky Mt. Prod., L.L.C. v. Ultra Res., Inc., 415 F.3d 1158, 1168 (10th Cir. 2005); Abraxas Petroleum Corp. v. Hornburg, 20 S.W.3d 741, 748 (Tex. App. El Paso 2000, no pet.). 41 Lobo Exploration Co. v. Amoco Prod. Co., 991 P.2d 1048, 1049 (Okla. Civ. App. 1999). 42 Tri-Star Petroleum Co. v. Tipperary Corp., 101 S.W.3d 583, (Tex. App. El Paso 2003, pet. denied). 43 at 590.

7 improper commingling of funds, 44 unexplained classification and reclassification of amounts billed to the joint account, 45 overcharges to the joint account, 46 and improper allocation of payments made by a non-operator. 47 Not only are non-operators initiating lawsuits asserting these types of claims, an operator that brings a JOA-related claim against one or more of its non-operators can expect to face counterclaims related to disputes over its management of the joint interest account. A. Cases Interpreting the Scope of the Exculpatory Clause Several of these recent cases have adopted or expanded upon the Abraxas Petroleum Corp. rationale in situations involving joint interest account disputes between operators and non-operators. As reflected below, operators have little remaining comfort that the JOA exculpatory clause will prevent claims by non-operators for accounting disputes. 48 Recent jurisprudence reflects a Grynberg v. Citation Oil & Gas Corp., 573 N.W.2d 493, (S.D. 1997); Stable Energy, L.P. v. Kachina Oil & Gas, Inc., 52 S.W.3d 327, (Tex. App. Austin 2001, no pet.). 48 Above and beyond cases involving the applicability of JOA exculpatory clauses, Grynberg v. Citation Oil & Gas Corp., 573 N.W.2d 493, (S.D. 1997), is an example of an accounting dispute involving conduct deemed so egregious as to support a cause of action for the tort of deceit independent of any contractual obligations. In Grynberg, the court found evidence that the operator intentionally and fraudulently misallocated costs to one well the entire cost of a production road, tank battery, costs associated with converting a well used to dispose of salt water, and other costs for work actually done on other wells for projects that served multiple wells or involved different wells. The operator did so general unwillingness to interpret JOA exculpatory clauses broadly when it comes to the operator s handling of non-operational activities. Moreover, courts are looking closely at the requirements imposed under the parties JOA and the COPAS Accounting Procedures, and an operator s failure to operate according to the terms of these detailed contracts could easily support a successful non-operator claim. Shell Rocky Mountain Production, L.L.C. v. Ultra Resources, Inc. is an example of an operator claim spurring counterclaims involving joint interest account issues by the non-operator. 49 In this case Shell brought a declaratory judgment action against Ultra Resources regarding which party was entitled to operate a well on jointly leased lands. 50 Ultra Resources counterclaimed against Shell asserting that Shell breached the JOAs by imposing excessive drilling and operations costs on wells for which Shell was already the operator. 51 The trial court granted summary judgment holding that, absent a showing of gross negligence or willful misconduct, the exculpatory clause barred Ultra Resources excessive costs claims against Shell. 52 The Tenth Circuit reversed the district court s decision barring the excessive costs claims. 53 In doing so, the court first noted the existence of specific duties in the JOA that the operator incur costs that are similar to those incurred by other operators in the contract area to drill and complete wells, and that the operator drill and complete wells at generally prevailing rates. 54 Ultra to maximize its non-consent penalties against non-consenting interest owners on one well. Such conduct supported a tort claim, which led to an award of $1 million in punitive damages against the operator F.3d 1158 (10th Cir. 2005). 50 at at at at 1168.

8 Resources alleged that Shell charged in excess of generally prevailing rates and, thus, breached the JOAs. 55 Shell argued that the exculpatory clause of the JOAs protected it from liability absent a showing of gross negligence or willful misconduct. 56 However, the Tenth Circuit rejected the argument that the exculpatory clause applied to the breach of express terms of the JOAs. 57 The court determined that (1) parties would not include such explicit directions on administrative matters if they did not intend the operator to be liable for breach of them; (2) the types of duties at issue did not involve extraordinary risk like drilling operations, etc.; and (3) an expansive reading of the exculpatory clause might encourage operators to take advantage of non-operators: While a higher standard for breach might apply to drilling, extraction, and other risky operations because most operators have the same incentive as non-operators to do well in physical operations, it is nonsensical to apply such a standard to administrative and accounting duties where the operator can profit by cheating, or simply overcharging, its working interest owners. 58 Interestingly, the court s concern about the potential for an operator to take advantage of non-operators is echoed in other recent decisions, and this concept appears to be a policy consideration that is driving courts to rule in favor of limiting the scope of JOA exculpatory clauses. Forest Oil Corp. v. Union Oil Co. 59 is an example of a court focusing on the detailed nature of the JOA the COPAS Accounting Procedure attachment, in particular and at No. 3:05-CV-0078-RRB, 2006 WL (D. Alaska Apr. 7, 2006). holding an operator to the accounting standards and methods contained therein. In Forest Oil Corp., the non-operator asserted claims against the operator for breach of the parties JOAs by charging inflated fees for the disposal of naturally occurring radioactive material (NORM). 60 The operator, Unocal, charged the joint interest account $275/barrel for disposal of NORM generated from the offshore oil and gas leases in which both Unocal and Forest Oil owned working interests in Alaska s Cook Inlet. 61 At the outset, the court noted that the JOAs between Unocal and Forest expressly incorporated documents titled Accounting Procedure Offshore Joint Operations, which were developed by COPAS. The COPAS Procedures identified two methods of calculating charges to the joint account for this type of expense: (1) rates commensurate with costs of ownership and operation, which includes labor, maintenance, repairs, insurance, taxes, depreciation, and the like; or (2) average commercial rates prevailing in the area less 20%. 62 However, Unocal did not base the $275/barrel charge on either of these methods and, instead, appeared to have focused more on getting the waste disposed and getting a fair cost recovery. 63 Based upon this evidence, the court determined that the operator failed to follow the express terms of the contract in calculating appropriate NORM disposal charges for the joint interest account: Unocal did not follow the procedures specified in... the COPAS Procedures. 64 In evaluating whether a breach of contract had occurred, the court first had to determine the scope of the exculpatory clause in the applicable operating agreement. It provided that the [o]perator shall conduct all operations in a good and workmanlike manner, and that the 60 at *1. 61 at * at *3. 64

9 [o]perator shall not be liable to the [parties to the agreement] for damages, unless such damages result from [o]perator s gross negligence or willful misconduct. 65 Unocal argued that the exculpatory clause included both operational and accounting activity, while Forest argued that the exculpatory clause applied only to operational activity. After noting the differing results reached by the Fifth Circuit in Stine and by the Tenth Circuit in Shell Rocky Mountain Production, the court chose to follow the Tenth Circuit and held that Unocal had breached its duty to charge for NORM disposal in accord with the parties JOAs: This Court agrees with the holding and reasoning of the Tenth Circuit. A broader reading of the clause would allow a party to act negligently (just not grossly) in following its express contractual administrative and accounting duties. 66 Interestingly, Unocal s testimony was to the effect that the $275/barrel NORM disposal charge likely was a significant undercharge for NORM disposal. 67 PYR Energy Corp. v. Samson Resources Co. 68 largely concerns the pooling of interests and the authority to do so. Yet, it also addresses the scope of a JOA exculpatory clause, although it does so in a hypothetical environment. The plaintiff nonoperator in PYR Energy Corp. claimed that Samson breached its duty to perform the JOA in a good and workmanlike manner when it allegedly formed a unit in order to maintain leases and by forming a unit that it knew or should have known included nonproductive acreage. 69 Samson argued for summary judgment in its favor based upon the fact that the JOA exculpatory clause required a showing of gross negligence or willful misconduct for it to be held liable, and there was no such showing in the record. 70 The court deferred until trial ruling on the at * F. Supp. 2d 709 (E.D. Tex. 2007). 69 at at 723. scope of the exculpatory clause and on the merits of whether the non-operator s argument could support a finding of failure to act as a reasonably prudent operator. 71 However, the federal district court did a thorough examination of Stine, Abraxas Petroleum Corp., and related cases, and found that it would be bound to follow the circuit precedent set forth in Stine: Although the Texas Supreme Court has not ruled on this issue, Stine may not accurately forecast Texas law. First, no Texas court has followed or even cited Stine s substantive holding in the almost fifteen years since the Fifth Circuit made its Erie guess. Second, subsequent holdings and statements by three separate Texas courts of appeals suggest that Stine may no longer correctly state Texas law....[yet], [t]his trial court surely is as bound to follow prior circuit precedent as are subsequent panels of the circuit court of appeals. Here, there is no clearly contrary subsequent holding of the Texas Supreme Court; nor is there subsequent statutory authority, squarely on point, available for guidance. Arguably, there are unanimous or near-unanimous intermediate appellate court holdings disagreeing with Stine, but they don t come close to a majority of Texas s 14 intermediate appellate districts. Therefore, even though Stine has never been followed, the preconditions for departing from Stine are not shown to exist in this case. 72 Samson s motion for summary judgment was denied on grounds of prematurity, and the court s analysis serves as nothing more than a possible forecast that it would follow Stine if these arguments were reasserted at at

10 trial or otherwise. 73 Ultimately, PYR Energy Corp. settled before trial, and, as a result, the district court never ruled on the scope of the exculpatory clause. B. Operator Removal Cases The JOA provisions concerning operator removal have proven useful to nonoperators seeking to bring claims against the operator without invoking the gross negligence or willful misconduct requirements of the exculpatory clause. In Tri-Star Petroleum Co. v. Tipperary Corp., a Texas appellate court affirmed a temporary restraining order removing the designated operator of a large natural gas project located in Queensland, Australia. 74 The JOA provided for removal of the operator upon a showing of its failing or refusing to carry out its duties under the agreement. The operator argued that the trial court should have applied the gross negligence standard of the JOA exculpatory clause, or, alternatively, that its removal was improper absent a showing of complete abdication of all activity and responsibility by abandonment or by allowing another party to conduct operations on the contract area. 75 The court of appeals found no evidence that the trial court had abused its discretion in finding that the non-operators had cause to remove the operator by virtue of its evidence that the operator: (1) improperly assessed charges to the joint account; (2) failed to supply reasonable information requested by the non-operators; (3) commingled funds that did not belong to the joint account; (4) inexplicably classified and reclassified amounts billed to the joint account; (5) failed to provide timely and proper adjustments to the joint account for surpluses in a foreign exchange account; (6) double-charged the non-operators on 73 at S.W.3d 583, 589 (Tex. App. El Paso 2003, pet. denied). 75 at 590. cash calls and other billings; (7) allowed the premature loss of acreage; and (8) was unable to sustain deliverable quantities of gas under existing contracts. 76 The appellate court s decision was based upon its review of the evidence and an examination of the JOA provisions to determine whether the non-operator had demonstrated a probable right to recovery the applicable injunction standard. The court concluded that the trial court could have determined that the JOA provisions were unambiguous and thus its terms should be given their plain, ordinary, and generally accepted meaning. 77 In R & R Resources Corp. v. Echelon Oil & Gas, L.L.C., 78 another Texas appellate court affirmed a temporary restraining order which approved the non-operators removal of the operator and enjoined the operator from refusing to turn over operations. The JOAs at issue, both A.A.P.L. Form Model Forms, provided for removal of the operator for good cause, which the agreement defined as gross negligence, willful misconduct, or the material breach of or inability to perform its obligations under the agreement. 79 In support of their claim for removal, the non-operators presented evidence of improper operational and accounting practices, including: excessive operational charges, late payment of lease expenses, loss or delay in production, and damage to the lease equipment. 80 The operator argued that removal was improper given that the wells at issue had produced oil and gas in paying quantities under its operatorship, that it had made proportional distributions of this income each month, and an audit of its financial records by nonoperators revealed no unpaid invoices, 76 at at No CV, 2006 WL (Tex. App. Austin Jan. 10, 2006, no pet. h.). 79 at *2. 80 at *6.

11 pollution, loss of acreage, liens, or claims against the wells. 81 However, testimony and evidence from the non-operators demonstrated that the operator had an I m going to do it the way I m going to do it and you can like it or dislike it attitude. 82 There was also testimony that continued late payments to vendors one of the complaints against this operator could cause vendors to refuse to extend credit, charge higher prices, or refuse to provide services. 83 Additionally, the non-operators presented evidence that the newly elected operator could do a better job, had more experience, more personnel, and a better location. 84 In light of this evidence, the court affirmed the trial court s decision that R & R Resources improper accounting and operation practices which were a material breach of the standards of operation and/or inability to meet the standards of operation and a material failure or inability to perform obligations under the joint operating agreements constituted good cause for its removal as operator. 85 negligence, there must be evidence that [the operator] had actual subjective knowledge of an extreme risk of serious harm. 86 The magnitude of the risk is judged from the viewpoint of the defendant at the time the events occurred. 87 The harm anticipated must be extraordinary harm, not the type of harm ordinarily associated with breaches of contract or even with bad faith denials of contract rights; harm such as death, grievous physical injury, or financial ruin. 88 In other states, such as Louisiana, the standard for establishing gross negligence is also a high one. Gross negligence is described as the want of even slight care and diligence and the want of that diligence which even careless men are accustomed to exercise. 89 Gross negligence has also been defined as: [T]he entire absence of care, or very great negligence. It consists of utter disregard of the dictates of prudence, amounting to complete neglect of the rights of others. 90 C. Gross Negligence and Willful Misconduct Defined The evolution of the interpretation of the scope of the exculpatory clause is important because, as demonstrated in cases such as IP Petroleum Co., the standard of proof required to establish liability based upon gross negligence or willful misconduct is very high. Accordingly, in many instances, success of a claim for breach of the parties JOA will hinge on whether or not the exculpatory clause applies. In IP Petroleum Co., the court discussed the standard under Texas law for proof of gross negligence: To support a finding of gross at *7. 83 at * at * S.W.3d 888, 897 (Tex. App. Houston [1st Dist.] 2003, pet. denied) (quoting Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 22 (Tex. 1994)) (quoting Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 24 (Tex. 1994)). See also Bluebonnet Sav. Bank, F.S.B. v. Grayridge Apartment Homes, Inc., 907 S.W.2d 904, 911 (Tex. App. Houston [1st Dist.] 1995, writ denied). 89 State v. Vinzant, 200 La. 301, 7 So. 2d 917 (1942); see also Okla. Stat. tit. 25, 6 ( [G]ross negligence [consists] in the want of slight care and diligence. ); Palace Exploration Co. v. Petroleum Dev. Co., 374 F.3d 951 (10th Cir. 2004). 90 Hendry Corp. v. Aircraft Rescue Vessels, 113 F. Supp. 198 (E.D. La. 1953) (applying Louisiana law).

12 And, courts in both Texas and Louisiana have ruled that there is no real distinction between willful misconduct and gross negligence. 91 In Colorado, willful misconduct and gross negligence are evaluated similarly, as the statutory definition of willful misconduct closely resembles the common law definition of gross negligence: willful and wanton conduct means conduct purposefully committed which the actor must have realized as dangerous, done heedlessly and recklessly, without due regard to consequences, or of the rights and safety of others, particularly the plaintiff. 92 And, while the Oklahoma Supreme Court has not expressly held that gross negligence and willful conduct are indistinct, the definition employed by that court implies that the two terms are nearly synonymous: gross negligence is [t]he intentional failure to perform a manifest duty in reckless disregard of the consequences or in callous indifference to the life, liberty or property of another [which] may result in such a gross want of care for the rights of others and the public that a finding of a willful, wanton, deliberate act is justified See IP Petroleum Co., Inc. v. Wevanco Energy Co., L.L.C., 116 S.W.3d 888, 898 (Tex. App. Houston [1st Dist] 2003, pet. denied); Falkowski v. Maurus, (La. App. 1st Cir. 9/9/93), 637 So. 2d Colo. Rev. Stat (1)(b); cf. White v. Hansen, 837 P.2d 1229, 1233 (Colo. 1992) (adopting the Black's Law Dictionary definition of gross negligence ( The intentional failure to perform a manifest duty in reckless disregard of the consequences as affecting the life or property of another; such gross want of care and regard for the rights of others as to justify the presumption of willfulness and wantonness. ), but noting that willful negligence, though rejected by some courts, connotes a higher or more aggravated form of negligence than gross ). 93 Fox v. Oklahoma Mem'l Hosp., 774 P.2d 459, 461 (Okla. 1989). IV. Other Recent Cases Involving JOA Issues Beyond litigation concerning the scope of the exculpatory clause and operator removal, two recent cases of note involve JOA issues related to the issues discussed above and are worthy of mention. Seagull Energy E&P, Inc. v. Eland Energy Inc., 94 is a much-discussed Texas case allowing an operator to recover current joint account expenses related to plugging and abandonment of two wells from the predecessor of the current non-operating interest. 95 And, in Burlington Resources, Inc. v. United National Ins. Co., 96 a Louisiana federal district court enforced an excess coverage insurance policy on a claim by a non-operator that had assumed partial liability pursuant to the parties JOA. In Seagull Energy, the operator and lessee of two federal offshore Gulf of Mexico leases, Seagull Energy, brought a breach of contract suit against its co-lessee, Nor-Tex Gas Corporation for failure to pay its share of the lease operating costs as required by the two operating agreements between the parties. 97 Nor-Tex had purchased its interest in the leases from Eland Energy, and Seagull also named Eland as a defendant in the lawsuit. 98 On cross motions for summary judgment, the trial court held both Nor-Tex and Eland jointly and severally liable to Seagull for the unpaid operating expenses. 99 The court found that Eland remained liable for the expenses even though it no longer owned an interest S.W.3d 342 (Tex. 2006). 95 For an in-depth consideration of the Seagull Energy decision, see David Patton, Bad Moon Rising The Continuing Liability of an Assignee After Assignment, 53 ROCKY MTN. MIN. L. INST (2007) F. Supp. 2d 567 (E.D. La. 2007) S.W.3d at

13 in the leases. 100 The court of appeal reversed, in part, concluding that Eland had no continuing liability under the operating agreements after it assigned its working interest to Nor-Tex because the agreements had no express provision imposing an obligation of continuing liability. 101 On review before the Texas Supreme Court, Eland argued that its responsibility for reimbursement of operating expenses terminated on the date it assigned its interest to Nor-Tex. Eland based its position on several provisions in the operating agreements that tied its obligation for payment of expenses to its participating interest, which was based on its ownership in the leases. For example, the contract provision concerning expenditures stated that the Operator shall pay all costs and each Party shall reimburse Operator in proportion to its Participating Interest. 102 The Texas Supreme Court rejected Eland s arguments finding it significant that none of the provisions relied upon related to sharing of costs and participating interests dealt with the subject of release or the consequences which are to follow the assignment of a working interest. 103 Instead, the court found nothing in the contracts expressly releasing the assignor upon assignment of its working interest, and, as a result, the general rule that a party cannot escape its obligation under a contract merely by assigning the contract to a third party was applied: Because the operating agreement did not expressly provide that Eland s obligations under the operating agreement should terminate upon assignment and Seagull did not expressly release Eland following the assignment of its working interest, we reverse the court of appeals judgment at at at 346. and render judgment for Seagull as the trial court did. 104 Significant to the Seagull Energy decision are several facts not mentioned in the Texas Supreme Court s opinion, namely, that Nor-Tex was bankrupt, and that it had acquired Eland s interests for $500 each at an auction with no minimum bid, which raised a significant policy issue of the propriety of allowing a party to assign away its interests in a lease once production waned to a financially insolvent party for minimal consideration in order to avoid plugging and abandonment obligations under the lease. 105 It is also significant that the leases involved were federal OCS leases, which allow the federal government s MMS to look to present owners, as well as any prior interest owners, in relation to plugging and abandonment responsibilities. 106 The result under the particular facts may not be undesired, but the purchase and sale agreement whereby Nor-Tex was assigned Eland s interests like virtually every other PSA stated that all obligations related to the interests passed to Nor-Tex as of the assignment date. 107 Accordingly, post- Seagull Energy, assignors of oil and gas interests need to pay close attention to their operating agreements and negotiate for the inclusion of language providing for an express release upon assignment or achieve the same result through an addendum or side agreement at the time the assignment is made. Burlington Resources, Inc. v. United National Insurance Co. concerned whether partial liability assumed under a contract is covered by an excess 104 at Eland Energy, Inc. v. Seagull Energy E&P, Inc., 135 S.W.3d 122, 129 (Tex. App. Houston [14th Dist.] 2004), rev d, 207 S.W.3d 342 (Tex. 2006). 106 See, e.g., 30 C.F.R , , S.W.3d at 123.

14 coverage insurance policy. 108 Burlington, as non-operator, and Meridian Resources & Exploration Company, as operator, were parties to a JOA covering oil and gas drilling on three compulsory units in Assumption Parish, Louisiana. 109 Under the JOA, Burlington did not have any operational or supervisory control, but it was required to reimburse Meridian for damages arising from well operations. 110 In response to a claim brought after a blowout on a well covered by the JOA, Meridian agreed to a settlement totaling $10,865,384, the first $1,000,000 of which was covered by Meridian s insurance. 111 Under the JOA, Burlington was obligated to pay 26% of the remainder, corresponding to its percentage of the non-operating interest. 112 Burlington s primary insurer covered the first $2,000,000 of Burlington s obligation, and Burlington sought reimbursement of the remainder from United National Insurance Company as its first layer excess insurer. United National denied coverage. 113 Burlington sued for breach of contract, and United National moved for summary judgment on the ground that Burlington s agreement to pay a certain percentage of the JOA obligations did not constitute an assumption of Meridian s liability, a prerequisite to the invocation of United National s liability coverage. 114 Burlington responded that although, as a nonoperator, it did not have any duty, and thus tort liability, to the blowout plaintiffs, its obligation to pay arose instead out of the JOA indemnification provision. 115 Because the blowout occurred in Louisiana and the JOA named Louisiana in its choice of law provision, the court F. Supp. 2d 567 (E.D. La. 2007). 109 at at at determined that Louisiana law applied to the parties claims. 116 Noting that it is the burden of the insurer to demonstrate that a policy provision excludes or limits coverage, the court held that the plain language of the contract required United National to provide coverage for any amount of money which Burlington must pay if it assumed such liability under a contract or agreement. 117 The court next considered whether Burlington s partial payment towards the settlement was excluded from the coverage of the United National policy. Louisiana law provides that a non-operator of a well without supervisory powers is not liable for the tortious acts of the operator, unless otherwise agreed. 118 Though Burlington did not have any direct tort liability to the plaintiffs, the JOA in question required Burlington to pay 26% of Meridian s liability for any settlement amount. 119 Moreover, the type of damages for which payment was sought was included in the specified categories of damages covered by the United National policy. 120 On these grounds, the court held that the plain language of the policy required United National to reimburse Burlington for its contractual payment to Meridian. 121 V. Conclusion At present, it appears that any claim by a non-operator that the operator has breached its obligation to conduct physical operations in a good and workmanlike manner will, in all likelihood, be subject to the gross negligence/willful misconduct standard of the exculpatory clause. Likewise, any claim by a non-operator that the operator has breached express administrative or accounting obligations will 116 at at at at at 575.

15 probably not be subject to the higher standards of the exculpatory clause under the most recent jurisprudence. The more interesting question is what lies ahead in the evolutionary process of JOA exculpatory clause interpretation. Will courts expand upon the incentive analysis set forth in the Tenth Circuit s Shell Rocky Mountain Production decision? If a nonoperator can show that its interests diverged from those of the operator or that the operator had an incentive to act contrary to the interests of its working interest owners, a strong argument could be made against application of the exculpatory clause. And, where exactly is the line drawn between physical operations and administrative actions? It may not always be so easy to separate a non-operator s troubles with an operator into purely physical or purely administrative issues. For example, in IP Petroleum Co., the failure to communicate with working interest owners was determined to be a claim related to physical operations. And, in Cone, claims related to a water flood program were found to be administrative in nature. In order to provide greater certainty to operators and non-operators alike, it just might be time for a new Model Form exculpatory clause.