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January 30, 2013 Articles

Oil and Gas Operator Liability in Texas—”What's in Your Contract?

Reeder v. Wood County Energy, LLC demonstrates the importance of seemingly minor differences in the language of exculpatory clauses. What does your contract say?

Jack G. Carnegie – January 30, 2013

The American Association of Professional Landmen (AAPL) Model Form Operating Agreement commonly used in the energy industry contains broad exculpatory language protecting the operator. For example, the 1982 AAPL Model Form Operating Agreement contains the following language:

________ shall be the Operator of 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. It shall conduct all such operations in a good and workmanlike manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except such as may result from gross negligence or willful misconduct.

This form imposes an obligation on the operator to conduct operations in a good and workmanlike manner. At the same time, it exempts the operator from liability as operator, except for gross negligence or willful misconduct.

Does this language exempt the operator from liability for breach of contract in Texas? Given the fact that this form has been in common use for 30 years, one might think that the courts would have definitively decided that question long ago. Not so. There has been a split of authority on the issue.

In Stine v. Marathon Oil Co., 976 F.2d 254 (5th Cir. 1992), Stine alleged that Marathon breached duties owed him under the joint-operating agreement (JOA) in connection with testing and completion of wells; that Marathon tortiously interfered with his gas-sale contract; and that Marathon, by failing to drill certain exploratory wells, abandoned a substantial portion of the lease acreage and, therefore, Stine was entitled to an assignment of that acreage.

The exculpatory language of the JOA in Stine was identical to the 1982 model form quoted above. The Fifth Circuit construed it as exempting the operator from liability for breach of contract unless the operator was grossly negligent or committed willful misconduct:

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 the 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 that amount to tortious interference with contracts with third parties. We, therefore, hold that the exculpatory clause protects Marathon from liability for any act taken in its capacity "as Operator" under the JOA (except for gross negligence or willful misconduct).

Id. at 261 (emphasis added).

Not all courts agreed with the ruling in Stine. For example, the court in Abraxas Petroleum Corp. v. Hornburg, 20 S.W.3d 741, 759 (Tex. App.-El Paso 2000, no pet.), reasoned that “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.” Based on that analysis, the court held 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.” Id.

Abraxas was not the only decision to reach that conclusion. The district court in PYR Energy Corp. v. Samson Resources Co., 470 F. Supp.2d 709 (E.D. Tex. 2007), pointed out that “three separate Texas courts of appeals suggest that Stine may no longer correctly state Texas law.” The issue of whether the exculpatory clause applied to contract breaches, however, had not been addressed by the Texas Supreme Court.

So does this standard form operating agreement protect the operator from breach of contract liability or not?

Enter the Texas Supreme Court in Reeder v. Wood County Energy, LLC, 2012 Tex. LEXIS 735; 55 Tex. Sup. J. 1366 (Tex. Aug. 31, 2012). Reeder involved a claim that Reeder breached his duty as operator by failing to maintain production in paying quantities. The JOA at issue in Reeder was based on the 1989 version of the AAPL form. The court noted that the language of the 1989 form is slightly different from the 1982 form. While the 1982 form says the operator “shall conduct all such operations in a good and workmanlike manner, but it shall have no liability as Operator . . . except such as may result from gross negligence or willful misconduct,” the 1989 form says the operator “shall conduct its activities under this agreement . . . in a good and workmanlike manner, . . . but in no event shall it have any liability as . . . except such as may result from gross negligence or willful misconduct.”

The court found the difference between “all such operations” and “its activities under this agreement” to be significant, and held that the 1989 form provided broader protection to the operator:

Reading the clause as written, we conclude that the model form transformation is significant, as the change in language broadens the clause's protection of operators. The model forms from 1977 and 1982 both contained clauses that protected operators from "all such operations," while the 1989 model form protects "its activities." Here, the parties modeled their JOA after the 1989 model form—recognizing the distinction between "such operations" and "its activities." The modifier "such" references operations under the JOA, while the deletion of that word and use of the term "its activities" includes actions under the JOA that are not limited to operations. The modification implicates a broader scope of conduct following the language of the contract.

Based on this analysis, the Supreme Court concluded that, “The agreed standard exempts the operator from liability for its activities unless its liability-causing conduct is due to gross negligence or willful misconduct.”

A motion for rehearing has been filed in Reeder and the Supreme Court has requested a response. The basis for the motion for rehearing, however, is whether a related agreement effectively trumps the exculpatory language in the operating agreement. It seems unlikely, therefore, that the Supreme Court’s interpretation of the 1989 form will change.

Reeder demonstrates the importance of seemingly minor differences in the language of exculpatory clauses. What does your contract say?

Keywords: energy litigation, American Association of Professional Landmen, AAPL, joint operating agreement, JOA

Jack G. Carnegie is a partner with Strasburger & Price, LLP in Houston, Texas.

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