Client Victories in Two Landmark Texas Supreme Court Oil-and-Gas Appeals
Posted by Ryan Clinton: 512-493-9603 or email@example.com
On April 13, 2018, the Supreme Court of Texas issued opinions in two landmark oil-and-gas appeals---Endeavor Energy Resources, L.P. v. Discovery Operating, Inc., Cause No. 15-1055, and XOG Operating, LLC v. Chesapeake Exploration Ltd. Partnership, Cause No. 15-0935. Both cases examined the acreage "earned" by an oil-and-gas operator---for use after the expiration of the contract's primary term---by successful development of a mineral lease within the contract's primary term.
In both cases, the Court affirmed the judgment of the court of appeals. In both cases, Davis, Gerald & Cremer's clients prevailed. And in both cases, the Supreme Court focused on the proper plain-language construction of the text of the applicable contract between the parties as understood in the context in which the parties contracted.
The Issues & Results
In Endeavor, the retained-acreage clause stated that after the primary term's expiration, the lease would terminate except for that acreage " within a governmental proration unit assigned to a well[,] ...  with each such governmental proration unit to contain the number of acres required to comply with the applicable rules and regulations of the Railroad Commission of Texas for obtaining the maximum producing allowable for the particular well."
Petitioner Endeavor argued that the first half of the clause was "ambiguous," and that the second half automatically retained the highest number of acres permitted under the applicable Railroad Commission field rules. On the other hand, Respondent Discovery Operating argued that there is only one way to "assign" a "governmental proration unit" to a well, and that's through the operator's proration-plat assignments filed in the Railroad Commission. Moreover, Discovery Operating argued that the second half of the clause didn't automatically retain the highest number of acres for any well under the field rules, but instead required that the operator assign only those acres "required" to obtain the particular well's "maximum allowable"---i.e., its fair share of the field's total production. The Court agreed with Discovery Operating, affirmed the court of appeals's judgment, and held that the operator retained only that acreage it actually assigned to its wells, which was also far more than sufficient to obtain all of the applicable wells' production under the field rules.
In XOG, the retained-acreage clause stated that after the primary term's expiration, the leasehold-transfer agreement would terminate except for that acreage "included within the proration or pooled unit of each well," and defined the term "proration unit" to mean: (1) the area "prescribed by field rules" for wells drilled into formations governed by special field rules; and (2) 320 acres of land for wells drilled into formations not governed by special field rules. In turn, five of the six wells were governed by special field rules, and those rules mandated 320-acre "prescribed proration units." Accordingly, the court of appeals concluded that the operator retained 320 acres for each of its six wells.
At the Texas Supreme Court, Petitioner XOG argued that a proration unit "prescribed by field rules" did not mean the number of acres prescribed by the applicable field rules, but instead meant the number of acres that the operator "assigned" to its wells in its Railroad Commission proration filings. Respondent Chesapeake, on the other hand, argued that under the field rules for the five wells regulated by field rules, the "prescribed proration unit" was mandated to be 320 acres; therefore, for purposes of the contract, the operator's proration filings at the Commission didn't matter. Each well retained 320 acres. The Supreme Court agreed with Chesapeake and affirmed the court of appeals's judgment.
(Note: as of April 29, 2018, both petitioners have indicated their intent to file motions for rehearing in the two cases.)
For oil-and-gas practitioners, these cases provide critical---although unsurprising---guidance from the Supreme Court. First, the text matters. The modern Texas Supreme Court has repeatedly emphasized that its aim is to give effect to the ordinary meaning of the words of a contractual agreement. The Court is also highly reluctant to declare "ambiguous" the words of sophisticated parties' agreements. Second, the context matters. Almost as important as the terms of an agreement is the context in which the agreement is written. In the oil-and-gas context, the terms used by the parties had long-settled and clear meaning. The Court rejected the petitioners' invitations to change the meaning of settled oil-and-gas terms. Third, authority matters. Both opinions looked to prior precedent, Railroad Commission rules, and legal commentary to help discern the meaning of the contracts' terms. And fourth, the Commission Rules matter. Or more specifically, when the parties to a contract incorporate particular parts of Railroad Commission rules, those rules become part of the parties' agreement. In Endeavor, that meant that the acreage "assigned" by the well operator pursuant to the applicable field rules governed the acreage retained. And in XOG, that meant that the acreage "prescribed by the field rules" governed the acreage retained.