By Kevin Connolly
On an issue of apparent national first impression, the Houston Court of Appeals, in XTO Energy Inc. v. Smith Production Inc., 14-07-0069-CV, 2009 WL 442003 at *1 (Tex. App.—Houston [14th] 2009, no pet. h.), held that once a party to a Joint Operating Agreement (“JOA”) timely and properly provides notice to a proposing party as to whether it elects to participate in the cost of a proposed operation, then that party may not change its election, even if it seeks to do so within the thirty day election period and regardless of whether the other parties have materially changed their positions in reliance on the initial selection. The Court reached this holding based on the wording of the applicable JOAs, which were both based on the American Association of Petroleum Landmen Model Form Operating Agreement 610-1982.
In XTO Energy, Smith Production Inc. (“Smith”) was the operator of the Bloomberg oil and gas lease, whose operations were governed by two JOAs. As required by the JOAs, Smith provided written notice to the Non-Operating Interest Owners of its proposal to drill four additional wells on the lease. The Non-Operating Interest Owners then had thirty days after receipt of Smith’s notice within which to notify Smith whether they would elect to participate in the cost of the proposed operations. After analyzing geological data and other information, Chevron, one of the Non-Operating Interest Owners, decided that it did not wish to participate and accordingly notified Smith of its intent not to participate. Shortly after receiving Chevron’s election, Smith advised the other Non-Operating Interest Owners, whom had all elected to participate, of the total interest of the parties approving the operations. Each of the electing Non-operating Interest Owners then agreed to carry their proportionate share of Chevron’s interests as required by the JOAs. Shortly thereafter, and within the thirty day election period, Chevron sent Smith a letter electing to participate in the cost of the additional operations and revoking its prior notifications to the contrary. Smith, however, refused to accept Chevron’s revocation of its prior election not to participate, and as such, treated Chevron as a “Non-Consenting Party” as defined by the JOAs. Several months later, Chevron sold its interest in the lease to XTO Energy Inc. (“XTO”).
XTO, as successor in interest to Chevron’s interest in the lease, filed suit against Smith for breach of contract and specific performance. XTO alleged that Smith breached the JOAs by not accepting Chevron’s notification purporting to change its elections. Specifically, XTO argued that Chevron had the right to change its elections within thirty days of receiving Smith’s notices proposing the four wells, provided the other parties had not materially changed their positions in reliance on the initial elections. Therefore, XTO believed that its interest should not have been subject to the Non-Consent Provision and its resulting penalties. Smith, however, moved for summary judgment on the basis that the unambiguous language of the JOAs does not allow a party to change its election after it has notified the proposing party of its election. The trial court granted Smith’s motion and ordered that XTO take nothing on its claims against Smith.
On appeal, the Houston Court of Appeals noted that the Court’s primary concern when construing the language of a contract is to ascertain and give effect to the intentions of the parties as expressed in the contract. Upon review of the applicable provision of the JOAs, the Court noted that there was no contractual language expressly allowing an electing party to change its election after it had notified the proposing party. Likewise, the Court failed to find language expressly disallowing a party to change its election. However, the Court determined that allowing such a change in election would conflict with the intent of the parties as expressed in the unambiguous language of the applicable provision. The Court did so based on its interpretation that once a receiving party timely gives notice of its election by properly replying within the thirty day period, the Notice Period has expired as to that party. Consequently, a receiving party does not have thirty days to give notice of an election and to give notice of a change in a prior election. Rather, a receiving party has only thirty days to notify the proposing party of its election. When, as was the case before the Court, all receiving parties have provided their respective elections in less than thirty days after receiving notice, the Notice Period expires when the last receiving party provides its election – and not at the end of the thirty day period.
The Court then addressed XTO’s assertion that a reasonable construction of the provision provided a party with the right to change its election within thirty days after receipt of the notice, provided that the other parties had not materially changed their positions in reliance on the initial election. The Court summarily dismissed this argument because the provision contained absolutely no reference as to whether the other parties had changed their positions in reliance on another party’s election. Likewise, the Court found that the provision did not contain any reference to a party’s right or ability to change a prior election. Recognizing that the parties were free to alter or amend the language of the JOAs to address such a situation, the Court stated that it must enforce the JOAs “as written” and that the Court could not “rewrite the agreements or add to their language under the guise of interpretation.” Because allowing a receiving party to change its election was not supported by the language of the JOAs, the Court refused to add such a provision. Furthermore, the Court noted that other model form operating agreements include a provision expressly allowing a receiving party to change its election if it gives the other parties written notice at any time before actual spudding of the proposed well. For these reasons, the Court concluded that XTO’s construction of the provision was not reasonable. Consequently, the Court held that under the unambiguous language of each of the JOAs, if, after proper notice of a proposal to drill an additional well, a party to the JOA timely and properly provides notice to the proposing party as to whether it elects to participate in the cost of the proposed operation, then that party may not change its election, even if it purports to do so within thirty days after receipt of the notice and regardless of whether the other parties have materially changed their positions in reliance on the initial election.