William D. Wood and Brian C. Boyle 2012-12-26 02:11:11
Space limitations guide us to discuss only a few new cases arising from energy industry activities, so we will highlight those that will likely stir the pot of energy disputes. Supreme Court Clarifies Standard of Care Under JOAs In a significant development for oil and gas operators working under standard joint operating agreements, the Texas Supreme Court recently construed the scope of exculpatory clauses that limit an operators’ liability to gross negligence or willful misconduct. In Reeder v. Wood County Energy, L.L.C., 2012 Tex. LEXIS 735, 55 Tex. Sup. J. 1366 (Tex. Aug. 31, 2012) (publication pending), working interest owners brought suit against an oil and gas operator for breach of the operator’s duties under a JOA. The jury found in favor of the working interest owners. However, the trial court entered a take-nothing judgment on the working interest owners’ claims based on an exculpatory clause in the JOA that exempted the operator from liability for activities performed under the JOA unless the liability arises from gross negligence or willful misconduct. The exculpatory clause, which was modeled after the 1989 Model Form Operating Agreement of the American Association of Petroleum Landmen, contained the following exculpatory clause: Operator shall conduct its activities under this agreement as a reasonable prudent operator, in a good and workmanlike manner, with due diligence and in accordance with good oilfield practice, 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. The Tyler Court of Appeals reversed the trial court’s take-nothing judgment, holding that the standard of care in the JOA’s exculpatory clause did not apply to the working interest owners’ breach of contract claims that are unrelated to operations under the JOA. The Texas Supreme Court reversed the judgment of the court of appeals, holding that the exculpatory clause applies to the claims against the operator. The court distinguished prior case law holding that exculpatory clauses applied only to claims that the operator failed to act as a reasonably prudent operator for operations under the JOA, and not for other breaches of the JOA. Exculpatory clauses in those cases were modeled after clauses in the 1977 or 1982 Model Form Operating Agreement, which referred to operations under the JOA. In contrast, the exculpatory clause at issue — which followed the 1989 Model Form — referred more broadly to activities under the JOA, thereby covering the operator’s misconduct that was unrelated to operations. The court found that the modification of the exculpatory clause from prior versions of the model form “implicates a broader scope of conduct” that “exempts the operator from liability for its activities unless its liability-causing conduct is due to gross negligence or willful misconduct.” Until clarified in future cases, litigants will argue that an operator will not be subject to liability for any of its activities under a JOA containing the modified exculpatory clause unless the operator’s conduct rises to the level of gross negligence or willful misconduct. One possible result will be the modification of the Model Form Joint Operating Agreement for future transactions, and perhaps some renegotiation of existing JOAs.1 Royalty Owners Must Stay Apprised of Relevant Public Information In December 2011, the Texas Supreme Court issued another important decision for operators that requires royalty owners to make themselves aware of relevant public information concerning the payment of royalties. In Shell Oil Co. v. Ross, 356 S.W.3d 924 (Tex. 2011), a royalty owner claimed that, during a three-year period that ended five years before the suit was filed, the operator underpaid royalties due under an oil and gas lease. The trial court found that the operator’s statute of limitations defense was barred by the jury’s finding that the operator fraudulently concealed the underpayment of royalties, and its finding concerning the date on which the royalty owners, using reasonable diligence, could have discovered the underpayment of royalties. After the Houston 1st District Court of Appeals affirmed, the Texas Supreme Court reversed the judgment of the court of appeals and rendered judgment in favor of the operator. The court held that the fraudulent concealment doctrine and the discovery rule did not toll the statute of limitations as a matter of law because the royalty owners — exercising reasonable diligence — could have discovered royalty underpayments from readily accessible and publicly available information before the limitations period expired. The court explained that “[r]easonable diligence requires that owners of property interests make themselves aware of relevant information available in the public record.” In the case of claims for underpaid royalties, the court found that “a royalty owner cannot avoid making a diligent investigation just because there might be a legitimate explanation for a suspicious royalty payment.” A Negligence Action May Be Cut Off By a Related Third-Party Contract In another recent Texas Supreme Court decision, the court found that a negligence claim by a power plant owner against a pipeline company was barred by a contract related to the claim, even though the pipeline company was no longer a party to the contract. In El Paso Mktg., L.P. v. Wolf Hollow I, 2012 Tex. LEXIS 489, 55 Tex. Sup. J. 877 (Tex. June 15, 2012) (publication pending), the owner of a gas-fired power plant sued the owners of the pipeline that supplies fuel to the plant for negligence in allowing interruptions in service and in delivering gas that did not meet contractual quality standards. The power plant owner also brought a breach of contract claim against the manager of the plant’s gas fuel supply for allowing interruptions in service. The trial court granted the pipeline owner’s motion for summary judgment on the negligence claim, finding that the plant owner could not maintain a negligence action because the claim sounded in contract and any damages were barred by the economic loss rule, even though there were no contracts between the plant owner and the pipeline company. The Houston 14th District Court of Appeals reversed, holding that the plant owner could bring a negligence claim against the pipeline owner because there was no contract between the parties. The Texas Supreme Court reversed the judgment of the court of appeals. The court found that the plant owner could recover its alleged damages from its gas supply manager pursuant to gas supply and transportation agreements between the parties. The gas transportation agreement was originally between the plant owner and the pipeline owner; however, the plant owner immediately assigned the agreement to the gas supply manager, resulting in neither of the agreements being between the plant owner and the pipeline owner. The court found that the negligence action against the pipeline owner was based on alleged viola- tions of gas delivery and gas quality obligations that exist only in the gas supply and transportation agreements. According to the court, “[t]he gist of [the plant owner’s] claims is not that [the pipeline owner] failed to act as a reasonable pipeline should have, which is the liability standard for negligence, but that it violated specific obligations [i.e., firm service for gas delivery and providing a certain quality of gas] that might or might not be unreasonable apart from the parties’ agreements.” As a result, the plant owner was barred from bringing a negligence action against the pipeline owner — regardless of the fact that there was no contract between the parties — because the claims arose from gas delivery and gas quality obligations in the contracts at issue, not from a separate legal duty that could give rise to liability independent from the contracts. Importantly, the court noted that this scenario may bar the recovery of consequential damages if such damages are precluded by the contract at issue, but such a limitation does not justify extending tort liability to obligations arising only from the contract. Litigants thus may argue that this case adds a new angle to the contort doctrine by limiting tort claims that touch upon a contract, even where the plaintiff is no longer a party to the agreement. As a result, this case is likely to be invoked by defendants attempting to avoid exposure to tort claims, especially where a contract contains favorable provisions limiting the defendant’s liability or waiving consequential damages. Scope of Hydraulic Fracturing Litigation Continues to Develop Another significant area in which the energy industry will continue to experience litigation involves hydraulic fracturing activities. Although the scope of such litigation continues to develop with increased hydraulic fracturing in shale plays throughout the United States — and the concomitant increase in tort claims by property owners — recent cases provide some guidance on issues that may affect such litigation going forward. In a case filed in Texas in late 2010,2 property owners claimed that their property was contaminated by hydraulic fracturing, as evidenced by groundwater testing performed before filing the litigation. The property owners sought damages against the operator in the area, seeking damages for lost property value, emotional harm, medical monitoring, and remediation of the property.3 The operator filed a motion for summary judgment, arguing that there was no scientific basis to establish that the alleged contamination was caused by its hydraulic fracturing activities. Because the motion was filed at an early stage of the litigation, the court denied the motion as premature, finding that the property owners should have an opportunity to conduct discovery before the court reconsiders the motion.4 After the operator’s testing of the property owners’ well water showed that any water contamination did not rise to the level of being toxic for human consumption, and the operator’s analysis showed that the contamination could not be tied to its hydraulic fracturing activities, the operator filed a second motion for summary judgment.5 Shortly thereafter, the property owners moved to dismiss the lawsuit without prejudice, presumably so that they could re-file the claims later after obtaining more favorable evidence.6 The operator opposed the motion, which was ultimately granted by the court in January 2012 over the operator’s objection.7 Although the court did not reach the merits of the pending motion for summary judgment, this case presents an example of the type of obstacles that may be faced by property owners attempting to prove that contamination was caused by hydraulic fracturing. If property owners involved in early litigation related to hydraulic fracturing are unsuccessful in establishing the causation element to support their tort claims, these early cases could impact the viability of future litigation, especially if the cost of developing scientific evidence is significant when compared to the scope of any potential damages. On the other hand, a recent opinion from the Texas Supreme Court may impact defenses that operators would have asserted in response to trespass claims arising from subsurface operations, including hydraulic fracturing activities. In FPL Farming Ltd. v. Environmental Processing Systems, L.C., 351 S.W.3d 306 (Tex. 2011), the court addressed trespass claims related to a wastewater injection well for commercial industrial waste. Although the case did not involve oil and gas operations, the implications of its holding may extend to such operations, including claims related to hydraulic fracturing. The Beaumont Court of Appeals held that, where a regulatory agency has issued a permit authorizing deep injection wells, trespass claims are not supported when fluids that were injected at deep levels later migrate to subsurface areas of nearby land. The Texas Supreme Court reversed, holding that a regulatory permit to drill an injection well does not relieve the permit holder of tort liability for conduct authorized by the permit. The court found that, under the express language of the Injection Well Act, the fact that a person holds a permit to drill a deep injection well does not relieve him from civil liability resulting from such activities. In addition, neither of the two Supreme Court cases8 relied upon by the court of appeals stood for the proposition that agency authorization results in blanket immunity from civil liability. In summary, oil and gas operators received favorable decisions this past year, with the Supreme Court’s clarifi- cation of the standard of conduct for operators under JOAs and the court’s warnings to royalty owners to stay apprised of relevant public information concerning their interests. Litigation in the area of hydraulic fracturing also continues to develop in Texas and nationwide. With the rapid growth in shale gas production over the past decade, associated litigation may soon result in more developed case law that provides guidance for important issues, including the element of causation for claims alleging contamination resulting from hydraulic fracturing. Notes 1. The latest form JOA issued by the AAPL for offshore operations — the 2007 AAPL Model Form of Offshore Deepwater Operating Agreement — mentions both “activities” and “operations” in the exculpatory provision: “The Operator shall timely commence and conduct all activities or operations in a good and workmanlike manner, as would a prudent operator under the same or similar circumstances. THE OPERATOR SHALL NOT BE LIABLE TO THE NON-OPERATING PARTIES FOR LOSSES SUSTAINED OR LIABILITIES INCURRED, EXCEPT AS MAY RESULT FROM OPERATOR’S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT.” Thus, it is possible that a court, following Reeder, may interpret this exculpatory provision as applying to all “activities” of the operator under the JOA. On the other hand, this provision also mentions “operations,” unlike the provision at issue in Reeder, and thus may be distinguished by parties arguing that Reeder should not apply. An earlier form JOA issued by the AAPL for offshore operations — the 2002 AAPL Model Form of Offshore Operating Agreement — mentions only “operations” in the exculpatory clause and thus would appear to fall under prior Supreme Court decisions limiting the reach of such clauses that reference only “operations,” rather than all “activities.” 2. See Harris v. Devon Energy Prod. Co., No. 4:10-cv-00708, in the U.S. District Court for the Eastern District of Texas. The case was filed on December 15, 2010. 3. See Plaintiffs’ Original Complaint [Dkt. #1], Harris v. Devon Energy Prod. Co., No. 4:10-cv-00708, in the U.S. District Court for the Eastern District of Texas. 4. See Report and Recommendation of U.S. Magistrate Judge [Dkt. #51] and Memorandum Adopting Report and Recommendation of U.S. Magistrate Judge [Dkt. #54], Harris v. Devon Energy Prod. Co., No. 4:10-cv-00708, in the U.S. District Court for the Eastern District of Texas. 5. See Second Motion for Summary Judgment and Brief in Support Thereof [Dkt. #55], Harris v. Devon Energy Prod. Co., No. 4:10-cv-00708, in the U.S. District Court for the Eastern District of Texas. 6. See Plaintiffs’ Motion to Dismiss Without Prejudice [Dkt. #56] and Report and Recommendation of U.S. Magistrate Judge [Dkt. #63], Harris v. Devon Energy Prod. Co., No. 4:10-cv-00708, in the United States District Court for the Eastern District of Texas. 7. See Order Adopting Report and Recommendations for Motion to Dismiss [Dkt. #68], Harris v. Devon Energy Prod. Co., No. 4:10-cv-00708, in the United States District Court for the Eastern District of Texas. 8. See Coastal Oil & Gas Corp. v. Garza Energy Trust, 268 S.W.3d 1 (Tex. 2008); R.R. Comm’n of Tex. v. Manziel, 361 S.W.2d 560 (Tex. 1962). WILLIAM D. WOOD is a partner in the Houston office of Fulbright & Jaworski, L.L.P., where he is a senior member of the firm’s Energy Practice Group and co-chair of the firm’s Energy Litigation Practice Group and Latin America Practice Group. His practice focuses on the prosecution and defense of domestic and international commercial litigation and arbitration, with an emphasis on energy industry matters. BRIAN C. BOYLE is a senior associate in the Houston office of Fulbright & Jaworski, L.L.P. His practice focuses on the prosecution and defense of commercial litigation and arbitration, with an emphasis on energy industry matters.
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