Exculpatory provisions are important considerations in JOAs. They can provide protection from certain claims and liabilities as an inducement to serve as the operator. But ensuring the clause does not extend too far is perhaps easier said than done.
In this case, Houston’s 14th Court of Appeals held that the exculpatory clause in a JOA did not exonerate an operator from claims of knowingly assigning unauthorized charges to the nonoperators. This case is notable in its analysis of Reeder v. Wood County Energy, LLC, 395 S.W.3d 789 (Tex. 2012). In the appellate court’s view, the case is one of first impression, addressing “whether ‘activities’ [in an exculpatory clause] is so broad as to protect an operator from any breach of contract so that the operator can have no liability for breach of any contractual provision, absent willfulness.”
The Details on Bachtell Enterprises, LLC v. Ankor E&P Holdings Corp.
This case involved a JOA similar to the 1989 form. The operator, Ankor, entered into a deal with a third party, CDM Max, for the construction of a gas production plant. Ankor sent the nonoperators an AFE for $385k to purchase a plant site, but Ankor stated that CDM would then bankroll construction and own the gas plant. Ankor said this structure would “eliminate the need for the [nonoperators] to provide capital for construction.” The non-operators approved and paid as requested.
However, after the plant was constructed, Ankor informed the nonoperators that CDM would be retaining all plant revenue until the construction costs, operating costs, and fees were paid off, and then Ankor billed the balance of $1.6 Million to the non-operators. The nonoperators refused to pay and demanded to see the agreement with CDM. Ankor refused, claiming it was confidential. Ankor filed suit against the nonoperators for failure to pay, and the nonoperators counterclaimed for fraud, money had and received, and breach of the JOA. A jury found that both Ankor and the nonoperators failed to comply with the JOA, that Ankor committed the first material breach, and that Ankor’s breach was not the result of “willful misconduct.”
Ankor did not dispute that it breached the single expenditure limit within the JOA, which required consent to undertake a project in excess of $50,000. However, Ankor argued that the JOA’s exculpatory clause exonerated it from any liability. The exculpatory provision was largely similar to the version contained in the 1989 Model Form JOA. It indicated that the operator was required to “conduct its activities under [the] Agreement” as a reasonably prudent operator, but that it would not be liable to nonoperators “for losses sustained or liabilities incurred, except such as may result from willful misconduct.”
The Court Disagreed with Ankor
The court disagreed with Ankor, holding the exculpatory clause did not relieve Ankor from liability for knowingly assigning unauthorized charges to nonoperators. The court acknowledged that Reeder v. Wood County involved a similar exculpatory clause, and that Reeder held that the operator was exempt from liability for all of its “activities under the agreement” including an alleged breach of the JOA for failure to maintain leases. However, the appellate court held that Reeder was not properly extended to this case because, in the appellate court’s view, Reeder did not hold that “activities” encompasses all intentional breaches of the JOA.
In the court’s view, exculpatory clauses are intended to relieve the operator from liabilities “in the performance of the contract,” but not “for offensive use to impose liabilities knowingly incurred without consent.” Also, exculpatory clauses are intended to cover liabilities caused by “ordinary negligence,” and “[n]o precedent requires us to extend that protection further than negligent injury.” The court also noted its duty to construe contracts from a utilitarian standpoint and to avoid unreasonable constructions.
The court also explained that the clause must be read in light of other provisions, briefly pointing to provisions indicating that parties are only responsible for their own obligations, that the operator is not the agent of the non-operators, that consent was required for this project, and that Ankor was only permitted to withhold revenues upon notice of a delinquent payment. Each of these would be rendered largely meaningless by Ankor’s interpretation.
This case is notable in its limited reading of exculpatory language similar to the 1989 JOA. This language is often troublesome to non-operators following the Reeder decision, and this case may help shed light on the proper application.