A recent decision by the Seventh District Court of Appeals in Amarillo gives excellent guidance on the drafting of Exploration Agreements, as well as the enforceability of an ultimately inequitable contract. The decision, rendered in February 2011, centers upon the analysis of an exploration agreement entered Aurora Petroleum, Inc. (Aurora) agreed to assign to Cholla Petroleum, Inc. (Cholla) its interest in four leases and share with Cholla certain geological and geophysical data. Cholla was to pay $50,000 to Aurora, and to commence the drilling of a test well on or before a certain date, at a location “mutually acceptable” to both parties. The Agreement provided that if Cholla failed to comply with its obligation to timely drill the test well, it was to “reassign to [Aurora], or to its designee, all of [Cholla's] rights, titles and interests in the Leases, this Agreement, and in the Prospect . . . .”

Cholla presented two drilling test sites to Aurora before the commencement deadline, but Aurora rejected both. With no agreement on where the test well was to be drilling, the drilling deadline passed. Aurora demanded the return of the lease interests it conveyed to Cholla, as well as another lease Cholla received from a third party. However, Aurora refused to return the $50,000 Cholla paid it as part of the transaction. When Cholla refused to assign the third-party lease, Aurora sued Cholla, seeking the Court to require Cholla to comply with the terms of the contract. Cholla asked the Court to determine that the contract was unenforceable, and that Aurora had been unjustly enriched by Cholla’s payment of $50,000.

The trial court determined that the “mutually acceptable” provision rendered the agreement unenforceable as a matter of law. Aurora appealed, and contended that there was no lack of mutual assent as to any essential term of the contract and it was not unjustly enriched by retaining the $50,000.

The Court of Appeals reviewed the issues, and noted that an enforceable contract requires the parties to agree to the material terms. They observed that when an agreement leaves material matters open for future agreement and that agreement never occurs, the contract is not binding on the parties and constitutes merely an agreement to agree.

In determining whether a term is “material”, the Court proposed that such a decision was made on a case-by-case basis. To make the decision, a court must consider whether the uncertainty imposed derails the greater purpose embodied in the agreement. In the case at hand, the Court said that the purpose of the agreement was to pool resources to produce oil and gas. The agreement depended upon Cholla drilling a test well by a certain date at a location mutually agreeable to Aurora and Cholla. If that did not happen, the contract ended. However, Aurora was under no obligation to approve of a drilling site before the drilling deadline. From this, the Court concluded “that both the time within which Cholla had to drill and the provision regarding the mutual selection of the initial drilling site were material, if not pivotal, to the existence of the accord. Both were more than mere incidental details.”

In discussing the return of the $50,000 payment to Cholla, the Court states, “In a nutshell, what we have here is a party who seeks to retain or recover more than it began with simply by invoking contractual provisions that effectively obligated it to do nothing. Admittedly, Aurora was bound to assign to Cholla four leases but those leases could be recovered by Aurora if the latter simply refused to approve any drilling site until the drilling deadline expired. So, not only was it actually free to give up nothing but now it wants to keep the fruits delivered or developed by Cholla.” As such, the Court determined that it would be inequitable to allow Aurora to retain the $50,000.

Here, the Court of Appeals got it right. This contract, although it may have seemed to be fair to the parties at the time of execution, did ultimately end up being extremely inequitable. If it had been enforced, Cholla would have paid $50,000 to assign a lease to Aurora. The reasons for the unenforceability, however, should give all of us pause before signing future contracts. Even if you choose (unwisely) not to have a lawyer review the contracts you enter into, you must be aware that every written term should be examined for vagueness or uncertainty. Once you identify those vague or uncertain terms, they should be examined with the purpose of the contract in mind. If the contract’s purpose could be thwarted by the uncertain terms, then they need to be more specific. Here, I am certain Aurora didn’t enter into the contract with bad intentions, but I am just as certain that Cholla didn’t grasp how the terms of the contract they signed could be so detrimental to them. In short, hire an expert. If you are stubborn, then be willing to read carefully, and take the time to consider all possible scenarios before you sign your next contract.