Joint Operating Agreements, (“JOAs”), while necessary to establish and define parties’ rights and duties with respect to working interest owned in a tract of land, are still a great source of debate (and litigation) for parties who feel they haven’t gotten a fair shake. Currently before the Texas Supreme Court is a Petition for Review that examines the “forfeiture clause” sometimes added to JOA. The forfeiture clause comes into play when a non-consenting party may be forced to assign its interest in the Leases covered by the JOA if that party does not consent to a “required operation”. A required operation is usually defined as an operation that is required to perpetuate an expiring lease (or leases) or earn an interest in a lease under a Farmout or other agreement.

In this case, Larry T. Long v. RIM Operating, Inc., RIM, operator of the “Lindsey Well” – the only producing well on a 160-acre tract – submitted an Authorization for Expenditure (“AFE”) to the working interest owners because the Lindsey Well stopped producing. Larry T. Long, a working interest owner, did not respond to the AFE. After attempting to repair the well, RIM drilled a replacement well and reestablished production. RIM then sent Long an assignment of his interest in the 160-acre tract to the consenting working interest owners. Again, Long did not respond. RIM filed a declaratory judgment action, requesting that the trial court declare that Long forfeited his interest pursuant to the JOA by not consenting to a required operation.

The JOA contained a provision titled “Required Well or Operations”, that provided, in pertinent part:

Any well drilling or other operation which is necessary to perpetuate or earn a lease or interest therein shall be deemed to be a “required well” or “required operation”. As to any required well or required operation proposed by any party hereto in which any other party hereto elects not to participate, the non-participating party shall release and relinquish forever proportionately to the participating parties all of non-participating party‘s interest in and to the lease or leases or interest (“relinquished leases”) herein which would be perpetuated by such required well or required operation. The interest in such relinquished leases shall be assigned by the non-participating party to the participating parties without warranty of title except as to claims by, through or under assignor and shall be free of any additional burdens […].

The trial court granted RIM’s Motion for Summary Judgment, declaring that Long forfeited his interest by not consenting to a required operation. Long appealed this decision to the Eleventh Court of Appeals in Eastland. The Court of Appeals upheld the forfeiture declaration of the trial court. Long then filed a Petition for Review with the Texas Supreme Court. The Texas Supreme Court granted the petition, and briefs have been filed.

In his brief, Long, argues that “[I]t has long been ‘settled law of this State that the rule of construction against the right of forfeiture’ is applicable to all oil and gas grants” and that such clauses do not automatically terminate. Instead, Long argues, a forfeiture clause is a “condition subsequent”, where “title does not change until the party seeking forfeiture based on a condition subsequent elects to take advantage of the breached condition by physically occupying the premises or by judicially claiming the interest.” As such, courts should not declare forfeiture unless they are compelled to do so by language which can be construed in no other way. Further, the plaintiff must be held to “strict proof that the grantee has not complied with the conditions” and that “the interest owner was given the benefit of notice of any default and an opportunity to cure it.”

In other words, if there is any doubt, Long argues that it “must be resolved against forfeiture, including whether a ‘party hereto’ ‘proposed’ a ‘required well’ or ‘required operation’ that proved necessary to perpetuate specific, identifiable leases, or that Long ‘elect[ed] not to participate’ after receiving proper notice of a party’s proposal for a required well or operation that perpetuated the lease.” Long argues that, under strict construction, RIM was not a ‘party’ to the JOA. As such, RIM was not authorized to propose a required operation that could result in forfeiture. Moreover, the proposed operation “did not include a sidetrack operation or drilling a replacement well,” which required a new proposal. Long also urges that the proposal was not sufficient notice to invoke forfeiture, as there was no “notice of intent to forfeit and an opportunity to cure.”

Long correctly points out that the Texas Supreme Court, in Coastal Oil & Gas Corp. and Coastal Oil & Gas USA v. Coates Energy Trusts and Coates Energy Interests, granted a petition to review the issue of whether an oil and gas lease could be forfeited following a notice of default that did not mention forfeiture. The Court previously held that “a lessor had no right to declare a forfeiture ‘without notifying the [lessee] of its intention to forfeit and affording them a reasonable opportunity to comply.’” Both Coastal Oil and the previous case dealt with leases cancelled by the lessor for violations of the leases, but Long hopes to apply this law to the forfeiture clause in JOAs.

Whether the Court upholds the use of unmitigated forfeiture clauses remains to be seen, but the opinion from the Texas Supreme Court will certainly provide guidance for operators with respect to their invocation of these clauses in the future. Forfeiture certainly seems to be a harsh result, but when faced with the possibility of lease expiration, operators and consenting working interest owners should be entitled to some type of leverage and even reward for ‘doing what it takes’ to keep a lease. And it certainly appears, at least as to procedure, that operators may soon have clear guidance when they wish to invoke these types of clauses, to ensure that there is no loophole for the hold-outs.