Recently, the Texas Supreme Court heard oral argument in its review of a decision by the Court of Appeals in Tyler. The case involves the finding of liability by an operator for, among other claims, failing to maintain production or operations on leased acreage, causing the leases to terminate. What makes the anticipated opinion from the Supreme Court interesting is that it centers around the interpretation of certain language in a Joint Operating Agreement. Specifically, the language at issue are called ‘exculpatory clauses’. In JOAs, when these clauses apply, an Operator may not be held liable to the other parties to the JOA for acts that do not constitute gross negligence or willful misconduct. The question here is, in what circumstances does the particular exculpatory clause apply?

Wendell Reeder, the Operator, was sued by the Non-Operators, Wood County Energy, LLC, Wood County Oil & Gas, Ltd., Nelson Operating, Inc., Dekrdour, Inc., Bobby Noble, Exzena Oil Corporation, David Fry and Patricia Fry, for breaching his duty under the JOA for his failure to maintain leases covering certain acreage by production or operations. Reeder argued that, under the JOA, he could not be held liable for breaching this duty unless his actions (or inactions) were found to be either grossly negligent or were acts of willful misconduct. He relied on the exculpatory clause found in the JOA at issue to assert this ‘standard of care’ (i.e. his duty to the other parties). The clause at issue is as follows:

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.

This is the standard exculpatory clause found in the A.A.P.L. 1989 Model Form Joint Operating Agreement. Reeder argued that because this clause used the phrase “activities under this agreement”, the limitation on his liability applied to all of his activities as operator. Wood County Energy, LLC, et al., argued that Reeder breached a contractual duty, and that this limitation on Reeder’s liability applied only to his actual operations on the leased premises, and not to his other contractual duties.

Wood County Energy, et al., argued that Reeder’s liability for breach of the JOA was not limited to only Reeder’s acts of gross negligence or willful misconduct when the acts were not actual operations on the leased premises. They relied upon previous Texas Appellate Court opinions that restricted the exculpatory clause to operations only. However, the cases relied upon examined the standard exculpatory clause from the A.A.P.L. 1982 Model Form Joint Operating Agreement, specifically:

[The Operator] shall be the Operator of the Contract Area, and shall conduct and direct and have full control of all operations on the Contract Area as permitted and required by, and within the limits of this agreement. It shall conduct such operations in a good and workmanlike manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except as may result from gross negligence or willful misconduct.

Reeder’s argument is that the evidence is insufficient to show that his inaction was grossly negligent or an act of willful misconduct. Since, he argued, failing to maintain the leases was an activity under the JOA, he could only be found liable if he was found to be grossly negligent or acted with willful misconduct. Reeder complains to the Supreme Court that the Court of Appeals misconstrued the plain meaning of the JOA’s exculpatory clause by interpreting the language “activities under this agreement” to be restricted to actual operations.

What I find particularly interesting is that if the Supreme Court agrees with Reeder on this issue, then Operators may never be found to be liable for any breach of the JOA (under the 1989 Model Form). That spells bad news for Non-Operators. We may also see a more consistent reversion to the 1982 Model Form or even a new Model Form- which will elicit more arguments over interpretation (which could be good news for lawyers). The Supreme Court typically takes months to issue its opinions, but parties to JOAs should be on the lookout for an interpretation of this clause, as it will affect the relationships between working interest owners.