Texas Supreme Court stresses the importance of agreement language in interpreting retained-acreage clauses

On April 13, 2018, the Texas Supreme Court resolved an apparent appellate court split between XOG Operating LLC v. Chesapeake Expl. Ltd.[1] and Endeavor Energy Res., L.P. v. Discovery Operating Inc.[2] concerning the interpretation of retained-acreage clauses.

A common provision in oil and gas leases, a retained-acreage clause defines what portion of an oil and gas lease an operator will retain after the primary term of its lease. In XOG and Endeavor the Court firmly established how any differences in retained-acreage clauses are to be interpreted going forward—apply a “reasonable” reading of the “plain language” of the clause.[3] A court will look to the retained-acreage clause’s text to determine how much acreage will be retained by an operator in a lease’s secondary term, which may be different from the acreage the operator assigned to a particular well in a P-15 Railroad Commission proration form.

Background

Highly similar factually, both the XOG case and the Endeavor case center around disputes as to whether the operators of an oil and gas lease (Chesapeake and Endeavor) had lost their rights to some portion of the properties they had leased. On one side, the operators contended that they had the right to all of the acreage under their respective oil and gas leases. And on the other side, the lessors contended that the operator’s rights to the land during their secondary term should be limited to the acreage the operators identified in the proration unit forms they filed with the Texas Railroad Commission. In both cases, success for the lessors would have meant that the operators would lose the rights to half of the acreage that they had leased.

Although the retained-acreage clauses that governed the outcome of both disputes were similar, they differed slightly in the way that they defined what property either operator would retain rights to in their secondary terms. Specifically, both clauses differed in the extent to which they referenced the proration forms the operators filed with the Railroad Commission.

In XOG for example, the retained-acreage clause stated that the operator’s “assigned interest would revert to XOG after the primary term, ‘save and except that portion of the leased acreage’…‘included within the proration…unit’ ‘prescribed by field rules’ or, ‘absent…field rules,’ 320 acres.”[4] While in Endeavor, the retained acreage clause stated that the operator’s lease “’shall automatically terminate as to all lands and depths covered herein, save and except’ certain lands within certain governmental proration units ‘assigned to’ a producing well.”[5]

The court’s decision

In companion opinions, the Court sided with the operator in the XOG case and the lessor in the Endeavor case. Seemingly contradictory, the Court reconciled these results by explaining that they were the outcome of a thorough individualized analysis of the language of the retained-acreage clauses in both cases.

Since retained-acreage clauses are “contractual,” the court stated, it should be of no surprise that they “vary widely because parties are free to contract in any way they choose not prohibited by law.”[6] Therefore, how retained-acreage clauses are interpreted will “turn on [their] text.”[7] It is the court’s responsibility to give a “reasonable” reading of the retained-acreage provisions “plain language” to determine its meaning.[8] “And as with any contract, the parties to a retained-acreage provision are presumed to know the law and to have stated their agreement in light of it.”[9]

Accordingly, in the Endeavor decision, the Court paid special attention to the retained-acreage clauses use of the phrase “assigned to” in order to determine how it should be interpreted.[10] As the court explained, “the Commission does not ‘assign’ acreage to proration units—it merely quantifies the amount of acreage an operator assigns.”[11] So, “within this regulatory context” the use of the word “assign” “can only refer to the operator’s assignment.”[12] Therefore, the Court found that when the parties used the phrase “assigned to” in their retained-acreage clause, they were attempting to identify the land the operator identified in its proration form as the land that should be retained by the operator in the secondary term of its lease. For this reason, the Court found that the lessor’s theory of the retained-acreage clause’s interpretation was correct and held that the retained-acreage clause only preserved the 81 acres assigned to the well by the operator, even though the field rules would have allowed 160 acres to be preserved.

Conversely, in XOG, since the parties did not use any terms of art that flagged an intent to retain the acreage identified in the proration form as the acreage that should be retained by the operator in the secondary term of its lease, the Court came to a different result. There, the parties clearly stated that the land that should be retained by the operator should be the acreage identified in the “field rules” or “absent…field rules” 320 acres.[13] A typical practice in oil and gas contracts, parties often “refer to [these field rules] as the lodestar for determining which acreage has been obtained and which acreage has been surrendered” in the context of a retained-acreage dispute.[14] Since the field rules were specifically invoked as a lodestar in XOG, the Court sided with the operator’s interpretation of the retained acreage clause by holding that the operator was entitled to the entire 320 acres it leased, rather than the 160 acres it designated in the proration form it filed with the Railroad Commission.

Key takeaways

A. Terms of art in an oil and gas lease will be strictly applied

The Court’s decision in XOG and Endeavor emphasizes the importance of the agreement language in interpreting retained-acreage clauses. Where parties use terms of art like “assigned to” or “field rules,” the Court will focus on these terms to glean from them any evidence of the parties’ original intent. As in other instances of contract interpretation, the Court will assume that the parties to a retained-acreage clause are aware of the law and negotiated in light of it. Therefore, even if parties are not specifically aware of a term of art’s use, the Court will require the parties to “meet ‘the condition which they imposed upon themselves….For their failure to do so they have only themselves to blame.’”[15]

B. Reinforces incentives for operators to maximize acreage in proration units under the field rules

Often, oil and gas fields have field rules that dictate how much acreage can be assigned to any producing oil and gas well. This assignment process can determine the profitability of a well because it limits how much oil and gas can be recovered from any particular well for conservation purposes. Operators assign acreage to an oil or gas well by filling out a P-15 form and filing it with the Texas Railroad Commission.

The decisions in XOG and Endeavor have provided further incentivizes for operators to maximize the allowable acreage when filling out their proration forms. In that way, an operator will never risk, as in Endeavor, losing rights to acreage that it originally leased because the operator attributed less acreage to a well in a P-15 form than was allowed by field rules. Although doing this may “open [an operator] up to claims that it is not acting in good faith and purporting to retain a substantially greater amount of acreage”[16] than it should be entitled to, depending on the profitability of the oil and gas lease, this may be a risk worth taking.

C. Proration forms are not dispositive in a retained-acreage clause dispute

“The Commission’s statewide rules typically require operators to designate a well’s acreage and proration unit by filing certified plats and other forms, such as a P-15 form.”[17] Although a P-15 form describes the acreage that should be associated with a particular well, the decision in XOG illustrates that this acreage assignment by an operator is not dispositive in resolving a retained-acreage dispute. As in XOG, a court will look to the retained-acreage clause’s text to determine how much land will be retained by an operator in its secondary term (in XOG the field rules), not necessarily how much land that operator assigned to a particular well in a P-15 form.

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[1] XOG Operating, LLC v. Chesapeake Expl. Ltd. P'ship, No. 15-0935, 2018 Tex. LEXIS 308, 2018 WL 1770506 (Tex. Apr. 13, 2018), aff’g, 480 S.W.3d 22 (Tex. App.—Amarillo 2015) [hereinafter XOG, and all cites to Westlaw].

[2] Endeavor Energy Res., L.P. v. Discovery Operating, Inc., No. 15-0155, 2018 Tex. LEXIS 316, 2018 WL 1770290 (Tex. Apr. 13, 2018), aff’g, 448 S.W.3d 169 (Tex. App.—Eastland 2014) [hereinafter Endeavor, and all cites to Westlaw].

[3] Endeavor, at *9.

[4] XOG, at *1.

[5] Endeavor, at *2.

[6] XOG, at *3.

[7] XOG, at *1.

[8] Endeavor, at *9.

[9] XOG, at *3.

[10] Endeavor, at *10.

[11] Endeavor, at *10.

[12] Endeavor, at *10.

[13] XOG, at *1.

[14] Endeavor, at *6.

[15] Endeavor, at *13.

[16] Endeavor, at *12.

[17] Endeavor, at *4.