Bonn Operating Company v. Devon Energy Production Co.

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Bonn Operating Company v. Devon Energy Production Co.

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Case: 09-11040

Document: 00511189903

Page: 1

Date Filed: 07/30/2010

IN THE UNITED STATES COURT OF APPEALS United States Court of Appeals FOR THE FIFTH CIRCUIT Fifth Circuit FILED
July 30, 2010 N o . 09-11040 Lyle W. Cayce Clerk

B O N N OPERATING COMPANY P la in t iff- Appellant v. D E V O N ENERGY PRODUCTION COMPANY, L.P. D e fe n d a n t -Appellee

A p p e a l from the United States District Court for the Northern District of Texas

B e fo r e HIGGINBOTHAM, DAVIS and BENAVIDES, Circuit Judges. W . EUGENE DAVIS, Circuit Judge: B o n n Operating Company ("Bonn") appeals the district court's grant of s u m m a r y judgment in favor of Devon Operating Company ("Devon") on issues a r is in g out of the joint operating agreement governing their relationship. The p la in language of the agreement and the undisputed facts do not support Bonn's c h a lle n g e s to that judgment. Accordingly, we affirm. I. B o n n Operating Company ("Bonn") and Devon Energy Production C o m p a n y ("Devon") are co-working interest owners in oil and gas leases in W y o m in g . Under a Form 610 Model Form Operating Agreement-1956 executed

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Case: 09-11040

Document: 00511189903

Page: 2

Date Filed: 07/30/2010

No. 09-11040 b y the parties' predecessors-in-interest ("JOA"), Devon is the operator of the le a s e s and Bonn is a non-operating working interest owner. Under the terms of the operating agreement, if a party desires to drill a w e ll it "may give the other party written notice of the proposed operation" with s p e c ifie d information. Upon receipt of notice, the other parties to the JOA have 3 0 days to elect whether they will participate in the operation. Declining to p a r tic ip a t e or failing to make an election causes a party to be a non-consenting p a r ty . Consenting parties bear the cost and risk of drilling. Non-consenting p a r tie s avoid those risks, but are subject to a penalty. Under the penalty p r o v is io n , consenting parties are entitled to the non-consenting party's share of a n y production from the well until their proceeds equal the cost of 100% of the n o n -c o n s e n t in g party's share of certain costs (such as the cost to operate the w e ll) and 300% of other costs (such as the cost to drill and complete the well b e fo r e it becomes operational and producing). Although the JOA provision regarding operations is written in terms of s e n d in g notice of proposed operations, Devon sent Bonn notice by letter dated F e b r u a r y 12, 2003, that the Marquis Federal 15W-12 well had been drilled and c o m p le t e d . Bonn was aware that the completion was successful, but elected not t o participate by notifying Devon in writing on the ballot that it "elect[ed] to go n o n -c o n s e n t on this well." The cost of the well was $135,139.38, of which Bonn's s h a r e was 50% or $67,569.69. The non-consent penalty charged to Bonn was $ 1 0 5 ,4 9 1 .3 3 . Bonn filed suit against Devon in October 2006 alleging breach of contract a n d contending that Devon improperly charged it with non-consent penalties r e la t e d to the Marquis Federal well. Bonn also contends that Devon failed to t im e ly ballot Bonn regarding the Marquis Federal 15W-12 well and that Devon fa ile d to pay interest on sums due to it pursuant to a Wyoming statute.

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Case: 09-11040

Document: 00511189903

Page: 3

Date Filed: 07/30/2010

No. 09-11040 B o n n and Devon filed competing motions for summary judgment on the b r e a c h of contract claim. In its orders on these motions, the district court made r u lin g s concerning the appropriate choice of law and concluded that Devon did n o t breach the JOA by failing to give notice prior to the time the well was drilled a n d completed. It also found that Bonn waived any claims related to late b a llo t in g by Devon. Finally, the district court held that Devon did not

im p r o p e r ly charge penalties to Bonn. The parties subsequently executed a Settlement Agreement and Mutual R e le a s e , by which they released each other from the remaining claims in the la w s u it not resolved by the court's orders on the motions for summary judgment. The parties filed a joint motion to dismiss those claims and Bonn timely a p p e a le d the court's orders. II. B o n n argues first that Devon improperly charged contractual penalties r e la t e d to costs incurred before drilling and after completion of the well, contrary t o the terms of the JOA. Devon acknowledged charging Bonn's interest in v a r io u s wells with penalties both prior to spudding and subsequent to the r e le a s e of the drilling and completion rig, but argues that those charges are p r o p e r under the terms of the JOA. Although the parties disagree as to whether t h e charges were proper, both agree that the JOA and the attached Accounting P r o c e d u r e s in Exhibit C govern the issue. Paragraph 12 of the JOA details the non-consent penalty. It states that t h e non-consenting party is deemed to have relinquished its interest in the well " [u ]p o n commencement of operations for the drilling, reworking, deepening or p lu g g in g back of any such well" until such time as payout. Case law is clear that " c o m m e n c e m e n t of operations" for the drilling of a well occurs before the well is spu dded.

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Case: 09-11040

Document: 00511189903

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Date Filed: 07/30/2010

No. 09-11040 V a r io u s activities preliminary to actual drilling have been held to r e p r e s e n t commencement of operations. To mark commencement of o p e r a tio n s , actual drilling is unnecessary. See Petersen v. Robinson O il & Gas Co., 356 S.W.2d 217, 220 (Tex. Civ. App.-Houston 1962, n o writ). D o r s e tt v. Valence Operating Co., 111 S.W.3d 224, 230 (Tex. App. 2003), reversed o n other grounds in Valence Operating Co. v. Dorsett, 164 S.W.3d 656 (Tex. 2 0 0 5 ). Dorsett specifically rejected the suggestion that operations are not

c o m m e n c e d until the well is spudded. Id. P a y o u t is defined in the JOA as the time when the proceeds from the well e q u a l 100% of the non-consenting party's share of certain costs and 300% of the n o n -c o n s e n t in g party's share of drilling costs. Payout is thus determined by the a c c o u n t in g records for the well. It is not tied to any operational milestone, like c o m p le tio n . Accordingly Devon states that it properly charged Bonn for

p e n a lt ie s from the date it commenced operations on the well until payout. We agree. B o n n argues that the proper time period for accumulation of penalty costs is from the date the well is spudded (the drill bit pierces the surface of the earth) u n t il completion (or commencement of production). Bonn bases its argument on a misreading of the Accounting Procedures in Exhibit C to the JOA. Section III o f the Exhibit deals with the application of Indirect Charges or overhead to p a r tic u la r wells. Paragraph III.2. allows Devon to charge overhead to a well at a fixed monthly rate per well. The drilling overhead rate, which varies

d e p e n d in g on the depth of the well, applies during the drilling of the well. A d iffe r e n t rate applies during production. Paragraph III.4., the provision relied o n by Bonn, states when the different rates apply. The drilling overhead rate " s h a ll begin on the date each well is spudded and terminate on the date the d r illin g or completion rig is released." However, this time limitation applies only 4

Case: 09-11040

Document: 00511189903

Page: 5

Date Filed: 07/30/2010

No. 09-11040 t o indirect charges for overhead. It does not limit Devon's ability to charge nonc o n s e n tin g parties for all direct costs, and associated penalties, applicable to a w e ll pursuant to the terms of Paragraph 12 of the JOA. Bonn's argument is w it h o u t merit. III. In addition to alleging that Devon charged costs to its account for an im p r o p e r period, Bonn argued that no penalties should be owed at all because o f improper balloting for the Marquis Federal well. Devon drilled and completed t h e Marquis Federal well prior to sending notice of operations or intent to drill t o Bonn. Bonn responded to the notice by stating in writing "we elect to go nonc o n s e n t on this well." Bonn argues that because notice was sent after the well w a s drilled it was improper and the JOA penalty provisions do not apply. The d is t r ic t court found that Devon did not breach the JOA by balloting Bonn after t h e well was drilled, that Bonn was not damaged as a result of the late ballot, t h a t the non-consent penalties applied because Bonn elected to go non-consent, a n d that Bonn is estopped from claiming that the expenses incurred on the well b e fo r e the ballot are not properly chargeable. We agree. S e c t io n 12 of the JOA does clearly speak in terms of proposed operations in d ic a tin g that the notice should be sent prior to operations being commenced.

any party or parties wishing to drill, rework, deepen or plug back s u c h a well may give the other party written notice of the proposed o p e r a t io n , specifying the work to be performed, the location, p r o p o s e d depth, objective formation and the estimated cost of the o p e r a tio n . The party receiving such notice shall have thirty (30) d a y s . . . within which to notify the party wishing to do the work w h e t h e r they elect to participate in the cost of the proposed o p e r a tio n .

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Case: 09-11040

Document: 00511189903

Page: 6

Date Filed: 07/30/2010

No. 09-11040 H o w e v e r , the Texas Supreme Court has held that this language in a JOA does n o t forbid the operator from commencing work before the end of the 30-day n o tic e period. In Valence Operating Co. v. Dorsett, 164 S.W.3d 656 (Tex. 2005), the o p e r a t o r sent notice of a proposed operation but commenced drilling before the 3 0 -d a y period to elect to participate expired. The non-operator argued that this fa ilu r e constituted a breach of contract and therefore prevented enforcement of t h e non-consent penalty. The operator, Valence, argued that the operator can c o m m e n c e work on the proposed operation during the notice period or even b e fo r e the 30-day notice period begins. The Texas Supreme Court agreed with V a le n c e that the JOA "places no temporal limitation on Valence's ability to c o m m e n c e work on proposed projects." After citing the provision that is

s u b s t a n t ia lly similar to the one in this case, the Texas Supreme Court stated This plain language in the Agreement describes Dorsett's right to r e c e iv e notice of proposed operations and to elect to participate in t h o s e operations. It places no restrictions on when Valence may c o m m e n c e drilling or preparations for drilling. .... I n short, the thirty-day notice period sets a deadline for Dorsett to d e c id e whether to participate in proposed operations. Nothing in the la n g u a g e of the Agreement forbids the operator from commencing w o r k before the end of the notice period. Id. at 662-663. Unlike in Dorsett, in this case that operations were essentially completed b e fo r e Devon sent the notice of operations to Bonn. However, that fact actually w o r k s in favor of Bonn. It had the opportunity to decide its participation in the w e ll after the majority of the risk associated with drilling had been determined. Bonn knew that the well was completed and successfully producing. As stated

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Case: 09-11040

Document: 00511189903

Page: 7

Date Filed: 07/30/2010

No. 09-11040 in Valence, early commencement does not harm the non-operators. It simply p la c e s greater risk on the operator that the cost of the operation will fall entirely o n him. Id. at 663. In addition, Aaron Cawley, Bonn's managing partner, a c k n o w le d g e d that the JOA contains no provision requiring balloting prior to d r illin g and also stated that Bonn suffered no damage as a result of Devon's o p e r a t io n s before balloting Bonn. With full knowledge of the costs of the well and its successful completion, B o n n elected to go non-consent. Cawley acknowledged that this election was c le a r ly pursuant to the terms of the JOA. These facts establish waiver. "Under T e x a s law, the elements of waiver are (1) an existing right, benefit, or a d v a n t a g e ; (2) actual or constructive knowledge of its existence; and (3) actual in t e n t to relinquish that right." GP Plastics Corp. v. Interboro Packaging Corp., 1 0 8 Fed. Appx. 832, 836 (5th Cir. 2004). The district court did not err in

c o n c lu d in g that Bonn waived any rights, if any exist, related to Devon's late b a llo t in g . IV. The final issue Bonn raises in this case relates to the appropriate choice o f law for determining the interest rate to apply to the payment of proceeds. The d is t r ic t court analyzed choice of law and determined that Oklahoma law supplies t h e interest rate. This rate only applies if any damages are assessed. Because o f our disposition of the issues above, there are no damages on which to calculate in t e r e s t and this issue is moot. V. For the foregoing reasons, we affirm the judgment of the district court. AFFIRMED.

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