Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca5-09-11040/USCOURTS-ca5-09-11040-0/pdf.json

Parties Involved:
Bonn Operating Company
Appellant
Devon Energy Production Company, L.P.
Appellee

Document Text:

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 09-11040

BONN OPERATING COMPANY

Plaintiff- Appellant

v.

DEVON ENERGY PRODUCTION COMPANY, L.P.

Defendant -Appellee

Appeal from the United States District Court

for the Northern District of Texas

Before HIGGINBOTHAM, DAVIS and BENAVIDES, Circuit Judges.

W. EUGENE DAVIS, Circuit Judge:

Bonn Operating Company (“Bonn”) appeals the district court’s grant of

summary judgment in favor of Devon Operating Company (“Devon”) on issues

arising out of the joint operating agreement governing their relationship. The

plain language of the agreement and the undisputed facts do not support Bonn’s

challenges to that judgment. Accordingly, we affirm.

I.

Bonn Operating Company (“Bonn”) and Devon Energy Production

Company (“Devon”) are co-working interest owners in oil and gas leases in

Wyoming. Under a Form 610 Model Form Operating Agreement-1956 executed

United States Court of Appeals

Fifth Circuit

F I L E D

July 30, 2010

Lyle W. Cayce

Clerk

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No. 09-11040

by the parties’ predecessors-in-interest (“JOA”), Devon is the operator of the

leases and Bonn is a non-operating working interest owner.

Under the terms of the operating agreement, if a party desires to drill a

well it “may give the other party written notice of the proposed operation” with

specified information. Upon receipt of notice, the other parties to the JOA have

30 days to elect whether they will participate in the operation. Declining to

participate or failing to make an election causes a party to be a non-consenting

party. Consenting parties bear the cost and risk of drilling. Non-consenting

parties avoid those risks, but are subject to a penalty. Under the penalty

provision, consenting parties are entitled to the non-consenting party’s share of

any production from the well until their proceeds equal the cost of 100% of the

non-consenting party’s share of certain costs (such as the cost to operate the

well) and 300% of other costs (such as the cost to drill and complete the well

before it becomes operational and producing).

Although the JOA provision regarding operations is written in terms of

sending notice of proposed operations, Devon sent Bonn notice by letter dated

February 12, 2003, that the Marquis Federal 15W-12 well had been drilled and

completed. Bonn was aware that the completion was successful, but elected not

to participate by notifying Devon in writing on the ballot that it “elect[ed] to go

non-consent on this well.” The cost of the well was $135,139.38, of which Bonn’s

share was 50% or $67,569.69. The non-consent penalty charged to Bonn was

$105,491.33.

Bonn filed suit against Devon in October 2006 alleging breach of contract

and contending that Devon improperly charged it with non-consent penalties

related to the Marquis Federal well. Bonn also contends that Devon failed to

timely ballot Bonn regarding the Marquis Federal 15W-12 well and that Devon

failed to pay interest on sums due to it pursuant to a Wyoming statute.

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Bonn and Devon filed competing motions for summary judgment on the

breach of contract claim. In its orders on these motions, the district court made

rulings concerning the appropriate choice of law and concluded that Devon did

not breach the JOA by failing to give notice prior to the time the well was drilled

and completed. It also found that Bonn waived any claims related to late

balloting by Devon. Finally, the district court held that Devon did not

improperly charge penalties to Bonn.

The parties subsequently executed a Settlement Agreement and Mutual

Release, by which they released each other from the remaining claims in the

lawsuit 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

appealed the court’s orders.

II.

Bonn argues first that Devon improperly charged contractual penalties

related to costs incurred before drilling and after completion of the well, contrary

to the terms of the JOA. Devon acknowledged charging Bonn’s interest in

various wells with penalties both prior to spudding and subsequent to the

release of the drilling and completion rig, but argues that those charges are

proper under the terms of the JOA. Although the parties disagree as to whether

the charges were proper, both agree that the JOA and the attached Accounting

Procedures in Exhibit C govern the issue.

Paragraph 12 of the JOA details the non-consent penalty. It states that

the non-consenting party is deemed to have relinquished its interest in the well

“[u]pon commencement of operations for the drilling, reworking, deepening or

plugging back of any such well” until such time as payout. Case law is clear that

“commencement of operations” for the drilling of a well occurs before the well is

spudded.

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Various activities preliminary to actual drilling have been held to

represent commencement of operations. To mark commencement of

operations, actual drilling is unnecessary. See Petersen v. Robinson

Oil & Gas Co., 356 S.W.2d 217, 220 (Tex. Civ. App.-Houston 1962,

no writ).

Dorsett v. Valence Operating Co., 111 S.W.3d 224, 230 (Tex. App. 2003), reversed

on other grounds in Valence Operating Co. v. Dorsett, 164 S.W.3d 656 (Tex.

2005). Dorsett specifically rejected the suggestion that operations are not

commenced until the well is spudded. Id.

Payout is defined in the JOA as the time when the proceeds from the well

equal 100% of the non-consenting party’s share of certain costs and 300% of the

non-consenting party’s share of drilling costs. Payout is thus determined by the

accounting records for the well. It is not tied to any operational milestone, like

completion. Accordingly Devon states that it properly charged Bonn for

penalties from the date it commenced operations on the well until payout. We

agree.

Bonn 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)

until completion (or commencement of production). Bonn bases its argument on

a misreading of the Accounting Procedures in Exhibit C to the JOA. Section III

of the Exhibit deals with the application of Indirect Charges or overhead to

particular 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

depending on the depth of the well, applies during the drilling of the well. A

different rate applies during production. Paragraph III.4., the provision relied

on by Bonn, states when the different rates apply. The drilling overhead rate

“shall begin on the date each well is spudded and terminate on the date the

drilling or completion rig is released.” However, this time limitation applies only

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to indirect charges for overhead. It does not limit Devon’s ability to charge nonconsenting parties for all direct costs, and associated penalties, applicable to a

well pursuant to the terms of Paragraph 12 of the JOA. Bonn’s argument is

without merit.

III.

In addition to alleging that Devon charged costs to its account for an

improper period, Bonn argued that no penalties should be owed at all because

of improper balloting for the Marquis Federal well. Devon drilled and completed

the Marquis Federal well prior to sending notice of operations or intent to drill

to Bonn. Bonn responded to the notice by stating in writing “we elect to go nonconsent on this well.” Bonn argues that because notice was sent after the well

was drilled it was improper and the JOA penalty provisions do not apply. The

district court found that Devon did not breach the JOA by balloting Bonn after

the well was drilled, that Bonn was not damaged as a result of the late ballot,

that the non-consent penalties applied because Bonn elected to go non-consent,

and that Bonn is estopped from claiming that the expenses incurred on the well

before the ballot are not properly chargeable. We agree.

Section 12 of the JOA does clearly speak in terms of proposed operations

indicating that the notice should be sent prior to operations being commenced.

any party or parties wishing to drill, rework, deepen or plug back

such a well may give the other party written notice of the proposed

operation, specifying the work to be performed, the location,

proposed depth, objective formation and the estimated cost of the

operation. The party receiving such notice shall have thirty (30)

days . . . within which to notify the party wishing to do the work

whether they elect to participate in the cost of the proposed

operation.

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However, the Texas Supreme Court has held that this language in a JOA does

not forbid the operator from commencing work before the end of the 30-day

notice period.

In Valence Operating Co. v. Dorsett, 164 S.W.3d 656 (Tex. 2005), the

operator sent notice of a proposed operation but commenced drilling before the

30-day period to elect to participate expired. The non-operator argued that this

failure constituted a breach of contract and therefore prevented enforcement of

the non-consent penalty. The operator, Valence, argued that the operator can

commence work on the proposed operation during the notice period or even

before the 30-day notice period begins. The Texas Supreme Court agreed with

Valence that the JOA “places no temporal limitation on Valence’s ability to

commence work on proposed projects.” After citing the provision that is

substantially similar to the one in this case, the Texas Supreme Court stated -

This plain language in the Agreement describes Dorsett's right to

receive notice of proposed operations and to elect to participate in

those operations. It places no restrictions on when Valence may

commence drilling or preparations for drilling.

. . . .

In short, the thirty-day notice period sets a deadline for Dorsett to

decide whether to participate in proposed operations. Nothing in the

language of the Agreement forbids the operator from commencing

work before the end of the notice period.

Id. at 662-663.

Unlike in Dorsett, in this case that operations were essentially completed

before Devon sent the notice of operations to Bonn. However, that fact actually

works in favor of Bonn. It had the opportunity to decide its participation in the

well 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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in Valence, early commencement does not harm the non-operators. It simply

places greater risk on the operator that the cost of the operation will fall entirely

on him. Id. at 663. In addition, Aaron Cawley, Bonn’s managing partner,

acknowledged that the JOA contains no provision requiring balloting prior to

drilling and also stated that Bonn suffered no damage as a result of Devon’s

operations before balloting Bonn.

With full knowledge of the costs of the well and its successful completion,

Bonn elected to go non-consent. Cawley acknowledged that this election was

clearly pursuant to the terms of the JOA. These facts establish waiver. “Under

Texas law, the elements of waiver are (1) an existing right, benefit, or

advantage; (2) actual or constructive knowledge of its existence; and (3) actual

intent to relinquish that right.” GP Plastics Corp. v. Interboro Packaging Corp.,

108 Fed. Appx. 832, 836 (5 Cir. 2004). The district court did not err in

th

concluding that Bonn waived any rights, if any exist, related to Devon’s late

balloting.

IV.

The final issue Bonn raises in this case relates to the appropriate choice

of law for determining the interest rate to apply to the payment of proceeds. The

district court analyzed choice of law and determined that Oklahoma law supplies

the interest rate. This rate only applies if any damages are assessed. Because

of our disposition of the issues above, there are no damages on which to calculate

interest and this issue is moot.

V.

For the foregoing reasons, we affirm the judgment of the district court.

AFFIRMED.

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