Addressing All Eventualities in Contract Procedures

A recent Texas case, XTO Energy, Inc. v. Smith Production, Inc., 2009 WL 442003, No. 14-07-00069-CV (Tex. App. Hous., Feb. 24, 2009), shows why it’s a good idea to be excruciatingly comprehensive when specifying in a contract the procedures to be followed when the parties make important decisions.

Appellee Smith was an operator under two joint operating agreements (JOAs) governing exploration and production on an oil and gas lease known as the Bloomberg lease. Chevron was a non-operating interest owner under the JOAs.

In accordance with the JOAs, in May and June of 2004 Smith notified the non-operating interest owners of its proposal to drill four more wells on the lease. Under the JOAs, the non-operating interest owners then had 30 days to notify Smith whether they wanted to participate in the cost of the proposed operations.

On June 17, 2004, Chevron notified Smith that it didn’t want to participate. By then, all the other non-operating interest owners had notified Smith that they wanted to participate. But on June 24, 2004, still less than 30 days after Chevron had received Smith’s notice, Chevron attempted to revoke its previous notice. Smith declined to accept Chevron’s revocation.

So what was at issue in the litigation was whether the notice period ended once each non-operating interest owner notified Smith of its decision or whether the notice period continued for 30 days, leaving open the possibility of a change of heart on the part of a non-operating interest owner.

The court held that the notice period ended once each non-operating interest owner had notified Smith of its decision; in a dissenting opinion, one judge disagreed. I’ll let you read the opinion and dissent (or this ContractsProf Blog post) if you want the gory details, but for our purposes, suffice to say that the JOAs weren’t sufficiently clear one way or the other. Here’s the main language at issue:

1. Proposed Operations: Should any party hereto desire to drill any well on the Contract Area other than the [initial well], . . . the party desiring to drill . . . such a well shall give the other parties 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 parties receiving such a notice shall have thirty (30) days after receipt of the notice within which to notify the party wishing to do the work whether they elect to participate in the cost of the proposed operation. . . . Failure of a party receiving such notice to reply within the period above fixed shall constitute an election by that party not to participate in the cost of the proposed operation.

The moral of this story for the drafter is that when drafting a set of such procedures, ask yourself what might happen at every step and address all reasonable eventualities. That makes such provisions a drag to draft, but not as much of a drag as a lawsuit that arises because you failed to address a given eventuality.

By the way, the dissent said that the JOA language was ambiguous. That’s consistent with the tendency of courts to use the word “ambiguous” too loosely. That’s something I discuss in chapter 6 of MSCD and in this March 2008 blog post. To my mind, the language at issue wasn’t ambiguous—it was just insufficiently specific.

My thanks to the indefatigable Steven Sholk for letting me know about this case.

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.