United States: Protecting Operators Under The 1989 AAPL Form Of Operating Agreement

Article V.A. of the 1989 AAPL form of Joint Operating Agreement ("JOA") contains the following exculpatory clause:

"Operator shall conduct its activities under this agreement as a reasonable prudent operator, in a good and workmanlike manner, with due diligence and dispatch, in accordance with good oilfield practice, and in compliance with applicable law and regulation, but in no event shall it have any liability as Operator to the other parties for losses sustained or liabilities incurred except as may result from gross negligence or willful misconduct. [emphasis added]"

How broad is that release? The answer may depend upon which AAPL form JOA you've used.

On August 31, 2012, the Texas Supreme Court released its opinion in Reeder v. Wood County Energy, LLC et al. Wendell Reeder, an individual, was the operator under a 1989 form of JOA, which covered existing, producing wellbores located in Wood County, Texas. Reeder did not own any working interest in the wellbores personally, but he did own a percentage interest in a limited partnership which held 87.5% of the working interest in the wellbores covered by the JOA. Individuals and estates held the remaining 12.5% of the working interest in the wellbores. The wells covered by the JOA needed expensive repairs but the working interest owners ("WIOs"), including the limited partnership (which was not controlled by Reeder), refused to pay. Reeder, as operator, spent his own money trying to preserve the wells but, ultimately, the RRC suspended production from the wells. The WIOs sued Reeder for damages for failing to maintain production in paying quantities, for lost leases and loss of the unit.

In the trial court, the jury found that Reeder had breached his duty as operator by failing to maintain production in paying quantities or other operations in the field and that the exculpatory clause above applied to the breach of contract claim. The court of appeals disagreed and held that the gross negligence and willful misconduct instruction should not have been included in the jury charge. Reeder then appealed to the Texas Supreme Court.

The Court started by asking whether the exculpatory clause in the JOA sets the standard to adjudicate breach of contract claims.

The Court then compared the language to prior cases analyzing the exculpatory clause. A similar clause was found in Castle Tex. Prod. Ltd. P'ship v. Long Trusts, 134 S.W.3d 267 (Tex. App. – Tyler 2003, pet denied):

[Operator] ... 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 all 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 such as may result from gross negligence or willful misconduct.

The court of appeals noted the difference between the phrase "its activities under this agreement" contained in the Reeder JOA and the phrase "all such operations" contained in the Long Trusts case. Nevertheless, the court of appeals held that the exculpatory clause applied only to claims that Reeder breached his duties in operations not that he breached the JOA more generally. In several prior cases, courts of appeal had construed the phrase "all such operations" to apply the exculpatory clause only to claims that the operator had failed to act as a reasonably prudent operator for operations in the field and not for other breaches of the JOA.

The AAPL changed the exculpatory clause in the 1989 Model Form Operating Agreement to cover "activities under [the JOA]" whereas the 1977 and 1982 forms' exculpatory clause covered "all such operations [under the JOA]" The state and federal cases limiting the scope of the exculpatory clause in JOAs were interpreting the 1977 and 1982 forms of JOA. In the Reeder case, the parties had used the 1989 form of JOA which refers to operator's "activities under this agreement" instead of "all such operations."

The court found the change significant and broadened the protection of operators. The court found that "agreed standard exempts the operator from liability for its activities unless its liability-causing conduct is due to gross negligence or willful misconduct."

Finding that Reeder did not act with gross negligence or willful misconduct, the court rendered judgment in favor of operator (Reeder) on the contract claims.

The court did not address the meaning of "activities" and, thus, sets the stage for additional lawsuits. In fact "activities" is used in the 1989 JOA in the exculpatory clause and in only two other provisions; once in Article IV.A. where costs for hearings on spacing or pooling applications are allowed if "necessary and proper for the activities ... under this agreement," and once in Article VII where the parties are obliged to "act in good faith in their dealings with each other with respect to activities hereunder."

It is our surmise that the AAPL changed the wording, abandoning one of the few interpreted clauses in the JOA, because of the argument that "operations" (which is used upwards of 50 times in the JOA but is not defined) was too narrow and applied only to actions taken on and around the drillsite; in attempting to broaden the protection to cover physical actions taken under the agreement which do not constitute operations, the court may have restricted all contract claims by Non-Operators against Operators including such things as making COPAS audit adjustments, liability for production proceeds or funds received under AFEs, and even the Operator's share of JIBs—unless the Non-Operators can prove that the Operator acted with gross negligence or willful misconduct.

If you are drafting a new JOA, care should be taken to distinguish between contract claims that arise solely under the JOA between WIOs and claims that are based on the Operator's "activities" that could involve third party claimants, so that the higher standard of gross negligence or willful misconduct will apply only to the latter. One should also be aware that most of the contract claims addressed by the courts are claims that the Operator failed to conduct its activities as a reasonably prudent operator or in a good and workmanlike manner—which obligations appear in Article V.A. of the JOA, immediately before the exculpatory clause. Courts, generally, have not specifically addressed contract claims arising outside of Article V.A., but, as in the Reeder case, they have not limited their decisions to Article V.A.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.