3. Seventh District Court of Appeals—Amarillo
This case illustrated the importance of contract drafting to avoid confusion between business parties. More particularly, the court addressed issues with contract interpretation arising from a dispute over an oil and gas farmout agreement. The court relied on the specific language used in the farmout agreement in order to determine the definition of capital costs and project payout as it applied to these parties.143
The origins of the dispute arose after Sutherland Energy Company, LLC (“Sutherland”) and Dimock Operating Company and Joe W. Dimock, doing business as Dimock Petroleum (collectively, Dimock), executed a Seismic Exploration and Farmout Agreement (“SEFA”) in November 2012. The SEFA was executed for the purpose of drilling a replacement well on Dimock’s lease and exploring and developing a surrounding 15-section area of Hardeman County, also known to the parties as the “Hamrick Area 3D Shoot.”144 Additionally, the SEFA gave Sutherland the right to conduct seismic exploration operations on the land covered by the SEFA and granted them sole discretion in determining the need for such measures.
Sutherland, as Farmee, fronted the cost to drill the replacement well and had 240 days to spud the replacement well. Otherwise, they would forfeit the $50,000 drilling deposit paid to Dimock as well as any funds spent on the project. Sutherland timely completed the replacement well, “Hamrick No. 3,” which went on to produce oil in June 2013. In accordance with the SEFA, the successful completion of the replacement well entitled Sutherland to the assignment of Dimock’s 100% working interest in the drilling unit until they were able to recover two times their “capital costs” from the well’s production revenue. At that point, the project was to be considered having reached “project payout,” and Sutherland was to assign 51% of the working interest back to Dimock and the remaining 49% working interest to various charities.145
In March 2014, revenue from the Hamrick No. 3 amounted to $2,195,191, which was more than twice Sutherland’s stated costs of $1,007,445 that were spent to drill and complete Hamrick No. 3. Having determined that project payout had been met, Dimock instructed Sutherland to refrain from incurring additional capital costs on the project in April 2014. Dimock insisted that capital costs were limited to those spent on the Hamrick No. 3 well and did not include subsequent costs incurred by Sutherland related to seismic exploration of the Hamrick Area 3D Shoot. Sutherland disagreed and eventually filed suit against Dimock.146
Sutherland’s suit alleged breach of contract and sought a declaratory judgment as to the legal effect of the SEFA’s terms.147 In response, Dimock filed counterclaims for breach of contract, breach of fiduciary duty, fraud and declaratory judgment. The trial court addressed several issues that were brought up by partial summary judgment motions, and after the parties reached a partial settlement in 2015, a jury trial resolved the matter of attorney’s fees. On appeal, Dimock claimed the trial court erred on several grounds, including the granting of Sutherland’s first motion for partial summary judgment wherein they agreed that “capital costs” are clearly defined in the SEFA and that land and seismic expenditures are included in the definition of capital costs.148
The main reason for the litigation in this case was the parties’ lack of planning and failures in memorializing and defining their agreement. Sutherland sought a declaration that costs incurred for land and seismic expenditures for the Hamrick Area 3D Shoot should have been included in the calculation of capital costs when determining project payout. Dimock insisted that capital costs as applied to the determination of when payout occurred only included costs for the Hamrick No. 3 well. The disputed language that led to the confusion occurred in two provisions with one located in the SEFA and the other located in the parties’ Operating Agreement. Sutherland relied on the SEFA, which provides: “When the Farmee’s cumulative revenue equals two (2) times the Farmee’s capital cost the Initial Earning Well will have reached ‘project payout.’”149 The SEFA also provides the following definition of capital costs:
The Farmee’s capital cost is defined as cost incurred by Farmee for land and seismic [expenditures] for the Hamrick Area 3D Shoot . . ., a fifty thousand-dollar ($50,000) prospect fee, and cost for drilling, testing, completing, and equipping, the Initial Earning Well.150
Dimock relied on provisions found in the parties’ Operating Agreement that was executed in conjunction with the SEFA for its claims that not all of Sutherland’s expenditures for land and seismic data were recoverable. The Operating Agreement provided:
Operator [Sutherland] shall not undertake any single project reasonably estimated to require an expenditure in excess of twenty-five thousand dollars ($25,000.00) except in connection with the drilling, sidetracking, reworking, deepening, completing, recompleting, or plugging back of a well that has been previously authorized by or pursuant to this agreement…151
Dimock relied on this provision to limit Sutherland’s land and seismic costs that were not specifically authorized by Dimock to $25,000.
The trial court granted Sutherland’s motion for partial summary judgment based off the SEFA’s definition of capital costs, which included land and seismic expenditures and the further agreement that the parties’ Operating Agreement did not limit Sutherlands’ land and seismic expenditures.152 The appellate court similarly agreed with the trial court in both respects and rejected Dimock’s appeal. The court first looked to the specific language in the SEFA in making their decision about the definition of capital costs and rejected an argument presented by Dimock in an attempt to direct the court toward interpreting the language differently due to the placement of a comma. The court read the SEFA to define capital costs as: (1) land and seismic costs for the Hamrick Area 3D shoot, (2) the prospect fee, and (3) the cost for drilling, testing, completing and equipping the Initial Earning Well.153 Secondly, the court agreed that the SEFA controlled over the Operating Agreement because of a limitation provision therein that provided that the “[SEFA] shall be the governing Agreement.”154 Additionally, the court found the provision in the SEFA gave Sutherland the discretion to make decisions concerning seismic expenditures controls over anything to the contrary in the Operating Agreement.155
Overall, this case is about clearly defining the agreement and leaving no room for ambiguity when drafting for costs that lead to payout. Here, Dimock’s failure to clearly limit expenditures for land and seismic expenditures left the calculation of capital costs and project payout open to interpretation. This case will be helpful for attorneys and landmen when considering entering into an agreement similar to the farmout described here.
142 Dimock Operating Co. and Joe W. Dimock d/b/a Dimock Petroleum v. Sutherland Energy Co., LLC , No. 07-16-
00230-CV, 2018 WL 2074643 (Tex. App.—Amarillo Apr. 24, 2018).
143 Id. at *1.
146 Id. at *2.
149 Id. at *3.
152 Id .
153 Id. at *4.
154 Id .
155 Id .