This case dealt with a dispute between consenting and nonconsenting parties to a drilling project under the terms of a joint operating agreement (“JOA”). More specifically, whether the consenting party actually commenced operations on the project within a timely manner as required under the JOA. The Supreme Court of New Mexico held that actual drilling is not the only way to effectively commence operations, and that certain site activities necessary for the drilling of a well can satisfy the requirements as a matter of law.
Enduro Operating LLC (“Enduro”) and Echo Production, Inc. (“Echo”) are parties to a JOA. The JOA requires that notice be given to members of the JOA in the event that one of the parties wants to start a new drilling project. Once notice of the project is received, the parties have thirty (30) days to determine whether they want to participate in the project or opt out. If a party opts out, the parties that opt in are entitled to recover 400% of the labor and equipment costs they invested into the project before the nonconsenting parties can recover any profits.2 However, for the consenting parties to recover the forfeited profits of the nonconsenting parties the consenting parties must “within ninety (90) days after the expiration of the notice period of thirty (30) days … actually commence the proposed operation and complete it with due diligence.”3 If actual commencement does not occur within the 120-day window, then the consenting parties must again re-propose the project as if the first proposal was never sent. Echo sent their notice of a proposal to drill a new well on December 1, 2010; therefore, Echo had until April 2, 2011, to commence operations.4 Evidence was submitted that prior to April 2, 2011, Echo had: surveyed and marked the well site, contacted a petroleum engineer to help with acquiring a drilling permit, designed a closed loop waste-removal system for the well, consulted with a geologist for horizontal drilling advice, contacted and received a commitment from a fracking contractor, entered into a contract with JW Drilling to provide drilling services, and on March 31, 2011, submitted their drilling permit application to the New Mexico Oil Conservation Division.5 Following the April 2, 2011, deadline, Echo moved forward with the drilling, without having submitted a re-proposal to Enduro, and had a producing well around August 5, 2011.6
Nearly four years after the initial notice of proposal to drill a new well was sent, Enduro filed suit against Echo with claims for breach of contract, conversion, and violations of the Oil and Gas Proceeds Payment Act. Both parties filed motions for summary judgment, the central issue being whether Echo commenced operations in a timely manner under the JOA. The district court granted Echo’s motion for summary judgment; however, on appeal, the court of appeals reversed the district court and held that Echo’s “lack of on-site activity at the proposed well site, other than surveying and staking, and lack of a permit to commence drilling was evidence as a matter of law that Echo had not actually commenced drilling operations.”7 Echo filed a timely appeal and asserted that they actually commenced operations within the 120-day period.
The court first analyzed the issue by looking at how commencement clauses have been interpreted in oil and gas leases. The majority rule for leases is that a party commenced operations when “modest preparations for drilling have been made” and were done so in good faith.8 With that in mind, the court decided that actual drilling would clearly be evidence of actual commencement, as well as the commitment of resources at the well site; however, the determinative issue for this case is whether the commitment of off-site resources can “ever be adequate evidence of the parties’ present good-faith intent to diligently carry on drilling activities until completion.”9 Previously, the court of appeals relied heavily on a provision in the New Mexico Administrative Code (“NMAC”) to answer this question in the negative. The NMAC states that the purpose of the rules for drilling was “to require an operator to obtain a permit prior to commencing drilling;”10 therefore, since Echo had not obtained a drilling permit, by law, they could not have commenced drilling. The court disposed of this argument quickly by noting that the NMAC serves a different purpose than the JOA and, as such, terms used within both do not necessarily possess the same meaning. By examining relevant case law, the court held that actual commencement can occur without a party having obtained drilling permits. Furthermore, the court held that to prove actual commencement has occurred:
(1) actual drilling is conclusive proof, but is not necessary, (2) obtaining a permit is not essential, (3) activities such as leveling the well location, digging a slush pit, or other good-faith commitment of resources at the drilling site will suffice as evidence of the parties’ present intent to diligently carry on drilling activities until completion, and (4) the off-site commitment of resources, such as entering into an enforceable drilling contract requiring the diligent completion of the well, will also suffice as evidence that the operator actually commenced drilling operations.
In the instant case, Echo did enter into a contract with a drilling company for drilling services, however, the court noted there was a question with the drilling contract as to whether it was signed and accepted prior to the termination date on the contract. Therefore, the court remanded the case to determine if the contract was signed and accepted in time, and if it was then, as a matter of law, Echo had actually commenced drilling operations within the 120-day time required under the JOA.11
The court concluded that to actually commence drilling operations under a JOA off-site, preparations can serve as evidence of a good-faith commitment to drill a well to completion to satisfy actual commencement under JOA time constraints. Enduro has not filed an appeal. This case is important for attorneys and landmen because, for the first time, the Supreme Court of New Mexico determined the meaning of actual commencement under a JOA, which will have a substantial effect on how operators move forward with satisfying time requirements under JOAs.
1 Enduro Operating LLC v. Echo Production, Inc., 2018-NMCA-016, 413 P.3d 866. [published after Volume 150 of the New Mexico Reports].
2 Id. at ¶1.
4 Id. at ¶19.
5 Id. at ¶20.
6 Id. at ¶21.
7 Id. at ¶3.
8 Id. at ¶6.
9 Id. at ¶8.
10 Id. at ¶11.
11 Id. at ¶26.