On August 31, 2012, the Texas Supreme Court issued two decisions of importance to the Texas energy industry – one dealing with pipeline condemnation and one dealing with the scope of the exculpatory clause in a 1989 AAPL model form joint operating agreement.

I. The Enbridge Decision

In Enbridge Pipelines (East Texas) L.P. v. Avinger Timber, the Texas Supreme Court reversed a $20,955,000 condemnation judgment against Enbridge Pipelines (East Texas) L.P. and remanded the case for a new trial. In an opinion authored by Justice Debra Lehrmann and joined by five other justices, the court held that the expert opinion offered by the landowner violated the “value-to-the-taker” rule. The expert opinion violated the rule, which prohibits basing an award on a tract’s unique value to the condemnor, by impermissibly focusing on the costs that Enbridge would have incurred had it been required to remove a gas processing plant previously constructed on the condemned tract. Citing a landmark United States Supreme Court opinion by Justice Oliver Wendell Holmes for the proposition that “the question is, what has the owner lost, not what has the taker gained,” the court reasoned that the moving costs that Enbridge avoided by condemning the land resulted in a unique benefit to the taker and did not enhance the value of the land that Avinger lost. The court recognized that the landowner was entitled to have the land valued as a site for a gas processing plant but found no evidence in the record of what that value would be if the existing plant and Enbridge’s moving-cost obligations under the lease were ignored. The decision represents the first time that the court has explicitly considered the applicability of the value-to-the-taker rule to a project constructed on land long before the land was condemned.

II. The Reeder Decision

In Reeder v. Wood County Energy, LLC, et al., the Texas Supreme Court, in a unanimous opinion authored by Justice Dale Wainwright, held that the exculpatory clause in a 1989 AAPL model form joint operating agreement exempts an operator from liability for its activities unless its conduct amounts to gross negligence or willful misconduct.

The matter arose out of a disagreement between the operator, Reeder, and his working interest partners regarding operations under the JOA, including whether Reeder had failed to obtain production in paying quantities, thus causing a loss of leases and a related unit. The Texas Supreme Court held that the exculpatory clause in the 1989 AAPL model form JOA expressly covered the operator’s activities “under this agreement”, and therefore a working interest partner wishing to sue an operator for breach of contract under the 1989 version must prove gross negligence or willful misconduct.

The court referred to an often-cited line of Texas appellate court cases reviewing prior versions of the AAPL Model Form exculpatory clauses—including Long Trusts, Wevanco, Fagadau, and Abraxas1 — and holding that the exculpatory clause extended only to claims that the operator failed to act as a reasonably prudent operator for operations under the JOA, allowing non-operating parties to pursue breach of contract claims against the operator arising from non-operation related conduct without making a showing of gross negligence or willful misconduct. The supreme court also noted the Fifth Circuit’s decision in Stine v. Marathon,2 where the court found that even under the prior versions of the model form JOA, the exculpatory clause extended to all of the operator’s activities under the JOA—not just operations. The court did not resolve the conflict between Stine and the other cases and left open the possibility that the older AAPL model form exculpatory clauses may not have as broad an application as the 1989 AAPL model form exculpatory clause.

Finally, the supreme court held that there was legally insufficient evidence to support the jury’s findings that the operator had acted with gross negligence in failing to maintain production from wells on the contract area. The court detailed evidence showing that the operator had tried to maintain production from the wells as long as he could before he had to spend his own money and that the other working interest partners had refused the operator’s request for additional funding. The court held that this was insufficient to support a finding of gross negligence — i.e. that Reeder knew about the risk of not obtaining production in paying quantities, but did not care about the consequences. The court also held that the operator’s failure to offer a well to the other working interest owners before plugging the well was legally insufficient to support a finding of gross negligence because the Railroad Commission of Texas had ordered Reeder to plug the well.

The Reeder decision is important for several reasons. First, it is the first time that the supreme court has interpreted the exculpatory clause in the 1989 AAPL model form JOA. Second, an operator conducting operations under a JOA with similar exculpatory language may not be liable for breach of contract unless it is grossly negligent or commits willful misconduct. Finally, Reeder is instructive of the kind of activities that the supreme court deems legally insufficient to support a finding of gross negligence against an operator.