In brief: energy contract performance and liability in USA

Commercial/civil law – substantive

Describe any industry-standard form contracts used in the energy sector in your jurisdiction.

Common standard-form contracts include joint operating agreements (JOAs), oil and gas leases, farmout agreements, assignments and surface use agreements, although the terms may be negotiated. The most commonly used JOAs are based on the American Association of Professional Landmen (AAPL) Form 610, the Association of International Petroleum Negotiators (AIPN) International Model (2012), AAPL Form 710 and the AIPN International Model (2014).

Other commonly used model contracts are created by the American Petroleum Institute; the International Association of Drilling Contractors, an industry group including producers, manufacturers and suppliers of oilfield equipment and services; and the North American Energy Standards Board (NAESB). Commodity transactions are often conducted using forms promulgated by the International Swaps and Derivatives Association (ISDA).

What rules govern contractual interpretation in (non-consumer) contracts in general? Do these rules apply to energy contracts?

Generally, there is no federal contract law; instead, states determine rules of contract interpretation. Several states have adopted the Uniform Commercial Code (UCC) for disputes related to the sale of goods, while others follow general common law contract rules. All states generally follow common law rules for other contracts such as JOAs or contracts in manuscript form.

Under both rules, contractual terms are given their plain and ordinary meaning, interpreted as a reasonable person would understand them. In most states, the parol evidence rule prevents parties to a written contract from using extrinsic evidence to aid in the interpretation of the contract. If the language of the contract is unambiguous, courts will enforce the contract as written. If the contract’s terms are ambiguous, they are construed against the parties who draft the contracts. Accordingly, in disputes among landowner-lessors and energy-company lessees, ambiguous contracts are often construed against lessees as the scriveners of the contract.

Under common law, other considerations may be relevant, such as previous dealings between parties, the course of performance of the contract, and industry norms. However, under the UCC, these considerations may only explain or supplement, not contradict, contractual terms.

Describe any commonly recognised industry standards for establishing liability.

Subsurface oil and gas are subject to the common law rule of capture: a landowner has the right to oil and gas under his or her property, even if the oil and gas migrated from adjacent tracts of land. The first person to extract oil and gas from the land is its owner. A landowner who extracts hydrocarbons from a well on his or her land will not be liable for draining adjacent tracts of land. However, this right of appropriation does not cover negligence and waste (eg, letting gas escape). In some states, the common law rule of capture is modified by regulatory rules such as well-spacing requirements, forced pooling and unitisation.

As for production matters, oil and gas lessees are held to a reasonably prudent operator standard, rather than a fiduciary standard. They must consider both their own interests and those of their lessors.

Lessees may also be subject to implied contractual covenants, which vary from state to state. The most common implied covenants are to reasonably develop the leasehold; to protect the leasehold against drainage; to market oil and gas as a reasonable and prudent operator; and to manage and administer the lease.

Industry contracts in the commodity marketing and trading sector from ISDA, the NAESB and other organisations regularly limit liability for incidental, consequential, indirect or punitive damages, or for lost profits. Indemnity agreements may also offset liabilities between parties.

Are concepts of force majeure, commercial impracticability or frustration, or other concepts that would excuse performance during periods of commodity price or supply volatility, recognised in your jurisdiction?

US contract law is generally hostile to concepts excusing performance during periods of commodity price or supply volatility. Under common law and the UCC, unless otherwise agreed, price increases and supply volatility are considered foreseeable risks and do not excuse contract performance.

Force majeure clauses are common in energy contracts but they only excuse contract obligations when performance is prevented by unforeseeable events. Force majeure generally will not excuse performance due to predictable risks. Absent contrary language in an oil and gas lease, some states recognise the temporary cessation of production doctrine, which provides that circumstances causing a well to cease production temporarily will not automatically terminate a lease. While generally not applicable to strictly economic circumstances, courts have applied this doctrine to a wide variety of reasons for stoppages.

What are the rules on claims of nuisance to obstruct energy development? May operators be subject to nuisance and negligence claims from third parties?

Energy companies confront US nuisance suits with varied success. Common law, as interpreted and developed in each state, governs private nuisance claims. Generally, an activity is a nuisance if it unreasonably interferes with the enjoyment and use of one’s property. Because this question focuses on reasonableness, outcomes in nuisance suits are largely determined by the trier of fact, typically a jury, on a case-by-case basis. For example, in Crosstex North Texas Pipeline, LP v Gardiner, the plaintiffs brought a nuisance suit under Texas law alleging that the defendant’s pipeline activities, specifically the operation of a compressor near the plaintiffs’ land, caused noise pollution. The jury found for the plaintiffs, but the appellate court reversed and remanded, citing factual insufficiency in light of the care shown by the defendant in building and maintaining the compressor. Contrastingly, in Parr v Aruba Petroleum, plaintiffs won a US$3 million US jury verdict for a private nuisance claim that alleged the plaintiffs were affected by the defendant’s emissions and spills. However, on appeal, the court reversed and rendered a take-nothing judgment upon a finding that the plaintiff failed to establish that the defendant actually intended or desired to create the alleged interference.

There have also been several reported cases alleging that wind farms constitute a nuisance. The principal Texas case is Rankin v FPL Energy LLC, where the plaintiffs’ principal objection to the wind farm was that the wind turbines would destroy their view, cause excessive noise and reduce the value of their property. The appellate court upheld the jury’s ruling in favour of the defendant. It agreed with the trial court on the major issue: aesthetics is not admissible as evidence of nuisance under virtually any circumstances.

In the United States, there is no privity requirement to bring nuisance or negligence lawsuits. Anyone affected by energy development activities, such as homeowners, may have standing to bring such lawsuits if they allege damage caused by these activities.

One active area of development in nuisance litigation has been climate change-related nuisance claims against energy companies – primarily large, vertically-integrated ones. Generally, the plaintiffs in these cases claim that energy companies have contributed to climate change by virtue of the greenhouse gases emitted in the production and use of the companies’ oil and gas products. In some cases, the plaintiffs are seeking to obstruct hydrocarbon energy development. The viability of these claims is a developing area of the law, as the parties have been fighting for years over whether the claims must proceed in federal or state court. The plaintiffs generally try to avoid federal court, where the claims may be precluded by previous Supreme Court decisions. In state courts, the law varies across jurisdictions and is less developed in this context. Although there are several pending appeals regarding the venue for these cases, a Hawaiian climate change nuisance case became the first such case to enter the discovery phase in 2022.

How may parties limit remedies by agreement?

Parties have wide latitude to limit their remedies by contract. Although the limitation of remedies must adhere to a standard of conscionability and exclusive contractual remedies must not fail their essential purpose, parties may limit remedies to liquidated damages, replacement or refund, or exclusion of or caps on some damages (eg, consequential).

The definition of certain kinds of damages is often subject to dispute. For example, consequential damages often denote damages unaccounted for by contract that results naturally but not necessarily from a breach of contract. However, parties often dispute whether their contracts contemplate naturally resulting damage, a prerequisite for recovery. If the losses are contemplated, they are recoverable. See McKinney & Moore, Inc v City of Longview.

Is strict liability applicable for damage resulting from any activities in the energy sector?

Courts apply strict liability standards to activities that are deemed abnormally dangerous or ultra-hazardous. In deciding whether an activity is abnormally dangerous, most courts apply a balancing test based on the following factors:

• the existence of a high degree of risk of some harm to the person, land or chattels of others;
• the likelihood that the harm that results will be great;
• the inability to eliminate the risk by exercise of reasonable care;
• the extent to which the activity is not a matter of common usage;
• the inappropriateness of the activity to the place; and
• the extent to which its value to the community is outweighed by its dangerous attributes.

Generally, US courts find that traditional activities in the energy industry are not abnormally dangerous, and strict liability standards are seldom used. However, some pockets of strict liability exist. The Oil Pollution Act imposes strict liability for oil pollution on owners and operators of vessels. The Trans-Alaska Authorization Act imposes strict liability on owners of the Trans-Alaska Pipeline right of way for all damages resulting from activities along or near the right of way. Moreover, oil tankers carrying Alaskan oil transported through the pipeline are also strictly liable for pollution damage. Some states also impose strict liability on oil and gas operators for any surface damage caused (eg, New Mexico’s Surface Owner Protection Act).

The recent boom in hydraulic fracturing has spurred litigation on whether such activities are abnormally dangerous. Though the applicability of strict liability is a question of law to be decided by judges, recent litigation suggests that judges are unwilling to decide this issue without a developed record of facts. See Ely v Cabot Oil & Gas Corp (after initially declining to decide the issue without a more developed record, holding after further discovery that ‘natural gas drilling operations and hydraulic fracturing are not abnormally dangerous activities’, and claims for property damage and injury resulting from such operations ‘should continue to be limited to, and considered against, the standards governing negligence’ rather than strict liability); and Kamuck v Shell Energy Holdings GP LLC (refusing to decide on the pleadings whether fracking is abnormally dangerous, but rather deciding to wait until the close of discovery).