Exxon Corporation v. Crosby-Mississippi ( 1998 )

Revised October 5, 1998
UNITED STATES COURT OF APPEALS
For the Fifth Circuit
No. 96-60761
EXXON CORPORATION, A New Jersey Corporation,
Plaintiff - Appellant-Cross-Appellee,
VERSUS
CROSBY-MISSISSIPPI RESOURCES, LTD., A MS Limited
Partnership; LYNN CROSBY GAMMILL, General Partner;
STEWART GAMMILL, III, General Partner; STEWART
GAMMILL, III, as successor Trustee for
Stewart Gammill IV, Trust No. 2;
LUCIUS OLEN CROSBY GAMMILL, Trust No. 2;
JENNIFER LYNN GAMMILL, Trust No. 2; LUCIOUS OLEN
CROSBY GAMMILL; STEWART GAMMILL, IV; JENNIFER LYNN
GAMMILL; STEWART GAMMILL, III, as successor
Trustee for Stewart Gammill, IV,
Defendants - Appellees-Cross-Appellants.
Appeals from the United States District Court
for the Southern District of Mississippi
September 2, 1998
Before POLITZ, Chief Judge, HIGGINBOTHAM, and DEMOSS, Circuit
Judges.
DeMOSS, Circuit Judge:
This case requires us to interpret an oil and gas agreement
entered into by Exxon Corporation (Exxon) and Crosby-Mississippi
Resources, Ltd., et al. (CMR). Both parties appeal various rulings
made by the district court. For the following reasons we affirm
the district court in part and vacate and remand in part.
I. Background
In 1983, Exxon and CMR entered into a joint oil and gas
Exploration Agreement to develop their respective mineral resources
in an area of Mississippi. Exxon held oil and gas leases covering
more than 60,000 acres in the contract area, while CMR owned
approximately 20,000 mineral acres in the contract area. Both
Exxon and CMR contributed what they owned to the joint oil and gas
exploration effort. The parties agreed that Exxon contributed 76%
and CMR 24% of the oil and gas interests in the contract area.
Under the terms of the Exploration Agreement, Exxon had the
exclusive right to propose the first exploratory well. CMR could
choose to participate in the exploratory well up to its 24%
contractual share. If CMR chose to participate, it was required to
bear its proportionate share of the costs of the drilling, testing,
completion, and production expenses of the well. By doing so, CMR
would be entitled to 24% of the well's commercial production. If
CMR chose not to participate, however, CMR could still be entitled
to a "royalty" due to certain provisions which are further
explained below.
2
A substantial number of wells were drilled by the parties.
CMR participated in some but not in others. Almost from the
beginning the parties were in disagreement over a number of issues.
The disagreements eventually led to the filing of this action by
Exxon in 1989 to collect amounts it claims are due from CMR for its
share of various expenses. CMR filed a counterclaim alleging
numerous claims of its own.
Because of the complexity of this case, the district court
held a status conference on February 15, 1994. At the conference
the court entered an order delineating nine issues for separate
discovery and trial. This case is an appeal from the bench trial
before the district court on the first of those issues: to what
extent Exxon "earned" CMR’s interest in one particular section of
the contract area. Because this first issue controlled many of the
later disputes between the parties, the district court certified
its ruling for immediate appeal under Rule 54(b) of the Federal
Rules of Civil Procedure.1
The Exploration Agreement
1
Rule 54 (b) provides in relevant part:
When more than one claim for relief is presented in an
action, whether as a claim, counterclaim, cross-claim or
third-party claim, or when multiple parties are involved,
the court may direct the entry of final judgment as to one
or more but fewer than all of the claims or parties only
upon an express determination that there is not just reason
for delay and upon express direction for the entry of
judgment.
3
Under the Exploration Agreement, Exxon was to drill the first
exploratory well. CMR could choose to participate in that well up
to CMR's 24% contractual interest. If CMR chose not to
participate, Exxon could "earn" CMR's 24% interest in the well so
long as it was drilled in accordance with Paragraph 7 of the
Exploration Agreement. CMR, however, might still be entitled to a
1/8 "customary royalty"2 if it owned the "actual, unleased mineral
interests" in the drilling unit.3 Moreover, Paragraph 7 of the
contract provided CMR with an additional 1/8 "overriding royalty"
interest on "production allocated to the parties . . . calculated
on . . . the non-consenting party's4 contractual interest
percentage." Thus, in the simplest case -- where both parties
collectively possessed 100% of the interests underlying a
particular exploratory well -- CMR would receive an overriding
royalty of 1/8 of 24% of the 100% joint interests of Exxon and
2
Under the majority of oil and gas leases, it is "customary"
that the lessor retains a royalty interest consisting of a fraction
of the gross amounts of oil or gas produced. This customary
royalty interest is often a 1/8 interest.
3
The Exploration Agreement defines a drilling unit as "the area
fixed for the drilling of one well by order or rule of any state or
federal body having authority."
4
The Exploration Agreement defines a consenting party as "a
party who agrees to join in and pay its share of the drilling cost
of any operation conducted under the provisions of this agreement."
By contrast, a non-consenting party is "a party who elects not to
participate in a proposed operation." For all issues addressed in
this appeal, Exxon is the consenting party and CMR is the non-
consenting party.
4
CMR.5
If, under Paragraph 7, Exxon earned CMR's interest in an
exploratory well, Paragraph 8 permitted Exxon to earn CMR's
interest in any offset wells to the exploratory well, called
"development wells." To earn CMR's interest in a development well,
Paragraph 8 required Exxon to "commence drilling" on the
development well within 180 days of the completion of the
exploratory well. Each subsequent development well had to be
drilled within 180 days of the completion of the previous
development well. If Exxon complied with these time limits, it
could earn CMR's interest in the development wells, subject to
CMR's customary 1/8 royalty (if CMR owned the "actual unleased
mineral interests") and the 1/8 overriding royalty on "production
allocated to the parties."
Exxon timely commenced drilling on the first exploratory well,
Southern Minerals No. 1. CMR chose not to participate. This well
was successful and produced gas. Exxon then drilled the first
development well for Southern Minerals No. 1, called Southern
Minerals No. 2, and a second development well, called Crown-
Zellerbach No. 24-11. Exxon ultimately drilled six more wells in
the area, which are not relevant to this appeal.
At trial, CMR challenged the procedures employed by Exxon in
drilling the three wells in dispute here. First, CMR claimed that
5
Paragraph 7 also gave CMR the option to covert its royalty to
a working interest when the well reached payout.
5
Exxon failed to comply with the Exploration Agreement with regard
to the drilling of Southern Minerals No. 1, thus forfeiting its
rights to earn CMR's interest in the eight other development wells.
The district court ruled against CMR on this issue, and CMR does
not appeal this ruling. CMR does appeal the district court's
rulings on three other arguments CMR made at the bench trial.
First, CMR asserts that Exxon improperly drilled the first
development well, Southern Minerals No. 2, because it failed to
"propose" the well to CMR in accordance with Paragraph 8. Second,
it contends that Exxon did not "commence drilling" Southern
Minerals No. 2 within 180 days from the "completion" of Southern
Minerals No. 1, as stipulated in the contract. Third, it argues
that Exxon violated the Exploration Agreement on the second
development well, Crown-Zellerbach No. 24-11, because Exxon
contracted with a third-party to operate the well. According to
CMR, each of these failures caused Exxon to forfeit its rights to
CMR's interest in the relevant wells. The district court, however,
ruled against CMR on each contention, and CMR appeals these
rulings.
Exxon was not completely successful in the bench trial,
however. Subsequent to the signing of the Agreement, Exxon
acquired "farm-ins" from various sources.6 The trial court ruled
6
Exxon and CMR did not own all of the drilling rights
throughout the Contract Area. This is not an uncommon situation in
the oil and gas business. The parties desiring to drill may
acquire the outstanding interests by leasing them from the third
6
that the contract unambiguously required Exxon to pay CMR the 1/8
overriding royalty on gas production occurring on the farm-ins that
Exxon acquired after the inception of the Exploratory Agreement.
Exxon appeals this ruling.
II. Analysis
A district court's interpretation of a contract is a matter of
law which we review de novo. American Totalisator Co. v. Fair
Grounds Corp., 3 F.3d 810, 813 (5th Cir. 1993). Accordingly, we
review the record independently and under the same standards that
guided the district court. Id.
Because this suit is founded on diversity jurisdiction, the
district court appropriately turned to Mississippi law for the
applicable standard of contract interpretation. See Erie R.R. Co.
v. Tompkins, 304 U.S. 62 (1938). Under Mississippi law, "[w]here
the interests of the parties to an instrument appear clear and
unambiguous from the instrument itself, the Court should look
parties who own unleased and outstanding interests.
If those mineral interests are already under lease, the parties
desiring to drill may purchase the leases from the holders of the
leases. If the parties holding such leases wish to participate in
the well, the parties may "farm-out" their leased interest to the
parties desiring to drill the well. In such an event the original
leaseholders pay their proportionate share of the production if the
well is a producer.
When the original leaseholder of a mineral lease sells (or
"farms-out") its mineral rights to a purchaser wishing to drill in
the leasehold, the purchaser acquires a "farm-in."
7
solely to the instrument and give same effect as written." Barnett
v. Getty Oil Co., 266 So. 2d 581, 586 (Miss. 1972). See also
Century 21 Deep South Properties, Ltd. v. Keys, 652 So. 2d 707, 716-
17 (Miss. 1995). It is by this standard that we, too, review the
language of the Exploration Agreement and all other agreements
incorporated therein.7
A. CMR's Claims
CMR first claims that Exxon violated the Exploration Agreement
by failing to "propose" the first development well, Southern
Mineral No. 2. CMR points to the unambiguous language of Paragraph
8 of the Exploration Agreement.8 CMR asserts that Paragraph 8
7
The parties incorporated an Operating Agreement and several
attachments into the Exploration Agreement.
8
Paragraph 8 of the Exploration Agreement reads in pertinent
part:
If at the time each new exploratory well is proposed
. . . then the consenting party shall by earning the
non-consenting party's contractual interest in said
exploratory well likewise earn the non-consenting
party's rights to said non-consenting contractual
interest to propose, drill, and complete or plug and
abandon development wells which are drilled in
offsetting contract units provided that no more than
one hundred and eighty (180) days shall elapse between
the date said exploratory well is completed . . . and
the actual commencement of drilling of the first
development well drilled in an offsetting contract
unit to said exploratory well . . . . At such time as
said consenting party fails to drill such development
wells on said one hundred and eighty (180) day
continuous basis and carry said non-consenting party's
contractual interest, all unearned rights attributable
8
requires the proposal of development wells based merely on the fact
that the word "propose" appears in the language of Paragraph 8,
which pertains to development wells. CMR also argues that the
proposals are necessary because they serve the informational
purpose of allowing CMR to monitor whether Exxon was meeting the
180-day "continuous drilling" time frame required by the contract.
We disagree with CMR's interpretation of the Agreement.
CMR chose not to participate in the Southern Minerals No. 1
exploratory well under Paragraph 7. As such, Paragraph 8 provides
that Exxon obtained the right to earn CMR's interest in the first
development well, Southern Minerals No. 2. By obtaining the right
to earn CMR's interest in the well, under the express language of
Paragraph 8, Exxon "likewise" earned CMR's "right to propose" the
development well. Furthermore, under Paragraph 7, it appears the
purpose of proposing the initial exploratory well was to give CMR
a chance to participate in that well. However, when Exxon earned
CMR's interest in the exploratory well, CMR could not participate
in the subsequent development wells. Essentially, proposing the
development well at that point would serve no purpose.
As evidence that development wells must be proposed, CMR also
points to the beginning language of Paragraph 12: "When a
development well is proposed . . . ." This provision, however, is
not helpful to CMR, as Paragraph 12 would have only applied if CMR
to said non-consenting party's contractual interest
shall revert to said non-consenting party . . . .
9
had participated in the exploratory well.
CMR also claims that proposal was required even if it could
not participate in the development well because CMR needed the
information to keep track of whether Exxon was complying with the
180-day continuous drilling time frame. We again disagree.
Under Paragraph 16 of the Exploration Agreement, and under the
incorporated Operating Agreement, CMR was given access to all
information that Exxon had concerning the contract area: "All
parties shall have access at all reasonable times . . . to all
information concerning the contract area which is in the possession
of any other party." Thus, CMR did not need to rely on the
proposal mechanism to acquire needed information.
Since CMR already had chosen not to participate in the
Southern Minerals No. 1 exploratory well, we find that Exxon was
under no contractual duty to propose subsequent development wells.
We thus affirm the judgement of the district court with regard to
this claim.
CMR's second claim is that Exxon forfeited its right to CMR's
interest in the Southern Minerals No. 2 well, the first development
well, because Exxon failed to commence drilling on that well within
the 180-day time frame dictated by the Exploration Agreement. In
order to rule on this claim, we must decide when Exxon "actually
commenced drilling" of the Southern Minerals No. 2 development
well.
The district court found the terms "complete" and "actual
10
commencement of drilling" ambiguous, and thus considered parol
evidence in determining the parties' intended definition of these
terms. Once terms of a contract are found to be ambiguous, "the
determination of the parties' intent through extrinsic evidence is
a question of fact." See Ham Marine, Inc. v. Dresser Indus., Inc.,
72 F.3d 454, 459 (5th Cir. 1995) (quoting Watkins v. Petro-Search,
Inc., 689 F.2d 537, 538 (5th Cir. 1982)). We review bench trial
findings of fact for clear error. See Baldwin v. Stadler, 137 F.3d
836, 839 (5th Cir. 1998). Such a finding is clearly erroneous
"when we are left with a definite and firm conviction that a
mistake has been made." Sunbeam Oster Co. v. Whitehurst, 102 F.3d
1368, 1373 (5th Cir. 1996) (quotations and citations omitted).
CMR challenges the district court's determination as to both
when the Southern Minerals No. 1 exploratory well was "completed"
and when "actual commencement of drilling" began on the Southern
Minerals No. 2 development well. We first consider on what date
the "actual commencement of drilling" began on Southern Minerals
No. 2, as our ruling in this regard may preclude the need for a
determination of when the Southern Minerals No. 1 exploratory well
was completed.
On March 11, 1985, Griner Well Service drilled the hole for
the conductor pipe of Southern Minerals No. 2. The conductor pipe
is an essential component of a gas well. It is designed to prevent
the hole from caving-in and to support the great weight of the
11
drill pipe. The conductor pipe consists of a large diameter casing
that was placed, in this case, 133 feet in the ground. The drill
is then sent through the conductor pipe in the process of drilling
for the gas.
Griner Well Service used a small, truck-mounted "auger rig" to
drill the hole for the conductor pipe. After this was completed,
a large drilling rig was used to drill for the gas. On March 20,
1985, Exxon completed its construction of the larger drilling rig.
On this date, the primary drilling bit broke ground at the base of
the conductor pipe. Accordingly, Exxon reported March 20 as the
"spud" date of the well.
The district court determined that drilling "commenced" on
Southern Minerals No. 2 on March 11, when Exxon had Griner Well
Service drill the hole for the conductor pipe. The court reasoned
that the conductor pipe is an essential part of the well, and Exxon
had no choice but to "drill" a hole in which to place the pipe.
Moreover, concluded the district court, if the parties had meant
for the "commencement of drilling" to involve the larger drilling
rig only, they could have used language to that effect in the
contract.
CMR argues on appeal that the conductor pipe is merely a
preparatory step to actual drilling. It contends that actual
drilling involves the use of drill equipment capable of uncovering
gas, not the digging of a hole for conductor pipe that is necessary
to commence later operations. Thus, according to CMR, drilling did
12
not actually commence on Southern Minerals No. 2 until the well's
larger drill-bit broke the surface of the ground.
Unfortunately, the reported case law in Mississippi gives no
clear answer to the question of what activities constitute the
"commencement of drilling." CMR does cite several cases that it
asserts establish that the laying of conductor pipe does not
constitute the "commencement of drilling." See Muth v. Aetna Oil
Co., 188 F.2d 844, 848-49 (7th Cir. 1951), vacated on other
grounds, 342 U.S. 844 (1951); Hughes v. Ford, 92 N.E.2d 747, 749-51
(Ill. 1950). As Exxon points out, however, these cases are
distinguishable because they involve bad faith attempts by
operators to prolong mineral leases. Presumably these courts would
also hold that the bad faith use of the actual drill bit would
likewise not constitute the commencement of drilling.
Here, there is no question that the gas that was eventually
extracted from the well came up through the hole containing the
conductor pipe. Thus, the creation of the conductor pipe hole was
part and parcel of the actual drilling process, and was more than
mere preparatory activity, such as the gathering of equipment or
the clearing of land. Rather, in creating the conductor hole,
Exxon actually broke the surface of the land and drilled toward the
gas. We cannot find clear error in the district court's
determination that in drilling the conductor pipe hole, Exxon
actually commenced drilling.
13
CMR argues that the Southern Minerals No. 1 exploratory well
was completed on September 15, 1984, whereas the district court
found that this well was completed on September 27, 1984. Because
we find that the district court was not clearly erroneous in
determining that drilling of the Southern Minerals No. 2 well
commenced on March 11, 1985, we do not reach the question regarding
the completion date of the Southern Minerals No. 2 well since both
the date proposed by CMR and the date determined by the district
court fall within 180 days of March 11.
CMR's final claim is that Exxon failed to drill and operate
the second development well, Crown-Zellerbach No. 24-11, in
accordance with the terms of the Operating Agreement, incorporated
by reference into the Exploration Agreement. This claim arises
from the fact that Exxon contracted with a third party, Prosper
Energy Company, to operate the Crown-Zellerbach No. 24-11. CMR
contends that the Operating Agreement expressly appoints Exxon as
the sole operator, and that under the Exploration Agreement the
Operating Agreement "shall govern all operations under this
Exploration Agreement." CMR's argument is that because Exxon
entered into a separate operating agreement that designated Prosper
Energy Company as the operator of Crown-Zellerbach No. 24-11, Exxon
could not earn CMR's interest in that unit.
14
Unlike the Exploration Agreement, which was written by the
parties, the Operating Agreement is a standard form. "Exxon" was
typed in and appears in two blanks that name the operator. Article
V.D. of the Operating Agreement, however, was altered by the
parties to include the following introductory phrase: "Except as to
wells in which Exxon or one of CMR, et al is operator." Obviously,
the Operating Agreement itself contemplates the situation where
someone other than Exxon would operate a well. CMR's contention
that the Agreement specifies only Exxon as the operator cannot be
sustained.
We also reject CMR's argument that the identity of the
operator is tied to whether one of the parties can earn the other's
interest. This contention finds no support in Paragraph 8 of the
Exploration Agreement, which explicitly addresses the procedures
necessary for one party to earn the interest of the other. Nowhere
in Paragraph 8 is there any mention of the identity of an operator
or how the identity of an operator affects the earning of another
party's interest.
CMR further argues that a third party is authorized to operate
a well under Paragraph 10 of the Exploration Agreement only when
CMR and Exxon do not together own a majority of the drilling
interests in the drilling unit for that well. We find this
argument unpersuasive and contrary to our reading of the contract.
Nowhere in Paragraph 10 do we find anything to support CMR's
reading of this provision.
15
Paragraph 10 does not address when a third party can operate
a well.9 Rather, this provision addresses the situation in which
one of the parties to the Exploration Agreement desires to contract
with a third party. In such a situation, Paragraph 10 provides
that the party wishing to contract with a third party must notify
the other party to the Exploration Agreement of all terms and
conditions of the contemplated contract. However, notice is
required only when CMR and Exxon do not together own a majority of
the drilling interests in the drilling unit for that well.
Paragraph 10 is nothing more than a notice provision.
Furthermore, Paragraph 10 is not even applicable in this situation
since CMR and Exxon did, in fact, together own the majority of the
drilling interests in the drilling unit on which the Crown-
Zellerbach No. 24-11 was operated. Accordingly, we find that
neither Paragraph 10, nor any other provision in the Exploration or
9
Paragraph 10 provides in pertinent part:
If any party should desire to enter into any agreement
or agreements (1) for the drilling of any well or
wells (other than Drilling Contracts and related
service contracts) in any area in which any drilling
unit will contain any part of the contract area, and
in which are the parties' interests committed under
this exploration agreement will not constitute a
majority of the drilling interests, or (2) for farming
out any interests in the contract area, said party
shall give written notice to all other parties of the
specific lands to be covered by said agreement(s) and
of all terms and conditions under which said party
desires to enter into said agreement(s), together with
all other requirements for notice under Article VI.B.
[of the Operating Agreement].
16
Operating Agreements, prohibited Exxon from contracting with a
third party to operate the Crown-Zellerbach No. 24-11 well.
B. Exxon's Claim
Having affirmed the district court's ruling with regard to all
claims raised on CMR's cross-appeal, we now turn to Exxon's appeal
of the district court's determination that the contract
unambiguously entitles CMR to a 1/8 overriding royalty on
production from farm-ins acquired solely by Exxon. Cities
Services, Clayton Williams, and David Smith owned drilling
interests in the contract area. Exxon negotiated with these
parties and they "farmed-out" their interests to Exxon.10 Both
Exxon and CMR agree that these farm-ins are "acquisitions" under
the terms of the Exploration Agreement.
We note that our "broad standard of review includes the
initial determination of whether the contract is ambiguous."
American Totalisator Co. v. Fair Grounds Corp., 3 F.3d 810, 813
(5th Cir. 1993). And, whether a contract is ambiguous is a
question of law reviewed de novo. Triad Elec. & Controls, Inc. v.
Power Sys. Eng'g, 117 F.3d 180, 187 (5th Cir. 1997).
With regard to this particular issue, we look to all
provisions in the Agreement that address the overriding royalty and
10
From Exxon's point of view, these farm-outs are considered
"farm-ins."
17
all provisions that address acquisitions. Having thoroughly
reviewed all such provisions, we find the language dealing with the
overriding royalty ambiguous regarding the applicability of the
overriding royalty to acquisitions made solely by one party. See
Century Twenty-One v. Keyes, 652 So. 2d 707, 716-717 (Miss. 1995)
("If . . . a careful reading of the instrument reveals it to be
less than clear, definite, explicit, harmonious in all its
provisions, and free from ambiguity throughout, the court is
obligated to pursue the intent of the parties, and, to determine
the intent, must resort to extrinsic aid.").
We turn first to the relevant portions of the Agreement that
refer to the overriding royalty. Paragraph 7 of the Exploration
Agreement creates "an overriding royalty of one-eighth (1/8) of
eight-eighths (8/8) of production allocated to the parties, without
any reduction for any royalties and/or any other burdens, and
calculated on said non-consenting parties' contractual interest
percentage . . . subject to the right of conversion at payout."
Paragraph 7 applies to all exploration wells, including Southern
Minerals No. 1.
CMR is a non-consenting party as to the Southern Minerals No.
1 well. Since Exxon earned CMR's interest in Southern Minerals No.
1, Exxon acknowledges that it has the obligation, under Paragraph
7, to pay CMR, in addition to its royalty on "actual unleased
mineral interests," the overriding royalty on its contractual
18
interest (24%) of the combined working interest controlled by CMR
and Exxon jointly. But Exxon does not agree that the combined
working interest on which the overriding royalty is calculated
includes the working interest acquired by Exxon from the farm-ins.
The same dispute exists under Paragraph 8 regarding the
development wells. Since Exxon earned CMR's interest in the
Southern Minerals No. 1 well, Paragraph 8 provides that Exxon also
obtained the right to earn the interest of CMR in development wells
(the remaining 8 wells in the contract area). Since Exxon earned
the interest of CMR in the other 8 wells, Exxon incurred the
obligation, under Paragraph 8, to pay CMR the same overriding
royalty interest. Where we find the Agreement ambiguous is in its
silence as how the overriding royalty applies to acquisitions made
solely by one party.
In addressing this issue, the district court reasoned that
"production allocated to the parties" referred to all working
interests of Exxon and CMR, regardless of when and how those
interests were acquired. The district court thus found that CMR
deserved an overriding royalty interest on all production jointly
controlled by the two parties in the contract area, including the
production from Exxon's newly acquired interests. While this is a
reasonable interpretation of the overriding royalty provision,
Exxon asserts an equally plausible interpretation of "production
allocated to the parties."
The purpose of the Agreement was to pool the combined
19
interests of Exxon and CMR, with each party receiving a
proportionate contractual interest in the pooled interests based on
each party's proportionate contribution to that pool. The
contractual interests granted to each party corresponded to the
proportionate contribution to the pool by each party. The parties
agreed that Exxon's contribution to the pool was 76% of the whole,
and CMR's was 24%. But Exxon later acquired additional interests
by way of farm-ins. Thus, the district court's ruling grants CMR
an overriding royalty in these later-acquired acquisitions for
which CMR made no contribution. Exxon contends that to give CMR an
overriding royalty on farm-ins which Exxon alone purchased would
upset the original calculations of the parties used to determine
each party's contractual interest.
Unlike the district court, we find ambiguity in the statement
"production allocated to the parties" because it is simply unclear
whether "production allocated" refers to working interests
acquired solely by one party after the inception of the agreement.
Review of the provisions in the Agreement that address acquisitions
are not helpful to resolving this ambiguity, and serve only to
further confuse the issue.
Exxon calls our attention to Paragraph 13 of the Exploration
Agreement as the critical provision of the contract that concerns
acquisitions. We, however, do not find Paragraph 13 instructive on
the issue of the overriding royalty. Paragraph 13 of the Agreement
simply requires Exxon to notify CMR of the farm-in acquisitions and
20
to give CMR the chance "to participate in such acquisition[s], for
the dollar price paid and/or possible participation in the drilling
of the well, if that be required to earn the farm-out."11
Thus, Paragraph 13 only provides a mechanism by which one
party can choose to participate in another's acquisition.
Paragraph 13 does not speak to whether acquisitions in which one
party does not participate become part of the pool of interests to
which the overriding royalty applies. Paragraph 13 is not
instructive with regard to the overriding royalty.
Though another provision of the contract also brought to our
attention by Exxon appears relevant to the issue of the overriding
royalty, we find it creates further ambiguity in the contract. As
11
In this case, both Exxon and CMR agree that participation in
the drilling of a well was required in order to participate in the
acquisitions.
Preliminary notice of the acquisition of the farm-ins was given
by Exxon to CMR by letter after Southern Minerals No. 1 had been
proposed but before drilling was commenced. Negotiations regarding
the farm-ins had not been completed and the letter stated that
"[f]ull information regarding participation in these acquisitions
will be provided by separate letter." The parties agree that
additional and complete information regarding the farm-ins was
never provided by Exxon to CMR.
The district court found that the notice was insufficient to
comply with the requirements of Paragraph 13. Thus, CMR was never
given its opportunity to participate in the farm-ins. Exxon points
out that CMR decided not to participate in the Southern Minerals
No. 1 exploratory well and as a result, CMR lost its right to
participate in any other development well in the contract area.
The district court found that the notice issue was not controlling
on the question of whether CMR is entitled to an overriding royalty
on the interests acquired by Exxon by way of the farm-ins. We
agree with the district court in this respect.
21
previously discussed, the Operating Agreement is incorporated by
reference into the Exploration Agreement as Exhibit II.12
Exhibit A to Exhibit II has five separate provisions. The
third provision pertains to the "percentages or fractional interest
of parties to this Agreement." In this provision, the parties
agree to the contractual interest percentages of Exxon (76%) and
CMR (24%). This provision also includes a statement pertaining to
acquisitions: "An Acquisition by less than all of the Parties shall
not affect the percentages of parties to this agreement except as
to the Contract Unit[s]13 in which all or any part of said
Acquisition may be included." We consider this statement in light
of Paragraph 8, the applicable overriding royalty provision of this
contract.
Paragraph 8 provides that the overriding royalty is
"calculated on said non-consenting party's (CMR's) contractual
interest." Contractual interest is defined in Exhibit I as "the
contractual percentage interest attributable to each party as shown
on Exhibit A."
Exhibit A, however, seems to provide that the contractual
percentages are not "affected" when fewer than all parties
participate in an acquisition "except as to the Contract Unit[s] in
12
Exhibit I to the Exploration Agreement is a list of
definitions clarifying the meaning of terms used in the agreement.
13
The Contract Unit is the area ultimately established for the
well to be drilled.
22
which [the] Acquisition may be included." This provision seems to
suggest that percentages of contractual interests change with
respect to wells drilled in contract units where there are
acquisitions made solely by one party. If this is the case, it is
unclear to this Court whether the overriding royalty that is
"calculated on said non-consenting party's contractual interest" is
calculated on the original overall contractual interest, the
contractual interest in a particular contract unit, or some
combination thereof.
We find that the phrase "production allocated to the parties
. . . calculated on said non-consenting party's contractual
interest" is ambiguous. The intent of the parties simply can not
be determined from the language, and thus, the district court was
obligated to pursue the intent of the parties, and, to determine
the intent, should have examined parol evidence. Century Twenty-
One v. Keyes, 652 So. 2d 707, 716-717 (Miss. 1995).
For the foregoing reasons, we AFFIRM the district court's
rulings on CMR's claims and VACATE the decision of the district
court that the Exploration Agreement is unambiguous with respect to
whether CMR is entitled to an overriding royalty on Exxon's farm-in
acquisitions. Accordingly, we REMAND this case for the
consideration of parol evidence to determine the parties' intent
with respect to that issue.
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