XTO Energy Inc. v. Smith Production Inc.

Affirmed and Majority and Dissenting Opinions filed February 24, 2009

Affirmed and Majority and Dissenting Opinions filed February 24, 2009.

In The

Fourteenth Court of Appeals

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NO. 14-07-00069-CV

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XTO ENERGY INC., Appellant

V.

SMITH PRODUCTION INC., Appellee

On Appeal from the 281st District Court

Harris County, Texas

Trial Court Cause No. 2004-68579

D I S S E N T I N G    O P I N I O N

The majority concludes that a receiving party cannot change its election within thirty days after receipt of the notice because the Notice Period expires upon the earlier of (a) thirty days after receipt of the Notice, or (b) the date on which the receiving party responds.  Because I do not believe this interpretation is consistent with the contracts= language, which is ambiguous at best, I respectfully dissent.

I.  Applicable Principles of Contract Construction

In determining whether the language of a contract is ambiguous, we look to the contract as a whole, in light of the circumstances present when the contract was executed.  Sun Oil Co.  (Del.) v. Madeley, 626 S.W.2d 726, 731 (Tex. 1981);^[1] see also Lenape Res. Corp. v. Tenn. Gas Pipeline Co., 925 S.W.2d 565, 574 (Tex. 1996) (op. on reh=g). (A[A] court should construe a contract from a utilitarian standpoint, bearing in mind the particular business activity sought to be served.@).  We first examine the words of the contract, and considering the business activity to be served, determine whether both proffered interpretations are reasonable.  XCO Prod. Co. v. Jamison, 194 S.W.3d 622, 628 (Tex. App.CHouston [14th Dist.] 2006, pet. denied) (sub. op.).  If both interpretations are reasonable, then the contract is ambiguous and there is a genuine issue of material fact regarding the parties= intent.  J.M. Davidson, Inc. v. Webster, 128 S.W.3d 223, 229 (Tex. 2003); Columbia Gas Transmission Corp. v. New Ulm Gas, Ltd., 940 S.W.2d 587, 589 (Tex. 1996).  This is so even if it appears that one interpretation is more reasonable than another.  See Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118, 121 (Tex. 1996) (stating that a contract is ambiguous if it is Areasonably susceptible to more than one interpretation@); Coker v. Coker, 650 S.W.2d 391, 393 (Tex. 1983); cf. In re D. Wilson Constr. Co., 196 S.W.3d 774, 782 (Tex. 2006) (holding that agreements were Anot susceptible to more than one reasonable interpretation and are therefore not ambiguous@).

Ambiguity must be evident when the contract is read in context of surrounding circumstances, not after parol evidence of intent is admitted.  Nat=l Union Fire Ins. Co. of Pittsburgh, Pa. v. CBI Indus., Inc., 907 S.W.2d 517, 521 (Tex. 1995) (per curiam); Williams v. Williams, 246 S.W.3d 207, 211 (Tex. App.CHouston [14th Dist.] 2007, no pet.).  Stated differently, although parol evidence of the parties= intent is not admissible to create an ambiguity, see National Union, 907 S.W.2d at 520, the contract may be read in light of the surrounding circumstances to determine whether an ambiguity exists.  Balandran v. Safeco Ins. Co. of Am., 972 S.W.2d 738, 741 (Tex. 1998) (citing Columbia Gas, 940 S.W.2d at 589, and Nat=l Union, 907 S.W.2d at 520).  Such circumstances include Athe commonly understood meaning in the industry of a specialized term, which may be proven by extrinsic evidence such as expert testimony or reference material.@  XCO Prod. Co., 194 S.W.3d at 627B28; see also Floboots Corp. v. Teas, 110 S.W.2d 180, 183 (Tex. Civ. App.CSan Antonio 1937, writ dism=d) (holding trial court=s finding that slate, indurated shale, and quartzite are Ametamorphic formations@ was supported by properly-admitted expert testimony concerning the meaning of those terms).  However, we may not rewrite the contract Aor add to its language under the guise of interpretation.@  Helmerich & Payne Int=l Drilling Co. v. Swift Energy Co., 180 S.W.3d 635, 641 (Tex. App.CHouston [14th Dist.] 2005, no pet.).

II.  Language of the Joint Operating Agreements

The contract provisions at the heart of this dispute provide in relevant part as follows:

1.  Proposed Operations:  Should any party hereto desire to drill any well on the Contract Area other than the [initial well], . . . the party desiring to drill . . . such a well shall give the other parties written notice of the proposed operation, specifying the work to be performed, the location, proposed depth, objective formation and the estimated cost of the operation.  The parties receiving such a notice shall have thirty (30) days after receipt of the notice within which to notify the party wishing to do the work whether they elect to participate in the cost of the proposed operation. . . . Failure of a party receiving such notice to reply within the period above fixed shall constitute an election by that party not to participate in the cost of the proposed operation.

If all parties elect to participate in such a proposed operation, Operator shall, within ninety (90) days after expiration of the notice period of thirty (30) days (or as promptly as possible after the expiration of the forty-eight (48) hour period when a drilling rig is on location, as the case may be), actually commence the proposed operation and complete it with due diligence at the risk and expense of all parties hereto; provided, however, said commencement date may be extended upon written notice of same by Operator to the other parties, for a period of up to thirty (30) additional days if, in the sole opinion of Operator, such additional time is reasonably necessary to obtain permits from governmental authorities, surface rights (including rights-of-way) or appropriate drilling equipment, or to complete title examination or curative matter required for title removal or acceptance.  Notwithstanding the force majeure provisions of Article XI, if the actual operation has not been commenced within the time period provided (including any extension thereof as specifically permitted herein) and if any party hereto still desires to conduct said operation, written notice proposing same must be resubmitted to the other parties in accordance with the provisions hereof as if no prior proposal had been made.

2.  Operations by Less than All Parties:  If any party receiving such notice as provided in Article VI.B.1. . . . elects not to participate in the proposed operation, then, in order to be entitled to the benefits of this Article, the party or parties giving the notice and such other parties as shall elect to participate in the operation shall, 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.

If less than all parties approve any proposed operation, the proposing party immediately after the expiration of the applicable notice period, shall advise the Consenting Parties of the total interest of the parties approving such operation and its recommendation as to whether the Consenting Parties should proceed with the operation as proposed. Each Consenting Party, within forty-eight (48) hours (exclusive of Saturday, Sunday and legal holidays) after receipt of such notice, shall advise the proposing party of its desire to (a) limit participation to such party=s interest as shown on Exhibit AA@ or (b) carry its proportionate part of Non-Consenting Parties= interests, and failure to advise the proposing party shall be deemed an election under (a). . . . The proposing party, at its election, may withdraw such proposal if there is insufficient participation and shall promptly notify all parties of such decision.

The entire cost and risk of conducting such operations shall be borne by the Consenting Parties in the proportions they have elected to bear same under the terms of the preceding paragraph. . . . Upon commencement of operations . . . of any such well by Consenting Parties in accordance with the provisions of this Article, each Non-Consenting Party shall be deemed to have relinquished to Consenting Parties, and the Consenting Parties shall own and be entitled to receive, in proportion to their respective interests, all of such Non-Consenting Party=s interest in the well and share of production therefrom until the proceeds of the sale of such share . . . shall equal the total of the following: . . . .

Joint Operating Agreements, Art. VI.B. (emphasis added).  From this language, the majority draws dispositive inferences with which I disagree.

III.  Contract Defines Notice Period=s Expiration Date

Under the majority=s interpretation, the Notice Period is subject to several different expiration dates.  First, there is the thirty-day deadline described in the contract; this could be called the ADefault Expiration Date.@  In addition to the thirty-day period described in the contracts, however, the majority has discovered two other expiration dates.  First, there is the date that could be considered the AResponder=s Expiration Date.@  According to the majority, A[o]nce a receiving party timely gives notice of its election regarding the drilling operation by properly replying within the thirty days, the Notice Period has expired as to that party.@^[2]  Building on this inference, the majority next asserts that A[o]nce all parties have communicated their election regarding the proposed operation, the Notice Period has expired.@^[3]  This could be considered a AGeneral Expiration Date.@ 

I have discovered no authority for the existence of a General or Responder=s Expiration Date in the language of the contracts.  Although the Notice Period can expire for the various receiving parties on different days, the parties have unambiguously specified the method by which these dates are calculated.  Under the terms of the joint operating agreements, the expiration date of the Notice Period is determined not by the date on which a party replies, but by the date on which the party received the notice of the proposed operations:   AThe parties receiving such a notice shall have thirty (30) days after receipt of the notice within which to notify the party wishing to do the work whether they elect to participate in the cost of the proposed operation.@ (emphasis added).  This court cannot assert its contrary inferences as facts, as the majority has done, without rewriting the contract. 

The contractual provisions at issue describe no circumstance under which the thirty-day Notice Period expires in less than thirty days; to the contrary, the parties have agreed that this is the period Afixed@ for the receiving party to reply: AFailure of a party receiving such notice to reply within the period above fixed shall constitute an election by that party not to participate in the cost of the proposed operation.@ (emphasis added).  To fix means to A[a]djust or regulate; determine; settle; make permanent.  [The] [t]erm imports finality; stability; certainty; definiteness.@  Black=s Law Dictionary 637 (6th ed. 1990).^[4] The majority=s interpretation, however, eliminates the certainty to which the parties agreed.

The inferences drawn by the majority are inconsistent with other express terms of the parties= agreements as well.  Under Article VI.B.2., for example, if any receiving party elects not to participate in the proposed operations, then the parties who have chosen to participate Ashall, within ninety (90) days after the expiration of the notice period of thirty (30) days . . . actually commence the proposed operation . . . .@ (emphasis added).  Because the phrase of thirty (30) days Acan be given a definite or certain legal meaning,@ it is unambiguous and thus, this court should afford the words their plain meaning.  See Am. Mfrs. Mut. Ins. Co. v. Schaefer, 124 S.W.3d 154, 157 (Tex. 2003).  Under the majority=s interpretation, however, the Notice Period expires in a week if all receiving parties respond within seven days.  See ante, at 8B9.  Thus, application of the majority=s interpretation would result in a direct conflict with the unambiguous language of the contract.

The majority=s rationale for rejecting XTO=s interpretation of the contract is equally flawed. The majority states that XTO=s suggested construction Aconflicts with language indicating that, once all of the receiving parties have given notice of their respective elections, the Notice Period is over.@^[5]  As previously discussed, however, the language of the contracts expressly provides that the Notice Period expires thirty days after the receiving party receives the notice.  In light of these unequivocal terms fixing the end of the Notice Period, the contracts cannot be said to support an inference that the Notice Period expires on the earlier of thirty days or the date on which the receiving party makes an election. 

The majority also reasons that,

[I]f a party could change its election if the other parties had not materially changed their positions in reliance on the initial election, it is not clear why the ability to exercise such a privilege would be limited to thirty days after receipt of the proposing party=s notice.  If a party inadvertently sent notice of its election to participate 33 days after receiving notice and if no party had materially changed its position in reliance on the initial deemed election of non-participation, it is not clear why the passage of thirty days would stop a party from changing its election to one of participation. 

Ante, at 10.  This confusion arises only because the majority has disregarded the actual language of the contracts, which expresses the parties= agreement on this point in unambiguous terms: AThe parties receiving such a notice shall have thirty (30) days after receipt of the notice within which to notify the party wishing to do the work whether they elect to participate in the cost of the proposed operation.@  The parties= repeated statements that the Notice Period for each receiving party ends thirty days after receipt of the noticeCnot earlier, not laterCcould hardly be clearer.  The passage of thirty days would stop a party from changing its election because the contract says it does.

A.      Case Law Follows Contractual Expiration Dates

Finally, the authorities on which the majority relies do not support its reasoning.^[6] In Nearburg v. Yates Petroleum Corp., Nearburg notified Yates on December 1, 1994 of his proposal to drill a well.  1997-NMCA-069, & 5, 123 N.M. 526, 943 P.2d 560.  Yates did not respond within thirty days but instead obtained his own drilling permit.  Id.  On January 11, 1995, Yates wrote to Nearburg, proposing to drill the well himself.  Id.  Nearburg sued for, inter alia, Aan order for specific performance requiring Yates to act as a non-consenting party and to refrain from interfering with Nearburg=s proposed drilling . . . .@  Id. at & 6.  Yates counterclaimed, seeking a declaratory judgment that Yates was the operator of the proposed well and a consenting party under the operating agreement.  Id. According to Yates, he could change his election any time before Nearburg began operations.  Id.  at & 11.  The New Mexico Court of Appeals found in favor of Nearburg, stating, AWe see no indication that the parties to the operating agreement intended to allow a change in election after the thirty day notice period.@  Id. at & 24 (emphasis added).  The court further explained that Yates=s Aanalysis is inconsistent with express contract language, because it virtually ignores the provision in Article VI(B)(1) requiring an election to be made within thirty days.@  Id. at & 12 (emphasis added) (citing Kirkpatrick v. Introspect Healthcare Corp., 845 P.2d 800, 805 (N.M. 1992) (holding that the interpretation of a contract cannot ignore the contract=s express provisions)).  Thus, Nearburg undermines rather than supports the majority=s analysis.

The same is true of Valence Operating Co. v. Dorsett. 164 S.W.3d 656 (Tex. 2005).  In Valence, the issue was whether the parties= joint operating agreement Arequire[d] a thirty-day notice period to expire before the operator [could] commence work on the proposed operations.@  Id. at 658. (emphasis added).  The court concluded that Valence could begin operations less than thirty days after notifying the parties of its proposed operations, but stated, Athe risk of early commencement of such operations falls entirely on the operator because if none of the working interest owners consent to participation within thirty days, the operator bears the full cost of operations.@  Id. at 663.  The court provided no exception for circumstances in which the receiving parties= time for electing to consent to participation in the operation is less than thirty days.

Although the dispute addressed in Oxley v. General Atlantic Resources., Inc. is much closer to the issue presented in this case and requires much the same analysis, the majority dismisses it.  936 P.2d 943, 944B46 (Okla. 1997).  In Oxley, a provision in the parties= joint operating agreement provided that A[s]hould a sale be made by Operator of its rights and interests, the other parties shall have the right within sixty (60) days after the date of such sale, by majority vote in interest, to select a new Operator.@ Id. at 944.  The issue presented was whether a party could change its vote for a successor operator within that sixty-day period.  Id. at 944B45.  The court concluded, AThe JOA does not expressly address whether a party can change its vote for a successor operator, which creates an ambiguity and requires construction.@  Id. at 945.  Due primarily to contested facts regarding the custom and usage in the industry,^[7] the Oklahoma Supreme Court could not resolve the ambiguity, and it remanded the case.  Id. at 946.  Although Oxley is not binding on this court, its reasoning is sound, and I similarly would conclude that, at a minimum, a fact issue is present in this case.

In sum, the majority has chosen to add some words to the contract rather than others. Although it is true that the contract provisions do not state that a receiving party has Athirty days to give notice of an election and to give notice of a change in a prior election,@^[8] it is equally true that the contract states no circumstances under which the thirty-day Notice Period expires in less than thirty days.

B.      Contract is Ambiguous

As in Oxley, the issue here is whether a party can change its decision within the time limit fixed by the contracts for making the decision.  The contracts here, like the contract in Oxley, do not expressly state the answer.  Nevertheless, courts must interpret a contract by Aascertaining the true objective intentions of the parties, based on the contract language.@  SAS Inst., Inc. v. Breitenfeld, 167 S.W.3d 840, 841 (Tex. 2005) (per curiam) (citing Coker, 650 S.W.2d at 393).  The intent of a contract is not changed simply because the circumstances do not precisely match the anticipated scenarios.  Id. Because the interpretation urged by XTO is reasonable, the contracts are, at best, ambiguous.  Thus, I would reverse and remand the case for further proceedings, and in light of that decision, I would not reach the question of whether the trial court properly excluded or limited the purpose for which the Barnhill affidavits were admitted.^[9]

/s/      Eva M. Guzman

Justice

Judgment rendered and Majority and Dissenting Opinions filed.

Panel consists of Justices Frost, Seymore, and Guzman.

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^[1]  AConsideration of the facts and circumstances surrounding the execution of a contract, however, is simply an aid in the construction of the contract=s language.  There are limits.  For example, when interpreting an integrated writing, the parol evidence rule circumscribes the use of extrinsic evidence.@  Id.

^[2]  Ante, at 8.

^[3]  Ante, at 8.

^[4]  Although there are more recent editions of Black=s Law Dictionary, the sixth edition was released in 1990, the same year in which XTO=s predecessor-in-interest signed the first joint operating agreement.  The second joint operating agreement repeated the same language.  This edition therefore is more likely to express the common understanding of the ordinary meaning of the words in light of the circumstances present when the contract was executed.  See Sun Oil Co, 626 S.W.2d at 731.

^[5]  Ante, at 10.

^[6]  In light of the parol evidence rule, I also am not persuaded that it is appropriate to take notice of the existence or contents of other model form operating agreements.

^[7]  In addition, factual determinations were necessary to address the argument that a candidate operator relied to its detriment on the receiving party=s original vote.  This argument was of secondary importance, because if the terms of the contract did not permit a party to change its vote, then the court would not reach the question of whether equitable grounds prevented a party from changing its vote in a particular case.  See id. at 946B47.

^[8]  Ante, at 7.

^[9]  Like the majority, I would not reach the question of whether XTO=s interpretation is the only reasonable construction of the contractual language because, as the majority has explained, the ruling on XTO=s motion for partial summary judgment is not properly before this court for review.  See ante, at 5, n.3.