Ambiguity and Trade Usage in Texas: XTO Energy v. Smith Production

Smith Production, Inc was the operator under two joint operating agreements (JOAs) governing exploration and production on and oil and gas lease. Chevron was one of the four non-operating owners. As required under the JOAs, Smith gave Chevron notice of its intent to drill four wells on the lease. The JOAs gave non-operating owners 30 days after receipt of notice to tell Smith whether or not they wanted to participate in the cost of proposed operations. If they chose not to participate, a "non-consent provision" in the JOAs, sometimes called a non-consent penalty, provided that non-consenting non-operating owners cede their rights to the proceeds from an operation up to certain caps provided for in the JOAs.

Chevron first told Smith that it did not wish to participate in the costs of the proposed wells. The other three non-operating owners informed Smith that they did. Then, a week after telling Smith it did not want to participate, Chevron stated that its earlier non-consent had been sent in error, but Smith would not change Chevron's status from non-consenting to consenting. XTO Energy succeeded to Chevron's interest in the lease and sued, arguing that the language in the JOAs was ambiguous with respect to a party's ability to change its election within the 30-day window parties have to respond to notice of new operations. The trial court ruled for Smith, finding the JOAs unambiguous. It also excluded XTO's expert testimony relating to trade custom and usage. In XTO Energy, Inc. v. Smith Production, Inc., 2009 WL 442003, No. 14-07-00069-CV (Tex. App. Hous., Feb. 24, 2009), Texas's Court of Appeals for the 14th District affirmed. The first footnote in the opinion indicates that the court here construes a standard form contract, so its holding may have significance for future litigants.

On ambiguity, the Court noted:

There is no language in the JOAs expressly allowing an electing party to change its election once it has notified the proposing party of the election. Nor is there language expressly disallowing such a change in election.

However, the Court found that permitting a change in election was inconsistent with other portions of the JOAs. The Court found reasonable Smith's proffered interpretation, according to which the JOAs provide that each party's Notice Period expires when it makes its election. The Court rejected as unreasonable XTO's reading of the JOAs, according to which a party is entitled to change its election so long as the other parties have not materially changed their positions in reliance on the original election.

The Court did not reach the issue of whether exclusion of expert testimony as to custom was erroneous, as it concluded that any error would have been harmless. The Court noted that the excluded testimony would not have satisfied the relevant standard in any case:

XTO's expert did not show that the alleged custom and usage to which he testified is so general and universal that the parties to the JOAs are charged with knowledge of its existence to such an extent to raise a presumption that they dealt with reference to it.

Justice Eva Guzman filed a dissenting opinon on the ambiguity issue. Among other things, Justice Guzman noted that the JOAs referred to the 30-day notice period as "fixed," suggesting at least a triable ambiguity regarding the ability of non-operating owners to change their election throughout the 30-day period.

[Jeremy Telman]