United States: Texas' New (And Old) Take On Exculpatory Clauses

After more than two decades, at least one US federal court in Texas has followed the view of Texas state appellate courts on the limitation of the application of the exculpatory clauses found in both the AAPL 1977 and 1982 model form operating agreements to claims for breach of the operating agreement.

On February 14, 2014, the US District Court for the Southern District of Texas, Houston Division, entered its order on a motion to dismiss in MDU Barnett Limited Partnership v. Chesapeake Exploration Limited Partnership, 2014 U.S. Dist. LEXIS 18769 (S.D. Tex. Feb. 14, 2014). In doing so, the district court relied on the Texas Supreme Court's recent decision in Reeder v. Wood County Energy, 395 S.W.3d 789 (Tex. 2012), which was determined to endorse previous Texas appellate court's limited application of the exculpatory clause contained in both the 1977 and 1982 AAPL model form operating agreements, as held in in Castle Tex. Prod. Limited Partnership v. Long Trusts, 134 S.W.3d 267 (Tex. App. – Tyler 2003, pet. denied) and Abraxas Petroleum Corp. v. Hornburg, 20 S.W.3d 741 (Tex. App. – El Paso 2000, no pet.).

State and federal courts in Texas have taken conflicting positions on the scope and application of the exculpatory clause in the AAPL 1977 and 1982 model form operating agreements. Specifically, in 1992 the Fifth Circuit addressed the issue in Stine v. Marathon Oil Co., 976 F.2d 254 (5th Cir. 1992), which reviewed the following exculpatory clause language contained the AAPL 1977 and 1982 operating agreement at section V.A.:

[Operator] ... shall conduct and direct and have full control of all operations on the Contract Area as permitted and required by, and within the limits of, this agreement. It shall conduct all such operations in a good and workmanlike manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except such as may result from gross negligence or willful misconduct.

The Fifth Circuit in Stine held that the exculpatory clause's "protection clearly extends to breaches of the JOA," and therefore the exculpatory clause protects an operator "for any act taken in its capacity as 'Operator' under the JOA (except for gross negligence or willful misconduct)." On that basis, the Fifth Circuit held that the exculpatory clause extends past the purely operational functions of an operator, and instead covers administrative functions as well as claims for breaches of the JOA.

About a decade later, the Texas state appellate courts in Castle and Abraxas disagreed with the Fifth Circuit's decision in Stine. Specifically, in both Castle and Abraxas the courts reviewed the exculpatory language contained in the AAPL 1977 and 1982 model form operating agreements and then held that the language did not extend to administrative tasks, but rather only applied to operational functions.

In 2012, the Texas Supreme Court in Reeder implicitly endorsed the holdings of Castle and Abraxas in dicta, but ultimately held that the modified language of the exculpatory clause contained in section V.A of the 1989 AAPL model form operating agreement extended the exculpatory clause's coverage to administrative tasks and claims for breaches of the operating agreement. Specifically, the Supreme Court in Reeder identified the difference between the phrase "all such operations," which was contained in the 1977 and 1982 AAPL model form operating agreements, and "its activities under this agreement," which was contained in the 1989 AAPL model form operating agreement at issue. Based on that modification, Reeder held that the exculpatory clause of the 1989 AAPL operating agreement "exempts the operator from liability for its activities unless its liability-causing conduct is due to gross negligence or willful misconduct." However, in its dicta, the Texas Supreme Court did not question the holdings of Castle and Abraxas as they related to the exculpatory clause of the 1977 and 1982 AAPL model form operating agreements. (See Dentons client alert, Protecting Operators Under the 1989 AAPL Form of Operating Agreement.)

This difference between Texas courts and Fifth Circuit decisions gave rise to potential forum shopping between the two courts when a joint operating agreement's exculpatory clause was at issue. This difference was apparent in the federal district court's holding in Chesapeake Operating, Inc. v. Sanchez Oil & Gas Corp., CIV.A. H-11-1890, 2012 WL 2133554 (S.D. Tex. June 12, 2012), which similarly reviewed the exculpatory clause contained in the 1977 and 1982 AAPL model form operating agreements. The court in Sanchez noted the difference between the Stine holding and the later Castle and Abraxas holdings, but stated that it was bound by Stine "until the Texas Supreme Court decides to take up this issue or several more intermediate appellate court[s] agree with the Abraxas holding...." Once Reeder was decided in 2012, the same judge in the US District Court for the Southern District of Texas, Houston Division who decided Sanchez went on to reach a different result in the MDU decision.

In MDU, the district court noted that Abraxas and Castle had "implicitly rejected a prior Fifth Circuit decision [the Stine decision] holding that the 1977 and 1982 exculpatory clause extends to any action performed by the operator under its authority from the JOA, include failure to account to working interest holders." The district court then noted that it "is ordinarily bound by the Fifth Circuit's interpretation of state law, 'unless a subsequent state court decision... renders [the Fifth Circuit's] prior decision clearly wrong.'" After stating that Reeder "demonstrates a clear departure from Stine's reasoning and agreement with the courts of appeals that had imposed a restrictive interpretation of the previous exculpatory clause," the district court declined to follow the Fifth Circuit's decision in Stine and instead held that the Texas Supreme Court's construction of state law as set forth in Reeder dictated that the district court was compelled to follow Abraxas and Castle. In reaching that holding, the court in MDU concluded that "Reeder clearly abrogates Stine." However, Reeder only addressed the 1989 AAPL model form operating agreement, whereas Stine addressed the exculpatory language of the 1977 and 1982 model form operating agreements. Whether Reeder "clearly abrogates" Stine, as the district court stated in MDU, remains to be finally decided. Nevertheless, the point of Reeder is that the exculpatory clause contained in the 1989 model form operating agreement broadens the operator's liability protections, not only to its operations, but to other claims for breach of contract, whereas non-operators would much rather prefer the application of the exculpatory language in the 1977 and 1982 AAPL model form operating agreements.

The MDU decision is an unpublished decision and is not yet a final judgment, subject to appeal. However, it is one of the first district court opinions to apply Reeder. It will be interesting to see whether MDU is appealed, and, if so, whether the Fifth Circuit will overrule Stine.

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