Lessons from an Operating Agreement Dispute

Originally published by Charles Sartain.

Co-author Rusty Tucker

Jatex Oil & Gas, L.P. v. Nadel & Gussman Permian, L.L.C. presents several teachable moments:

• The Texas Property Owner Rule does not allow a non-expert testify on matters requiring expert testimony.
• The operator may pay proceeds from a well to the lender to whom the working interest owner made a collateral assignment of net revenues from the well.
• A claim for failure to act as a reasonbly prudent operator for failing to comply with an operating agreement is a contract claim, not a tort claim.

Jatex owned a working interest and NGP was the operator of the Clyde Prospect in Glasscock County.

Jatex executed a promissory note to Security Bank secured by its working interest in the prospect. Jatex defaulted on the note. Security Bank foreclosed and purchased the working interest for $1,500,000.

History of operations

NGP proposed to deepen the Vaqueros 47 No. 1 Well.  Jatex alleged that NGP improperly included it in the project because Jatex did not make a written election to participate. Jatex contended that because of the resulting erroneous charges, Security Bank foreclosed on the working interest.

Jatex sued for breach of the JOA, failure to act as a reasonably prudent operator, and tortious interference with the promissory note.

The Property Owner Rule

In response to NGP’s motion for summary judgment Jatex submitted a declaration by its owner Truitt estimating the fair market value of the foreclosed working interest. His opinions were not admissible. A property owner is generally qualified to testify to the value of his property even if he isn’t an expert. But the rule doesn’t apply to matters that are of a “technical or specialized nature.” An owner of a working interest isn’t qualified under the Rule to give lay opinion evidence on the value of mineral reserves because of the technical, specialized nature of that valuation.

Deepening costs and withheld revenues

NGP didn’t wrongfully debit drilling expenses from Jatex’s account. NGP asserted that Jatex lacked standing to seek recovery of its share of the deepening costs because Jatex assigned its interest to Security Bank. The court disagreed. Jatex’s assignment did not terminate or release its rights under the JOA. However, Jatex had no claim for withheld revenues because Jatex had assigned them to Security Bank and NGP paid them to the bank.

Foreclosure damages

Relying on Truitt’s opinion, Jatex valued the foreclosed working interest to be worth closer to $12 million than the $1.5 million paid by Security Bank and based its damages on that calculation. Because the Truitt’s valuation was inadimissible that proof failed.

Jatex then cited a letter from Jatex to Security Bank and a “loan history” statement that were part of NGP’s motion for summary judgment. Because Jatex didn’t direct the trial court to the loan history in its response to the motion it could not point to that evidence for the first time on appeal. It didn’t matter anyway; neither the loan history nor the letter supplied a critical element of the income approach for determining fair market value.

Further, NGP could not have reasonably foreseen that debiting Jatex’s account would have likely caused Security Bank to foreclose on the lien. The foreseeability of consequential damages for breach of contract is assessed at the time the contract is formed, not at the time the contract is breached.

Tortious Interference.

Jatex’s assertion that NGP tortuously interfered with an oral forbearance agreement with Security Bank failed because it provided no details about the specific terms of the agreement or how Security Bank may have breached the agreement by foreclosing.

A musical interlude for the season.

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