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NOT PERFORMING DUE DILIGENCE ON OIL AND GAS ACQUISITIONS: A GUIDE TO GETTING INTO A LAWSUIT

By Russ Darbyshire
Mesilla Energy Acquisition LLC
www.mesillaenergy.com
July 2019
-Installment 3 of 3-

I used to have a Land Manager boss who would tell me, “The Maintenance of Uniform Interest clause in the Joint Operating Agreement (‘JOA’) is never enforced.  Don’t worry about it.” He was right, at that time, no one paid much attention to the Maintenance of Uniform Interest (“MUI”) clause in JOA’s.  Historically speaking in this business, it was never enforced. As is always the case, things change.

As this lawsuit tale shows, MUI’s, as well as other clauses in the JOA concerning transfers of interest, deserve attention in a due diligence effort, especially if they have been modified.  This is the third step to follow if you want to get into a lawsuit (and possibly commit professional suicide):

Step Three: Don’t Worry About it, Because it’s Never Enforced!

Background:

On August 15, 1983, ExxonMobil Corporation (“Exxon”), as Operator,
and Getty Oil Company, et al, entered into a JOA. The JOA covers a
contract area known as the Gladewater Gas Unit #16 (“GGU”) in Montgomery County, Texas. Later, Valence Operating Company (“Valence”)
succeeded Getty Oil Company under the JOA, with Exxon remaining the Operator. As Operator under the GGU, Exxon owned an 81.8% working interest.  Valence owned an 18.2% working interest.  Prior to Valence succeeding Getty, the working interests under the JOA had drilled three producing gas wells to the Lower Cotton Valley formation, the production of which was holding and maintaining the GGU.

The original parties to the JOA modified the MUI clause as shown below:

“E. Maintenance of Uniform Interest:

For the purpose of maintaining uniformity of ownership in the oil and gas leasehold interests covered by this agreement, and Notwithstanding any other provisions to the contrary, no party shall sell, encumber, transfer or make other disposition of its interest in the leases embraced within the Contract Area and in wells, equipment and production unless such disposition covers either:

1. the entire interest of the party in all leases and equipment and production; or

2. an equal undivided interest in all leases and equipment and production in the Contract Area.

Every such sale encumbrance, transfer or other disposition made by any party shall be made expressly subject to this agreement, and shall be made without prejudice to the rights of the other parties.” (Note: the rest of the MUI clause is not recited here, because it is irrelevant to our discussion.)

In 1996, Exxon entered into a farmout agreement (“Farmout”) with Wagner & Brown Ltd and C. W. Resources (collectively “the Farmees”), which gave the Farmees the right to drill in the GGU to test the Upper Cotton Valley formation, a non-producing formation whose depth was shallower than the already producing Lower Cotton Valley formation.  That Farmout gave the Farmees the right to earn a portion of Exxon’s leasehold interest, upon completion of a producing well in the Upper Cotton Valley formation. It was known by all the working interests in the GGU that there were reserves behind pipe in the existing producing gas wells (specifically in the Upper Cotton Valley), meaning there was untapped potential production in formations up-the-hole from the producing formation in the producing wells.

After execution of the Farmout, the Farmees gave notice to Valence of their intent to drill two wells. Not knowing the Farmees had any relationship with the GGU and knowing that the Farmees were not a party to the JOA, Valence made a written inquiry to Exxon about the well proposals sent by the Farmees.  Exxon at that point informed Valence of the existing Farmout. Valence did not respond to the first two well proposals sent to them by the Farmees and had their interests deemed non-consent under the JOA (non-consent meaning Valence’s interests in the well were taken over by parties participating in the drilling of the well, with Valence being able to come back into the wells’ revenue stream at a certain point in the future).

The Farmees proposed three more wells to Valence.  Valence participated in those three wells, “under protest”.

In March, 1998, Valence filed suit in the Harris County 198th District Court of Texas, against Exxon for breach of contract, alleging that Exxon’s Farmout to the Farmees breached the modified MUI of the JOA. Valence alleged that the modified MUI only allowed Exxon to either convey an undivided interest in its entire leasehold in the GGU, or 100% of Exxon’s entire interest in the GGU, but that Exxon could not convey a partial depth limited interest in the GGU.  Valence further contended that the reserves in the Upper Cotton Valley formation could be accessed in the current producing wellbores and that drilling new wells subjected Valence to non-consent penalties under the JOA, as well as causing Valence to spend more money to drill new wells to the Upper Cotton Valley than Valence otherwise would have had to spend re-completing the existing wells in the Upper Cotton Valley formation. Valence sought to recover the non-consent penalties it had incurred, as well as the difference between the cost of drilling new wells to the Upper Cotton Valley and the cost of recompleting the existing wells in the Upper Cotton Valley. Additionally, Valence sought not only attorney’s fees, but pre-trial interest and penalties on the damages in question.

The Farmees fulfilled the terms of the Farmout and on October 8, 1998, received an assignment of leasehold (“Assignment”) from Exxon, which conveyed all of Exxon’s right, title and interest in only Exxon’s leasehold, down to the base of the Upper Cotton Valley, reserving any formations below the Upper Cotton Valley to Exxon, with Exxon retaining an overriding royalty interest (“ORRI”) on all production. In the Assignment an option was given to Exxon to either increase the ORRI to a larger amount, or convert the ORRI to a working interest at a defined payout of each well drilled by the Farmees, to be exercised on a well-by-well basis. The date of the Assignment is important because Valence filed suit against Exxon before any conveyance by Exxon to the Farmees.

A trial was initially scheduled for February 18, 2000 but was postponed by the parties.  In that postponement process a “Rule 11” agreement was reached, an agreement that had stipulations and deadlines for amended pleadings and discovery leading up to the trial.  There was later on, contention and disagreement about this Rule 11 agreement when Valence amended its initial pleadings in the case, to which Exxon objected. Since this disagreement has no bearing on the issues being discussed, no attention will be given it in this writing, except to say the court ruled in Valence’s favor on these issues.

Exxon’s defense was that it did not violate the modified MUI of the JOA because no conveyance had been given to the Farmees at the time the suit was filed by Valence and even if there had been a conveyance, there was no violation of the MUI because Exxon only conveyed an interest in Exxon’s leasehold and not in wells, production and equipment.  Exxon’s contention was that by modifying the MUI as was done, the intent of the original parties to the JOA was not to maintain a “uniform” interest. Exxon further contended that the modified plain language of the MUI only applied to the sale of a party’s interest in leases AND in wells, production and equipment; and since Exxon’s Farmout and Assignment to the Assignees only covered Exxon’s interest in leasehold (and not wells, production and equipment), there had been no violation of the MUI.

Valence counters that Exxon’s interpretation of the modified MUI corrupts the true meaning of the modified MUI. While Exxon had not yet delivered an Assignment when the lawsuit was filed, Valence maintained that the Farmout was adequate proof of a coming conveyance of interest by Exxon. Valence alleges that the original parties’ modification of the MUI that struck references to “maintenances of uniform interest” were only because the parties did not have uniform interests to maintain.  Valence indicated that the altered MUI was intended to maintain the interests the parties contributed when the JOA was executed.  Further, Valence argued that the modified MUI required a party to transfer either an undivided or 100% interest in the leasehold, wells, equipment and production and if that is not adhered to, there is no way to maintain any party’s entire interest in the leases and the provision is essentially meaningless if a party can convey an entire interest in only a portion of a lease, as Exxon did. Valence pointed out that Exxon’s claim it only conveyed an interest in Exxon’s leasehold is false, that with that conveyance of leasehold came the right in wells, production and equipment.

In addition, Valence offered these arguments during the trial process:

1.  Pertaining to the damages regarding the modified MUI, the paragraph preceding the modified MUI in the JOA, Article VIII, entitled, “Acquisition, Maintenance or Transfer of Interest” states in part: “The leases covered by this agreement, insofar as they embrace acreage in the Contract Area, shall not be surrendered in whole or in part unless all parties consent thereto…. However, should any party desire to surrender its interest in any lease or in any portion thereof, and other parties do not agree or consent thereto, the party desiring to surrender shall assign, without express or implied warranty of title, all of its interest in such lease, or portion thereof, and any well, material and equipment which may be located thereon and any rights in production thereafter secured, to the parties not desiring to surrender it.” Exxon never gave Valence the chance to consent to Exxon’s ultimate Assignment, nor the opportunity to surrender Exxon’s interest to Valence if Valence did not agree to Exxon’s Assignment to the Farmees.

2.  Pertaining to the damages concerning non-consent, Valence argued that the JOA requires any party that intends to drill a well to give notice to the other parties, stating the particulars of that proposed wells (cost, objective depth, etc).  Once notice is received, the parties have 30 days to make an election.  Clearly, Exxon did not do that, with the two parties that were not part of the JOA attempting to provide notice.

There were other arguments and pleadings on other legal points, but the above is a concise summary of the main arguments.

After a bench trial on March 5, 2002, the court found for Valence on all points, awarding Valence $310,867.28 in damages for the cost of having to drill new wells, $523,432.00 for damages incurred in going non-consent in the first two wells, pre-trial interest and attorney’s fees. 

Exxon appealed this decision to the 1st District Court of Appeals in Houston in 2005, but the appeals court upheld the lower court decision on all counts.

Discussion

The point here is: During a due diligence project, never overlook the Maintenance of Uniform Interest, or any other clause dealing with transfers of interest, that are in a JOA that covers an interest a company is buying, or selling.  Always check the conveyance history of an interest that is being sold to see if it matches with the original interest that was contributed to the JOA when executed. Also, if a MUI clause is altered, don’t assume a meaning, as in this case, when interests have been conveyed out by a working interest owner.  One may argue that the statute of limitations will cover any transgression committed by a party under a MUI clause if that transgression was in the distant past, but that is not always the case.  All trial lawyers have a ready argument about why a statute of limitations can be tolled.

If you are a Seller, selling your working interest in production and if in the history of your ownership you have violated the MUI in a JOA, that is a potential lawsuit waiting to happen.  From the standpoint of Seller’s due diligence, this should be an item to remedy before a sale and before a possible suit is filed by an aggrieved party.

On the buying side of a working interest, one may also ask, “In this instance how would this type of violation of the MUI that Exxon committed affect due diligence and create a title defect?  Valence received monetary damages and usually a PSA would confine liability derived from after sale litigation to the Seller.  If you are a Buyer, this would not affect you.”

Let’s look at this suit a little closer.  Valence received monetary damages from the court based on their calculations of being subjected to a 200% payout on 2 producing wells. That 200% figure is the 300% non-consent penalty minus 100% at well payout. The court awarded Valence those damages based on that calculation, erasing the payout penalty. It can be assumed that Valence got back its working interest (and with that its revenue interest) in those two producing wells at 100% payout. That’s the practical effect of this award. So even though the Seller would be responsible for the monetary liability incurred with this type of lawsuit post-closing on a sale, the interest purchased by the Buyer is suddenly reduced after the fact. A potential reduction of interest from what a Seller has represented in a sale is usually a pretty standard defect under any PSA.

As I look back on my history of running due diligence projects when I was consulting, I never was instructed by my client to check the conveyance history of the interest under the JOA to verify if there was a violation of the MUI clause or for that matter, any other clause in the JOA that a conveyance of an interest could affect.  That was because at the time, the belief in the industry was that these were issues that hardly ever came up and if they did, these clauses were never enforced.  As this case proves, these types of issues can come up and prudent due diligence dictates that MUI and transfer of interest clauses must be checked for compliance. 

Acquisition of Oil & Gas Properties: Land and Title Data Checklist For a Due Diligence Review

Acquisition of Oil & Gas Properties:  Land and Title Data Checklist For a Due Diligence Review

by  Jack M. Wilhelm

THE WILHELM LAW FIRM, 5524 Bee Caves Road, Suite B5, Austin, Texas  78746; (512) 236 8400 (phone); (512) 236 8404 (fax); www.wilhelmlaw.net

Okay; a sale is going to be made.  Let’s get started on the due diligence review – let’s make sure the seller owns what he says he owns and that the buyer understands the liabilities he is purchasing.

You have to start somewhere  –  Land and Title Data

Before your “small army” of consultants descend upon the seller’s records, making sure that you have asked for all documents is important.  Sellers and buyers, alike, struggle with how to best provide information – and how the information is requested, may well make the task more manageable.

Make a copy

A “bonded” copying service can be invaluable.  Often, their costs charged in making a complete working set of documents (and reducing them to a diskette or thumbdrive) are surprisingly reasonable.  But, as a word of caution, more likely than not these documents are being reviewed subject to a confidentiality and noncompete agreement.  It is important that each individual involved in the due diligence process be properly advised (and in some cases identified and documented) and you may have to return “all” of the copies if the sale does not “go through.”

A Land and Title Data Checklist – be sure and request:

  1. Title Opinions, including supplements and division order title opinions
  2. Oil & Gas Leases and Oil & Gas Lease files (including assignments, ownership change records, lease summaries or abstracts); of course leases (or memorandums of lease) should properly reflect recordation in the governing official records of the county or parish
  3. Conveyance documents, including leasehold assignments, assignments creating overriding royalty interests, and files pertaining to lessor assignments (sales and devolution due to death)
  4. Farmout, Exploration, and Participation Agreements
  5. Pooling and Unitization Agreements (and unit pooling authority agreements), all of which should reflect book and page recordation information
  6. Joint Operating Agreements; Joint Venture Agreements; and Areas of Mutual Interest Agreements
  7. Division Orders/Transfer Orders/Paydecks/Net Revenue Interests
  8. Right-of-Way, Easement, and Surface Use Agreements
  9. Third party and internal Correspondence (including emails and royalty relations correspondence & files)
  10. Maps and Plats
  11. A schedule of all liens or encumbrances covering or affecting the properties and copies of the documents creating such liens or encumbrances (reflecting recordation information)
  12. A schedule of outstanding litigation affecting the properties

_____________________________________________________________________________

Edward Wilhelm and Jack Wilhelm provide assistance to buyers and sellers of oil and gas properties. If you would like to know more about Edward and Jack, view their respective profiles:  Edward Wilhelm-LinkedIn     Jack Wilhelm-LinkedIn

DISCLAIMER: The information on this site is not intended to and does not offer legal advice, legal recommendations or legal representation on any matter.  You need to consult an attorney in person for legal advice regarding your individual situation. 

 

 

Acquisition of Oil & Gas Properties: Confidentiality Agreements

by  Jack M. Wilhelm

THE WILHELM LAW FIRM, 5524 Bee Caves Road, Suite B5; (512) 236 8400 (phone); (512) 236 8404 (fax); www.wilhelmlaw.net

If you are looking to purchase oil and gas properties, you can safely assume that, prior to entering into negotiations, you will be required to into an agreement concerning the confidential nature of the information and data that will be exchanged.  In short, you will be required to keep a lot of information confidential.

Confidentiality Agreement

Among the provisions typically found in such agreement, are the following:

  1. Identification of the material that is confidential
  2. An agreement that you will have your contractors, employees, and other advisors bind themselves to the confidentiality agreement
  3. Any exceptions to non-disclosure requirements
  4. An agreement that you will return any evaluation materials (and all copies) provided to you if a sale is not consummated
  5. If it is a proposal to jointly acquire oil and gas assets, properties, or leases, there may be a term limited noncompete agreement
  6. Remedies for a breach of the confidentiality agreement, including a forum where any dispute is resolved and the contractual shifting of legal fees to the prevailing litigant

The Industry Standard & Credibility

If you find yourself spending a great deal of time and energy negotiating the confidentiality agreement, then there is a problem.  There are clear industry standards – and they are advantageous to all parties involved.  The only issue that should ever be a matter of serious discussion is the scope (often geographic) and term of the noncompete agreement. 

Of equal importance, it is imperative that your contractors and employees be aware of the nature of the confidential relationship – and that the information you receive is properly managed in a confidential manner.  Aside from obvious legal problems for your failure to do so, your credibility will be completely lost.  You will be responsible if your contractors or employees are sloppy – confidentiality is your job, and it is a serious one.

Bottom Line

Confidentiality is a serious matter and serious purchasers (and their contractors, employees, and agents) take it seriously.  If someone does not, they should not be on the acquisition team.

______________________________________________________________________________

Edward Wilhelm and Jack Wilhelm provide assistance to buyers and sellers of oil and gas properties. If you would like to know more about Edward and Jack, view their respective profiles:  Edward Wilhelm-LinkedIn     Jack Wilhelm-LinkedIn

DISCLAIMER: The information on this site is not intended to and does not offer legal advice, legal recommendations or legal representation on any matter.  You need to consult an attorney in person for legal advice regarding your individual situation. 

The Informal NAPE Summit 2019 Poll on Due Diligence

From Russ Darbyshire

The question I asked on the NAPE floor: Do you agree or disagree with this statement: No one is running due diligence on A&D transactions any more.

Disclaimer: This poll is not a proper statistical poll and the results don’t represent a significant statistical result.

I spoke to 30+ companies on the floor at NAPE on Thursday, February 14, 2019, asking the above question.

In regard to acquisitions, everyone I spoke to said, “We always run due diligence.”  Three companies said, “We would not do a deal any other way.” A couple of companies said, “But sometimes we are limited in our ability to run due diligence, it just depends.”  Many companies added, “The depth and scope of our due diligence depends on the deal.”  One company did imply that they would cut corners on due diligence if that was the only way they could make a deal with the Seller.

On divestment due diligence, the answers were pretty much uniform.  Most said that they normally don’t run due diligence before a divestment because, “We know the properties we are selling.  We have a history of managing them and know all the issues with them.”

When I asked who ran their due diligence, the answer was, “We have in-house people that perform it.”  But when I asked, “Do you mean company employees that perform due diligence?”, that answer was: “Well, no, we have some contractors that help.”

Another question I asked, was this: “Have you ever done a deal where there was no upfront due diligence, but the Seller gave you a limited title warranty after the sale to perform due diligence?” A few of the people I talked to did not know exactly what I was talking about.  Most said, “No, we would never do a deal like that.”  I asked why, “Because we would never get our money back on defects.”  I will note that my recent experience as an expert witness in a couple of lawsuits where there was a limited title warranty provided by the Seller, with a time frame for the Buyer to perform due diligence, bore this out.

As part of my discussion with them, I also asked if they had any “due diligence screw-ups” I could blog about.  Everyone laughed and said, “Yes, but we don’t like to talk about that!”

The bird’s eye view of all of this is:

1.  When the price of oil is high and there is a lot of money chasing too few acquisition deals in active basins, the Seller is in the driver’s seat.  That means the Seller will dictate the terms of the due diligence effort in most PSA’s and if a Seller wants the deal closed, they are going to eliminate or cut due diligence.

2.  The companies most likely to bend to the situation described above, where the Seller has the power to dictate the due diligence effort, were companies funded by private equity and companies operating in the Permian Basin. The large independents and majors said, “We won’t take the deal if the Seller starts limiting our ability to perform due diligence on an acquisition.”

3.  Most of the Permian companies I talked to pointed out that the “Seller’s market” has rapidly diminished the past few weeks, with the fluctuation of the price of oil.

4.  Companies running due diligence are probably not doing it with experienced personnel, as evidenced with the high number of answers indicating due diligence screw-ups.

The informal results of my discussions all seem logical, based on the current state of the industry.  However, I don’t see any evidence that “due diligence screw-ups” have produced any effort by companies to either upgrade their personnel performing due diligence, or advance along the learning curve to eliminate future errors.  It has become “all about doing the deal” and volume, doing many deals.

NOT PERFORMING DUE DILIGENCE ON OIL AND GAS ACQUISITIONS: A GUIDE TO GETTING INTO A LAWSUIT

By Russ Darbyshire, Mesilla Energy Acquisition LLC
www.mesillaenergy.com

August, 2018

-Installment 2 of 3-

With the price of natural gas being close to historically low, it hardly seems worthwhile to hit on the subject of gas imbalances at the closing of a PSA.  But, in this lawsuit tale, there are several lessons to be learned, to avoid getting into a lawsuit. After being in the business 38 years, I have seen too many lawsuits that could have been avoided had both the parties, the seller and the purchaser, performed correct due diligence prior to the closing of the sale. This is the second step to follow if you want to get into a lawsuit (and possibly commit professional suicide).

Step Two: Ignore the Discomfort of Gas.  https://youtu.be/VPIP9KXdmO0

Background:
In July, 2001, Wapiti Energy, L.L.C. (“Wapiti”) entered into a purchase and sale agreement (“PSA”) with Petro-Hunt, L.L.C. (“Petro”) for the sale of Petro’s interest in a producing oil and gas property located in the Conroe Field, Montgomery County, Texas.  In that PSA, Petro represented and warranted that none of Petro’s interests being sold were “overproduced” relative to the other interests in the property. Overproduction is a liability on a working interest and represents an “imbalance” where a party’s interest is not produced according to that party’s share of ownership in the well.* The PSA required Wapiti to assume all liabilities associated with Petro’s interest.  As is common with many PSA’s, a “Final Settlement” takes place after the closing date of the PSA, to reconcile monetary issues related to production revenues and imbalance valuations.

After the closing date of the PSA, ExxonMobil (“Exxon”), the Operator of the property in question, informed Petro that Petro’s interest was overproduced by an “undetermined” amount. Petro informed Wapiti of this fact on October, 2001, before the Final Settlement date. Both parties acknowledged that the overproduction was a breach of Petro’s warranty under the PSA and that it lessened the value of Petro’s interest being sold to Wapiti.  Because of the looming deadline of the Settlement Date and the knowledge that Exxon could not arrive at an overproduced amount before then, the parties agreed to an additional agreement (“Extended Settlement”) that allowed for one more adjustment that would address gas imbalances to be reconciled once the overproduction amount was known.  In the Extended Settlement, both parties agreed that $3.70/MMBTU was the price any overproduced amount would be valued at.

In November, 2002, Exxon delivered its report on the overproduction amount to the parties indicating the overproduced amount was 115,518 MMBTU’s.  A few months later, Wapiti contacted Petro to reconcile the imbalance with an adjustment and close the books on the sale.  Because there was some disagreement on the amount of overproduction that Exxon reported, Petro refused to pay Wapiti for the imbalance.

On October 14, 2005, Wapiti filed suit against Petro to recover payment for the overproduced gas.  In the months leading up to the lawsuit, Wapiti had acquired other interests in this field, including the interest of Exxon. In the Exxon transaction, the Exxon interest was underproduced, to which Wapiti paid an additional amount for.

In 2009, Wapiti sold all of its interest in the Conroe Field to Denbury Resources, Inc. Wapiti claimed that it received less in the way of consideration for this sale because of the overproduced interest.  Petro disputed that claim, saying Wapiti, because of its prior acquisitions, had a net underproduced interest during the time of the sale.

Through years of legal maneuvers by both parties the trial court eventually found Petro had beached the Settlement Extension and awarded Wapiti $424,811.80 in damages for the overproduced position as well as prejudgment interest, taxable costs of court, and post-judgment interest, with the final judgement being entered on August 26, 2010.  The judgement was upheld in 2012 through subsequent appeals by Petro.

*Note: Overproduction is where a party does not take gas attributable to its share of production and instead, that gas production is allocated to another working interest owner in the well, where it is sold. In that instance, the interest attributable to the party not taking the gas is “underproduced”.  The interest of the party that did take the gas is thus “overproduced”.  An overproduced interest represents a liability on that party’s interest, because that party must either pay the underproduced party back in gas, or in cash.  Usually, a Gas Balancing Agreement, attached as an exhibit to a Joint Operating Agreement, governs the taking of production and the method of balancing that production imbalance between the parties.  Many times, reconciling of the imbalances can occur at the depletion of the well, where upon a cash amount, attributable to the imbalance, is given to the underproduced party.

Discussion:
There are several lessons here:

  1. If you are a Seller, never represent and warranty something you are not completely sure about. The way to be certain about a representation one is considering making is to perform proper due diligence to confirm that representation before you make it.
  2. If you are a Buyer, never rely on a warranty or representation: in fact, good due diligence researches all representations and warranties, sometimes even before a PSA is executed.
  3. When reconciling with a post settlement after the closing of a PSA, its important to get everything reconciled, even in the case of imbalances that might not be known with any certainty. Imbalances are not rocket science and can be estimated using revenue stubs and production runs with pretty close certainty.  In the era of depressed gas prices, the cost of any error is low (compared to the cost of possible litigation to collect).
  4. The longer you wait to reconcile any amounts under a PSA (whether its defect amounts, gas imbalances or other issues), the higher the chance one party will breach a settlement agreement. I make this last statement based on experience.

All of these issues point to failures in the due diligence process.  Presumably there was a period to conduct due diligence before the closing of the sale (if not, then that would more adequately explain this mess).  In that due diligence period, Wapiti could have requested pay stub information from Petro and could have easily calculated an approximate amount of the imbalance burdening Petro’s interest.  Yes, I know there are issues with processing costs, settlements and net backs that need to be taken into account, but even still, you can estimate those.  The judgment awarded Wapiti was a little over $424K and that included attorneys’ fees, damages and interest.  If you were to calculate the actual dollar amount of the overproduced gas, based on the gas price agreed to in the Extended Settlement and the overproduced volume Exxon reported, that comes to $427K, which is greater than the judgment.  So it would appear that Petro had legitimate concerns about the amount of overproduction that Exxon reported, or that as Petro asserted, Wapiti’s acquisitions in this field diminished the amount of the overproduced interest, issues that apparently the court took into consideration in its monetary award. It is unknown if any attempt to agree to an overproduced amount was made by the parties before the final settlement date, but it would appear that someone came up with the idea of having a side agreement to have another settlement when the final overproduced amount was arrived at by Exxon.  On the surface, that would seem a practical approach, to have another settlement when the final amount is known. The reality is this: if parties don’t settle monetary issues within the confines of the PSA and either a deadline of a closing date or a settlement date, instead delaying the day of reckoning, the chances increase someone is going to breach the agreement.  Even if Wapiti had to take a “haircut” on the amount of overproduction, I would assert that given the time from 2001 to 2012, when the final judgment was rendered, if Wapiti and Petro had agreed on an overproduced volume based on estimates, Wapiti would have had that money in hand and could have earned interest on it in the 11 years it took to collect (plus not have expended attorney’s fees and litigation costs), coming out ahead of the game.

From Petro’s side, how hard would it have been to run some preliminary due diligence on their gas sales and discover even a hint that their interest was overproduced?  Just a hint would have kept them from warranting that there was no overproduction and put in place a way to value and deal with any imbalance in the PSA.  This is a lesson that applies to not just gas balancing, but land issues, too.

Representations and warranties are always a red flag for me when I perform due diligence.  In one transaction I ran a due diligence team on, a mineral transaction, the Seller made representations as to what minerals were leased and unleased.  That opened the door for us: because how many chains of title are riddled with unreleased oil and gas leases, whose status is unclear?  Needless to say, such a claim created nothing but multitudes of clouds of title.  In fact, there were many interests that were claimed to be unleased, that were indeed under an in-force oil and gas lease and vice versa. 

I like takeaways.  The takeaway on this tale: run your diligence seriously, as a Seller and as a Buyer.

DISAGREE OR AGREE?  PLEASE TELL US YOUR OPINION.

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