1997 -NMCA- 69, Nearburg v. Yates Petroleum Corp.
| Citation | 123 N.M. 526,943 P.2d 560,1997 NMCA 69 |
| Decision Date | 10 June 1997 |
| Docket Number | No. 16783,16783 |
| Parties | , 1997 -NMCA- 69 Charles E.NEARBURG, dba Nearburg Exploration Company, Plaintiff-Appellant, v. YATES PETROLEUM CORPORATION, a New Mexico Corporation, Defendant-Appellee. |
| Court | Court of Appeals of New Mexico |
¶1 The opinion filed in this case on April 17, 1997 is hereby withdrawn and the following substituted therefor. Yates Petroleum Corporation's motion for rehearing is denied.
¶2 Operating agreements are commonly used in the oil and gas industry in New Mexico and other producing states to set forth the arrangement between interest owners as to exploration and development of jointly owned interests. See generally Gary B. Conine, Property Provisions of the Operating Agreement--Interpretation, Validity, and Enforceability, 19 Tex.Tech L.Rev. 1263, 1265 n. 3 (1988) [hereinafter Conine, Property Provisions] (citing numerous articles on operating agreements). The issue in this appeal is whether the failure of Defendant Yates Petroleum Corporation (Yates) to give timely notice of election to participate in a drilling operation proposed by Plaintiff Nearburg Exploration Company (Nearburg) subjects Yates to a non-consent penalty under the parties' operating agreement. We hold that it does and reverse the decision of the district court.
¶3 Nearburg and Yates are joint owners of a leasehold estate in Eddy County, New Mexico, under a New Mexico Oil and Gas Lease. On January 15, 1993, the parties entered into an operating agreement to drill oil and gas wells on that estate. The operating agreement was prepared by Yates and is based on a preprinted Model Form Operating Agreement published by the American Association of Professional Landmen, A.A.P.L. Form 610-1977. The critical provisions relevant to the issue on appeal were not changed from the Model Form, Article VI(B)(1) and (2). 1 Under these provisions, after the initial well is drilled, either party can propose to drill an additional well by giving the other party written notice of the proposed operation. See Art. VI(B)(1), A.A.P.L. Form 610-1977. The other party has thirty days after receipt of the notice in which to give notification of whether it elects to participate in drilling that particular well. Failure to respond within this period constitutes an election not to participate in the cost of the proposed operation, according to Article VI(B)(1) of the operating agreement. If one party proposes a drilling operation and the other party does not elect to participate, the former is called the "consenting party" and the latter the "non-consenting party."
¶4 The consenting party may proceed with the drilling project, bearing the entire cost and risk, even if the other party is non-consenting. If the consenting party "actually commence[s] work" within sixty days as required by Article VI(B)(2) and if the well produces, the non-consent penalty provision states that the consenting party is allowed to recoup up to 200% of its cost of new surface equipment and up to 500% of its cost of drilling and new equipment in the well before the non-consenting party shares in the production. Thereafter the non-consenting party shares equally in any further proceeds. See Art. VI(B)(2), Form 610-1977.
¶5 In accordance with the operating agreement, Nearburg sent Yates a certified letter proposing to drill an additional well, "Boyd 'X' # 5." Yates received this letter on December 1, 1994, but failed to respond within thirty days. Yates did, however, send Nearburg a letter dated January 11, 1995, stating that Yates proposed to drill the Boyd 'X' # 5 well. On December 29, 1994, Yates also obtained a permit to allow Yates to drill the Boyd 'X' # 5 well.
¶6 Nearburg then filed a complaint alleging that Yates' actions violated Nearburg's rights under the operating agreement and prevented Nearburg from obtaining a drilling permit for Boyd 'X' # 5. Nearburg requested the following relief: a declaratory judgment that Nearburg is the operator of the Boyd 'X' # 5 well; an order for specific performance requiring Yates to act as a non-consenting party and to refrain from interfering with Nearburg's proposed drilling of Boyd 'X' # 5; and an order enjoining Yates from proceeding to drill the Boyd 'X' # 5 well itself or interfering with Nearburg's proposed drilling of Boyd 'X' # 5, including preventing Nearburg from obtaining a drilling permit for Boyd 'X' # 5. Yates counterclaimed for a declaratory judgment that Yates was the operator of the Boyd 'X' # 5 well and that Yates was a consenting party under the operating agreement. The district court dismissed Nearburg's complaint with prejudice and entered a declaratory judgment that Yates was to be considered a consenting party under the operating agreement. Nearburg appeals.
¶7 Interpretation of an unambiguous contract is a question of law which we review de novo. Peck v. Title USA Ins. Corp., 108 N.M. 30, 33, 766 P.2d 290, 293 (1988). Whether a contract contains an ambiguity is also a question of law reviewed de novo. Mark V, Inc. v. Mellekas, 114 N.M. 778, 781-82, 845 P.2d 1232, 1235-36 (1993). A contract is ambiguous if the court determines it can reasonably and fairly be interpreted in different ways. Id. at 781, 845 P.2d at 1235.
¶8 Although Nearburg and Yates argue for different interpretations of the critical contract provisions, neither party argues that the operating agreement is ambiguous. See Kirkpatrick v. Introspect Healthcare Corp., 114 N.M. 706, 711, 845 P.2d 800, 805 (1992) (). Since resolution of the issue on appeal depends upon interpretation of documentary evidence, we are in as good a position as the district court to interpret the operating agreement. See id. We consider the operating agreement as a whole in determining how it should be interpreted. See id.
¶9 To the extent, however, that the district court granted equitable relief, we review its decision for abuse of discretion. See City of Albuquerque v. Brooks, 114 N.M. 572, 574, 844 P.2d 822, 824 (1992); Wolf & Klar Cos. v. Garner, 101 N.M. 116, 118, 679 P.2d 258, 260 (1984).
¶10 We note preliminarily that, although we follow custom by referring to the operating agreement provisions at issue as a "penalty," they do not meet the definition of a penalty as set forth in the Restatement and Corbin on Contracts. See Restatement (Second) of Contracts § 356 (1981); 5 Arthur Linton Corbin, Corbin on Contracts § 1057 (1964). A penalty is a term fixing unreasonably large liquidated damages and is ordinarily unenforceable on grounds of public policy because it goes beyond compensation into punishment. See Restatement, supra, § 356(1) & cmt. a; 5 Corbin, supra, § 1057, at 334. It has been held that a non-consent penalty similar to the one at issue in this appeal was a valid liquidated damages provision rather than an unenforceable penalty provision. See Hamilton v. Texas Oil & Gas Corp., 648 S.W.2d 316, 321 (Tex.Ct.App.1982). We do not agree with the Hamilton court's analysis because a liquidated damages provision applies in case of a breach of contract. The parties to the operating agreement are not obligated to participate in all proposed operations, and a non-consent election cannot convincingly be characterized as a breach. See Gary B. Conine, Rights and Liabilities of Carried Interest and Nonconsent Parties in Oil and Gas Operations, 37 Inst. on Oil & Gas L. & Tax'n § 3.04[c], at 3-32 (1986) [hereinafter Conine, Carried Interest]. Therefore, we do not regard the non-consent penalty provision as involving liquidated damages or an unenforceable penalty.
¶11 Turning to the parties' arguments concerning the non-consent penalty provisions, Yates asserts that an election not to participate constitutes an offer to relinquish the party's interest in production from a proposed operation, and that this offer can be accepted by the proposing party's action in "actually commencing work" within sixty days of the end of the election period. See Art. VI(B)(2), A.A.P.L. Form 610-1977. Therefore, until Nearburg, the proposing party, accepts by this performance, Yates argues that it has the right to change its election by withdrawing its offer. Yates states that it terminated its offer to relinquish by its January 11, 1995 letter communicating its intent to participate in the drilling of Boyd 'X' # 5.
¶12 We find this position to be a strained interpretation of the operating agreement. See Kirkpatrick, 114 N.M. at 711, 845 P.2d at 805 (). In addition, this analysis 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. See id. (interpretation cannot ignore express provisions of contract). Yates' analysis also fails to give any real significance to the fact that the parties have already agreed, in signing the operating agreement, to the relinquishment resulting from the operation of the non-consent penalty provisions. See Bank of N.M. v. Sholer, 102 N.M. 78, 79, 691 P.2d 465, 466 (1984) ().
¶13 Nearburg argues that the operating agreement provisions at issue create an option. Under...
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