NL Industries, Inc. v. GHR Energy Corp.
| Citation | 940 F.2d 957 |
| Decision Date | 10 September 1991 |
| Docket Number | No. 90-2235,90-2235 |
| Parties | NL INDUSTRIES, INC., Plaintiff-Appellant, v. GHR ENERGY CORPORATION, Southern States Exploration, Inc., and S.A. Holditch & Associates, Inc., Defendants-Appellees. |
| Court | United States Courts of Appeals. United States Court of Appeals (5th Circuit) |
Jack G. Carnegie, Emil T. Bayko, Michael M. Gibson, Holtzman & Urquhart, Houston, Tex., for plaintiff-appellant.
Jesse R. Pierce, Warren W. Harris, David S. Ross, Porter & Clements, Houston, Tex., for S.A. Holditch.
J. Kyle McClain, Houston, Tex., John C. Nabors, Liddell Sapp Zivley Hill & LaBoon, Dallas, Tex., for GHR Energy Corp., Southern States Exploration, Inc. and Transamerican Natural Gas Corp.
Appeal from the United States District Court for the Southern District of Texas.
Before THORNBERRY, JOLLY, and SMITH, Circuit Judges.
This court withdraws its earlier opinion reported at 934 F.2d 580, and substitutes the following opinion.
In 1983, GHR Energy Corporation and Southern States Exploration, Inc. (collectively referred to hereinafter as "GHR") filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code. As part of GHR's reorganization, NL Industries, Inc. ("NL") agreed to service ten of GHR's gas wells in an attempt to increase their production. The agreement required NL to service the wells using whatever method GHR stipulated but also provided that S.A. Holditch & Associates, Inc. ("Holditch"), an engineering firm, would review GHR's designs. NL agreed to be paid solely from the revenue produced by the re-worked wells.
NL performed the services that GHR requested, but the wells failed to produce as expected, and NL did not recover its costs. NL sued GHR under a variety of theories, but the pith of its complaint was that GHR used a much riskier and more expensive method to re-work the wells than the method NL thought it would use. NL also sued Holditch, asserting that Holditch failed to use reasonable care in reviewing GHR's designs.
GHR moved for partial summary judgment asking the district court to dismiss only NL's claim for punitive damages and its breach of contract and negligence theories. The district court, however, issued an order dismissing NL's entire complaint against GHR. Also, the district court granted Holditch's motion for summary judgment after concluding that Holditch was an arbiter under the agreement and, therefore, was not liable to NL for negligence.
We AFFIRM the district court's decision to dismiss Holditch from the litigation, but because the district court did not notify NL that its entire complaint against GHR was at risk, we REVERSE that portion of the district court's order which dismissed issues not raised in GHR's motion for partial summary judgment; those claims are REMANDED to the district court for further proceedings. We AFFIRM the dismissal of NL's claim for punitive damages, negligence, and most of the issues raised under its breach of contract theory. But NL has produced enough evidence that GHR's method for servicing the wells did not conform to the agreement to survive summary judgment; therefore, we REVERSE the dismissal of that portion of NL's breach of contract theory and REMAND it back to the district court.
Most of GHR's income comes from the production of oil and gas from more than 300,000 acres of mineral leaseholds in Webb and Zapata counties in Southwest Texas. To generate more revenue for GHR's bankruptcy estate, 1 in April 1985 the bankruptcy court authorized GHR to enter into a workover agreement with NL, an internationally known corporation specializing in wellsite drilling services. See Agreement for Recompletion, Reworking and Related Activities on Oil and Gas Wells in Webb and Zapata Counties, Texas ("Agreement") reprinted in Exhibits to NL's Memorandum in Opposition to GHR's Motion for Partial Summary Judgment ("NL's Exhibits"), vol. 1, tab 1. The workover agreement provided that NL would use "production enhancement procedures" to increase production from ten of GHR's existing gas wells.
Production from a well can be increased in a number of ways, 2 but in this case, GHR asked NL to augment production by fracturing the hydrocarbon formations under the wells. "Fracturing" is "[a] process of opening up underground channels in hydrocarbon-bearing formations, by force, rather than by chemical action such as acidizing." See 8 H. Williams & C. Meyers, Oil and Gas Law 379 (1987) [hereinafter Oil and Gas Law ]. A liquid or other substance, such as sand, is pumped into a well "to crack (fracture) and prop open the hydrocarbon bearing formation" and create channels through which the gas or oil can be extracted. See id. at 377. The method by which this is done is referred to as a "fracture treatment" or "frac."
The agreement required NL to finance the workover of the ten wells. To compensate NL for its services, GHR assigned NL a "proceeds production payment" equal to seventy-five percent of the "incremental net revenues" attributable to GHR's working interest in the wells. See Agreement, Exhibit 7. In other words, NL would receive seventy-five percent of the net revenue from the sale of that portion of the gas attributable to the production enhancement procedures. The agreement stated that the income from the proceeds production payment was to be NL's only source of compensation. See articles 5.1, 5.2. NL also received a right of first refusal for the performance of similar procedures on forty of GHR's other wells.
The agreement stipulated that GHR was to determine the method for servicing the wells. GHR was to give NL a "detailed written prognosis" explaining how the production enhancement procedure for each well should be carried out, and NL was to perform each procedure "in strict accordance" with the prognosis unless GHR and NL agreed otherwise. See articles 4.1.a., 4.3.a. If GHR failed to submit the prognosis or if GHR's instructions were inadequate, NL was required to notify GHR in writing. If GHR did not provide NL with the proper instructions within ten days, NL had the right to terminate the agreement. See article 4.3.d.
GHR wanted NL to fracture the wells. As with other production enhancement procedures, the agreement required GHR to instruct NL how to perform the fracture treatment, but its frac design was to be based on a model supplied by Holditch, a petroleum engineering consultant. 3 The agreement required GHR to provide NL with instructions for fracturing the well and with a fracture program approved by Holditch; if it failed to do so within ten days after being notified by NL, GHR was deemed to have elected not to fracture the well, and NL was to perform other production enhancement procedures stipulated by the prognosis. See article 4.3.i.3.
The agreement also contained provisions to comfort GHR's secured lenders, referred to as the "Banks." From the beginning, the Banks were intimately connected to the agreement between GHR and NL. Before GHR could assign the proceeds production payment to NL, the Banks had to subordinate their pre-existing security interests in the production of GHR's wells. Moreover, like any secured lender, the Banks needed to be confident about the financial viability of GHR before they would confirm GHR's plan of reorganization. Recognizing this, the bankruptcy court required GHR to insert several provisions into the workover agreement to protect the Banks. 4
The agreement contained other clauses that benefitted the Banks in addition to those required by the bankruptcy court, 5 the most important of which provided that GHR could not authorize workovers on any well before Holditch and two other petroleum engineering consultants, Netherland, Sewell and Associates ("NSA") and B.P. Huddleston & Co. ("Huddleston"), certified to the Banks that the workover would increase the discounted present value of future net revenue realized from each well by more than the anticipated cost of the workover. See article 4.1.c. Although the Banks required GHR to include these provisions in the agreement, the Banks were not a third-party beneficiary of the agreement. See article 6.8.
As GHR explained to the bankruptcy court when it sought permission to consummate the agreement with NL, the parties expected the agreement to benefit everyone. GHR's bankruptcy estate would be benefitted by increased production, and "[n]et revenues to GHR [would] increase dramatically once the procedures desired [were] employed." See Motion for Authority to Enter Into Agreement with NL Industries, Inc. to Perform Recompletions, Workovers, and Related Activities at 6, reprinted in Defendants GHR Energy Corporation and Southern States Exploration Inc.'s Motion for Partial Summary Judgment, Exhibit B, tab 135. Moreover, the agreement would impose no cash drain on the resources of GHR because NL would be paid only from increased production. As it turned out, the agreement benefitted no one. A portion of the parties' misfortune can be ascribed to gas prices, which, instead of increasing from $3.40 to $7.50 per mcf (1000 cubic feet), as the parties had predicted, plummeted to less than $2.50 per mcf. NL attributes the remainder of the blame for its misadventure to GHR.
To induce NL to enter into the agreement, GHR had assured NL that the revenue produced by the workovers would compensate it for its expenses within six months. GHR estimated that the production enhancement procedures on the ten wells would cost about $9 million and would produce almost $65 million in present value net revenue. The workover actually cost more than $14 million and produced only $5.4 million in revenue. But NL did not rely solely on GHR's sales pitch; before signing the agreement, NL received a more modest projection from NSA. Using GHR's estimates of the cost of the workovers, NSA estimated that future revenue, discounted to present value, would be...
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