Gadeco, LLC v. Indus. Comm'n of State

• Decision Date: 17 February 2012
• Docket Number: Nos. 20110131,20110140.,s. 20110131
• Citation: 2012 ND 33,812 N.W.2d 405
• Parties: GADECO, LLC, Appellee, v. INDUSTRIAL COMMISSION OF the STATE of North Dakota, Appellant, and Slawson Exploration Company, Appellee. Gadeco, LLC, Appellee, Industrial Commission of the State of North Dakota, Appellee, and Slawson Exploration Company, Appellant.
• Court: North Dakota Supreme Court

812 N.W.2d 405

2012 ND 33

GADECO, LLC, Appellee,

v. INDUSTRIAL COMMISSION OF the STATE of North Dakota, Appellant,andSlawson Exploration Company, Appellee.Gadeco, LLC, Appellee,Industrial Commission of the State of North Dakota, Appellee,andSlawson Exploration Company, Appellant.

Nos. 20110131, 20110140.

Supreme Court of North Dakota.

Feb. 17, 2012.

Ariston Edward Johnson (argued), Dennis Edward Johnson (appeared), Watford City, N.D., for Gadeco, LLC.

Lawrence Bender (argued), Amy Lynn De Kok (on brief), Bismarck, N.D., for Slawson Exploration Company.

Charles M. Carvell (argued), Assistant Attorney General, Office of Attorney General, Bismarck, N.D., Todd Adam Sattler (on brief), Bismarck, N.D., for Industrial Commission.

VANDE WALLE, Chief Justice.

[¶ 1] The Industrial Commission and Slawson Exploration Company appealed from a district court judgment reversing the Commission's assessment of a risk penalty against Gadeco, LLC. Because we are unable to discern the basis for the Commission's decision, we reverse the judgment and remand to the Commission for the preparation of findings that explain the reasons for its decision.

I

[¶ 2] Before reciting the facts, we provide some legal background that is helpful to understand the controversy in this case.

[¶ 3] “In the beginning of the industry, oil and gas development was largely governed by traditional property law concepts, and the rule of capture prevailed.” Continental Res., Inc. v. Farrar Oil Co., 1997 ND 31, ¶ 10, 559 N.W.2d 841. Under the rule of capture, the law analogized the ownership of oil to the ownership of water which flowed in underground streams, and it was lawful to capture oil and gas that migrated from another landowner's property. Id. The remedy for the injured landowner was to “go and do likewise.” Texaco Inc. v. Industrial Comm'n, 448 N.W.2d 621, 623 n. 2 (N.D.1989) (internal quotations omitted). “The rule of capture made it economically imperative that each mineral owner drill his land and produce at as rapid a pace as possible, for otherwise his land would be drained of oil and gas by wells on adjacent properties.” 8 P. Martin & B. Kramer, Williams & Meyers Oil and Gas Law, Manual of Oil & Gas Terms 932 (2011). The court explained in Western Land Servs., Inc. v. Department of Envtl. Conservation, 5 Misc.3d 1013, 798 N.Y.S.2d 714, 2004 WL 2563598, at *1 (N.Y.Sup. Nov. 1, 2004):

In the early years of the last century, the rule of capture led to the waste of oil and gas due to a multiplicity of wells in close proximity to each other. A consequence of too many wells over the pool was that the pressure in the pool would drop rapidly with much product being left in the ground with no way to put pressure on it to get it out. It eventually occurred to those in the oil industries and state governments that this was a process wasteful of natural resources and overly expensive due to the proliferation of wells and delivery systems.

[¶ 4] “Like other states, the North Dakota legislature recognized that traditional property law principles contributed to inefficiency and waste in oil and gas development, and so enacted an Act for the Control of Gas and Oil Resources in 1953.” Continental Res., Inc., 1997 ND 31, ¶ 12, 559 N.W.2d 841. The Act, which is codified at N.D.C.C. ch. 38–08, modifies the rule of capture “by authorizing the Commission to set spacing units for a common source of supply ‘[w]hen necessary to prevent waste, to avoid the drilling of unnecessary wells, or to protect correlative rights.’ ” Texaco Inc., 448 N.W.2d at 623 (quoting N.D.C.C. § 38–08–07(1)). When separately owned interests are embraced within a spacing unit, the working interest owners may voluntarily pool their separately owned interests or, in the absence of voluntary pooling, the Commission must enter an order pooling all interests in the spacing unit, and the working interest owners must pay their share of the costs of drilling, operating, and supervising the well on the spacing unit. SeeN.D.C.C. § 38–08–08; Egeland v. Continental Res., Inc., 2000 ND 169, ¶ 12, 616 N.W.2d 861;Continental Res. Inc., at ¶¶ 13–14. When a pooled working interest owner does not pay, the owner who drills and operates the well has a lien on that owner's share of production for the proportionate share of expenses. SeeN.D.C.C. § 38–08–08(2).

[¶ 5] Although N.D.C.C. § 38–08–08(2) allows the working interest owner who drills a well a lien against a nonparticipating interest owner's share of production on the well, state law did not afford a mechanism to recover costs if the well was unsuccessful. Consequently, in situations where working interest owners could not agree on the drilling of a well, “[i]f the well [wa]s a dry hole, a nonparticipating owner los[t] nothing and owe[d] nothing.” Matter of SAM Oil, Inc., 817 P.2d 299, 302 (Utah 1991); see also 1 B. Kramer & P. Martin, The Law of Pooling and Unitization § 12.01 (3rd ed. 2011) (“Success has a thousand fathers; a dry hole is an orphan.”). Courts and state governments recognized that it is “unfair for a nonconsenting owner or nondriller lessee to be relieved of the costs and risks associated with drilling a producing well, but at the same time reap the benefits of another's efforts in extracting oil or gas from beneath his or her land.” Western Land Servs., Inc. v. Department of Envtl. Conservation, 26 A.D.3d 15, 804 N.Y.S.2d 465, 467 (2005) (footnote omitted). In an effort “to ensure that nonparticipating owners do not benefit from the successful outcome of risks they do not take,” Matter of SAM Oil, Inc., 817 P.2d at 302, states have authorized penalties typically called a “nonconsent penalty” or “risk penalty” to be imposed on nonconsenting working interest owners as “a reasonable way to allocate risks and balance the diverse interests involved in the pooling of oil and gas interests.” Bennion v. ANR Prod. Co., 819 P.2d 343, 347 (Utah 1991); see also 1 B. Kramer & P. Martin, The Law of Pooling and Unitization, supra.

[¶ 6] North Dakota's “risk penalty” provisions were first adopted by the Legislature in 1991. See 1991 N.D. Sess. Laws ch. 388. Section 38–08–08(3), N.D.C.C., currently provides:

3. In addition to any costs and charges recoverable under subsections 1 and 2, if the owner of an interest in a spacing unit elects not to participate in the risk and cost of drilling a well thereon, the owner paying for the nonparticipating owner's share of the drilling and operation of a well may recover from the nonparticipating owner a risk penalty for the risk involved in drilling the well. The recovery of a risk penalty is as follows:

a. If the nonparticipating owner's interest in the spacing unit is derived from a lease or other contract for development, the risk penalty is two hundred percent of the nonparticipating owner's share of the reasonable actual costs of drilling and completing the well and may be recovered out of, and only out of, production from the pooled spacing unit, as provided by section 38–08–10, exclusive of any royalty or overriding royalty.

b. If the nonparticipating owner's interest in the spacing unit is not subject to a lease or other contract for development, the risk penalty is fifty percent of the nonparticipating owner's share of the reasonable actual costs of drilling and completing the well and may be recovered out of production from the pooled spacing unit, as provided by section 38–08–10, exclusive of any royalty provided for in subsection 1.

c. The owner paying for the nonparticipating owner's share of the drilling and operation of a well may recover from the nonparticipating owner a risk penalty for the risk involved in drilling and completing the well only if the paying owner has made an unsuccessful, good-faith attempt to have the unleased nonparticipating owner execute a lease or to have the leased nonparticipating owner join in and participate in the risk and cost of drilling the well. Before a risk penalty may be imposed, the paying owner must notify the nonparticipating owner with proof of service that the paying owner intends to impose a risk penalty and that the nonparticipating owner may object to the risk penalty by either responding in opposition to the petition for a risk penalty or if no such petition has been filed, by filing an applicationor request for hearing with the industrial commission.

A 200 percent risk penalty means the nonconsenting owner will relinquish his or her right to receive his or her share of production revenue until the consenting parties recover two times the nonconsenting owner's share of the expenses. See Dorsett v. Valence Operating Co., 111 S.W.3d 224, 229 (Tex.Ct.App.2003), reversed on other grounds,164 S.W.3d 656 (Tex.2005).

[¶ 7] The Commission has promulgated an administrative rule governing the requirements for an owner's recovery of a risk penalty:

1. An owner may recover the risk penalty under the provisions of subsection 3 of North Dakota Century Code section 38–08–08, provided the owner gives, to the owner from whom the penalty is sought, a written invitation to participate in the risk and cost of drilling a well, including reentering a plugged and abandoned well, or the risk and cost of reentering an existing well to drill deeper or a horizontal lateral. If the nonparticipating owner's interest is not subject to a lease or other contract for development, an owner seeking to recover a risk penalty must also make a good-faith attempt to have the unleased owner execute a lease.

a. The invitation to participate in drilling must contain the following:

(1) The location of the proposed or existing well and its proposed depth and objective zone.

(2) An itemization of the estimated costs of drilling and completion.

(3) The approximate date upon which the well was or will be spudded ¹ or reentered.

(4) A statement indicating the invitation must be accepted within thirty days of receiving it.

(5) Notice that the participating owners plan to impose a risk...