The 11th Court of Appeals in Texas recently issued an opinion analyzing provisions of purchase and sale agreements (PSAs) governing working interests in oil and gas leases. In the opinion in Apollo Exploration, LLC v. Apache Corp. (Tex. App.—Eastland, June 10, 2021, no pet.), the Court highlights important considerations for drafting PSAs and — in particular — terms aimed at preserving a seller’s interests.
The case involved the sale of the working interest in oil and gas leases covering over 120,000 acres of land in the Texas Panhandle. Apollo Exploration, Cogent Exploration, Ltd., Co., and SmellmoCo, LLC (appellants), along with Gunn Oil Co. (collectively with appellants, sellers), owned 98 percent of the working interest in 109 oil and gas leases. On March 22, 2011, the appellants and Gunn sold 75 percent of their interests to Apache Corp. To memorialize the transaction, the appellants and Gunn each executed separate, but substantively identical, PSAs with Apache. A few years later, the appellants sued seeking a declaration of their rights under the PSAs and asserting breach of contract and various tort claims against Apache. In relevant part, the appellants’ claims arose out of the parties’ disparate interpretations of certain provisions in the PSAs.
First, the Court analyzed a provision purporting to require Apache to offer its interest in the leases to the sellers under certain terms. Section 4.1 of the PSAs required Apache to conduct an annual review and provide the respective seller a written, budgeted drilling commitment for the upcoming year. Importantly, if the commitment contemplated or would result in the loss or release of “one or more of the Leases (or parts thereof),” then Apache “shall concurrently offer all of [its] interest in the affected Leases (or parts thereof) to Seller at no cost to Seller and upon Seller’s acceptance of such Leases, [Apache] shall transfer and assign the affected Leases (or parts thereof to Seller).”
The appellants argued that, since several leases were for fractional interests in the minerals over a certain acreage, the term “affected Leases” contemplated Apache’s release of all other leases that covered the same acreage — not just the individual leases that would be lost or released based on the commitment. Apache argued that the term “Leases” referred to the 109 individual oil and gas leases in which Apache acquired an interest and, thus, the term “affected Leases” meant only those “Leases” that would be lost or released in the next calendar year. The Court looked to the common understanding of the word “affected,” but ultimately relied heavily on the PSAs’ definition of the term “Leases” in determining that “affected Leases” as used in Section 4.1 meant “those of the 109 Leases . . . whose loss or release was contemplated by or would result from one of Apache’s Commitments.”
However, with respect to the requisite release of “all” of Apache’s interest in the affected leases, the Court sided with the appellants holding that the “unavoidable” interpretation required Apache to offer “all” of its interest in an affected lease to each of the four sellers concurrently. Importantly, the Court likened Apache’s obligation under Section 4.1 to a right of first refusal, noting the seller’s opportunity to choose to accept or refuse the interest in an offered lease. Further, and contrary to Apache’s assertion, the Court found that the offer of “all” of Apache’s interest to all of the sellers was not impossible because, for example, only one seller could accept the offered assignment or Apache could transfer and assign all of its interest in an affected lease to the participating sellers collectively.
Next, the Court turned to the interpretation of the seller’s back-in option. Section 2.5 of each respective PSA provided the seller the right, but not the obligation, to “back-in” for up to one-third of the conveyed interest. This right was exercisable at “Two Hundred Percent (200%) of Project Payout.” “Project Payout,” in turn, meant the first day of the next calendar month following that point in time when the sum of certain defined revenue equaled the sum of certain defined expenses.
Apache had requested that the Court declare that Apache must achieve “a 2:1 return on its investment in the properties” to trigger the back-in option and to declare which revenues and costs were to be included in the calculations. Refusing Apache’s interpretation, the Court again stuck closely to the express terms of the PSAs, holding that the “ ‘200% of Project Payout’ must be calculated based on the defined terms in Section 2.5,” which painstakingly defined each element of the calculation. The Court reiterated its commitment to the terms memorialized in the PSAs with respect to the revenues and costs to be included in the calculation of the “back-in trigger.” Finally, the Court determined that despite the parties’ differing interpretations as to the language in the agreements, they did not dispute the material and essential terms and thus the agreements were not too indefinite to be enforced.
Interestingly, this case seems to provide juxtaposed examples of drafting PSA provisions. In interpreting Section 4.1, the Court was forced to resort to the defined terms available to it and the common meaning of the words therein. This resulted in appellants and Apache losing an argument with respect to the breadth of the provisions and the protected interests. By comparison, Section 2.5 was more painstakingly drafted, with a wealth of defined terms to guide the requisite calculations. Accordingly, the Court refused to construe the agreed language of the parties with respect to the back-in provision.
TAKEAWAYS
- Courts heavily rely on defined terms and the plain language within a PSA. Thus, any intended variations of defined terms should likewise be defined in the PSA.
- Contractual language that preserves the seller’s right, but not obligating a seller, to accept offered interests under certain circumstances constitutes a preferential right that does not violate the rule against perpetuities.
- A court will avoid construing a contract in a manner that makes performance impossible. Thus, to avoid an unintended interpretation, parties should clearly delineate procedures in a PSA.