Forced Integration in Mississippi

The Court of Appeals of the State of Mississippi in Tellus Operating Group, LLC v. Maxwell Energy, Inc.  No. 2012-CA-00354-COA, 2014 Miss. App. LEXIS 209 addressed the appropriate standard of review required by a chancery court when reviewing forced integration decisions rendered by the Mississippi Oil and Gas Board under Miss. Code Ann. § 53-3-7(1)(a).

The dispute between Maxwell Energy, Inc. and Tellus Operating Group, LLC, arose from the Mississippi Oil and Gas Board’s decision to approve a well proposed by Tellus and the subsequent forced integration of Maxwell in Jefferson Davis County, Mississippi.  In September 2006, Tellus filed a petition with the Board regarding the formation of drilling unit to drill the Chianti Well No. 1.  Id., at *4-7.  Maxwell owned drilling rights associated with the well and drilling unit, but at the time of its petition, Tellus had agreements with approximately ninety-six percent of the working interest owners, whether by leases, farm outs, or participation agreements in the proposed well.  Id., at *4.  Maxwell did not agree to join the proposed unit and well.  Id.

Under Miss. Code Ann. § 53-3-7(1)(a), when two or more separate interest owners cannot reach a voluntary pooling arrangement to facilitate drilling between the interest owners, the Mississippi Oil and Gas Board may step in and order the parties to integrate.  The Board requires that notice be granted to the parties involved and a hearing on the matter before it gives its final order. According to the statute, the purpose behind forced integration is to prevent waste, as well as to prevent unnecessary drilling.

In its petition, Tellus asked the board to “force integrate, with alternate charges, a drilling unit for a proposed gas well, approve an exception well and an exception location, and grant related relief.”  Id., at *6.  Maxwell was notified by Tellus as required by Miss. Code Ann. § 53-3-7(2)(a), whereby Tellus submitted to Maxwell a standard industry form operating agreement and AFE, which Maxwell did not sign.  Id., at *6-7.  At the October 2006 hearing on Tellus’s petition, Maxwell’s only evidence in support of its position against the forced integration of its interest was the testimony of D.W. Maxwell, the owner of Maxwell Energy, LLC. Id., at *7.  Tellus, on the other hand, provided evidence and two witnesses who supported the forced integration.  Id.

The Board found in favor of Tellus and determined that the evidence Tellus provided at its October hearing satisfied the statutory requirements for forced integration.  Id., at *8.  The order stated:

“…each non-consenting owner shall be afforded the opportunity to participate in the development and operation of the well in the pooled unit as to all or any part of said owner’s interest on the same cost basis as the consenting owners by agreeing in writing to pay that part of the costs of such development and operation chargeable to said non-consenting owner’s interest, or to enter into such other written agreement with the operator as the parties may contract, provided such acceptance in writing is filed with the board within twenty (20) days after this order is filed for record with the Board.”

Maxwell did not comply with the Board’s order; instead, it mailed a letter to Tellus and the Board “of its agreement to voluntarily integrate its interest in the unit and to participate and join in the costs of the development to the extent of Maxwell’s own calculation of its estimated proportional share of all associated costs.”  Id., at *10Maxwell subsequently sent a check to Tellus for what it believed to be its share of the costs, which Tellus returned to Maxwell.

Maxwell appealed the order of the Board on December 27, 2006, to the Jefferson Davis Chancery Court.  Id., at *11The court concluded that Tellus’s terms were unreasonable and that Maxwell agreed to participate in the well.  Id., at *12The Supreme Court of Mississippi concluded that the chancellor applied the incorrect standard of review.  Id., at *12The Mississippi Supreme Court explained that the Chancery Court utilized a de novo standard of review instead of examining whether substantial evidence supported the Board’s decision.  Id., at *12.

When reviewing decisions of the Mississippi Oil and Gas Board, the Mississippi Supreme Court uses a “well-settled standard…The Board’s order will only be reversed where the decision is (1) beyond the Board’s legal power, (2) violates some statutory or constitutional right of the complaining party, (3) is arbitrary and capricious, or (4) is not supported by substantial evidence.”  Id. at *13.

On review, the Mississippi Supreme Court concluded that the decision of the Board was supported by substantial evidence for several reasons.  First, the Court explained that Miss. Code Ann. § 53-3-7(1)(c) states that a nonconsenting owner is an owner of drilling rights who has not agreed in writing to integrate into the drilling unit and that Miss. Code Ann. § 53-3-7(2) allows for forced integration, where those nonconsenting owners are subject to ‘alternate charges’ that are “‘designed to ensure that nonparticipating owners do not benefit from the successful outcome of risks they do not take.’”  Id. at *15 (citing Waller Bros. Inc. v. Exxon Corp., 836 F. Supp. 363, 371 (S.D. Miss. 1993).  Second, the Court noted that Tellus followed the statutory procedure for bringing a petition before the Board regarding the formation of a unit and integration of the nonconsenting owner.  Id. at *16.  In this case, Tellus and Maxwell did not reach an agreement, and Tellus then petitioned the Board to form the proposed unit.  Next, a hearing was held and the Board ruled in favor of Tellus.  Maxwell then failed to accept and agree to the three statutory options, within twenty days of the Board’s ruling.  Id. at *18.[1]  The Mississippi Supreme Court held that no fourth option existed outside of the three statutory options to permit Maxwell to bind Tellus unilaterally with its letter mailed after the Board’s ruling.  Id. at *19. The Mississippi Supreme Court determined that the Board properly ruled in this case and that Maxwell was a nonconsenting owner.

Following the Tellus decision, it is important to note that Chancery Court review of Mississippi Oil and Gas Board decisions should not be considered on a de novo standard of review, but instead whether the decision is (1) beyond the Board’s legal power, (2) violates some statutory or constitutional right of the complaining party, (3) is arbitrary and capricious, or (4) is not supported by substantial evidence.”  Id. at *13.  Further, any orders granted by the Mississippi Oil and Gas Board are granted deference so long as its decisions are in accordance with the applicable statute.  Therefore, it is important for any operator seeking to overturn a Mississippi Oil and Gas Board decision to have substantial evidence available for the reviewing court to show that the Board’s decision was beyond the scope of its decision making powers, that a statutory or constitutional right was violated, the decision was arbitrary and capricious, or a lack of substantial evidence in favor of the Board’s decision.

[1] Section 53-3-7(2)(a) prescribes three statutory options that operates can offer to nonconsenting owners before petitioning the Board to allow the operator to charge alternative charges: (1) a written agreement to lease, or (2) farm out, or (3) participate in the cost and risk of developing and operating the proposed unit well.