Vermillion FC, LLC v. 1776 Energy Partners

November 15, 2021 In Vermillion FC, LLC v. 1776 Energy Partners, the Court of Appeals of San Antonio determined the extent to which a retained acreage clause in an oil and gas lease was modified by a “notwithstanding the above” reference to “governmental authority.”[1]  Specifically, under the terms of the lease the parties agreed to abide by the applicable field rules for designating how much acreage would be retained.  The Eagleville (Eagle Ford-1) Field Rules in turn incorporated by reference portions of Statewide Rule 86, which allows for additional “tolerance” acreage to be retained.[2]  In essence, the dispute in this case was whether 1776 Energy Partners (“1776”) was entitled to retain 40 acres around the horizontal Byrd Ranch No 1H Well, as argued by Vermillion FC, LLC (“Vermillion”), or 320 acres around said Well, as argued by 1776.  For the reasons discussed below, the Court found that both parties were wrong and remanded the case to the trial court for an award of damages consistent with this finding.

Vermillion originally entered into an oil and gas lease with 1776 in 2010, leasing 1,100 acres in Zavala County.  1776 commenced operations on a horizontal well in 2011 which began producing in paying quantities by August of that year.  The lease established a three-year primary term and that it would continue in effect after continuous development only as to acreage designated as part of a particular “well tract,” as defined in the lease.

Under the first retained acreage provision set forth in the lease, 1776 would arguably only have been able to retain 40 acres surrounding the Byrd Ranch No 1H Well.  However, a subsequent clause stated that “notwithstanding the above, in the event any governmental authority having jurisdiction should hereafter establish a density or spacing pattern of a different number of acres around oil and/or gas wells for full allowable purposes than the number of acres specified above, then lessee may only retain around each oil well and each gas well such number of acres as necessary to allow maximum production.”[3] 1776 invoked this “notwithstanding the above” clause to designate 320 acres.[4]

As a result of the foregoing, the parties spent several years disputing whether 1776 breached the contract by retaining excess acreage and by untimely filing a partial release of non-released acreage.  Vermillion filed suit in 2016 and moved for summary judgement, arguing that 1776 was only entitled to retain said 40 acres.  The trail court ultimately ruled in favor of 1776 on all issues, and Vermillion appealed.

In resolving the portions of this case of most interest to oil and gas practitioners, the court of appeals first gave effect to the “notwithstanding the above” portion of the retained acreage clause.  It noted that such a “notwithstanding” clause “contemplates the possibility that other parts of the provision may conflict with it, and they agree that this paragraph must be given effect.”[5]  The court then went on to analyze 1776’s well tract designation in light of the retained acreage provision.

The Railroad Commission of Texas (“RRC”) promulgates spacing rules between wells to prevent waste; this spacing is dependent on operators assigning certain acreage to wells in a proration unit.  A proration unit is the acreage assigned to a well in order to allocate production allowables to that well.  Essentially, a production allowable is the maximum number of hydrocarbons that a well may produce from a particular well tract.

Here, the “notwithstanding” clause incorporated by reference the Eagleville (Eagle Ford-1) Field Rules, which establish that proration units shall consist of 80 acres, but that additional acreage may be assigned to each horizontal drainhole well in accordance with Statewide Rule 86.[6]  Thus, the field rules set forth a “baseline” acreage and incorporate by reference Statewide Rule 86 which allows tolerance acreage to be assigned based on horizontal drainhole displacement.[7]  Rule 86 defines a “horizontal drainhole” as that portion of the wellbore drilled in the correlative interval between the penetration point and terminus and “horizontal drainhole displacement” as the calculated horizontal displacement of the horizontal drainhole from the first take point to the last take point.[8]  Rule 86 also includes an assignments charts that specifies additional amounts of tolerance acreage that may be assigned based on said horizontal drainhole displacement.[9]  1776’s Byrd Ranch No 1H Well was found to have a horizontal drainhole displacement of 3,962 feet, entitling them to an additional 200 acres.  Thus, the Court found that 1776 could retain a total of 280 acres, and not the 320 they originally claimed.[10]

This case first provides a reminder of the deference a court will give to “notwithstanding” language in a lease. It also provides an excellent demonstration of the multi-tiered analysis that must often take place with regard to retained acreage provisions (in this case three distinct steps). First, 1776 had to analyze which retained acreage provision was operative.  It then had to consult the field rules to determine the default proration acreage size and the available amount of tolerance acreage.  However, the analysis did not stop there, as 1776 then had to look to Rule 86 to determine the exact amount of tolerance acreage it could assign.  Tellingly, neither party brought to the lawsuit a correct interpretation of the provision, at least per the San Antonio Court of Appeals.  It turned out that the correct amount of acreage was not 40 acres, 80 acres or even 320 acres, but instead was 280 acres.

As always, when faced with a convoluted retained acreage provision, we encourage you to seek the advice of counsel familiar with these issues to avoid finding yourself in a lengthy and expensive dispute such as Vermillion FC, LLC v. 1776 Energy Partners.

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[1] Vermillion FC, LP v. 1776 Energy Partners, LLC, No. 04-20-00089-CV, 2021 WL 3743514, at *1 (Tex. App. Aug. 25, 2021)

[2] Id. at 6.

[3] Id. at 5.

[4] Id. at 1.

[5] Id. at 5.

[6] Id. at 6.

[7] Id.

[8] Id.

[9] Id.

[10] Id. at 10.


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