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Fasken Land and Minerals, Ltd. v. Occidental Permian Ltd.

Court of Appeals of Texas, Eighth District, El Paso

June 30, 2005


          Appeal from the 385th District Court of Midland County, Texas (TC# CV-43, 029)

          Before Barajas, C.J., McClure, and Chew, JJ.



         This is yet another oil and gas case originating from the attempted removal of an operator under an operating agreement. But it is of historic note as it may be the last oil and gas case from the Permian Basin that will reach this Court -- certainly, the last one from Midland County[1]. The Appellants Fasken Land and Minerals, Ltd., Crane Avenue, Inc., and D.H. Acquisition, Ltd. (collectively “Fasken entities”) appeal from a take-nothing judgment rendered in favor of Appellees Occidental Permian Ltd. (“OPL”), OXY USA, Inc., and Occidental Petroleum Corporation (“OPC”).[2] Appellants sued Appellees for inter alia alleged breaches of an oil and gas unit operating agreement, concerning the provisions related to operator removal and election of a successor, and Fasken entities' preferential purchase right.[3] Fasken entities also sought a declaratory judgment on their preferential purchase right and OPL's removal as Unit Operator and its successor's election under the Unit Operating Agreement.[4] On appeal, Fasken entities bring four issues, in which they assert the trial court erred: (1) by refusing to award them administrative overhead charges paid to OPL; (2) by failing to render judgment that D.H. Acquisition, Ltd. is the successor Unit Operator; (3) by failing to declare the preferential purchase right notice invalid or alternatively erred by improperly instructing the jury; and (4) by impermissibly taxing certain items as costs. We affirm.

         Fasken entities and OPL are working interest owners of the Midland Farms Unit (“MFU”), an oil and gas unit located on C Ranch in Andrews County, Texas. In 1913, David Fasken bought the C Ranch, which then consisted of 250, 000 acres northwest of Midland. In the 1940s, Fasken family members leased out a portion of the property to Stanolind Oil Company. The Faskens retained a royalty interest in three-quarters of the property under the lease and held a working interest in one-quarter of the property. In the early 1960s, the property was unitized and divided into tracts for purposes of initiating secondary recovery operations. As a result, Pan American Oil Company (“Pan American”), formerly Stanolind, held approximately 75 percent of the working interest over the entire acreage covered by the unit. In 1961, the working interest owners and royalty owners executed a Unit Agreement and a Unit Operating Agreement. The Unit Agreement was incorporated into the Unit Operating Agreement by reference and Pan American was designated as the initial Unit Operator. Pan American, which later became American Oil Company ("AMOCO") operated the Unit for several decades.

         In 1995, Fasken entities initiated an audit of the MFU, and thereafter claimed a number of exceptions to its joint interest billing charges as a working interest owner of the Unit. Fasken entities later filed suit against AMOCO over the accounting issues and its operational practices and also attempted to remove it as operator. As part of the settlement of that lawsuit, the Unit Operating Agreement was amended to include a preferential right to purchase provision, contained in Article 24. In settlement negotiations, Fasken entities also agreed to the transfer of AMOCO's 75 percent working interest in the MFU to Altura Energy Ltd. ("Altura"), a limited partnership formed between AMOCO and Shell Oil Company in 1997 to operate their Permian basin assets as a single entity.

         The present lawsuit arises from the purchase of Altura's working interest in the MFU by OPC through one of its subsidiaries in April 2000. In 1999, OPC, a Los Angeles-based oil and gas company, learned that AMOCO and Shell were considering selling the Altura properties. OPC expressed its interest in the assets and later received a formal letter inviting it to be part of the bidding process for the Altura acquisition. According to the letter, Altura was focusing its effort on companies that had expressed an interest in acquiring Altura in its entirety.[5] As a result of a multi-step bidding process, OPC was selected as the potential purchaser and if offered to purchase 100 percent of the Altura assets for approximately $3, 550, 000, 000. The total purchase price included a small amount of assumed liabilities which added another $50 million to the transaction. AMOCO and Shell accepted the offer and the parties began negotiating the terms of the purchase and sale agreement.

         During the due diligence process, OPC personnel and AMOCO representatives discussed whether the transaction triggered the provision for preferential right to purchase the MFU asset. OPC did not believe that the provision would be triggered by the transaction, but AMOCO felt strongly that it should offer the MFU as a preferential right. The MFU was the only Altura partnership interest that was subject to a preferential right.

         Jim Lyerly, Senior Vice President in Financial Planning Analysis for Occidental Oil and Gas Company, an OPC subsidiary was part of the acquisitions team. Mr. Lyerly volunteered to work on the allocation of the purchase price for the MFU. In his testimony, Mr. Lyerly explained how he arrived at the later disputed $63 million figure as the allocation of the purchase price for the MF U.Since OPC was the buyer, they were asked to determine the allocated price of MFU, rather than have the seller make the determination outright, because they would know what they were paying for it. Mr. Lyerly knew the purchase price for the Altura properties was $3.8 billion in terms of total asset value and $3.6 billion in terms of the dollar amount. In undertaking to determine the allocated price for the MFU component, Mr. Lyerly first asked Terry Lindquist and Ed Behm, engineers experienced at building development and exploitation programs, to build a technical case for the value of the property, that is, an analysis of the projects based on technical matters in engineering and geology. Mr. Lyerly explained that the value of the property is centered on future capital, including the capability of reserves projects beyond the proved developed resources.

         Before receiving the engineers' independent opinion, Mr. Lyerly conducted his own analysis, relying primarily on the Netherland Sewell reserve report, which evaluated all the Altura properties in the acquisition.[6] The Netherland Sewell report provided data on the properties in aggregate form -- on more than 8, 000 wells, of which the MFU interest was just a component. Mr. Lyerly knew the general background assumptions underlying all the evaluations in the report. In his evaluation, he adjusted for differences in their global assumptions and their discount rate for instance. Mr. Lyerly cut the MFU's probable reserves numbers in half in his assessment, but made no adjustment to the proved developed reserve numbers or the proved developed nonproducing reserve numbers. In Mr. Lyerly's opinion, the MFU had significantly more potential on average than all the other properties. He believed that a lot of oil had not been developed yet, thus, this particular property had a “disproportionate amount of upside.” Mr.Lyerly then met with Mr. Lindquist and Mr. Behm and in their view there was tremendous potential in these properties. According to Mr. Lyerly, their evaluation was higher than his $63 million figure. He asked if they could support the $63 million figure and their answer was yes because their valuation actually supported a much higher number.

         Concurrently with the OPC allocation process, Lon Buehner, an executive of AMOCO, had discussions internally with Stanley Davidson (“David”) Grubb, Jr., the director of the acquisitions and divestments group, about the allocated value of the MFU in the Altura acquisition. There had been no agreement on the purchase price for Altura when Mr. Buehner first talked to Mr. Grubb and asked him to prepare a valuation of the MFU. Mr. Grubb tabulated information on the MFU, relying mostly on the numbers in the Netherland Sewell report. Mr.Grubb stated that no risking was done in the Netherland Sewell report. He prepared a table of information which he gave to Mr. Buehner. Mr. Grubb did not know the purchase price and never did any other work related to allocating a portion of the purchase price to MFU. Mr.Grubb explained that the “sell” side never does the allocation. Rather, the seller looks at the allocation done by the buyer for a reasonableness check. Mr. Grubb knew that the information he provided to Mr. Buehner was for the purpose of checking that the allocated value was reasonable and within the bounds of petroleum engineering practices.

         Mr. Buehner had a conversation with Mr. Grubb about his tabulated information on the MFU. They discussed the range of values for the MFU to be as low as $40 million and as high as $110 million, depending on the risk weighting put on the information.[7] Mr. Buehner then had a conversation with Mr. Lyerly about a range of numbers, but Mr. Lyerly indicated that he strongly believed that OPC had a technical justification for the $63 million figure. Following that discussion, Mr. Buehner spoke with Mr. Grubb again and informed him that the OPC value was in the $63 million range. According to Mr. Buehner, he and Mr. Grubb believed that there was a wide range with regard to the potential value of the MFU because of oil price sensitivity and based on how one would risk weight the upside of the MFU. They concluded that it was feasible for OPC to have a technical case that would support a value of $63 million. Mr. Grubb testified that the $63 million figure looked reasonable to him and that he never took into account the total purchase price for Altura in his determination.

         Shortly before the purchase and sale agreement was executed, Mr. Buehner had a second meeting with Mr. Lyerly. Mr. Buehner mentioned to him that the higher end of his previous range of $60 million was very feasible and Mr. Lyerly reiterated that OPC felt they had a strong technical case that supported the $63 million figure. At that meeting, they determined that $63 million was the figure to be inserted in the purchase and sale agreement as the allocation of the purchase price for the MFU. Mr. Buehner also testified that the AMOCO legal department asked if $63 million was the appropriate value to be allocated to the MFU from the purchase price and he told them he believed it was. The parties ultimately executed the purchase and sale agreement, which listed the $63 million figure as the allocation of the purchase price attributable to the MFU in Article 3.2 (b) of the purchase and sale agreement.[8]

         On March 22, 2000, Altura sent a letter to each of the Fasken entities, notifying them that Altura had executed a purchase and sale agreement to sell a portion of their partnership interests to OPC. The letter stated that pursuant to Article 24 of the Unit Operating Agreement, the nonoperating working interest owners in the MFU may have a preferential right to purchase Altura's interest in the MFU.[9] The letter notified Fasken entities that the allocated value for the MFU was $63 million, payable in cash at or before the closing date, which was scheduled to occur by April 30, 2000. A copy of the purchase and sale agreement was attached, but did not include the exhibits. In the letter, Altura requested that Fasken entities respond to the notice within fifteen days after its receipt if they intended to exercise the preferential right to purchase the MFU. Altura also requested that a copy of the letter be returned to it, with a mark placed in the space provided as evidence of Fasken entities' election to purchase or not to purchase the MFU.

         Fasken entities received the Altura letter on March 27, 2000. Norbert Dickman, general manager of the Fasken company, Sally Kvasnicka, the land manager, Mark Merritt, the engineering manager, and general counsel met and briefly discussed the letter. They scanned through the purchase and sale agreement and found the section that referred to the preferential purchase right for the MFU and provided that the allocated purchase price was $63 million.

         On April 5, 2000, the Fasken entities sent a letter to Altura requesting more information about the proposed sale. In their letter, Fasken entities stated that it was their position that the proposed sale triggered Article 24 of the Unit Operating Agreement and that under the terms of that agreement, they had a right to “sufficient information to enable them to make an informed decision with respect to whether or nor to exercise their rights to acquire the Interest.” Fasken entities asserted that the March 22, 2000 letter failed to satisfy the specific notice requirements of Article 24. Specifically, Fasken entities complained that the document they received was incomplete in that it was missing the referenced exhibits, which they stated were essential to their informed decision. Fasken entities also complained that neither the March 22 letter nor the attached documents provided any basis for the $63 million allocation price or for Altura's assertion that payment in cash at closing was a term or condition of the proposed sale to which they must agree in order to acquire the MFU. Fasken entities requested that Altura provide them with “all documents and other information necessary to verify the basis for the $63, 000, 000 allocation, the interest to which the allocation pertains, and provide an explanation for your assertion that the allocated purchase price is payable in cash at or before the Closing of the Proposed Sale.” In closing, Fasken entities stated that until they had received all of the information Altura was required to provide under Article 24, Awe will not consider the fifteen (15) day notice period to have commenced.”

         Fasken Engineering Manager Mark Merritt testified that after being presented with the $63 million figure, he began to run the economics on the MFU, which included looking at the current oil and gas price outlooks and operating expense forecasts, in order to determine whether $63 million was a reasonable number. Mr. Merritt made some adjustments to his calculations because he felt that Fasken could operate the property more cheaply, but could not come up with that high a value. The only way he could value the MFU at $63 million was to assume oil prices which at that time seemed outrageously high. Mr. Merritt's analysis of the MFU placed its value in the range of $35 - $43 million.[10]

         On April 10, 2000, Fasken entities requested a meeting of the working interest owners in the MFU for the purpose of removing the unit operator, Altura, and to elect a successor operator. In explaining this decision, Mr. Merritt stated that they were concerned about the continual change of personnel in the operation and felt they could operate the MFU more effectively and more efficiently. At the time, the Fasken company had its affiliate D.H. Acquisitions in mind as the successor operator.

         On April 25, 2000, Occidental Permian Ltd. (“OPL”), formerly called Altura Energy Ltd., sent a letter to the MFU non-operating working interest owners of the MFU.[11] In the letter, OPL disagreed with Fasken entities' objections to the March 22 notice letter, but wrote “[r]ecognizing that Fasken asked some legitimate questions (although beyond the requirements of Article 24), we are providing each of you with certain additional information that Fasken requested.” OPL also wrote that “out of a spirit of cooperation and in light of your request for more information” it was extending another fifteen day deadline to the working interest owners to exercise its preferential right to purchase its interest in the MFU for $63 million. OPL enclosed a copy of the exhibits to the purchase and sale agreement, but stated that the exhibits “address the structure of the OPL's partnership and the sale of interests in OPL, not the conveyance of the Affected Interest or any particular real property.” In response to Fasken entities' request for the basis of the allocation of 63 million dollars to the MFU, OPL stated that Article 24 did not require an explanation of the allocation in the event of a sale, “[h]owever, OPL in good faith considers sixty-three million dollars to be a reasonable allocation of the consideration to the Affected Interest.”[12] OPL also explained that it had requested a cash payment because the sellers were receiving cash in consideration for the sale of their equity.

         Fasken entities received the second notice letter on April 27. In Mr. Merritt's opinion, Fasken's primary issue was the allocation of the purchase price and the opportunity it presented to increase the value of the MFU in order to defeat their preferential purchase right. Mr. Merritt did not believe the $63 million figure was inconceivable, but he wanted to see what the basis was for that figure and believed that Article 24 indicated that they were entitled to full information, including information on the allocation of the purchase price. Mr. Dickman also testified that the primary concern was the issue of sufficient information, that is, the basis for the $63 million allocation. Mr. Dickman also did not believe he could rely on OPL's good faith assertion of the allocation because of his fiduciary duties and because of Mr. Merritt's advice that the figure was far off.

         On May 4, 2000, OPL and Fasken entities held a meeting at the Fasken company offices to discuss the concerns raised by Fasken entities. According to Mr. Dickman, OPL did not provide further information about how it determined the $63 million figure. On May 12, 2000, Mr. Dickman, as the Fasken entities agent, sent a letter to OPL, informing the company that it had not fully satisfied the notice requirements under Article 24 because the “full information” term in Article 24 required an explanation for the basis for the $63 million allocation to Altura's interest in the MFU, which had not been done. In the letter, Mr. Dickman stated that:

It will be Altura's burden to establish the reasonableness of that allocation, your refusal to provide even an explanation of the purported allocation does not satisfy your obligation to provide 'full information' concerning a material element of the PSA. As such, your attempted notice remains ineffective to impose any deadlines for the exercise of the Fasken Entities' rights under Article 24.

         Mr. Dickman also asserted that the Fasken entities wished to exercise their rights to purchase the MFU interest, but had been denied that opportunity and considered OPL to be in material breach of the Unit Operating Agreement. Mr. Dickman requested a stated basis for the allocation and full information “concerning how that allocation was made and why it was considered to be reasonable.” On behalf of the Fasken entities, Mr. Dickman also proposed an offer to purchase the MFU interest for $38, 000, 000 before June 1, 2000, “in an effort to resolve this matter without the need for protracted and expensive litigation . . . .”[13] On June 9, 2000, the Fasken entities filed their original petition in this lawsuit.

         On June 16, 2000, the MFU working interest owners met in Fasken's offices in Midland. At the time of the meeting, OPL owned almost 75 percent of the working interest, the Fasken entities collectively owned less than 24 percent, and Lowe Partners LP (“Lowe Partners”) and Valence Operating Company (“Valence”) each owned less than 1 percent. Mr. Behm acted as chairman and was the representative for OPL. The first item on the agenda was a vote to remove OPL as the operator. OPL voted its 74.67 percent interest against removal. The Fasken entities, Lowe Partners and Valence voted their combined 25.32 percent interest in favor of OPL's removal as operator.[14]

         The next item considered at the meeting was the nomination of a successor operator of the MFU. Mr. Dickman nominated D.H. Acquisition and the Fasken entities, Lowe Partners, and Valence voted their combined interest in favor of D.H. Acquisition as the successor operator. OPL voted its 74.67 percent interest against the nomination. The meeting minutes show that Mr. Behm stated that the item failed and the ballot sheet reflects that the vote did not carry. After the voting, Mr. Dickman stated that OPL had been removed as operator and D.H. Acquisition had been properly elected and demanded that operations be ...

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