Legal Watch: Volume 22

Prepared by William H. Bode
Bode & Grenier, LLP
1150 Connecticut Ave., NW
Washington, D.C. 20036
Telephone: 202-862-4300 | Email: wbode@bode.com

FEDERAL APPEALS COURT HOLDS INSURANCE COMPANY REQUIRED TO DEFEND OPERATING COMPANY SUED FOR POLLUTING LAND DESPITE POLLUTION EXCLUSION CLAUSE

Case Summary: Primrose Operating Company and CADA Operating Company operated an oil and gas lease on the Senn family ranch beginning in 1992. In 1999, Senn sued the operating companies for polluting the ranch claiming gross negligence, trespass, and nuisance. Chubb Insurance Group, Mid-Continent Casualty, and National American Insurance Company (NAICO) insured the operators at various times during their drilling operations. NAICO refused to defend the operators, or pay for any of the $2,194,000 damages assessed at trial, citing the pollution exclusion provisions in its Comprehensive General Liability (CGL) policies with Primrose and CADA. The operators sued NAICO and the trial court held that NAICO had a duty to provide a defense to the Senn law suit. The trial court also ruled that the operators were entitled to recover the attorney fees incurred in bringing the action against NAICO, including $183,741 charged by a second, assisting law firm. NAICO appealed the decision, and the Fifth Circuit Court of Appeals affirmed the lower court. In its decision, the Appeals Court ruled that the Pollution Exclusion Clause, as amended by a "Pollution Endorsement" and "Saline Endorsement" did not bar coverage when the CGL policies otherwise clearly covered the Senn law suit. In reasoning important to independent crude producers, the Appeals Court was called upon to determine whether the pollution was "sudden and accidental." NAICO argued that only pollution incidents that are "sudden and accidental" are covered, and that damages from pollution occurring over many years of crude oil and gas production cannot qualify for coverage. The Appeals Court agreed that "sudden and accidental" had a temporal quality, but found that the spills could have been quickly released. Specifically, the Court noted that, "the oil companies' flow lines carry petroleum under extreme pressure and that when the lines burst, the event occurs suddenly, sometimes resulting in a spray of water as high as forty feet in the air." "While the breaks causing the leaks and spills were undoubtedly caused by conditions created over a number of years, the policy's 'sudden' requirement is satisfied as long as the actual break is 'sudden and accidental.'" Finally, the Appeals Court held that the "saline endorsement" was not part of the Pollution Endorsement as NAICO contended, but provided separate and additional coverage.

LESSON: CGL insurance policies with Pollution Exclusion clauses may nevertheless cover damages from pollution at drilling sites. Independent crude producers should not accept at face value an insurance company's decision to decline coverage, but should seek qualified counsel to review all insurance policies in the event of a claim for damages from pollution. (Primrose Operating Company; CADA Operating, Inc. v. National American Insurance Company)

APPEALS COURT SLASHES $40 MILLION PUNITIVE DAMAGES AWARD AGAINST OPERATOR FOUND TO HAVE DEFRAUDED OPERATING PARTNER

Case Summary: We have previously reported on a jury verdict in the Reagan County District Court entitled Frank W. Cass and Michael L. Cass v. Patricia Love Stephens, et al . Please be aware that the decision by the Texas Court of Appeals apparently has been reversed in part by the Texas Supreme Court. Accordingly, the facts set forth in the original case summary should not be relied upon. Readers should be aware that the summary of facts of any reported decision may be subject to reversal on appeal. Furthermore, we have been advised that the original statements in the case summary concerning a finding of fraud are inaccurate. We apologize for any embarrassment or inconvenience stemming from our summary of facts set forth in the original Case Summary. The purpose of these reported cases is to assist energy companies in the management of their businesses by reporting situations that have given rise to litigation.

LESSON: Operators must be meticulous in accounting for revenues and expenses under Joint Operating Agreements. Because accounting documents are confidential, and because documents viewed out of context could be misconstrued, operators should use shredding machines as part of their normal document destruction practice. (Frank W. Cass and Michael L. Cass v. Patricia Love Stephens, et al. )

SUIT BY LAND OWNER CLAIMING TRESPASS FOR CONDUCT OF UNAUTHORIZED THREE-DIMENSIONAL SEISMIC SURVEYS DISMISSED

Case Summary: Grand Geophysical and Millennium Seismic, Inc., using three-dimensional technology, conducted a three dimensional survey of a 300 square mile area on behalf of CNG Producing Company and Cabot Oil. The surveyors obtained permission to conduct the survey from over 2,100 surface and mineral estates owners, paying over $4 million in permit fees. It did not obtain permission from the Villarreals, who then sued for trespass when the "Tri-County Speculative 3-D Survey" -- that included their property -- was published. The trial court found for the surveyors and the Texas Court of Appeals affirmed. The Appeals court found that for "geographical trespass" to occur, a physical object must cross the property line. Thus, courts have found trespass can arise by shooting onto or over the land, by explosions, by throwing flammable substances, by blasting operations, and by discharging soot and carbon, but not by mere vibrations. Here, the Court found that three dimensional seismic exploration consists of placing "shot" and "receiver" points on the surface and then using energy sources (vibrioses or explosives) to send vibrations into the earth. In conducting the Tri-County Survey, Grant had placed the shot and received points only on land where they obtained permits. Thus reasoned the Court, the land owner failed to prove "trespass." The Court also ruled that as a mater of law there was no "unjust enrichment" (which requires some unlawful act by the defendant), the thus affirmed the dismissal of the land owner suit.

LESSON: The failure to obtain the permission of every land and mineral owner within the areas surveyed to perform a three-dimensional geologic survey is not necessary in Texas, so long as the surveyors do not cross the non-participating land-owner's property. (Villarreal, et al. v. Grant Geophysical, et al. )

NEW YORK DEPARTMENT OF ENVIRONMENTAL CONSERVATION CAN NOT INCREASE THE "RISK PENALTY" PAID BY NON-CONSENTING OWNER UNDER A COMPULSORY INTEGRATION ORDER

Case Summary: In recent years, large pools of natural gas have been discovered in the Finger Lakes region of New York, especially in a rock formation commonly referred to as the "Trenton-Black River" formation that exists 3,000 to 12,000 feet below ground surface. The discovery of these pools has resulted in numerous applications to the New York Department of Environmental Conservation (DEC) for integration orders. Western Land Service, the lessee of mineral rights in the region, wished to drill but needed a clarification of a directive of the DEC. This Directive, ECL section 23-0901, covered the drilling company's ability to recoup costs from non-consenting owners once drilling operations commenced. Western sued the DEC for a Declaratory Ruling on the application of the "risk-penalty" provisions of the statute. The New York Court reversed the DEC with regard to its interpretation of the risk-penalty provisions. Applying statutory interpretation tools, the Court held that a non-consenting party to an integration order was required to pay its proportionate share of spacing, unit drilling, equipping and operating expenses, plus a reasonable charge for supervision, plus a 100% penalty, minus a royalty not to exceed one-eight of the production. The Court ruled, however, that the DEC has no authority to make the non-consenting land owner pay additional "just and reasonable" penalties, as provided in the Directive. The Court also held that the DEC does not have statutory authority to compel a well owner to order a non-consenting owner to share production expenses to avoid the 100% penalty, or to order a well owner to transport the natural gas attributable to a non-consenting owner.

LESSON: An operator is well advised to seek a Declaratory Judgment regarding its rights under statutes and regulations detailing the implementation of integration orders by State oil and gas regulatory agencies.(Western Land Services, Inc. v. Department of Environmental Conservation, et al. )

DRILLING COMPANY NOT LIABLE FOR DAMAGES FROM OIL WELL BLOWOUT BECAUSE OPERATOR STOPPED IT FROM IMMEDIATELY SHUTTING WELL WHEN "KICK" DETECTED

Case Summary: Rebel Oil Company held a 33 1/3% non-operating interest in a well in the Smackover formation in Wayne County, Mississippi. Rand Paulson Oil Company, the 66 2/3% operating interest partner, hired Nabors Drilling USA, Inc. to drill a well pursuant to a "day-work" contract. The Smackover formation is known to have high pressure concentrations of toxic, hydrogen sulfide gas. While approaching target depth, Nabor's man recognized several indications of a "kick," which he confirmed when he shut down the mud pumps and the well still flowed. At that point the well should have been immediately shut down to avoid a blow-out, but Rand's man, Mr. Little, insisted that the pumps be turned back on. About 30 minutes later, Little realized his mistake and shut in the well using the annular blowout preventers (BOPs). The annular BOPs failed, however, and the well began leaking gas. The hydrogen choke was then found to be inoperable, and other steps taken by the crew were unsuccessful. The upper rams failed hours later causing a violent eruption of wellbore product. Moments later attempts to secure the lower rams failed because the hand wheel used to lock the rams was missing, and the locking rims were corroded and could not be turned. Fearing for the safety of the crew and area residents, Rand ignited the gas plume. After emergency measures, the well was eventually capped. Rebel then sued Nabors to recover the costs to control the well, re-drill the well, restore the surrounding area, contain pollution, and for lost production. Rebel contended that Nabors failed to immediately shut in the well when the kick was detected, and failed to properly test the BOPs before the blowout. The jury ruled for Nabors and Rebel appealed. The Texas Court of Appeals in affirming the jury's decision observed that under a "day-work" contract, the operator (Rand) was in charge of the drilling and had final authority to make all decisions, and Nabors could not countermand Mr. Little's order to resume pumping. The Appeals Court also held that the jury could reasonably have found that Rand, not Nabors, was responsible for testing the BOPs.

LESSON: An operator contracting out a drilling operation under a day work contract should assure that it assigns an experienced wildcatter to supervise the drilling. This case demonstrates that the operator is primarily responsible for the operation, and liable for damages in the event of a blowout. (Rebel Drilling Company, L.P. v. Nabors Drilling USA, Inc. )

Please address any comments or questions to Mr. Bode at 202-862-4300 or wbode@bode.com.

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