Exculpatory Clause vs Novation Clause

Top Leases, Assignments, Farmout Agreements, and Joint Operating Agreements. 

Something that every petroleum landman and/or oil and gas lease agent should know is what the difference is between an Exculpatory Clause and a Novation Clause and how they can affect the most common agreements used in the oil and gas industry.

If these clauses are not worded carefully, it can have a real adverse effect on the meaning or intent of the agreement.  Note: The following images were taken from “Wallstreet Mojo.”

An exculpatory or disclaimer of warranties clause releases a party from the liability for damage that may occur to the other party due to the former’s future negligence. Such a provision is stated by the party seeking a waiver from paying off the other party’s damage or loss while the execution of a contract.

The court declares an exculpatory clause void if it finds it excessive or unreasonable. It is different from the indemnity clause that secures a party from the waiver of loss incurred by the other party due to the actions of a third party.

How does an Exculpatory Clause compare to an Indemnity Clause?

Exculpatory Clause:

An Exculpatory Clause is a provision of a contract that relieves one party of liability if damages are caused during the execution of the contract (oil and gas lease assignments).  The party that issues the Exculpatory Clause is typically the one seeking to be relieved of the potential liability (for example, the Assignor).  Two common agreements that the petroleum landman needs to be familiar with where the Exculpatory Clause is most often used are the oil and gas lease assignment and the joint operating agreement.

In an oil and gas lease assignment an Exculpatory Clause example would read something like this:

“Assignee assumes all liability of plugging wells, environmental issues, restoration of the land and all other obligations regarding the Oil and Gas Lease including but not limited to implied and express covenants.”

A ‘Novation Clause’ is a provision of a contract that replaces an obligation to perform with another obligation, or adding or subtracting an obligation to perform, or replaces a party to an agreement with a new party. Three common agreements that the petroleum landman needs to be familiar with where the Novation Clause is most often used are the oil and gas lease assignment, farmout agreement, and top leases. In an oil and gas lease assignment, for example, a Novation Clause example would read something like this:

“Assignee shall perform all tasks of Assignor which are covered in or associated with the Oil and Gas Lease, including all compliance obligations with all state and federal regulatory bodies and any such compliance attributable to the Assignor which may not be complete as of the date of this Assignment.”

In joint operating agreement (Article V.A. of the 1977 and 1982 A.A.P.L. Form 610) an Exculpatory Clause example would read something like this:

“The Operator shall conduct all such operations in a good and workmanlike manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except such as may result from gross negligence or willful misconduct.” The 1956 Form substituted the words “or from breach of the provisions of this agreement” in place of “or willful misconduct.”

In joint operating agreement (Article V.A. of the 1989 Form 610) a Novation Clause example would read something like this:

“Operator shall conduct its activities under this agreement as a reasonable prudent Operator, in a good and workmanlike manner, with due diligence and dispatch, in accordance with good oilfield practice, and in compliance with applicable law and regulation, but in no event shall it have any liability as Operator to the other parties for losses sustained or liabilities incurred except such as may result from gross negligence or willful misconduct.”

Older joint operating agreements (1956, 1977 and 1982) use the words “all such operations” which refer to the operations conducted on the Contract Area described in the JOA.  Newer versions, have language that expand the protection for operators by its extension of the Exculpatory Clause to protect the operator with respect to “its activities under this agreement.”

Some interesting cases involving the joint operating agreement, the operator’s judiciary responsibilities to the non-operators, and the “Exculpatory Clause” are as follows:

See: Spring 2003 issue of the Southern Methodist University Law Review.

In Stine v. Marathon Oil Co., 976 F.2d 254 (5th Cir. 1992).

Abraxas Petroleum Corp. v. Hornburg, 20 S.W.3d 741 (Tex. App. 2000).

Cone v. Fagadau Energy Corp., 68 S.W.3d 147 (Tex. App. 2001).

Castle Texas Production Ltd. Partnership v. The Long Trusts, 2003 Tex. App. LEXIS 6640 (Tex. App. 2003) (approved for publication).

IP Petroleum Inc. v. Wevanco Energy, L.L.C., 116 S.W.3d 888 (Tex. App. 2003).

Palace Exploration Co. v. Petroleum Development Co.[PDC], 316 F.3d 1110 (10th Cir. 2003.

Shell Rocky Mountain Production, L.L.C. v. Ultra Resources, Inc., 226 F.Supp.2d 1331 (D. Wyo. 2003).

Novation Clause: 

Whereas assignments only transfer a party’s rights under a contract, novation transfers both a party’s rights and its obligations. A properly drafted Novation Clause in an agreement, such as a farmout agreement, generally makes it clearer as to whether the outgoing party (farmor) remains responsible for liabilities accrued prior to the transfer, or whether these become the incoming party’s (farmee) problem.

TOP LEASES: Avoiding the risks of Novation. The following was taken in part from the Oil and Gas Report, Holland, and Hart.

You took an oil and gas lease five years ago which had a 1/8^th royalty. You’re coming up on the expiration date in just five months. You have applied for a drilling permit that you expect to obtain prior to the expiration date, which will allow you sufficient time to commence operations to hold the lease.  But to play it safe, you hired a petroleum landman to obtain a top lease on the minerals, which he did, but the top lease was a 3/16ths lease.  The landman failed to expressly state that it is a top lease to the existing lease and doesn’t contain any other language clarifying that the top lease will only be effective if and when the underlying existing lease expires. After acquiring the top lease, you received your drilling permit, and you were able to commence operations in time to hold the original lease.

Without the above-mentioned top lease language in the top lease and even though the well was drilled and completed under the terms of the original oil and gas lease, there is a risk that the mineral could successfully argue that the new top lease is a replacement of the existing lease, and you may be required to pay a 3/16ths royalty instead of a 1/6th royalty. The question in this example is, whether the top lease will be deemed a “novation” of the prior existing lease.

How can an operator protect itself from novation claims?  To make the intent of the top lease clear, the best approach is to always put the above-mentioned top lease language in any top lease. Or, if the well is successfully completed in time to hold the existing lease, a good approach would be to have the mineral owner and operator sign and record a ratification document where the parties acknowledge that the base lease was held by the drilling of the well, and that the top lease will remain of record as a top lease only in the event the well ceases operations.

Another approach would be to send an informative letter to a landowner prior to drilling, informing them of the pending well, stating that the operator will deem the base lease as held by the drilling of the well. That would at least set up an estoppel argument, and the operator will know prior to drilling the well whether the landowner objects and claims a novation.

Some interesting cases involving the “Novation Clause” are as follows:

• Mason v. Range Resources-Appalachia LLC, 120 F. Supp. 3d 425, 433 (W.D. Pa. 2015).
• Warrior Drilling & Eng’g Co. v. King, 446 So. 2d 31, 33-34 (Ala. 1984).
• In re United Display & Box, Inc., 198 B.R. 829, 831 (Bankr. M.D. Fla. 1996).
• Fusco v. City of Union City, 618 A.2d 914 (App. Div. 1993).
• Alexander v. Angel, 236 P.2d 561 (1951); Scott v. Bank of Coushatta, 512 So. 2d 356 (La. 1987).
• Credit Bureaus Adjustment Dep’t, Inc. v. Cox Bros., 295 P.2d 1107 (1956).
  First Am. Commerce v. Washington Mut., 743 P.2d 1193 (Utah 1987).
• Tri-State Oil Tool Indus., Inc. v. EMC Energies, Inc., 561 P.2d 714, 716 (Wyo. 1977).

A cautionary tale is to be aware of the seller’s assignment or purchase and sale agreement where they try to incorporate extensive Exculpatory Clauses which are carefully worded in such a way that the buyer would inherit serious problems from the previous operators.