Removing a Financially Troubled Operator Under a JOA

Earlier this year, the El Paso Court of Appeals—whose jurisdiction includes the counties covering much of the Delaware and Permian Basins—issued Flamingo Permian Oil & Gas, L.L.C. v. Star Exploration, L.L.C., 569 S.W.3d 329, 332 (Tex. App.—El Paso 2019, no pet.), a decision that may give non-operators a useful tool to remove financially shaky operators under a joint operating agreement (“JOA”).

Companies often like to serve as operators under a JOA when given the opportunity. Being the operator provides day-to-day control of the leases subject to the JOA, keeps the operator’s employees gainfully employed, usually provides some contractual protection through the JOA’s exculpatory clause, and allows the operator to take the lead in setting the pace and scope of development. Not surprisingly, when non-operators want to remove an operator under a JOA, the operator often refuses to leave without a fight and litigation results. In just the last few years, I’ve been involved in multiple cases with this fact pattern.

While non-operators will usually file a lawsuit seeking a declaratory judgment on operatorship, they are usually not content to wait months or years for the lawsuit to wind its way through the court system. They want to get the operator out as soon as possible, and the best way to do that is through a temporary injunction.

But non-operators quickly find that they’ll have to overcome a major obstacle: They’ll have to show “a probable, imminent, and irreparable injury” based on the operator remaining as the operator through trial. Butnaru v. Ford Motor Co., 84 S.W.3d 198, 204 (Tex. 2002).

The Flamingo Permian case provides non-operators a new potential argument to prevail on this challenge. In that case, the non-operator (Star Exploration) was also the majority interest owner in the JOA and had the ability to vote the operator (Flamingo Permian) out as operator if it violated the JOA. Star Exploration did just that, based on Flamingo Permian allowing contractors to place liens on JOA property. Litigation ensued, and Star Exploration secured a temporary injunction requiring Flamingo Permian to help turn over and not fight the change in operatorship.

Flamingo Permian filed an appeal and argued that “Star Exploration did not show it would suffer a probable, imminent, and irreparable injury.” Flamingo Permian, 569 S.W.3d at 332. Star Exploration claimed that “damages [were] an inadequate remedy in the event the property is lost because the value of the minerals present on the leasehold asset and the projected recovery in years to come is speculative.” Id. The court was, however, hesitant to affirm the injunction on that basis. Instead, the court affirmed on the basis that Flamingo Permian would be unable to pay damages if Star Exploration prevailed at trial:

Still, even if damages could be quantified, we believe that Star Exploration has shown a likelihood that [Flamingo Permian] is unable to pay damages, which would justify the grant of injunctive relief. Star Exploration presented evidence at the hearing that Flamingo repeatedly failed to pay debts, allowed liens to accrue against the property in violation of the JOA, and did not participate in legal proceedings such that several default judgments had been taken against Flamingo. Flamingo did not offer any evidence to the contrary, nor did Flamingo challenge the trial court’s fact-findings related to these issues. This evidence supports the rational inference that Flamingo cannot pay damages.

Id. (citation omitted).

Flamingo Permian is hardly the only oil and gas company that has been unable to pay its debts in recent years. And cash-strapped operators may fight hard to stay in the position as operator under a JOA in order to preserve this valuable position, or even to avoid defaulting on credit agreements tied to operatorship. Flamingo Permian provides non-operators extra support when trying to remove these financially troubled yet stubborn operators.

Even if an operator is financially solvent, though, it does not give the operator carte blanche to violate a JOA without risk of immediate removal as operator. At least two Texas appellate courts have held that an operator’s refusal to relinquish operatorship alone is a basis for finding irreparable injury. See R & R Resources Corp. v. Echelon Oil & Gas, L.L.C., 03-05-00479-CV, 2006 WL 66458, at *7 (Tex. App.—Austin Jan. 10, 2006, no pet.) (“Ongoing and continuing harm resulting from an operator’s refusal to relinquish operations is one basis for finding irreparable injury in support of a temporary injunction.”); DSJT, L.L.P. v. M & M Res., Inc., 09-06-073 CV, 2006 WL 1360509, at *2 (Tex. App.—Beaumont May 18, 2006, no pet.) (same). And the El Paso Court of Appeals in Tri-Star Petroleum Co. v. Tipperary Corp., 101 S.W.3d 583, 591 (Tex. App.—El Paso 2003, pet. denied) affirmed a trial court’s temporary injunction removing an operator under a JOA because “there was no adequate remedy for the loss of unexplored acreage in the Project or for the loss of long-term contracts” that could result if the operator were not immediately removed. Temporary injunctions are often difficult to secure in Texas state courts, but these cases provide plenty of ammunition for non-operators seeking to immediately remove an operator under a JOA.".