In SM Energy Company v. Buzzard Roost Farms, Inc. a Surface and Subsurface Use and Compensation Agreement between operator SM and surface owners included a right of first refusal (ROFR) relating to placement of saltwater disposal wells drilled within five miles of the “Surface Lands”. Failing to notice the ROFR, SM evaluated options for saltwater disposal, elected to buy nearby tracts, and drilled two SWD wells within the five miles. The owners demanded that SM comply with the ROFR. SME sued for a declaration that the ROFR was invalid or ambiguous; the owners counterclaimed for breach.
SM argued that the owners didn’t sustain damages because they would have rejected the only offer that SM would have extended.
The jury found for the owners and awarded $9.3 million+/- in damages; the court later awarded attorneys’ fees and prejudgment interest.
On appeal, SM argued that the ROFR required it only to offer the owners the same terms and conditions that SM offered third parties to purchase their land, and that the jury charge and evidence on readiness and damages were legally deficient.
The ROFR
The Court began with the text:
“… should Operator choose to drill a [SWD well] within 5 miles of the Surface Lands, Operator shall give Surface Owner first right of refusal to have said [SWD well] placed on the Surface Lands or other lands adjacent thereto which are owned by Surface Owner,”
Applying the contract’s ordinary meaning, the Court held the provision required SME to offer to drill and place on the Surface Lands or adjacent land they own, any SWD SM chose to drill within five miles. SME conceded it made no such offer and that its purchase‑to‑own “self‑development” strategy was beyond the ROFR’s scope and not a term or condition the owners were required to accept.
The ROFR was triggered by SM’s decision to drill within five miles, which SM breached by failing to offer the owners the right to have the two wells placed on their land. The Court concluded that rights holder could not be compelled to accept terms beyond the scope of the ROFR absent express contract language. The ROFR did not tie the owners to third‑party land‑purchase terms, and the owners were not required to sell their land to exercise their right.
Readiness
The owners testified that they would have accepted an offer to drill and place SWDs on the Surface Lands, which aligned with the ROFR’s scope (SM asserted that the owners would have rejected any compliant offer). The jury found that the owners were “ready, willing, and able” to accept the same terms that SM had offered to drill and place the wells
Damages
Benefit‑of‑the‑bargain damages are to restore the injured party to the economic position it would have occupied had the contract been performed, and a jury’s award within the range of trial evidence should be affirmed. The jury awarded $4.9+ million for the value of the SWD wells, $2.9+ million in disposal fees, and $1.5 million in skim‑oil revenue.
The “value of the wells” award was improper and was vacated. Texas law rejects using cost to drill or construct as the measure of benefit-of-the-bargain for a breached drilling or similar obligation and the owners offered no competent valuation evidence distinct from the revenue streams.
The Court affirmed the disposal‑fee award as within the benefit‑of‑the‑bargain measure supported by SM’s internal economic analysis.
The Court affirmed the skim‑oil award. SM’s own model assumed a skim‑oil value and the owners’ provided testimony and calculations using actual injected volumes.
The trial court deemed the ROFR ambiguous and submitted questions to the jury. the appellate court disagreed but said the jury’s instructions matched the law so the error was harmless.
RIP Sly Dunbar, drummer and half of the one of the funkiest rhythm sections ever.
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