Chisos LTD. v. JKM Energy, L.L.C.

I attest to the accuracy and
integrity of this document
New Mexico Compilation
Commission, Santa Fe, NM
'00'04- 13:13:17 2011.04.27
IN THE COURT OF APPEALS OF THE STATE OF NEW MEXICO

Opinion Number: 2011-NMCA-026

Filing Date: January 13, 2011

Docket No. 29,265

CHISOS, LTD.,

Plaintiff-Appellant,

v.

JKM ENERGY, L.L.C.,

Defendant-Appellee.

APPEAL FROM THE DISTRICT COURT OF EDDY COUNTY
Ralph D. Shamas, District Judge

Sonnenschein Nath & Rosenthal LLP
Barry F. Cannaday
Dallas, TX

Marek & Francis, P.A.
Jay L. Francis
Carlsbad, NM

for Appellant

Hinkle, Hensley, Shanor & Martin, L.L.P.
Richard E. Olson
Jared A. Hembree
Roswell, NM

for Appellee

OPINION

BUSTAMANTE, Judge.

{1} This case involves a dispute over the ownership of certain interests in two oil
wells—the Stetson well and the HL2 well—both of which are located in the W/2 of Section

1
2, Township 19 South, Range 29 East, N.M.P.M., Eddy County, New Mexico (the W/2 of
Section 2). The case presents two issues: (1) Did the “Conveyance and Bill of Sale”
Appellant Chisos, Ltd. (Chisos), and Appellee JKM Energy, L.L.C. (JKM) entered into
convey all of Chisos’ operating rights in the W/2 of Section 2, or did it convey rights only
in the Stetson well? (2) Is the district court’s finding that Chisos failed—in bad faith—to
give JKM proper notice of its intent to “recomplete the HL2 Well” supported by substantial
evidence?

{2} After a bench trial on the merits, the district court found the conveyance to be
ambiguous and interpreted it as a conveyance of all of Chisos’ rights in the W/2 of Section
2. The district court also ordered Chisos to provide JKM with an accounting of the costs and
revenues of the HL2 well and an opportunity to retroactively elect to participate. We affirm.

I. BACKGROUND

{3} On August 17, 2005, Jack Matthews, president of JKM, made an offer to Sue Ann
Craddock, president of Chisos, to purchase “the Stetson #1 in Eddy County, New Mexico”
for $43,000. The offer indicated that JKM desired to obtain “100% of the [working interest]
and all of the [net revenue interest].” Chisos countered that it would be willing to “sell
[JKM a] 100% Working Interest and a 75% Net Revenue Interest for $55,000.”

{4} JKM prepared a conveyance for the deal. The conveyance was for the entire W/2 of
Section 2, not simply for the Stetson well. Both the Stetson well and the HL2 well were
located in the W/2 of Section 2. The HL2 well was one of dozens of wells that could be seen
from the Stetson well. Although Matthews had worked on the HL2 well before, he was not
aware at the time he made the offer that it was in the W/2 of Section 2.

{5} Craddock was not satisfied with the conveyance. She testified that she called
Matthews and clearly explained that Chisos was willing to make a wellbore conveyance
only. Matthews testified that a call took place, but that Craddock was worried mainly about
a royalty override. The district court found Matthews to be more credible. Craddock
prepared a new conveyance, which she signed and forwarded to Matthews. Craddock
testified that her intent in preparing this new conveyance was to convey only the wellbore.
Starting with the original conveyance, Craddock added sections from other documents in her
possession and removed or changed language she felt was inappropriate. Matthews signed
the “Conveyance and Bill of Sale” forwarded by Craddock and recorded it on September 30,
2005. A copy of the document is attached as Appendix 1.

{6} The HL2 and Stetson wells were subject to a joint operating agreement (JOA). At
the time the JOA was executed, Pure Energy Group, Inc. (Pure) had a 50% interest in both
wells, and Bellwether Exploration Company (Bellwether) also had a 50% interest in both
wells. Chisos acquired Bellwether’s interest when it purchased the W/2 of Section 2.
Among other things, the JOA contained a procedure for parties to elect whether to participate
in the drilling and reworking of the wells. If a party elected to participate, it would share the
costs of the work. If it elected not to participate, the participating parties would receive its

2
share of the profits from the well until those profits amounted to six times the non-
consenting party’s share of the participation costs.

{7} About two months after the conveyance was recorded, Chisos received notice from
the State of New Mexico that the HL2 well had shown no production for the previous twelve
months. Chisos understood this notification to mean that it was required to either plug the
HL2 well or return it to production. In August 2006 Chisos obtained a non-consent election
from Pure in anticipation of bringing the HL2 well back online. Chisos then sent a crew to
the HL2 well to fracture the well. On October 19, 2006, Matthews saw the crew and
informed them that Chisos was trespassing on his well. Chisos immediately stopped work
on the HL2 well.

{8} Chisos filed its lawsuit against JKM on November 2, 2006. Several months later,
Chisos decided to proceed with the work, apparently assuming that JKM had no interest in
the HL2 well. On March 13, 2007, in lieu of obtaining another letter of non-consent, Chisos
acquired a limited term assignment of Pure’s rights in the HL2 well. Chisos also arranged
for a workover rig to be at the HL2 well by May 8, 2007. Once again, Matthews only learned
of the work on the HL2 well when he happened to be on site and noticed it. JKM
communicated to Chisos that, pursuant to this litigation, JKM asserted rights in the well.
Chisos responded by sending JKM an election letter. The letter, which purported to give
JKM forty-eight hours to make its decision, was faxed late on a Friday afternoon and
required JKM to commit almost $170,000 or elect not to participate. The forty-eight-hour
deadline was based on a provision of the JOA that allowed for a reduced deadline if a
drilling rig was on the premises. The letter claimed that this provision applied because a
“drilling/workover” rig was on the premises. Craddock testified that the rig was a workover
rig, and that drilling rigs and workover rigs were not the same.

II. DISCUSSION

{9} On appeal, Chisos raises questions about the interpretation of the conveyance and
about the obligations of the parties under the joint operating agreement. We address the
issues in the order they were raised.

A. Ambiguity of the Conveyance

{10} Chisos contends that the district court’s conclusion that the “Conveyance and Bill of
Sale” was ambiguous was in error. Ambiguity exists if the contract is “reasonably and fairly
susceptible of different constructions.” Mark V, Inc. v. Mellekas, 114 N.M. 778, 781, 845
P.2d 1232, 1235 (1993). A court may hear evidence of the circumstances surrounding the
making of the contract in order to determine if it is unclear. C.R. Anthony Co. v. Loretto
Mall Partners, 112 N.M. 504, 508-09, 817 P.2d 238, 242-43 (1991). In fact, “[w]ithout a
full examination of the circumstances surrounding the making of the agreement, ambiguity
or lack thereof often cannot properly be discerned.” Mark V, 114 N.M. at 781, 845 P.2d at
1235. The existence of ambiguity is an issue of law that we review de novo. Id. at 782, 845
P.2d at 1236.

3
{11} The circumstances surrounding the making of the contract were discussed at length
at trial. The original conveyance prepared by JKM was for the entire W/2 of Section 2.
Craddock testified that Chisos desired to convey only the Stetson well. To accomplish this,
Craddock asserted she modified the original conveyance, incorporating fragments from other
assignments she had used previously. The district court concluded that under these
circumstances, Chisos was aware of JKM’s intent, but JKM was not aware of Chisos’ intent.

{12} Craddock’s modifications created significant ambiguities. As Craddock observed,
her modified conveyance contained language referring to a lease and to the conveyance of
operating rights that she should have removed. Chisos’ own expert testified that “there were
some questions in [his] mind as to exactly what the parties intended with some of the
language that they used.” Chisos’ expert also frequently referenced the document’s
ambiguity. On cross-examination, Chisos’ attorney led JKM’s landman expert Carl
Shellinger to admit that the conveyance was “very ambiguous” and that “reasonable people
could interpret it either way.” Chisos’ cross-examination of JKM’s legal expert, Phil
Brewer, also resulted in admissions that the conveyance was confusing and ambiguous.
Brewer also testified at length as to the impediments to clear title that the conveyance
language caused.

{13} Chisos asserts that this issue “was preserved in the court below through [r]equested
[f]indings of [f]act and [c]onclusions of [l]aw.” We harbor some concern about this
assertion. Chisos began its opening argument by noting that “[b]oth sides agree that there
is [sic] some potential ambiguities in the conveyance.” Chisos made JKM’s experts admit
the conveyance was ambiguous. And Chisos requested a conclusion of law that the
conveyance was “ambiguous on its face.” In fact, the only time at trial that Chisos suggested
the document was not ambiguous was during its closing statement. Perhaps these persistent
attempts to obtain a result opposite to the one Chisos now advocates could be said to have
“fairly invoked a ruling . . . on the same grounds argued in the appellate court.” Woolwine
v. Furr’s, Inc., 106 N.M. 492, 496, 745 P.2d 717, 721 (Ct. App. 1987). However, even if
this were true, “[a] party who has contributed . . . to perceived shortcomings in a [district]
court’s ruling should hardly be heard to complain about those shortcomings on appeal.”
Cordova v. Taos Ski Valley, Inc., 121 N.M. 258, 263, 910 P.2d 334, 339 (Ct. App. 1995).

{14} In any event, it is clear that the conveyance is ambiguous. Ultimately, nobody who
testified was willing to state that the conveyance was unambiguous. Chisos’ expert thought
it was closer to a wellbore assignment. JKM’s experts thought it was closer to an assignment
of lease or operating rights. We agree with the district court that neither interpretation is
necessarily wrong. Since the conveyance is reasonably susceptible to different
constructions, we conclude that it is ambiguous.

B. Interpretation of the Conveyance

{15} Chisos next contends that the district court erred in determining that the ambiguous
language was not a wellbore assignment. We have said that “[o]nce [an] agreement is found
to be ambiguous, the meaning to be assigned the unclear terms is a question of fact.” Mark
V, 114 N.M. at 781, 845 P.2d at 1235. Factual issues include evidence which is “in dispute,

4
turns on witness credibility, or is susceptible of conflicting inferences.” C. R. Anthony, 112
N.M. at 510, 817 P.2d at 244. “We review factual questions for substantial evidence.
Substantial evidence is relevant evidence that a reasonable mind would find adequate to
support a conclusion.” Sitterly v. Matthews, 2000-NMCA-037, ¶ 22, 129 N.M. 134, 2 P.3d
871 (citation omitted).

{16} When the parties attach different meanings to the same terms, we apply the test from
the Restatement (Second) of Contracts § 201 (1981) (Restatement) to determine their
meaning. Farmington Police Officers Ass’n v. City of Farmington, 2006-NMCA-077, ¶ 17,
139 N.M. 750, 137 P.3d 1204. The Restatement provides that

(2) Where the parties have attached different meanings to a promise or
agreement or a term thereof, it is interpreted in accordance with the meaning
attached by one of them if at the time the agreement was made

(a) that party did not know of any different meaning attached by
the other, and the other knew the meaning attached by the first party;
or

(b) that party had no reason to know of any different meaning
attached by the other, and the other had reason to know the meaning
attached by the first party.

Restatement § 201(2). This inquiry is a question of law based on findings of fact. “We
review legal questions de novo.” Consol. Elec. Distribs., Inc. v. Santa Fe Hotel Group, LLC,
2006-NMCA-005, ¶ 7, 138 N.M. 781, 126 P.3d 1145.

{17} Applying Restatement Section 201, the district court concluded that the conveyance
should be interpreted in favor of JKM. The district court provided findings of fact to support
its conclusion. First, it found that “Chisos knew or had reason to know that JKM intended
for the Conveyance and Bill of Sale . . . to be a conveyance of all of Chisos’ operating rights
in the W/2 of Section 2.” Second, it found that “JKM did not know or have reason to know
that Chisos intended the Conveyance and Bill of Sale . . . to be a producing wellbore
assignment only.” These findings would support a decision in favor of JKM under either
Section 201(2)(a) or Section 201(2)(b) of the Restatement.

{18} The district court did not err if these findings of fact are supported by substantial
evidence. We first examine the district court’s finding that Chisos knew or had reason to
know that JKM intended the conveyance to encompass all of Chisos’ operating rights
covering in the W/2 of Section 2. Both parties agree that the original conveyance sent by
JKM to Chisos was a conveyance of operating rights covering all of W/2 of Section 2. The
only evidence suggesting that JKM’s intentions might have changed was Craddock’s
testimony regarding her phone conversation with Matthews prior to changing the
conveyance. However, the district court did not credit this testimony. We cannot second-
guess the district court’s decision in this regard. We conclude that this evidence is adequate
to support at least the conclusion that Chisos should have known of the meaning attached
by JKM.

5
{19} We next examine the district court’s finding that JKM was unaware of Chisos’ intent.
The district court found that Craddock had never informed Matthews of Chisos’ intent to
convey only the wellbore. Although Craddock and Matthews presented conflicting
testimony on this point, the district court found Matthews to be more credible. As this
finding relates to witness credibility, we defer to the fact finder. See State v. Quintana,
2009-NMCA-115, ¶ 22, 147 N.M. 169, 218 P.3d 87. Furthermore, Matthews was not aware
that any other wells were on the W/2 of Section 2. The experts also noted that wellbore
conveyances were uncommon. Accordingly, Matthews had no reason to think that Craddock
was proposing a wellbore conveyance. To the extent that Chisos argues that the use of well
names in various communications put JKM on notice of Chisos’ intent, we note that JKM’s
experts testified that it was common for parties to refer to properties by well name. Chisos’
expert said this was not common, but conceded that Matthews might have used the term that
way. Under these conditions, we conclude that the district court’s finding that Craddock’s
changes to the conveyance “would not have reasonably prompted . . . Matthews to think that
the transaction involved only a wellbore interest” is supported by substantial evidence.

{20} Because we conclude that a reasonable mind would find the above evidence adequate
to support the district court’s findings of fact, the findings are supported by substantial
evidence. Applying Section 201 of the Restatement, we hold that the district court did not
err in assigning to the conveyance the meaning intended by JKM. Further, given that
significant evidence addressing the meaning of the conveyance was presented at trial, we
need not address Chisos’ argument about canons of construction. See Mark V, 114 N.M. at
782, 845 P.2d at 1236 (observing that canons of construction may be used to interpret
contracts as a matter of law when no evidence is presented to decide the issues as a matter
of fact). Accordingly, we affirm the district court’s interpretation of the “Conveyance and
Bill of Sale.”

C. Breach of the Operating Agreement

{21} Chisos appeals the district court’s conclusion that it violated its obligations under
Section VI.A of the JOA and under the Oil Conservation Division (OCD) regulation
19.15.3.104. “Breach of contract is a question of fact that we review under a substantial
evidence standard.” Collado v. City of Albuquerque, 2002-NMCA-048, ¶ 15, 132 N.M. 133,
45 P.3d 73.

{22} The district court found that the conveyance made JKM a party to the JOA. As such,
JKM was “entitled to the protections and rights provided therein.” By virtue of its limited
term acquisition of Pure’s interest in the HL2 well, Chisos was also a party to the JOA.
Under Section VI.A.1 of the JOA, Chisos was required to give JKM notice of its intent to
recomplete the HL2 well and allow JKM thirty days to elect whether or not to participate in
the operations. However, the district court determined that Chisos did not provide the
required notice, but instead “made a disingenuous and bad faith attempt to force JKM to opt
out of the operations in regard to HL2, and contrary to the JOA, gave JKM only [forty-eight]
hours to commit to the expenditure of $170,000.” JKM did not respond to the notice.
Chisos went ahead with the operations and, between August 2007 and May 2008, the HL2
well produced $367,539 of product. The district court ordered Chisos to prepare an

6
accounting of all costs and proceeds of the HL2 well and to give JKM at least thirty days to
elect either to pay its 50% share of the costs or to elect not to participate under the JOA.

{23} Chisos argues that the district court’s finding that it had violated Section VI.A.2 of
the JOA was in error because of language in that section that states:

Notwithstanding the provisions of this Section VI.A.2., it is agreed that
without the mutual consent of the parties, no wells shall be completed in or
produced from a source of supply from which a well located elsewhere on the
Contract Area is producing, unless the well conforms to the then-existing
well spacing pattern for such source of supply.

Chisos maintains that returning the HL2 well to production conformed with the then-existing
spacing pattern. However, Section VI.A.2 only applies if “either party receiving a notice
elects not to participate in the proposed operation.”

{24} Election can only happen after notice. The district court’s findings were directed to
the inadequacy of Chisos’ notice to JKM. Notice is governed by Section VI.A.1, which
requires a party desiring to rework a well to provide thirty-days written notice of proposed
operations. As discussed below in the discussion of bad faith, there is substantial evidence
that Chisos could have provided such notice but did not. Because the district court’s finding
of breach related to the notice provisions found in Section VI.A.1, this same evidence is
substantial evidence of breach.

{25} Chisos also argues that the district court erred in finding that Chisos violated
19.15.3.104(C)(2) NMAC (10/21/2001) (replaced by 19.15.15.10 NMAC (12/01/2008)),
which regulates well spacing in Eddy County. Chisos contends that this is important because
of language in the JOA stating that

[n]otwithstanding the provisions of this Section VI.A.2, it is agreed that
without the mutual consent of the parties, no wells shall be completed in or
produced from a source of supply from which a well located elsewhere on the
Contract Area is producing, unless the well conforms to the then existing
well spacing pattern for such source of supply.

But this language appears in Section VI.A.2 of the JOA, which describes the procedures for
non-consent operations. Because the breach issue depends on Section VI.A.1, not Section
VI.A.2, this finding does not affect the outcome in any way. Accordingly, we decline to
disturb this finding. See In re Estate of Heeter, 113 N.M. 691, 695, 831 P.2d 990, 994 (Ct.
App. 1992) (“On appeal, error will not be corrected if it will not change the result.”).

D. Bad Faith and Retroactive Election

{26} In its final argument, Chisos contends that the district court erred in finding that it
acted in bad faith and that, as a consequence, the district court erred in ordering Chisos to
provide JKM a retroactive opportunity to participate in the HL2 well. The district court
found that Chisos’ letter giving JKM forty-eight hours to consent to work on the HL2 well

7
and to contribute $170,000 related to that work was sent in bad faith. Chisos argues that this
finding was “inexplicable.” In the contracts context, bad faith exists when the “breaching
party is consciously aware of, and proceeds with deliberate disregard for, the potential of
harm to the other party.” Paiz v. State Farm Fire & Cas. Co., 118 N.M. 203, 213, 880 P.2d
300, 310 (1994). The issue of bad faith is a factual question that we review for substantial
evidence. McKay v. Farmers & Stockmens Bank of Clayton, 92 N.M. 181, 183, 585 P.2d
325, 327 (Ct. App. 1978). Certainly, a finding of bad faith that was “inexplicable” would
not be supported by substantial evidence.

{27} Nevertheless, the record does provide an explanation. Even before it learned of the
dispute, Chisos intended to work on the HL2 well. It stopped work for several months when
it learned of the possibility that it might have no ownership interest in the well. However,
in March 2007 it proceeded, disregarding this possibility. It procured the limited term
assignment from Pure in order to continue with the rework. For two months, it did not give
JKM the thirty-day notice required by the JOA. However, during that time it did arrange for
a workover rig to be sent to the well. Once the rig was in place, it attempted to pass the
workover rig off as a “drilling/workover” rig that would trigger the forty-eight-hour notice
provision in the JOA applicable to drilling rigs. Chisos knew that the rig was not a drilling
rig. Chisos also knew that JKM asserted ownership of the HL2 well. And, despite the fact
that the rig was on site earlier in the week, Chisos sent the letter late on a Friday. These facts
are substantial evidence supporting a finding of bad faith.

{28} By upholding the bad faith finding, we dispose of Chisos’ argument that the order
for a retroactive election was improper. Upholding the bad faith finding also disposes of
Chisos’ argument that JKM was not entitled to an equitable remedy. See Romero v. Bank
of the Sw., 2003-NMCA-124, ¶¶ 37-38, 135 N.M. 1, 83 P.3d 288. Chisos also cites to no
authority in support of this argument, which appears only in the heading and in the last
sentence of the section. We need not and do not address arguments that are not supported
by authority. See ITT Educ. Servs., Inc. v. Taxation & Revenue Dep’t, 1998-NMCA-078,
¶ 10, 125 N.M. 244, 959 P.2d 969.

III. CONCLUSION

{29} For the foregoing reasons, we affirm the district court’s decision.

{30} IT IS SO ORDERED.

______________________________________
MICHAEL D. BUSTAMANTE, Judge

WE CONCUR:

______________________________________
RODERICK T. KENNEDY, Judge

______________________________________

8
MICHAEL E. VIGIL, Judge

Topic Index for Chisos, Ltd. v. JKM Energy, LLC, Docket No. 29,265

CN CONTRACTS
CN-AM Ambiguous Contracts
CN-GF Covenant of Good Faith and Fair Dealing
CN-IN Interpretation

NR NATURAL RESOURCES
NR-OG Oil and Gas

PR PROPERTY
PR-CY Conveyances
PR-PH Purchase Agreement

9
10
11
12
13
14