Background and Parties

SM Energy Company, an oil well operator, entered into a surface use and compensation agreement with Buzzard Roost Farms, Inc. and C&L Solutions, Inc., the surface owners of land in Howard County. The agreement contained a right of first refusal provision requiring SM Energy to offer the surface owners the opportunity to have any saltwater disposal well that SM Energy chose to drill within five miles of the surface lands placed on the surface owners' property or other adjacent lands they owned. When SM Energy subsequently drilled saltwater disposal wells within the five-mile radius without first offering placement to the surface owners, the surface owners brought suit for breach of contract. Following a jury trial in the 118th District Court of Howard County, the court entered judgment on the jury verdict awarding damages to the surface owners and awarded attorney's fees. SM Energy appealed.

The Contractual Dispute

The central issue turned on the scope and enforceability of the right of first refusal provision in the surface use agreement. SM Energy argued on appeal that the agreement was ambiguous and that its obligation extended only to offering well placement, not to offering the land purchase that it had negotiated with third parties for the disposal well sites. The surface owners contended that SM Energy's failure to provide any offer before drilling the wells constituted a clear breach, entitling them to benefit-of-the-bargain damages including revenue from skim oil that would have been recovered from the produced saltwater.

The Court's Analysis

The Eastland Court of Appeals addressed multiple issues on appeal. First, the court held that the agreement unambiguously obligated SM Energy to offer placement of the saltwater disposal wells on the surface owners' property. This was a critical threshold determination that established SM Energy's contractual duty.

Second, and importantly, the court clarified the scope of what SM Energy was required to offer under the right of first refusal provision. The court held that SM Energy's purchase of land from third parties on which it sought to drill the saltwater disposal wells was not part of the offer that had to be extended to the surface owners. In other words, the right of first refusal concerned the placement of wells on the surface owners' property, not an obligation to offer the surface owners the opportunity to purchase the third-party lands that SM Energy had acquired.

On the damages question, the court found that the evidence was sufficient to support the jury's finding that the surface owners were ready, willing, and able to accept placement of the saltwater disposal wells on their property. The court further held that the surface owners were entitled to use SM Energy's own calculations, including its assumptions for revenue from skim oil recovered from produced saltwater, to establish the value of the benefit of the bargain. The court affirmed the jury's award of $1,449,179 in skim oil revenue damages, finding sufficient evidence to support this element of damages.

However, the court reversed one portion of the damages award. The court held that the evidence did not support the "value of the wells" element of damages awarded to the surface owners, and reversed that portion of the judgment.

Implications for Practitioners

This decision provides important guidance on the interpretation and enforcement of right of first refusal provisions in surface use agreements. The court's distinction between the obligation to offer well placement versus the purchase of underlying land clarifies that such provisions must be carefully drafted to specify exactly what opportunity must be extended to the surface owner. The decision also demonstrates that operators' own financial projections and calculations can be used against them in establishing benefit-of-the-bargain damages when they breach contractual obligations. Finally, the partial reversal on the "value of the wells" damages element underscores the importance of presenting sufficient evidence to support each distinct component of a damages claim.