September 15, 2014

Freedom of contract takes a hit in New Mexico

By Deborah J. La Fetra Senior Attorney

The First Baptist Church of Roswell and others own mineral rights in the Runnin’ AZH oil well near Roswell, New Mexico.  Yates Petroleum operates the well pursuant to standard contracts with all of the mineral right owners.  These contracts, called division orders, require owners to provide proof of title of ownership and state that Yates need not pay any interest on payments due to the owners until the owners provide satisfactory proof of ownership.   The contract explicitly states, “In the event of failure to furnish such evidence of marketable title, [Yates] is authorized to withhold payments without payment of interest until the claim is settled.”

However, a state statute says that interest accrues on funds held in suspense during the time title questions prevent disbursement, and once title is resolved, both principal and accrued interest are payable to the owners.  The question before the New Mexico Supreme Court was whether the mineral owners could contract around the default rule established by the statute.  PLF filed an amicus brief arguing that the public policies supporting freedom of contract would allow parties to negotiate around default rules, thereby increasing efficiency by ensuring that parties are not required to purchase costly overprotection, or be deprived of protections that they desire.

Unfortunately, today the court invalidated the contract.  It declared that the statute furthered a “strong public policy…in favor of royalty interest owners.”  The court found that the “disparity in bargaining power” between Yates and the mineral rights owners was severe and that the statute served  to “equalize” that power.  The court distinguished an earlier case that had permitted waiver on payment of interest because that case involved general commercial transactions and this case involved specialized oil and gas contracts.  This is another unfortunate aspect of the decision, because even specialized contracts should be interpreted according to basic contract law principles, which would allow changing default rules.  Moreover, specialized contracts, if they must be considered in their unique context, are well suited to customization by the parties who best understand the context of their contract.  As a result of this decision, parties to contracts in New Mexico have fewer options to write their own preferences into their contracts.  The court decided that the legislature will choose for them.

Thanks to A. Blair Dunn, our local counsel in this case.

What to read next