Parties often negotiate farmout agreements through an exchange of letters. Disputes may arise over whether the parties have formed a binding contract, or whether they have merely engaged in preliminary negotiations.73 Smith v. Sabine Royalty Corp.74 illustrates the problem. In Sabine Royalty Corp. Sabine, a fractional mineral interest owner, wrote Smith, another mineral interest owner who had expressed an interest in acquiring the right to drill, proposing terms under which it “would be willing” to lease to Sabine’s subsidiary, which in turn would farm out to Smith.75 The letter concluded: “If you wish to pursue this arrangement, please let us know and the appropriate instruments will be forwarded for your review.”76 Without replying, Smith drilled on the premises and claimed the right to a farmout of Sabine’s interest. A Texas court of civil appeals rejected the claim on the ground that the parties had never agreed to be bound.77
70. The farmout agreement should entitle the farmee to all of the farmor’s title informa- tion. Often, the farmout agreement specifically provides for this right. See infra note 161 for an example of language that provides for title information to be delivered to the farmee. As a practical matter, however, title information may be made available to the farmee before the parties form the agreement so that the farmee can evaluate the feasibility of drilling within the time proposed.
71. In Oklahoma, for example, extensive title work prior to obtaining orders from the Corporation Commission spacing property for drilling is required. See Harry R. Carlile Trust v. Cotton Petroleum Corp., 732 P.2d 438 (Okla. 1986), cert. denied, 55 U.S.L.W. 3871 (U.S. June 30, 1987). In Carlile the Oklahoma Supreme Court held that publication notice to those whose interests are affected by spacing is constitutionally insufficient if the applicant could ascertain their identity with due diligence, because establishment of spacing units is an adjudicative function of the Corporation Commission. Id. at 444. Locating those owners and giving them notice is time-consuming as well as expensive.
72. In Texas, for example, the Railroad Commission may require special proceedings if the farmout well is to be drilled on an exception tract under rule 37, or if sour gas may be anticipated under rule 36.
73. See generally Trower, Enforceability of Letters of Intent and Other Preliminary Agreements, 24 ROCKY MTN. MIN. L. INST. 347 (1978) (discusses whether parties have formed binding contract or have merely engaged in preliminary negotiations).
74. 556 S.W.2d 365 (Tex. Civ. App.—Amarillo 1977, no writ). 75. Id. at 367.
76. Id.
A more recent case on point is Getty Oil Co. v. Blevco Energy, Inc.78 Blevco Energy requested a farmout of certain leases from Getty, and Getty replied that “Getty Oil will farmout to Blevco Energy, providing a mutually acceptable agreement can be resolved . . . .”79 Subsequently, however, Getty drilled upon the property itself and completed an excellent well. Blevco sued Getty, and the trial court awarded Blevco Energy $2 million in actual damages and $4 million in punitive damages. The appellate court reversed on the grounds that no contract existed; the parties had merely an agreement to agree.80
These cases suggest that the best course is to state clearly in any letter exchange whether or not the parties intend to create a binding agreement.81 In addition, an offer to farmout should be subject to a specific termination date.82
At least two writers have urged that farmout agreements ought not be entered into in the form of “letter agreements,” an exchange of letters, or a letter signed by both of the parties.83 Letter agreements may be a perfectly adequate vehicle for a contract, of course, and they are appealing because of their apparent simplicity. The problem is that “the nature of a letter agreement makes it improbable that the parties have included detailed provisions which will apply in the event the transaction does not progress as expected.”84 The better practice is to take the extra step of preparing a formal farmout agreement.85
78. 722 S.W.2d 51 (Tex. App.—Eastland 1986, no writ). 79. Id at 53–54.
80. Id. at 54.
81. See Schaefer, supra note 3, at 18-1, -8; see also infra note 85 (illustrates language used in this type of farmout agreement).
82. The following clause limits the duration of the farmout offer: “9. EXECUTION. This Farmout Agreement shall be null and void at Farmor’s option if the duplicate original hereof enclosed herewith is not executed by Farmee and returned to Farmor within — days after the date shown below Farmor’s signature.” T. FAY, supra note 3, at 48.
83. Cage, supra note 3, at 156; Scott, supra note 3, at 65.
84. E. KUNTZ, J. LOWE, O. ANDERSON & E. SMITH, supra note 5, at 618. Petroleum Fin. Corp. v. Cockburn, 241 F.2d 312 (5th Cir. 1957), exemplifies the complications that may occur with letter agreements. In Petroleum Pin. Corp. the parties disagreed, and the court found that the letters and telegrams exchanged were ambiguous as to whether the farmor warranted a present title subject to defeasance or merely agreed to transfer merchantable title in the future. Id. at 317–18.
85. The parties might include the following language, modeled upon language suggested by Schaefer, supra note 3, at 18-9, in routine proposal letters:
[insert if the parties intend to be bound] We agree that the copy of this letter executed by both of us shall constitute a binding agreement between us to all of