When “We’re All Family” Ends in a Corporate Divorce

Link to Co-Author: David Pruitt Co-Author: David Pruitt

Why should related companies lawyer-up to protect themselves when entering a contract to manage an oil and gas property? The question is not rhetorical. Mesquite Energy, Inc. v. Sanchez Oil & Gas Corporation is a cautionary tale about what can happen when affiliated entities don’t sort out, until it’s too late, who owns intellectual property they create together.

The facts

The Sanchez family operated Sanchez Energy Corporation (“SN”), a public E&P company, and Sanchez Oil & Gas Corporation (“SOG”), the family’s private company. Under a Services Agreement, SOG employees provided management and operational support to SN, executives routinely held the same titles at both companies, and SOG’s personnel directed day-to-day operations that SN funded. In 2014, SN acquired the Catarina Asset for $639 million. Facing declining commodity prices, SN and SOG jointly developed “Zero Dark Forty,” a cost-reduction program that significantly slashed drilling and operational costs at Catarina.

In 2016, three SOG employees left for a competitor, Terra Energy Partners, absconding with thousands of proprietary files, including Zero Dark Forty data. SOG, SN, and a related partnership, SNMP, sued Terra and the disloyal employees. (SNMP is not relevant to the outcome or this discussion.) SN paid the legal fees. The Terra litigation eventually settled in 2024, and the net proceeds went into escrow while SOG and Mesquite (SN’s post-bankruptcy successor) fought over how to split up the proceeds.

The question

Who owned the Zero Dark Forty trade secrets – the company that wrote the checks or the company whose employees built the program?

The law and the ruling

Mesquite argued: Because SN funded Zero Dark Forty, it owned the trade secrets. SOG countered: Its employees developed the program under its operational control and the effect of the Services Agreement was to vest ownership in SOG.

The Texas Business Court determined that neither party was entitled to sole ownership. Funding is probative of contribution but not dispositive of exclusive title, especially where the parties operated as an integrated enterprise. And the Services Agreement itself contained no express language assigning newly developed trade secrets to either party. With executives wearing two hats and employees holding concurrent roles at both companies, the court found the relationship was anything but arm’s-length. The trade secrets were jointly developed, and the settlement proceeds were split 50/50.

The court also invoked unjust enrichment to order SOG to reimburse Mesquite for half of the pre-contingency legal fees SN had paid. SOG passively received a benefit, half a settlement, that would not exist but for SN’s sole funding of the litigation. One cannot sit on the sidelines and then claim a full share of the rewards without contributing to the cost.

Takeaway

It is probably not realistic to expect related parties, especially family-affiliated companies sharing officers, employees and office space, to negotiate as though they were strangers, each suspicious of the other guys. At the time the arrangement was established it didn’t matter, everyone being on the same team. But when the relationship changes, whether through bankruptcy, a sale of one entity or the other, the passage of time or whatever no one was thinking about happens, it matters a great deal.

Draw your own lessons from Mesquite. Maybe its not that affiliated entities should treat every intra-family collaboration as it would if the counterparty were a stranger. Perhaps the question should at least be considered: If we create something valuable together, who owns it if, for example, an unanticipated but not unimaginable event occurs? (After all, how unforseeable is an oil and gas bankruptcy?) An IP ownership provision in the Services Agreement could have resolved this dispute before it started.

Your musical interlude.