What is your guiding principle when writing agreements?
“The more the words the less the meaning, and how does that profit anyone?” Ecclesiastes 6:11.
“The beginning of wisdom is the definition of terms.” Socrates
The Legal Issue
A lease grants “a perpetual, cost-free (except only its portion of production taxes) overriding royalty of five percent … of gross production obtained” for directional wells drilled on the lease but bottomed on nearby land (emphasis mine). Are deductions of post-production costs allowed? No, says the Texas Supreme Court in Hyder v. Chesapeake Exploration, a decision long-awaited by those of us who pay attention to these matters.
The court of appeals decision was the subject of a prior post. The Supreme Court affirmed the court of appeal, which had affirmed the trial court.
Is This a Big Deal?
It certainly is for the Hyders and lessors with the same provision. Otherwise, I’m not so sure.
- The court was split five to four.
- The court emphasized that it was merely determining the parties’ intentions based on the language of the lease, disclaiming a broader agenda.
- The court recognized a basic proposition in Texas law: A royalty is usually subject to post-production costs, but the parties can modify the general rule by agreement. They just didn’t do it in this case, said the court.
- The court declined to read into Heritage Resources, Inc. v. NationsBank anything other than that the meaning of a lease is governed by a fair reading of its text.
In the Hyder lease the basis for royalty payment is the price received by the lessee, which the court noted is often sufficient in itself to excuse lessors from bearing post-production costs. “Cost free”, said the majority, is not merely a synonym for an ORRI. Scriveners often include “cost free” in a royalty clause to make certain that everybody understands the royalty is free of production costs, but not necessarily post-production costs, even though the language is not necessary (royalties are cost-free as a matter of law).
The court did not believe that “cost free” means free of post-production costs. But the Ecclesiastes way didn’t serve Chesapeake well. In order to prevail Chesapeake had to prove that “cost free” could not refer to post-production costs. The court concluded that the ORRI was to be paid on the price received by Chesapeake after post-production costs are paid.
Four justices would have gone with the default – ORRIs bear post-production costs. The way they saw it:
- The ORRI clause did not allow valuation of the ORRI downstream at any point of sale. It implicated only one location – the wellhead. Post-production activities would add value to the Hyders’ ORRI, but had not yet done so at the wellhead.
- Although the ORRI may not have been expressed using the familiar market-value-at-the-well language, they read its value to be just that. The “cost free” designation did not express an intent to abrogate the default rule. They would recognize that “cost free” simply stressed the cost free nature of the royalty without struggling to ascertain any additional meaning.
- Siding with Socrates, they focused on the vast differences between the royalty and ORRI provisions in the Hyder lease, concluding that if the extensive, specific, and detailed free-and-clear language in the royalty clause was surplusage, so should be bare bones “cost free” designation in the ORRI clause. “Cost free” is redundant, but not meaningless. We discussed the court of appeal interpretation of the detailed royalty clause in another post.
Today’s musical interlude: Backup singers.
Bobby King, Terry Evans, and (?) Herman Johnson
Mary Wilson and Florence Ballard
All of the Platters except the dude in the middle