Freeeport-McMoRan Oil and Gas, LLC and Ovintiv USA Inc. v. 1776 Energy Partners LLC presented a recurring question faced by Texas oil and gas producers: When can proceeds of production be withheld by the operator without liability for interest?
Ovintiv and its predecessor operator, Freeport-McMoRan, represented by Gray Reed partners Jim Ormiston and David Leonard, suspended proceeds it was contractually obligated to pay to non-operator 1776 in reliance on the safe harbor provisions of Section 91.402(b) Texas Natural Resources Code.
Upon learning that a Final Judgment had been entered in an unrelated case in favor of Longview Energy Company and against 1776 (then called Riley-Huff Energy), awarding title to leasehold interests and production proceeds to Longview, Ovintiv placed the disputed proceeds in suspense pending resolution of the underlying title dispute. Ovintiv advised Longview and 1776 that it would deliver the proceeds to their rightful owner once the title dispute was resolved. The Texas Supreme Court issued its mandate reversing the Longview Judgment and Ovintiv promptly paid the suspense funds to 1776, but 1776 continued to prosecute its claims for statutory interest and attorney’s fees.
Section 402(b) permits a payor (operator) to withhold payment of production proceeds without interest under several circumstances, including when “there is … a dispute concerning title that would affect distribution of payments” or if “there is… a reasonable doubt that the payee… has clear title to the interest in the proceeds of production.”
The trial court granted summary judgment for Ovintiv. The safe harbor statute applied as a matter of law to Ovintiv’s suspense of the proceeds. The final judgment also awarded Ovintiv and Freeport-McMoRan legal fees against 1776 pursuant to a prevailing party clause in the Joint Operating Agreements.
The Court of Appeals reversed finding that there were fact issues regarding whether the safe harbor statute applied, even though the underlying facts were not disputed.
The Supreme Court reversed and reinstated the trial court’s judgment, finding the safe harbor statute applied as a matter of law and Ovintiv was entitled to suspend the proceeds without liability for interest or attorney’s fees.
1776 argued that the Longview Judgment did not “affect distribution of payments” because 1776 retained legal title to the leasehold interests and proceeds or held them as trustee under the constructive trust for the benefit of Longview. 1776 also argued that its $25 million supersedeas bond in connection with the appeal of the Longview Judgment entitled it to continue to receive proceeds during the appeal. The Supreme Court rejected both arguments, reasoning that the plain meaning of “would,” as “expressing a contingency or possibility,” and the plain meaning of “affect,” as “to produce an effect on,” justified application of the safe harbor statute as a matter of law.
The Court also analyzed whether Ovintiv had a reasonable doubt that 1776 had clear title to the proceeds as an independent ground for safe harbor protection. Although reasonableness sometimes is a fact question, the Court reasoned that Ovintiv’s reasonable doubt must be determined based on an objective standard premised on persons of ordinary sensibilities. Because the underlying facts were undisputed, Ovintiv’s reasonable doubt presented a question of law where only one rational inference can be drawn.
The Court held as a matter of law that Ovintiv had reasonable doubt that 1776 had clear title to the proceeds of production. The Longview Judgment imposed a constructive trust over the subject leasehold interests and associated proceeds, which clouded 1776’s title. Thus, the very existence of the underlying title dispute, so long as it was not frivolous, clouded the title even though the Longview Judgment was ultimately reversed.