Precious little legal analysis is required to grasp the lesson from Springbok Royalty Partners v. Cook.  No mode or manner of legal gymnastics is likely to save parties from the legal effect of a contract they didn’t bother to read before they signed it.

The agreement

Following a lengthy conversation between the Cooks and a Springbok employee, the parties agreed to a price for the sale of the Cooks’ minerals and signed a letter agreement entitled “Offer to Purchase Mineral Interests in Lands”. Springbok made a cash offer of $575,000 in consideration for a mineral deed for all of the right, title and interest they held and/or owned in and to 111 net mineral acres under land in DeSoto Parish, Louisiana.

The agreement included language to the effect: It would form a binding agreement; the Cooks would be deemed to have received good, valuable and sufficient consideration for their execution and delivery of their counterpart of the letter and performance of their obligations thereunder; they would not take a position to the contrary; if they signed the agreement they would be obligated to execute and deliver a mineral deed covering all their interest in the property.

The suit

Springbok sued the Cooks to enforce the letter agreement. The Cooks refused to conclude the sale after receiving a better offer. Summary judgment in favor of Springbok was affirmed.

The Cooks’ summary judgment affidavits testified that they thought they were selling half of their interests and that they never intended to sell the entirety. They also testified that they did not read the agreement prior to signing it.

The Cooks’ futile arguments

The contract was ambiguous:  The agreement was clear and explicit and led to no absurd consequences. It unambiguously stated that they were selling all of their mineral interests. When Mr. Cook read the contract two days after he signed, it became clear to him then that they had sold the entirety of their interests.

Unilateral error: Consent may be vitiated by error, fraud or duress only when it concerns a cause without which the obligation would not have occurred and that cause was known or should have been known to the other party. Unilateral error will not vitiate consent to a contract unless the error was inexcusable.  The Cooks were sophisticated landowners who had previously executed leases and engaged in other complicated property transactions.

Fraud:  The Springbok employee knew or should have known that their intent was to only convey half of their minerals. Fraud does not vitiate consent where the party against whom the fraud was directed could have ascertained the truth without difficulty, inconvenience or special skill. The record showed no evidence of fraud.

Accounting was error. because Springbok did not plead for it. The trial court had discretion to allow enlargement of the plaintiff’s recovery to conform to the evidence. The final judgment must grant the relief to which the party whose favor it is rendered is entitled even if the party has not demanded such relief in his pleadings and there is no prayer for general and equitable relief.

New Orleans’ own Walter “Wolfman” Washington RIP

Anita Pointer RIP

We’ll end the year end with a look at “COP27”, the all-expense-paid shindig that was the 27th United Nations Climate Change Conference of the Parties, featuring exaggerations, hysteria, and outright misstatements burning with greater intensity and frequency than their beloved climate itself.

Before you decide who to trust, remember who says they “own the science”.

Conservation for thee but not for me

A reported 400 private jets made their carbon-spewing way to a luxury resort in Egypt to again pronounce the fiery demise of Mother Earth. This is just fine with the BBC because the work of saving the planet is much more important than anything you do.

A word from our sponsor

Get your Greta Thurnberg thermostat!

Crying “wolf”

U.S. warming could be exaggerated by 50%, says Watts Up With That!, citing sources.

Chicken Little speaks

Mainstream media, including my own overmatched Dallas Morning News, succumbs to hysteria from the Associated Press. “Act Now or Die!” … as in, give them lots of money!

Your legitimacy is in question when University of Colorado Boulder scientists worry about mental health crises in youth because of climate change catastrophism.

Pinocchio speaks

Blame the Morning News for being understaffed. The Seattle Times, though, censors “disinformation” and issues demonstrably false “information” of its own.

According to Heartland Institute, a new poll casts considerable doubt on the “97 percent consensus” among scientists about climate change.

Reality speaks

The problem, says Matt Ridley in Not Alot of People Know That, is that green zealots are threatening real conservation.

According to Dan Eberhart in Forbes, the delusion is that alternatives can carry the day. We will need fossil fuels for a long time.

And by some accounts the Polar Bears are doing fine.

Closer to home, and to your wallet and our energy security, Alex Epstein exposes 12 myths about the “Inflation Reduction Act” .

Grifting speaks

Ignoring the life-changing benefits of fossil fuels to their standard of living, less-developed countries trolling for free cash are hard at work to appropriate your taxes, and they are enabled by our enerzy czar and COP27 delegate. What’s the over/under on the kleptocracy quotient? Half, … most? How about politically driven, crony-directed misspending?

Your musical interlude

Authors Chris Davis and Joshua Smeltzer

Originally Published by the Texas Lawbook.

Cryptocurrency is in the news of late. Its relationship with Texas energy is significant. As reported by Ryan Dusek and Cooper Ligon at Opportune.com, its because of our abundant energy supply, a mix of oil and gas and renewables, and good government policy.

With that in mind, here is a report by my Gray Reed colleagues that describes the larger cryptocurency phenomena. It is longer than our usual posts but well worth the read.

Blockchain and its related cryptocurrencies were intended to upend a financial system completely reliant on trusted intermediaries. Starting in 2021 the adoption rate of cryptocurrencies skyrocketed. However, most of these new adopters are not making use of the underlying blockchain technology and instead interact with cryptocurrencies using a variety of mostly unregulated intermediaries, including exchanges like FTX.com.

Trust has, therefore, been reinserted for millions of users into a system designed to eliminate such trust. Where trust is required, trust can be abused. And the news is littered with examples of cryptocurrency investors losing money at the hands of these intermediaries.  

Stablecoins appeared to be anything but stable when the Terra network and its algorithmic stablecoin (i.e. a digital asset collateralized by calculations instead of independent reserves of actual dollars) failed. Investors who didn’t understand these types of “stable” coins suffered when the calculations failed. Then the drop in cryptocurrency prices started to expose mismanagement and other risks in many other cryptocurrency companies (e.g. Celsius, Voyager and Three Arrows Capital). Sam Bankman Fried (SBF) and his FTX exchange became the latest very public example— admitting an inability to account for billions of invested capital and filing for bankruptcy. It will take time before the entire impact of the FTX failure and bankruptcy is known. However, here are five things for investors to take away from the recent events involving FTX when considering the future of digital assets. 

1. Beware the cult of personality.

FTX’s explosive growth was driven largely by the popularity of SBF himself and a roster of celebrity promoters—including Tom Brady, Giselle Bündchen, Steph Curry and Shaquille O’Neal. Perhaps most notably, Larry David appeared in a Super Bowl ad touting FTX as a “safe and easy way to get into crypto.” FTX also bought naming rights to the Miami Heat’s basketball arena, which in the eyes of many lent additional credibility to the company. SBF himself shamelessly promoted FTX—for instance, sitting for an “exclusive” CNBC interview in which he discussed surviving the “Crypto Winter” and his purportedly unique investment strategy. This interview aired less than a month before FTX collapsed. If this type of over-the-top promotional strategy conjures up memories of past frauds, it should. Remember Enron Field in Houston? The Stanford-St. Jude Championship and Allen Stanford’s ties to many notable professional golfers? Elizabeth Holmes “firing back at doubters” on CNBC, while popular “Mad Money” host Jim Cramer described her company Theranos as “one of the most exciting privately-held companies in Silicon Valley”?

Fraudsters know that investors are wowed by TV appearances, corporate sponsorships and celebrity endorsements. But TV commentators, corporate marketing departments and celebrities are not vetting these companies. If anything, these parties are blinded by sponsorship dollars or the competition to land an interview with “the next Steve Jobs” (as Holmes was described). And while the SEC’s recent wave of enforcement actions against celebrity crypto promoters like Kim Kardashian is a good message to the market, average investors continue to be fooled. The FTX fraud reinforces the need for skepticism and diligence.

2. Invest in a business, not a cause.

SBF was a major proponent of a movement called “effective altruism.” This philosophy dictated that the end game of SBF’s and FTX’s success was not their own wealth—but rather using that wealth to do good. To wit, SBF pledged to eventually donate substantially all of his net worth to charitable causes. This messaging dovetailed perfectly with much of the philosophy behind the development of cryptocurrencies—in which proponents advocated the “democratization” of the financial world, as power would be decentralized rather than concentrated in powerful financial institutions. Consequently, money poured in from those looking to not only profit, but to do good in the process.

Unbeknownst to these investors, rather than doing good with their money, SBF was misappropriating it to buy himself, his family and his friends 19 Bahamian properties worth roughly $121 million. This reinforces the fact that someone bent on fraud is not above lying about alleged charitable intentions. The FBI, IRS and other agencies for years have warned the general public about those who tug at the heartstrings of their victims in order to get them to part with their money. SBF’s version of this tactic was just more brazen and more public.

The bottom line is that investment decisions should be based first and foremost on the underlying business—not its good intentions. These purported good intentions may just be a vehicle to hide fraud.

3. Garbage in = garbage out.

The FTX exchange, and many other cryptocurrency exchanges, are not really decentralized. For most of the recently failed or bankrupt companies, there is a centralized group of managers interacting on behalf of investors with the actually decentralized networks. Therefore, it is the quality of these managers and their companies, and reserves on hand to protect investors, that must succeed and not the blockchain network used or the associated cryptocurrencies unconnected to the company.

Multiple commentators have indicated that FTX was horribly mismanaged and its books were beyond inaccurate. Including, as mentioned above, misplacing billions of dollars. The amounts invested don’t matter if the exchange, as FTX claims, can’t find and return the money invested when asked. There were advisors and accountants involved, but it didn’t appear to matter. There were little to no internal controls, the apparent outside controls of auditors also failed, and there were no regulatory reporting or other compliance requirements that might have signaled a problem. If the investment is going into a faulty company with a faulty system, it has very little, if any, chance of success.

Customers and legislators are almost guaranteed to demand more of the digital asset companies and exchanges going forward. This will likely require proof of adequate reserves and more public disclosure and reporting to both oversight government agencies and investors.

4. Compliance is a good investment.

The collapse of FTX has ushered in a significant change in dialog within the cryptocurrency community. After years of antagonism towards regulators (a two-way street, to be sure, as many regulatory agencies have been likewise antagonistic towards the industry and unfairly painted it with a broad brush), many within the community are now acknowledging that regulation could be a good thing. And whether it’s a good thing or not, it’s coming. FTX’s collapse has, predictably, led to calls for tighter regulation.

This reinforces that compliance is a good investment and a potential competitive differentiator. For instance, Coinbase stands out as a cryptocurrency exchange that has taken a markedly different compliance approach from FTX. Coinbase is a U.S.-based, publicly traded company. This requires it to comply with SEC and NASDAQ rules and regulations, to provide audited financials to the public, etc. This is not to say, of course, that every cryptocurrency or blockchain company can or should go public. These companies should, however, ensure that they have made the investment needed to both understand and meet certain compliance obligations demanded by the government and/or their investors. This will not only keep them out of trouble but also set them apart from their competitors.

5. Blockchain and digital assets will survive.

Bitcoin has a history of being discounted as a fad and has been pronounced dead multiple times. However, it always seems to survive, and the failure of specific digital asset companies are unlikely to be the demise of Bitcoin and other digital assets.

The blockchain technology, the networks employing that technology and the associated cryptocurrencies are built to be trustless, and they remain trustless. The blockchain technology and its underlying cryptocurrencies provide something that millions of new users flocked to in 2021 and are still adopting, albeit at a slower rate. There is clearly a demand. The intermediaries failed, not the blockchain networks.

In an ironic twist, the failure of centralized cryptocurrency intermediaries further supports the need for the actual decentralized financial exchange system. What users need is an easier way to access the actual blockchain network without the need for intermediaries acting on their behalf. Access to the actual blockchain system remains remarkably difficult for an average user, and that’s how intermediaries flourished and recruited customers by offering a user-friendly way to invest.

However, as a new innovation, it will hopefully become easier to access and use as the technology develops. Then users will not need to rely as heavily on outsiders to act on their behalf.  

FTX, mostly because of its penchant for publicity, is a very public failure, but it is not the entire blockchain and digital asset ecosystem—it’s just one piece. Investors must be careful but shouldn’t necessarily give up entirely on blockchain and digital assets because of recent events. Instead, they should demand more business and compliance formalities common in other industries to ensure that the risks involved are adequately disclosed and considered. Investors should also demand more protections, accountability, and punishment for companies acting on their behalf.

There will always be risks, but risks can be managed if the company and the investor deal in good faith with knowledge and understanding of all the facts. That should be the goal going forward.

Musical interludes, your choice

Christmas

Advent

Let’s begin with some Texas law on what a seller sells when he executes a deed:

Generally, a Texas real property deed will confer upon the grantee the greatest estate as the terms of the instrument will permit. This “greatest estate …” differs in concept from the “greatest estate possible”.

A deed will pass whatever interest the grantor has in the land unless the deed contains language showing a clear intention to grant a lesser estate.  Such a clear intention can be accomplished by withholding part of the estate by express reservation or by granting only the portion the grantor desires to convey.

Translation: you’ve got to read the entire document to know.

So said the court of appeals in Mark S. Hogg, LLC v. Blackbeard Operating LLC.

The facts

1994 the Hoggs granted an oil and gas lease on a 160-acre tract in Winkler County to Three-B. In 1998 they granted a lease on 120 of those acres to Three-B. Three B assigned several leases to Stanolind. The granting clause transferred all identified “properties and assets” and then defined 10 “Assets” in eight subparagraphs:

(a) Leases and Lands; (b) Wells; (c) Units and Properties; (d) Contracts; (e) Surface Contracts; (f) equipment, machinery, fixtures and other intangible personal property and improvements on the Properties; (g) oil, gas and condensate and other minerals produced from the Leases, Lands Wells; and (h) Records.

References were made to Exhibits A and A-1. Exhibit A named the 1994 lease and others but did not name or include the 1998 lease. However, Exhibit A-1 named the Hogg #2 Well, which was located on the 1998 lease.

The 1998 lease was assigned to Blackbeard by a Stanolind successor via an assignment that expressly identified the 1998 lease.

The contentions

Hogg claimed that the Stanolind-to-Blackbeard assignment did not include the 1998 lease. Blackbeard sued Hogg for trespass to try title and to quiet title in the disputed interest in the 1998 lease and for declaratory judgment; Hogg counterclaimed for the same relief. The court granted Blackbeard’s motion for summary judgment.

On appeal, Hogg alleged that the Stanolind-to-Blackbeard assignment did not convey the 1998 lease, that the conveyance language limited “Leases” to those specifically defined; alternatively, the assignment could not have conveyed the unnamed lease when A-1 merely identified the name of a unit.

The result

Blackbeard prevailed. The court examined each category of Assets in the eight subparagraphs (too much detail to discuss here). The Court determined that the subparagraphs made clear that the assignor intended to transfer all the interests in the Assets described.

The question still remained whether the 1998 lease was included as an “Asset”. It was. Nothing in the granting clause or Exhibit A precluded other leasehold interests from being conveyed by some additional provision.  By describing the Lands as including the acreage covered by the 1998 lease, the definition of “Lands” in subparagraph A included all of the assignor’s interest in the 120 acres covered by the 1998 lease. And there was sufficient language in subparagraph C conveying all “leasehold interests …. “ to include the 1998 lease.

Further, the court concluded that the assignment satisfied the statute of frauds requirement that a conveyance must contain a valid legal description of the land to be conveyed with reasonable certainty. The assignment satisfied this requirement by referencing recordation information in the Real Property Records of Winkler County.

Your musical interlude, a harmonica blow-off. Pick your winner.

Sonny Boy

Kim Wilson

Kitty (or maybe Daisy) and Lewis

Paul Butterfield

Co-author Brittany Blakey

Wagner v. Exxon Mobil Corporation is an example of the misfortune that can befall the purchaser who assumes the burden of comprehensive, one-sided indemnity obligations. We will disregard evidentiary and other issues in this case and will focus on indemnity.

The parties executed an Agreement to Purchase and Sell in 1994 whereby the Wagners acquired oil and gas interests in Louisiana from Exxon. In a corresponding Assignment, Exxon conveyed a 50% interest in a mineral servitude encumbering over 120,000 acres.  The Wagners agreed to indemnify Exxon for what looks like every environmental liability a diligent scrivener could imagine.

The parties were sued for environmental contamination and for remediation of the properties in two Louisiana lawsuits: M.J. Farms, and Agri-South. The cases settled and Exxon sued the Wagners for indemnification, and after trial sought judgment on a jury verdict for $57.5 million paid to M.J. Farms and $14.1 million paid to Agri-South. The Wagners sought a directed verdict in their favor on both settlements.

The trial court granted the JNOV motion in part, reasoning that Exxon “clearly received valuable consideration in the settlement in the form of collateral transactions for which the [Wagners] had not indemnified Exxon[.]” Exxon failed to prove “an allocation of the [M.J. Farms] settlement between non-indemnity consideration and indemnified losses.” The trial court disregarded the jury finding in part and determined that only $14.11 million of the M.J. Farms settlement “should be considered applicable to the indemnified claims.” The judgment awarded Exxon $14.11 million for each settlement. Both parties appealed.

The appeal and the result

Essentially, the Wagners asserted that Exxon’s failure to allocate the M.J. Farms settlement between those benefits that were covered by the indemnity agreements and those that were not was fatal to a recovery. In response, Exxon pointed to Wagners’ failure to timely object to the jury charge and to raise res judicata as a defense. (Trial lawyers, pay attention!)

In the PSA and Assignment the Wagners agreed to:

  • indemnify Exxon ” … from and against all damages … as a result of … the ownership or the operation of, or any act or omission in connection with, the interests or property, by buyer, … or by Exxon, … including, but not limited to: … claims, [etc.] arising out of, or in connection with, the plugging and abandoning and reabandoning of any wells, … closure of pits, and restoration of the surface, … [.]”
  • accept all liability for the environmental condition of the property, including “… all existing and prospective claims, … including … costs to cleanup or remediate … and … to indemnify, defend, and hold Exxon … harmless from any and all claims … and liabilities whatsoever in connection with the environmental condition of the property … [.]”
  • indemnify Exxon for claims “on account of … contamination or threat of contamination of natural resources … or other threat to the environment” arising from operations before or after the PSA’s effective date.

The court determined that these provisions obligated the Wagners to indemnify Exxon for damages, losses, and expenses:

(1) as a result of the Wagners’ ownership of or any act taken on the properties;

(2) arising out of the “closure of pits, and restoration of the surface”;

(3) arising from the property’s environmental condition, including “costs to cleanup or remediate”; and

(4) sought by any person on action of contamination of natural resources.

The court concluded that all costs related to the settlement of the M.J. Farms litigation likely fell within the scope of the Wagners’ indemnity obligations.

The trial court erred in disregarding the jury’s finding with respect to the M.J. Farms settlement. Trial court judgment reversed, jury’s verdict reinstated, case remanded for entry of judgment in accordance with the verdict.

THE COURT’S WEBSITE REPORTS THAT THIS OPINION HAS BEEN WITHDRAWN.

Christine McVie, RIP.

The Kingfish would be proud of the Louisiana Supreme Court in Louisiana Ex Rel Tureau v. BEPCO, L.P. et al. The issues were the prescriptive period applicable to a citizen suit for injunctive relief under R.S. 30:16 and whether the petition stated a cause of action under R.S. 30:14 and 30:16. The court held that a 30:16 citizen suit is not subject to liberative prescription of any duration and, insofar as the petition accused the defendants of violating Louisiana conservation laws, rules, regulations or orders, the allegations were sufficient to defeat an exception of no cause of action. The common man wins … for now.

The Court relied on the environmental protection provisions of Louisiana Constitution Art. IX, §1. It was up to the legislature to set forth procedures to ensure that damage to the environment is remediated to the standard that protects the public interest. The legislature established the Louisiana Office of Conservation to oversee and enforce conservation laws. The Commissioner of Conservation has a duty to restrain any person who is violating or threatening to violate conservation laws. Should the Commission fail to honor its duty, 30:16 authorizes any person in interest adversely affected by the violation to institute proceedings to prevent further violations. 30:16 does not allow for recovery of damages by the citizen.

Tureau’s claim was that the defendants operated numerous wells on his property or adjacent property and constructed and used unlined earthen pits that were either never closed or not closed in conformance with environmental rules and regulations, in particular Statewide Order 29:B.

Liberative Prescription

On the defendants’ exception raising the objection of one-year liberative prescription under Civil Code Art. 3492, the Court noted that the State of Louisiana is the real party in interest in these cases. A request for injunctive relief differs from a suit for property damages and for the remediation of contamination, which has a one-year prescriptive period.

Statutes on the subject cannot be extended from one action to another, nor to analogous cases beyond the strict letter of the law. The Court noted that the legislature has not enacted a specific liberative prescription statute applicable to claims for injunctive relief under 30:16.

Defendants’ effort to apply the one-year prescription by analogy failed. The Court noted that citizen suits to enforce environmental regulations pertain to fundamentally different public law matters and are nothing like private tort claims. Relief is limited to injunctive relief, and a notable distinction of a 30:16 action is that the citizen is essentially acting for the Commissioner. Clear language of the statute authorizes a person in interest adversely affected by a violation of Louisiana’s environmental laws to bring suit to prevent any or further violations. The Court concluded that the statute is narrowly tailored to serve the best interest of the public and is not intended to provide a citizen with a private personal action for damages.  

No cause of action

The court denied defendants’ no cause of action exception based upon the cessation of operations on the property years ago. The question is whether, considered in a light most favorable to the plaintiff, and with every doubt resolved in the plaintiff’s favor, the petition states a valid cause of action. Tureau’s petition alleged that the property had been contaminated as a result of oil and gas activities and that the defendants were currently in violation of Statewide Order 29:B and other regulations.

Defendants argument that their failure to remediate contamination to the minimum required standards does not in and of itself constitute a violation of laws, regulations, or orders goes to the merits of plaintiff’s claims and not the sufficiency of the pleading.

The failure to remedy past contamination and comply with regulations can constitute a continuing violation. The Court denied defendants’ argument that only violations involving present, ongoing conduct or threatening future conduct give rise to a citizen suit under 30:16.

Your musical interlude

Let’s proceed directly to the takeaways from Fort Apache Energy, Inc. v.  Short OG III, Ltd., et al, a Southern District of Texas bankruptcy district court opinion. (Gray Reed partners Jim Ormiston, Gabe Vick and Kristen Kelly represented Short OG III)

The other guy’s operations will not extend your lease beyond the primary term.

Texas law does not allow an oil and gas lessee to rely on a cotenant’s production to extend the term of the lease. Fort Apache and Short et al owned competing leases on 112 acres in Tyler County. The Southern Star lease expired because Fort Apache did not operate on the land during the primary term and could not rely on its lack of operations to extend the lease. Fort Apache testified that it was not economically viable to drill its own well on already developed land and it had no intention to develop the lease. The fact that an operation is uneconomical is not a reason to justify a lack of production. As cotenant Fort Apache had equal rights and access to produce.  

If you sue me, I have standing to assert lease expiration

Fort Apache argued without success that Short et al lacked standing to challenge a motion for summary judgment on expiration of the Southern Star lease because they were not third-party beneficiaries or contracting parties. Their standing was derived from their defense against Fort Apache’s trespass claim.

No trespass by a cotenant

A cotenant has the right to possess land to extract minerals and only owes an accounting of the proceeds less reasonable costs in production and marketing. Short et al, as owners of a competing lease, did not trespass because they were cotenants. Fort Apache’s trespass claim failed because it did not offer evidence to show that Short et al dispossessed it from the land.

Reliance on repudiation?

A lessee who never intends to drill a well cannot rely on its lessor’s repudiation of an oil and gas lease.

Background

In this limited space I will try (sub-optimally) to do justice to the maze of facts and events behind this ruling. Let’s just say, generally speaking, the following happened:

Hranivitz, Sr. and McBride each owned half of the land and signed competing leases. People died. Their descendants and successors signed some leases and ratified others, some with authority and some without, some timely and some not. More people died, leading to a legal tug of war over who had legal title to the property and the right to dispose of it: the administrator of the estate or the testamentary trustee?

Fort Apache sued alleging seven assorted causes of action: Short et al counterclaimed.

Working interest owner (with Short et al) Aztec filed for bankruptcy. The working interest owners’ counterclaims and third-party claims are still pending in a baknruptcy adversary proceeding.

The Bankruptcy Court issued an opinion that the Southern Star lease was superior to the Miller lease and ratification of the Miller lease was void, but at the time the prevailing lease might have expired.

Conclusion, for now

Short et al’s claim for expiration of the Southern Star lease prevails. Because Fort Apache never conducted operations on the lease after trying and failing to negotiate a joint development agreement with Short et al., the lease expired. Fort Apache’s partial summary judgment motion on trespass is denied.

*

Your musical interlude.

Co-author David Gair

The principal contention in the tax refund case of Exxon v. United States was whether certain mineral related transactions between Exxon and the countries of Qatar and Malaysia were sales or leases.  Originally Exxon treated the transactions as leases on its tax returns.

As a lease, Exxon’s income didn’t include the portion of oil and gas revenues it paid to Qatar and Malaysia as royalties.  A few years later, Exxon decided it was wrong in its characterization and filed refund claims to take advantage of foreign tax credits.

The determination of whether a taxpayer has a sale or a lease turns on the concept of “economic interest”: the right to share in the profits and losses of a business.  For oil and gas, the party entitled to a percentage of profits from oil extraction has an economic interest in the oil.  Royalty holders are deemed to have an economic interest in oil on which they are paid a royalty.

The IRS regulations crystalize this understanding.  To have an economic interest in minerals in place a person must have:

  • An investment in the minerals, and
  • Income derived SOLELY from the extraction of minerals.

Exxon’s argument was that its arrangement with the countries secured other benefits in the same bargain, so the arrangement should be treated as a sale.  The Court said that if Exxon were right, taxation would depend on how many transactions are cobbled into one contract.  Instead, the Court elected to look at the source of the payment obligations in each part of the contract to determine whether it is a sale or a lease.  Exxon said that this is “unworkable” “disaggregating” of its agreements.

At the end of the day, without oil and gas production, Qatar and Malaysia would receive no royalties.  Supplemental income was irrelevant and is subject to its own tax treatment.  Exxon lost its novel argument.

One the bright side for Exxon, it avoided a $200 million dollar penalty.  The court said their position was close to crossing the line.  But because this is a complex area of the law, like “occult mysteries”, they should be given a break.

Don’t pity Exxon; while it lost its request for a $1.5 Billion refund, it reported colossal profits in Q1 2022.

Your musical interlude.

Plaquemines Parish, et al v. Chevron et al has characteristics of the many pending climate-change suits brought by governments in state courts against Big Oil, which Big Oil tries to remove federal court. In this case the question was whether the producers were acting under federal officers’ control when they ramped up oil production during World War II. Removal failed. The Fifth Circuit affirmed the District Court’s remand to state court.

The cause of action is for violation of the Louisiana State and Local Coastal Resources Management Act, enacted in 1980, which requires a party seeking to use coastal areas (in this case for oil and gas extraction) to obtain and comply with coastal use permits. The Act grandfathered uses that were legally commenced or established prior to the effective date of the permit program. Plaquemines alleges that the producers’ operations dating back to the 1940’s were not lawfully commenced or established because of they departed from prudent industry practice and thus were not begun in good faith. Therefore, it is alleged, the pre-1980 operations were not grandfathered and the producers can be liable under the Act for environmental damage (primarily, degradation of the coastal marshes) resulting from permit violations from 1980 onward.

In the producers’ telling, the history of the federal government‘s oversight, conscription, and vertical integration of the oil industry during World War II justifies federal jurisdiction because the producers’ acted under federal officers by increasing oil output to help fuel the war effort. They also clim to have served as federal contractors or subcontractors to refineries with government contracts and thus were contractually directed by federal officers to perform the activities for which they are now being sued. The courts found no federal contract or subcontract and refused to infer the existence of subcontracts on the basis of the producers’ buyer-supplier relationships with government-contracted refineries.

The burden was on the producers to show that federal jurisdiction exists and removal was proper.  The Fifth Circuit concluded that the producers failed to meet their burden that they had asserted a colorable federal defense that they acted pursuant to federal officers’ or agencies’ directions and the charged conduct is connected or associated with an act pursuant to the federal officers’ directions. If there is no contract, then evidence of any payment, employer employee relationship, or principal-agent arrangement could indicate the requisite delegation of legal authority to act on the government’s behalf. But there was insufficient evidence of such relationships.

The producers also alleged an unusually close and special relationship with the federal government during the war and that they were essential suppliers for refineries that were contractually obligated to deliver to the government, which made them contractors. But merely being subject to federal regulations is not enough to bring a private action within federal officer removal jurisdiction. Merely complying with the law does not suffice.

The producers’ further argued that they were obliged as federal subcontractors to prioritize fulfillment of governmental defense orders. That was denied. No documents evidenced such a subcontract, and supply relationships do not create subcontractor relationships. The producers did not show that they were subjected to the federal government’s guidance or control as subcontractors.

This is only one of 42 such cases, and leads the way for all 42 to return to the parish whence they came.

And at least one has settled.

RIP the Killer, son of Ferriday, Louisiana, cousin of Jimmy Swaggart. Was this the real Jerry Lee Lewis, or this, or maybe even this?

Co-author, Gray Reed partner Jim Reed

The common thread throughout the myriad oil and gas royalty cases decided recently by Texas courts could be “harmony”, the reading of different, seemingly conflicting, contract provisions so as to give meaning to all.

In Enervest Operating, LLC v. Mayfield and Ingham the Fourth Court of Appeal harmonized a market-value-at-the-mouth-of-the-well royalty clause and a free-use provision to conclude that the royalty owners must bear their share of fuel gas, which the court deemed to be a post-production cost.

The facts

Gas royalties were to be paid on “ … gas … produced … and sold or used off the premises, … the market value at the mouth of the well of one-eighth of the gas … .”

The free-use provisionallwed the lessee to have ” …  free use of … gas … from said land … for all drilling operations hereunder, and the royalty shall be computed after deducting any so used.”

Enervest uses some of the gas sent downstream for sale as fuel gas to power compressors and dehydrators and does not pay royalty on that gas.  Lessors asserted that Enervest improperly deducted this fuel gas from their royalties. Enervest responded that the market-value-at-the-mouth-of-the-well provision requires the lessors to bear their share of PPC’s, including fuel gas, as a matter of law.

The result

The court of appeal concluded that “market-value-at-the-mouth-of-the-well” has a commonly accepted meaning in the industry that identifies the location for the calculation of royalties and requires royalty owners to share the burden of PPC’s.

The Court deemed fuel gas to be a PPC because it is used to facilitate the production of gas that is sold and contributes to the material enhancement of the value of the gas. Trial court judgment for lessors was reversed.

According to the court, the trial court’s judgment was based on an “isolated reading of the free use clause” that ignored the plain language of the royalty clause requiring that royalty be based on market value at the well.

Arguments rejected

The court denied lessors’ argument that Enervest’s predecessors paid royalty on fuel gas and therefore Enervest must do the same. When a contract is unambiguous, estoppel as a result of past conduct of the parties has no application.

The Court found a difference in the free-use language in Bluestone v. Randle “in all operations hereunder” compared to the language in the case at bar, “for all drilling operations hereunder” and did not find Bluestone to be instructive.

The court did not accept lessors’ comparison of the oil royalty clause, which states specifically that the lessor shall bear its proportion of oil treating expenses, to the gas royalty, which does not have that language to mean that the gas royalty must not bear PPC’s. Such a reading would ignore the gas royalty provision’s express language.

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