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.

Your musical interlude

Let’s begin with a quiz. Armour purchases non-recourse mortgage notes, becoming a lienholder in 99 oil and gas leases and 13 wells; fails to record the transfer documents in the real property records; assigns the leases to Sandel, reserving an overriding royalty interest in 23 of the leases; and can’t show that the liens were ever foreclosed.  Litigation arises among Armour, Sandel and the operator CML. What is the result:

A. Armour wins on estoppel by deed.

B. Armour wins against CML on breach of contract.

C. The purported reservation is void; Armour is a stranger to the title.

D. It doesn’t matter. The EPA, after “mostly peaceful” protests by PETA (only three tank batteries, seven F-250’s, and an amine unit destroyed and one toolpusher thrown into the mudpit), shuts down operations because the wells impinge on the ever-shrinking habitat of Jackalopus Westexacanus, a precious but rarely seen denizen of Grimes County, Texas, that is protected by federal law.

In Armour Pipe Line Company et al v. Sandel Energy Inc. et al., “C” was the correct answer.

In the first assignment, Armour reserved the override. In a second assignment, Armour sold the override to Sandel. Sandel farmed out to CML who drilled several successful wells.

CML concluded that the reservation was ineffective and suspended funds. Sandel sued for a declaratory judgment that the first assignment was void, alternatively that Armour’s rights in the override were extinguished such that Armour had no claim to the royalty, and for declaratory judgment based upon Armour’s release of the liens.

Armour counterclaimed for judgment based on the doctrine of estoppel by deed that it was the rightful owner of the override and for breach of contract against CML for not paying revenues from production.

There were motions and cross motions for summary judgment, an appeal, followed by more motions and cross motions.

The holding

Armour was a stranger to the title. An exception or reservation in favor of a purported owner of real property who in fact is a stranger to the title with no interest in the property creates no title in the stranger.

Armour’s claim of estoppel by deed was unsuccessful. Under estoppel by deed, a party claiming through a deed is bound by recitals in a deed in which the party or its predecessor in title was a party. A “recital” is a formal statement or setting forth of a matter of fact in a deed in order to explain the reasons upon which the transaction is found.

The first assignment’s granting clause, the reservation of the override, and excepting the override from the grant were not recitals. Assignment of an assignor’s right, title and interest reflects an intent to convey whatever interest the assignor may have had rather than a statement that it owns the interests. Likewise, a reservation or exception create a right in favor of the grantor. Armour’s purported reservation and exception were not recitals.

Armour’s argument that the second assignment was a basis for estoppel by deed was denied. Sandel did not claim its title based on the second assignment. Because there was no evidence that Armour foreclosed on the lien, its lienholder status did not give it any right, title or interest in the leases.

The court awarded legal fees to CML as interpleader to the tune of $42,000+. See pages 16 – 20 of the opinion for a tutorial on a stakeholder’s right to fees in an interpleader, including when the stakeholder also has an interest in the claim.

Your musical interlude, dedicated to our political parties.

Its time again to report on climate-related news from a perspective other than the alarmists. I’ll leave it to those who know more than I.

First, have you wondered why all the news from your Google search seems to spell climate D-O-O-M?  Maybe its because the UN has teamed up with the search engine to bury the kind of stories you see here. Don’t take my word for it. Here is the UN under-secretary for global communications explaining that they “own the science”.

How reliable are climate-change forecasts? Not very; Larry Elder in the Daily Signal recounts nine of them.

And here is a well-documented review by the American Enterprise Institute’s Mark J. Perry of the 41 climate doomsday predictions over the past 50 years that did not come to pass (and the none that did).

The threat of melting Antarctic glaciers is not as portrayed in overhyped news reports, says Steven Koonin in the Wall Street Journal. (Apologies, full access requires a subscription). This piece is interesting because Koonin is a physicist, Under Secretary for Science in the Obama administration’s Department of Energy, author of Unsettled, What Climate Science Tells Us, What it Doesn’t, and Why it Matters, and hardly a fossil fuel apologist.

To learn more, read Unsettled. In which Mr. Koonin explains how the IPCC climate reports are political documents built to persuade rather than to inform, and are not scientific presentations subject to peer review and scrutiny.

Despite what you will hear from the hysterics, there is no evidence of an increase in the frequency of hurricanes since 1980, says Dr. Roy Spencer.

As the United States heedlessly commits our economy to the green revolution, threatening our energy independence and economic prosperity, China is building carbon-spewing coal fired power plants at an alarming rate, says Mark Green of the Wilson Center. Are they laughing at us? Mark Bastasch at the Daily Caller thinks so.

Bjorn Lomborg shows us that  there’s plenty of good news about the environment.

Daniel Markind in Forbes explains how the current Administration is using every effort to stifle domestic oil and gas production while Europe is starving for energy and Germany is returning to the coal mines after its disastrous foray into green energy.

Says Robert Bradley, Jr. at Master Resource, there is increasing pushback against the “scientific consensus” promoted by climate ideologues.

Portions of the Great Barrier Reef that were studied are healthy and growing.

California has a solution!

And as long as we are talking California …

Loretta Lynn RIP

and another one.

This seems to be the season for oil patch courts to return property to its rightful owners. Last week it was a regulatory taking by the City of Dallas. This week it is Northwest Landowners Association v. State of North Dakota, in which the North Dakota Supreme Court deemed unconstitutional on its face a statute that stripped landowners of their rights in subsurface pore space.

SB 2344

In 2019 the North Dakota Legislature passed SB 2344, which allowed an oil and gas operator to use subsurface pore space in its operations and denied the surface owner the right to exclude others or demand compensation for subsurface use. The Bill granted the North Dakota Industrial Commission rulemaking authority to effectuate the purposes of the Bill and revised the definition of land to exclude pore space. The purpose was to overcome North Dakota’s Damage Compensation Act, which requires mineral developers to compensate landowners for lost land value and use. Finally, the Bill barred tort claims for injection or migration of substances into pore space.

The suit

The Association alleged that 2344 constituted an impermissible taking because it stripped landowners of their right to possess and use pore space and allowed the State to redistribute that right to others without the consent of or compensation to the landowners. The Fifth Amendment of the US Constitution guarantees that private property shall not be taken for public use without just compensation. The North Dakota Constitution prohibits taking or damage to private property for public use without just compensation having been first made to or paid into court for the owner.

The result

In its analysis the Court found a number of existing laws establishing the surface owner’s right to subsurface pore space, providing a statutory definition of pore space, and confirming that title to pore space is vested in the surface owner. The Court concluded that the surface owners demonstrated a constitutionally protected property interest in pore space that is recognized under state law.

The Court concluded that 2344 constituted a per se taking by allowing third-party oil and gas operators to physically invade a landowner’s property by injecting substances (such as CO2 or produced water) into the pore space.

An oil and gas operator does have an implied easement to dispose of wastewater into pore space produced within the same unit or pool, but the operator must compensate the surface owner for such disposal.

The Court relied on the plain meaning of ths statute to reject the State’s argument that the dominant mineral estate principle saved 2344 from constitutional infirmity. The statute applied to a broader set of circumstances.

The Court noted that although the use of pore space does not seriously interfere with a landowner’s use of the rest of his land because the pore space is beneath the surface, compensation is required for physical invasions even if the owner suffers only a minimal economic impact. This refuted intervenor Continental Resources’ assertion that pore spaces have no inherent value.

The Court denied the State’s argument that 2344 is not an unconstitutional taking because it is a proper exercise of its police power. The State may use police power only within constitutional limitations.

The Court determined that the constitutional and unconstitutional portions of the statute are independent and that the valid portions could be given effect without the invalid portion. Thus, the entire statute was not unconstitutional.

Your musical interlude

Co-author Trevor Lawhorn

If you have ever wondered how many ways a cocktail of stupidity*, treachery and feckless government can inflict financial harm on the undeserving, including the citizens the feckless government leaders are supposed to serve, see City of Dallas v. Trinity E. Energy, LLC.

 Facts

In 2008 during the Barnett Shale drilling boom, the City of Dallas issued an RFP to lease several thousand acres owned by the City. Trinity won the bid and agreed with the City that two additional tracts (the “Radio Tower Tract” and the “Gun Club Tract”) would be included in the lease, but only as drill site locations. Trinity paid a $19 million bonus for the lease.

Trinity submitted applications for special use permits (SUPs) from the City for the two tracts and a a private tract. The applications were filed correctly and in accordance with applicable laws. Pulling a Lucy on Trinity’s Charlie Brown, after a lengthy delay the City Plan Commission denied the applications. No other drill sites were feasible for various reasons. Trinity lost its appeal of the SUP denials to the city Council.

The City then amended its gas drilling ordinance to impose restrictions that effectively precluded drilling anywhere on the lease. The lease expired and the interest reverted to the City, never to be drilled.

Procedure

Trinity sued the City on several causes of action. The jury found the City committed statutory fraud and negligent misrepresentation and awarded damages to Trinity.

Over the City’s objection, the trial court submitted a jury question of the fair market value of Trinity’s property before and after denial of the SUPs. The jury found the FMV before denial was $33,639,000 and zero after. The trial court determined that the City committed a regulatory taking by failing to approve the SUPs and awarded Trinity $33,639,000.  The City appealed.

Regulatory taking

The Texas Constitution prohibits the taking, damaging or destroying of private property for public use without adequate compensation.  Inverse condemnation is a cause of action against a governmental defendant to recover the value of property which has been taken in fact by the governmental defendant, even though no formal exercise of the power of eminent domain has been attempted by the taking agency.  To plead a claim for inverse condemnation, the claimant must allege an intentional government act that resulted in the uncompensated taking of his property.

The City’s arguments:

  • There was insufficient evidence to support the finding that the City’s action constituted a regulatory taking. Trinity still had beneficial use of its property because it had other drill sites from which it could access some of the leased acreage. Trinity produced evidence that the best way to maximize the value of its interest was to use the three tracts as drill sites. This was why the sites were included in the lease.
  • Trinity could have drilled on other tracts in Irving and Farmers Branch to access its acreage. The City produced no evidence that those drill sites provided reasonable or economically viable access to Trinity’s minerals. Trinity showed that those sites would require complex drilling and excessively long well bores.
  • Trinity could have sought SUPs for different sites. But there was no evidence that Trinity would have been able to obtain SUPs for other sites that would have permitted Trinity to reasonably and economically develop its interests.

 The court of appeals affirmed the judgment.

 Sufficiency of expert testimony

 The City argued that Trinity’s expert’s testimony on market value was unreliable and therefore the evidence was insufficient to support the jury’s findings. In short, the court found that the expert’s testimony regarding value using the “proposed units” method was sufficient.

 The court also found that the expert’s use of the “comparable sales” method was sufficient. Testimony regarding comparable sales from other counties was appropriate because those sales included acreage with similar thickness as the City acreage. Comparable sales need not be in the immediate vicinity of the subject land, so long as they meet the similarity test.

Finally, the court found that the expert’s “discounted cash-flow” analysis was sufficiently certain. The expert relied on estimated future production, future prices, and estimated costs of production to calculate the net income for the property. He used publicly available price forecasts for his calculations.  While there was conflicting evidence regarding whether Trinity’s interests would be productive, resolving those conflicts was for the jury.

Your musical interlude.

* This is an opinion of course. We can’t certify that the then-City Council members who voted against granting the SUPs have IQ’s of two digits. Maybe they were driven by misinformed and misplaced ideology. Either way, $36 Million would fill a lot of potholes in South Dallas. Can’t blame Mayor Rawlings; he warned them.

Co-author Justin Cowan

Just because parties agree that disputes over a contract will be subject to binding arbitration doesn’t mean there won’t be wrestling at the courthouse beforehand. In LLOG Exploration Offshore, LLC v. Samson Contour Energy E&P, LLC, the United States District Court for the Eastern District of Louisiana resolved a motion to compel arbitration and to dismiss a lawsuit by staying the litigation pending the outcome of the arbitration but not dismissing the case. Continue Reading Arbitration Over Offshore Leases Does Not Warrant Lawsuit Dismissal

Co-author Jeremy Walter

Ark Sand Co., Inc. v. Bradley Demolition & Constr., LLC, et al has the appearance of a Hatfield and McCoy-grade grudge match. As often happens when litigation gets personal, the Texas Citizens Participation Act was invoked. The TCPA is the statute that protects citizens’ First Amendment rights such as free speech and the right to petition the government. As we will see, the statute will not cure all insults, real or perceived.

Ark owned an industrial sand pit, which it leased to Bradley Demolition & Construction, LLC (“BD&C”).  Ark alleged the lease was oral only, for a term of five years with no option to renew.  BD&C showed a written lease with a term of ten years.  Ark claimed that the signature on the lease was a forgery and the lease was unenforceable. BD&C refused to vacate after the five-year term.

Ark sued BD&C for several causes of action, inflammatory and otherwise, and sought a declaratory judgment.  BD&C counterclaimed.

The parties tried the declaratory judgment claim first because whether the purported written lease was valid would determine whether Ark had other claims.  The jury found that Ark did not sign the purported written lease and that lease was not valid.  The trial court granted declaratory relief and granted possession of the sand pit to Ark.

Ark then amended its petition to reflect that it owned the sand pit and added BD&C’s president Edward Bradley and BD&C affiliate Bradley Sand and Concrete Crushing Company to the suit, alleging BD&C sold them sand without authority, adding conspiracy, conversion, and other claims.

Turning up the heat, Defendants filed third-party claims against the president of Ark and others, alleging the sand pit was worthless when Defendants took over.  Defendants alleged a handshake deal whereby the president tricked Defendants into revitalizing the sand pit by leading them to believe they would own and operate it for ten years.  They argued the president always secretly intended to evict Defendants once the pit was profitable and that he operated Ark as his alter ego.

Ark moved to dismiss all third-party claims under the TCPA, arguing those claims were based on Ark’s exercise of its right to petition because they complained of Ark’s conduct in the lawsuit, pleadings, and previous trial. Defendants argued that Ark lacked standing to dismiss the third-party claims, that the motion was premature because those parties had not yet answered the lawsuit, and that the TCPA did not apply. The trial court denied the TCPA motion.

Ark argued on appeal that the TCPA applied to the third-party claims, specifically that those claims were based on Ark’s exercise of its right to petition and that Defendants failed to provide prima facie evidence of their claims.

Holding:

Ark Sand was not a named party in the third-party petition and the TCPA only allows “parties” to move to dismiss.  Although the third-party petition alleged Ark’s president operated Ark as his alter ego, it did not seek to hold Ark liable for the president’s conduct (only vice versa).

The Court held that a party cannot avail itself of a TCPA motion to dismiss unless the target of the TCPA motion seeks relief from the moving party. “Because Ark [Sand] is not named as a third-party defendant and the third-party petition does not otherwise seek to hold Ark [Sand] liable, Ark [Sand] has no need of protection from the third-party action [under the TCPA].”, said the Court.

The Court upheld the denial of Ark’s TCPA motion.

Your musical interlude.

You might recall this post on Broadway National Bank, Trustee v. Yates Energy Corporation. We now have Yates Energy Corporation et al v. Broadway National Bank, Trustee, the court of appeals’ ruling after remand. Recall the result from the Supreme Court: Execution of the 2013 Amended Correction Mineral Deed by the parties to the original 2005 Mineral Deed and the 2006 Correction Mineral Deed, without joinder of the current owners of the minerals, complied with Texas Property Code §5.029. The question remaining was whether the current owners were bona fide purchases for value without notice. Skipping all sorts of rulings on side issues, the result is that current owner Yates was not a BFP.  Other appellants survived to fight another day. Continue Reading Texas Correction Deed Statute Revisited … Again