Co-author Bill Drabble

It must be maddening to non-lawyers that a large segment of an industry can operate in harmony by agreeing that a contract in widespread use means one thing, only to have party-crashers decide it means another. Total E & P U.S.A., Inc. v. Kerr-McGee Oil & Gas Corp. et al arose out of assignments of overriding royalty interests in an offshore Louisiana lease. The assignments had “calculate and pay” clauses stating that the assigned interest “shall be calculated and paid in the same manner and subject to the same conditions as the landowner’s royalty under the Lease.” The Outer Continental Shelf Deep Water Relief Act suspended the federal government’s royalty until 87.5 million BOE had been produced. Lessees Total and Statoil argued that the calculate and pay clauses also suspended payment of the overrides. The other working interest owner, Chevron, disagreed and paid on the overrides.

Reversing a district court ruling in favor of the lessees, the 5th Circuit said the assignment was, at the very least, ambiguous.

An overriding royalty is different from a lessor’s royalty.

The court relied upon the “well-recognized distinction between overriding royalty interests and a lessor’s royalty” under Louisiana law. According the court, an overriding royalty is in addition to the royalty paid to the landowner. Thus, the court disagreed with the trial court that the language had to explicitly state that the royalty suspension would not apply to the overrides.

Because the assignments did not explicitly state that the suspension of the federal government’s royalties counter-intuitively applied to the overrides, the contracts were ambiguous. Furthermore, the assignments stated the overrides shall be paid out of “all oil, gas, and casinghead gas … produced, saved, and marketed from the lease.” This broad language indicated that the royalty would be calculated based on total production, and not merely on the period in which the federal government was entitled to its royalty.

You go your way, I’ll go mine

The aspect of the case likely to frustrate the override owners the most was an expert’s survey, ignored by the trial court (but not by the appeals court because they took the time to mention it) that in 80 other overriding royalty instruments with language like the that at issue no other party interpreted the provisions so as to subject the overrides to the DWRRA royalty suspension.

A concurring opinion arrived at the same conclusion – the agreements were ambiguous – from another direction, relying on the structure of the calculate and pay clause to create the ambiguity. The meaning turned on what portion of the clause was modified by “in the same manner and subject to the same terms and conditions”.  If you want more grammar, I respectfully refer you to the opinion.

What next?

The case was remanded for a trial at which extrinsic evidence, perhaps including the report on the 80 similar agreements and Chevron’s position, will be admitted to determine the intent of the parties.

Most of the time, if you read Stroud et al v. Hosford et al. even Hamilton Burger might have won on these facts. But when a lease subject to an override is terminated and replaced by another, Texas cases usually end up against the overriding royalty owner.

The Holding:

The court agreed with the jury that the lessee intentionally terminated the lease to, in part, terminate the overrides. The question was whether that conduct is actionable under Texas law. The court reviewed Texas decisions on the subject and said that, even with what appeared to be bad faith, absent a relationship giving rise to a duty of good faith and fair dealing the override owners had no right to recover. The lessee doesn’t generally owe an implied contractual covenant or a fiduciary type duty to protect the interest of an override owner such as to require the lessee to make repairs to well equipment, perpetuate the lease, and ensure that overrides are not extinguished, and the lessee was not precluded by any contract from entering into a new lease.

The court acknowledged cases suggesting that a party that engages in conduct to intentionally wash out an override may be subject to liability. But the facts of this case did not support liability. The override owners have asked the Texas Supreme Court to review the decision. 

The (Simplified) Facts:

Do the facts get more “intentional” than these?

  • A few days after the lessee was notified that the ORRI owners didn’t have renewal and extension clauses, the well ceased to produce because of a mechanical defect (not caused by the lessee).
  • The lessee was advised by his lawyer that he had no obligation to pay the ORRI owners.
  • He knew he had a 90-day cessation of operations clause.
  • He didn’t order repairs on the well because, among other reasons, he had already offered interests in the property to other investors under other (new) leases.
  • There was no work during the 90 days and the lease terminated.
  • The lessee admitted that he intentionally returned the well to production after the lease had terminated and he had obtained a new lease.
  • He did it that way because he didn’t want overrides on the new lease.
  • The new lease was signed less than one month after the well ceased to produce and during the 90-day continuance operations period.
  • After the 90-day period expired, the lessee represented to potential investors that he intended to repair the broken well.
  • The well was repaired at a cost of $7,500 and production was resumed under the new lease.
  • The new lease and well were sold for $2.5 million.

The Dissent

The lone dissent appeared to be offended that such disregard for the rights of others could be rewarded.  Relying on lease provisions ignored by the majority and viewing some of the same cases differently, she would have reached a different result.  She also would have found that the lessee tortuously interfered with the override owners’ rights in the leases.

Where Do Override Owners Go Now? 

I’m sorry to say, it could be here.  

Thanks to Bill Drabble for his valuable assistance.

Noted scientists Yoko and Sean share their knowledge of fracking

Gasland II made its villainous debut this week on HBO.  It‘s more egregious than the first in that it not only repeats disproven scenarios, but adds new ones that are equally misinformed. I complain about these injustices as a hobby, so don’t take my word for it. Listen to someone who makes a living understanding and explaining these matters.      

Steve Everley of Energy in Depth reveals Gasland II‘s misstatements and exaggerations about Dimock, Pennsylvania; Dish, Texas; the Lipskys in Parker County, Texas; methane leaks and climate change; water quality in Pavillion, Wyoming (and the EPA’s testing malpractice); Deborah Rogers in Fort Worth; fracking and earthquakes; alleged well failures and casing leaks, and more.

To be fair to the many Americans who have formed a negative opinion about oil and gas exploration, movies like Gasland could be their only source of information on the subject. Those who haven’t heard the other side of the story can now be enlightened. Let them decide for themselves.

Many years ago, in the days of cheap oil and cheaper natural gas, The Superior Oil Company often hired geologists and engineers away from Mobil Oil. As a result of many years of attracting good talent, Superior became the largest independent producer in the U.S. In 1986 Mobil acquired Superior. It was said at the time that the only reason for the transaction was so that Mobil could get its maps back. Sounds like a joke, but it makes you wonder how often things like that go on in the oil business. I don’t know, but I’d bet the answer is, with electronic records and the thumb-drive, more than you would think.

I’ve written before on the importance of protecting trade secrets, and how miscreants who’ve been careless on their journey to perdition have paid the price. Now it will be more difficult for data thieves.       

The Texas legislature adopted the Uniform Trade Secrets Act, effective September 1, 2013.  I direct you to Tilting the Scales, a blog from Jamie Ribman and Cleve Clinton, two of  my Looper Reed colleagues who explain the changes in the law very well.

The good news is the opportunity for a musical interlude about treachery, one of  a trial lawyer’s favorite topics.   

 

We begin with a tribute to global warming of a different sort.

For those not yet overexposed to reports on President Obama’s climate change policy announcement, I offer this reasonably objective factual summary of the highlights from the Washington Post (rather than the platitudes underlying many reports). A link to the text of the President’s plan is embedded in the Post article.

Also here is a reasonably objective and factual commentary from Bjorn Lomborg and criticism from the Heritage Foundation (rather than the hysteria from some on that side of the debate).

A provision in a contract, no matter how unequivocal, does not always trump the law. The oil and gas lease allowed assignments, but no change or division in ownership of  the land or royalties would be binding on the lessee until the acquiring party had furnished lessee with the instruments constituting his chain of title from the original lessor. Jones v. Clem says that the lessee could not rely on that clause if the lessor’s change of ownership occurred prior to the lessee’s acquisition, even if no notice was given to the previous lessee. (The case is not new, but is worth your attention.)

The Purchaser’s “Mistake”

When new lessee Jones acquired the lease from original lessee Western, he relied on a document he referred to as a “division order” – an unsigned piece of paper from Western’s lease records indicating that the original lessor Smith owned a .125 royalty interest. That document is not a division order under the Texas Natural Resources Code (See §91.401 (3)).

The lessor – Smith’s predecessor – quitclaimed to Clem, who recorded the deed but did not notify the lessee, Western. Nevertheless, Western paid Clem until 1999 before ceasing payment. Jones acquired the lease from Western in 2002 and received the so-called “division order” showing the .125 royalty interest is Smith, so Jones began paying Smith. Clem testified that he thought the well had ceased to produce after 1999, but later learned that the well had been producing. Clem sued Jones and Smith for improperly-paid royalties.

“Constructive Notice” – Again

As the courts often remind royalty owners, the doctrine of constructive notice creates a harsh but irrebutable presumption of actual notice of matters in the public records. Jones was charged with constructive notice of Clem’s right to be paid royalties, and his reliance on the purported “division order” was misplaced. Constructive notice trumped the change-in-ownership clause.

Jones reminded the court that ordinarily, change-in-ownership clauses override the constructive notice doctrine. But Clem’s ownership through the quitclaim deed was a matter of public record when Jones acquired the lease. Clem was already in the chain of title and his ownership would have been easily discoverable by searching the county clerk’s records or obtaining a title opinion. Jones could not rely on failure of notice because the change occurred prior to the time Jones took over the lease.

The Takeaway – They Call it Due “Diligence” For a Reason

The urge to reduce pesky land and legal costs when acquiring a property is strong and understandable, especially when the well has been producing and royalties have been paid with no complaints. But there are limits to what you should rely on without conducting your own investigation. As the court saw it, Jones could have ordered a title opinion, or at least a landman’s examination of the public records. It isn’t clear why Jones didn’t notice in 2002, when he acquired the lease, that Western had not been paying Smith since 1999, but that should have been a warning.

At Looper Reed we advise our clients that it is good business to accommodate your neighbor informally, if you can. Sometimes that leads to attempted world domination, as Chamberlain learned from Hitler in 1938. Closer to home it is my college-age son using his bedroom floor as a summertime closet. It can also lead to litigation. This is how it was at the Texas Supreme Court in Merriman v. XTO Energy.

What is the accommodation doctrine?

If the mineral owner has only one method for developing and producing the minerals, that method may be used regardless of whether it precludes or substantially impairs an existing use of the serving surface estate. On the other hand, if the mineral owner has reasonable alternative uses, one of which permits the surface owner to continue to use the surface in the manner intended and one of which would preclude that use by the surface owner, the mineral owner must use the alternative that allows continued use of the surface by the surface owner.

What must the surface owner prove?

The surface owner must prove that (1) the lessee’s use completely precludes or substantially impairs the existing use; and (2) there is no reasonable alternative method available to the surface owner by which the existing use can be continued. If he carries that burden, then he must further prove that given the particular circumstances there are alternative, reasonable and customarily industry accepted methods available to the lessee which would allow both uses.

How did he do in this case?

Merriman owns a 40 acre tract with a home and a barn, permanent fencing, and corrals used in cattle operation. He leases several other tracts and once a year brings his cattle to the 40 acres for a round-up.

XTO was lessee of the severed mineral estate. Merriman claimed the proposed location would interfere with his cattle operation and that XTO failed to accommodate his existing use of the surface, exceeded its rights in the mineral estate, and trespassed.

This decision turned on some inside-baseball summary judgment evidence rules. It is best to leave your trial lawyers in charge of such details. The point is that Mr. Merriman did not produce evidence that he had no reasonable alternatives for his cattle operation. The good news was that a surface owner need not prove that he has no reasonable alternative for general agricultural purposes.

The court concluded that the well was an inconvenience to Mr. Merriman and would result in some amount of additional expense and reduced profitability. That hindrance does not rise to the level of evidence that the surface owner has no reasonable alternative method to maintain the existing use.

Is there an unspoken issue?

XTO’s lease was of the severed minerals. You can count on a surface owner who will never benefit from a well in his backyard to be a tougher customer than the royalty owner who stands to receive a fat monthly check for his troubles.

We offer Mr. Merriman our condolences and this musical tribute to his cattle operation. Or you might prefer this one.

Politico and other sources report that President Obama promised a crowd of supporters in northern California recently that he would unveil his climate change strategy sometime soon. What it might look like is unknown.  It has been suggested that the policy will revolve around EPA pollution sources like power plants. 

It is reported that there is no relation between the Keystone and climate change initiatives. The State Department concluded that the Keystone XL pipeline which, as if you didn’t know it already, would import Canadian tar sands oil, would not meaningfully increase global pollution. This finding was attacked by environmental groups, and even another government agency, the EPA.

Before the election the President’s spokesperson said he had no plans for a carbon tax. It appears that he has changed his mind.  

Could this be the result they have in mind for oil and gas?

Speaking of climate change, as in any debate the same data can be used bydifferent sides for opposing purposes.  But there is always someone who seeks somthing closer to the rational center of the debate than do the radical elements.

Co-author Jason Emmitte

The Texas Railroad Commission has clarified and strengthened Rule 13, relating to requirements for drilling, putting pipe down, and cementing wells. The amendment will go into effect on January 1, 2014.

Generally, the revisions govern the casing and cementing of all wells, unlike previous versions.  Highlights are:

  • New and more precise definitions, for example, “hydraulic fracturing”.
  • Transfer from the Texas Commission of Environmental Quality (TCEQ) to the Groundwater Advisory Unit of the Oil and Gas Division of the RRC of responsibility for determining at what depth usable-quality water must be protected.
  • The authority to require a better quality of cement mixture to further protect groundwater that could be harmed by a poor casing job or the use of below-grade cement.
  • A cementing report must be filed with the RRC within 30 days of completion of a well or within 90 days of cessation of drilling, whichever is earlier.
  • Operators will be required to pressure-test well casings to the maximum pressure expected, monitor the annular space for pressure changes that could indicate a casing leak, verify the mechanical integrity of surface and intermediate casing when drilling time exceeds 360 hours, and seek prior approval before setting surface casing deeper than 3,500 ft.
  • Additional testing on wells less than 1,000 ft below usable groundwater
  • Use of air- and water-based drilling fluid until surface casing is cemented.
  • New requirements for well control measures and blowout preventers.
  • Additional cementing when an injection or disposal well is within a quarter mile.

The effect of the amendment is to more clearly outline the requirements for all wells, consolidate the requirements for well control and update the requirements for drilling, casing, cementing and fracture stimulation.

These revisions are timely, amid the debate over whether there should be  federal rules governing hydraulic fracturing.  Here is an article in Scientific American offering arguments for and against federal fracking rules. 

  

Co-author Travis Booher

The regular session of the 2013 Texas Legislature is over and now it’s time to assess the damage. Bills significant to the oil and gas industry, and their fate, are as follows:

HB 100 – Forced unitization: Failed. Regardless of your opinion of the merits, this was no surprise.

SB 108 – Allowing adverse possession of property by a cotenant heir after 15 years: Failed. That was a good thing. The bill would have created adverse possession of  lands from a cotenant who is also a family member (hence, a “cotenant heir”). The bill may have intended to clear title to land in which numerous heirs own an interest because of intestate succession, but it surely would have created conflict at family reunions. Texas already has a method to adversely possess lands, and having numerous affidavits claiming that lands have been successfully adversely possessed (as allowed by the bill) would create title uncertainty.

SB 873 – Permitting process for oil and gas wells and use of water: Failed (left pending in committee).

SB 1747 – Transportation reinvestment zones: Passed.

See our May 14 entry  for comments on these last two.

HB 2166 – Railroad Commission’s sunset bill: Failed. “Touchy” parts (as in strongly resisted by those with something to lose, to wit, some or all of the RRC commissioners) of the bill were new ethical requirements for the commissioners, including resigning before running for another statewide office, prohibitions on campaign contributions, and reporting of contributions from parties having business before the commission.

SB 219 – The Texas Ethics Commission’s sunset bill: Passed. The resign-to-run portion of failed HB 2166 found its way into this one. We understand that the rationale for opposition to the resign-to-run requirement was that the same rule would not apply to other statewide officeholders. This bill is awaiting the Governor’s signature.

HB 2590 – Effect of foreclosure sale of property subject to an oil and gas lease: Passed, awaiting the Governor’s signature. This bill, sponsored by a producer, attracted opposition by other producers after the session closed. They promise to ask the Governor to veto it. If you take a lease subject to a deed of trust and the property is later foreclosed, you lose your lease unless you have a subordination agreement. This bill changes that: You wouldn’t lose your lease (if recorded before the security interest or after the security interest but before the foreclosure sale).  You would lose use of the surface, however, and the bill imposes new indemnification obligations on the lessee.

CR 53 – Confirming the pecan pie as the official pie of Texas. Passed.