Articles Posted in Recent Cases

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On January 29, the Texas Supreme Court issued its opinion in Hysaw v. Dawkins, a unanimous decision with opinion by Justice Guzman. Our firm represents one group of the plaintiffs in the case, which concerns construction of Ethel Hysaw’s will.

Ethel Hysaw had three children: Dorothy, Howard and Inez. Her will, executed in 1947, divided her lands in Karnes County among her three children. She gave one tract to each child. But she divided the royalties on oil and gas differently, and the dispute in the case was over how the will disposed of her royalty interest in the three tracts. The descendants of Dorothy and Howard argued that Ethel’s will divided all oil and gas royalties equally among Dorothy, Howard and Inez. The descendants of Inez argued that Ethel’s will divided a 1/8th royalty equally among her children, but left all other royalties to the child who got the surface of the property.  Wells producing from the Eagle Ford shale were drilled on the lands willed to Inez, and the lease signed by Inez’s descendants provides for 22.5% royalty. Inez’s heirs argued that Dorothy and Howard’s descendants each should receive 1/3 of 1/8th royalty, or 4.1666%, from those wells, and that they should receive the rest, .141666%. Dorothy and Howard’s descendants argued that each family should receive 1/3 of the 22.5% royalty, or 7.5% each.

Ethel’s will provided that

each of my children shall have and hold an undivided one-third (1/3) of an undivided one-eighth (1/8) of all oil, gas or other minerals in or under or that may be produced from any of said lands, the same being a non-participating royalty interest.

Other language in the will provided that, if Ethel sold any of her royalty during her lifetime, then her children “shall each receive one-third of the remainder of the unsold royalty.”

The trial court sided with Howard and Dorothy’s descendants. The San Antonio Court of Appeals reversed, holding that Inez’s descendants’ construction of the will was the correct one. The Supreme Court held that the trial court was correct, ruling that Ethel intended to devise all of her royalty equally among her three children.

The issue addressed by the Supreme Court in construing Ethel’s will is known as the “double-fraction problem.” It appears more often in construction of deeds that convey or reserve a royalty interest. The problem arises when the royalty interest conveyed or reserved is described as a fraction of 1/8th — as, in Ethel’s will, she described the interest devised to each child as 1/3 of 1/8. As Justice Guzman says, “when viewed against a historical backdrop in which the standard royalty was 1/8 and many landowners erroneously believed the landowner’s royalty could be no greater than 1/8, the quantum of the interest conveyed or reserved by double-fraction language is subject to disagreement.” The Supreme Court decided to take the case because “the proper construction of instruments containing double-fraction language is a dilemma of increasing concern in the oil and gas industry, as uncertainty abounds, disputes proliferate, and courts have seemingly varied in their approaches to this complicated issue.”  After reviewing all of the language of Ethel’s will, the Court concluded that Ethel intended to treat her three children equally, giving each 1/3 of the royalty in all of her property.

Our firm has handled several disputes involving the double-fraction problem. Justice Guzman’s opinion is a valuable addition to the jurisprudence in this area and will provide guidance to lawyers construing instruments that contain double fractions.

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Last week the Texas Supreme Court denied Chesapeake’s motion for rehearing in Chesapeake v. Hyder. The court originally affirmed the lower courts’ opinions in favor of the Hyders, with four justices dissenting. On rehearing, the court’s alignment did not change, but Justice Hecht issued a new opinion for the majority, and Justice Brown issued a new dissenting opinion, joined by Justices Willett, Guzman and Lehrmann.

These new opinions end a long fight between Chesapeake and the Hyders over the deductability of post-production costs from their gas royalties in the Barnett Shale area. Although the leases contain strong language against deduction of post-production costs, Chesapeake argued that, under the precedent of the prior Supreme Court decision of Heritage Resources v. NationsBank, 929 S.W.2d 118 (Tex. 1996), it could deduct post-production costs. Chesapeake lost in the trial court and the court of appeals. The Supreme Court granted Chesapeake’s petition for review but affirmed the decisions below, split 5 to 4. With the denial of Chesapeake’s motion for rehearing, that decision is now final.

The Hyders’ lease allows Chesapeake to drill horizontal wells from surface locations on the Hyders’ property which produce from adjacent lands — in other words, to use the Hyders’ land to produce oil and gas from adjacent properties. As consideration for that right, the Hyder lease grants the Hyders a royalty interest in production from those wells — an “overriding royalty,” carved out of Chesapeake’s working interest in the leases covering those adjacent lands. The Hyder lease provides that the Hyders are granted “a perpetual, cost-free (except only its portion of production taxes) overriding royalty of five percent of gross production obtained” from such wells. The argument was over the meaning of that language. Chesapeake argued that “cost-free” meant free of production costs; the Hyders argued that “cost-free” means fee of production and post-production costs.

Originally, Chesapeake also contended it had the right to deduct post-production costs from the royalty paid on production from wells producing from the Hyders’ property. The no-deduction language in the lease related to royalties on Hyder wells was more clear than the language related to the overriding royalty, and Chesapeake’s appeal to the Supreme Court did not dispute the lower courts’ opinions on the lease royalty clause. Nevertheless, the Supreme Court opinions address the lease language related to the royalty on Hyder wells, as relevant to its construction of the “no cost” language in the overriding royalty clause. The opinions’ discussion of this royalty clause gives clarity to how courts should construe other gas royalty clauses, and how lawyers should draft them to avoid disputes.

The Hyder lease provides that royalty on gas produced from the Hyders’ lands shall be 25% “of the price actually received by Lessee.” Because of other language in the lease, Chesapeake did not dispute that the “price actually received by Lessee” was the price received by Chesapeake’s affiliate, Chesapeake Energy Marketing, which bought the gas from Chesapeake and resold it to third parties. The lease also provided that the gas royalty would be paid “free and clear of all production and post-production costs and expenses.” Referring to this language, Justice Hecht said:

Often referred to as a “proceeds lease”, the price-received basis for payment in the lease is sufficient in itself to excuse the lessors from bearing postproduction costs. … But the royalty provision expressly adds that the gas royalty is “free of all production and post-production costs and expenses,” and then goes further by listing them. This addition has no effect on the meaning of the provision. It might be regarded as emphasizing the cost-free nature of the gas royalty, or as surplusage.

In other words, if a lease simply says that royalty shall be based on the price received by the Lessee (or, if the gas is sold to an affiliate of Lessee, the price received by the affiliate), then the Lessee may not deduct post-production costs from the royalty. It is not necessary to add language that the royalty is “free of all post-production costs,” and in fact such language is “surplusage.”

Notably, Justice Brown’s dissenting opinion agrees with the majority on this point:

… the Hyders’ gas royalty is “twenty-five percent (25%) of the price actually received” upon resale by Chesapeake. That price necessarily reflects any post-production value added, and the Court rightly observes it thus does not bear post-production costs.

Chesapeake v. Hyder is the first Supreme Court case since Heritage v. NationsBank to examine lease language regarding deductability of post-production costs from lease royalties. And it is the first Texas Supreme Court case in some time upholding a judgment in favor of royalty owners.

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The Texas Supreme Court recently denied a petition for review filed by the Aycocks in their suit against Vantage Fort Worth Energy. The trial court and  court of appeals both ruled against the Aycocks’ claims. The holding in the case is not surprising, but dicta in the court of appeals’ opinion may raise some eyebrows among oil and gas lawyers.

Desdemona Cattle Company owned an undivided mineral interest in 1,409 acres in Erath County. In March 2008 Desdemona leased its undivided interest to Vantage Fort Worth Energy for $750 per net mineral acre, for a total of $394,574.60. The Aycocks also owned an undivided mineral interest in the 1,409 acres, and when they learned of Desdemona’s lease to Vantage, they contacted Vantage and sought to lease their interest. Vantage never replied. No well was ever drilled, and the Desdemona lease expired in March 2011.

In May 2012, the Aycocks sued Vantage. They claimed that they had ratified the Desdemona lease and were entitled to be paid a bonus of $750 per net mineral acre for their mineral interest. The trial court denied the Aycocks’ claim. The Eastland Court of Appeals affirmed, holding that the Aycocks had no basis to assert a claim for unpaid bonus against Vantage.

The interesting part of the court’s opinion is what it says the Aycocks could have done. The court says the Aycocks could have sued Desdemona and recovered a share of the lease bonus Vantage paid to Desdemona. The reasoning goes like this: Desdemona is a cotenant in the mineral estate with the Aycocks. The oil and gas lease signed by Desdemona purported to lease the entire mineral estate to Vantage. The Aycocks had the right to ratify Desdemona’s lease, thereby approving Desdemona’s unauthorized act of purporting to lease the Aycocks’ undivided mineral interest; and having ratified Desdemona’s unauthorized act, the Aycocks are entitled to their share of any bonus and royalties paid under or for the oil and gas lease.

Typically, an oil and gas lease does not specify the undivided interest owned by the lessor. The lease simply says that the lessor is leasing the oil and gas in the land. A proportionate reduction clause in the lease provides that, if the lessor owns less than all of the oil and gas in the property, then any royalties owed under the lease will be proportionately reduced to reflect the undivided interest owned by the lessor. The bonus paid for the lease is calculated based on the parties’ understanding of the mineral title owned by the lessor when the lease is signed. So, even though the lease does not specify the undivided interest owned by the lessor, the lessor is not attempting or purporting to lease any other cotenants’ undivided interest in the property.

Cases cited by the court of appeals do hold that a cotenant can ratify an oil and gas lease and thereby become subject to that lease. None of those cases has held that a ratifying cotenant can recover a share of the bonus paid to the signing cotenant for the lease. Unless it can be shown that the lessee erroneously paid the signing cotenant for a mineral interest owned by a non-signing cotenant, I don’t think a signing cotenant should be required to share his/her bonus with another cotenant to decides to ratify the lease. To that extent, it appears to me that the court of appeals’ dicta is not correct.

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Lawyers have filed a new class action against Chesapeake in Pennsylvania. The suit is against Chesapeake Energy and Chesapeake Marketing, filed in the US District Court for the Middle District of Pennsylvania. The plaintiffs also filed a demand for arbitration with the American Arbitration Association against Chesapeake Appalachia, LLC. According to the arbitration demand, title to Chesapeake’s leases in Pennsylvania is held by Chesapeake Appalachia, and many of those leases contain arbitration clauses requiring the lessor to arbitrate its claims. The complainants make the arbitration demand on behalf of all royalty owners in Pennsylvania who have leases with arbitration clauses.

The suit and the arbitration demand make similar claims, that Chesapeake through its affiliated companies “(1) paid the royalties on less than the revenue paid by the buyer, (2) paid no royalty on the proceeds of derivative contracts, (3) deducted costs incurred after [Chesapeake] no longer held title to the gas, (4) deducted gathering costs that were inflated through collusion and self-dealing with Access Midstream Partners, L.P., (5) deducted transportation costs that were fraudulent in their amounts, (6) deducted marketing fees that were never incurred, and (7) calculated the royalties on some of the gas without determining either the price paid or the costs deducted.”

The plaintiffs are represented by Caroselli Beachler McTiernan & Coleman, LLC in Pittsburgh and Robert C. Sanders, of Upper Marlboro, Maryland.

The class action suit:  OSTROSKI CLASS ACTION – FINAL FILED VERSION

The arbitration complaint:  Class Arbitration Demand and Complaint

A class action against Chesapeake for underpayment of royalties was filed in 2013 in Pennsylvania, Demchak Partners Limited Partnership, et al., v. Chesapeake Appalachia, LLC, Case No. 3:13-CV-02289-EM (US Dist. Court M.D. Pa.). A proposed settlement of that case has been submitted to the court for approval. It appears that the settlement of that case only applies to certain royalty owners who have “market enhancement clauses” in their leases, defined by the settlement agreement as “clauses or provisions in an oil and gas lease that preclude the lessee from deducting Post-Production Costs
incurred to transform leasehold gas into marketable form or make such gas ready for sale or use but permit the lessee to deduct a pro rata share of Post-Production Costs incurred after the gas is marketable or ready for sale or use.”

Chesapeake’s stock has taken a beating. From a high of $29.22/share on June 14, 2014, the stock closed at $4.27/share on December 7.

CHK shares

 

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Three amicus briefs have been filed in support of the Hyders, opposing Chesapeake’s motion for rehearing of the Texas Supreme Court’s decision in Chesapeake v. Hyder.

An amicus brief was filed by the City of Fort Worth and others who have filed suits against Chesapeake and Total to recover additional royalties on production in the Barnett Shale area:  City of Fort Worth Amicus Brief

An amicus brief was filed by a group of royalty owners represented by Dan McDonald, a Fort Worth attorney who has filed 430 separate suits against Chesapeake, representing more than 20,900 royalty owners in Johnson and Tarrant Counties: Barnett Shale Royalty Owners Amicus Brief

Our firm, on behalf of Texas Land & Mineral Owners’ Association and the National Association of Royalty Owners-Texas, filed an amicus brief supporting the Hyders: TLMA and NARO Texas Amicus Brief

Chesapeake lost its appeal to the Texas Supreme Court in a 5-4 decision and has asked the Texas Supreme Court to reconsider its decision. Amicus briefs supporting Chesapeake’s motion for rehearing have been filed by the Texas Independent Producers and Royalty Owners’ Association (TIPRO), the Texas Oil & Gas Association (TXOGA), Sandridge Exploration & Production, BP America, Devon Energy, EOG Resources, EXCO Resources, Shell Western E&P, Trinity River Energy, Unit Corp. and XTO Energy.

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The Texas Supreme Court asked the Hyders to respond to Chesapeake’s motion for rehearing in Chesapeake v. Hyder, after the court’s recent 5-4 decision in favor of the Hyders. Several amicus briefs (“friend of the court” briefs by entities not parties to the case) were filed in support of Chesapeake’s motion for rehearing. Exploration companies are clearly unhappy with language in Chief Justice Hecht’s majority opinion and asking the court to modify its language. The amicus briefs made the San Antonio Business Journal’s “Eagle Ford Shale Insight” feature.

I’ve written about this case before, and our firm filed an amicus brief in the case before the court issued its opinions, on behalf of Texas Land & Mineral Owners’ Association and the National Association of Royalty Owners-Texas.

So far, on rehearing, the following parties have joined in amicus briefs criticizing the court’s majority opinion:

  • Texas Oil & Gas Association
  • Texas Independent Producers and Royalty Owners Association
  • BP America Production Co.
  • Devon Energy Production Co. LP
  • EOG Resources Inc
  • EXCO Resources Inc
  • Shell Western E&P Inc
  • Trinity River Energy LLC
  • Unit Corp.
  • XTO Energy Inc
  • SandRidge Exploration and Production LLC

The Texas General Land Office, joined by Longfellow Ranch LP and Wesley Ranch Minerals, LP have filed an amicus brief supporting the court’s opinion. The GLO and SandRidge are engaged in a separate suit that concerns a lease provision in the Texas Relinquishment Act lease form and Sandridge is concerned that the court’s opinion could impact its case, prompting its interest in Hyder.

The issue in Hyder is the meaning of a clause that grants the Hyders an overriding royalty on horizontal wells drilled on adjacent leases from locations located on the Hyder property. The lease provision granting the overriding royalty calls for “a perpetual, cost-free (except only its portion of production taxes) overriding royalty of five percent (5%) of gross production obtained” from wells bottomed under neighbors’ land.” The parties dispute whether, in paying the Hyders this overriding royalty, Chesapeake can deduct post-production costs. The court held that it cannot. “Cost-free” includes post-production costs, according to the majority opinion.

One might think it curious that Texas Independent Producers and Royalty Owners Association (TIPRO) would file an amicus brief supporting Chesapeake’s reading of the lease. How can an organization purporting to represent royalty owners advocate a position detrimental to their interests? The San Antonio Business Journal quotes TIPRO’s President Ed Longanecker’s press release on its support of Chesapeake:

TIPRO believes the Court’s erroneous interpretation of the overriding royalty interest (“ORRI”) at issue will affect thousands of ORRIs in the state of Texas, many of which have been in existence for decades. If allowed to stand, the ruling that the ORRI prohibits the deduction of post-production costs will result in substantial unintended windfalls for ORRI owners. It may also call into question the commercial viability of marginal wells, leading to the possible plugging of wells across the state and thus less production and royalty revenue.

One might think that, if an oil company agreed to pay a “cost-free” overriding royalty, that payment – free of post-production costs – would not constitute an “unintended windfall” to the royalty owner. Perhaps TIPRO should reconsider its name.

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The Texas Supreme Court heard arguments yesterday in the fight between the City of Lubbock and Coyote Lake Ranch over whether the accommodation doctrine applies to severed water rights. Here is a good article from the Texas Tribune summarizing the arguments. The oral arguments can be viewed on the Texas Supreme Court website, here.  My earlier discussion of the case can be found here.

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I have written before about landowners’ efforts to collect damages for personal injury and property damage caused by nearby oil and gas exploration operations on the theory that such activities cause a nuisance. Nuisance is a recognized tort claim. To recover, a person must prove that (1) the person has an interest in land (2) the defendant interfered with or invaded the person’s interest in the land by conduct that was negligent, intentional, or abnormal and out of place in its surroundings, (3) the defendant’s conduct resulted in a condition that substantially interfered with the person’s use and enjoyment of his land, and (4) the nuisance caused injury to the plaintiff.

In the case decided by the court of appeals in San Antonio, Cerny v. Marathon Oil, the Cernys bought an acre of land with a residence on it in 2002. In 2012, Marathon began drilling wells in the area. Plains Exploration and Production also constructed production facilities in the area. Eventually, there were 22 well sites within 1 1/2 mile of the Cernys’ home.  The Cernys hired experts, who measured chemicals in the air around their home and near oil and gas production sites in the area. The experts included an air quality expert, a forensic meteorologist, and a toxicologist.

The Cernys sued Marathon and Plains, alleging that the fumes, odors and dust from their facilities caused physical health symptoms and made their home uninhabitable. Marathon asked the trial court to dismiss the case, on the ground that the Cernys had no evidence that their facilities were the “proximate cause” of the Cernys’ alleged damages.

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During my vacation I read The Quartet: Orchestrating the Second American Revolution, 1783-1789, by Joseph J. Ellis. Ellis tells the story of the writing and passage of the US Constitution, orchestrated, he asserts, by George Washington, Alexander Hamilton, John Jay and James Madison (the quartet).

Before the adoption of the Constitution, the thirteen states were essentially independent countries who had won their independence but failed to found a new country. The “United States” were always referred to in the plural. The genius of the quartet, says Ellis, was the compromise they crafted in the Constitution in the debate over federal vs. state power. States were understandably reluctant to relinquish their sovereignty, but the quartet knew that the new nation, to survive, had to have federal power – to levy taxes, provide for common defense, and regulate commerce among the states. The Constitution enumerates the powers of the federal government. The Bill of Rights – the first ten amendments to the Constitution, passed simultaneously — enumerates the rights retained by the states and the people, limitations on federal power. The tenth amendment provides: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.” The contours of this compromise are still being debated in courts across the land. “States rights” were fighting words in the civil war, and today are the battle cry of states seeking to curb the federal government’s regulation of health care, water quality, voting rights, and abortion.

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