Articles Posted in Recent Cases

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A team of lawyers in Pennsylvania has filed an anti-trust suit against Chesapeake and Williams Partners (Formerly Access Midstream Partners) alleging that they conspired to restrain trade in the market for gas gathering services in and around Bradford County, Pennsylvania. The plaintiffs also sued Anadarko, Statoil, and Mitsui, all of whom own interests in Chesapeake’s leases. The suit alleges violation of the oil and gas leases granted by the plaintiffs, violations of ant-trust law, and violation of the Racketeer Influenced and Corrupt Organizations Act (RICO). A copy of the complaint, filed in federal court in Pennsylvania, can be found here.

The team of lawyers who filed this suit have their own website, “Marcellus Royalty Action.” They say that their approach differs from other suits against Chesapeake in that they will not seek class action status, they intend to pursue discovery before negotiating settlements, and they will sue all working interest owners responsible for royalty payments.

Royalty owner suits against Chesapeake have become a growth industry for attorneys. Recently, Chesapeake requested that multiple royalty owner suits against it in the Barnett Shale region of Texas be assigned to a pretrial court for consolidated and coordinated pretrial proceedings.  (Defendants Joint Motion for Transfer and Request for Stay) The request says that more than 3,200 landowners have filed 97 separate suits in Johnson, Tarrant and Dallas Counties alleging that Chesapeake and Total E&P, USA, Inc. (Chesapeake’s working interest partner in the Barnett Shale) have charged excessive post-production costs. This request results primarily from multiple suits filed by the McDonald Law Firm. See http://royaltyripoff.com/.  McDonald has said he does not oppose Chesapeake’s request.

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On February 6, 2015, The Supreme Court of Texas released its second opinion in FPL Farming Ltd. (“FPL”) v. Environmental Processing Systems, L.C. (“EPS”).  The Beaumont court of appeals had held that injected fluids that migrate beyond the boundary of the land owned by the surface owner constitute a trespass on a neighbor’s property.  The Supreme Court declined to address whether or not subsurface wastewater migration is actionable as a common law trespass in Texas, and instead focused on consent as a general element of a trespass cause of action.

Until recently, subsurface wastewater migration had never been addressed by a Texas appellate court, and the assumption in the disposal industry was that such incursion was not actionable. But the Beaumont Court of Appeals, in FPL v. EPS, concluded that the neighbor does have a trespass claim.  The Beaumont Court issued two opinions in the case; the first was appealed to the Supreme Court which reversed and remanded to the Court of Appeals, and the second resulted in the opinion released February 6.

The facts in FPL are these: EPS operates an injection well for non-hazardous waste on land adjacent to the land owned by FPL. FPL had previously objected to an amendment of EPS’s permit that increased the rate and volumes allowed to be injected. The Austin Court of Appeals affirmed the permit amendment over FPL’s objections, ruling that “the amended permits do not impair FPL’s existing or intended use of the deep subsurface.” FPL Farming Ltd. v. Tex. Natural Res. Conservation Comm’n, 2003 WL 247183 (Austin 2003, pet. denied). FPL then sued EPS for trespass and negligence, alleging that injected substances had migrated under FPL’s tract causing damage. FPL lost a jury trial and appealed. The Beaumont Court affirmed, holding that because EPS held a valid permit for its well, “no trespass occurs when fluids that were injected at deep levels are then alleged to have later migrated at those deep levels into the deep subsurface of nearby tracts.” FPL Farming Ltd. v. Environmental Processing Systems, L.C., 305 S.W.3d 739, 744-745 (Tex.App.-Beaumont). The Supreme Court reversed, holding that Texas laws governing injection well permits “do not shield permit holders from civil tort liability that may result from actions governed by the permit.” FPL Farming Ltd. v. Environmental Processing Systems, L.C., 351 S.W.3d 306, 314 (Tex. 2011). But the court was careful to say it was not deciding that owners of injection wells could be guilty of trespass if their injected fluids migrated onto other lands. “We do not decide today whether subsurface wastewater migration can constitute a trespass, or whether it did so in this case.” The court remanded to the court of appeals for it to consider the other issues raised by the appeal. Continue reading →

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On January 30, the Supreme Court issued its opinion in Hooks v. Samson Lone Star, Limited Partnership, No. 12-0920. In doing so, it kept alive a $21 million verdict against Samson and limited its prior holdings barring suits by mineral owners based on the statute of limitations.

The principal claim the Hooks made against Samson alleged breach of a lease provision intended to protect the Hooks’ lease against drainage from wells on adjacent lands. The lease provided that, if a gas well is drilled within 1,320 feet of the lease, Samson must either drill an offset well, release sufficient acreage for an offset well to be drilled, or pay “compensatory royalty” – the amount of royalty the Hooks would be entitled to if the well on adjacent lands had been drilled on their lease.

In 2000, Samson permitted a well on lands adjacent to the Hooks lease, and it approached the Hooks asking permission to pool portions of the Hooks land with that well. Mr. Hooks asked Samson how close the well would be to the Hooks lease boundary. Samson sent him a plat showing that the location of the well would be 1,400 feet from the lease. Based on this, the Hooks agreed to the pooling.

In 2007, in connection with related litigation, the Hooks discovered that the adjacent well in fact was located within 1,320 feet of the Hooks lease, and the Hooks sued Samson for misrepresenting the well’s location and inducing them to agree to the pooling. They sought damages under the lease compensatory royalty clause – the royalty they would have received had the offending well been located on the Hooks’ lease. They argued that the four-year statute of limitations applicable to their claim should not apply because Samson had fraudulently induced them to believe that the well was 1,400 feet from their lease. The jury found that the Hooks should not have discovered the true facts until less than four years before bringing suit. It awarded more than $20 million damages to the Hooks. Continue reading →

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As I have written, Chesapeake has asked the Texas Supreme Court to reverse the San Antonio Court of Appeals’ decision in Chesapeake v. Hyder. The court of appeals ruled that Chesapeake could not deduct post-production costs from the Hyders’ royalty.

The Texas Land & Mineral Owners’ Association and the National Association of Royalty Owners – Texas have filed an amicus brief in Hyder supporting the Hyders’ case. The brief can be viewed here. Final Amicus_Brief_Chesapeake_v__Hyder.pdf It was authored by my firm and by Raul Gonzalez, who was a member of the Texas Supreme Court when the court decided Heritage v. NationsBank, the case relied on by Chesapeake as authority for its deduction of post-production costs.

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Last week the San Antonio Court of Appeals decided Lightning Oil Company v. Anadarko, No. 04-14-001152-CV, a case involving “mineral trespass.”  What is interesting about the case is what the court did not decide.

Lightning Oil Company owns two oil and gas leases covering 3,250 acres within the Briscoe Ranch in Dimmit County. The Briscoe Ranch owns the surface but not the minerals in this 3,250 acres. To the south of Lightning’s leases is the Chaparral Wildlife Management Area, a wildlife sanctuary managed by Texas Parks and Wildlife Department. TPWD owns the surface and 1/6 mineral interest in the Chaparral WMA. The Light family (some of whom own Lightning Oil) own the other 5/6 mineral interest. Anadarko holds oil and gas leases on the Chaparral WMA.

The TPWD lease to Anadarko prevents use of the surface of the Chaparral WMA for oil and gas wells except with TPWD consent, and says that Anadarko must use off-site drilling locations “when prudent and feasible.” Anadarko made an agreement with Briscoe Ranch to use the surface of the Ranch to drill horizontal wells under the Chaparral WMA. The first location Anadarko chose is located on the land covered by the Lightning Oil Company leases. So Anadarko proposed to drill a horizontal well from a surface location on Lightning’s lease; the well would penetrate the Eagle Ford formation on Lightning’s lease, but no perforations, or “take points,” in the well would be located on Lightning’s lease.

Lightning sued Anadarko to prevent it from drilling its well, and it sought a temporary injunction to stop the well while the case was pending. After a hearing on Lightning’s application for temporary injunction, the trial court refused to grant the injunction, and Lightning appealed.

The opinion of the San Antonio Court of Appeals (Lightning Oil Co v. Anadarko.pdf ) affirmed the trial court, holding that Lightning had failed to prove a probable, imminent and irreparable injury if Anadarko is allowed to drill its well.

To obtain a temporary injunction, the plaintiff must prove that it can probably prevail when a trial on the merits of its case is held, and that it probably will suffer irreparable injury if the temporary injunction is not granted to maintain the status quo until trial on the merits.

Lightning alleged that Anadarko’s well would trespass on Lightning’s mineral estate. Anadarko argued that its well would not result in a trespass.  The Court of Appeals decided not to address that question. Instead, it focused on whether Lightning’s evidence showed that it would probably suffer irreparable harm if the well were drilled. After reviewing the parties’ testimony, the Court held that Lightning’s evidence failed to show probable irreparable harm. The testimony, said the Court, only showed a “potential” for injury, and Lightning failed to show that the potential injury would not be “susceptible to quantification and compensation.”

The more interesting question in this case is the one the Court of Appeals elected not to address — whether the drilling of Anadarko’s well would constitute a trespass.  In my experience, operators routinely obtain permission from the surface owner to locate well pads off-lease, but do not consider it necessary to obtain consent of the mineral owner. The general theory is that the owner of the surface estate owns the land from the surface to the center of the earth; the owner of the mineral estate owns only the oil, gas and other minerals under the land. Under this theory, a mineral trespass can occur only if a well actually produces (or perhaps harms) the oil, gas or other mineral under the land. Following this line of reasoning, drilling a well through a formation capable of producing oil or gas would not constitute a mineral trespass. And the right to grant permission to use the surface estate for an off-lease location, under this theory, belongs to the surface owner.

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Last week the Texas Supreme Court heard oral arguments in Steadfast Financial v. Bradshaw, No. 13-0199. The case presents the court with another opportunity to grapple with an issue that Texas courts have struggled with since the court first addressed it in 1937 – what duty does the owner of the mineral estate owe to a non-participating royalty owner?

The term “non-participating royalty owner” is the name commonly given to a royalty interest in minerals created by a grant or reservation in a deed.  “Non-participating” is really redundant; it means that the holder of the royalty estate has no right to lease the mineral estate or to receive any bonus for a lease.  In fact, that is true of all royalty interests. A better name for this type of royalty interest might be “fee royalty interest,” to distinguish it from a royalty interest reserved by the mineral owner in an oil and gas lease.

The owner of a fee royalty interest, having no right to lease or to drill wells, is dependent on the owner of the mineral estate out of which his/her royalty interest must be paid; the royalty interest has no value unless the mineral interest is leased and wells are drilled. In recognition of this fact, court decisions have imposed a duty on the mineral owner to protect the royalty owner’s interest. How this duty is defined, and in what situations the duty is imposed, have been issues Texas courts have struggled with for many years. The cases that have addressed this issue over the years show how the common law develops — very slowly, and with varied results for the litigants involved.

In Steadfast, Steadfast Financial owned the surface and mineral estates in 1,800 acres of land in Hood County. In 2006, Steadfast entered into a transaction with Range Resources: it sold the surface estate to Range for $8,976,600, and it granted an oil and gas lease to Range providing for a 1/8th royalty. At the time, Betty Lou Bradshaw owned a royalty interest in the 1,800 acres that she had inherited from her parents. When her parents sold the land in 1960, they reserved a royalty interest of 1/2 of the royalty; in other words they were entitled to 1/2 of any royalty reserved by the mineral owner in any oil and gas lease covering the 1,800 acres. 

When Ms. Bradshaw learned about the Steadfast-Range transaction, she sued Steadfast and Range. She claimed that the going royalty rate for oil and gas leases in Hood County in 2006 was 1/4th, and that Steadfast had a duty to her to get the best royalty it could obtain. She alleged that Steadfast and Range had conspired to breach Steadfast’s duty to her, and that Range should be liable for its participation in Steadfast’s scheme. She argued that Steadfast got a much better deal on its sale of the land to Range by agreeing to reduce the royalty rate in its lease to Range from 1/8 to 1/4.

The trial court threw out all of Ms. Bradshaw’s claims, but the Fort Worth Court of Appeals held that she was entitled to a trial and remanded the case to the trial court.  Bradshaw v. Steadfast Financial, 395 S.W.3d 348 (Tex.App.-Fort Worth 2013). Steadfast appealed to the Texas Supreme Court, which agreed to hear the case. You can view the oral arguments in the Supreme Court here.

The Texas Supreme Court first considered the mineral owner’s duty to a royalty interest owner in Schlittler v. Smith, 101 S.W.2d 543 (Tex. 1937), where it described the mineral owner’s duty as one of “utmost fair dealing.”  One of the most important Supreme Court cases on the topic is Manges v. Guerra, 673 S.W.2d 180 (Tex. 1984), involving the infamous Clinton Manges. Manges leased the minerals under his ranch in Duval County to himself for 1/8th royalty, and then sold the lease, reserving an additional 1/8th royalty for himself. The Court held that in doing so he breached his duty to the Guerras, who owned a royalty interest in the ranch. The Court held that Manges breached his “duty of utmost good faith” to the Guerras.

More recently, the Supreme Court has grappled with the mineral owner’s duty to royalty owners in In re Bass, 113 S.W.3d 735 (Tex. 2003) and Lesley v. Veterans Land Board, 352 S.W.3d 479 (Tex. 2011). In Bass the Court held that a mineral owner has no duty to the royalty owner to grant an oil and gas lease. In Lesley the Court appeared to backtrack on what it had held in Bass, holding that a mineral owner does have a duty to a royalty owner to lease under some circumstances.

The lawyers arguing for Steadfast and Range said that Steadfast had no duty to Ms. Bradshaw to obtain the highest royalty rate it could, and that Steadfast should have the right to enter into a lease with 1/8th royalty and the highest bonus it could negotiate, even though the result would be to lessen Ms. Bradshaw’s share of production. Bradshaw’s attorney said that such a rule would be contrary to the substantial body of case law that had recognized a duty of “utmost good faith” owed by the mineral owner to its royalty owner. Questions from some members of the Court indicated that they were reluctant to require Steadfast to negotiate the best royalty it could obtain. If the Court decides to rule against Ms. Bradshaw, it could show an increasing reluctance by this Court to impose implied covenants or higher standards of conduct in the relationship between mineral and royalty owners in Texas.

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Trail Enterprises’ efforts to collect an inverse condemnation judgment against the City of Houston have finally come to an end. The US Supreme Court has refused to hear its case. Trail Enterprises’ story is instructive to parties who may be thinking of challenging cities’ decisions to ban drilling within their boundaries.

The dispute has a long history.  Lake Houston is a major source of drinking water for the City of Houston. In 1967, the City passed an ordinance restricting the drilling of new oil and gas wells in a “control area” around the lake. That restriction has remained in place except for an eleven-month gap in 1996-97, when the lake was annexed into the City and the City passed a new ordinance protecting the lake. 

In 1995, Trail Enterprises, an owner of mineral interests in the restricted area around the lake, sued the City, claiming that the 1967 ordinance restriction amounted to a “taking” of the mineral interests in violation of the US Constitution. The trial court dismissed that suit, and the Houston Court of appeals affirmed. Trail Enters., Inc. v. City of Houston, 957 S.W.2d 625 (Tex.App.-Houston [14th Dist.] 1997, writ denied). In 1999, Trail sued again, this time arguing that the City’s 1997 ordinance resulted in a taking of its property. The trial court held that the ordinance did not constitute a taking. This time the Houston Court of Appeals reversed and remanded the case for a trial. Trail Enters., Inc. v. City of Houston, 2002 WL 389448 (Tex.App.-Houston [14th Dist.] Mar. 14, 2002, no pet.). But the parties decided to dismiss that case.

Finally, in 2003, Trail, joined by other mineral owners, filed suit a third time. In 2005 a trial was finally held and a jury awarded the plaintiffs $19 million. But the trial judge dismissed the case on the ground that the plaintiffs had never applied to the City for a drilling permit.  That order was again appealed. The appeal was transferred to the Waco Court of Appeals, which affirmed the trial court’s dismissal. Trail Enters., Inc. v. City of Houston, 255 S.W.3d 105 (Tex.App.-Waco 2007). Trail appealed to the Texas Supreme Court, which reversed and remanded the case back to the trial court. City of Houston v. Trail Enters., Inc., 300 S.W.3d 736 (Tex. 2009). This time, the trial court, after another evidentiary hearing, entered judgment against the city for $17 million.

The City appealed again, and in an opinion in 2012 the Houston Court of Appeals held that no “compensable taking” had occurred and reversed the trial court’s judgment.  City of Houston v. Trail Enters., Inc., 377 S.W. 3rd 873 (Tex.App.-Houston [14th Dist.] 2012). Trail sought review by the Texas Supreme Court, but in October last year that court refused to hear the case.  And this week, the US Supreme Court also refused to hear Trail’s appeal. After 19 years, Trail’s efforts have finally come to naught.

Why such a tortuous fight through the courts? One reason is the very murky law of inverse condemnation. The Fifth Amendment to the US Constitution provides: “nor shall private property be taken for public use, without just compensation.” The US Supreme Court has struggled mightily over the years to define what this means. Its seminal case on the matter is Penn Central Transp. Co. v. New York City, 438 U.S. 104 (1978).  In that case, the court attempted to define when a government’s restriction of use of private property was so onerous as to require the government to pay the property owner — when governmental restrictions amount to a “taking” of private property. The court’s decision in Penn Central laid out a three-part test. Under this test, a court must evaluate a regulatory takings claim based on (1) the economic impact of the regulation, (2) the owner’s “reasonable investment-backed expectations,” and (3) the character of the regulatory action. Those words don’t mean much until fleshed out by subsequent cases, and the factors are fuzzy and subjective. So inverse condemnation cases like Trail Enterprises become very fact-specific analyses, and the subjectivity of the test sometimes allows the biases of court judges to emerge.

I’m no expert on takings law. But recent developments in Texas and other states, centered around municipalities’ increasing efforts to restrict drilling for oil and gas within their limits, may end up in takings cases like Trail Enterprises. The mineral owners’ extreme difficulty in getting a final determination of their claim in Trail, and the multiple appellate opinions grappling with the takings issues, is an indication of the hurdles that other mineral owners may face in seeking compensation for cities’ restrictions on drilling that affect the value of their mineral interests. In Texas, the City of Denton has a proposition on the November ballot:  “Shall an ordinance be enacted prohibiting, within the corporate limits of the City of Denton, Texas, hydraulic fracturing ….”  See “In Texas, a Fight Over Fracking,” in the New York Times, Oct. 8.  Already a group of mineral owners has sued Denton over its temporary moratorium on drilling within city limits. If Denton’s referendum passes, more lawsuits are a certainty. Similar bans are being passed by cities in Colorado and Pennsylvania, and the State of New York has had a moratorium on fracking since 2008. All good news for lawyers specializing in inverse condemnation suits.

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Last month I wrote about two cases recently decided by the U.S. Court of Appeals for the 5th Circuit in which Chesapeake defeated royalty owners’ efforts to prevent it from reducing their royalties by deducting post-production costs. One of those cases is Potts v. Chesapeake. The plaintiffs in that case have asked the Court of Appeals to reconsider its appeal “en banc,” meaning that it has asked the other judges on the court to grant its petition for rehearing and reconsider the decision of the three-judge panel who decided the case. Plaintiffs’ Petition for Rehearing may be viewed here:  Potts Petition for Rehearing En Banc.pdf

Yesterday, our firm filed a friend-of-the-court brief in the Potts case, on behalf of the Texas Land and Mineral Owners Association and the National Association of Royalty Owners – Texas, asking the Court to grant the plaintiff’s motion for rehearing and either consider the case en banc or refer the question to the Texas Supreme Court for its consideration. A copy of our brief may be viewed here:  Potts v. CHK Amicus Brief.pdf

Meanwhile, in Pennsylvania, suit has been filed against Chesapeake claiming that its conduct in selling gas to its affiliate company at prices well below market, and then selling its affiliate company for a substantial profit, constituted fraud on its royalty owners in violation of the Racketeer Influenced and Corrupt Organizations Act, known as RICO.  That petition can be viewed here:  Suessenbach v. Chesapeake.pdf

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The 5th Circuit Court of Appeals in New Orleans has ruled for Chesapeake in two cases, holding that it can deduct post-production costs from gas royalties. Potts v. Chesapeake Exploration, No. 13-10601, and Warren v. Chesapeake Exploration, No. 13-10619. Both cases were decided by the same three judges, and both opinions were written by Judge Priscilla R. Owen. In both cases, Judge Owen relied on the Texas Supreme Court case of Heritage Resources v. NationsBank, 939 S.W.2d 118 (Tex. 1996). Judge Owen was on the Texas Supreme Court when Heritage v. NationsBank was decided, and she wrote an opinion in that case. Judge Owen cites her own opinion in Heritage as the principal precedent for her opinions in Potts and Warren.

The Potts and Warren cases were tried in federal district court. Because Chesapeake’s home office is in Oklahoma, it has the right to remove suits filed against it in Texas to federal court. Federal courts have “diversity” jurisdiction over cases between citizens of different states. In diversity cases, federal courts must follow the law of the states. No federal law is involved. So, in deciding Potts and Warren, the 5th Circuit judges were attempting to predict what a Texas court would do, following prior precedent from Texas courts — in this case, Heritage v. NationsBank.

Heritage v. NationsBank is a seminal case in oil and gas law, some would say infamous. The question in Heritage was whether Heritage, the lessee, could deduct transportation costs for gas from royalties owed to NationsBank. NationsBank’s lease provided that royalties on gas would be “the market value at the well of 1/5 of the gas so sold or used, … provided, however, that there shall be no deductions from the value of the Lessor’s royalty by reason of any required processing, cost of dehydration, compression, transportation or other matter to market such gas.” The Texas Supreme Court held that Heritage could deduct transportation costs from NationsBank’s royalty. In her concurring opinion, Justice Owen said that the no-deductions proviso on NationsBank’s lease was “circular” and “meaningless”:

There is little doubt that at least some of the parties to these agreements subjectively intended the phrase at issue to have meaning. However, the use of the words “deductions from the value of Lessor’s royalty” is circular in light of this and other courts’ interpretation of “market value at the well.” The concept of “deductions” of marketing costs from the value of the gas is meaningless when gas is valued at the well.

There were three opinions from the court in Heritage: a majority opinion written by Justice Baker, joined by Chief Justice Phillips, and Justices Cornyn, Enoch and Spector; a concurring opinion by Justice Priscilla Own, joined by Justice Hecht; and a dissenting opinion by Justice Gonzalez, joined by Justice Gregg Abbott.  (Cornyn went on to be Texas’ U.S. Senator; Justice Abbott subsequently became Texas Attorney General and is now running for Texas Governor; Justice Owen was nominated by President Bush to fill the vacancy on the 5th Circuit left by Judge Will Garwood’s retirement in 2001, but she was not confirmed by the Senate until 2005.)

Several amicus briefs were filed in Heritage asking the court to reconsider its decision, but the court refused. Justice Gonzalez, however, wrote an opinion dissenting on motion for rehearing, in which Justices Cornyn, Spector and Abbott joined. It is published at 960 S.W.2d 619. In that opinion, Justice Gonzalez said that the court was evenly divided, 4 to 4, on whether to grant the motion for rehearing. Justice Enoch had recused himself from the case, for reasons not stated, and Justices Cornyn and Spector had changed their minds, now siding with Justice Gonzalez’s dissent. And Justice Phillips had decided to concur in Justice Owen’s opinion rather than join Justice Baker’s original majority opinion. Because a vote of 5 justices is required to grant rehearing, the motion failed. But, said Justice Gonzalez, there was no longer any majority opinion. “Because we are without majority agreement on the reasons supporting the judgment,” he said, “the judgment itself has very limited precedential value and controls only this case.” And, he predicted, “the Court’s error in this case will have far-reaching effects on the oil and gas industry in Texas, as millions of dollars will now be placed in dispute.”  His prediction has proven true.

Of the two cases decided by the 5th Circuit, Potts is the most interesting. The oil and gas lease from Potts to Chesapeake provided that royalties on gas would be “the market value at the point of sale of 1/4 of the gas sold or used.” It also provided:

Notwithstanding anything to the contrary herein contained, all royalty paid to Lessor shall be free of all costs and expenses related to the exploration, production and marketing of oil and gas production from the lease including, but not limited to, costs of compression, dehydration, treatment and transportation.”

Another lease provision said:

Payments of royalties … shall be based on sales of leased substances to unrelated third parties at prices arrived at through arms length negotiations. Royalties to Lessor on leased substances not sold in an arms length transaction shall be determined based on prevailing values at the time in the area.

As I have written before, Chesapeake has created a complex relationship among its affiliate companies. One affiliate, Chesapeake Operating, operates the lease for Chesapeake. Another affiliate, Chesapeake Energy Marketing (CEMI), buys the gas from Chesapeake Operating at the wellhead. CEMI gathers the gas from Chesapeake’s wells and resells it to purchasers at remote points of sale. The price that CEMI pays Chesapeake for the gas is based on the weighted average price of all gas sold at those remote points of sale, less the post-production costs CEMI incurs between the wellhead and the points of sale. Royalties were paid to Potts based on that net price, so that Potts, as royalty owner, was bearing his share of those post-production costs.

Justice Owen’s opinion holds that Chesapeake is entitled to pay Potts royalties net of post-production costs, relying on her own opinion in Heritage v. NationsBank. Potts argued that Heritage was distinguishable, and he pointed to the following sentence from Justice Owen’s opinion in Heritage:

There are any number of ways the parties could have provided that the lessee was to bear all costs of marketing the gas. If they had intended that the royalty owners would receive royalty based on the market value at the point of delivery or sale, they could have said so.

Potts’ lease provides, as Justice Owen had suggested, that his royalty shall be based on the “market value at the point of sale.” But, said Judge Owen, in this case Chesapeake’s sale (to its affiliate CEMI) is at the well, so the “point of sale” is on the lease, and the market value at that point is the price received by Chesapeake from its affiliate, net of post-production costs. “Chesapeake has sold the gas at the wellhead. That is the point of sale at which market value must be calculated under the terms of the lessors’ lease.”

I have seen many lease clauses attempting to prohibit deduction of post-production costs. Some of those clauses include language such as this: “This provision is intended to avoid the result in Heritage v. NationsBank.” I’ve not seen a case construing such a clause. Despite Justice Gonzalez’s insistence that Heritage has very limited precedential value, companies have made the most of it, and lessors continue to try to avoid it.

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Jimmy McAllen’s battle against Forest Oil has moved one step closer to conclusion. Last week the Corpus Christi Court of Appeals affirmed an arbitration award of more than $20 million against Forest Oil for environmental and other damages to the McAllen Ranch and personal injuries to Mr. McAllen.

The fight began in 2004, when McAllen sued Forest. He claimed that Forest had buried mercury-contaminated iron sponge wood chips on the 27,000-acre McAllen Ranch. The wood chips are waste from Forest’s gas plant on the Ranch. He also claimed that he had contracted cancer from pipe containing naturally occurring radioactive material (NORM) that Forest had given him to build pens on his Santillana Ranch.  The pens were built to house endangered rhinoceroses.  McAllen contracted cancer that required amputation of his leg.

Forest responded that McAllen was bound by a prior settlement agreement that required him to arbitrate any claims arising out of Forest’s operations on his ranch.  McAllen opposed arbitration. The trial court denied Forest’s motion to require arbitration, and the Corpus Christi Court of Appeals affirmed. Forest appealed to the Texas Supreme Court, which held that McAllen was bound by the arbitration agreement. Forest Oil v. McAllen, 268 S.W.3d 51 (Tex. 2008).

So the parties arbitrated McAllen’s claims before three arbitrators, one chosen by McAllen, one by Forest, and the third chosen by the other two.  Forest chose Daryl Bristow, McAllen chose Donato Ramos, and the third arbitrator was Clayton Hoover. The arbitration hearing lasted for 17 days.  The arbitrators issued a split decision, with Bristow dissenting. The arbitration award gave $15 million to McAllen for the reduced value of the McAllen Ranch resulting from Forest’s contamination of the ranch, and $500,000 to Jimmy McAllen for his personal injuries. The panel also awarded $500,000 in exemplary damages and $5 million in attorneys’ fees. Bristow dissented, based on his conclusion that the award interfered with the Texas Railroad Commission’s jurisdiction to regulate remediation of hazardous waste associated with oil and gas production.

McAllen filed a motion in the trial court to confirm the arbitration award, which the trial court granted. Forest then appealed to the Court of Appeals in Corpus Christi.

Texas courts favor arbitration of disputes, so it is difficult to overturn an arbitration award. A court’s review of arbitration awards is very limited.

The Court of Appeals first held that the award did not interfere with the Railroad Commission’s jurisdiction over oil field contamination. The court made reference to sections 85.321 and 322 of Texas Natural Resources Code, the first of which expressly grants a private cause of action for damages for violation of Texas conservation laws, and the second of which provides that nothing in the law governing Railroad Commission jurisdiction “shall impair or abridge or delay a cause of action for damages or other relief that an owner of land …. may have or assert against any party violating any rule or order of the commission or any judgment under this chapter.”

Forest also argued that the award should be vacated because of the “evident partiality” of Donato Ramos, the arbitrator chosen by McAllen. An arbitration award may be overturned if an arbitrator fails to disclose to the parties known facts that “might, to an objective observer, create a reasonable impression of the arbitrator’s partiality.” In other words, it is not the partiality per se that is objectionable, but the arbitrator’s failure to disclose facts that might show his partiality. Forest said that Ramos failed to disclose that McAllen had proposed Ramos as a mediator in another suit brought by McAllen against Chevron. Evidence in the case indicated that Ramos was never told that he had been proposed as a mediator in that other litigation.  Because there was evidence that Ramos never knew he was being proposed as a mediator, the Court of Appeals held that Forest had not shown grounds for overturning the arbitration — Ramos could not fail to disclose something that he never knew. The Court of Appeals distinguished a recent Texas Supreme Court case that did overturn an arbitration award on the same grounds, Tenaska Energy v. Ponderosa Pine Energy,  2014 WL 2139215. In that case, the arbitrator failed to disclose the full extent of his business relationship with a party’s attorneys in the case.

There is some irony in Forest’s complaints about the arbitration award in light of its insistence that McAllen’s claims had to be resolved by arbitration. One of Forest’s arguments for overturning the award was that McAllen’s expert-testimony evidence of damages to the ranch would not have been admissible testimony in a trial court. The Court of Appeals cited the Texas Supreme Court’s conclusion that an arbitration award need not be based on admissible evidence. “For efficiency’s sake, arbitration proceedings are often informal; procedural rules are relaxed, rules of evidence are not followed, and no record is made.” Nafta Traders v. Quinn, 339 S.W.3d 84, 101 (Texas 2011).

Forest is sure to seek review by the Texas Supreme Court. So Jimmy McAllen’s ten-year fight with Forest is not quite over yet. 

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