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BP America v. Red Deer Resources – the Shut-in Royalty Clause

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On April 28, the Texas Supreme Court issued its opinion in BP America Production Company v. Red Deer Resources, LLC, No. 15-0569, a unanimous opinion written by Justice Green. The case concerns operation of a shut-in royalty clause in a lease granted in 1962 covering 2,113 acres in Lipscomb and Hemphill Counties.  BP had one gas well on the lease that produced less than 10 mcf per day. In 2011, Red Deer obtained a top lease on the 2,113 acres. BP turned off the valve on the well on June 12, 201 and tendered a shut-in royalty payment to the lessors on June 13. The well last produced gas on June 4. In August 2012, Red Deer sued BP, alleging that the lease had terminated for lack of production in paying quantities prior the date the well was shut in.

The shut-in royalty clause reads:

Where gas from any well or wells capable of producing gas … is not sold or used during or after the primary term and this lease is not otherwise maintained in effect, lessee may pay or tender as shut-in royalty …, payable annually on or before the end of each twelve month period during which such gas is not sold or used and this lease is not otherwise maintained in force, and if such shut-in royalty is so paid or tendered and while lessee’s right to pay or tender same is accruing, it shall be considered that gas is being produced in paying quantities, and this lease shall remain in force during each twelve-month period for which shut-in royalty is so paid or tendered ….

The jury was asked four questions. The Court considered the jury’s answer to two of those questions:

Question 1: from April 27, 2009 to June 12, 2012, did the Vera Murray lease fail to produce oil and gas in paying quantities?

Answer: No, the Vera Murray lease did not fail to produce in paying quantities.

Question 3: Was the Vera Murray #11 well incapable of producing in paying quantities when it was shut-in on June 13, 2012?

Answer: Yes, the Vera Murray #11 well was incapable of producing in paying quantities when it was shut-in on June 13, 2012.

Based on the jury’s answer to Question 3, the trial court held that the lease had terminated. The court of appeals affirmed. 466 S.W.3d 335 (Tex.App.-Amarillo 2015).

The Supreme Court reversed and rendered. It held that Question 3 asked the wrong question. The correct question would have been: Was the Vera Murray #11 well incapable of producing in paying quantities “on the last day gas was sold or used–June 4, 2012.” The Court also held that BP had preserved the error in Red Deer’s jury question and that it would not remand for a new trial because Red Deer “submitted a theory upon which it could not recover.”

It seems to me that this case and several of the Court’s statements suffer from failing to distinguish between two circumstances: in the first, a well ceases to produce and cannot return to production without additional work on the well. In the second, a well’s production is not in paying quantities. In both cases, courts have held that the lessee may not rely on a shut-in royalty clause to extend the term of the lease. In the first instance, courts have held that a shut-in royalty payment cannot extend the term of the lease if the well was not capable of producing gas at the time it was shut-in without additional work on the well. In the second instance, courts have held that a shut-in clause cannot save a lease if it has already terminated because the well shut in had already ceased to produce in paying quantities — it might still be capable of producing some gas, but the lease has terminated before the well was shut in because of lack of production in paying quantities. The Court does not distinguish between these two circumstances. For example, the Court says that the tender of the shut-in payment would keep the lease in force “so long as the well was capable of production in paying quantities over a reasonable period of time on the date that gas was last sold or used.”  Or again: “to negate BP’s invocation of its shut-in royalty rights Red Deer bore the burden of proving that the #11 well was incapable of production in paying quantities over a reasonable period of time as of June 4, 2012.”

Red Deer did not convince the jury that the lease had terminated for failure to produce in paying quantities before the well was shut-in. Its second question should have been: Was the Vera Murray #11 well incapable of producing after June 4, 2012? If the well was incapable of producing at all after June 4 without first being worked over, then BP’s tender of shut-in royalty would not be able to sustain the lease past that date.

 

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