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Chesapeake v. Bell – Another Decision Construing an Express Drainage Offset Clause

Last March the San Antonio Court of Appeals handed down its decision in Bell v. Chesapeake Energy, No. 04-18-00129-CV. Chesapeake has asked the Texas Supreme Court to review the case. The facts bear a resemblance to Murphy v. Adams, decided by the Supreme Court last year. Both involve construction of an express offset clause in an oil and gas lease.

A typical express offset clause provides that, if a well is drilled within a certain distance from the lease boundary, the lessee must either drill an offset well or pay compensatory royalty based on the production from the adjacent well. The lessor is not required to show that the adjacent well is actually draining the leased premises. In Murphy v. Adams, the issue was what constitutes an “offset well.” The Supreme Court held (in a 5 to 4 decision) that, in the context of horizontal drilling in the Eagle Ford formation, any well drilled on the leased premises, regardless of its location, may satisfy the lessee’s obligation to drill an offset well.

In Bell v. Chesapeake, the issue is what amount of compensatory royalty Chesapeake must pay. The wells drilled on tracts adjacent to Chesapeake’s leases were not drilled parallel to the lease line, but a portion of the adjacent wells’ horizontal wellbore was within the minimum distance from the lease line to trigger the offset-well obligation. The lessors contend that Chesapeake must pay compensatory royalty based on 100% of the production from the adjacent well. Chesapeake argues that it should have to pay compensatory royalty only on the portion of the adjacent well’s production coming from perforations or “take points” that are within the minimum distance from the lease line specified in the lease.

The San Antonio Court of Appeals rejected Chesapeake’s argument. It held that the lease language is clear: compensatory royalty is based on the “Gross Proceeds of production from the Adjacent Well,” “regardless of whether that well thereafter runs parallel or perpendicular to, or toward or away from, the Leased Premises.”

Chesapeake argued that the Court should follow the logic of the Supreme Court’s opinion in Murphy v. Adams; that the Court “must look beyond the language of the Leases and consider the ‘realities’ of horizontal drilling as surrounding facts and circumstances that inform the court’s construction of that language.” But the Court distinguished Murphy:

The difference … is that the Murphy leases did not expressly address the issue presented to the court for construction–whether a required offset well may be drilled anywhere on the leased premises or whether there was an implied requirement of proximity to the lease boundary. … In the present case, the Leases expressly address the issue presented. Compensatory royalty is computed based on “production from the Adjacent Well.” And, in the context of a horizontal well deemed to be draining the Leased Premises, an Adjacent Well is one whose surface location or subsurface path “from its point of entry into the productive horizon to its terminus” is within the Trigger Distances. This language clearly demonstrates that the parties were aware of the realities of horizontal drilling and made provision for those realities. Chesapeake may not now assert those “realities” to alter or contradict the unambiguous Lease language.  …

The gist of Chesapeake’s argument is that calculating Compensatory Royalty according to the plain language of the Leases is a bad deal. Regardless, that is the deal the parties made and this court is not permitted to rewrite it under the guise of interpreting it.

It will be interesting to see if the Supreme Court agrees to consider the case. In my humble opinion, the majority opinion in Murphy strayed very far from the Court’s stated policy of enforcing contracts as written regardless of the consequences. Chesapeake is seeking to take advantage of the Murphy precedent to ask the Court to do so again.

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