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Devon v. Sheppard — A Win for Royalty Owners

Today the Texas Supreme Court issued its opinion in Devon v. Sheppard, No. 20-0904, again addressing post-production cost deductions from royalties. The Court affirmed the court of appeals’ ruling in favor of the royalty owners.

Sheppard leased minerals in the Eagle Ford Shale in 2007, before the first successful well in the Eagle Ford. Sheppard is a lawyer in Cuero, Texas. His lease required payment of royalties on gross proceeds of sale, without deduction of post-production costs. The lease also contained this provision:

If any disposition, contract or sale of oil or gas shall include any reduction or charge for the expenses or costs of production, treatment, transportation, manufacturing, processing or marketing of the oil or gas, then such deduction, expense or costs shall be added to … gross proceeds so that Lessor’s royalty shall never be chargeable directly or indirectly with any costs or expenses other than its pro rata share of severance or production taxes.

Sheppard learned that his lessee was selling oil under a contract that set the price based on an index and then subtracted $18 per barrel for “gathering and handling, inclusive of rail car transportation.” On further examination, Sheppard learned that the lessee also contracted for gas sales under contracts that made deductions for other post-production costs incurred by the purchaser.

The trial court and court of appeals agreed with Sheppard. I wrote more extensively about the rulings of the court of appeals here.

After accepting Devon’s petition for review, the Supreme Court affirmed the court of appeals in all respects. The above add-to language was not, as Devon argued, “surplusage.”

Producers often sell oil and gas under contracts based on an index price less certain deductions for post-production costs incurred by the purchaser. Gas may be sold at or near the well under a contract providing that the buyer will pay the net proceeds received by the buyer from sale of residue gas and natural gas liquids after the gas is processed, less a marketing fee. Under typical no-deductions lease clauses, the lessee may pay royalty on its proceeds after post-production costs incurred by the purchaser because those costs are not incurred before the oil or gas is sold. To avoid that result, Sheppard added its “add-to” clause. The Court enforced the clause as written. A rare win for royalty owners.

Justice Blacklock filed a dissent.

I understand that Sheppard used this same lease form for many clients who leased their lands in the Eagle Ford during the same time period.

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