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Royalty Owners and Cotenancy: Devon Energy Production Co. v. Apache Corporation

In Devon v. Apache, No. 11-16-00105-CV, the Eleventh Court of Appeals sheds some light on a vexing problem that remarkably has never been addressed by a Texas court.  To understand the problem, consider the facts in Devon v. Apache:

Norma Jean Hester leased her one-third mineral interest in land in Glasscock County to Apache, reserving a one-fourth royalty. The remaining mineral owners leased to Devon, also reserving a one-fourth royalty. Apache and Devon were not able to reach agreement on joint development of the property, and Apache drilled seven wells on the property without Devon’s participation. Under Texas law, Devon and Apache were co-tenants, and Apache is obligated to account to Devon for 2/3rds of the net profits from the wells, which Apache did. But Apache refused to pay Devon’s royalty owners.

Devon’s lessors then sued Apache and Devon for their royalties.  Apache responded that it had no obligation to pay those royalties since it did not lease their minerals. Devon argued that it had no obligation to pay royalties until it received payments from Apache. Devon cross-claimed against Apache, arguing that Apache owed royalties to its lessors under Section 91.402 of the Texas Natural Resources Code.  Devon’s lessor’s settled their claims against Devon. The trial court held that Apache owed no royalties to Devon, and the court of appeals agreed.  It held that Section 91.402 did not require Apache to pay royalties to Devon’s royalty owners.

No prior Texas case has addressed the problem faced by Devon’s lessors.  The problem is discussed in a law review article by Caleb A. Fielder, Blood and Ol: Exploring Possible Remedies to Mineral Cotenancy Disputes in Texas, 50 Tex. Tech L. Rev. 173 (2017).  The situation faced by Devon’s lessors raises several questions: first, does the cotenant who drills wells owe royalties to the lessors of the cotenant who fails to participate?  Devon v. Apache holds at least that the Natural Resources Code imposes no such obligation. Since the drilling cotenant has no contractual relationship with the other cotenant’s lessors, it is difficult to see what other claim to royalties those lessors would have against the drilling cotenant. So the non-participating cotenant’s lessors’ remedy must be against their own lessee.

The nonparticipating cotenant will argue that it owes no royalties to its lessors until it receives payments from the drilling cotenant. But if that is so, the royalty owners may argue that their lease is not maintained by production and so terminates at the end of its primary term.  One Oklahoma case has so held:  Earp v. Mid-Continent Petroleum Corp., 27 P.2d 855 (Okla. 1933).  If that is the law and the lease terminates, then the royalty owners become cotenants with the drilling lessee and entitled to their share of net profits. Probably not what the royalty owners would prefer.

Fielder suggests that the royalty owners may have a claim against their lessee for failure to protect the leasehold estate against drainage, or to prudently administer the lease.

The one time I have encountered this problem, the two lessees have apparently agreed that, although they could not agree on a joint development agreement, the drilling cotenant would pay all royalties due to the lessors of the nonparticipating cotenant until the well has paid out, after which the nonparticipating cotenant assumes that obligation.

Fielder suggests in his article that this problem be addressed in the lease, and he proposes this language:

If, at the expiration of the primary term or at any time or times thereafter, Operations, as the term is herein defined, are conducted on the leased premises to which lessee is not a party, this lease shall continue in force as though Operations were being conducted by lessee on said land. In the event production of covered minerals is obtained from a well drilled on the leased premises to which lessee is not a party (a “Third-Party Well”), Lessee covenants to pay or tender, by check or draft of Lessee, as royalty, a sum consistent with the Royalty Payment as provided in paragraph [x], equal to the amount which would be due [to] Lessor as royalty from the production of the same quantity of oil, gas or other hydrocarbon produced by Lessee (based on the quantity of production from the Third-Party Well which is reported to the regulatory agency having jurisdiction).


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