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White v. Hilcorp – Heritage v. Nationsbank Again Rears its Ugly Head

In January the US 5th Circuit Court of Appeals submitted a “certified question” to the Texas Supreme Court. Federal courts have jurisdiction over cases involving only state-law issues if the parties are from different states – diversity jurisdiction. This is one such case. Carl v. Hilcorp Energy Company, No. 24-0036.

The trustees of the Carl/White Trust sued Hilcorp Energy on behalf of royalty owners with language in their leases providing that the lessee must pay royalties on gas “sold or used off the premises.” The suit seeks class-action status on behalf of these royalty owners. The Trust’s lease also provides that royalty on gas should be paid on the “market value at the well.” Hilcorp moved to dismiss the claim, arguing that under a “market-value-at-the-well” lease, Hilcorp was allowed to deduct all post-production costs and therefore had no obligation to pay for gas used in processing. The trial court agreed with Hilcorp and dismissed the case; the Trust appealed to the 5th Circuit.

When a case in federal court is governed by state law, a federal appeals court may ask the state’s top court to opine on a question of law critical to its case – to submit the question as a “certified question” to the state court.  The 5th Circuit did so here, asking the Texas Supreme Court: “can a market-value-at-the-well lease containing an off-lease-use-of-gas clause and a free-on-lease-use clause be interpreted to allow for the deduction of gas used off lease in the post-production process?” The Texas Supreme Court agreed to consider the question, and the parties have submitted briefs. Two amicus briefs, one from Texas Oil & Gas Association supporting Hilcorp’s arguments, and one by Texas Land & Mineral Association and National Association of Royalty Owners-Texas, Inc., supporting the Trusts’ arguments.

I have written numerous posts about Heritage v. NationsBank and its progeny. I recommend reading the amicus brief submitted by TLMA and NARO Texas as a good summary of the problems Heritage has created in subsequent cases on post-production costs in the Texas Supreme Court.

The logic of the Heritage opinion has always been impossible to square with traditional legal principles on construction of contracts. Since it was issued operators have consistently maintained that, under the court’s faulty reasoning, if a lease provides for gas royalties based on “market value at the well,” the operator can deduct all post-production costs from lessor’s royalty regardless of any other language in the lease. This contradicts the most basic rule of contract construction that all provisions of a contract must be read together to arrive at the parties intent. Even the majority opinion in Heritage paid lip service to this cannon of construction:

In construing an unambiguous oil and gas lease our task is to ascertain the parties’ intentions as expressed in the lease. To achieve this goal, we examine the entire document and consider each part with every other part so that the effect and meaning of one part on any other part may be determined. We presume that the parties to a contract intend every clause to have some effect. We give terms their plain, ordinary, and generally accepted meaning unless the instrument shows that the parties used them in a technical or different sense. This Court will enforce the unambiguous document as written. Both the trial court and the court of appeals determined that the leases in question were unambiguous. We agree.

Heritage Res., 939 S.W.2d at 121 (citations omitted)

But then the court held that the market-value-at-the-well language controlled over another lease provision prohibiting deduction of post-production costs, holding that the no-deduction clause was “surplusage” (a new legal term invented by the court). Since then, as related in TLMA’s amicus brief,

Time and again (starting with the result in Heritage Resources and expanding ever onward), courts have used Heritage Resources to ignore negotiated, clear terms of oil and gas leases—under the guise of “surplusage.” That should stop. And this Court should take the opportunity presented to stop it.

The Texas Supreme Court should take advantage of this opportunity to admit that its reasoning in Heritage was flawed; that leases, like other contracts, should be construed considering all of their provisions to ascertain the parties’ intent; and that courts cannot rely on Heritage to ignore lease provisions as “surplusage.” As stated in the conclusion to TLMA’s brief, “No ‘magic words’ trump all others in the contract. Lessees and courts have used Heritage Resources to avoid provisions to which both parties agreed. This Court should end that here.”

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