Royalty Decisions Continue

RECENT DEVELOPMENTS
Affecting Petroleum Land Practices
September/October, 1997 - Vol. 2, No. 5

Royalties and Take-or-Pay
By Professor Marla E. Mansfield
The University of Tulsa, College of Law

Perhaps the name of this column should be re-titled "The Continuing Saga of Take-or-Pay." Four more cases dealing with attributes of these controversies have been decided. Before allowing these issues to totally consume our column, and for some variation in our fare, we will also look at the ongoing struggle in Texas to define fractional interests in deeds.

Two of the take-or-pay cases are Texas cases and continue its trend away from settlement sharing. In the first, Alameda Corp. v. TransAmerican Natural Gas Corp., 1997 WL 456595 (Tex. App. Hous. No. 14-96-00044-CV) (March 27, 1997), the settlement canceled all obligations to make future purchases and rights of recoupment. The pipeline paid $360 million in cash and property. The pipeline received a credit for gas that was sold to others on the spot market. The royalty owners therefore argued that this nonrecoupable payment was related to the price of gas actually sold. They demanded to share in that part of the settlement that was contract repudiation damages. The court rejected the claim. It noted the relevant royalty clause required production. The settlement was characterized as a settlement of a dedication claim that existed separate from the lease. Not being tied to actual production, it was a payment for non-production and thus non-royalty bearing.

A similar result occurred Condra v. Quinoco Petroleum, Inc., 1997 WL 375206 (Tex.App. San Antonio No. 04-95-00492-CV) (July 9, 1997). In this case, the original lessee, in assigning its working interest, retained an overriding royalty. The current holder of the overriding royalty interest sought a royalty interest in the non-recoupable portion of a take-or-pay settlement. It also argued that the express covenant in the lease concerning marketing was breached. The district court denied the claim.

The appeals court agreed. The division order covering payment of the overriding royalty required production before payments were due. Therefore, as with lessors' royalties in this situation, the settlement was not royalty bearing because, like repudiation damages, the payment was for non-production. On the issue of a breach of marketing duties, the court held that a party tracing its rights to the lessee of an oil and gas lease cannot enforce the implied or express covenants of the lease, which are designed to benefit the lessor and burden the lessee. However, an implied covenant to market can arise under the assignment creating the override. Nevertheless, the covenant to market is only triggered by production.

The Condra case was not without dissent. Justice Rickhoff disagreed with most of the court's reasoning. On the take-or-pay issue, he noted that the nonrecoupable payment could be a buy-down or otherwise impact on the price paid for future gas. He also questioned the holding that production is required to invoke the covenant to market, citing cases that held it applicable to the terms and conditions of a contract covering future sales of gas.

The Tenth Circuit is more in line with the dissent in Condra. The setting for the decision was the Wilburton Field of Oklahoma. Lessors sued ARCO on several grounds. First, they claimed some of the settlement of a contract dispute was royalty-bearing. The leases required royalty on gas produced, not on amounts realized from a sale. Second, they maintained that ARCO breached the implied duty to market when it accepted a settlement price for future gas that was not the highest price available. Finally, they claimed that ARCO failed to protect some of the units from drainage when ARCO selectively re-worked some wells in which it had a larger working interest. The district court granted a summary judgment to ARCO on all issues. It ruled that the payments were not payments for the taking of gas and the lease did not state that take-or-pay settlements were subject to royalty. It also found that the plaintiffs had not shown that the price was not the highest available and therefore ARCO met its marketing duties. Finally, the court absolved ARCO of any liability for drainage because the workovers were done in conformity with field regulations for overages and underages; the lease stated the lessee would not be liable for violation of implied covenants if compliance is prevented by or the result of state rules or orders.

In Watts v. Atlantic Richfield Co., 115 F.3d 785 (10th Cir. 1997), the 10th Circuit reversed on all issues and ordered a trial. The court found that it was possible some of the settlement was royalty-bearing:

In sum, a lessor's royalty interest is not limited to settlements involving an actual "buy down," as in Yates [v. Powell, 98 F.3d 1222 (10th Cir. 1996)], but extends to any settlement in which a producer receives consideration for compromising its pricing claim, assuming of course that the pricing claim relates to either past or future production actually taken by the settling producer.

There was a question of fact on the nature of the settlement which precluded summary judgment. The case arose in Oklahoma, and the 10th Circuit law may conflict with Roye Realty &Developing, Inc. v. Watson, 1996 WL 515794 (Okla. No. 76,848) (Sept. 10, 1996). This case broadly rejects settlement sharing with a royalty owner without distinguishing types of settlements unless the lease expressly provides for royalties on settlements.

Mercifully perhaps, for I am beginning to feel repetitive, the Tenth Circuit in the Watts case also provides some law on matters. On the marketing issue, the court found that even if the settlement per se may have been a prudent business decision, the marketing duty may not have been met. The lessors had shown some facts that supported their claim that a higher price was required or possible. Finally, on the drainage claim, the court ruled that the lease provision did not absolve ARCO of liability simply because its actions were "in compliance" with Field Rules. The Field Rules neither commanded the selective workovers nor prevented ARCO from protecting the wells of the lessors.

The final take-or-pay related case (this time) is Lewis v. Texaco Exploration & Production Co.,Inc., 1997 WL 451354 (La.App. 1 Cir. No. 96 CA 1458 (July 30, 1997). It is, however, more of a procedural than substantive case. The facts reveal that Texaco is the lessee of approximately 375 separate leases, including one community lease, in the Hollywood Field. The leases were subject to two take-or-pay contracts with United, both of which were settled in 1987. The trial court certified a class of all royalty owners under leases with Texaco that were dedicated to the settled United contracts. The requested relief was sharing in the settlement, Louisiana having precedent that makes settlement royalty-bearing.

The class certification was affirmed on appeal. The first issue addressed was peculiar to Louisiana law: before a suit seeking lease cancellation or damages for failure to pay royalties, the lessor must give notice to the lessee. LSA-R.S. 31:137. Texaco argued that notices by five members of the class individually and also as representatives of the class of all royalty owners was insufficient; each lessor must provide notice. The court disagreed. The notices given Texaco clearly expressed the common request of sharing in the settlement, thereby informing it of the nature of the complaint. Moreover, Texaco could apprise itself of the members of the class from its records.

The court also examined more general requirements for a class action suit. It found the "numerosity" requirement for a class action was met; the 4,269 royalty owners would be impractical to join yet was a clearly definable group. Moreover, adequate representation of the class would follow from the participation of the representative class members despite the fact that class members would be entitled to differing royalty amounts. The court also found a "common question of law" dominated the action. The question is whether Texaco need share the 1987 settlement. Differing language in the two sales contracts and eight different royalty provisions did not negate the commonality. The court also thought a class action here was appropriate on fairness grounds and judicial efficiency. Many claims would have been too small to pursue alone.

To fully leave take-or-pay issues for a time, Texas courts continue to grapple with conveyances of fractional interests in minerals and how to interpret deeds. In Temple-Inland Forest Products Corp.v. Henderson Family Partnership, Ltd., 1997 WL 378434 (Tex. No. 96-0124) (July 9, 1997), deeds granted a 15/16 mineral interest and also stated:

In respect to the undivided one-sixteenth part of and interest in the oil, gas and other minerals retained and reserved by the Grantor ..., it is understood and agreed that said 1/16th interest is and shall always be a royalty interest, and shall not be charged with any of the costs ... and the Grantor's 1/16th royalty interest above referred to shall be delivered free of cost to the Grantor....

The deed continued and specified that the grantee had no obligation to develop and the grantor would not share in bonuses or delay rentals. The trial court found a mineral interest had been reserved and the court of appeals concurred, finding the grantors retained a mineral interest, and then conveyed four of the five attributes of a mineral interest (right to develop, right to lease, right to bonus, and right to delay rentals). The court opined that if the grantors intended the interest to be a royalty, there would be no need to expressly grant these rights to the grantee.

The Texas Supreme Court reversed. The court found the use of the word "royalty" six times showed the intent to reserve a royalty. Moreover, the deed said the interest was free of costs, the hallmark of a royalty. The court chided the court of appeals for interpreting prior decisions to require a reference to "royalty from actual production" to reserve or grant a royalty. The prior Supreme Court decisions did not so require. This latest decision seems a common sense approach towards the intent of the parties.

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