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Munsch Hardt Upstream Energy Alert - Recent Texas Supreme Court Rulings

07/26/2017

The Texas Supreme Court recently issued two decisions that affect the exploration and production sector of the oil and gas industry. Please contact the Munsch Hardt Energy Group for more information on these decisions and how we can help you, should they affect your business.

Samson Exploration, LLC v. T.S. Reed Properties, Inc., et al.; 2017 WL 2713047 (June 23, 2017)(Not yet released for publication).

Samson was required to double-pay royalties because it designated two units that inadvertently overlapped and included the same well. Samson held adjacent leases from several mineral owners. The leases each granted Samson the unilateral right to pool them with other leases. Samson exercised that right, pooled its interests in certain depths beneath certain tracts, drilled a successful well within those boundaries, and began paying royalties to the mineral owners in the pooled tracts. (The unit originally included two wells; however, the unit designation was amended to remove one of the original wells after the lessor for that acreage exercised its right to object to the pooling of its lease.) 

Years later, Samson again pooled its leasehold interests in several depths beneath certain tracts to form a second unit. The surface boundaries of the second unit overlapped partially with first unit, but also included tracts that were outside of the first unit’s boundaries. Samson intended to limit the second unit to depths that were more shallow than the top boundary of the first unit, so that a well drilled in the overlapping area would be in one unit or the other, depending on its depth. Unfortunately, Samson made a mistake and defined the depth interval in the second unit to include depths that also were included in the first unit. As a result, depending on its depth, a well drilled in the overlapping area could simultaneously be within both units. 

For more than 15 years, Samson paid royalties on the first well to mineral owners in the first unit and royalties on the second well to mineral owners in the second unit. When the mineral owners in second unit discovered their unit designation included the depth interval in which the first well had been completed, they sued Samson to recover royalties derived from the first well. The trial court granted summary judgment for the mineral owners, requiring Samson to pay royalties from the first well to mineral owners in the second unit from its own working interest, in addition to the royalties that it paid to the mineral owners in the first unit. Samson was required to pay the extra royalties from it own working interest, without any right of recoupment. Both the court of appeals and the Texas Supreme Court affirmed that judgment.  

In holding Samson responsible for payment of double royalties, the courts reasoned that Samson never amended the error in its unit designations to cure the defect and, because the mistake was unilateral, Samson was not entitled to reformation. The court also held that the second unit’s mineral owners did not waive their claim by accepting less than the total amount of royalties they were owed, and that the fact the mineral owners in the overlapping unit could not cross-convey title to the same minerals twice to two different sets of unit owners would not render the second unit void.  

The biggest take-away from this case is that Texas courts are not inclined to relieve exploration and production companies from the financial consequences of unilateral drafting errors. When land departments exercise rights to unilaterally pool leases, they need to be very careful to assure there is no overlap.  

Wenske v. Ealy; 2017 WL 2719330 (Tex. June 23, 2017)(not yet released for publication)

When mineral owners execute a deed conveying their mineral fee interest, “subject to” a non-participating royalty interest (“NPRI”) reserved by a prior owner, and except for a fractional interest the sellers reserve for themselves, it does not mean the purchaser’s interest is the only one that is “subject to” the NPRI burden; rather, absent clear language to the contrary, the NPRI proportionately burdens both the purchaser’s acquired interest and the sellers’ retained interest. In this case, Vyvjala and Novak owned 55 acres of land. They sold it to the Wenskes, but reserved for themselves a 1/4 non-participating royalty interest in all oil, gas and other minerals produced from the property for a period of 25 years. The Wenskes then sold the property to the Ealys, “subject to” the Vyvjala/Novak 1/4 NPRI, except for a 3/8 interest that the Wenskes retained for themselves in all oil, gas and other minerals produced from the property. 

The Wenskes claimed the Ealys purchased only a 3/8ths interest in the produced minerals, consisting of the 8/8ths mineral fee, minus the 1/4th (or 2/8ths) NPRI, minus the 3/8ths interest retained by the Wenskes. The Ealys claimed they purchased a 5/8ths interest, consisting of the 8/8ths mineral fee, minus the 3/8ths interest retained by the Wenskes, with both interests subject to their proportionate share of the 1/4th NPRI. The trial court agreed with the Ealys, and the court of appeals affirmed the trial court’s judgment. Citing Pich v. Lankford, 302 S.W.2d 645, 650 (Tex. 1957), the court of appeals purported to apply a general rule of deed construction that a royalty interest ordinarily is carved proportionately from both the mineral interests conveyed and the mineral fee interests retained unless the deed states the burden will be allocated differently.  

The Supreme Court affirmed the Court of Appeals’ decision, but strongly criticized the idea that deeds may be construed according to any “general rules of deed construction.” Nevertheless, the Supreme Court itself relied upon “general principles of oil-and-gas law” to support its holding, stating:  

The principles of oil-and-gas law inform our interpretation. Generally, “the conveyance of an interest in the minerals in place carries with it by operation of law the right to a corresponding interest in the royalty.” [Citations omitted.] As the dissent correctly notes, this means when a deed conveys or reserves a 3/8ths interest in the minerals, the nature of that interest, by operation of law, includes the right to receive 3/8ths of the royalties. [Citation omitted.] And under the same principle, a severed fraction of the royalty interest—like the Vyvjala NPRI—generally would burden the entire mineral estate because it necessarily limits the royalty interests attached to the underlying mineral interests. [Citation omitted.]

But that principle does not compel an outcome in this case. Parties are free to contract for whatever division of the interests suits them. Their intent, as expressed in the deed, controls. If they want their agreement to operate differently from this basic principle of mineral conveyance, this Court has said they should “plainly and in a formal way express that intention.” [Citation omitted.] We see no expression of such intent, plain or not, in the deed here.

Further, the exceptions to conveyance and exceptions to warranty are combined into one clause in this deed (“Exceptions to Conveyance and Warranty”). That combined clause, read with the subject-to clause and compared with the reservations-from-conveyance clause, indicates an intent to avoid a breach of warranty (and therefore an over-conveyance problem), rather than a clear attempt to reserve a full 3/8ths interest, free of the Vyvjala NPRI, to the Wenskes.

The Supreme Court then went on to explain why the particular language in the instrument at issue did not plainly express an intention to deviate from the “general principle of oil and gas law” that a severed fraction of the royalty interest, like the NPRI, typically would burden the entire mineral estate.

The main takeaway in this case appears to be that the Texas Supreme Court is very particular about semantics. To construe a deed’s legal meaning and effect, Texas courts must not apply “general rules of deed construction;” however, they should apply what the Texas Supreme Court refers to as “general principles of oil-and-gas law” or “basic principles of mineral conveyance.” One of those “basic principles” (which no longer should be referred to as a “general rule”) is that a royalty interest will burden both the mineral interests conveyed to a purchaser and the mineral interests retained by the seller, unless the deed “plainly and in a formal way” states that the parties intend to place the royalty burden solely upon one of them or the other.