Apache Deepwater, LLC v. McDaniel Partners, Ltd.

Citations: 485 S.W.3d 900; 59 Tex. Sup. Ct. J. 411; 2016 Tex. LEXIS 179; 2016 WL 766731Docket: NO. 14-0546

Court: Texas Supreme Court; October 14, 2015; Texas; State Supreme Court

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The case addresses the calculation of a production payment associated with four oil and gas leases assigned in 1953. After two leases terminated, a dispute emerged regarding whether the production payment should be adjusted due to the loss of the underlying leases. The payor contended that the payment should be reduced, while the payee argued that the payment burdened all four leases jointly, with no provision for adjustment in the assignment. The trial court agreed with the payee, allowing for adjustment based on lease expiration, but the court of appeals reversed this decision. The appellate court maintained that the assignment fixed the production payment at a specified percentage of the cumulative working interest, without a mechanism for reduction if any lease expired, and that the payment would continue as long as production occurred under at least one lease. Ultimately, the reviewing court sided with the trial court, affirming that adjustments to the production payment are permissible based on lease expirations. The leases included a detailed accounting of mineral interests and the production payment structure, which was reserved as 1/16 of 35/64 of 7/8 of total production, with specific caps on net proceeds and oil volume. The Cowden Leases expired after approximately twenty years, but production from the Peterman and Broudy Leases continued, maintaining their validity.

Production under the Cowden Leases had ceased prior to Apache's acquisition, leaving only the 3/64 mineral interest from the Peterman and Broudy Leases subject to the assignment. Apache acquired additional leases in Surveys 36 and 37, initiated production there, and sent a division order to McDaniel Partners, Ltd., Ferguson’s successor, stating the production payment should now be 1/16 of 3/64 of 7/8 due to the expiration of the Cowden Leases. McDaniel contested this and requested a revised division order based on the original assignment equation. Apache’s payment to McDaniel for the 3/64 interest, rather than the originally calculated 35/64 interest, led to a lawsuit. The trial court ruled against McDaniel, concluding that the production payment was separate for each lease and extinguished upon lease expiration. Apache’s division order was deemed correct post-expiration. McDaniel appealed, and the appellate court reversed the trial court's judgment, asserting that the assignment did not permit Apache to modify the production-payment calculation based on expired leases. The appellate court determined McDaniel was owed 1/16 of 35/64 of 7/8 of production and remanded for damage assessment. The ongoing dispute centers on the assignment's interpretation regarding the production payment percentage, with McDaniel asserting it should be about 3% of production from the two surveys, based on the original cumulative working interest, while Apache argues it should correlate with the current working interest.

Apache asserts that the production payment consists of 1/16 of the 7/8 working interest from four leases, originally totaling 35/64 of the leasehold estate for Surveys 36 and 37, which has now diminished to a 3/64 interest. The term 'respective' indicates the distinct nature of each lease and the production payment's burden on each. Apache argues that the phrase 'entire interest in the production' actively explains how to calculate the production payment over time, reflecting the impact of the production payment on each lease. Following the termination of the Cowden Leases, Apache contends that the production payment was reduced to approximately 0.26% of production from the surveys. 

Both parties acknowledge differing views on calculating the production payment but agree that the assignment is not ambiguous. Ambiguity arises only when an agreement's meaning is uncertain or open to multiple interpretations. The courts found the assignment unambiguous, supporting McDaniel’s interpretation that the production-payment equation remained at 1/16 of the original working interest (35/64) as long as any lease was active. The court acknowledged Apache's view that the assignment provided for a reduction of the production payment if a lease terminated but ruled that the assignment did not allow for a 'piecemeal reduction' based on individual lease expirations without an explicit clause to that effect. Apache contends that the inherent nature of the production payment should allow for adjustments without a proportionate-reduction clause and argues that if the parties intended for the payment to remain unchanged despite lease terminations, an express clause would have been necessary. Apache believes the court misapplied the analysis by suggesting that the original payment fraction continued unless explicitly stated otherwise in the assignment.

The court of appeals assessed a production payment similarly to an overriding royalty interest, agreeing that both share essential characteristics. A production payment, often termed an 'oil payment,' functions as a share of production from specified premises, exempt from surface production costs, and ceases after a certain production volume or sale amount is reached. Production payments can originate from various estates and are categorized as either 'hen' type or 'title' type. When derived from a lessee's working interest, a production payment resembles an overriding royalty, though it has a more limited duration. Both types of payments terminate if the lease is ended, unless explicitly stated otherwise in the contract.

The court recognized that while production payments generally cease with the termination of the leasehold, it lacked authority to apply this to a multi-lease assignment where only some leases remained effective. It likened this scenario to a partial-lease failure, concluding that Apache had not shown that the nature of a production payment required a decrease after a partial lease failure without contractual provisions for such adjustments. Apache contended that similar legal principles apply, asserting that overriding royalties terminate when part of a leasehold is surrendered and that this principle is even more applicable since two leasehold estates expired completely. However, the court maintained that the production payment could not be reduced due to the absence of explicit language in the assignment allowing for a gradual reduction.

A clause was deemed necessary by the court due to the assignment's lack of a mechanism for adjusting the specified production payment of $3,550,000 or the volumetric total of 1,420,000 barrels of oil in the event of lease termination. The court noted that if the parties intended for periodic adjustments, the assignment would have explicitly included such language. While acknowledging that the assignment fixed the monetary and volumetric amounts owed to the assignor, the court disagreed that this determined the rate of delivery to the assignor's account, which is central to Apache's complaint. The production payment consists of two elements: (1) a fractional share of production that Apache must pay, and (2) a total amount of money and production that must be realized before the interest terminates. Apache accepts that the latter is fixed but contends that the fractional share attributable to the Cowden Leases was extinguished upon lease expiration, impacting the first part of the reserved payment.

The court emphasizes that the nature of the production payment and its implications on the underlying leases depend strictly on the assignment's language, not on parties' interpretations of what it should have stated. When a contract is unambiguous, the focus is on the parties' intentions as expressed within the document. The court applies a holistic approach, considering the entire contract to ensure all provisions are meaningful, and no single provision holds controlling weight. The assignment details four oil and gas leases in Upton County, individually describing the Cowden, Peterman, and Broudy Leases, and includes a warranty clause specifying the mineral interests conveyed. The assignor reserves a production payment interest of 1/16 of the total production from the two surveys, which integrates into the calculation specified in the assignment's reservation clause.

McDaniel interprets the assignment to reserve a production payment from the overall conveyance, binding all assigned leases together. He argues that the production-payment interest was carved out of the conveyance, applicable to total production from the lands rather than individual leases. However, the assignor conveyed four specific leasehold estates and reserved a 1/16 production payment directly linked to these leases, defined as "one-sixteenth of the entire interest in the production" from the respective leases. McDaniel's view misrepresents this reservation as unrelated to the conveyable interests, while the assignment ties the reservation explicitly to the individual leases. The use of the term "respective" suggests clear separateness in the leases’ interests. The assignment does not imply that the production payment remains intact if the leaseholds end; rather, it follows the general rule that an overriding royalty is extinguished upon the lease's termination. Therefore, the trial court's judgment is upheld, reversing the court of appeals’ decision and stating that McDaniel Partners, Ltd. should take nothing. The assignment specifies the reserved production payment interest as one-sixteenth of a defined fraction of production from the relevant lands until a set financial and production threshold is met, and it notes that the Cowden Leases did not partially fail but completely failed.