Burlington Resources Oil & Gas Co. LP v. Texas Crude Energy, LLC

Citations: 516 S.W.3d 638; 2017 Tex. App. LEXIS 1753; 2017 WL 1228908Docket: NUMBER 13-16-00248-CV

Court: Court of Appeals of Texas; March 1, 2017; Texas; State Appellate Court

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Burlington Resources Oil and Gas Company LP (Burlington) sought to deduct post-production expenses from overriding royalty payments under specific assignment instruments. The trial court ruled that such deductions were not permitted, granting summary judgment in favor of Texas Crude Energy, LLC (Texas Crude) and Amber Harvest, LLC (Amber). The background outlines that in 2004, Burlington and Texas Crude entered into a Prospect Development Agreement (PDA) and a Joint Operating Agreement (JOA) for the Sugarkane Field in the Eagle Ford Shale region. Burlington was designated as the operator, holding 87.5% of the working interest in existing leases, while Texas Crude retained 12.5%. For future leases within the 'Area of Mutual Interest,' both parties agreed to maintain these percentages.

Texas Crude was entitled to retain overriding royalty interests (ORRIs) in every lease owned or acquired within the area. On May 22, 2006, Texas Crude assigned an 87.5% interest in certain leases to Burlington, with the assignment subject to the PDA and JOA. Texas Crude reserved ORRIs and assigned them to Amber before assigning the working interest to Burlington. Each ORRI assignment to Burlington was subject to all existing burdens, including prior ORRIs. Burlington also acquired leases and assigned the necessary ORRIs to Texas Crude, which then conveyed them to Amber. The granting clauses of these ORRI assignments specified that the interests would be delivered free from all development, operating, and production costs, though the assignee would bear windfall profits, production, and severance taxes.

The assignments stipulate that the overriding royalty interest (ORRI) share of production must be delivered to the Assignee free of all burdens except taxes. If the Assignee opts for in-kind delivery, it must be sent to the appropriate receptacle; alternatively, if cash payment is preferred, it must reflect the amount realized from an arm's length sale or the market value at the wells. Burlington, the operator, sold all production through arm's length transactions, while Amber chose to receive royalties in cash. Disputes arose regarding Burlington's deductions for post-production expenses from ORRI payments to Amber, leading to a lawsuit by the appellees claiming Burlington improperly deducted these costs and failed to meet obligations under the PDA and JOA. They sought breach of contract damages based on the difference between the actual ORRI payments and what they would have received if calculated correctly. Burlington filed a motion for partial summary judgment asserting it was entitled to deduct post-production costs under Texas law, while appellees filed a cross-motion claiming entitlement to judgment. The trial court denied both motions initially but later granted appellees’ motion upon reconsideration, allowing Burlington to appeal the interlocutory ruling based on the potential impact on the litigation's outcome.

Burlington's petition for a permissive appeal has been granted, leading to two main arguments regarding the trial court's decisions: the denial of Burlington's motion for summary judgment and the approval of the appellees' motion. The review of summary judgments is conducted de novo, requiring the moving party to demonstrate the absence of genuine material fact issues and entitlement to judgment as a matter of law. Evidence is assessed in favor of the party opposing the summary judgment, and when both sides seek summary judgment, the court evaluates the evidence from both, rendering the appropriate judgment.

In the context of mineral leases, these are interpreted to reflect the parties' intentions, with the entire document considered to ensure all provisions are harmonized. An Overriding Royalty Interest (ORRI) typically does not bear production costs—such as exploration and drilling expenses—but does generally incur post-production costs unless otherwise agreed. The central legal question is whether the specific assignments in this case alter the general rule, preventing Burlington from deducting post-production expenses from ORRI payments.

The Texas Supreme Court case, Chesapeake Exploration v. Hyder, is referenced to illustrate similar legal considerations. In that case, three royalty provisions were examined, including one that specifically exempted certain costs. The outcome of this appeal may hinge on the interpretation of the assignments in light of established precedents regarding royalty structures and costs.

Chesapeake sold gas produced from a lease to its marketing affiliate, which then sold it to third-party buyers. The affiliate paid Chesapeake a 'gas purchase price' derived from a weighted average of the third-party sales prices minus post-production costs. The Hyders, who held an overriding royalty interest (ORRI) in the gas from seven directional wells, argued they were entitled to 5% of the 'gas sales price' rather than the 'gas purchase price,' which Chesapeake paid. The trial court, court of appeals, and a majority of the Texas Supreme Court sided with the Hyders. 

The Court noted that the lease's royalty provisions specified how post-production costs applied: the 25% oil royalty included these costs, while the 25% gas royalty did not, as it was based on the price received after such costs. The ORRI language was less clear, with the Hyders asserting 'cost-free' referred to post-production costs, while Chesapeake claimed it merely meant the ORRI was free of production costs. The majority countered that the term 'gross production' referred to production at the wellhead, insinuating that this royalty would incur post-production costs. 

The Court criticized Chesapeake's argument regarding the exclusion of production taxes from the ORRI, stating it contradicted the notion of a 'cost-free' royalty. The majority noted that lease drafters often specify that overriding royalties do not bear production costs, despite the inherent nature of royalties being free of such costs. The Court concluded that the lack of specificity in the ORRI regarding post-production costs did not diminish its cost-free status compared to the other royalty provisions, reinforcing the simple 'cost-free' requirement.

The overriding royalty provision indicates that while the royalty appears to be in kind, it has consistently been paid in cash. The Hyders have the option to take their overriding royalty in kind, which would allow them to utilize the gas, transport it independently, or hire a third party for transportation, potentially incurring post-production costs. However, this choice does not imply that they will incur such costs if the royalty is paid in cash. The provision allows the Hyders to decide how to take their royalty and the associated consequences, including the interpretation of 'cost-free' to encompass post-production costs.

Burlington contends that the assignments must be interpreted alongside the Production and Development Agreement (PDA) and Joint Operating Agreement (JOA), which supposedly do not permit Amber to retain anything beyond a typical overriding royalty interest (ORRI) that would incur post-production costs. In contrast, the appellees argue that the merger doctrine dictates that the specific language of the ORRI assignments takes precedence over the PDA and JOA. This doctrine asserts that when the terms of an instrument differ from those in the underlying contract, the instrument alone must define the parties' rights. Therefore, even if the PDA and JOA anticipated only typical ORRIs with post-production costs, the assignments are the definitive documents for determining the nature of the conveyed ORRIs.

The assignments in question clearly dictate that post-production costs are allocated based on whether the royalty is taken in-kind or in cash. Specifically, when the royalty is taken in cash from an arm's-length sale, it is calculated based on the "amount realized" by Burlington, exempting it from post-production costs. This aligns with precedents such as Hyder, which confirms that a price-received basis for royalty payments relieves lessors of post-production costs. Burlington argues against this interpretation, citing that language in the granting clause implies the ORRI should share these costs post-delivery. Scholarly works support the view that such delivery provisions indicate the royalty owner bears post-production costs. However, even if the delivery is designated "at the well," the parties retain the right to allocate post-production costs differently. Ultimately, the explicit terms of the assignments affirm that, due to the cash royalty structure and arm's-length sales, Burlington's royalties are based on the amount realized and are not subject to post-production costs.

Burlington asserts that Hyder is not applicable to the current case because the lease in Hyder included a 'cost-free' royalty, while the assignments here specify that the ORRI is 'free and clear of all development, operating, production and other costs.' Burlington argues that under the doctrine of ejusdem generis, the phrase 'and other costs' should be interpreted to include only costs similar to those explicitly listed, thereby excluding post-production costs. The doctrine limits general terms to matters similar to those specifically defined. Burlington contends that even if this doctrine restricts the 'free and clear' clause to production costs, the assignments may still allocate post-production costs elsewhere.

Additionally, Burlington claims Hyder is distinguishable because the lease did not specify a royalty valuation point. However, the Texas Supreme Court interpreted the Hyder lease as providing for an ORRI of five percent 'of gross production,' meaning the valuation point is at the well, prior to post-production costs. The court also held that the Hyders could choose to accept the royalty in-kind at the well and thus bear post-production costs or opt for a cash payment, which would not entail such costs.

Burlington argues that the term 'amount realized' in the assignments does not necessarily indicate a payment free from post-production costs, referencing Warren v. Chesapeake Exploration, LLC. However, this case is deemed distinguishable because the lease in Warren explicitly stated that the royalty was computed at the mouth of the well, which included deductions for post-production costs. The current assignments lack similar language, suggesting that 'amount realized' should not be interpreted to allow for such deductions.

Assignments require cash payments without deductions for post-production costs, as established in relevant case law. The trial court's summary judgment favoring the appellees on post-production costs was upheld, rejecting Burlington's appeal. A 'working interest' entails bearing production costs and paying royalties. Texas Crude's overriding royalty interest (ORRI) varied between 0% and 6.25%, depending on royalty burdens tied to the lease. Plaintiffs sought damages equal to 87.5% of underpaid royalties, which Burlington, as the owner of that percentage of working interest, retained. The trial court indicated that a trial would be necessary to evaluate Burlington's deductions related to its working interest, while emphasizing that Amber was not claiming recovery for deductions from the remaining 12.5% working interest. Burlington also raised an indemnity claim based on the joint operating agreement (JOA), contingent on the legal question resolved by the order. Although the assignments are agreed to be unambiguous, the parties dispute their interpretation. The 25% gas royalty clause is specified to be free of all production and post-production costs, with prior rulings indicating this clause does not alter the provision's meaning. Burlington argued that the terms of the JOA and the production and development agreement (PDA) should govern in case of conflict, but this was not supported by the ORRI assignments in question, which did not explicitly reference the PDA or JOA, despite acknowledging they were subject to burdens of record and underlying lease terms.