Chesapeake Exploration, L.L.C. v. Hyder, 427 S.W.3d 472

Background

Hyder lease (Sept. 1, 2004) between lessors and Four Sevens Oil Co.; Four Sevens assigned to appellants Chesapeake Exploration, L.L.C. and Chesapeake Operating, Inc.; lease covers ~1,037 surface acres and ~948 mineral acres in Johnson and Tarrant Counties, TX; off-lease wells allowed; as of Dec 1, 2011, 22 wells on lease and 7 off-lease wells drilled/completed.
Dispute over interpretation of royalty and overriding royalty clauses for on-lease and off-lease wells.
Appellees claim royalties/overriding royalties should be free of post-production costs; appellants seek deductions of post-production costs between delivery and sale.
Trial court ruled in favor of appellees for breach of royalty and overriding royalty clauses, awarded damages, attorneys’ fees, and prejudgment/post-judgment interest; appeal affirming the judgment.
Royalty clause states 25% of market value at well for oil and gas royalties; royalty is free and clear of production and post-production costs and expenses incurred between wellhead and appellants’ point of delivery or sale; overriding royalty clause provides a 5% cost-free overriding royalty from first production from off-lease wells, carved out of leasehold; court interprets contract as excluding all production and post-production costs (except production taxes).
The case also addresses interest on past due payments and royalty for gas lost/unaccounted for.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Are post-production costs deductible from royalties for on-lease wells under the royalty clause?	Appellants argue deductions allowed for post-production costs between delivery and sale.	Appellees contend no post-production costs may be deducted; clause is ‘free and clear’ of costs.	Royalties exclude all production and post-production costs; interpretation harmonizes the entire lease.
Does the 'cost free' overriding royalty for off-lease wells permit post-production deductions?	Appellants contend cost-free means only production costs are excluded.	Appellees contend cost-free excludes both production and post-production costs.	Overriding royalty is free of all production and post-production costs, subject to production taxes.
What interest rate applies to past-due payments for on-lease vs off-lease royalties?	One-percent-per-month provision applies to all past due payments.	One-percent-per-month applies only to on-lease royalties; Finance Code rate governs off-lease.	One percent per month applies to on-lease royalties; Finance Code 304.003 applies to off-lease damages.
Does the lease require royalty on gas lost and unaccounted for?	Gas lost should still be royalty-bearing if produced and not actually sold.	Gas lost/unaccounted is not royalty-bearing since not sold or used.	No royalty on gas lost or unaccounted for; royalty payable only on gas sold or used.
Attorney’s fees and breach finding			Appellees entitled to attorney’s fees; appellants breached the lease.

Key Cases Cited

Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996) (no-deduct clause is surplusage when measuring value of royalty, but can be overridden by agreement)
Martin v. Glass, 571 F. Supp. 1406 (N.D. Tex. 1983) (overriding royalty free of production costs; discussions of 'free and clear' limits)
Danciger Oil & Refineries v. Hamill Drilling Co., 171 S.W.2d 321 (Tex. 1943) (overriding royalty free of operating expenses; interpretation of 'free and clear')
Retamco Operating, Inc. v. Paradigm Oil, Inc., 372 S.W.3d 177 (Tex. 2012) (overriding royalty; cost-free concept; production vs post-production costs)
Yzaguirre v. KCS Res., Inc., 53 S.W.3d 368 (Tex. 2001) (distinguishes market value vs proceeds royalty)
Dynegy Midstream Svcs., Ltd. P’ship v. Apache Corp., 294 S.W.3d 164 (Tex. 2009) (proceeds royalties measured by actual sales)
Hurd v. Alamo Nat’l Bank, 485 S.W.2d 335 (Tex.App.—San Antonio 1972) (royalty not subject to production costs absent agreement)