Chesapeake Exploration, L.L.C. v. Hyder
483 S.W.3d 870
Tex.2016Background
- The Hyders leased 948 acres in the Barnett Shale; Chesapeake Exploration acquired the lessee interest and operates the wells.
- The lease contains three royalty provisions: a 25% oil royalty (market value at the well), a 25% gas royalty (25% of "price actually received by Lessee" and expressly "free and clear of all production and post-production costs"), and a 5% overriding royalty on gross production from certain directional wells described as "cost-free (except only its portion of production taxes)."
- Chesapeake markets production through an affiliate (Marketing); Marketing deducts postproduction costs (gathering, transportation, marketing fee) and pays Chesapeake a "gas purchase price" calculated as downstream sales price less postproduction costs; Chesapeake pays the Hyders 5% of that purchase price.
- Hyders claim Chesapeake improperly deducted postproduction costs from the 5% overriding royalty and sought recovery; trial court and court of appeals awarded Hyders damages for wrongfully deducted postproduction costs.
- The Texas Supreme Court granted review to decide whether the lease’s overriding-royalty language makes that 5% royalty free of postproduction costs.
Issues
| Issue | Hyders' Argument | Chesapeake's Argument | Held |
|---|---|---|---|
| Whether the 5% overriding royalty is free of postproduction costs | "Cost-free" means free of postproduction costs (production costs are already excluded); the tax exception is consistent with excluding postproduction costs | "Cost-free overriding royalty" is equivalent to a standard overriding royalty (already free of production costs only); "gross production" refers to production at the wellhead and does not imply downstream valuation | The lease language reasonably reads the 5% overriding royalty as cost-free of both production and postproduction costs (tax exception does not change that); judgment for Hyders affirmed |
Key Cases Cited
- Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996) (royalties valued at the well are generally net of reasonable marketing costs; "no deductions" language can be surplusage)
- Paradigm Oil, Inc. v. Retamco Operating, Inc., 372 S.W.3d 177 (Tex. 2012) (an overriding royalty is an interest in production free of production expenses)
- French v. Occidental Permian Ltd., 440 S.W.3d 1 (Tex. 2014) (royalty interests usually bear postproduction costs unless parties agree otherwise)
- MacDonald v. Follett, 180 S.W.2d 334 (Tex. 1944) (historical definition of overriding royalty as carved from working interest and not chargeable with operating expenses)