643 S.W.3d 186
Tex. App.2020Background
- Lessors (Sheppard/Crain) leased minerals in DeWitt County with unique royalty language: royalties based on gross proceeds or market value, plus paragraph 3(c) requiring that any reduction or charge in a sale "shall be added" so lessor’s royalty is never charged, directly or indirectly, with post-production costs. Addendum L reiterates royalty free of costs and cites Heritage/Judice.
- Appellees sued alleging 23 marketing/contract practices (exemplar downstream contracts) reduced appellants’ sales prices (e.g., $18/barrel gathering charge; T&F fees; fixed differentials; processor retention; lost/unaccounted-for gas; unit/lease fuel; recovery-factor excess value) and that paragraph 3(c) required add-back to royalty base.
- Parties filed a joint stipulation listing 23 discrete issues; cross-motions for summary judgment followed. Trial court excluded appellants’ experts, admitted appellees’ experts, and granted summary judgment to appellees on all 23 issues; final judgment was later entered after a nonsuit on fees.
- On appeal, appellants challenged (1) summary judgment rulings interpreting paragraph 3(c) and (2) the trial court’s evidentiary rulings excluding their expert affidavits. Parties agreed leases were unambiguous; dispute was contract construction as a matter of law.
- The court framed the leases as generally creating a “proceeds-plus” royalty: paragraph 3(c) can require adding specified reductions/charges back to gross proceeds so the royalty base can exceed the lessee’s gross proceeds in many circumstances, but not in all.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Scope of paragraph 3(c) add-back | Paragraph 3(c) requires adding any reduction/charge in a disposition, contract, or sale to royalty base regardless who bears the cost | Royalties are based on lessee’s gross proceeds at point of sale; deductions by downstream purchaser after point of sale need not be added | Court: Paragraph 3(c) generally requires add-back; leases effectuate a "proceeds-plus" valuation so base may exceed gross proceeds in many cases |
| Fixed-dollar deductions with stated purpose (e.g., $18/barrel for gathering) | Such stated-purpose fixed deductions are post-production charges under 3(c) and must be added | If deduction occurs downstream after point of sale, it need not be added | Held: Must add when contract expressly states deduction is for listed post-production costs |
| Fixed-dollar deductions without stated purpose | These fixed-dollar differentials are reductions subject to add-back | Absent stated purpose, plaintiff hasn’t shown they are for enumerated post-production costs | Held: No add-back — appellees failed to show the deduction served a 3(c) purpose |
| Deductions based on processor’s actual costs (T&F, transportation, fractionation) | Actual-cost deductions taken by purchaser reflect post-production costs and must be added | Lessee didn’t incur costs; add-back not required | Held: Add-back required — the lease does not require lessee to be the cost-bearer for 3(c) to apply |
| Unit fuel / Lease fuel (producer’s own use) | Producer’s use reduces volumes paid and is a "disposition" that should be added | Leases expressly allow deduction of volumes used for operations; "disposition" refers to transfers to third parties | Held: No add-back — paragraph 3(c) does not cover lessee’s unilateral use of gas for operations |
| Volumetric reductions / lost or retained by third-party purchaser | Processor retention or lost/unaccounted-for volumes reduce producer receipts and should be added | Such volumetric reductions are not shown to be charges for the specific costs enumerated in 3(c) | Held: No add-back — appellees offered no evidence these reductions were for the enumerated post-production costs |
| Excess value from contractually fixed recovery factors (heating-value vs volume) | Excess liquids/value retained by processor is in-kind compensation for processing and must be added | The differential is not proven to be a charge for costs listed in 3(c) | Held: No add-back — difference not shown to be within the enumerated 3(c) expenses |
| Evidentiary rulings on expert affidavits | Appellants: trial court improperly excluded their experts and admitted appellees’, affecting summary judgment | Appellees: rulings within trial court discretion and any error was not shown to be harmful | Held: Affirmed — appellants did not show reversible harm from evidentiary rulings |
Key Cases Cited
- Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996) ("market value at the well" may be calculated by subtracting post-production costs; a no-deductions clause can be surplusage)
- Judice v. Mewbourne Oil Co., 939 S.W.2d 133 (Tex. 1996) ("net" or "at the well" language controls whether post-production costs may be deducted)
- Chesapeake Exploration, Inc. v. Hyder, 483 S.W.3d 870 (Tex. 2016) ("cost-free" overriding royalty can include post-production costs; context of multiple royalty provisions controls)
- Burlington Res. Oil & Gas Co. v. Tex. Crude Energy, 573 S.W.3d 198 (Tex. 2019) (specifying an "at the well" valuation point controls over an "amount realized" method; post-production value must be subtracted to approximate at-the-well value)
- Bowden v. Phillips Petroleum Co., 247 S.W.3d 690 (Tex. 2008) ("gross proceeds" or "amount realized" means the amount the lessee actually receives under its sales contract)