668 S.W.3d 332
Tex.2023Background
- Leases (Sheppard and Crain) of Eagle Ford interests contain an unusual clause (Paragraph 3(c) and Addendum L) requiring that any "reduction or charge" for production, treatment, transportation, manufacturing, processing, or marketing "included" in a disposition be "added to . . . gross proceeds" so the lessor's royalty "shall never be chargeable directly or indirectly" with those costs.
- Producers sold hydrocarbons to unaffiliated downstream buyers using published index prices and contracts that reduced the price by fixed or actual amounts the contracts described as buyer post-sale postproduction costs (e.g., gathering, handling, transportation and fractionation (T&F)).
- Producers paid royalties on their defined "gross proceeds" (not including buyers’ post-sale costs) and did not "add back" buyer-incurred downstream costs when the sales price was stated as an index less such costs.
- Landowners sued for declaratory relief and breach of contract, arguing the leases require adding those contractual deductions to gross proceeds before calculating royalty. The trial court entered summary judgment for landowners on many disputed issues.
- The court of appeals characterized the leases as "proceeds-plus" (royalty base may exceed gross proceeds) and affirmed summary judgment for landowners on the disputed issues that involved contractual reductions expressly tied to the enumerated postproduction cost categories. The Texas Supreme Court granted review and affirmed.
Issues
| Issue | Plaintiff's Argument (Sheppard/Crain) | Defendant's Argument (Producers) | Held |
|---|---|---|---|
| 1) Does Paragraph 3(c) require adding contractual deductions for enumerated postproduction costs (even if incurred after point of sale by buyer) to the lessee's gross proceeds before computing royalty? | Paragraph 3(c) is an "add-to-proceeds" clause: any stated reduction for the listed postproduction costs must be added so royalty never bears such costs, direct or indirect. | The leases are ordinary gross‑proceeds leases; the add-back clause applies only to pre‑sale deductions or seller‑incurred costs; requiring royalty on non‑proceeds is contrary to industry expectations and must be stated plainly. | Held for landowners: Paragraph 3(c) unambiguously requires adding such deductions when the sales contract attributes them to the enumerated categories; leases are "proceeds‑plus." |
| 2) Is the Paragraph 3(c) language ambiguous or merely surplusage (i.e., should it be limited to seller pre‑sale costs)? | The language is not surplusage; it serves a distinct purpose—allowing royalty base to exceed gross proceeds to preserve a cost‑free royalty regardless of sale point. | Treating the clause as creating royalty on non‑proceeds would be surprising and should be limited or treated as redundant. | Held for landowners: Court enforces the plain, broad text; construction avoids surplusage by giving effect to the add‑to‑proceeds requirement. |
| 3) Do Addendum L and citation to Heritage/Judice imply the parties meant only to prohibit lessee deductions (i.e., not buyer post‑sale costs)? | Addendum L reinforces royalty free of costs but does not nullify 3(c)’s add‑to‑gross‑proceeds directive; Heritage/Judice addressed valuation at the well and do not override explicit contractual additions. | Citing Heritage/Judice, producers say parties intended only to block seller postproduction deductions and not to create an exception to the usual rule about post‑sale costs. | Held for landowners: Heritage and Judice do not conflict with Paragraph 3(c); the leases both shift valuation and specify additions, so court enforces 3(c) as written. |
| 4) Are transportation and fractionation (T&F) charges exempt from Paragraph 3(c)? | T&F are processing/postproduction costs expressly or reasonably covered by the enumerated categories and thus must be added back when contracts attribute deductions to them. | Producers argued T&F should be treated differently or excluded because not separately enumerated in some language. | Held for landowners: T&F is a term of art for processing; it falls within the enumerated processing/transportation/marketing costs and must be added when so stated in the contract. |
Key Cases Cited
- Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118 (Tex. 1996) (plurality addressed limits of prohibiting deductions when value is fixed "at the well")
- Judice v. Mewbourne Oil Co., 939 S.W.2d 133 (Tex. 1996) (construing "market value at the well" royalty clauses and division‑order language)
- Chesapeake Expl., L.L.C. v. Hyder, 483 S.W.3d 870 (Tex. 2016) ("gross proceeds" means royalty based on price received without deduction)
- Burlington Res. Oil & Gas Co. v. Tex. Crude Energy, LLC, 573 S.W.3d 198 (Tex. 2019) (parties may define postproduction costs as they choose)
- BlueStone Nat. Res. II, LLC v. Randle, 620 S.W.3d 380 (Tex. 2021) (distinguishing gross‑proceeds and net‑proceeds royalties and context for postproduction allocation)