United States: Supreme Court Of Texas Issues Three Important Oil And Gas Decisions

This month, the Texas Supreme Court decided three cases implicating oil and gas contract interpretation issues with important consequences to the industry. The Court held in all three cases that the plain meaning of a contract will prevail over an interpretation based on the industry's common views of the intended effect of a provision. This result can be troublesome for attorneys, landmen, and commercial dealmakers in the industry, as each has felt comfortable in the past relying on a common industry view of how certain key provisions in oil and gas contracts work. Consequently, these cases reinforce the need for a more careful review of key contract terms to ensure that the plain meaning of the text correctly expresses the intended commercial arrangement without the need to rely on what may have been the industry's customary interpretation.

Kachina Pipeline Co. Inc. v. Lillis

In Kachina Pipeline Co. Inc. v. Lillis, case number 13-0596, Supreme Court of the State of Texas, the central issue was whether the transporter, a natural gas transportation company, improperly charged a natural gas producer for compression costs associated with compressors located downstream from the transporter's receipt of the producer's gas into its gathering system and upstream from a third-party processing facility.

The gathering agreement between the transporter and the producer provided that the transporter could charge the producer for compression costs "to effect delivery" of the producer's gas. The producer argued that the natural pressure from his well was sufficient to deliver his gas to the transporter's pipeline system, and the downstream compressors only served the purpose of transporting the gas through the transporter's pipeline system and into the third-party processing facility. On the other hand, the Texas Pipeline Association and Gas Processors Association expressed their concern in amicus curiae letters to the Court, arguing that the language "to effect delivery of [producer's gas]" is common in the natural gas industry, and that these kinds of provisions are negotiated with the understanding that a pipeline will install compressors to serve multiple producers in a gathering system, who will share those centralized compression costs proportionally based on their share of total production.

Despite these protests, the Court held that the transporter could not pass these compression costs to the producer. The Court said that although the industry amici made it clear that producers often contract to share in the costs of downstream centralization of compression, "the Agreement does not express an objective intent that the producer would do so, and industry custom cannot impose obligations beyond those within the written Agreement." The Court interpreted the compression cost provision to be contingent upon the producer failing to overcome the transporter's working pressure. Based on this, the transporter could deduct only "the costs of compression installed during the term of the Agreement if required to overcome the working pressure in [the transporter's] system."

The Court's decision here demonstrates the consequences of relying on industry custom instead of the plain meaning of the words. The transporter could have easily clarified its intent by expressly providing that "delivery" includes final delivery to a third party.

Chesapeake Exploration LLC and Chesapeake Operating Inc. v. Hyder et al.

In Chesapeake Exploration LLC and Chesapeake Operating Inc. v. Hyder et al., case number 14-0302, Supreme Court of the State of Texas, the Court was presented with the issue of whether an oil and gas lease allowed a producer to deduct postproduction costs from overriding royalty owners, as is typical of an overriding royalty, or whether the lease expressed a different agreement. Of three royalty provisions in the parties' lease, only one was in dispute. The disputed clause calls for "a perpetual, cost-free (except only its portion of production taxes) overriding royalty of five percent (5.0%) of gross production obtained" from directional wells drilled on the lease but bottomed on neighboring land.

The royalty owners argued that the "cost-free" requirement on the royalty could refer only to postproduction costs, because a royalty, by definition, is free of production costs. The producer, on the other hand, argued that "cost-free overriding royalty" is synonymous with overriding royalty, and that "cost-free" is simply emphasizing that the overriding royalty is free of production costs. The Court noted that leases discussed in previous cases support the producer's view. However, the Court found that "cost-free" in the overriding royalty provision includes postproduction costs—reasoning that if the royalty owners were to take their gas in kind, as they are entitled to do, they "might or might not incur postproduction costs equal to those charged by [the producer's marketing company]..." and "[t]he fact that the [royalty owners] might or might not be subject to postproduction costs by taking the gas in kind does not suggest that they must be subject to those costs when the royalty is paid in cash."

This was the first Texas Supreme Court case to discuss the 1996 Heritage Resources Inc. v. NationsBank ruling, which held that a royalty could be made free of postproduction costs. The Court made it clear that whether a royalty is free of postproduction costs depended on the text of the lease itself. As in the Kachina holding, this case demonstrates the importance of clear, careful drafting in oil and gas agreements. The fact that the Court agreed that "cost-free" typically means free of production costs in common industry practice, but still held that "cost-free" was not simply superfluous language, should further sensitize practitioners to the need to take better care in choosing language in reliance on past practice.

Plains Exploration & Production Co. v. Torch Energy Advisors Inc.

In Plains Exploration & Production Co. v. Torch Energy Advisors Inc., case number 13-0597, Supreme Court of the State of Texas, the Court was asked to determine whether the excluded-assets provision of a purchase and sale agreement for certain oil and gas leases excluded a particular claim relating to reimbursement of bonus payments made by the seller to secure the leases. The seller under the purchase and sale agreement at issue argued that a particular claim for restitution of lease-bonus payments was excluded from the sale and that it was entitled to a portion of the related $83 million judgment that the new owner of the interests was awarded. The Court noted that this case was a "conventional contract-interpretation dispute" as to whether the seller was entitled to a portion of that judgment.

The seller sold its interest in certain oil and gas leases to the buyer pursuant to a 1996 purchase and sale agreement that excluded certain assets from the sale in an excluded-assets provision. The excluded assets expressly excluded claims and causes of action arising before the sale contract's effective date. A federal court subsequently determined that the leases at issue had been repudiated by federal law, and the buyer was awarded restitution of the lease-bonus payments the seller had originally paid to secure the leases.

The Court found that "the relevant excluded-assets provisions in the 1996 purchase and sale agreement are unambiguous and, as a matter of law, [the seller] did not retain ownership of the claimed asset." The excluded assets provision at issue provided that the seller would retain "claims and causes of action 'arising' or 'attributable to periods of time' before the contract's stated effective date of October 1, 1995, and all revenue 'attributable' to the conveyed property for any period before the contract effective date." The parties did not dispute that the claim did not accrue until after the effective date of the PSA, but rather they disputed "whether the excluded-assets provision applies to unripe claims." The Court determined that because the terms "arising from," "arising under or with respect to," and "attributable to" were used in reference to claims, a "pre-effective date causal nexus" was required for the seller to retain such claims. Because this claim arose after the effective date, the seller was not entitled to any of the judgment as a matter of law.

As with the previous two cases, the Court's decision demonstrates that unambiguous, explicit drafting is required in order for the intent of the parties to be respected, and that drafters must be meticulous in including exceptions, explanations, and standards for complicated subjects in order for the parties' agreed commercial expectations be respected by the courts.

Conclusion

These recent decisions by the Texas Supreme Court should put practitioners and industry members on notice that attention to specific language in a contract is crucial, and that even if certain language has a common understanding in the industry, the court will defer to the plain meaning of that language over industry custom and practice in the event of a dispute as to interpretation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Omar Samji
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions